Posted on 09/08/2008 5:33:29 PM PDT by bruinbirdman
One of the largest defaults in the history of the $62,000bn credit derivatives market has been triggered by the US government’s seizure of Fannie Mae and Freddie Mac, raising questions about how dealers will unwind billions of dollars worth of contracts.
Although the $1,600bn of debt issued by the troubled mortgage groups is regarded as safe after the US government’s move to take control of the companies, their move into “conservatorship” counts as the equivalent of a bankruptcy in the credit derivatives market.
This triggers a default on credit default swaps – instruments that provide a form of insurance on fixed-income assets. Dealers in the market are now working to settle these contracts.
The exact amount of CDS on Fannie Mae and Freddie Mac are not known, reflecting the private nature of the market, but they are part of widely traded indices and the amounts are likely to be significant. Analysts at Lehman Brothers said: “There is likely to be a considerable amount of notional protection outstanding.”
The industry body, International Swaps and Derivatives Association, said on Monday it would launch a protocol to facilitate settlement of credit derivative trades involving Fannie Mae and Freddie Mac and would publish further details in due course.
The uncertainty surrounding the Fannie Mae and Freddie Mac CDS contacts highlights the need for improved settlement and trading procedures. Already, regulators have put pressure on CDS dealers, including all the large financial institutions, to reduce settlement and trading risks.
The near-collapse of Bear Stearns in March highlighted the extent to which many large financial institutions were linked together through the CDS market, and the Federal Reserve and other regulators want to reduce such systemic financial risks.
The growth of the CDS market over the past decade has outpaced development of settlement systems and trading infrastructure. One worry is the lack of standard procedures in contracts for dealers to agree ways to settle defaulted credit derivatives.
The actual payments on credit default swaps on Fannie Mae and Freddie Mac are expected to be limited because the value of the mortgage agencies’ debt remains high after the US government stepped in to back it.
That means that meeting any claims on CDS may not be that costly, although the details are still being worked out and the impact is unknown.
Analysts at Creditsights said regulators could “use the bail-out as another lever” to enhance the CDS market’s efficiency.
What we really need is a BDS default.
Why aren’t the CEOs of Fannie and Freddie committing seppuku? Oh, yeah, gotta get Obama elected.
Is that really $62,000 Billion ___________ ?
The headline kind of makes it sound more serious than this final sentence does.
"Is putting Fannie/Freddie into conservatorship going to trigger default swaps on the paper? Is the Treasury seizing control of the GSE’s considered a “credit event” that triggers the swaps?
If it does, I think that there’s going to be some more pain than the boys at Treasury think, and a whole lot more behind the scenes wrangling necessary to keep the debt markets from going ape than just this plan.
yitbos
yes...62 trillion.
$62 trillion is the NOTIONAL VALUE of the underlying capital.
How much stands to be gained or lost depends on how the contracts are written.
If I bet you $1 the stock market will go up tomorrow, the notional value of the contract is the total value of all stock traded. However, when it is time to settle up, someone makes or loses a dollar.
I bet that Rogers dude owns some of that action.
The derivative market has been estimated at $600 trillion. Highly leveraged instruments. A big change in value of a fundamental unit supporting many 30-1 leveraged instruments, as we have here, will cause a tsunami to rip through the system. If you are not on high ground now - get there fast!
Warren Buffett famously described derivatives bought speculatively as "financial weapons of mass destruction." In Berkshire Hathaway's annual report to shareholders in 2002, he said, "Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses -often huge in amount- in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen)." The same report, however, also states that he uses derivatives to hedge, and that some of Berkshire Hathaway's subsidiaries have sold and currently sell derivatives with notional amounts in the tens of billions of dollars.$ 62 Trillion. Let's say that the CDS in question are now worth about 25% of the book value they held last month. That is a hell of a lot of mortgage paper.
How would any mortgage lender foreclose on that pile of rubbish now?
This seems to reiterate the serious questions I raised three years ago about forged documents being used by mortgage lenders and Wall Street banks. Think about it some more.
This Shi'ite is gonna get deeper and wider very quickly.
I cannot see how the government’s takeover of Fannie/Freddie is any better. Government always fails, everytime it is tried. Are these not the same people (Congress) who had oversight of Fannie/Freddie? Are these not the same people who urged Frannie/Freddie to back loans to borrowers who had bad credit and insufficient incomes to pay their mortgages? Are we nuts?
I heard on Rush today that HUD back in the 90’s under Andrew Cuomo mandated that freddie and fannie had to make loans to low income households–ie high risk households. And this on top of the loans to low income neighborhoods (ie high risk loans) fostered by the Community Reinvestment Act 1979.
The CDO concept was developed by (convicted) Michael Milken of (now-defunct) Drexel Burnham Lambert. After the securities scandal, the vehicle lay dormant until picked up by the mortgage industry around 1999/2000. CSPAN aired an interview with a journalist who looked into the subject; took more than a few calls from some articulate folks who objected to placing the blame on Fannie/Freddie for exactly the reason I stated. The CDO package - courtesy of Mikey Milken - is flawed.
It is going to be worse than I thought. Much worse. Friends living in La La Town have gone through hell during the past 18 months. Their 401(k) programs were nearly wiped out because they had too much company stock. Over $ 1.5 million evaporated in the subprime crisis. They both last their high paying jobs. Now she has another job but he is still looking. Home values nearby dropped about 40% and are sill going down.
I do not have the heart to tell him what I really think. Somebody here said when there is a tsunami coming, you must head for the hills. My friends don't want to hear that type of advice. The want to stay in LA. Sad, but true.
Ping!
The problem is, where the he!! are the hills!
This is what capitalism USA has come to. We don’t produce shit but we sure do know how to trade derivatives and other loony financial instruments (CDOs). We sure know how to flip illegal alien built houses. We sure know how to get Gubbermint agencies like Freddy Mac to demand by law more home loans for the poor and illegal immigrants
I liked the old robber barons and captaisn of industry. At lesat they got rich making useful trhings
The use of imaginary monies (heavy over leveraging) have been used through the years to cook the books so those at the top could skim their fat bonuses, i.e. real money.
Amazing the hoodwink allowed to basically bet the same money over and over again at the same time in different crap games and the shooter carrying a pair o loaded dice.
The depth of the level of the deceitful debt shell game is just now starting to show and peoples' retirement funds was the front monies laid at risk.
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