Monday, September 8, 2008

GSE Bailout: The Morning After

Well Paulson has fired his bazooka and the market is selling on the pop. We started off up 350 points on the DOW as the market initially cheered the news. We have since pulled back to as low as up 211 points.

I have started to notice some dislocations in the market. Gold surged up $16 and oil also rose on a day when the dollar was up. This breaks a recent trend of stronger dollar=weaker commodities. Gold is a great fear indicator folks!

So why should we be afraid? The government saved the day with the bailout right?

Wrong! You see there are repercussions when you cross the line of moral hazard. Here is the first one folks. Pay very close attention to this news:

"Sept. 8 (Bloomberg) -- Investors may be forced to settle contracts protecting more than $1.4 trillion of Fannie Mae and Freddie Mac bonds against default after the U.S. seized control of the companies in a bid to bolster the housing market.

Thirteen ``major'' dealers of credit-default swaps agreed ``unanimously'' that the rescue constitutes a credit event triggering payment or delivery of the companies' bonds, the International Swaps and Derivatives Association said in a memo obtained by Bloomberg News today. Market makers for the privately traded contracts will discuss how to settle them in a conference call at 11 a.m. in New York, the document said.

``This is a big deal,'' said Sarah Percy-Dove, head of credit research at Colonial First State Global Asset Management in Sydney. ``The market is not experienced at settling a credit event for a name of this size, so it is a bit of an unknown.''

A settlement likely would be the largest in the market's decade-long history. Credit-default swaps on Fannie and Freddie have been among the most actively traded the past few months, according to reports from broker GFI Group Inc. Both companies also are among 125 companies in the benchmark Markit CDX North America Investment Grade Index, the most actively traded contract in credit markets, which investors use to speculate on corporate creditworthiness or to hedge against losses."

My take on todays action:

If we close flat or in the red today be afraid, be very afraid. I expect the "bubble boys" will most likely take us much higher today in the end.

The CDS(credit default swaps) story above is one to watch. The Fannie/Freddie CDS unwind involves $1.4 trillion dollars. These contracts are settled with cash not debts folks. We have never unwound something so large so there is some risk here.

An unwind of the derivatives market is something that would be catastrophic for the financial system. I believe(don't quote me on this) that the derivatives market involves around $60 trillion dollars.

Hank Paulson better pray that this unwind goes smoothly. Lets see how we end the day. I am seeing much less enthusiasm in the markets today than I expected.

Maybe investors are realizing that this solves none of the problems that currently face our economy. The bailout doesn't make houses more affordable nor does it put more money into the consumers wallet.

What it does do is take us one step closer towards the socialization of the financial markets, Of course it also again saves the pigmen.

I have a question for Paulson and the Treasury:

When do WE the people get our bailout?


Minton Mckarkquey said...

Hey Jeff, can someone remind me when the Republicans became socialist? I could have sworn they used to be small-government and laissez-faire, but I could be mistaken.

It's no big surprise the markets are up - the US taxpayer just wrote a trillion-dollar check to insure banks and foreign investors. While they can celebrate in the short term, it's you and me who'll still be hurting in 10 years and battling the inevitable inflation well after the housing bubble is a distant memory.

I miss the gold ol' days when all the Fed could do was screw around with interest rates... where the hell is Jim Rogers when you need him?!

Jeff said...


I agree. We will be paying for this mess. I don't understand why people aren't protesting all of this crap.


Have you been watching the markets this morning? Its been absolute chaos. DOW is moving 100 points up and down every 5 monutes.

I have never seen anything like it.

Lehman and WAMU are plunging. I wouldn't be surprised to see one or both of those companies go under this week.

UAL was rumored to be going BK then they retracted the story.

The market is insane today! What a roller coaster. This turbulence is not a good sign for the bulls.

Lets see how it all ends.

All I can say is WOW!

Minton Mckarkquey said...

Indeed, I haven't seen a market like this in a long time - it certainly doesn't fill me with much confidence.

Yesterday I commented the LEH would get a boost out of this. It did. But I didn't expect it to only last an hour! This to me shows how short-lived the 'Fed Saved Us All' story could last. As you said in your post, it's a possibility that we could end today flat... or even in the red.

Let's keep watching!

Jeff said...

Maybe Hank wishes now that he never shot the bazooka and bailed the GSE's out.

It looks like this bailout is backfiring. Nasdaq is now in the red. DOW now only up 159 points!

I hope you caught that 1 hour rally on Lehman!

It looks like the pigmen may swirl down the toilet bowl!

Avl Guy said...

Jeff, the CDS 'market'and requisite bluffing (see Pimco lessons) will be key. The assorted Treasury & FHFA bailout provisions allows an incredible number of individual institutions to wriggle around the Paulson Headfake & Paulson Punt, via CDS and other vehicles, angling for the best way to cover their own behinds.
Will today's market churning produce ice cream....or sour milk?
Im catching a matinee movie, will tune in later after 4pm.

Jeff said...


Its looking like we are getting a big pump job towards the close here.

Its looking like ice cream!