Hard Stop

I wish they had told me they were coming up on a hard stop at Bloomberg Television.

Talking in sound bytes is difficult if you want to be accurate, but we all know that, from hearing sound bytes for years.

To finish my point:

You can put any financial business into bankruptcy by denying them credit.  And you can deny any company credit by buying enough protection in the CDS market.

It might not be so bad if it stopped there.  Unfortunately, when the CDS on subprime mortgages came due, they overwhelmed the companies that had written the insurance.

When the insurance providers went under, and no one knew who had bought the insurance, then no investor could safely lend to any private company, no matter how well capitalized they might have been the week before.

Treasury Bills had so much demand in September of 2008 that yields went negative.  You need no other proof that even the best banks weren’t safe enough.

One area that was utterly stopped cold by that fact was the international commodity business. After all, the only way a producer would ship their goods was to get assurance they would be paid.

That assurance came from Letters of Credit issued by banks.

But what if the bank held $20 billion in AAA CDO’s in a “matched book” with insurance, and the insurance provider just went belly up?  Suddenly the bank might be insolvent.

As the owner of a big pile of iron ore, or wheat, or any other trade goods, I might have my doubts about being able to collect what was due several months in the future if the only assurance I had was from a bank that might not be there in three months.

Better to be cautious, and wait.

That happened all over the world.

Imagine what would have happened if that state continued.  Too much of the world economy operates on the “just in time” principal of inventory control for the system to absorb that kind of interruption.

And that’s just one obvious spillover of this hidden $60 trillion casino.

Others were longer term, and still in place.

Half the US mortgage market was private companies issuing private MBS in 2007.  By 2009, that avenue for financing home purchases was gone.  The taxpayer was “forced” to try to take up the slack, making us the proud owners of Fannie and Freddie, and leaving us on the hook for losses.

Nice choice.  Either you agree that you can only sell your house to someone who can pay all cash, or you agree to be taxed for the next 30 years to cover losses.

About 5 million households have to sell every year for life reasons (new job, divorce, medical bills, death, for example).  Imagine if there were no money being lent by anyone (government Agencies included) to finance home purchases.

That would guarantee that five million families go bankrupt every year, on top of those who ended up there when they couldn’t pay the co-pays on their hospital bills.

Debtors’ prison, anyone?

hh

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5 Responses to Hard Stop

  1. […] But, as the clock is an evil beasty, Howard didn’t get to finish his whole thought on how “You can put any financial business into bankruptcy by denying them credit. And you can deny any company credit by buying enough protection in the CDS market.”  That – and a lot more – over at Howard’s site which you can think of as “The Daily Howard”.  […]

  2. Eric iousa says:

    “You can put any financial business into bankruptcy by denying them credit. And you can deny any company credit by buying enough protection in the CDS market.”

    I am not the smartest guy, but this paragraph confused me some. I think what you are saying is if there is no “insurance” (CDS) then no one will lend. Hmmm. If this is the case and regulators force the market on a heavily regulated exchange that requires capitol to back up the “claim” , then won’t that cause less “insurance” to be written and thus higher rates overall and no financing for others?

    One other thing along these lines has always bothered me. Lets say a company called God Sachs is willing to buy bonds or hold bonds at 5 percent but only if God can get insurance from a TBTF entity at 50 basis points. If Joe and Diane place there life savings to buy these bonds with no ubber cheap insurance, haven’t they over paid at the least?

    Thank you!
    Eric

    • hhill51 says:

      Hi, Eric….

      I tried to clarify in my next post. When a customer buys CDS from their dealer or banker, that dealer or banker is taking the risk for that credit, which is the same as lending money to that credit (economically). If enough of this insurance gets bought, then every possible lender will be overloaded in exposure to that name, even if the company itself isn’t doing the borrowing.
      When the company needs to borrow (and all financials do need to borrow), the banks essentially say they’ve got too much exposure already, so they won’t lend at all, or they will set the rate so high that the borrower goes out of business.
      hh

  3. Jay Litman says:

    I share Eric’s confusion. I remember asking early on in 08. “What are CDSwaps?” I did not understand any of the answers then, (most usual answer was “just insurance”). And in spite of HHill’s lovely attempts to explain what they are, and what happened, I still don’t know what they were and what happened. Extremely convoluted, IMHO. and I’m not the dullest bulb in the pack. Not the brightest, but not the dullest.

    • hhill51 says:

      Perhaps another read of my post “Black Ice” from last October is in order.
      Yes, they are insurance, with the “buyer of protection” being the bear, and the “seller of protection” being the bull. A synthetic CDO would be a seller of protection, and receive monthly payments of interest from the buyer. When the dealers created these synthetic deals, they would sell bonds that were backed by a reserve fund that just held cash or equivalents for the principal, and the interest would come from the bears (protection buyers), who paid the monthly insurance premium.
      If there was no loss, the bear would lose their interest payments, but no principal. If there was a credit loss on the bonds, the investors in the CDO bonds would not get all their principal back, with money from the reserve equal to the losses being handed over to the buyers of the protection.

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