Meredith Whitney, the analyst at Oppenheimer who has become the scourge of Wall Street, points out a disturbing fact. In the 4th quarter of 2008, more than $2.3 Trillion of securities were downgraded by ratings agencies. That's over 2 1/2 times the pace of the previous quarter. All these securities are structured bonds and mortgage backed securities, otherwise known as debt based derivatives.
What this means in real terms is this: Any publicly traded company or any fund used for investment must have reserves matching the risk represented in the securities they hold for investment. Bond issues (which all debt based derivatives are) rated AAA need very little capital to be held in reserve as a safety net should that bond issue go belly up. This is because anything rated AAA is assumed to have little or no risk of failing. As a bond issue loses its AAA rating, each downgrade significantly raises the amount of money needed to hold in reserve by the holder of that bond.
In the 4th quarter of 2008, $2.3 Trillion more of these bonds were downgraded. So, the reserves needed rose, in some cases, dramatically. Please, do not think of this in terms of only the 4th quarter 2008. There have been a lot more before this, and there will be a dramatic amount after this.
Guess where all that money from the "bailouts" is going. That's right, almost every penny is going to the reserve accounts as these derivatives are downgraded. That money cannot be used to lend out, because it is already covering part of the loss in value of these derivatives.
If Company Z has $1 Billion invested in a CDO, which was rated AAA when they bought it, what would the value be of that CDO be if it is now rated only A? I can tell you this, it ain't $1 Billion anymore. It may only return 80% of its purchase price. That's a 20% loss, or in the view of Company Z, a $200 Million loss. But, the reserve requirement needed from AAA to A may only have increased to $20 Million.
That is a $180 Million gap between known loss and reserve requirement. Should Company Z be forced to sell, today, that CDO, the reserve would only cover a fraction of the loss. The rest is "writedown" in accounting jargon.
The reason there are Billions of dollars in the bailouts is because there are hundreds of Trillions of dollars in derivatives. All based on debt that is falling in value. Most of these downgrades have reduced the ratings on derivatives far more than AAA to A. Many have gone to "junk" status, meaning they went from AAA to AA to A to BBB to BB to B, and now some have gone further. Because these derivatives are all predicated on housing values always going up, the reality they are really worth something close to ZERO is very likely.
It is not very honest for the talking heads on television to state "The banks are not lending because they are hoarding." The banks are using all the bailout money to meet the increasing reserve requirements as these derivatives are downgraded. The really bad part of all this is the reserve requirements are far, far less than the actual loss in value. The banks need the bailout money to be applied to their reserve accounts, or else they are forced to sell these derivatives, and instantaneously go bankrupt due to the aforementioned "gap."
That is correct. If the largest banks, pension funds, corporations etc were forced to sell their derivative holdings today, almost all of them will be out of business tomorrow.
Every penny given in all the bailouts is lost forever. It is, at best, a lie to suggest the American taxpayer will realize a gain on any of this bailout money. At worst, if you are a politician or able to influence investment, it is a felony to suggest this.
What this means in real terms is this: Any publicly traded company or any fund used for investment must have reserves matching the risk represented in the securities they hold for investment. Bond issues (which all debt based derivatives are) rated AAA need very little capital to be held in reserve as a safety net should that bond issue go belly up. This is because anything rated AAA is assumed to have little or no risk of failing. As a bond issue loses its AAA rating, each downgrade significantly raises the amount of money needed to hold in reserve by the holder of that bond.
In the 4th quarter of 2008, $2.3 Trillion more of these bonds were downgraded. So, the reserves needed rose, in some cases, dramatically. Please, do not think of this in terms of only the 4th quarter 2008. There have been a lot more before this, and there will be a dramatic amount after this.
Guess where all that money from the "bailouts" is going. That's right, almost every penny is going to the reserve accounts as these derivatives are downgraded. That money cannot be used to lend out, because it is already covering part of the loss in value of these derivatives.
If Company Z has $1 Billion invested in a CDO, which was rated AAA when they bought it, what would the value be of that CDO be if it is now rated only A? I can tell you this, it ain't $1 Billion anymore. It may only return 80% of its purchase price. That's a 20% loss, or in the view of Company Z, a $200 Million loss. But, the reserve requirement needed from AAA to A may only have increased to $20 Million.
That is a $180 Million gap between known loss and reserve requirement. Should Company Z be forced to sell, today, that CDO, the reserve would only cover a fraction of the loss. The rest is "writedown" in accounting jargon.
The reason there are Billions of dollars in the bailouts is because there are hundreds of Trillions of dollars in derivatives. All based on debt that is falling in value. Most of these downgrades have reduced the ratings on derivatives far more than AAA to A. Many have gone to "junk" status, meaning they went from AAA to AA to A to BBB to BB to B, and now some have gone further. Because these derivatives are all predicated on housing values always going up, the reality they are really worth something close to ZERO is very likely.
It is not very honest for the talking heads on television to state "The banks are not lending because they are hoarding." The banks are using all the bailout money to meet the increasing reserve requirements as these derivatives are downgraded. The really bad part of all this is the reserve requirements are far, far less than the actual loss in value. The banks need the bailout money to be applied to their reserve accounts, or else they are forced to sell these derivatives, and instantaneously go bankrupt due to the aforementioned "gap."
That is correct. If the largest banks, pension funds, corporations etc were forced to sell their derivative holdings today, almost all of them will be out of business tomorrow.
Every penny given in all the bailouts is lost forever. It is, at best, a lie to suggest the American taxpayer will realize a gain on any of this bailout money. At worst, if you are a politician or able to influence investment, it is a felony to suggest this.
As Financial Times writes;
"The problem of toxic assets is facing not just large banks. University endowments to small regional banks across the world bought chunks of structured bonds or mortgage-backed securities. Is the $10m, $100m or $1bn they own worth anything at all?
Finding a reliable source to value these toxic assets remains a near-impossible task. Indeed, the US government cleverly skirted the issue in its bail-out of Citigroup by offering a blanket guarantee on over $300bn of troubled assets. The rescue left the troubled asset conundrum on ice to deal with in the future."
I will add to the list of who bought these - Money Market funds, Pension funds (both public and private), Foreign Central Banks (all of the Fannie and Freddie money has gone to buy back MBS sold to the Chinese), Annuity funds, Insurance companies and Hedge funds.
To date, globally there has only been around $20 trillion in "writedowns" (there may be more, it is the closest I can come with the available information.) There is somewhere between $600 Trillion to $1 Quadrillion in derivatives, again, hard to quantify exactly because almost all of these structured finance derivatives are bought and sold outside of any regulatory control. Almost all of these have been sold by US investment banks in the last 6 1/2 years.
What happens if all these derivatives are worth only 50% of their original value? A $300 Trillion dollar loss, at minimum? The world markets are already reeling with $20 Trillion in losses.
Until these derivatives are forced out into the open, and can be cleared from the system, our economy, no, the global economy, has no chance of recovery. Every day that goes by the losses mount. Every dollar that goes to help hide these derivatives is lost, because tomorrow they will be downgraded more.
To date, globally there has only been around $20 trillion in "writedowns" (there may be more, it is the closest I can come with the available information.) There is somewhere between $600 Trillion to $1 Quadrillion in derivatives, again, hard to quantify exactly because almost all of these structured finance derivatives are bought and sold outside of any regulatory control. Almost all of these have been sold by US investment banks in the last 6 1/2 years.
What happens if all these derivatives are worth only 50% of their original value? A $300 Trillion dollar loss, at minimum? The world markets are already reeling with $20 Trillion in losses.
Until these derivatives are forced out into the open, and can be cleared from the system, our economy, no, the global economy, has no chance of recovery. Every day that goes by the losses mount. Every dollar that goes to help hide these derivatives is lost, because tomorrow they will be downgraded more.
Better to take our lumps today, than let tomorrow have us in a hole that is a few feet deeper.
1 comment:
Hey Rick, you get em' brother! The things that are going on today are amazing, people need to wake up! Pete.
http://www.PeteElsner.com
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