Posted on 03/23/2008 5:49:23 PM PDT by DeaconBenjamin
It's not a loan. It is a swap of a stream of interest payments.
One interesting aspect of this mess is that courts are refusing to go along with many foreclosures, because the ownership of the mortgages cannot be accurately determined. The mortgage originator sold it the day after cutting the loan, and that loan has since been sliced and diced and resold in a thousand fragments. So who owns the house? It’s going to get VERY interesting, pulling apart this snake pit.
The Cubs beat the Dodgers yesterday, 4-1. Forbes estimates the Cubs are worth $592 million and the Dodgers are worth $431 million.
You can pretend that a $10 bet on yesterdays game put $1 billion at risk, because the performance of your bet was derived from the performance of $1 billion in underlying assets, but you really know it's only a $10 bet.
I think that the key component is vast misallocation of resources that becomes unsustainable. Leverage is often part of this process, but once someone screams that the emperor has no clothes and everyone has a look for himself and sees the shriveled up assets, you cannot reflate the whole thing. Unfortunately, the Federal Reserve has proven time after time that it will do everything in its power to sustain the unsustainable. Remember Michael Milkin? That was his thesis at Wharton, and he build the junk bond markets on it.
You have the $50M in your pocket which would have made you rich, but now you owe $300 to the Yankees, because the Cubs have defaulted.
That wasn't an analogy, it was a derivative.
A better analogy would be that someone set up a trading company to swap the market value of sports clubs to provide insurance against the drop in the club's value created by winning and losing baseball games.
Okay. let's examine your idea.
The Cubs increasing in value by $300M would offset the Yankees dropping $300M . What if the cubs go into bankruptcy and cannot pay the $300M they owe, and which you owe the Yankees.
Back up. Who is buying this insurance? Who is selling?
The best definition I can come up with would be an example.
The State of North Carolina issues a billion dollar bond. They now have a long term liability of one billion dollars and the interim interest payments thereon.
For whatever reason they choose to swap those fixed interest payments into floating rate payments and they create a transaction with JP Morgan to do that. Now JP Morgan owes a stream of payments to NC and NC owes a stream of payments to JP Morgan and its bondholders. If JP goes out of business the only effect is to the stream of interest payments owed to NC on a billion dollars NOT the billion dollars itself.
The billion dollars is a notional amount defining the agreement between JP and NC. The other billion, the one NC owes to all of the investors that own its bonds is the real deal.
Similarly, the state of California could issue a billion dollars of debt and in the six months leading up to the issue date they could by a "cap" on interest rates from JP Morgan and that cap represents one billion in notional value. Again, if JP goes out of business the only effect is that California has lost its hedge and the "premium" it paid for protection.
Notional amounts are the amounts being hedged. Derivatives going bust on notional amounts don't necessarily have an affect on the underlying amount of the original issue.
Trillions of dollars of interest rate swaps, caps, floors, etc. are NOT necessarily principal that is at risk.
LOL!
No. I do believe that outrageous claims of hellfire based on notional values is stupid.
Is this why the Bear Stearns debacle occurred, because of purely imaginary notional funny money?
Bear and every other WS denizen is flying on collateralized borrowed money. There's nothing wrong with that until the counter parties freeze up. Why do they freeze up? Because of irrational fear. Once upon a time WS firms didn't have credit departments because it was all repo. Then Drysdale Securities blew up and couldn't make interest payments on its repo book. Now WS has designated credit officers who have to approve repo counter parties - even though each transaction is delivery vs. payment and collateralize with government securities or something equivalent.
BSC is hardly the first debacle. Remember the dot com pop after the Fed started tightening, the Orange County, Cal blow up after the Fed tightened in 1994? The S&L crisis makes all this look like a picnic.
Is this why Bernanke and Paulson are sweating bullets?
Who says they are?
Do you honestly believe this?
What I believe is that the Armagedden idea is an endorphin release for a lot of petty people.
Very interesting response.. Thank you for the effort. But, you didn’t address my question: I wanted reasons why I SHOULDN’T be worried.... You just made me MORE worried. :-)
Many years ago, a good friend told me : When the banking system collapses (and it will) you don’t want to be invested in gold... you want to be invested in, lead. Preferably, the kind in the shape of bullets.
Your scenario makes me want to stock up...
That's what I was wondering: Just how much of these trillions are in positions that off-set one another. Just as.... a Vegas casino can take in $200M in wagers on the Super Bowl, but... not really have anything at risk...since they offer wagers on both sides. Is that how it works on these "hedge positions"?
You never discuss anything. LOL
Try again?
BSC is solvent and the rest of us are endorphin junkies. Whew. Glad we settled that little issue. Just take a little vacation, relax, detox and the whole problem will be over.
LOL!
Ah HA! Now, I’m starting to get it. One thing I remember from economics class: When interest rates go UP, tradable bond values go DOWN.
I’ve always understood why bond rates would increase w/o a re-insurer. But, I never really considered what the lost of such would do to those already owning bonds..
And, of course... I understand Mongolian Fluster Clucks...
And depending upon the swap let us say that the stream JPM owed to NC amounts to 20% of the interest that NC owes to the bondholders. Let us suppose further that based on that stream NC took out another bond issue. The taxpayers are now stuck with an extra 20% in interest payments above what the state had budget. Do this a few times and the state is going to have a hard time meeting the payroll for its schools.
“The Producers” comes to mind.
#1 There is no "house" that handles and regulates the derivative bets that hedge funds make or that any financial entity (Bear Stearns for example) makes
#2 With derivatives you have two parties making an elaborate bet based on arcane mathematical formulas as applied to financial instruments such as bonds, CMOs etc
#3 .Worst part is these two parties are betting against each other with lots and lots of borrowed money
#4 To borrow such money from Bear Stearns and others they do have to have some collateral. But lately their collateral seems dubious because it is based on sub prime mortgages and other shaky investments
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