Thursday, 23 October 2008

The Tsunami Offshore: the on-coming CDS meltdown

The blogosphere has been buzzing the past few weeks with talk of the huge Credit Default Swap tsunami currently being held offshore by the global bail-out. Speculation is that it'll come crashing in shortly after the US elections - the stability of which is the main reason our futures have been hocked.

This morning blogger GolemXIV posted the following summary of where we're currently at on the Guardian website. Manuscripts Don't Burn cannot better it, so with due credit to GolemIV, we'd like to post it in its entirety. You can see the original here.

"We are entering the second and more dangerous phase of this financial melt down. As corporations begin to go down the CDS and CDO's written on their debt will blow up.

"When they do, the holders lose massive amounts of money. They are losing often 90 cents in every dollar. Most of the institutions making these losses are also still highly leveraged. This means a small loss is enough to force them to have to raise more real cash to cover their losses and replace their capital holdings.

"To raise the cash they have to sell assets, call in debts or seek yet more help from the governments.

"Selling assets is depressing the value of those asset types on the market making all the other holders of that kind of asset a little bit poorer. Bringing them, in turn, a little closer to having to sell themselves.

"Calling in debts forces those from whom you call in the debts closer to bankruptcy. This is the situation with Gmac the finance arm of GM. It is virtually bankrupt and may file very soon. To stave that off, Gmac is forcing the GM dealers to whom it has loaned money to pay up. They are starting to go bust. They default on loans and round we go.

"Sovereign nations have been offering themselves as the backstop to every bad debt brought to them. If they don't stop NOW they will find their own debt, sovereign national debt, is down graded. This may happen to US national debt quite soon.

"Once that happens we are facing a Bond market dislocation. After that I won't be writing any more as there will be no point.

"This is NOT a liquidity crisis it is a Solvency crisis. The banks are insolvent. They know it. It is why they won't lend. The only lending they are doing is on the basis of the real cash the governments have injected. The governments have essentially created little banks inside the carcasses of the banks who are still poisoning the financial stream with all the worthless and toxic debt backed paper they refuse to admit is worthless.

"The banks and governments have refused to admit these assets are worthless. Refused to force them out and to take the losses and begin to rebuild.

"All that is happening is the real worthlessness of the paper is leaking out slowly as one entity after another is poisoned and goes under. Basically the stuff is putrefying and leaking out.

"This isn't rocket science. Even though the bankers would like you to think it is.

"Imagine a group of men walking across an ice sheet. They are roped together for safety. Or as the financial world characterizes it - to spread the risk. Great in theory. But each man is carrying an anvil of debt. One man, lets call him Lehman, falls through. The ropes tighten, everybody stops still. No one can move. Lending stops.

"What they should do is collectively put down their anvils and let them slip down the hole Lehman made. Huge losses but the ice is safe, then hole doesn't widen. But none of them will do this. Each is convinced that one day their anvil of debt will turn to gold and they'll be rich once more. So they stand there slowly dragging each other towards the hole.

"As they get pulled closer together, their combined weight threatens to crash the entire ice sheet. The bad news is WE are all living on that sheet."

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