"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

23 November 2006

Blowing up a $370TRILLION Derivatives Market


London Hedgies often lead on market turns

Why GM is Worth Less than its Stated Debt-not off-balance sheet and not equity. Why Kerkorian is dumping his position (finally)

here's what is really interesting about the Kerkorian news: Kerk has seen the inside numbers. he has been advised by Jerome York from beginning. I hate York, but he's an original Chrysler guy from when Chrysler financially reorganized and an ex-CFO and he understands auto industry accounting. this news event means that York has told Kerk to bail after examining the books for the last 6 or so months.

what reinforces this is the fact that Renault/Nissan took at pass at investing in GM - remember during the summer when it was made a big media deal that GM was seeking 3 billion each from Renault and Nissan? They too got to check under the hood and see the real numbers and they too passed.

Now, the question begs, what did they most likely see that they did not like?

1) GMAC. the widely heralded sale of GMAC was more like a partial sale/leaseback with several free options for the buyers (Cerberus and banks) to bail. GMAC is a junk-rated entity that I'm sure is loaded beyond belief with derivatives, and GM could not monetize GMAC for obvious reasons and GM is still carrying GMAC on its balance sheet, despite efforts to effect a transaction which would shed GM of the burden of GMAC. GMAC is financial nuclear waste.

2) Pension woes. That explains itself. However, I will add that GM raised $18 billion in a bond deal about 20 months ago or so. $13 billion of that was injected into the pension fund in a financial engineering move that supposedly was going to eliminate the pension funding deficit. About 6 months after the bond deal, one of the better Wall Street credit analysts announced that GM's pension was underfunded by at least $31 billion...why bond investors would bail out GM's pension fund is a complete mystery to me. but the deal added 18 billion in debt to GM's balance sheet and GM's ability to service its debt has deteriorated since the time of that bond deal.

3) failed operating model. that explains itself.

The bottom line is that GM, in total (GM + GMAC), is more than likely not worth even the face amount of the outstanding debt, let alone the debt plus the market value of the stock (enterprise value). If I had to hazard an educated guess, absent a Government bail-out "in the best interests of the public," I believe GM will be in bankruptcy within 2 years.
GM Being Looted before Bankruptcy Filing-Kirk Dumping
- a total fiasco and no one seems to care about the individual shareholder, workers, past employees and car buyers. Gee, how good a vehicle would YOU build if your pension benefits were eliminated, half your co-workers got laid off over the past two years, and your housing market is collapsing..

Kerkorian selling GM says Faber on CNBS
Faber said everyone was talking about the price declines over the last few days. Surprise. York off the board, GM parts suppliers getting stiffed, derivatives blowing out and oh, the former Treasury Secretary John Snow-job is stealing GMAC from the GM equity holders. This stock is going to be a shell with lots of pension and health care obligations and NADA else

GM Got No Bailout from USG during Nov 14 meeting- BUT $21.75B Treasury TOMO and FED repos pre Thanksgiving

TOPIX, Nikkei down as banks drop, small-caps hit

(Reuters) - Tokyo's broad TOPIX share index fell 2.52 percent on Monday, logging its lowest close in nearly four months as bank shares declined ahead of earnings and investors fretted about a possible end to tax breaks. Some market participants said rumours of trouble at U.S. hedge fund Citadel Investment Group LLC triggered selling of stocks.

Small-cap shares plunged 6 percent to a three-year low, reflecting bearish retail investor sentiment. "The big investors are all too bearish, and individual investors are getting burned," said 77-year old Yoshio Tomita outside the trading room off a small Tokyo brokerage. "I don't own a lot of stocks, but I got hit pretty bad today." Sanyo Electric Co. Ltd. plunged to a 31-year-low on reports it would likely post a net loss for the current business year, missing its forecast for an annual profit. Other technology stocks also fell in the wake of drops in their U.S. counterparts, helping the Nikkei 225 average to post its biggest one-day percentage loss since July 18.

The TOPIX was down 39.60 points at 1,533.94, the lowest close since July 26. The TOPIX's percentage fall was also the biggest one-day drop since July 18. The Nikkei shed 2.27 percent, or 365.79 points, to 15,725.94, the lowest since late September. Shares of Japan's second-largest lender Mizuho Financial Group Inc. lost 3.1 percent to 823,000 yen, and Mitsubishi UFJ Financial Group Inc., the world's largest by assets, fell 2.8 percent to 1.38 million yen.After the market closed, Mizuho reported a 15.9 percent rise in first-half profit on Monday as falling bad-loan costs outweighed a decline in its mainstay lending business, and it left its full-year forecast unchanged.

Hurting market sentiment were concerns about the expiry of temporary Japanese tax breaks on stock investments in 2008. Preferential tax rates on capital gains and dividends were introduced in 2003 for a period of five years to support the faltering stock market. (US Tax cuts OVER in 2008 also. A government panel is expected to propose ending the tax breaks as planned, and a final panel decision will likely be made by next month. "Rich retail investors are quite sensitive about taxes. This will have a significant impact," said Norihiro Fujito, general manager, investment research and information division at Mitsubishi UFJ Securities Co. Ltd. Fujito's view was echoed by Taizo Nishimuro, president of the Tokyo Stock Exchange (TSE), who blamed concern about securities taxes for the recent sluggishness in the market.

Small caps led the fall. The Mothers index plunged 6.2 percent to 1,022.54, a three-year low. "Share prices are low enough and there are attractive issues, but they all fall once the market heads south," said Shuichi Hida, portfolio manager at Plaza Asset Management.

In addition, currency traders in New York on Friday cited rumours that a large U.S. hedge fund had suffered losses this month, prompting some closing out of dollar long positions. (Dollar is TOAST) A spokeswoman at Citadel's Tokyo office declined to comment, but the Wall Street Journal reported on Friday that a U.S. spokesman for the company had denied the rumours.
"The hedge fund in question did deny (the rumours), but hedge funds will be reporting their earnings this month, and it does seem that speculation is spreading," said Hiroaki Kuramochi, managing director at Bear Stearns (Japan) Ltd. Chicago-based Citadel manages some $12 billion in assets, according to the company's homepage.

Advantest, a manufacturer of chip-testing gear, fell 4.1 percent to 5,870 yen. Fellow chip-gear manufacturer Tokyo Electron Ltd. lost 4 percent to 8,570 yen after the tech-heavy Nasdaq Composite Index slipped 0.13 percent.

Oil and gas developer INPEX Holdings dropped 3.4 percent to 902,000 yen, adding to a 3.5 percent fall in the previous session. Crude oil futures were at $58.36 a barrel in early Asian trade on Monday after falling to a 17-month low of $54.86 last week.

Trade volume rose to 1.94 billion shares, the highest daily volume since Sept. 8. Decliners swept past advancers by a ratio of 24 to one.
(Additional reporting by David Dolan)

The broad TOPIX was down 2 ½ percent overnight. While the Nikkei 225 fared better, it was only because of the "flight to safety" (to big name stocks) that accompanies panic in herds of investors. A little more reasonable explanation is the extremely troubling report from the Bank for International Settlements that derivatives trading globally is up 25% Year on Year (YoY) and the shocker is that the notional value of the derivatives turnover this year will be (hold on to you coffee) 11½ times all of the money made on earth this year. In other words, Global GDP will be between $60.6-trillion and $61-trillion [plus or minus a small country or two] this year while the derivatives turnover will top $750. ($800T annualized)

The biggest bubble of all - derivatives Trading Soars to $370 Trillion – it will be the root cause for global depression
Alan Hershey
Nov. 17, 2006 -

An interesting data came out from the Bank for International Settlements. The global market for derivatives soared to a record $370 trillion in the first half of 2006. It is the highest ever and the bubble is bigger than any one can imagine.
The kind of euphoria in derivative trading has never been seen before. The amount of outstanding credit-default swaps contracts jumped by 60% at the end of last year. This year the rise is even faster. It is a typical pyramiding technique. Money is creating false concept of money and that in turn is creating ever lager conceptual money. When the tide blow off and balloon bursts, the catastrophe will be unimaginable. The 1929 debacle and resulting depression will be miniscule to what is coming.

The derivatives were initially designed for hedging. It has now become the instruments of trade. An example of what can happen is as follows. Recently when Amaranth, the hedge fund, did bet on the wrong side of the natural gas market, it lost billions in days and went out of business drowning the capital of many investors. But something more sinister happened in London credit swap market. On the news of Amaranth's problem, the credit swaps based on Amaranth funds collapsed creating massive problem for the London credit instruments markets. Even the little hedge fund was able to bring the market to its knees. Thinks what can happen when many hedge funds collapse at the same time.

Remember 1987. Before the October crash public were arguing about the fact that the market will not give an inch on the down side. Every individual investor was in the elevator at the Penhouse level. Finally when the crash came, the brokers did not pick up their phones and Dow lost more than 20% in one day. Something much more serious is getting cooked here. The complacency level, the sentiment indicators and above all the fundamentals are all ready to make the market collapse big time.

The biggest bubble of all - derivatives Trading Soars to $370 Trillion – it will be the root cause for global depression
Alan Hershey
Remember 1987. Before the October crash public were arguing about the fact that the market can give an inch away. Finally when the crash came, the brokers did not pick up their phones and Dow plunged for that 20% in one day.

Oil price and housing collapse continue as stocks look down to see the fundamentals to weak to support the recent hefty gains – a 40% correction
Sam Adelton
The real estate housing collapse continues. Housing starts fell in October by 14.6% to the lowest level in six years. Building permits, an indicator of future building activity, fell for a ninth straight time.
Since you mentioned derivatives..
NEW 11/21/2006 10:59:10 AM

...please allow me to take this opportunity to rant a little more on interest rate derivatives.

We are told that interest rate derivatives are innocuous and only help offload risk.

Well, let me give you a scenario where they screw shareholders and bondholders:

To take a simple example, let's say Company A has $100 million in floating-rate debt.

And Company B, with a better credit rating, has $100 million in FIXED-Rate debt.

So far, so good, right?

Now, the two companies do a swap. Company A agrees to pay Company B a "premium" to swap cash flows on the debt. Company gets to now enjoy a fixed rate on $100 million in debt.

Company B gets a premium payment from Company A

Finally, of course, Company B now has to pay the "floating-side" of the bet, er, swap, leaving them vulnerable to interest rate swings.

But of course, the argument goes, Company B has been compensated for this risk by whatever premium Company A paid them.

However, here is the reality:

Company a had to pay FLOATING rates in the first place because they are a POORER credit risk than Company B.

So, when Company A gets to switch out their floating rate debt for fixed, they are essentially "leaning on" the good credit rating of Company B.

Now, think about it. Did Company B's investors (shareholders AND bondholders)REALLY want to have Company A's floating rate debt on their backs?

Answer: NO, or they would have bought Company A stock or bonds in the first place!!!

Finally, since the entire swap transaction can be held "off balance sheet", Company B's investors probably don't even KNOW they are exposed to this risk.

Now, take that small example and times it by, literally, TWO-HUNDRED SEVENTY MILLION times (to get to the $270 TRILLION in interest rate derivatives alone!) and you can see why Bulldog is so, so right.

Monday, October 23, 2006
That Word Again, Derivatives
In what I believe will be a broken record, some firms are digging through their derivatives minefields and coming clean on "accounting issues.. As long as the cognoscenti can play Alice in Wonderland make believe, it apparently doesn't really matter. Ford is already a weakened, bleeding company, with massive credit swaps written against it, so Riskloves are once again treading in croc infested waters on this story. Ford said it discovered that since 2001, certain interest-rate swaps Ford Motor Credit had entered to hedge the interest-rate risk inherent in certain long-term fixed rate debt were accounted for incorrectly.

Elsewhere in toxic waste land, we see marked deterioration in various tranches of mortgage backed securities. The default rate for subprime loans rose to 7.35 percent in July (three more months of weak prices, and rate resets ago) from 5.51 percent a year earlier, according to investment bank Friedman Billings Ramsey Group Inc. in Arlington Virginia. Accordingly credit swaps backing this cesspool, have quickly spiked as well. The true test will come when these claims are actually presented for "collection" and we learn who the counterparties are.

The ABX index, which measures the risk of owning bonds backed by home-loans to people with poor credit, rose 30 percent since Aug. 9 to the highest since January. There are more than $500 billion of such notes outstanding.
The US Treasury will be putting the markets to the test this week, having announced that $10 billion in new money will be raised for the four week Bill, on top of the $21.5 billion for bills and notes. The five year TIPs Old Maid Card was once again nicely supported by FCBs who took half of it. Yields on three month and six month bills were pushed up however, going off at 5.124%, and 5.174% respectively.

On Sunday I conducted a radio interview with Lee Adler of Wall Street Examiner. I was on a cell phone so sound a little muffled, but think we covered Riskloves, Ponzi finance, credit spreads, moral hazard, and global carry trades pretty well. Hopefully this will help readers with those terms. Interesting, follow on from about the Las Vegas Ponzi unit example I cited in the interview:
David M. Crosby, a Las Vegas bankruptcy attorney, says he has seen a ’surge’ in borrowers with mortgage problems. ‘Most of it is [tied to] the end of the housing boom, but I do see a good percentage of clients who got caught by a change in their mortgage rates.’ In addition, some clients ‘bought a number of speculative homes,’ he says. ‘The market turned on them, and now they are in a real financial mess.’”“Some homeowners are calling it quits. ‘A surprising number of people are walking away from their homes rather than trying to save them,’ says Mr. Crosby, either because the rate on their loan has jumped or because they owe more than the home is worth.”
Business Week accurately portrays private equity firms in Gluttons at the Gates.

10:15 AM - 6 eprops - 3 comments - email it

Sunday, October 22, 2006
Weekend Reading
Recommended interview with David Levy nails the points, but I'm not so sure he's right about speculators refusing to budge on price. Flippers in trouble.

9:14 AM - add eprops - add comments - email it

Barbarian takes down the gate - BOJ can no longer manipulate currency to gain American jobs. The strong banks of Japan which buy US bonds to keep their currency low can not with stand the financial markets that are taking on the US dollar. Japan, also, is unable to keep wheat prices artificially low. A practice that they have used for years to deprive farmers in foreign countries the true market price of their grain.

The US dollar found itself defenseless against the world traders selling dollars ahead of the long holiday weekend, as traders pounced on the opportunity to send it significantly lower against its foreign counterparts. Experts cited a cascade of stop loss orders as the primary driver for the surprising move, with unchanged fundamentals providing little underlying cause for such a breathtaking dollar drop. Leading the barrage, the Swiss Franc was the top gainer with a 1.1 percent appreciation against the Greenback. Yen traders were not far behind unable to manipulate the currency by bond buying of US bonds, pushing the USDJPY 0.9 percent lower through the psychologically significant 117.00 mark. Japan also is unable to keep wheat prices locked in price. Japan has had a fixed price for 24 years for the sale of wheat by foreign countries. The market-up in the price of 70% on wheat sold by the government to gain millers is used as a subsidy for wheat farmers in Japan.

US traders hoping for a quiet market ahead of the extended holiday weekend were sorely disappointed to see the Dollar Index post its largest drop in over a month. What likely surprised the majority of traders was that such a decline occurred on no new US news, with relentless stop-hunting providing a jump in volatility. Market makers seemingly took advantage of low liquidity on the holiday-shortened week to drive dollar-long position off of their books. This notably sent currency pairs such as the EURUSD and GBPUSD beyond key resistance levels and the Dollar Index to two-month lows.

Pronounced dollar declines left many traders questioning whether this was the start of a larger-scale shift against previous Greenback resilience. Looking to other markets for clues, we see that specific US securities did not follow in the currency’s footsteps?leaving vague implications for the future of dollar movements. On the one hand, muted bond and interest rate futures action suggests that traders see little reason to change outlook on the US economy. On the other hand, the dollar's pronounced weakness on purely technical trades suggests that bears may dominate rolling forward. Proprietary volume data suggests that the former is the common perception, with speculators taking very one-sided US dollar long positions in expectation of a retrace. Regardless, traders will likely need to wait until Monday for an answer to this question, as trade is likely to prove uneventful through extended holiday weekends in the US and Japan.

And this perspective smells it too


Post a Comment

Links to this post:

Create a Link

<< Home

POST /RPC2 HTTP/1.0 User-Agent: Java Host: Content-Type: text/xml Content-length: 300 weblogUpdates.extendedPing personal|friends