Satyajit Das opines that the tools available to central banks are inadequate to address the scope of the global economic problems we face.  The black box or shadow economy may involve the unwinding of “innovative” financial products/derivatives such that monetary and fiscal policy simply will not work this time. 

http://www.boston.com/bostonglobe/ideas/articles/2008/01/27/the_black_box_economy/

It’s no secret anymore that the monolines really don’t have the wherewithal to properly “insure” credit derivatives such as CDOs.  And the first hand evidence is piling in that the monolines apparently knew all along what they were doing — and kept right on “insuring” CDOs and other junky derivatives.  Why?  Profit, of course.  Where did all that money go?  Wherever it went, it’s high time for someone to go and get it back. 

My idea:  let the ratings companies (Fitch, Standard & Poors, et al.) who bestowed AAA ratings to this mess.  Perhaps they should disgorge all the revenue they collected as a result.  Seems as if they were unjustly enriched at the expense of …. all of us?

So - who spilled the beans?  Well, for one, former ACA Capital honcho (now literally put out to pasture?) as quoted at length in Bloomberg:

“Municipal bond insurers such as MBIA Inc. and Ambac Financial Group Inc. had a good thing going.  For years, they earned some of the highest profit margins in any industry — by writing coverage for securities sold by states and cities to build roads, schools and firehouses. 

(more…)

As we try and get our arms around the ultimate scope and outcome of whatever deleveraging is underway, here is a  ISDA generated document showing the notional amounts outstanding of derivative transactions (note that they’ve already adjusted these figures to avoid double-counting) beginning in 1997: 

 isda-market-survey-historical-data.pdf

 In ISDA’s 2007 survey of collateral, they found that 59% of derivative transactions were secured by collateral agreements, and that 59% of mark-to-market credit exposures were covered by collateral agreements. 

This is the nightmare scenario:  pension funds invested in CDOs and/or other derivatives are swamped by the massive unwinding process underway.   Where then does the money come from to pay retirees? 

This great unwinding has potential consequences not only for U.S. pensioners, but certainly the U.K. and possibly beyond.  Here is a terrific and concise explanation of the relationship between CDO downgrades and U.K. pension funds by Ken Griffin and Jeff Moskowitz: (more…)

* Chinese bank earnings will suffer because of subprime crisis and tighter monetary policy and macro-economic controls

(more…)

The risks of CDO meltdowns have been well-recognized for at least the last decade.  CDOs are necessarily dependent on the underlying collateral portfolio because CDOs necessarily separate the performance of the issuing bank from the performance of the issued notes.  The inherent risks of CDO nonperformance have long been known and discussed.  In her November, 1998 analysis, Karen Spinner gives an exceptionally cogent listing and explanation of these risks.  For example, Model Risk dictates that the investor consider the possibility that the rating agency’s models “may not bee 100% accurate.”  Liquidity Risk means that it is hard for an issuer to unwind a closed CDO structure. 

Her excellent piece is entitled “CDOs Under Fire - What will happen to CDOs if credit fears paralyze financial markets?”.  Too bad more institutional investors and other players apparently did not pay enough attention here.  Apparently the credit fears have now virtually paralyzed the financial markets and we’ll have to observe the actual consequences to these derivative instruments. 

Link to Spinner piece here:

http://www.derivativesstrategy.com/magazine/archive/1998/1198fea1.asp