[NYTr] Mike Whitney: Bulletins from the Titanic

[All the News That Doesn't Fit]

Counterpunch - Nov 13, 2007
http://www.counterpunch.org/whitney11132007.html

"Steady as She Sinks!"

Bulletins from the Titanic

By MIKE WHITNEY

On Monday, Asian stock markets took another beating, on fears that the
credit squeeze which began in the United States will continue to worsen
in the months ahead. Every index from Tokyo to Sidney fell sharply
continuing the "self-reinforcing" cycle of losses started last week on
Wall Street. The Nikkei 225 average fell 3.3 per cent, India's Sensex
2.9 per cent, Taiwan's 3.5 per cent, and Hong Kong's Hang Seng slumped
4.5 per cent. The subprime tsunami is presently headed towards downtown
Manhattan, where nervous traders are already hunkered-down in the
trenches---ashen and wide-eyed.

Amid the deluge of bad news over the weekend; one story towers above
all the others. The yen gained 1.5 per cent against the dollar. (9 per
cent year-over-year) That means that Wall Street's biggest swindle, the
carry trade, is finally unwinding. The over-levered hedge funds will
now be forced to sell their positions quickly before the interest-rate
window shuts and they're stuck with humongous bets they cannot cover.
The faltering yen is the grease that lubricates the guillotine. $1
trillion in low interest loans--which keeps the trading whirring along
in US markets--is about to get a haircut. Cheap Japanese credit is the
hidden flywheel in Hedgistan's main-cylinder. Once it is removed, the
industry will seize up and clank to a halt. Fund managers can forget
about the vacation rental in the Hamptons. It'll be sloppy Joes and
Schlitz Malt-liquor on Coney Island from here on out.

Over the weekend Deutsche Bank announced that losses from "securitized"
subprime mortgages were likely to reach $400 billion. The news sparked
a sell-off in the Asian markets where investors have become
increasingly eager to pare down their holdings of US equities and
dollar-backed assets. Overnight, the greenback has become the leper at
the birthday party; everyone is steering clear for fear of contagion.
Foreign central banks are looking for any opportunity to dump their
stockpiles of dollars in a manner that doesn't disrupt their economies
or the global financial system. Their intentions may be prudent-even
honorable-but it won't forestall the inevitable blow-off of US dollars
that is likely to commence as soon as the financial giants reveal the
real size of their losses. New regulations have been put in place that
will require the banks to provide "market prices" for their assets.
This will expose the degree to which they are under-capitalized. When
word gets out that the banking system is underwater; there'll be a run
on the dollar.

On Sunday, the AFP reported that the Group of Seven richest nations
(G7) is considering direct "intervention" in the dollar's decline to
prevent a "disorderly correction".

"It is not too early contemplating the risk of coordinated
interventions by the G7," said Stephen Jen and Charles St-Arnaud of
investment bank Morgan Stanley. "History shows that multilateral,
coordinated interventions have been key in establishing turning points
in multi-year trends in major currencies in the past three decades." On
Thursday, Treasury Secretary Hank Paulson, full fathom five under the
waves on the poop deck of the Titanic communicated through speaker tube
the news that "A strong dollar is in our nation's interest and should
be based on economic fundamentals."

According to Bloomberg News: "More than $350 billion of collateralized
debt obligations comprising asset-backed securities may become
'distressed' because of credit rating downgrades."

What's clear is that the situation is getting worse, not better.
Honesty must at least be considered as one of many options, although
the Treasury Dept avoids that choice like the plague. Eventually, the
public will have to be told about what is going on. Last week, the
Financial Times reported: "In recent days, investors have been
presented with a stream of high-profile signs that sentiment in the
financial world is deteriorating. However, deep in one esoteric corner
of finance, another, little-known set of numbers is provoking growing
concern. So-called correlation - a concept that shows how slices of
complex pools of credit derivatives trade relative to each other - has
been moving in unusual ways 'What we are seeing in the synthetic
[derivative] markets is that there is a serious fear of systemic risk,'
says Michael Hampden-Turner, credit strategist at Citigroup. 'This is
not just about price correlation within the collateralized debt
obligation market, but about a potential rise in default correlation
and asset correlation.' Until recently, traders often tended to assume
that there was relatively little correlation between different chunks
of debt, because they thought that the biggest risk to the world was
idiosyncratic in nature - meaning that while one company, say, might
suddenly default, it was unlikely that numerous companies would default
at the same time. However, some regulators have been warning for some
time that in times of stress correlation does not always behave as
traders might expect."

The multi-trillion dollar derivatives industry-which has never been
tested in down-market conditions---is now moving sideways. No one
really knows what this means except that the most opaque and volatile
debt-instruments are now threatening to unravel, triggering a cascade
of unanticipated defaults and a colossal loss of market capitalization.
Credit default swaps (CDS) are rarely thrashed out in market
commentary. They are counterparty options which provide hedging against
the prospect of default. They are, in fact, a financial equivalent of
the San Andreas faultline which is quivering menacingly as foreclosures
mount and mortgage-backed bonds continue to implode. As the Financial
Times suggests, the shock waves should be sweeping through the Wall
Street trading pits in the very near future.

There are also new developments on the sale of "marked to model"
CDOs-the red-haired stepchild of the new structured finance paradigm.
"The trustee of a $1.5 billion collateralized debt obligation managed
by State Street Global Advisors has started selling assets, apparently
starting a process of liquidation," Standard and Poor's said. The sale
is a red flag for the other holders of $1.5 trillion of CDOs who've
been waiting for market conditions to change before they try to sell
their mortgage-backed bonds. The liquidation will assign a "market
price" to these complex structured investment vehicles. If the price at
auction is mere pennies on the dollar, then the banks, pension funds,
and insurance companies will have write down their losses or add to
their reserves to cover their weakening assets. Simply put, the State
Street sale could turn out to be doomsday for a number of
under-capitalized investment banks. Their revenues are already down;
this would be the last stake to the heart.

Finally, Greg Noland, at Prudent Bear.com reports on the "looming
disaster" at Fannie Mae where, the best-known Government Sponsored
Entity (GSE) has entered into the current housing slump with a "Book of
Business of mortgages, MBS and other credit guarantees of $2.7
trillion" which is backed by a measly "$39.9 billion of Shareholder's
Equity".

That's all?

As Noland concludes, "A devastating housing bust will bankrupt the
mortgage insurers, while the solvency of their derivatives
counterparties going forward will be in doubt in any number of
scenarios. The GSEs are now integrally linked to what I expect to be
Credit insurance's and "structured finance's" astonishing downfall."
Amen.

The only thing looking up are oil futures. And they'll be denominated
in euros soon enough.

[Mike Whitney lives in Washington state. He can be reached at:
fergiewhitney at msn.com ]