CDS Market Remains Biggest Issue Facing Monetary Authorities

[The following is excerpted from Bill Cara's Daily Report]

Markets remain uncertain. The only certainty in Congress today is the venting these House members are likely to have on behalf of an outraged public. It’s politics as usual, as this is also hard-ball negotiations.

The question is how long Paulson, at his age, can hold up. He is looking rather less the bully he has always been. But, when given the sharp edge Tuesday about taxpayers being on the hook and angry, he flashed anger, like a caged animal. Let’s see how he lets Dr. Ron Paul get to him today.

In any case, leaving the repugnant philosophical aspects aside, I think Paulson has a good package that Congress has to rein in with details that permit their continued oversight plus controls over executive pay-outs to management of the financial companies that come to government seeking a bailout. A quick agreement on a bill is essential.

There are too many market events to list and comment on here. Let me do a couple.

Goldman Sachs (GS) has just received a $10 billion capital injection. Morgan Stanley (MS) received theirs a day or so ago. These capital injections are far more attractive than what the government will provide to others that come to Washington. In fact, the Paulson Plan will focus on the weakest companies -- the ones that are breaking the credit ring -- and government will be negotiating hard in order to avoid putting good money after bad. Some of those companies will rightfully fail. Their key departments will be sold in bankruptcy, and some of the key people involved will be recruited. I myself will be listening to proposals from displaced Wall Streeters who can bring value.

Tuesday there was a report that the FBI is commencing criminal investigations into the failures at Fannie (FNM), Freddie (FRE), AIG (AIG) and Lehman (LEH). In my view, this is more to do with taking the edge off the emotions of the public than with serious criminal investigation. If there was fraud, it will take months or years to find it and years to prosecute. As traders, don’t waste your time even thinking about it.

The Shanghai Fly Wednesday reported that economically speaking, Citi (C) doesn’t think China is in the greatest shape. Here’s what the Fly sent Wednesday morning from Shanghai:

http://tinyurl.com/4nrkxv
"Hopes of a rapid recovery in the health of the Chinese economy after the Olympic Games are fading fast on weakening commodity as well as property prices, Citigroup said in a report released Wednesday." Lan said an unexpected reduction in steel prices for November announced last week by Baoshan Iron & Steel Co., China's largest steelmaker, suggested steel companies weren't expecting any major rebound in economic activities.
Baoshan last week announced a reduction of 800 yuan ($117) a ton, or more than 10% over October, in the prices of hot-rolled and cold-rolled steel coils for November, according to reports.

Do you recall me wondering how much capital T. Boone Pickens has lost for his hedge fund investors this year? Wednesday, he admitted to losing at least $1 billion so far! So, even the biggest belt buckles in Texas are tarnished today.

Tuesday evening there was a Reuters headline, “Europe shares end lower on anxiety over US plan”. That was misleading. From the time that the Senate hearing started, the European prices started to gain strength.

The Morgan Stanley and Goldman Sachs joining the Fed banks, which severely limits their use of leverage, will mean that many of their biggest-hitter front office staff will quit. They will not be able to service their hedge fund clients anymore, which will diminish their personal incomes and bonuses, so they will depart to join or set up boutiques. This issue was the big reason, in my mind, why in the past couple weeks, the share prices of MS and GS were dropping while the shares of traditional banks were relatively out-performing. I think insider trading resulted that is potentially criminal. That internal debate and subsequent decision was a material one; the public shareholder had every right to trade on the same basis as insiders and that was deliberately withheld from them. MS and GS CEOs should have disclosed these discussions, and should be held accountable. I do think there is a strong likelihood of criminality there that could easily be investigated and discovered for prosecutors.

The biggest issue facing the monetary authorities today is the credit derivative swap market. Do you recall how many times I stated that over the past two years? This is why the system collapsed in June 2007, and the enormity of the implications was the reason that HB&B withheld the info from the public, which permitted them the time their insiders needed to off their positions. I think the SEC ought to investigate personal trading by every registered officer and director of HB&B since the start of June 2006, and where some of these people can be linked back to knowledge of the CDS crisis, their profits should be retracted by the authorities.

Barry sent me this mail on the subject:

Hi Bill, I can no longer post for some reason so I am sending on this article on Credit Default Swaps as a significant cause of the current crisis. I found it quite helpful, and it may be of interest as Chris Cox said in the hearings today that regulation of CDSs was critical. If it has been on the board, I am sorry for the email intrusion as I can imagine how busy you are.
http://tinyurl.com/4amao3

Love the site and the blog!!

I could go on, but I have other work to do. Remember me when thinking about who called the bottom of this market. And look to the thousands of others who will lie to you when they too take credit.

Have a great day.

Comments

[Reinko:]

With 'Barry' I think you are talking about Barry Ritholtz?

Therefore it would be nice to know what the 'some reason' is that Barry cannot write here any longer.

At first you could read his wise stuff and place comments.

Later he placed less stuff and he was the only author on this website where you could suddenly no longer place comments.

And now he is completely gone...

But on his own website he is working frantic with many updates a day,
link:

bigpicture.typepad.com/

So what happened?

2008 Sep 24 02:34 PM

[Reinko:]

Here are some numbers as far as I know reality:

Total worldwide nominal value in CDS contracts is 62 trillion.
That is about 10% of all OTC contracts worldwide.

If CDS contracts are in line with the other OTC contracts (and why not, after all the Black Sholes model only needs two parameters known as average and volitility) then total contract value was about 1.4 trillion.

Rumors are that mortgage backed CDS stuff goes for 22 cents on the dollar but for other CDS stuff I miss info.

So all I can say is that on the CDS market in total we are looking at a few hundreds of billions in US$ losses but since most of that stuff is nicely parked in the Level 3 assets or are on the 'off balance' balances it is every body's guess how much that market has declined...

2008 Sep 24 02:40 PM

[Alex Filonov:]

I don't think anything criminal happened at GS and MS. There were runs on them last Thursday, and no financial company can survive big old-fashioned bank run. There were things bordering on criminal at both, for sure, but I doubt there is any evidence acceptable in court. Although it would be interesting to find out what happened on oil futures market on Monday and if GS, MS or Lehman Brothers has anything to do with it on either side of trades.

2008 Sep 24 03:16 PM