Anniversary Lesson

I bet some of you wonder why I went through that whole long rehash of the three-year and four-year anniversaries of the financial crisis.

Here’s why:

For some reason, the BS about “contained” exposure to Greek debt, PIIGs debt, Euro bank CP, etcetera and the subsequent “contagion” discussions is going on right now, and it’s just another chorus of the same sad song we heard about subprime mortgage bonds in 2007.

Once again, we are not looking at the ice beneath the water line as we merrily steam into the ice field.

Don’t we ever learn?

The real problem when Greece defaults isn’t going to be that some northern European monster banks hold 2% or 3% exposures to that debt in their investment portfolios.  It won’t even be that they have CP they are having trouble rolling over, at least not directly.

Here’s how the 2011/2012 financial crisis script will be written.  Then the anniversary everyone will remember will be when the events I’m about to describe become news.

The true crisis will be when some institution somewhere is shown to be insolvent because it just couldn’t resist the “easy profits” it was making by selling CDS insurance on Greece, Italy, Spain, or whatever.  Just like AIG was the biggest loser in the subprime debacle that nobody ever knew about, so there will be somebody, somewhere, that played with far too many CDS in the sovereigns, or, secondarily, in the banks that hold those sovereigns.

I could easily imagine that Unicredit bank in Italy is overweighted with Italian sovereign bonds.  I could also imagine that some clever macro hedge fund managers got several steps ahead of the Greek crisis by buying LOTS MORE of MUCH CHEAPER insurance on Unicredit than paying up for CDS on Greek bonds.

We saw when Fannie Mae was put into receivership that the total payment to CDS holders (not disclosed until after the default) amounted to over $360 billion.  At the time, it was a dollar figure bigger than all the realized losses on all subprime mortgages in America over a two decade period.  In just one day, with just one credit!

The best part for the holders of those Fannie Mae CDS contracts?

A year earlier, they were able to get into those contracts by agreeing to pay insurance premiums as low as 10 to 15 basis points per annum.  In terms of cash outlay, those CDS speculators had picked the right secondary victim of the coming disaster, and they had only agreed to pay a maximum of 0.75% ($7,500 over five years) for each $1 million of coverage.  For a billion dollars of winnings, some speculators had only laid out as little as $1 to $1.5 million!

All from picking the second, third or fourth domino in the line, rather than the first.

And if someone, somewhere happened to take on too much exposure to Unicredit, or SocGen, or whoever, then that writer of CDS could themselves be insolvent without anyone even knowing they were.  That’s why I’ve been wondering aloud since July who gets to play AIG in the sequel.

As you may recall in the crazy testimony from Lloyd Blankfein after he cashed our $10 billion check remitted via AIG, he was not worried even while making enormous margin calls on AIG in 2008, because Goldman was “covered” in case AIG defaulted.  Kind of makes you wonder whether JP Morgan, or Met Life, or Credit Suisse or (heaven help us) some major pension fund might be itself insolvent if Goldman had come knocking at the door to collect on it AIG CDS coverage.  The hidden daisy chain boggles the mind, and rightfully scares every investor charged with protecting client money.

If and when another credit meltdown chain reaction starts, we will see the world market for overnight credit freeze once again.

This time, though, the citizens of almost every country have their pitchforks sharpened and their torches ready to light.  I suspect the leaders of the top industrialized nations won’t find it nearly so easy to jump in and put their taxpayers on the hook to save the banks a second time around.

hh

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2 Responses to Anniversary Lesson

  1. Taymere says:

    true dat

  2. IG says:

    this is some great outside the box thinking. have not seen in layed out like this anywhere else

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