The Worst is Yet To Come….Part 2: To Shit or Go Blind…

[Junkdrawer]

In Part 1 of this series, I compared the Credit Default Swap (CDS) market to a London Gambling House and stated that the coming wave of Alt-A mortgage rate resets will lead to an even larger wave of CDS bet payoffs coming due. I ended that post with four possible government actions/inactions:

1.) We do nothing and watch the nation’s largest banks and insurance companies go bankrupt. Lehman Brothers on steroids.

2.) We try to make the bets good. How we can make tens or hundreds of trillions of dollars of bets good is anyone’s guess.

3.) We step in and make sure that almost no Alt-A loan goes bad. BTW: I think that’s in the “Economic Stimulus Bill”. But even with more favorable rates, I’m not sure people won’t default – they still have real-estate taxes and utility bills on houses they could never afford.

4.) We could nationalize the banks and insurance companies after declaring all their current CDS contracts null and void. That should prove interesting to all the foreign bettors who currently fund our deficits.

Well, today we chose Action 2.) and gave AIG $30 billion more to payout more of the bets. We’re stalling for time. Here’s a good summary:

The Real Reason We Keep Bailing Out AIG

How could one company be worth bailing out for $180 billion? That’s how much the US has contributed to AIG so far.

So what is it about an insurance company that makes AIG so central to the financial system that they can’t be allowed to fail at any cost?

Hank Paulson used to at least make a show of trying to explain the latest bailout moves. It seems that the Obama administration, despite all that talk about transparency, has just decided to keep Tim Geithner locked up on these critical days.

But let's light a match rather than curse the darkness. To understand why AIG is special, you need to understand how credit default swaps wound up playing an important role on the balance sheets of banks all around the world. Basically, as banks loaded up on risky corporate loans and mortgage backed securities, they were forced with a choice: sock away more money against a rainy day or buy an umbrella from AIG. If you bought the umbrella, you were allowed to keep using your capital for investments.

Now that it’s rained for something like 400 days, it’s all too clear that AIG didn’t have enough umbrellas to go around.

Let’s drop the metaphor. Banks all around the world never fully-accounted for the losses they would have to take if their loans stopped paying off at expected rates because they had bought insurance against these losses from AIG. If the banks had to account for those likely losses, they would have to start socking money away. This is what regulators are trying to prevent by bailing out AIG.

....

http://www.businessinsider.com/what-makes-aig-so-special-2009-3

Once again, look at this graph:



We’re going to have to make a decision. AIG’s losses are cumulative and are about to get much, much worse…

[rateyes]

1. I choose "shit."

That, and #4.

[Junkdrawer]

2. My wife and I talked about a modified #3....

We TRY to help the borrower stay in their home, but, if that fails, the government buys the property and holds onto the property until the housing market comes back.

Until then, we rent out the property at reduced rates to returning vets and other families who need housing.

[rateyes]

3. Or, rent it back to the family foreclosed on, with a "rent to own"

option. :shrug:

[Junkdrawer]

5. That too...assuming the property isn't completely beyond the means of said family. n/t

[InkAddict]

18. Too much CC debt and unemployment out there now. Everybody

clap harder to keep Tinkerbelle healthy.

[anigbrowl]

9. #4 would be a bad, bad option.

Right now the economy is like a car that's crashed into a tree. this is bad. Option #4 would be like getting out of the car and jumping off a nearby cliff - the economic equivalent of a nuclear first strike. I think it would lead to an out break of war. People who endorse these kind of drastic options seem to assume that the end result will be a bunch of people on Wall Street going to jail and life otherwise carrying on as normal, albeit more frugally. This is not the case. I'm more for a mix of options 2 + 3.

seriously, option #4 is like 'destroy the village in order to save it'.

[AllentownJake]

12. There are more AIGs out there

If this keeps up your going to have Weimar Germany very shortly.

[anigbrowl]

17. We'll get there a lot faster if we let it fail

You remember what happened when Lehman Brothers went bust? That's right, a chaotic mess. If AIG suddenly went offline, every major bank would start restricting cash withdrawals and pretty soon we'd be into nationwide riots and martial law. Unwinding things in this drip-drip way is annoying and stressful for all of us, but it sure beats a sudden disorderly collapse.

[stillcool]

4. Someone needs to have a press conference..

and explain what's going on here.

[Junkdrawer]

6. Yet another circumstance where the truth is so bad....

that the government leaks a little at a time out, hoping tempers will cool over time.

Meanwhile, inaction makes the problem bigger and bigger...

[neverforget]

7. It's amazing that this shitstorm is only just beginning and how many

have their heads in the sand.

[stillcool]

8. I think it's a must -do..

if for nothing else, just to make it look like someone knows what they're doing.

[Veritas_et_Aequitas]

10. Even when it's so obvious that no one knows what they're doing?

[stillcool]

13. especially when no one knows...

what they're doing. Silence only leads to speculation, and speculation leads to fear, and fear leads to all kinds of nasty things. They will take a hit no matter what they say, but by staying silent they deserve it.

[AllentownJake]

11. AIG isn't the only one who made those bets

There are so many bombs out there waiting to go off.

This is what happens when you let an insurance company sell an insurance product without requiring the insurance company to have reserves.

[Junkdrawer]

14. Indeed. AIG Claims they "only" have $450 billion of CDS liability...

Thet would be less than 1/60 of the declared/estimated CDS Market as of 2008:

DTCC, which maintains a database holding around 90% of all credit derivative transactions, held $29.2 trillion of outstanding CDS trades as of 26 December 2008.

It is important to note that since default is a relatively rare occurrence (historically around 0.2% of investment grade companies will default in any one year), in most CDS contracts the only payments are the spread payments from buyer to seller. Thus, although the above figures for outstanding notionals sound very large, the net cashflows will generally only be a small fraction of this total.

There is no centralised exchange or clearing house for CDS transactions; they are all done over the counter (OTC). This has led to recent calls for the market to open up in terms of transparency and regulation. In November 2008, the Depository Trust and Clearing Corp, which runs a warehouse for CDS trade confirmations accounting for around 90% of the total market, announced that it will release market data on the outstanding notional of CDS trades on a weekly basis.

...

http://en.wikipedia.org/wiki/Credit_default_swap

My guess is that no one knows, and if they do know, they're not saying, because the hope is that defaults can be held down and thus the true scope of the danger can be buried in history.

[Blackhatjack]

15. The Billions Are NOT Designed To Fix Anything, But Rather Delay Pulling Back The Curtain...

... revealing that they are all insolvent.

CDS in the numbers of trillions of dollars are larger than all the currency presently in circulation, and are worth pennies on the dollars if not zero.

[Junkdrawer]

16. Absolutely correct. The taxpayers get zero return on paying out CDS bets...

it just stalls the day of reckoning...

And we're quickly going to no longer afford the stall payments.

[AllentownJake]

21. This is why the insurance industry is so heavily regulated

because back in the day this happened on a much smaller scale to life and shipping insurance. A system was put into place where insurance companies had to keep reserves of highly liquid investments.

There is another bomb that is about to go off that no one is talking about. Pension funds. Back in the day the riskiest investment they could hold was bonds. The pensions are in alot of trouble.

[Greyhound]

24. That's what is so maddening, it's done already! The house has collapsed and burned

to the ground and we're being forced to pay the contractor-arsonist to get his ass out of the country, first class! Even if we could stave off this crisis, there are at least two others right behind that dwarf this one.

[Blackhatjack]

19. Bottom Line... When Truth Comes Out, ...The Game Is Over ...

It was reported that Bank of America 'bought out' Countrywide, rather than have to publicly disclose how much $$ they loaned Countrywide which they would never recover. It was therefore cheaper to buy them than suffer the repercussions of public disclosure.

That is basically what the Government is doing with its 'billions in taxpayer $$ bailouts.'

The pretense that keeping these 'too big to fail' banks on life support is enough to keep the economy from tanking ... was a bad idea from the start. Now we are painted into a corner.

[Double T]

20. BO inc. is just delaying the inevitable; the complete collapse of our economy.

Recession, then severe recession, then mild depression, then full blown catastrophic depression. Who the hell are THEY kidding?

[AllentownJake]

22. He's trying for a soft landing

and a rebuilding instead of a sudden crash and martial law.

[Double T]

23. Trying for a soft landing?

I'd put more credibility in the Mayan prophecies.