92% Losses In Lehman CDS Auction Explained

[Joanne98]

10/10/8

Elaine Meinel Supkis


Sorry about the choppy posting here today. Finally, real, hard information is flowing in. It seems that the messy auction of Lehman credit default swaps is NOT finished at all. We know that the amount these things are worth is around 8% which means the counterparties who promised to pay the insurance on these crappy CDOs will now have to make up the difference. NONE OF THEM HAVE, YET! How they will pull off this $400 billion minus $24 billion, is anyone's guess. I suspect Paulson will be the one who will pay up. Also, the threats against the dollar hegemony continue and Japan has retreated from these dark threats and now wants all the FOREX holders of massive dollar bags of money should use this via the IMF to bail out the US and not punish us but give us even more loans so we buy Toyotas again like in the good old days. This is impossible, I say, as well as undesirable.


Japan and China lead flight from the dollar

Japan and China led a record withdrawl of foreign funds from the United States in August, heightening fears of a fresh slide in the dollar and a spike in US bond yields.

Data from the US Treasury showed outflows of $163bn (£80bn) from all forms of US investments. "These numbers are absolutely stunning," said Marc Ostwald, an economist at Insinger de Beaufort.

Asian investors dumped $52bn worth of US Treasury bonds alone, led by Japan ($23bn), China ($14.2bn) and Taiwan ($5bn). It is the first time since 1998 that foreigners have, on balance, sold Treasuries.



Fears of dollar collapse as Saudis take fright

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

"This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas.
"Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said.



China threatens 'nuclear option' of dollar sales

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.



This article is dishonest. ALL our major dollar holding trade rivals are making the same noises. We are in a global conflagration event and there is no one who can escape. Just as good, solid stocks are all falling in all stock markets across the planet, this is true with all economic systems. No matter who the ruler is, the markets are going down, fast and hard.


Everyone holding dollars is feeling very insecure. All of them recognize that our government is way out on a limb here. As the final bank for all bad US paper, commercial, residential and local governments, the US central bank has run out of reserves, our government is very deep in debt. So the AAA ratings are as false as all those Moody ratings that turned out to be total fictions.


On top of this, the US trade deficit is not growing! This irritates ALL our trade partners, big and small. They don't care if we demand they hold more and more dollars so long as we suck up more and more trade. When this falters, the desire to hold dollars vanishes like snow in summer.


When US Treasuries pay a good return, all is well. If they pay nothing above the rate of inflation BUT trade grows in favor of the holders of these Treasuries, they consider this to merely be part of 'doing business'. But the entire point about monetary values is, the rate of flow, the direction of flow and the cause of these flows have to be suitable. The status quo which the entire planet INCLUDING THE US is to return to the wonderful days when the US dollar was super-strong, the US imported cheap energy and industrial products and paid for everything with super-cheap credit. Paying virtually no interest on increasing loans is fun.


We have to remember why the Federal Reserve raised interest rates in the past. They did this to stop a flood of easy lending because of inflation, over-valuation of stocks or properties or tulips and to stop the flood of imports as well as flood of money flowing into the country. This is a novel concept which is part of the business of 'balancing books' and 'correcting economic trends.' The Fed supposedly claims that they do this deliberately. They call it, 'Putting on the brakes'.


It seems to me that we can't put on brakes even slightly anymore! Even if we are obviously driving off a cliff, the application of brakes causes the entire unbalanced system to crash instantly. And no one wants that. They want things to roll on. Which defeats the notion of braking in the first place.


Japan to propose bailout fund at G-7

Continued>>>
http://elainemeinelsupkis.typepad.com/money_matters/2008/10/10108-elaine-me.html

[On the Road]

1. Let Me Understand the Situation According to the Article

Lehman Brothers went bankrupt and their assets are being sold off.

Some of the assets they held were insurance policies against default that they purchased on $400B of mortgages (ie credit default swaps on CDOs).

Those mortgages are worth 8% of face value (how is this possible?), meaning that the insurers will have to pay the other $376B.

The insurers have been unable or unwilling to pay.

-----------------------

Is the point that satisfying those policies will drive the insurers into bankruptcy? And that the issue is being forced by the bankruptcy courts because Lehman went belly up?

[SecularisX]

2. on why this is possible

It's possible because of leverage. In the case of CDO's, the "tranches" (actual securities) that they held were often the lowest part of the capital structure. This means that as borrowers default on their loans, these securities suffer losses first.

I saw Kudlow the moron on CNBC asking this question the other day... if the housing market is only down 15%, then how can these assets be worth 10 cents on the dollar? The answer is unequivocally leverage, and in this case leverage that comes not from borrowing, but from the structural characteristics of the bonds.

[On the Road]

3. OK -- So you're saying that the CDOs were Highly Leveraged

Does that mean that the holders borrowed most of the money at lower rates in order to purchase them? Were theses banks all lending massive amounts to each other based on their fractional reserves? And the credit default insured the whole future of those investments? So in a sense it wasn't the mortgages per se that caused a problem, it was the leverage on the mortgages and the insurance obligations? It is starting to make more sense.

[Pale Blue Dot]

5. Yes, that's closer to the truth.

It's an incredible mess.

[phantom power]

6. I've been wondering: to what extent is this "mess" self-contained...

by which I mean, in very broad terms, is it possible to isolate a sort of self-referential subset of all these over-leveraged obligations, and just declare them null-and-void, and then everybody gets to at least move forward, but with 10% of their previous value.

I'm sure to an economist what I just wrote is hash, but I'll hope I conveyed the basic idea.

[SecularisX]

8. a bit more...

So it's not even that they borrowed money to purchase them necessarily (though in the end that's what it looks like anyway). Here's the general timeline:

1 - buy up pool of mortgages
2 - create (say) 8 bonds (tranches) out of these mortgages.
3 - sell off the good bonds (these are the ones that suffer losses last)
4 - keep all the really crappy bonds! these are the ones that suffer losses first and are likely to be worthless or very near
5 - note that 4 doesn't look like such a bad idea since you effectively got them for free, since you sold the good bonds for the same amount it cost to buy the mortgages
6 - now comes the bad part. enter into a cds contract on the crappy bonds with some counterparty. ignore the fact that this counterparty does this regularly with many other people like yourself and so effectively has the same exposure to cdo's that you're trying to get rid of. this means that if they ever DO start going bad en masse, the person supposedly insuring you is going to be screwed (they now are).
7 - now we can count our combination of cdo/insurance as nice, solid capital that we can use as a backup for more borrowing! bring on the monies!

[Joanne98]

10. Welcome to DU

[Pale Blue Dot]

4. This is not the situation at all, ribofunk.

In order to understand the Credit Default Swap (CDS) mess, I cannot recommend strongly enough downloading the last episode of This American Life (www.thislife.org) that explains what happened and why it is so potentially devastating.

[On the Road]

12. Will Do That, Thanks

The details of the CDO crisis have escaped me, but I have been looking for an expanation somewhere between technical jargon and cartoon level.

[bemildred]

11. That is not what I understand.

Various parties bought, and other parties sold, insurance against Lehman defaulting on securities Lehman issued. It is the value of these securities that has been determined to be 8 cents on the dollar, the face value of the securities defaulted on (MBSs?, CDOs?) is $400 billion, so the issuers of the insurance are now to pay up 92 cents on the dollar to the holders of the insurance on the defaulted Lehman securities. The issues include that it is not clear in fact who is holding the bag, and it is doubtful that the holders of the bag, once determined to be holding the bag, have the funds to make good on the insurance. This seems like a rich field for litigation, and I expect that it will be bouncing around in the courts for decades, which is why Hank wants Godlike powers to make it go away.

[flamingdem]

7. I used to read Elaine Supkis and thought she was nuts

but now I wish I had paid attention.

[Joanne98]

9. LOL She is kinda nuts. But she's funny!

[Celebration]

13. She is *my* kind of nuts--

Chickens have to come home to roost at some point.