Tuesday, March 18, 2008

The real reason for the panic on Wall Street

Thanks to Mish's Global Economic Trend Analysis blog

This excellent table is in the heart of Wall Street's problems. For the Ben Stein's out there who think that market to markit is a mistake, and losses will be recovered, look carefully at this numbers. The current problem is not about subprime and it is not about foreclosure rates. This was just the spark that ignited the bush fire. This numbers show that Wall Street is a big poker table where success and defeat are dependent on confidence or lack of it. Confidence cannot be restored in an environment where Gold trades above a thousand dollar, oil above a hundred, a housing correction that is still ongoing and the dollar is being devalued by Central bank action. Maybe it was that inside that led Andrew Mellon to suggest to pres. Hoover "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.... That will purge the rottenness out of the system."

Warren Buffett in his latest letter to his shareholders:

Last year I told you that Berkshire had 62 derivative contracts that I manage. (We also have a few left in the General Re runoff book.) Today, we have 94 of these, and they fall into two categories. First, we have written 54 contracts that require us to make payments if certain bonds that are included in various high-yield indices default. These contracts expire at various times from 2009 to 2013. The second category of contracts involves various put options we have sold on four stock indices (the S&P 500 plus three foreign indices). These puts had original terms of either 15 or 20 years and were struck at the market. ....in all cases we hold the money, which means that we have no counterparty risk.

No matter what happens to the eventual payout of Buffett's derivative contracts no counter party in risk of default owes Berkshire money. I bet that any CEO of any Wall Street firm has no idea of their risk exposure to counter parties. Perhaps proper risk management is impossible with JPM's 91T USD outstanding. Today Wall Street firms know in troubling times the Fed and the government will bail them out, if their balance sheet and their exposure to counter parties is big enough. Proper risk management is not necessary. Now we might understand when we caution about moral hazards in the context of bailouts for Wall Street firms. Larry Kudlow shifted the blame to the Fed for not opening the discount window to IBs, in light of the recent developments with BSC. To LK I would suggest the following: Why not nationalizing all of Wall Street and let the Fed and the Treasury with its printing presses do the accounting for them. In that way we can eliminate all the risk and make sure that the CEOs and managers can continue buying a piece of dirt in the Hamptons for 200M, or after one's company and shareholders go bust buy an apartment in Manhattan's Plaza for 60M. I don't know is it just me or is this starting to stink like a dead fish in the sun.

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