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George Washington’s Blog
Forget the stock market gyrations. Forget Bernanke and Paulson’s ineffective, unconstitutional schemes.

Thursday’s auction for Lehman’s credit default swaps (CDS) is much more important.

Why?
Well, if banks are reassured by the CDS auction, it could do more to free up frozen capital than all of the Fed and Treasury’s ill-conceived plans put together.

As Bill Gross, head of $721 billion dollar fund Pimco, says:

Credit markets are based on trust and when there is no trust, markets can freeze up . . . . Imagine yourself at the drive-thru ordering a Big Mac. At one window you order and pay, at the other – 20 feet ahead – you pick up your lunch. What if you thought that after paying at the first window, your 1000 calorie sandwich might not be waiting for you a few seconds later. You might not pay; business as usual might not take place. That is what is happening in the credit markets. They are frozen in “McFear.” After the failure of Lehman Brothers – an investment bank which took orders at one window, and promised to pay at another for trillions of dollars of those CDS, swaps, and other derivative “sandwiches” – institutional investors said that they’d prefer to stay at home and have peanut butter instead of risking their money ordering a Big Mac. And so their money goes into that figurative mattress instead of the register at McDonald’s, people are laid off, profits go down, bank loans become less available, our economic center cannot hold.

An auction occurred today to determine the value of Freddie and Fannie’s CDS. While there were approximately $500 billion in CDS written against Freddie and Fannie, those who issued CDS will be repaid between 91.5 percent and 99.9 percent of protection they sold. In other words, the issuers of such CDS will only have to pay out between .1 and 8.5 cents on the dollar.

For a rough, back-of-the-envelope calculation, let’s split it down the middle and call it 95% of $500 billion, which means that the issuers of Freddie and Fannie CDS will only have to pay out about 5 cents on the dollars, or about $25 billion total. That’s a lot of money, but not catastrophic.

On the other hand, “investors who wrote protection on a Lehman default will have to pay out between 81 and 85 cents on the dollar.”

No one has disclosed how many billions of dollars in Lehman CDSs are out there. And no one knows the exact payout amount which will be determined at Thursday’s auction.

But it is known that “Lehman was one of the 10 largest parties participating in credit default swaps, the New York Times reports. The company’s most recent quarterly filing said it bought and sold $729 billion in derivatives with a fair net value of $16.6 billion.” And a lot of people bought CDS betting on Lehman’s failure in September.

D-Day

So Thursday is D-Day, where “D” is for “derivatives”.

If there are a lot of Lehman CDS out there, and if the auction price comes in high, it could greatly exacerbate the global economic crisis no matter what Bernanke and Paulson do. On the other hand, if there aren’t that many CDS out there, or if the price comes in lower than people expect, it would be a huge sign of stability in the CDS market that could reassure financial institutions and investors worldwide, which could “free up liquidity” and help avert a depression (no matter what Bernanke and Paulson do). More

The Automatic Earth.Blogspot.com
“…on the Freddie and Fannie deal. It is generally accepted that this kind of government action benefits taxpayers and prospective homebuyers. The former because it keeps the economy from collapsing, the latter because mortgage rates will be low(er). It’s accepted this way, because this is after all how Paulson presented the plan. In reality, the only parties profiting are the usual suspects: banks and other financial institutions, at least those that are Hank’s friends. US taxpayers? Get real, they are on the hook for trillions of dollars in potential losses from Fannie and Freddie, in essence for all of the rumored $9 trillion in debt they have. There are many people who claim that most of the loans in their books are “good”, but that’s not the whole story. After all, if that were the decisive factor, why did they need to be “rescued”? The more important point is that they are leveraged some 60 times, meaning they have 60 times more loans outstanding than they have capital in their accounts. If they lose on 1% of their loans, their capital is wiped out.” More

Posted by Jerome a Paris
The bailout of Freddie and Fannie has just been announced by Hank Paulson, with supporting words from Bernanke. What’s interesting in what’s proposed, as usual, is what’s unsaid. This would seem to be an incredibly ambitious gambit: a nationalisation, an attempted bailout of ALL the banks, and an open-ended commitment of taxpayer money to save the financial world. More

TheGlobeAndMail.com
North America is the midst of a “systemic financial meltdown,” Eric Sprott warned yesterday as his company turned a quarterly profit of more than $11-million. “I’m not trying to be shocking to anyone, but let’s face it,” said Mr. Sprott, chief executive officer of Sprott Inc. “When Bear Stearns goes down, Freddie and Fannie go down, and IndyMac goes broke, we have major issues out there.” Toronto-based Sprott runs mutual, hedge and offshore funds. Mr. Sprott said assets under management increased to $7.7-billion in the second quarter, up from $6.8-billion at the end of March, despite operating in what he called a bear market.

Profit was $11.4-million, or 8 cents a share, compared to a year-earlier loss of $7.7-million. Revenue - management fees, crystallized performance fees, gains or losses from proprietary investments, interest and other income - was $39.5-million. While the company charges performance fees, they are not calculated until the end of the year and are distributed as a special dividend. The firm, which went public in April with a $200-million offering on the Toronto Stock Exchange, will load its funds with gold and energy stocks in the months ahead while selling the financial industry short. “We’re trying to position our funds to survive the difficulties,” he said. “We’ve gone into gold on the long side because it will survive as a replacement to fiat currency and into energy stocks because of our belief in the peak oil thesis.”

The Market Ticker
Henry Paulson is about to be given an $800 BILLION dollar blank check in the form of an increased Federal Debt Ceiling which he can spend on Fannie Mae and Freddie Mac IN ANY WAY HE CHOOSES, INCLUDING BUYING THE CRAPPIEST LOANS THEY HAVE AND STICKING A ONE HUNDRED PERCENT LOSS, $800 BILLION WORTH, ON YOUR TAX BILL. A huge percentage of the debt issued by Freddie and Fannie - about $1.5 trillion worth - is held by foreign central banks. Paulson is proposing to bail out the Chinese and Japanese governments with our tax money! Paulson SAYS he will “protect the taxpayer.”

THE BILL ALLOWS HIM TO SCREW YOU WITH ABSOLUTELY NO RECOURSE. More

Market Oracle
Many investors don’t look at the long term picture of what is happening. I am talking about looking at 10 to 20 year periods of time. If you looked that far out on a number of key stocks and indexes, you would understand the gravity of the current condition we are in. Freddie and Fannie have been the under pinning structure of our mortgage industry. Both of these stocks and institutions have crashed to levels not seen in 18 years. The gravity of the situation is very serious and a challenge that Bernanke and Paulson either don’t understand, or don’t know how to solve. It used to be said that, “As the automotive industry goes, so goes the country”. That was said in the days when we were still a manufacturing country. Then in recent years, Greenspan consistently stated that we were shifting from a manufacturing economy to a service economy. In other words, we were shifting all our manufacturing jobs overseas. General Motors is still an important facet of our economy, only their stock has crashed as well, and GM is now in some very serious trouble. As of yesterday, its stock was lowest value it has seen in decades. More