Armaggeddon Or Just One More Central Bank Inspired ‘Justifiable Methodology To Ensure Market Stability?’

Latest update on fictitious capital carnage from a somewhat breathless insider.  This site (www.prudentbear.com) specializes in exactly this kind of thing: disenchanted Wall Street professionals almost gleefully and sometimes insightfully predicting their colleagues' imminent extinction, if not actually their own. 

Armaggeddon Or Just One More Central Bank Inspired ‘Justifiable Methodology To Ensure Market Stability?’February 22, 2006 In one of the least reported epochal stories in history, broken by the Wall Street Journal’s Wessel on Thursday’s obscure Page A2, the 14 Families, new nomenclature for the big 14 banks and brokers dominating the financial infrastructure, architecture, profits and bonuses of the world, snuck down to the Fed to try and do something about the coming Gotterdammerung in that new, but totally obscurant world known as credit derivatives. For a moment, let us hypothesize on who these Fabled 14 families are…We would have to be in the writer’s head to be completely accurate, but will make some broad and identifications. Given mergers in the last dozen years, some of the beasts then extant are extinct. Nevertheless, here goes: Citi, Banc of America, JP Morgan Chase, Goldman Sachs, Smith Barney, Merrill Lynch, Lehman, Bear, Morgan Stanley, Wells Fargo, Wachovia, USBancorp, Bank of New York, and CSFB. We might back out one or two of the domestics above and throw in Deutsche and ABN/Amro. Net/net it is the compendium of the big settlers, hedge fund financiers, deal makers etc. of Wall Street.DO ANY OF YOU FIND IT CURIOUS THAT THERE IS NO FURTHER MENTION OF THIS MEETING IN THE MOST ACIDULOUS READING OF THE Friday WSJ. ?  Searching that brave new world of the internet there is one brief Bloomberg reference to “these deals being settled in ‘cash’ to avoid a lengthy outcome.”IF THE AVERAGE OF THE 57,000 LOOSE CANNONS IN THE WAY OF DEALS OUT THERE IS $100 Million, peanuts in this game, THEN WE ARE TALKING $ 5.70 TRILLION IN POSSIBLE MAXIMUM EXPOSURE. This is not the FX game or the interest game where “Notional Amount” is a minimal fraction of the whole deal. If I sell $100 million on GM and it tanks, I owe $100 million!  If credit quality, truly dubiously written in today’s world, crashes, we are talking U.S. GDP Times 50-60 to sort it all out! To digress for a moment, we may have discovered here another reason behind the addled Greenspan’s conundrum. If there are $1.2 trillion in leveraged hedge funds out there and you figure what that number might be and if I can sit around, answer the phone and make several hundred bps every time some yawa wants credit default protection, AND I don’t even have to register my deal anywhere except my lower drawer, AND my bonus depends on how many yawa’s send me a bunch of moolah for writing this stuff!    A.      What is the total capacity for fraud? Notice, it is so big I don’t even have to underline or emphasize.B.      If my bosses get there $60 million bonuses and perks off a multiple of me, how close are they to me. I do piddling little $100 million deals?C.     If we take the sum aggregate of all of us writing credit insurance as if it is toilet paper, may we not collectively do a pretty fair job of extinguishing risk spreads thoughout the world?  Why in God’s name, would I, Old Backwoodsmen’s pension, buy a 19-year Ford piece at 11% if you will sell me the same piece with a 1 year credit default swap for 9%?D.      In my last missive, I had written an 8 part apologia on why so many of us missed the flat to declining long end of the curve in 2005.  Frankly, never in my wildest imaginative hallucination had it occurred to me that there were thousands, potentially, of risk assumers out there who did not even have to document the risk assumed.  WHAT A GAME - TELEPHONE A BUDDY - MANUFACTURE AN INCOMPREHENSIBLE BASKET OF CREDITS -  SET A FAT PRICE AND THROW WHATEVER DOCUMENTATION RESULTS TO SOME JERRY RIGGED CLERICAL SYSTEM WHICH WILL MISMATCH ALMOST AUTMATICALLY!I AM INTERPRETING WHAT Geithner, PRESIDENT OF THE NEW YORK FED, FOUND A YEAR AGO! I DID NOT CREATE THIS PIG BUT THE SQUEALS AT EXTINCTION WILL BE LOUD! It has been a wondrous three years, particularly for the last 1.5 since the Maestro started the baby-step parade. With the Greenspan now Bernanke put in effect, credit risk evaporated to invisibility. With durations and rates assured, your excellent credit default swap writer was only identifiable by the last basis point he was able to extract from the deal. (Far be it from the writer to suggest that bonus inducing reciprocity might have been part of the game!)Risk spreads shrank to levels that are still flat out incomprehensible. Iraq for 10 years at 9%. First of all, they have a war and second they don’t have a government. Is this a quasi U.S. Sovereign? With shrinking long rates and spreads, asphyxiation and suffocation set in among the long term buyers, who, after all, only have to outperform an index.  Mexico at 5%.  Hold your nose and buy! And sell it to the sucker who needs duration and something approaching yield. What the hell, there is no credit risk. Your friendly purveyor of that product will do 40-50 basis points for a year and you can tell the boss you have a Goldman credit. The permutations and combinations are endless and there should be a bit more price/bonus in each new creation.IS ANYBODY BUT ME BEGINNING TO SMELL SOMETHING ROTTEN BREWING AWAY BACK THERE?  Maybe it is only me. Basically here you have a credit product, originally contracted between a couple of 14 Family guys, but now done between any two schmucks who can pronounce the words “credit default swaps.” We KNOW that at one point 97,000 of these transactions were essentially invalid as they were unmatched and verified by both parties. We KNOW that these, at least started in the 14 Families, although unbridled assignment could have them anywhere.I EVEN HAVE THE ULTIMATE BAILOUT: GIVE UP A PIECE OF LAST QTRS/YRS ACTION AND I CAN SELL THIS FERSHLUGGINER MESS TO FARMER GILHOOLEY UP THE ROAD AT AN ENHANCED SPREAD OF A COUPLE OF HUNDRED BASIS POINTS AND AS LONG AS THERE IS THE GREENSPAN/Bernanke “Put” AND INFINITE LIQUIDITY AND A HELL OF A YIELD FOR THE FARMER OR THE TAIWANESE, JAPANESE OR SOME OTHER GENIUS HEDGE FUND GUY, I AM OUT MOSTLY WHOLE (TIME EROSION GIVING ME A LOT OF THE PREMIUM.) No wonder there are 57,000 contracts of this ordure floating around out there and Mr. Geithner and anybody with a mind should be terrified. There are millions of potential counter-parties, potentially all playing the same game.YET WE GET ONE, COUNT IT ONE, OBSCURE ARTICLE ON PAGE TWO ON A THURSDAY. If I were Governor Bies, I would give the president down there in DC another opportunity to appoint a Fed Governor. My nomination: Howdy Doody!Admittedly we are probably overstating the severity here but not necessarily. If one LTCM could run up liabilities with the selfsame, more or less, 14 Families a decade ago, of more than $1 Trillion, are we ready to argue that 1,200 firms and by orders of magnitude more bonus-greedy individuals serving them don’t have a greater potential disaster out there?  If one Barings player could take out the firm, who is to say that there are not lots more of them? Lastly, with compensation driven by the “nuts” from the deal, and the deals not even being recorded (we are told they will be down to half, or 45,000, of unreconciled deals by May), please refresh my sense of incredulity by telling me that these hotshot MBA’s and PhD’s NEVER did a deal to help the month or the yearend bonus check. I remain a skeptic of the first order and make the statement:THERE COULD EASILY BE A MULTI-HUNDRED TRILLION CESSPOOL OF UNRECONCILED CREDIT OUT THERE IN “CREDIT DEFAULT SWAP LAND.”  Admittedly there is potential massive overlap reducing a total aggregate beyond ultimately terrifying!GEITHNER (PRESIDENT OF THE NY FED), CORRIGAN, VOLCKER AND THE 14 FAMILIES WILL DO EVERYTHING IN THEIR POWER TO SMOTHER THIS MESS EVEN AT THE COST OF MUCH OF THEIR CAPITAL! This one may be too big for the LAST GREAT “SMOOTHING” AND GET OUT OF CONTROL! In here is a systemic crash of humongous magnitude, not only for some significant piece of the “Hedge Fund” Game, but for the 14 Families. What the hell, it’s only a few more billion of shareholder money and won’t really affect the 2006 bonuses pool if we can smooth and smother.BUT IT WILL CAUSE THE SYSTEMIC EVENT WHICH CONTRACTS, NOT EXPANDS CREDIT, AND THIS WHOLE GLOBAL CREDIT BUBBBLE WILL HAVE GREAT DIFFICULTY DEALING WITH ANY CONTRACTION OR EVEN FLATTENING OUT IN THE RATE OF GROWTH OF CREDIT! I was briefly involved with the development of one of these “products” in a 14 Family operation some 15 years ago and can testify to the “get the damn profits now” and account for the mess later. I have since known of the continuing ridiculous sales and accounting practices.Folks, I don’t know if you remember a certain wife as a commissioner on the CFTCC, married to a whopper of a “twig” friendly senator’ but the facts of life are that she, her husband and the usual cabal managed to keep the derivative industry (Now approaching $300 Trillion notional amount) out of any meaningful form of regulatory scrutiny! The argument was that the 14 Familiies (or whatever the number was then) could self police. Not only that, but transactions among the families could be “netted” thereby significantly reducing these multi-hundred trillion numbers! Most of these games are plain vanilla, I sell $ today, you buy them 90 days out and the risk, if any, is you overpaid me or underpaid me a few cents for the privilege.As a pregnant footnote, I would put in from the article that the 14 Families have now agreed to institute a protocol requiring that if a  trade is assigned, that they actually let the counter-party know that the trade is being assigned. The hedgies had a fit at the idea that a competitor might know of such a deal and was nearly a deal breaker.Getting back to the thought above, however, if there is no record of the total and detailof credit default swaps done, particularly with the “customization” aspects possible, the proliferation of assignment, massive hedge fund involvement and leverage, 14 Family massive financing, fabulous made-to-order swap basis point commission amounts, and possibly ancillary commissions, we really have NO idea of the magnitude, scope, dimensions or aggregate size of it to call it kindly, clusterswap! We could be looking at the admitted 14 Families amount of a measly $12 Trillion or multiples thereof. One rumor so extant as to carry some truth, is that the hedgies have been having a ball with the GM/Ford fiasco. They have multiples of the several hundred billions in actual bonds “protected” at all kinds of levels. Would it not be the ultimate irony if GM/Ford debt, saved through the usual industrial company bailout, occasioned a flood of 2007 bonuses for those hedgies smart enough to have been on the right side and levels?Even with the article, “Cleaning up the Derivatives Mess” in the WSJ and even the most astute may miss It! What we are really talking about here is something at least much above and possibly screamingly above $12 Trillion in the most hydra-headed mass of financial excreta ever created. This amorphous, slithering, pile of financial contract, started years ago by the 14 Families has morphed into the at least $12 Trillion worth of over-the counter, one-off, name your deal kind of financial quasi insurance as to sicken the most hardened observer.Every New York Fed Governor has to get the 14 Families out of their latest cesspool. Poor old Volcker has to take rates into double digits to do it. Poor old Corrigan had to get them to cough up a $4 billion bail-out for their self-created monster LTCM.Geithner, nor anybody else, has any idea of the real size of this steaming pile of excreta. Unlike real markets this stuff has never been exchange accounted. At September 30, when Geithner finally got the “Come to Jesus” started, there were 97,000 trades which could not be matched up. They hope to cut this by 50% BY NEXT SPRING!Let’s say as they do in the article that some genius hedge fund A has sold a “credit default swap” on Delphi. (Some observers think Delphi’s total debt has been insured some 10 times over!) That hedge fund on the other side of the deal will take 400 bps for the play for a year. Leverage my little 400 bps 10X and I have 4,000. Take 20% of that and I have a neat Bonus!  Far be it from me to hypothesize than any scion of a 14 Family would do such a thing but it sure makes financial sense.  Remember, you got 97,999 “we don’t know what’s where’s” in the 14 Families already. Outside the austere hall of the 14 Families you got WHO KNOWS WHAT!?! These things have been dealt like playing cards. Assign you a couple hundred bps of my Delphi when the union looks peaceful. Sure, just pony up a little vigorish. How big is the total! Nobody in the ferslugginer financial world has a clue!Concomitant with the Geithner crawl to the 14 Families to at least acknowledge the problem has been an astonishing exercise in Fed/Regulatory speak by perhaps the most believable of Fed Governors. Having read regulatory speak for years, I will go out on a limb and paraphrase her carefully parsed 5 page production to the banking fraternity (which includes the bulk of the 14 Families) as: “Your regulatory systems, particularly for this proliferation of new products, are woefully inadequate if not hopeless and you better get them fixed soon (or SOONER) or we will rain upon your collective heads.”Written with some ignorance but also some insight.