15 July 2009

Derivatives Crisis: More Bailouts On Deck?

The derivatives market is about as ugly as it gets, and puts a new edge on 'too big to fail, to big to exist."

The banks want to keep the game going because it suits their current model of taking risks, making huge bonuses, and writing off the losses to the public.

It remains to be seen if the Obama Administration has what it takes to regulate and rein in the banks. While Larry Summers and Tim Geithner are on the team the answer is probably 'no.'

One thing which strikes us as odd in this Bloomberg article is the emphasizing of stimulus as a source of future crisis. All things considered two trillion in stimulus across the globe is a relative drop in the buck-et compared to what the bank bailouts are costing in direct and indirect taxation on the real economy. Bloomberg seems to be crusading against anyone but the bigh banks getting public money, so perhaps it is not surprising.

As you know, CIT is deeply troubled, and most likely heading towards some sort of managed bankruptcy. The company is said to be holding counter party risk with many banks including Goldman Sachs. The rally may be based on strong rumours of an imminent bailout for CIT. The word on the Street is that Geithner and Summers caved again after a few key phone calls.

Let's see how the Obama Administration handles yet another financial institution brought low by bad risk management in pursuit of outsized profit.

Wall Street and their demimonde in the government and the media hate stimulus packages designed to assist the ordinary Joe, even if all it does is ease the pain during a steep downtrend (which was caused by the financial sector). They hate it, unless there is a way to charge fees in its distribution, and turn it into a profit-making venture for them where they derive most if not all of the benefits.

The dollar and the US bond are taking it repeatedly on the chin. As are most of the US public and the holders of its debt.

The timeframe Mr. Mobius has for the next major crisis is way out on the far edge of any projection we think is probable by quite some distance. Its not clear that it really matters, given the significant hurdles facing the economy this year.

Let's see how the Boys handle the burgeoning Commercial Real Estate, Pension, and Stage Government crises. I think they may very well precede the derivatives coup de grace, and several of them are big enough to be show-stoppers, if not triggers for a larger systemic meltdown.

Until the banks are restrained, and the financial system is reformed, and balanced is restored to the economy, there will be no sustained recovery.

The Obama team is incompetent, and probably worse. Its a great disappointment. They are showing all the wrong moves on the economy.

All the charts included here are from our friends at ContraryInvestor.

Mobius Says Derivatives, Stimulus to Spark New Crisis

By Kevin Hamlin (Beijing)

July 15 (Bloomberg) -- A new financial crisis will develop from the failure to effectively regulate derivatives and the extra global liquidity from stimulus spending, Templeton Asset Management Ltd.’s Mark Mobius said.

Political pressure from investment banks and all the people that make money in derivatives” will prevent adequate regulation, said Mobius, who oversees $25 billion as executive chairman of Templeton in Singapore. “Definitely we’re going to have another crisis coming down,” he said in a phone interview from Istanbul on July 13.

Derivatives contributed to almost $1.5 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg. Global share markets lost almost half their value last year, shedding $28.7 trillion as investors became risk averse amid a global recession.

The U.S. Justice Department is investigating the market for credit-default swaps, Markit Group Ltd., the data provider majority-owned by Wall Street’s largest banks, said July 13.

Mobius didn’t explain what he thought was needed for effective regulation of derivatives, which are contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather. The Bank for International Settlements estimates outstanding derivatives total $592 trillion, about 10 times global gross domestic product.

Looming Crisis

Banks make so much money with these things that they don’t want transparency because the spreads are so generous when there’s no transparency,” he said.

A “very bad” crisis may emerge within five to seven years as stimulus money adds to financial volatility, Mobius said. Governments have pledged about $2 trillion in stimulus spending.

The Justice Department’s antitrust division sent civil investigative notices this month to banks that own London-based Markit to determine if they have unfair access to price information, according to three people familiar with the matter.

Treasury Secretary Timothy Geithner last week urged Congress to rein in the derivatives market with new U.S. laws that are “difficult to evade.” He said strong capital requirements were the key.

Geithner repeated President Barack Obama’s call to force “standardized” contracts onto exchanges or regulated trading platforms, and regulate all dealers.

Credit Freeze

The plan to regulate the derivatives market is part of a wider overhaul of financial industry rules meant to prevent any possibility of a repeat of last year, when the collapse of Lehman Brothers Holdings Inc. and American International Group Inc. froze credit markets and worsened the global recession.

In the Senate, Agriculture Committee Chairman Tom Harkin, an Iowa Democrat, is pushing for legislation that would require all over-the-counter derivatives trades be traded on regulated exchanges, not just standardized ones as the Obama administration is seeking.

U.K. banks will be forced to curb trading activity that helped cause the global financial crisis, Britain’s top financial regulator said last month, while stopping short of seeking to separate their lending and securities units.

“Banks have lobbied hard against any changes that would make them unable to take the kind of risks they took some time ago,” said Venkatraman Anantha-Nageswaran, global chief investment officer at Bank Julius Baer & Co. in Singapore. “Regulators are not winning the battle yet and I’m not sure if they are making a strong case yet for such changes.”

Mobius also predicted a number of short, “dramatic” corrections in stock markets in the short term, saying that “a 15 to 20 percent correction is nothing when people are nervous.”

Emerging-market stocks “aren’t expensive” and will continue to climb, Mobius said. He said he favors commodities and companies such as London-based Anglo American Plc, which has interests in platinum, gold, diamonds, coal and base metals.

In China and India, Mobius sees value in consumer-oriented stocks and banks, he said.