Derivatives: The Great Unwind

by Morgan on October 14, 2008

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Another guest post from MG who went from Wharton to Wall St. to real estate to Blown Mortgage.

The market was up strong yesterday. Other than the shares of bank stocks, you have to wonder why. The worldwide central bank bailout is not intended for the equity investor, or general public, or business, or you, or me. It?s intended for banks, ostensibly to spur lending, but more likely to keep them afloat through next week?s Great Derivatives Unwind. This has got to be a big part of the motivation of the CBs to provide unlimited lending to banks.

Distracted by worldwide stock market crashes, attention shifted away from Lehman?s derivatives? payouts scheduled for October 21. Recovery value has been set at 8.625 cents per $1.00, which means that sellers of credit protection must pay 91.375 cents to the buyers (according to Creditex, the company that holds auctions).


More than 350 banks and investors signed up to settle credit-default swaps tied to Lehman. The list of participants in the auction includes Newport Beach, California-based Pacific Investment Management Co. PIMCO, manager of the world’s largest bond fund, Chicago-based hedge fund manager Citadel Investment Group LLC and AIG, the New York-based insurer taken over by the government, according to the International Swaps and Derivatives Association in New York.

According to JPMorgan, the largest foreign bank holders of Lehman?s derivatives are Deutsche Bank, Barclays, Societe Generale, UBS, Credit Suisse and Credit Agricole. Overall, as of June 30, 2008, the top ten US banks in terms of derivatives exposure were: JPMorgan Chase, Bank of America, Citibank, Wachovia, HSBC USA, Wells Fargo, Bank of New York, State Street Bank, SunTrust Bank, and PNC Bank, according to the Comptroller of the Currency Administrator of National Banks’ Quarterly Report on Bank Trading and Derivatives Activities for the second quarter of 2008. Lots of other good information too, if you like this sort of thing, as I do.

And this is just the beginning. Few losses are expected from the failed GSEs. Fannie Mae?s senior debt settled at 91.51 and subordinated debt at 99.9 cents on the dollar; Freddie Mac senior debt was 94.00 and subordinated debt was 98 cents on the dollar. Washington Mutual could be another story. It’s Credit Event Auction will settle, meaning prices will be determined, on October 23. Just last week there were credit events at the largest three Iceland banks, all of which have large quantities of derivatives outstanding. These are all financial institutions; industrials haven’t started yet.

Nonetheless, the market?s up. For technical types, Mish Shedlock has a good and almost-understandable-by-laymen explanation of where the market is in terms of Elliott Wave theory. He says, ?In terms of price, given the magnitude of today’s move on top of the huge move up from Friday’s low, the rally may be 65% over already. In terms of time, the rally likely has several weeks to a couple of months to play out.? See S&P 500 Crash Count at www.globaleconomictrendanalysis.com

In my opinion, the markets are still very fragile. Charts or no charts, it wouldn?t take much to see another cliff dive. We?ll see what happens next.

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Viewing 5 Comments

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    Anybody that has been following this mess closely can not be too surprised by the list of usual suspects that have high levels of exposure. My two favourites at the top of the list are JP Morgan & PIMCO (I'ld like to see them both burn in hell) or at least go bust big time. Which two names have been more active then these two over the last 6 months? (Nobody!) These two companies are the poster children for this Derivatives Crisis and should be called out and made to pay for it.

    It's just too bad that they run the "Shadow Government" and will surely only profit from what they have caused! But don't forget to a lesser degree Citibank, Bank of America, Wells Fargo, Bear Stearns and Wachovia ARE OR WERE big players in this mess too.

    The Government & Shadow Government story is this entire mess is the fault of Sub-prime. Why is that? It was only a $500 Billion Dollar Market which is chump change compared to what they are spending now. Well, because if they can get you to believe this is all happening because of Sub-prime loans then that makes a certain segment of the public to blame. BUT, IF THE TRUTH WAS KNOWN and the public found out the real problem is Wall Street Creation with Government backing "Derivatives" and has nothing to do with Mom & Pop US Citizen. Well that is a horse of a very different colour and I suspect more then a few people would be really pissed off and civil unrest might be in the cards.

    It's coming because the truth will get out eventually and the Corporate and Government Big Wigs better watch out. The French Revolution will go down in History as a camp fire compared to a 2008 - 2009 US Revolution.
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    Interesting points, Jim.

    I think the average, hard-working, family types are starting to figure out that something very bad is happening. And, as you point out, it isn't the fault of a relatively few people who paid too much for a house or even those walking away from that house.

    The blatant thievry is staggering.

    mg
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    Gee, Goldman Sachs had no counterparty risk to Lehman, no wonder HANK let them go....
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    Another excellent point.

    There's always something in the background that benefits GS, isn't there.

    mg
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    The bailouts were completely unnecessary and unwanted by much of the nation, something else definitely had there hand in the plan, to see so much resent for the bailout yet having the bailout passed anyway.

    I'm trying to get a forum for centralized discussion of the bailout.
 

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