MBIA, Ambac Losses Raise Concern Top Aaa Ratings May Again Be in Jeopardy Moody's Investors Service said deepening losses at MBIA Inc. and Ambac Financial Group Inc. may imperil their Aaa credit ratings less than three months after they were affirmed.
Fed Officials Warn on Inflation, Say Financial Markets Are Still Unsettled Federal Reserve Chairman Ben S. Bernanke and fellow policy makers said financial markets are still unsettled, while several officials said the central bank is challenged by unacceptably high inflation.
Full Version: Financial Turmoil
Common Ground Common Sense > National & International News > Op-Ed Articles from the Mainstream Media
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Get Ready to Spend $6,000 a Year on GasMark Clayton, Christian Science Monitor
With prices at $120 a barrel, Americans are feeling the pain.
THE MOGAMBO GURU 
Chicken feed so far on food prices Inflation in prices, and you don't have to go much further than the local grocery store to know that it is already with us, generally follows inflation in the money supply. And given the rate at which that is climbing, those rising prices are going to go way, way higher.
CREDIT BUBBLE BULLETIN
A new inflationary epoch
The world is awash in excess funds, large amounts of these in the form of foreign currency reserves, available to bid up prices of critical tradable resources. A key question is how much will China, India, Russia and others be willing to pay to procure adequate supplies of food and energy for their populations and economies? (May 12, '08)
Doug Noland reviews the previous week's events each Monday.
Chicken feed so far on food prices Inflation in prices, and you don't have to go much further than the local grocery store to know that it is already with us, generally follows inflation in the money supply. And given the rate at which that is climbing, those rising prices are going to go way, way higher. CREDIT BUBBLE BULLETIN
A new inflationary epoch
The world is awash in excess funds, large amounts of these in the form of foreign currency reserves, available to bid up prices of critical tradable resources. A key question is how much will China, India, Russia and others be willing to pay to procure adequate supplies of food and energy for their populations and economies? (May 12, '08)
Doug Noland reviews the previous week's events each Monday.
Sears: From majesty to hedge-fund dust
The life and near death of one store charts the rise and decline of the American economy, from frontier innovation to the present crisis of overconsumption. The great US money-creation machine of the past few years has shut down. As the dust settles, we see that very little of real worth remains. - Julian Delasantellis (May 13, '08)
The life and near death of one store charts the rise and decline of the American economy, from frontier innovation to the present crisis of overconsumption. The great US money-creation machine of the past few years has shut down. As the dust settles, we see that very little of real worth remains. - Julian Delasantellis (May 13, '08)
ECONOMY -- NEW POLLS SHOWS AMERICANS ARE PESSIMISTIC ABOUT THE ECONOMY: A new Washington Post/ABC News poll finds that "[n]early seven in 10 Americans are worried about maintaining their standard of living, as concern has spiked higher in just the past five months." Soaring consumer prices are also a major challenge, "with many people struggling under the weight of the rising costs of fuel, food and health care." A separate ABC poll released yesterday "showed economic anxiety at its highest level on record since 1981." Similarly, a new Los Angeles Times/Bloomberg poll found that "[m]ost Americans see little hope that the economy will improve in the next six months." All the polls suggested that high gas prices are fueling Americans' negative mood of the economy. The LA Times poll found that Americans "are decidedly pessimistic about the direction of oil prices and inflation," while according to the Post poll, "two-thirds called rising gasoline prices a financial hardship, including a third who said higher pump prices have proved to be a severe burden."
A deficit of intelligence, insanity in surplus The swing in US trade figures in March from a monthly surplus of US$63 billion to a deficit of $58 billion, a negative turn of $121 billion, and the stock market goes UP? Investors think this is good news? They are insane!
CREDIT BUBBLE BULLETIN
A new inflationary epoch
The world is awash in excess funds, large amounts of these in the form of foreign currency reserves, available to bid up prices of critical tradable resources. A key question is how much will China, India, Russia and others be willing to pay to procure adequate supplies of food and energy for their populations and economies? (May 12, '08)
Doug Noland reviews the previous week's events each Monday.
A new inflationary epoch
The world is awash in excess funds, large amounts of these in the form of foreign currency reserves, available to bid up prices of critical tradable resources. A key question is how much will China, India, Russia and others be willing to pay to procure adequate supplies of food and energy for their populations and economies? (May 12, '08)
Doug Noland reviews the previous week's events each Monday.
MARKET RAP
Shadows lighten over Asia
The receding fear of an immediate downturn in the US has lightened the shadows over Asian markets. National issues such as inflation or the attraction of regional stocks to Chinese investors found room to assert themselves. Confidence, however, remains in short supply. (May 9, '08) R M Cutler runs his eye over the ups and downs in the week's markets.
Shadows lighten over Asia
The receding fear of an immediate downturn in the US has lightened the shadows over Asian markets. National issues such as inflation or the attraction of regional stocks to Chinese investors found room to assert themselves. Confidence, however, remains in short supply. (May 9, '08) R M Cutler runs his eye over the ups and downs in the week's markets.
Institutional Selling Warns of Stock Market Weakness - 13th May 08 - Marty_Chenard
US Heading for Double-Digit Inflation - 13th May 08 - Money_and_Markets
Real Estate and Credit Deflation: The Next Dozen Shoes to Drop - 10th May 08 - Steve_Moyer
The Hard Facts of Manipulated Economic Statistics - 9th May 08 - Anthony_Cherniawski
US Government Facing Fiscal Armageddon- US Dollar in Deep Trouble - 6th May 08 - Money_and_Markets
Jobless Claims Rise to 371,000 bloomberg.com — The number of Americans filing applications for the first time increased to 371,000, in line with estimates, from 365,000 the prior week, the Labor Department said. Companies are stepping up the pace of firings as the worst housing slump in more than a generation undermines home values, consumer spending and overall growth. Economists forecast consumer spending would increase this quarter at the slowest pace in 17 years. 
Foreclosures Up 65 Percent guardian.co.uk — The wave of misery caused by America' sub-prime mortgage crisis engulfed more homeowners in April as foreclosures rose by 65% year-on-year, adding to pressure on the White House to provide relief for stricken borrowers. Banks filed foreclosure papers on 243,353 US properties last month according to RealtyTrac, an online marketplace for repossessed homes. The figure was up 4% on March and experts suggested that the rate of increase would be higher were it not for a logjam at courtrooms, with over-burdened clerks taking several months to process paperwork.
Countrywide To Face Shareholders' Suit money.cnn.com — A federal judge has ruled that a shareholder lawsuit against Countrywide Financial Corp. executives and directors should go to trial, rejecting several arguments by the troubled mortgage lender to dismiss the case. In a ruling issued Tuesday, U.S. District Judge Mariana R. Pfaelzer in Los Angeles sided with several public pension funds, finding that their witnesses' accounts of Countrywide's business practices were compelling. Several witnesses gave persuasive accounts of Countrywide's business, including allegations that the company rewarded employees for boosting loan volume rather than for generating quality loans.
Foreclosures Up 65 Percent guardian.co.uk — The wave of misery caused by America' sub-prime mortgage crisis engulfed more homeowners in April as foreclosures rose by 65% year-on-year, adding to pressure on the White House to provide relief for stricken borrowers. Banks filed foreclosure papers on 243,353 US properties last month according to RealtyTrac, an online marketplace for repossessed homes. The figure was up 4% on March and experts suggested that the rate of increase would be higher were it not for a logjam at courtrooms, with over-burdened clerks taking several months to process paperwork.
Countrywide To Face Shareholders' Suit money.cnn.com — A federal judge has ruled that a shareholder lawsuit against Countrywide Financial Corp. executives and directors should go to trial, rejecting several arguments by the troubled mortgage lender to dismiss the case. In a ruling issued Tuesday, U.S. District Judge Mariana R. Pfaelzer in Los Angeles sided with several public pension funds, finding that their witnesses' accounts of Countrywide's business practices were compelling. Several witnesses gave persuasive accounts of Countrywide's business, including allegations that the company rewarded employees for boosting loan volume rather than for generating quality loans.
DEAN BAKER
Progressives and the Housing Bailout tpmcafe.talkingpointsmemo.com — If the main beneficiaries of bailout programs are the banks, then we are using taxpayer dollars to shift income upward. We are giving money to to the banks' shareholders and their managers, some of the most highly compensated people in the country.
NICHOLAS VON HOFFMAN
Federal Reserve Freakout thenation.com — The other day Ben Bernanke came as close as a chairman of the Federal Reserve will come to a public freakout. Call it a subdued, bankerly freakout. What's got Bernanke scared is that "about one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure." That, and the rise in delinquency rates in the prime and near-prime mortgage markets. Oh, and the foreclosure rate that rose 53 percent last year and looks likely rise even higher this year.
Progressives and the Housing Bailout tpmcafe.talkingpointsmemo.com — If the main beneficiaries of bailout programs are the banks, then we are using taxpayer dollars to shift income upward. We are giving money to to the banks' shareholders and their managers, some of the most highly compensated people in the country.
NICHOLAS VON HOFFMAN
Federal Reserve Freakout thenation.com — The other day Ben Bernanke came as close as a chairman of the Federal Reserve will come to a public freakout. Call it a subdued, bankerly freakout. What's got Bernanke scared is that "about one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure." That, and the rise in delinquency rates in the prime and near-prime mortgage markets. Oh, and the foreclosure rate that rose 53 percent last year and looks likely rise even higher this year.
RICHARD HEINBERG
Oil and Politics truthout.org — It's understandable that our elected leaders would want to do something about the meteoric rise of gasoline, diesel and heating oil prices that are now bankrupting independent truckers and forcing many in colder states to choose between staying warm and driving to work. Yet, their efforts are based on a profound misperception of why oil prices are rising.
MARK CLAYTON
Oil Shock Two? csmonitor.com — With prices at $120 a barrel, Americans are facing an oil adjustment.
Oil and Politics truthout.org — It's understandable that our elected leaders would want to do something about the meteoric rise of gasoline, diesel and heating oil prices that are now bankrupting independent truckers and forcing many in colder states to choose between staying warm and driving to work. Yet, their efforts are based on a profound misperception of why oil prices are rising.
MARK CLAYTONOil Shock Two? csmonitor.com — With prices at $120 a barrel, Americans are facing an oil adjustment.
Does the Fed Have a Blank Check? : Steve Waldman vs. Mark Thoma
Is The Housing Crisis Over? : Moulle-Berteaux vs. Calculated Risk
What's Driving Rising Food Prices? : Krugman vs. Kelly
Debating Pros & Cons of Globalization : Summers vs. Buiter
Housing Prices: Have They Bottomed Out? : M. Shedlock vs. D. Luskin
Fed, BOE Foreshadow End of Rate Cuts as Prices Rise: World's Central Banks signal end of interest-rate cuts
Three Things That Won't Help End the Foreclosure CrisisDean Baker, Liz Chimienti, Center for Economic and Policy Research
Corporate Accountability and WorkPlace: Falling home prices, rising foreclosures rates, and a slowing economy have created a perfect storm for U.S. homeowners.
THE MOGAMBO GURU
The economic sky has fallen
Inflation is no longer just a nasty little thing that might or might not raise the "concern" of the US Federal Reserve, it is a horrible storming fact of life, climbing out of low single digits way up into the roaring 20s for key stuff such as imports. It isn't Zimbabwe yet, but it is heading in that direction.
CREDIT BUBBLE BULLETIN
A new inflationary epoch
The world is awash in excess funds, large amounts of these in the form of foreign currency reserves, available to bid up prices of critical tradable resources. A key question is how much will China, India, Russia and others be willing to pay to procure adequate supplies of food and energy for their populations and economies?
The economic sky has fallenInflation is no longer just a nasty little thing that might or might not raise the "concern" of the US Federal Reserve, it is a horrible storming fact of life, climbing out of low single digits way up into the roaring 20s for key stuff such as imports. It isn't Zimbabwe yet, but it is heading in that direction.
CREDIT BUBBLE BULLETIN
A new inflationary epoch
The world is awash in excess funds, large amounts of these in the form of foreign currency reserves, available to bid up prices of critical tradable resources. A key question is how much will China, India, Russia and others be willing to pay to procure adequate supplies of food and energy for their populations and economies?
Bernanke `Strongly' Urges U.S. Banks to Raise More Capital as Crisis Wanes Federal Reserve Chairman Ben S. Bernanke pushed banks to keep raising capital in the aftermath of losses from the credit crisis to avert deeper damage to the U.S. economy.
Fed Direct Loans to Commercial Banks Climb to Record $14.4 Billion in Week The Federal Reserve's direct loans of cash to commercial banks climbed to the highest level on record in the past week as money-losing lenders increasingly turn to the central bank for funds.
Fed Direct Loans to Commercial Banks Climb to Record $14.4 Billion in Week The Federal Reserve's direct loans of cash to commercial banks climbed to the highest level on record in the past week as money-losing lenders increasingly turn to the central bank for funds.
Lockhart Says Inflation Is `Elevated,' U.S. Slowdown May Hit World Economy Federal Reserve Bank of Atlanta President Dennis Lockhart said the U.S. economic slowdown may impede global growth, while rising consumer prices pose an increasing threat both at home and abroad.
U.S. Consumer Confidence Falls to 28-Year Low, Single-Family Starts Drop U.S. consumer confidence was the weakest this month since Jimmy Carter was president, and single- family home construction fell to a 17-year low in April.
Bush Says Saudi Oil Production Increase `Not Enough' to Ease U.S. Prices President George W. Bush said Saudi Arabia's decision to raise oil output 300,000 barrels a day is ``not enough'' to ease U.S. energy prices and that more domestic oil exploration and refining capacity are needed.
U.S. Consumer Confidence Falls to 28-Year Low, Single-Family Starts Drop U.S. consumer confidence was the weakest this month since Jimmy Carter was president, and single- family home construction fell to a 17-year low in April.
Bush Says Saudi Oil Production Increase `Not Enough' to Ease U.S. Prices President George W. Bush said Saudi Arabia's decision to raise oil output 300,000 barrels a day is ``not enough'' to ease U.S. energy prices and that more domestic oil exploration and refining capacity are needed.
Fed, BOE Signal End of Rate Cuts as Price Pressures Increase, Crisis Eases The world's most powerful central banks are telegraphing the end of interest-rate cuts, and traders already anticipate the first steps in the opposite direction.
Paulson Says Markets Showing `Signs of Progress,' Housing the Biggest Risk U.S. Treasury Secretary Henry Paulson said financial market conditions have improved to the point that they will be influenced more by economic forces such as housing than by the credit crisis.
Financial Conflicts Hobble Supreme Court - Editorial, Washington Post
Striking Out on Energy - Larry Kudlow, RealClearPolitics
Mexico's 'Oiling' Days are Numbered - Editorial, Investor's Bus. Daily
Striking Out on Energy - Larry Kudlow, RealClearPolitics
Mexico's 'Oiling' Days are Numbered - Editorial, Investor's Bus. Daily
Reaganomics: Friend or Foe? : W. Williams & B. Jones vs. D. Luskin
Globalization: A "Man-Made Catastrophe"? : T. Frank vs. J. Pethokoukis
Does the Fed Have a Blank Check? : Steve Waldman vs. Mark Thoma
Is The Housing Crisis Over? : Moulle-Berteaux vs. Calculated Risk
What's Driving Rising Food Prices? : Krugman vs. Kelly
Globalization: A "Man-Made Catastrophe"? : T. Frank vs. J. Pethokoukis
Does the Fed Have a Blank Check? : Steve Waldman vs. Mark Thoma
Is The Housing Crisis Over? : Moulle-Berteaux vs. Calculated Risk
What's Driving Rising Food Prices? : Krugman vs. Kelly
We Need to Shore Up the Dollar Now - Steve Forbes, Forbes
Spitzer, and the Decline of AIG - James Freeman, Wall Street Journal
It's Time to Summit About Oil - Editorial, Financial Times
A Disgraceful, Rich, Farm Bill - Editorial, New York Times
Spitzer, and the Decline of AIG - James Freeman, Wall Street Journal
It's Time to Summit About Oil - Editorial, Financial Times
A Disgraceful, Rich, Farm Bill - Editorial, New York Times
Existing Home Sales in U.S. Probably Dropped in April as Economy Stagnated Sales of previously owned U.S. homes probably fell in April and a gauge of the economy's prospects was unchanged, reinforcing concern that growth will stagnate, economists said before reports this week.
Fed's Lockhart Says Slowdown May Temper Inflation in Second Half of Year Federal Reserve Bank of Atlanta President Dennis Lockhart said the U.S. economic slowdown may moderate inflation that has been spurred by rising prices of energy and commodities.
Fed's Lockhart Says Slowdown May Temper Inflation in Second Half of Year Federal Reserve Bank of Atlanta President Dennis Lockhart said the U.S. economic slowdown may moderate inflation that has been spurred by rising prices of energy and commodities.
Lowe's Says Earnings Drop 18% on U.S. Housing Slump, 2008 Profit Will Fall Lowe's Cos., the second-largest home- improvement retailer, said first-quarter profit fell 18 percent and forecast more declines this year as the worst U.S. housing slump in more than 25 years slows spending on remodeling.
Goldman, Lehman, Morgan Profit Outlooks Cut at Citigroup on Trading Losses Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Morgan Stanley had their earnings estimates cut at Citigroup Inc., which said the investment firms face a ``tough operating environment'' in the second quarter.
Leading Index in U.S. Probably Unchanged, Signaling Prolonged Stagnation The index of U.S. leading indicators was probably unchanged in April, signaling a prolonged stagnation in growth, economists said before a report today.
Dell Names GE's Brian Gladden Chief Financial Officer, Replacing Don Carty Dell Inc., the world's second-biggest maker of personal computers, said Brian Gladden will take over as chief financial officer, replacing Don Carty.
Hess Reserves May Double on Field Near Brazil's Tupi, Carioca; Stock Jumps Hess Corp., the fifth-largest U.S. oil company, may double its reserves on a $36 million investment made seven years ago.
Auction-Rate Collapse Cost Google, UPS, JPMorgan Shareholders $1.8 Billion The collapse of the auction-rate bond market is costing shareholders of companies from Google Inc. to Royal Bank of Canada more than $1.8 billion in investment losses.
Goldman, Lehman, Morgan Profit Outlooks Cut at Citigroup on Trading Losses Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Morgan Stanley had their earnings estimates cut at Citigroup Inc., which said the investment firms face a ``tough operating environment'' in the second quarter.
Leading Index in U.S. Probably Unchanged, Signaling Prolonged Stagnation The index of U.S. leading indicators was probably unchanged in April, signaling a prolonged stagnation in growth, economists said before a report today.
Dell Names GE's Brian Gladden Chief Financial Officer, Replacing Don Carty Dell Inc., the world's second-biggest maker of personal computers, said Brian Gladden will take over as chief financial officer, replacing Don Carty.
Hess Reserves May Double on Field Near Brazil's Tupi, Carioca; Stock Jumps Hess Corp., the fifth-largest U.S. oil company, may double its reserves on a $36 million investment made seven years ago.
Auction-Rate Collapse Cost Google, UPS, JPMorgan Shareholders $1.8 Billion The collapse of the auction-rate bond market is costing shareholders of companies from Google Inc. to Royal Bank of Canada more than $1.8 billion in investment losses.
CREDIT BUBBLE BULLETIN
A red herring
The issue of how past and present US Federal Reserve chairmen Alan Greenspan and Ben Bernanke erred in their disregard of credit bubble dynamics has become little more than a red herring at a time when central bankers must start bringing some order to international finance. Any change they institute will arrive only after a post-bubble impetus that is bringing back a destabilizing speculation that goes well beyond commodities markets.
Doug Noland reviews the previous week's events each Monday.
A red herring
The issue of how past and present US Federal Reserve chairmen Alan Greenspan and Ben Bernanke erred in their disregard of credit bubble dynamics has become little more than a red herring at a time when central bankers must start bringing some order to international finance. Any change they institute will arrive only after a post-bubble impetus that is bringing back a destabilizing speculation that goes well beyond commodities markets.
Doug Noland reviews the previous week's events each Monday.
Fed pause promises
financial disaster
The US Federal Reserve's expansionary policy, particularly since August as it seeks to jerk up housing prices and bail out failing banks, has made speculation more remunerative, credit riskier and financial savings less attractive. The US central bank should start concentrating on what is under its control, that is liquidity, and give up trying, and failing, to manage the entire economy. - Hossein Askari and Noureddine Krichene
financial disaster
The US Federal Reserve's expansionary policy, particularly since August as it seeks to jerk up housing prices and bail out failing banks, has made speculation more remunerative, credit riskier and financial savings less attractive. The US central bank should start concentrating on what is under its control, that is liquidity, and give up trying, and failing, to manage the entire economy. - Hossein Askari and Noureddine Krichene
Jobs up for grabs
in cleaner economy
Talk of building a cleaner economy no longer automatically conjures up opposition on the grounds that jobs are at risk from cutting pollution. To the contrary, even politicians are becoming aware of the employment benefits that are being created in heading off climate catastrophe. Those jobs are local and global.
in cleaner economy
Talk of building a cleaner economy no longer automatically conjures up opposition on the grounds that jobs are at risk from cutting pollution. To the contrary, even politicians are becoming aware of the employment benefits that are being created in heading off climate catastrophe. Those jobs are local and global.
THE MOGAMBO GURU
The economic sky has fallen
Inflation is no longer just a nasty little thing that might or might not raise the "concern" of the US Federal Reserve, it is a horrible storming fact of life, climbing out of low single digits way up into the roaring 20s for key stuff such as imports. It isn't Zimbabwe yet, but it is heading in that direction.
The economic sky has fallen
Inflation is no longer just a nasty little thing that might or might not raise the "concern" of the US Federal Reserve, it is a horrible storming fact of life, climbing out of low single digits way up into the roaring 20s for key stuff such as imports. It isn't Zimbabwe yet, but it is heading in that direction.
What a Deal: Trash for Treasuries
Auction-Rate Collapse Costs Taxpayers $1.65 Billion
17-May-2008 World economy on thin ice - U.N.
17-May-2008 Confidence Slumps, Single-Family Home Starts Fall
16-May-2008 Scholes, Nobel Laureate, Says Credit Crisis May Not Be Over
16-May-2008 For Wall Street Workers, Ax Falls Quietly
16-May-2008 Color-Blind Merrill in a Sea of Red Flags
Danny Schechter:
Behind the Rise in Prices: A Plan to Torpedo the Dollar
Behind the Rise in Prices: A Plan to Torpedo the Dollar
The Markets Have a Chilly Feel - Irwin Kellner, MarketWatch
Investors Chase Poor Fundamentals - John Hussman, Hussman Funds
Investors Chase Poor Fundamentals - John Hussman, Hussman Funds
Is Paul Volcker Right? Not This Time
Jeff Madrick, 05.20.2008
Given the depth of the credit crisis and the ongoing fall in house prices, there is a far bigger risk of worldwide economic cataclysm than there was in the 1970s.
Prolonged Crisis Predicted ft.com — Wall Street stocks were set for a lower start after a leading banking analyst said the credit crisis will extend well into 2009 and possibly beyond and a rise in core inflation threatened to trim corporate profits and consumer spending. According to Meredith Whitney and a team of analysts, the extended credit crisis will results in "multi-billion dollar revenue reversals" and further significant writedowns and loan loss provisions.
Oil Tops $127 money.cnn.com — Oil futures settled at a record high, adding to the pressure on holiday drivers as gas and diesel also reached new records. Oil rose 76 cents to $127.05 a barrel on the New York Mercantile Exchange, eclipsing the previous record of $126.29. Americans are now paying an average of $3.79 for a gallon of regular gas, according to a survey by AAA and the Oil Price Information Service. Diesel now costs $4.52 a gallon.
Gas To Reach $4 By Summer usatoday.com — The average price of gasoline has jumped past $4 in two states and hovers just below that in three others as the nationwide average fuel price climbs relentlessly from record to record.
Repo Industry Booming iht.com — So many people have so many things they can no longer afford. As the economy falters, homes go into foreclosure, wages stagnate, and the prices of basic necessities rise ever higher, more people simply stop paying bills on everything from boats to cars. This is an excellent time to be a repo man.
Oil Tops $127 money.cnn.com — Oil futures settled at a record high, adding to the pressure on holiday drivers as gas and diesel also reached new records. Oil rose 76 cents to $127.05 a barrel on the New York Mercantile Exchange, eclipsing the previous record of $126.29. Americans are now paying an average of $3.79 for a gallon of regular gas, according to a survey by AAA and the Oil Price Information Service. Diesel now costs $4.52 a gallon.
Gas To Reach $4 By Summer usatoday.com — The average price of gasoline has jumped past $4 in two states and hovers just below that in three others as the nationwide average fuel price climbs relentlessly from record to record.
Repo Industry Booming iht.com — So many people have so many things they can no longer afford. As the economy falters, homes go into foreclosure, wages stagnate, and the prices of basic necessities rise ever higher, more people simply stop paying bills on everything from boats to cars. This is an excellent time to be a repo man.
The Old Titans All Collapsed. Is the U.S. Next?
By Kevin Phillips
The United States of 2008 is the world's leading debtor, has by far the largest current-account deficit and is the leading importer, at great expense, of both manufactured goods and oil. The potential damage if the world soon undergoes the greatest financial crisis since the 1930s is incalculable. The loss of global economic leadership that overtook Britain and Holland seems to be looming on our own horizon. Continue
By Kevin Phillips
The United States of 2008 is the world's leading debtor, has by far the largest current-account deficit and is the leading importer, at great expense, of both manufactured goods and oil. The potential damage if the world soon undergoes the greatest financial crisis since the 1930s is incalculable. The loss of global economic leadership that overtook Britain and Holland seems to be looming on our own horizon. Continue
SOVEREIGN WEALTH FUNDS
The forgotten issues
Demands by the US and others for rules to limit the policies and operations of sovereign wealth funds highlight the vast amount of money at the funds' disposal. Overlooked are questions such as to whom does this wealth belong and how can it benefit the citizenry of the oil and gas-rich countries holding, or misspending, the cash? - Hossein Askari and Noureddine Krichene
This is the first article in a two-part report.
The day free markets died
The theory that the US stock market operates under free-market principles was looking deeply flawed before the present financial crisis. Price movements over the past few months and the actions of the US Federal Reserve have blown what is left of the free-market myth out of the water. - Doug Wakefield
The forgotten issues
Demands by the US and others for rules to limit the policies and operations of sovereign wealth funds highlight the vast amount of money at the funds' disposal. Overlooked are questions such as to whom does this wealth belong and how can it benefit the citizenry of the oil and gas-rich countries holding, or misspending, the cash? - Hossein Askari and Noureddine Krichene
This is the first article in a two-part report.
The day free markets died
The theory that the US stock market operates under free-market principles was looking deeply flawed before the present financial crisis. Price movements over the past few months and the actions of the US Federal Reserve have blown what is left of the free-market myth out of the water. - Doug Wakefield
THE SHAPE OF US POPULISM, Part 6
The birth of the New Deal
Jimmy Carter in 1979 warned of a "crisis of the soul and confidence". With gas and gold prices more than treble those confronting Carter and a trade surplus with China turned to an annual US$200 billion deficit, the US needs its next president to match Franklin D Roosevelt's Great Depression battle cry that "the only thing we have to fear is fear itself".
Henry C K Liu continues his analysis of US populism.
Part 5: Rubin's poisoned chalice
The birth of the New Deal
Jimmy Carter in 1979 warned of a "crisis of the soul and confidence". With gas and gold prices more than treble those confronting Carter and a trade surplus with China turned to an annual US$200 billion deficit, the US needs its next president to match Franklin D Roosevelt's Great Depression battle cry that "the only thing we have to fear is fear itself".
Henry C K Liu continues his analysis of US populism.
Part 5: Rubin's poisoned chalice
THE MOGAMBO GURU
Golden experience to relish
The US Federal Reserve has one very good reason to continue nudging life into a decaying economy - not to please the consumer but to keep tax dollars flowing to the government. Consumers are the mugs whose savings are drained to pay the higher prices created by the Fed money machine. Gold buyers excepted of course
Golden experience to relishThe US Federal Reserve has one very good reason to continue nudging life into a decaying economy - not to please the consumer but to keep tax dollars flowing to the government. Consumers are the mugs whose savings are drained to pay the higher prices created by the Fed money machine. Gold buyers excepted of course
CREDIT BUBBLE BULLETIN
A red herring
The issue of how past and present US Federal Reserve chairmen Alan Greenspan and Ben Bernanke erred in their disregard of credit bubble dynamics has become little more than a red herring at a time when central bankers must start bringing some order to international finance. Any change they institute will arrive only after a post-bubble impetus that is bringing back a destabilizing speculation that goes well beyond commodities markets.
Doug Noland reviews the previous week's events each Monday.
A red herring
The issue of how past and present US Federal Reserve chairmen Alan Greenspan and Ben Bernanke erred in their disregard of credit bubble dynamics has become little more than a red herring at a time when central bankers must start bringing some order to international finance. Any change they institute will arrive only after a post-bubble impetus that is bringing back a destabilizing speculation that goes well beyond commodities markets.
Doug Noland reviews the previous week's events each Monday.
Fed's Kohn Says U.S. Economy Should Improve, Signaling No Rate Cut in June Federal Reserve Vice Chairman Donald Kohn said the economy should gradually strengthen as the central bank's interest-rate reductions take effect, reinforcing speculation policy makers will refrain from a cut next month.
Lockhart Says U.S. Slowdown May Temper Inflation in Second Half of Year Federal Reserve Bank of Atlanta President Dennis Lockhart said the U.S. economic slowdown may moderate inflation that has been spurred by rising prices of energy and commodities.
Bernanke `Strongly' Urges U.S. Banks to Raise More Capital as Crisis Wanes Federal Reserve Chairman Ben S. Bernanke pushed banks to keep raising capital in the aftermath of losses from the credit crisis to avert deeper damage to the U.S. economy.
Lockhart Says U.S. Slowdown May Temper Inflation in Second Half of Year Federal Reserve Bank of Atlanta President Dennis Lockhart said the U.S. economic slowdown may moderate inflation that has been spurred by rising prices of energy and commodities.
Bernanke `Strongly' Urges U.S. Banks to Raise More Capital as Crisis Wanes Federal Reserve Chairman Ben S. Bernanke pushed banks to keep raising capital in the aftermath of losses from the credit crisis to avert deeper damage to the U.S. economy.
U.S. Economy in "Uncharted Waters" ft.com — The U.S. economy is in "uncharted waters," Federal Reserve vice-chairman Don Kohn said, warning that both financial and economic recovery was likely to be slow. Mr Kohn said inflation was also an "area of concern." But he characterised recent inflation news as "mixed" rather than bad. His comments came as new data showed that input price inflation was lower than expected in April, but core input prices — excluding food and energy — rose at twice the expected rate.
Hedge Funds in Swaps Face Peril With Rising Junk Bond Defaults
By David Evans
May 20 (Bloomberg) -- It's Friday, March 14, and hedge fund adviser Tim Backshall is trying to stave off panic. Backshall sits in the Walnut Creek, California, office of his firm, Credit Derivatives Research LLC, at a U-shaped desk dominated by five computer monitors.
Bear Stearns Cos. shares have plunged 50 percent since trading began today, and his fund manager clients, some of whom have their cash and other accounts at Bear, worry that the bank is on the verge of bankruptcy. They're unsure whether they should protect their assets by purchasing credit-default swaps, a type of insurance that's supposed to pay them face value if Bear's debt goes under.
Backshall, 37, tells them there are two rubs: The price of the swaps is skyrocketing by the minute, and the banks selling the insurance are also at risk of collapsing. If Bear goes down, he tells them, it may take other banks with it.
``There's always the danger the bank selling you the protection on Bear will fail,'' Backshall says. If that were to happen, his clients could spend millions of dollars for worthless insurance.
Investors can't tell whether the people selling the swaps - - known as counterparties -- have the money to honor their promises, Backshall says between phone calls.
``It's clearly a combination of absolute fear and investors really not knowing,'' he says.
On this day, a CDS-market meltdown doesn't happen. In a frenzy of weekend activity, the Federal Reserve and JPMorgan Chase & Co. rescue Bear Stearns from bankruptcy -- removing the need for the sellers of credit-default protection to pay up on their contracts.
Chain Reaction
Backshall and his clients aren't the only ones spooked by the prospect of a CDS catastrophe. Billionaire investor George Soros says a chain reaction of failures in the swaps market could trigger the next global financial crisis.
CDSs, which were devised by J.P. Morgan & Co. bankers in the early 1990s to hedge their loan risks, now constitute a sprawling, rapidly growing market that includes contracts protecting $62 trillion in debt.
The market is unregulated, and there are no public records showing whether sellers have the assets to pay out if a bond defaults. This so-called counterparty risk is a ticking time bomb.
``It is a Damocles sword waiting to fall,'' says Soros, 77, whose new book is called ``The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means'' (PublicAffairs).
``To allow a market of that size to develop without regulatory supervision is really unacceptable,'' Soros says.
`Lumpy Exposures'
The Fed bailout of Bear Stearns on March 17 was motivated, in part, by a desire to keep that sword from falling, says Joseph Mason, a former U.S. Treasury Department economist who's now chair of the banking department at Louisiana State University's E.J. Ourso College of Business.
The Fed was concerned that banks might not have the money to pay CDS counterparties if there were large debt defaults, Mason says.
``The Fed's fear was that they didn't adequately monitor counterparty risk in credit-default swaps -- so they had no idea of where to lend nor where significant lumpy exposures may lie,'' he says.
Those counterparties include none other than JPMorgan itself, the largest seller and buyer of CDSs known to the Office of the Comptroller of the Currency, or OCC.
The Fed negotiated the deal to bail out Bear Stearns by allowing JPMorgan to buy it for $10 a share. The Fed pledged $29 billion to JPMorgan to cover any Bear debts.
`Cast Doubt'
``The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets,'' Fed Chairman Ben S. Bernanke told Congress on April 2. ``It could also have cast doubt on the financial positions of some of Bear Stearns's thousands of counterparties.''
The Fed was worried about the biggest players in the CDS market, Mason says. ``It was a JPMorgan bailout, not a bailout of Bear,'' he says.
JPMorgan spokesman Brian Marchiony declined to comment for this article.
Credit-default swaps are derivatives, meaning they're financial contracts that don't contain any actual assets. Their value is based on the worth of underlying loans and bonds. Swaps are similar to insurance policies -- with two key differences.
Unlike with traditional insurance, no agency monitors the seller of a swap contract to be certain it has the money to cover debt defaults. In addition, swap buyers don't need to actually own the asset they want to protect.
It's as if many investors could buy insurance on the same multimillion-dollar home they didn't own and then collect on its full value if the house burned down.
Bigger Than NYSE
When traders buy swap protection, they're speculating a loan or bond will fail; when they sell swaps, they're betting that a borrower's ability to pay will improve.
The market, which has doubled in size every year since 2000 and is larger in dollar value than the New York Stock Exchange, is controlled by banks like JPMorgan, which act as dealers for buyers and sellers. Swap prices and trade volume aren't publicly posted, so investors have to rely on bids and offers by banks.
Most of the traders are banks; hedge funds, which are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall; and insurance companies. Mutual and pension funds also buy and sell the swaps.
Proponents of CDSs say the devices have been successful because they allow banks to spread the risk of default and enable hedge funds to efficiently speculate on the creditworthiness of companies.
`Seeing the Logic'
The market has grown so large so fast because swaps are often based on an index that includes the debt of scores of companies, says Robert Pickel, chief executive officer of the International Swaps and Derivatives Association.
``Whether you're a hedge fund, bank or some other user, you're increasingly seeing the logic of using these instruments,'' Pickel says, adding he doesn't worry about counterparty risk because banks carefully monitor the strength of investors. ``There have been a very limited number of disputes. The parties understand these products and know how to use them.''
Banks are the largest buyers and sellers of CDSs. New York- based JPMorgan trades the most, with swaps betting on future credit quality of $7.9 trillion in debt, according to the OCC. Citigroup Inc., also in New York, is second, with $3.2 trillion in CDSs.
Goldman Sachs Group Inc. and Morgan Stanley, two New York- based firms whose swap trading isn't tracked by the OCC because they're not commercial banks, are the largest swap counterparties, according to New York-based Fitch Ratings, which doesn't provide dollar amounts.
Untested Until Now
The credit-default-swap market has been untested until now because there's been a steady decline in global default rates in high-yield debt since 2002. The default rate in January 2002, when the swap market was valued at $1.5 trillion, was 10.7 percent, according to Moody's Investors Service.
Since then, defaults globally have dropped to 1.5 percent, as of March. The rating companies say the tide is turning on defaults.
Fitch Ratings reported in July 2007 that 40 percent of CDS protection sold worldwide is on companies or securities that are rated below investment grade, up from 8 percent in 2002. On May 7, Moody's wrote that as the economy weakened, high-yield-debt defaults by companies worldwide would increase fourfold in one year to 6.1 percent by April 2009.
The pressure is building. On May 5, for example, Tropicana Entertainment LLC filed for bankruptcy after the casino owner defaulted on $1.32 billion in debt.
`Complicate the Crisis'
A surge in corporate defaults may leave swap buyers scrambling, many unsuccessfully, to collect hundreds of billions of dollars from their counterparties, says Satyajit Das, a former Citigroup derivatives trader and author of ``Credit Derivatives: CDOs & Structured Credit Products'' (Wiley Finance, 2005).
``This is going to complicate the financial crisis,'' Das says. He expects numerous disputes and lawsuits, as protection buyers battle sellers over the technical definition of default - - this requires proving which bond or loan holders weren't paid -- and the amount of payments due.
``It's going to become extremely messy,'' he says. ``I'm really scared this is going to freeze up the financial system.''
Andrea Cicione, a London-based senior credit strategist at BNP Paribas SA, has researched counterparty risk and says it's only a matter of time before the sword begins falling. He says the crisis will likely start with hedge funds that will be unable to pay banks for contracts tied to at least $35 billion in defaults.
$150 Billion Loss Estimate
``That's a very conservative estimate,'' he says, adding that his study finds that losses resulting from hedge funds that can't pay their counterparties for defaults could exceed $150 billion.
Hedge funds have sold 31 percent of all CDS protection, according to a February 2007 report by Charlotte, North Carolina-based Bank of America Corp.
Cicione says banks will try to pre-empt this default disaster by demanding hedge funds put up more collateral for potential losses. That may not work, he says. Many of the funds won't have the cash to meet the banks' requests, he says.
Sellers of protection aren't required by law to set aside reserves in the CDS market. While banks ask protection sellers to put up some money when making the trade, there are no industry standards, Cicione says.
JPMorgan, in its annual report released in February, said it held $22 billion of credit swap counterparty risk not protected by collateral as of Dec. 31.
`A Major Risk'
``I think there's a major risk of counterparty default from hedge funds,'' Cicione says. ``It's inconceivable that the Fed or any central bank will bail out the hedge funds. If you have a systemic crisis in the hedge fund industry, then of course their banks will take the hit.''
The Joint Forum of the Basel Committee on Banking Supervision, an international group of banking, insurance and securities regulators, wrote in April that the trillions of dollars in swaps traded by hedge funds pose a threat to financial markets around the world.
``It is difficult to develop a clear picture of which institutions are the ultimate holders of some of the credit risk transferred,'' the report said. ``It can be difficult even to quantify the amount of risk that has been transferred.''
Counterparty risk can become complicated in a hurry, Das says. In a typical CDS deal, a hedge fund will sell protection to a bank, which will then resell the same protection to another bank, and such dealing will continue, sometimes in a circle, Das says.
`Daisy Chain Vortex'
The original purpose of swaps -- to spread a bank's loan risk among a large group of companies -- may be circumvented, he says.
``It creates a huge concentration of risk,'' Das says. ``The risk keeps spinning around and around in this daisy chain like a vortex. There are only six to 10 dealers who sit in the middle of all this. I don't think the regulators have the information that they need to work that out.''
And traders, even the banks that serve as dealers, don't always know exactly what is covered by a credit-default-swap contract. There are numerous types of CDSs, some far more complex than others.
More than half of all CDSs cover indexes of companies and debt securities, such as asset-backed securities, the Basel committee says. The rest include coverage of a single company's debt or collateralized debt obligations.
A CDO is an opaque bundle of debt that can be filled with junk bonds, auto loans, credit card liabilities and home mortgages, including subprime debt. Some swaps are made up of even murkier bank inventions -- so-called synthetic CDOs, which are packages of credit-default swaps.
AIG $9.1 Billion Writedown
On May 8, American International Group Inc. wrote down $9.1 billion on the value of its CDS holdings. The world's largest insurer by assets sold credit protection on CDOs that declined in value. In 2007, New York-based AIG reported $11.5 billion in writedowns on CDO credit default swaps.
Michael Greenberger, director of trading and markets at the Commodity Futures Trading Commission from 1997 to 1999, says the Fed is fully aware of the risk banks and the global economy face if CDS holders can't cover their losses.
``Oh, absolutely, there's no doubt about it,'' says Greenberger, who's now a professor at the University of Maryland School of Law in Baltimore. He says swaps were very much on the Fed's mind when Bear Stearns started sliding toward bankruptcy.
``People who were relying on Bear for their own solvency would've started defaulting,'' he says. ``That would've triggered a series of counterparty failures. It was a house of cards.''
Risk Nightmare
It's concerns about that house of cards that have kept Backshall, the California fund adviser, up at night. His worries about a nightmare scenario started in early March. The details of what happened are still fresh in his mind.
It's Monday, March 10, and the market is rife with rumors that Bear Stearns will run out of cash. Some of Backshall's clients have pulled their accounts from Bear; others are considering leaving the bank. Backshall's clients are exposed to Bear in multiple ways: They keep their cash and other accounts at the firm, and they use the bank as their broker for trades. Backshall advises them to spread their assets among various banks.
That same day, Bear CEO Alan Schwartz says publicly, ``There is absolutely no truth to the rumors of liquidity problems.''
Backshall's clients are suspicious. They see other hedge funds pulling their accounts from Bear. In the afternoon after Schwartz's remarks, the cost of protection soars past 600 basis points from 450 before Schwartz's statement.
CEO Didn't Calm Fears
Swaps are priced in basis points, or hundredths of a percentage point. At 600 basis points, a trader would pay $6,000 a year to insure $100,000 of Bear Stearns bonds.
``I don't think his comments did anything to calm fears,'' Backshall says.
The next day, March 11, Securities and Exchange Commission Chairman Christopher Cox says his agency is monitoring Bear Stearns and other securities firms.
``We have a good deal of comfort about the capital cushions at these firms at the moment,'' he says.
Cox's comments are overshadowed by rumors that European financial firms had stopped doing fixed-income trades with Bear, Backshall says.
``Nobody has a clue what's going on,'' he says. Bear swap costs are gyrating between 540 and 665.
For most investors, just getting default-swap prices is a chore. Unlike stock prices, which are readily available because they trade on a public exchange, swap prices are hard to find. Traders looking up prices on the Internet or on private trading systems see information that is hours or days old.
`Terribly Primitive'
Banks send hedge funds, insurance companies and other institutional investors e-mails throughout the day with bid and offer prices, Backshall says. For many investors, this system is a headache.
To find the price of a swap on Ford Motor Co. debt, for example, even sophisticated investors might have to search through all of their daily e-mails, he says.
``It's terribly primitive,'' Backshall says. ``The only way you and I could get a level of prices is searching for Ford in our inbox. This is no joke.''
In the past three years, at least two companies have developed software programs that automatically parse an investor's incoming messages, yank out CDS prices and build them into real-time price displays.
The charts show the highest bids and lowest offering prices for hundreds of swaps. Backshall tracks prices he gets from banks using the new software.
`It's Very Hard'
Backshall has been talking with hedge fund managers in New York all week.
``We'd quite frankly been warning them and giving them advice on how to hedge,'' he says of the Bear Stearns crisis and banks overall. ``It's very hard to hedge the counterparty risk. These institutions are thinly capitalized in the best of times.''
The night of Thursday, March 13, Backshall can't sleep. He lies awake worrying about Bear and counterparty risk. The next morning, he arrives at work at 5 a.m., two and a half hours before sunrise.
Through the window of his ninth-floor corner office, he takes a moment to watch the distant flickers of light in the rolling foothills of Mount Diablo. Across the street, he sees the still-dark Walnut Creek train station, about 30 miles (48 kilometers) east of San Francisco.
Backshall, wearing jeans and a blue, button-down shirt, sits at his desk, staring at a pair of the 27-inch (68.6- centimeter) monitors that display swap costs. CDS prices jumped by more than 10-fold in just a year. The numbers show rising fear, he says.
Until early in 2007, the typical price of a credit-default swap tied to the debt of an investment bank like Merrill Lynch & Co., Bear Stearns or Morgan Stanley was 25 basis points.
`Unknowns Are Out There'
If a swap buyer wanted to protect $10 million of assets in the event of a company default, the contract would cost about 0.25 percent of $10 million, or $25,000 a year for a five-year protection contract.
Backshall's screens tell him the cost of buying protection on Bear Stearns debt in the past 24 hours has been moving in a range between 680 and 755 basis points.
``The unknowns are out there,'' Backshall says.
He advises his clients not to buy CDS protection on Bear because the price is too high and the time is wrong. It's too late to buy swaps now, he says.
At 9:13 Friday morning in New York, JPMorgan announces it will loan money to Bear using funds provided by the Federal Reserve. The JPMorgan statement doesn't say how much it will lend; it says it will ``provide secured funding to Bear Stearns, as necessary.''
`Significantly Deteriorated'
Bear CEO Schwartz says his firm's liquidity has ``significantly deteriorated'' during the past 24 hours. Protection quotes drop immediately into the low 500s, as some dealers think a rescue has begun.
That doesn't last long.
``Very quickly, the trading action is swinging violently wider,'' Backshall says. Bear's swap cost jumps to 850 basis points that afternoon, his screen shows. ``When fear gets hold, fundamental analysis goes out the window,'' he says.
In the calmest of times, making reasoned decisions about swap prices is a challenge. Now, it's impossible. Traders don't have access to any company data more recent than Bear's February annual report. Sharp-eyed investors looking through that filing might have spotted a paragraph that's strangely prescient.
``As a result of the global credit crises and the increasingly large numbers of credit defaults, there is a risk that counterparties could fail, shut down, file for bankruptcy or be unable to pay out contracts,'' Bear wrote.
`Material Adverse Effect'
``The failure of a significant number of counterparties or a counterparty that holds a significant amount of credit-default swaps could have a material adverse effect on the broader financial markets,'' the bank wrote.
Even after JPMorgan's Friday morning announcement, the market is alive with rumors. Backshall's clients tell him they've heard some investment banks have stopped accepting trades with Bear Stearns and some money market funds have reduced their short-term holdings of Bear-issued debt.
On Sunday, March 16, the Federal Reserve effectively lifts the sellers of Bear Stearns protection out of their misery. JPMorgan agrees to buy Bear for $2 a share.
While that's devastating news for Bear shareholders -- the stock had traded at $62.30 just a week earlier -- it's the best news imaginable for owners of Bear debt. That's because JPMorgan agreed to cover Bear's liabilities, with the Fed pledging $29 billion to cover Bear's loan obligations.
Turned to Dust
For traders who sold protection on Bear's debt, the bailout is a godsend. Faced with the prospect of having to hand over untold millions to their counterparties just three days earlier, they now have to pay out nothing.
For traders who bought protection swaps just a few days earlier -- when prices were in the 600s to 800s -- the Fed bailout is crushing. Their investments have turned to dust.
On Monday morning, the cost of default protection on Bear plunges to 280. Backshall sits back in his chair and for the first time in two weeks, he can breathe easier.
``No wonder I look so tired all the time,'' he says, finally showing a bit of a smile.
When it bailed out Bear Stearns, the Federal Reserve effectively deputized JPMorgan to monitor the credit-default- swap market, says Edward Kane, a finance professor at Boston College. Because regulators don't know where the risks lie, they're helpless, Kane says.
Default swaps shift the risk from a company's credit to the possibility that a counterparty might fail, says Kane, who's a senior fellow at the Federal Deposit Insurance Corporation's Center for financial Research.
`Off Balance Sheet'
``You've really disguised traditional credit risk, pushed it off balance sheet to its counterparties,'' Kane says. ``And this is not visible to the regulators.''
BNP analyst Cicione says regulators will be hard-pressed to prevent the next potential breakdown in the swaps market.
``Apart from JPMorgan, there aren't many other banks out there capable of doing this,'' he says. ``That's what's worrying us. If there were to be more Bear Stearnses, who would step in and give a helping hand? You can't expect the Fed to run a broker, so someone has to take on assets and obligations.''
Banks have a vested interest in keeping the swaps market opaque, says Das, the former Citigroup banker. As dealers, the banks see a high volume of transactions, giving them an edge over other buyers and sellers.
``Dealers get higher profitability through lack of transparency,'' Das says. ``Since customers don't necessarily know where the market is, you can charge them much wider margins.''
Banks Try to Hedge
Banks try to balance the protection they've sold with credit-default swaps they purchase from others, either on the same companies or indexes. They can also create synthetic CDOs, which are packages of credit-default swaps the banks sell to investors to get themselves protection.
The idea for the banks is to make a profit on each trade and avoid taking on the swap's risk.
``Dealers are just like bookies,'' Kane says. ``Bookies don't want to bet on games. Bookies just want to balance their books. That's why they're called bookies.''
The banks played the role of dealers in the CDO market as well, and the breakdown in that market holds lessons for what could go wrong with CDSs. The CDO market zoomed to $500 billion in sales in 2006, up fivefold from 2001.
Banks found a hungry market for CDOs because they offered returns that were sometimes 2-3 percentage points higher than corporate bonds with the same credit rating.
CDO Market Dried Up
By the middle of 2007, mortgage defaults in the U.S. began reaching record highs each month. Banks and other companies realized they were holding hundreds of billions in toxic debt. By August 2007, no one would buy CDOs. That newly devised debt market dried up in a matter of months.
In the past year, banks have written off $323 billion from debt, mostly from investments they created.
Now, if corporate defaults increase, as Moody's predicts, another market recently invented by banks -- credit-default swaps -- could come unstuck. Arturo Cifuentes, managing director of R.W. Pressprich & Co., a New York firm that trades derivatives, says he expects a rash of counterparty failures resulting in losses and lawsuits.
``There's a high probability that many people who bought swap protection will wind up in court trying to get their payouts,'' he says. ``If things are collapsing left and right, people will use any trick they can.''
Frank Partnoy, a former derivatives trader and now a securities law professor at the University of San Diego School of Law, says it's high time for the market to let in some sunshine.
Centralized Pricing
``There should be a centralized pricing service for credit-default swaps,'' he says. Companies should disclose their swaps holdings, he adds.
``For example, a bank might disclose the nature of its lending exposure based on its use of credit-default swaps as a hedge,'' he says.
Last year, the Chicago Mercantile Exchange set up a federally regulated, exchange-based market to trade CDSs. So far, it hasn't worked. It's been boycotted by banks, which prefer to continue their trading privately.
Leo Melamed, 76, chairman emeritus of Chicago Mercantile Exchange Holdings Inc., says there aren't any easy solutions.
``Plus we're not sure the banks want us to be in this business because they do make a good deal of money, and we might narrow the spreads considerably,'' he says.
`Central Clearing House'
For now and for some time in the future, CDSs will remain unregulated and their trades will be done in the secrecy of Wall Street's biggest securities firms. That means counterparty risk will stay out of the sight of the public and regulators.
``In order for us to get away from worries about counterparty risk, in order for us to encourage more trading and more transparency, there's got to be some way to bring all the price data together with exchange trading or a central clearinghouse,'' Backshall says.
Until that happens, the sword of Damocles will remain poised to fall, as banks, hedge funds and insurance companies can only guess whether their trillions of dollars in swaps are covered by anything other than darkness.
To contact the reporter on this story: David Evans in Los Angeles at davidevans@bloomberg.net.
By David Evans
May 20 (Bloomberg) -- It's Friday, March 14, and hedge fund adviser Tim Backshall is trying to stave off panic. Backshall sits in the Walnut Creek, California, office of his firm, Credit Derivatives Research LLC, at a U-shaped desk dominated by five computer monitors. Bear Stearns Cos. shares have plunged 50 percent since trading began today, and his fund manager clients, some of whom have their cash and other accounts at Bear, worry that the bank is on the verge of bankruptcy. They're unsure whether they should protect their assets by purchasing credit-default swaps, a type of insurance that's supposed to pay them face value if Bear's debt goes under.
Backshall, 37, tells them there are two rubs: The price of the swaps is skyrocketing by the minute, and the banks selling the insurance are also at risk of collapsing. If Bear goes down, he tells them, it may take other banks with it.
``There's always the danger the bank selling you the protection on Bear will fail,'' Backshall says. If that were to happen, his clients could spend millions of dollars for worthless insurance.
Investors can't tell whether the people selling the swaps - - known as counterparties -- have the money to honor their promises, Backshall says between phone calls.
``It's clearly a combination of absolute fear and investors really not knowing,'' he says.
On this day, a CDS-market meltdown doesn't happen. In a frenzy of weekend activity, the Federal Reserve and JPMorgan Chase & Co. rescue Bear Stearns from bankruptcy -- removing the need for the sellers of credit-default protection to pay up on their contracts.
Chain Reaction
Backshall and his clients aren't the only ones spooked by the prospect of a CDS catastrophe. Billionaire investor George Soros says a chain reaction of failures in the swaps market could trigger the next global financial crisis.
CDSs, which were devised by J.P. Morgan & Co. bankers in the early 1990s to hedge their loan risks, now constitute a sprawling, rapidly growing market that includes contracts protecting $62 trillion in debt.
The market is unregulated, and there are no public records showing whether sellers have the assets to pay out if a bond defaults. This so-called counterparty risk is a ticking time bomb.
``It is a Damocles sword waiting to fall,'' says Soros, 77, whose new book is called ``The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means'' (PublicAffairs).
``To allow a market of that size to develop without regulatory supervision is really unacceptable,'' Soros says.
`Lumpy Exposures'
The Fed bailout of Bear Stearns on March 17 was motivated, in part, by a desire to keep that sword from falling, says Joseph Mason, a former U.S. Treasury Department economist who's now chair of the banking department at Louisiana State University's E.J. Ourso College of Business.
The Fed was concerned that banks might not have the money to pay CDS counterparties if there were large debt defaults, Mason says.
``The Fed's fear was that they didn't adequately monitor counterparty risk in credit-default swaps -- so they had no idea of where to lend nor where significant lumpy exposures may lie,'' he says.
Those counterparties include none other than JPMorgan itself, the largest seller and buyer of CDSs known to the Office of the Comptroller of the Currency, or OCC.
The Fed negotiated the deal to bail out Bear Stearns by allowing JPMorgan to buy it for $10 a share. The Fed pledged $29 billion to JPMorgan to cover any Bear debts.
`Cast Doubt'
``The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets,'' Fed Chairman Ben S. Bernanke told Congress on April 2. ``It could also have cast doubt on the financial positions of some of Bear Stearns's thousands of counterparties.''
The Fed was worried about the biggest players in the CDS market, Mason says. ``It was a JPMorgan bailout, not a bailout of Bear,'' he says.
JPMorgan spokesman Brian Marchiony declined to comment for this article.
Credit-default swaps are derivatives, meaning they're financial contracts that don't contain any actual assets. Their value is based on the worth of underlying loans and bonds. Swaps are similar to insurance policies -- with two key differences.
Unlike with traditional insurance, no agency monitors the seller of a swap contract to be certain it has the money to cover debt defaults. In addition, swap buyers don't need to actually own the asset they want to protect.
It's as if many investors could buy insurance on the same multimillion-dollar home they didn't own and then collect on its full value if the house burned down.
Bigger Than NYSE
When traders buy swap protection, they're speculating a loan or bond will fail; when they sell swaps, they're betting that a borrower's ability to pay will improve.
The market, which has doubled in size every year since 2000 and is larger in dollar value than the New York Stock Exchange, is controlled by banks like JPMorgan, which act as dealers for buyers and sellers. Swap prices and trade volume aren't publicly posted, so investors have to rely on bids and offers by banks.
Most of the traders are banks; hedge funds, which are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall; and insurance companies. Mutual and pension funds also buy and sell the swaps.
Proponents of CDSs say the devices have been successful because they allow banks to spread the risk of default and enable hedge funds to efficiently speculate on the creditworthiness of companies.
`Seeing the Logic'
The market has grown so large so fast because swaps are often based on an index that includes the debt of scores of companies, says Robert Pickel, chief executive officer of the International Swaps and Derivatives Association.
``Whether you're a hedge fund, bank or some other user, you're increasingly seeing the logic of using these instruments,'' Pickel says, adding he doesn't worry about counterparty risk because banks carefully monitor the strength of investors. ``There have been a very limited number of disputes. The parties understand these products and know how to use them.''
Banks are the largest buyers and sellers of CDSs. New York- based JPMorgan trades the most, with swaps betting on future credit quality of $7.9 trillion in debt, according to the OCC. Citigroup Inc., also in New York, is second, with $3.2 trillion in CDSs.
Goldman Sachs Group Inc. and Morgan Stanley, two New York- based firms whose swap trading isn't tracked by the OCC because they're not commercial banks, are the largest swap counterparties, according to New York-based Fitch Ratings, which doesn't provide dollar amounts.
Untested Until Now
The credit-default-swap market has been untested until now because there's been a steady decline in global default rates in high-yield debt since 2002. The default rate in January 2002, when the swap market was valued at $1.5 trillion, was 10.7 percent, according to Moody's Investors Service.
Since then, defaults globally have dropped to 1.5 percent, as of March. The rating companies say the tide is turning on defaults.
Fitch Ratings reported in July 2007 that 40 percent of CDS protection sold worldwide is on companies or securities that are rated below investment grade, up from 8 percent in 2002. On May 7, Moody's wrote that as the economy weakened, high-yield-debt defaults by companies worldwide would increase fourfold in one year to 6.1 percent by April 2009.
The pressure is building. On May 5, for example, Tropicana Entertainment LLC filed for bankruptcy after the casino owner defaulted on $1.32 billion in debt.
`Complicate the Crisis'
A surge in corporate defaults may leave swap buyers scrambling, many unsuccessfully, to collect hundreds of billions of dollars from their counterparties, says Satyajit Das, a former Citigroup derivatives trader and author of ``Credit Derivatives: CDOs & Structured Credit Products'' (Wiley Finance, 2005).
``This is going to complicate the financial crisis,'' Das says. He expects numerous disputes and lawsuits, as protection buyers battle sellers over the technical definition of default - - this requires proving which bond or loan holders weren't paid -- and the amount of payments due.
``It's going to become extremely messy,'' he says. ``I'm really scared this is going to freeze up the financial system.''
Andrea Cicione, a London-based senior credit strategist at BNP Paribas SA, has researched counterparty risk and says it's only a matter of time before the sword begins falling. He says the crisis will likely start with hedge funds that will be unable to pay banks for contracts tied to at least $35 billion in defaults.
$150 Billion Loss Estimate
``That's a very conservative estimate,'' he says, adding that his study finds that losses resulting from hedge funds that can't pay their counterparties for defaults could exceed $150 billion.
Hedge funds have sold 31 percent of all CDS protection, according to a February 2007 report by Charlotte, North Carolina-based Bank of America Corp.
Cicione says banks will try to pre-empt this default disaster by demanding hedge funds put up more collateral for potential losses. That may not work, he says. Many of the funds won't have the cash to meet the banks' requests, he says.
Sellers of protection aren't required by law to set aside reserves in the CDS market. While banks ask protection sellers to put up some money when making the trade, there are no industry standards, Cicione says.
JPMorgan, in its annual report released in February, said it held $22 billion of credit swap counterparty risk not protected by collateral as of Dec. 31.
`A Major Risk'
``I think there's a major risk of counterparty default from hedge funds,'' Cicione says. ``It's inconceivable that the Fed or any central bank will bail out the hedge funds. If you have a systemic crisis in the hedge fund industry, then of course their banks will take the hit.''
The Joint Forum of the Basel Committee on Banking Supervision, an international group of banking, insurance and securities regulators, wrote in April that the trillions of dollars in swaps traded by hedge funds pose a threat to financial markets around the world.
``It is difficult to develop a clear picture of which institutions are the ultimate holders of some of the credit risk transferred,'' the report said. ``It can be difficult even to quantify the amount of risk that has been transferred.''
Counterparty risk can become complicated in a hurry, Das says. In a typical CDS deal, a hedge fund will sell protection to a bank, which will then resell the same protection to another bank, and such dealing will continue, sometimes in a circle, Das says.
`Daisy Chain Vortex'
The original purpose of swaps -- to spread a bank's loan risk among a large group of companies -- may be circumvented, he says.
``It creates a huge concentration of risk,'' Das says. ``The risk keeps spinning around and around in this daisy chain like a vortex. There are only six to 10 dealers who sit in the middle of all this. I don't think the regulators have the information that they need to work that out.''
And traders, even the banks that serve as dealers, don't always know exactly what is covered by a credit-default-swap contract. There are numerous types of CDSs, some far more complex than others.
More than half of all CDSs cover indexes of companies and debt securities, such as asset-backed securities, the Basel committee says. The rest include coverage of a single company's debt or collateralized debt obligations.
A CDO is an opaque bundle of debt that can be filled with junk bonds, auto loans, credit card liabilities and home mortgages, including subprime debt. Some swaps are made up of even murkier bank inventions -- so-called synthetic CDOs, which are packages of credit-default swaps.
AIG $9.1 Billion Writedown
On May 8, American International Group Inc. wrote down $9.1 billion on the value of its CDS holdings. The world's largest insurer by assets sold credit protection on CDOs that declined in value. In 2007, New York-based AIG reported $11.5 billion in writedowns on CDO credit default swaps.
Michael Greenberger, director of trading and markets at the Commodity Futures Trading Commission from 1997 to 1999, says the Fed is fully aware of the risk banks and the global economy face if CDS holders can't cover their losses.
``Oh, absolutely, there's no doubt about it,'' says Greenberger, who's now a professor at the University of Maryland School of Law in Baltimore. He says swaps were very much on the Fed's mind when Bear Stearns started sliding toward bankruptcy.
``People who were relying on Bear for their own solvency would've started defaulting,'' he says. ``That would've triggered a series of counterparty failures. It was a house of cards.''
Risk Nightmare
It's concerns about that house of cards that have kept Backshall, the California fund adviser, up at night. His worries about a nightmare scenario started in early March. The details of what happened are still fresh in his mind.
It's Monday, March 10, and the market is rife with rumors that Bear Stearns will run out of cash. Some of Backshall's clients have pulled their accounts from Bear; others are considering leaving the bank. Backshall's clients are exposed to Bear in multiple ways: They keep their cash and other accounts at the firm, and they use the bank as their broker for trades. Backshall advises them to spread their assets among various banks.
That same day, Bear CEO Alan Schwartz says publicly, ``There is absolutely no truth to the rumors of liquidity problems.''
Backshall's clients are suspicious. They see other hedge funds pulling their accounts from Bear. In the afternoon after Schwartz's remarks, the cost of protection soars past 600 basis points from 450 before Schwartz's statement.
CEO Didn't Calm Fears
Swaps are priced in basis points, or hundredths of a percentage point. At 600 basis points, a trader would pay $6,000 a year to insure $100,000 of Bear Stearns bonds.
``I don't think his comments did anything to calm fears,'' Backshall says.
The next day, March 11, Securities and Exchange Commission Chairman Christopher Cox says his agency is monitoring Bear Stearns and other securities firms.
``We have a good deal of comfort about the capital cushions at these firms at the moment,'' he says.
Cox's comments are overshadowed by rumors that European financial firms had stopped doing fixed-income trades with Bear, Backshall says.
``Nobody has a clue what's going on,'' he says. Bear swap costs are gyrating between 540 and 665.
For most investors, just getting default-swap prices is a chore. Unlike stock prices, which are readily available because they trade on a public exchange, swap prices are hard to find. Traders looking up prices on the Internet or on private trading systems see information that is hours or days old.
`Terribly Primitive'
Banks send hedge funds, insurance companies and other institutional investors e-mails throughout the day with bid and offer prices, Backshall says. For many investors, this system is a headache.
To find the price of a swap on Ford Motor Co. debt, for example, even sophisticated investors might have to search through all of their daily e-mails, he says.
``It's terribly primitive,'' Backshall says. ``The only way you and I could get a level of prices is searching for Ford in our inbox. This is no joke.''
In the past three years, at least two companies have developed software programs that automatically parse an investor's incoming messages, yank out CDS prices and build them into real-time price displays.
The charts show the highest bids and lowest offering prices for hundreds of swaps. Backshall tracks prices he gets from banks using the new software.
`It's Very Hard'
Backshall has been talking with hedge fund managers in New York all week.
``We'd quite frankly been warning them and giving them advice on how to hedge,'' he says of the Bear Stearns crisis and banks overall. ``It's very hard to hedge the counterparty risk. These institutions are thinly capitalized in the best of times.''
The night of Thursday, March 13, Backshall can't sleep. He lies awake worrying about Bear and counterparty risk. The next morning, he arrives at work at 5 a.m., two and a half hours before sunrise.
Through the window of his ninth-floor corner office, he takes a moment to watch the distant flickers of light in the rolling foothills of Mount Diablo. Across the street, he sees the still-dark Walnut Creek train station, about 30 miles (48 kilometers) east of San Francisco.
Backshall, wearing jeans and a blue, button-down shirt, sits at his desk, staring at a pair of the 27-inch (68.6- centimeter) monitors that display swap costs. CDS prices jumped by more than 10-fold in just a year. The numbers show rising fear, he says.
Until early in 2007, the typical price of a credit-default swap tied to the debt of an investment bank like Merrill Lynch & Co., Bear Stearns or Morgan Stanley was 25 basis points.
`Unknowns Are Out There'
If a swap buyer wanted to protect $10 million of assets in the event of a company default, the contract would cost about 0.25 percent of $10 million, or $25,000 a year for a five-year protection contract.
Backshall's screens tell him the cost of buying protection on Bear Stearns debt in the past 24 hours has been moving in a range between 680 and 755 basis points.
``The unknowns are out there,'' Backshall says.
He advises his clients not to buy CDS protection on Bear because the price is too high and the time is wrong. It's too late to buy swaps now, he says.
At 9:13 Friday morning in New York, JPMorgan announces it will loan money to Bear using funds provided by the Federal Reserve. The JPMorgan statement doesn't say how much it will lend; it says it will ``provide secured funding to Bear Stearns, as necessary.''
`Significantly Deteriorated'
Bear CEO Schwartz says his firm's liquidity has ``significantly deteriorated'' during the past 24 hours. Protection quotes drop immediately into the low 500s, as some dealers think a rescue has begun.
That doesn't last long.
``Very quickly, the trading action is swinging violently wider,'' Backshall says. Bear's swap cost jumps to 850 basis points that afternoon, his screen shows. ``When fear gets hold, fundamental analysis goes out the window,'' he says.
In the calmest of times, making reasoned decisions about swap prices is a challenge. Now, it's impossible. Traders don't have access to any company data more recent than Bear's February annual report. Sharp-eyed investors looking through that filing might have spotted a paragraph that's strangely prescient.
``As a result of the global credit crises and the increasingly large numbers of credit defaults, there is a risk that counterparties could fail, shut down, file for bankruptcy or be unable to pay out contracts,'' Bear wrote.
`Material Adverse Effect'
``The failure of a significant number of counterparties or a counterparty that holds a significant amount of credit-default swaps could have a material adverse effect on the broader financial markets,'' the bank wrote.
Even after JPMorgan's Friday morning announcement, the market is alive with rumors. Backshall's clients tell him they've heard some investment banks have stopped accepting trades with Bear Stearns and some money market funds have reduced their short-term holdings of Bear-issued debt.
On Sunday, March 16, the Federal Reserve effectively lifts the sellers of Bear Stearns protection out of their misery. JPMorgan agrees to buy Bear for $2 a share.
While that's devastating news for Bear shareholders -- the stock had traded at $62.30 just a week earlier -- it's the best news imaginable for owners of Bear debt. That's because JPMorgan agreed to cover Bear's liabilities, with the Fed pledging $29 billion to cover Bear's loan obligations.
Turned to Dust
For traders who sold protection on Bear's debt, the bailout is a godsend. Faced with the prospect of having to hand over untold millions to their counterparties just three days earlier, they now have to pay out nothing.
For traders who bought protection swaps just a few days earlier -- when prices were in the 600s to 800s -- the Fed bailout is crushing. Their investments have turned to dust.
On Monday morning, the cost of default protection on Bear plunges to 280. Backshall sits back in his chair and for the first time in two weeks, he can breathe easier.
``No wonder I look so tired all the time,'' he says, finally showing a bit of a smile.
When it bailed out Bear Stearns, the Federal Reserve effectively deputized JPMorgan to monitor the credit-default- swap market, says Edward Kane, a finance professor at Boston College. Because regulators don't know where the risks lie, they're helpless, Kane says.
Default swaps shift the risk from a company's credit to the possibility that a counterparty might fail, says Kane, who's a senior fellow at the Federal Deposit Insurance Corporation's Center for financial Research.
`Off Balance Sheet'
``You've really disguised traditional credit risk, pushed it off balance sheet to its counterparties,'' Kane says. ``And this is not visible to the regulators.''
BNP analyst Cicione says regulators will be hard-pressed to prevent the next potential breakdown in the swaps market.
``Apart from JPMorgan, there aren't many other banks out there capable of doing this,'' he says. ``That's what's worrying us. If there were to be more Bear Stearnses, who would step in and give a helping hand? You can't expect the Fed to run a broker, so someone has to take on assets and obligations.''
Banks have a vested interest in keeping the swaps market opaque, says Das, the former Citigroup banker. As dealers, the banks see a high volume of transactions, giving them an edge over other buyers and sellers.
``Dealers get higher profitability through lack of transparency,'' Das says. ``Since customers don't necessarily know where the market is, you can charge them much wider margins.''
Banks Try to Hedge
Banks try to balance the protection they've sold with credit-default swaps they purchase from others, either on the same companies or indexes. They can also create synthetic CDOs, which are packages of credit-default swaps the banks sell to investors to get themselves protection.
The idea for the banks is to make a profit on each trade and avoid taking on the swap's risk.
``Dealers are just like bookies,'' Kane says. ``Bookies don't want to bet on games. Bookies just want to balance their books. That's why they're called bookies.''
The banks played the role of dealers in the CDO market as well, and the breakdown in that market holds lessons for what could go wrong with CDSs. The CDO market zoomed to $500 billion in sales in 2006, up fivefold from 2001.
Banks found a hungry market for CDOs because they offered returns that were sometimes 2-3 percentage points higher than corporate bonds with the same credit rating.
CDO Market Dried Up
By the middle of 2007, mortgage defaults in the U.S. began reaching record highs each month. Banks and other companies realized they were holding hundreds of billions in toxic debt. By August 2007, no one would buy CDOs. That newly devised debt market dried up in a matter of months.
In the past year, banks have written off $323 billion from debt, mostly from investments they created.
Now, if corporate defaults increase, as Moody's predicts, another market recently invented by banks -- credit-default swaps -- could come unstuck. Arturo Cifuentes, managing director of R.W. Pressprich & Co., a New York firm that trades derivatives, says he expects a rash of counterparty failures resulting in losses and lawsuits.
``There's a high probability that many people who bought swap protection will wind up in court trying to get their payouts,'' he says. ``If things are collapsing left and right, people will use any trick they can.''
Frank Partnoy, a former derivatives trader and now a securities law professor at the University of San Diego School of Law, says it's high time for the market to let in some sunshine.
Centralized Pricing
``There should be a centralized pricing service for credit-default swaps,'' he says. Companies should disclose their swaps holdings, he adds.
``For example, a bank might disclose the nature of its lending exposure based on its use of credit-default swaps as a hedge,'' he says.
Last year, the Chicago Mercantile Exchange set up a federally regulated, exchange-based market to trade CDSs. So far, it hasn't worked. It's been boycotted by banks, which prefer to continue their trading privately.
Leo Melamed, 76, chairman emeritus of Chicago Mercantile Exchange Holdings Inc., says there aren't any easy solutions.
``Plus we're not sure the banks want us to be in this business because they do make a good deal of money, and we might narrow the spreads considerably,'' he says.
`Central Clearing House'
For now and for some time in the future, CDSs will remain unregulated and their trades will be done in the secrecy of Wall Street's biggest securities firms. That means counterparty risk will stay out of the sight of the public and regulators.
``In order for us to get away from worries about counterparty risk, in order for us to encourage more trading and more transparency, there's got to be some way to bring all the price data together with exchange trading or a central clearinghouse,'' Backshall says.
Until that happens, the sword of Damocles will remain poised to fall, as banks, hedge funds and insurance companies can only guess whether their trillions of dollars in swaps are covered by anything other than darkness.
To contact the reporter on this story: David Evans in Los Angeles at davidevans@bloomberg.net.
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