On Monday, Asian stock markets took another
beating, on fears that the credit squeeze which began in the United States will
continue to worsen in the months ahead. Every index from Tokyo to Sidney fell
sharply continuing the "self-reinforcing" cycle of losses started
last week on Wall Street. The Nikkei 225 average fell 3.3 percent, India's
Sensex 2.9 percent, Taiwan's 3.5 percent, and Hong Kong's Hang Seng slumped 4.5
percent. The subprime tsunami is presently headed towards downtown Manhattan,
where nervous traders are already hunkered-down in the trenches -- ashen and
Amid the deluge of
bad news over the last weekend, one story towers above all the others. The yen
gained 1.5 percent against the dollar. (9 percent year-over-year) That means
that Wall Street's biggest swindle, the carry trade, is finally unwinding. The
over-levered hedge funds will now be forced to sell their positions quickly
before the interest-rate window shuts and they're stuck with humongous bets
they cannot cover. The faltering yen is the grease that lubricates the
guillotine. $1 trillion in low interest loans -- which keeps the trading
whirring along in US markets -- is about to get a haircut. Cheap Japanese
credit is the hidden flywheel in Hedgistan's main cylinder. Once it is removed,
the industry will seize up and clank to a halt. Fund managers can forget about
the vacation rental in the Hamptons. It'll be sloppy Joes and Schlitz Malt
Liquor on Coney Island from here on out.
Over the weekend,
Deutsche Bank announced that losses from "securitized" subprime
mortgages were likely to reach $400 billion. The news sparked a sell-off in the
Asian markets where investors have become increasingly eager to pare down their
holdings of US equities and dollar-backed assets. Overnight, the greenback has
become the leper at the birthday party; everyone is steering clear for fear of
contagion. Foreign central banks are looking for any opportunity to dump their
stockpiles of dollars in a manner that doesn't disrupt their economies or the
global financial system. Their intentions may be prudent -- even honorable --
but it won't forestall the inevitable blow-off of US dollars that is likely to
commence as soon as the financial giants reveal the real size of their losses.
New regulations have been put in place that will require the banks to provide
"market prices" for their assets. This will expose the degree to
which they are under-capitalized. When word gets out that the banking system is
underwater, there'll be a run on the dollar.
Last Sunday, the AFP
reported that the Group of Seven richest nations (G7) is considering direct
"intervention" in the dollar's decline to prevent a "disorderly
"It is not too
early contemplating the risk of coordinated interventions by the G7," said
Stephen Jen and Charles St. Arnaud of investment bank Morgan Stanley.
"History shows that multilateral, coordinated interventions have been key
in establishing turning points in multi-year trends in major currencies in the
past three decades." Last Thursday, Treasury Secretary Hank Paulson, full
fathom five under the waves on the poop deck of the Titanic, communicated
through speaker tube the news, "A strong dollar is in our nation's
interest and should be based on economic fundamentals."
Bloomberg News: "More than $350 billion of collateralized debt obligations
comprising asset-backed securities may become 'distressed' because of credit
What's clear is that
the situation is getting worse, not better. Honesty must at least be considered
as one of many options, although the Treasury Dept. avoids that choice like the
plague. Eventually, the public will have to be told about what is going on.
Last week, the Financial Times reported: "In recent days, investors have
been presented with a stream of high-profile signs that sentiment in the
financial world is deteriorating. However, deep in one esoteric corner of
finance, another, little-known set of numbers is provoking growing concern.
So-called correlation -- a concept that shows how slices of complex pools of
credit derivatives trade relative to each other -- has been moving in unusual
ways 'What we are seeing in the synthetic [derivative] markets is that there is
a serious fear of systemic risk,' says Michael Hampden-Turner, credit
strategist at Citigroup. 'This is not just about price correlation within the
collateralized debt obligation market, but about a potential rise in default
correlation and asset correlation.' Until recently, traders often tended to
assume that there was relatively little correlation between different chunks of
debt, because they thought that the biggest risk to the world was idiosyncratic
in nature -- meaning that while one company, say, might suddenly default, it
was unlikely that numerous companies would default at the same time. However,
some regulators have been warning for some time that in times of stress
correlation does not always behave as traders might expect."
dollar derivatives industry -- which has never been tested in down-market
conditions -- is now moving sideways. No one really knows what this means
except that the most opaque and volatile debt-instruments are now threatening
to unravel, triggering a cascade of unanticipated defaults and a colossal loss
of market capitalization. Credit default swaps (CDS) are rarely thrashed out in
market commentary. They are counterparty options which provide hedging against
the prospect of default. They are, in fact, a financial equivalent of the San
Andreas fault line which is quivering menacingly as foreclosures mount and
mortgage-backed bonds continue to implode. As the Financial Times suggests, the
shock waves should be sweeping through the Wall Street trading pits in the very
There are also new
developments on the sale of "marked to model" CDOs, the red-haired
stepchild of the new structured finance paradigm. "The trustee of a $1.5
billion collateralized debt obligation managed by State Street Global Advisors
has started selling assets, apparently starting a process of liquidation,"
Standard and Poor's said. The sale is a red flag for the other holders of $1.5
trillion of CDOs who've been waiting for market conditions to change before
they try to sell their mortgage-backed bonds. The liquidation will assign a
"market price" to these complex structured investment vehicles. If
the price at auction is mere pennies on the dollar, then the banks, pension
funds, and insurance companies will have write down their losses or add to
their reserves to cover their weakening assets. Simply put, the State Street
sale could turn out to be doomsday for a number of under-capitalized investment
banks. Their revenues are already down; this would be the last stake to the
Noland, at Prudent Bear.com reports on the "looming disaster" at
Fannie Mae, where the best-known Government Sponsored Entity (GSE) has entered
into the current housing slump with a "Book of Business of mortgages, MBS
and other credit guarantees of $2.7 trillion" which is backed by a measly
"$39.9 billion of shareholder's equity."
As Noland concludes,
"A devastating housing bust will bankrupt the mortgage insurers, while the
solvency of their derivatives counterparties going forward will be in doubt in
any number of scenarios. The GSEs are now integrally linked to what I expect to
be Credit insurance's and 'structured finance's' astonishing downfall."
The only thing
looking up are oil futures. And they'll be denominated in euros soon enough.
Whitney lives in Washington state. He can be reached at email@example.com.