Does Santa Take Side Bets?

Coal in some stockings, treats in others, but who’s been naughty and who’s been nice? In the world of big-time financial side bets (Credit Default Swaps), it isn’t exactly clear.

When I heard about the unusual happenings that kept Radio Shack open for at least one more Christmas season, my thoughts went to the decision process for the traders on each side of a massive CDS trade. Making money is the primary reason they play, but there is something else going on.

Senior people on Wall Street have their own version of Black Friday – the day after Thanksgiving that some retailers need to push their full year into the black. It’s not the same day at every Street firm or hedge fund, but it’s just as manic as the mall scenes with people trampling each other to get enormous televisions. On one day each year, everybody gets their “number” – their bonus for the year.

This year, as every year, people are trying their best to book big profits while the bosses are deciding who gets how much of the bonus pool.

From the glossary of Finance Monsters, here’s the definition of the Bonus Pool: 

Lowering Threat Level to Orange

That doesn’t mean we can’t have a crisis, but the threat is less than it might be.

There’s been quite a reaction to the posts from two weeks ago about the potential that our next financial meltdown might be quietly germinating in the dark recesses of the credit derivative market, and rightly so. There are still people linking to the second in the series today.

After the break, I’ll follow some clues we can look at to see whether another mega-mushroom of risk is growing in the dark basement of finance, the way it was in Finance Monsters….

Financial Love Canal

How to make a startling headline if you’re a financial reporter:  just look for owners of junk bonds that might be in trouble, and make that your story.

Remember SIVs?

Not many people seem to remember that the very first bailout proposed by Treasury Sec. Paulson wasn’t for mortgages. It was for Structured Investment Vehicles (SIVs), and he proposed it in late 2007.  He wanted the government to sponsor a $100 billion “super-SIV” to buy performing assets from bank-sponsored SIVs if they had a problem selling the paper that they relied on for funding.

What a Weekend!

Over the weekend, MindonMoney and Finance Monsters both picked up a larger circle of readers, and they weren’t all the usual suspects. For example, blogs in Sweden, China and Malaysia linked to the post Three Conditions and Three Warning Signs. Since I don’t read Swedish or Chinese, I can’t say what those blogs focus on, but as they say, “There’s no such thing as bad publicity.”

National Memo carried an excerpt of the book from the chapter Contagion as its featured “Weekend Reader” that was especially timely, given the unknown secondary effects of the collapse in oil prices. FWIW, energy high yield spreads are now above 1,000 basis points for the first time ever.

Finance Monsters even flirted with the most fleeting of all honors – Amazon bestseller – that is, if you count being the bestseller in a quiet category like bond investing e-books. The rankings are recalculated every hour, so I’m not quite ready to run a press release claiming bestseller status. What would it say? Six hours on the Amazon (bond category) bestseller list? It does make me wonder how many books it would take to get to the top of the main list, at least long enough to take a screen shot of that exalted status.

The biggest effect had to be from Zero Hedge, the blog/rant/gossip/research site that’s wildly popular on trading desks around the Street. By late Sunday the copy of the Three Conditions post that “Tyler Durden” put up on Saturday had over 30,000 readings. After the break, a tip of the hat to a dozen other blogs and sites that linked over the weekend…

Not a Lone Voice Any More

Mainstream commentators finally noticed.

It’s been a bit lonely sounding the alarm that the next crisis and bailout was on the runway waiting to take off.

That all changed this week as Congress debated whether to extend funding for the “discretionary” chunk of government. You know, stuff like defense department contractors, highway construction and repair, national parks, food stamps, scientific research, border patrols and so on.

Much to my surprise, the long-time policy that derivatives trading is a “Heads – we win; Tales – taxpayers lose” business became an issue that bubbled up to general consciousness.

To Hear My Radio Interview

Tomorrow morning at 9 AM, the radio show “Everything Financial” with my interview will broadcast on several stations in the Grand Rapids Michigan area.  Here’s the link to hear their broadcast live:

http://www.iheart.com/live/wood-radio-1069-fm-1300am-1165/?autoplay=true&pname=1236&campid=play_bar&cid=%2Fonair%2Fsunday%2F

Radio Interview This Sunday

Did my first radio interview since publishing Finance Monsters. It was recorded for Dennis Tubbergen’s “Everything Financial” radio show that broadcasts Sunday mornings on news radio WOOD and on WTKG in Grand Rapids, MI. We talked mostly about the current situation with the derivatives market, and Dennis was nice enough to remind listeners about the book.

I’ll post a link when it gets up on Itunes as a podcast.

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It’s a Wonderful Business

Bailey Bros Building and Loan

Throughout the mortgage meltdown and wider financial crisis, we all heard a hundred times that the whole problem was that lenders didn’t keep the risk of mortgage loans they made. You know, like George Bailey did when he didn’t foreclose on the good people of Bedford Falls, and kept the town’s mortgage lender alive?

Tonight I had the chance to watch the classic “It’s a Wonderful Life,” and it was much as I remembered it, with a few details that hadn’t registered before. For example, did you remember that Bailey Brothers were also builders of “spec” houses? Or that they financed those houses with no-down-payment subprime loans to borrowers who couldn’t qualify at a regular bank?

Three Conditions and Three Warning Signs

How to Tell if the Next Financial Crisis is Upon Us.

In the last post, it was suggested that the rapid collapse in oil prices might have set up a repeat of the 2008 financial crisis. Before we all run for the bunkers and the freeze-dried food, we should know the conditions needed for a crisis to happen, and the signposts we’ll see if the crisis gets going.

For a sector correction to become a meltdown, and for that to turn into a global crisis, several preconditions need to be in place.

The first condition is a serious market sector correction.

According to some participants in the market for energy company bonds and loans, such a correction is already underway and heading toward a meltdown (the second condition). Others are more sanguine, and expect a recovery soon.

Are We There Yet?

The Next Big One Might Already Be Warming Up

We probably aren’t at the cusp of the next financial crisis, but we can’t be sure, given the pathetic nature of the “reforms” that are already being curtailed even before taking full effect.

As we enjoy a rare market gift to the masses, the first sub-$3 gasoline in several years, we might want to temper our holiday cheer just a bit. Not because cheaper gas doesn’t help “everyman,” but because the presence of rapid price swings in one market can quickly turn into disaster for all markets.

It’s not that market volatility is in itself contagious. It’s the fact that there’s a hidden part of our financial system that works behind the scenes and takes advantage of opportunities in the market. Even if those opportunities benefit only them, and hurt the rest of us.