One-Two Punch for the Default Swap Market

Submitted by Rich Toscano on September 16, 2008 - 9:01am

A quick update to the last post. This morning I read in Housing Wire that ailing insurance company AIG poses an even bigger threat to the CDS market than Lehman:

AIG sold banks and other investors CDS protection on $441 billion of fixed-income assets, including $57.8 billion in subprime-mortgage related securities. There are likely very few firms with this much exposure into the CDS market

My snarky comment in the prior post notwithstanding, the folks at the Treasury have to their credit not directly bailed out either Lehman or AIG.  (They have stepped up the indirect bailouts, however: the Fed will now be lending more money to more people with more questionable collateral, and word is that they may also cut rates again today.)

But while they are finally turning some pigs away from the trough, the government's frantic interventions to date suggest that they will not sit idly by as things get really out of hand. We shall see.

I haven't gone into much detail on this week's drama because for the most part I'd be rehashing what's already been, uhm, hashed many times over. All the mainstream outlets are covering the issue, but for good up-to-the-minute updates and commentary I've been enjoying the coverage at the blog Naked Capitalism.

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Submitted by SD Realtor on September 16, 2008 - 9:15am.

I was amazed at the announcement about that yesterday Rich.

You were much to kind... "questionable collateral" is quite a nice way of saying POS collateral. What nobody seems to have noticed is this is basically the government trading cash for crap. I am not sure how long the terms are for those loans. Are they 30 days?

Anyways I would strongly agree that for better or worse, (I think worse) the government is going to be proactive as the storm gets worse.

Submitted by sdduuuude on September 16, 2008 - 9:41am.

I'm starting to wonder if the gubmint hasn't drawn a line in the sand with Fannie and Freddie. They bailed out Bear Sterns because the thought it was a one-off deal, not realizing the storm was a-brewin'.

Then, they realized it and decided to back F/F. By doing this, they solve a large percentage of the problem with a single act, and keep mortgage deals flowing. Plus, the F/F move is much more justifiable and more politically acceptable than saving private banks.

I'm wondering (hoping) they are done with the individual bail-outs at this point. They did their thing with F/F and may be out of money and/or political clout to do mre. Sure, they'll pump money into the system, lower rates, lend more, but my uneducated guess is that the banks will fall where they may from here on out.

Submitted by peterb on September 16, 2008 - 3:40pm.

Failures seem to be que'd-up for weeks to come. I think we've had about 4 weeks in a row of failure news and activity. I guess the DOW at 7500 is not that far away. What will RE prices look like this time next year???

Submitted by no_such_reality on September 16, 2008 - 9:26pm.

Do you think many CEO's will line up for an AIG style bail-out? Let's see, the Fed takes 80% of your company, fire you, get's veto rights on dividends and sets a plan to liquidate your assets all for a loan paying Libor + 850 basis points?

For some reason, I don't see Wagoneer liking that deal. Nor do I see the replacement at Wamu liking it.

and I wonder if 'too big to fail' BofA's Lewis will want a piece of it if Countrywide and Merrill's problems prove too big.

I don't really see CEO's lining up for a bailout like this...

Submitted by 34f3f3f on September 17, 2008 - 8:18am.

I'm not going to try and pretend I understand CDSs, but like any insurance, I would expect large risk to be re-insured out through the market. The reinsurance market is complex, and security therefore impossible to assess, but it at least offers a buffer by spreading the risk down through several layers. Does anyone know if this is the case?

Submitted by sdduuuude on September 17, 2008 - 9:15am.

I'm proven wrong so quickly.

Submitted by tibuan on February 19, 2009 - 12:12am.

Where do you get these questions? I have been investing all my life and I have never run into terms like this. I am glad I made my million before knowing this stuff was necessary.

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