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Crooked banks using credit default swaps to reduce regulatory capital requirements would have fallen over if AIG had not been saved.







I think that article deserves better prominence. This is the real problem.




AIG and an overlevered Europe?

Paul Kedrosky at Infectious Greed posted yesterday on how the US bailout of AIG “saved the European banking system”.

He picks up on a report from the Centre for European Policy Studies:

The AIG case shows the importance of another link across financial markets, namely massive regulatory arbitrage. The K-10 annex of AIG’s last annual report reveals that AIG had written coverage for over US$ 300 billion of credit insurance for European banks. The comment by AIG itself on these positions is: “…. for the purpose of providing them with regulatory capital relief rather than risk mitigation in exchange for a minimum guaranteed fee”. AIG thus helped to organise regulatory arbitrage on a gigantic scale. A formal default of AIG would have had a devastating impact on banks in Europe.

Yves Smith at Naked Capitalism also has a post.

It’s all true, but it’s only one half of the story. This kind of “regulatory arbitrage” is not just a game played in Europe. More or less every Wall Street bank does it - did it - too.

Under the Basel II capital rules securities have risk weightings based on their risk ratings. The riskier a security, the more capital a bank must set aside as a regulatory requirement. In the case of securitised securities, the standard Basel II risk weightings look like this:


(Tangentally, if it isn’t already, it should be pretty clear how absolute devastating mass rating agency downgrades can be to banks’ balance sheets)

This exciting table, however, isn’t the whole story.

And so we turn to the Basel II Accord, Part 2, section IV, subsection D, rule 4, paragraphs 583-588: treatment of credit risk mitigation for securitisation purposes.

Credit risk mitigants include guarantees, credit derivatives, collateral and on-balance sheet netting.

586. Credit protection provided by the entities listed in paragraph 195 may be recognised. SPEs cannot be recognised as eligible guarantors.


587. Where guarantees or credit derivatives fulfil the minimum operational conditions as specified in paragraphs 189 to 194, banks can take account of such credit protection in calculating capital requirements for securitisation exposures.


588. Capital requirements for the guaranteed/protected portion will be calculated according to CRM for the standardised approach as specified in paragraphs 196 to 201.

In non-Basel speak: if you own a risk weighted security, you can reduce its regulatory risk weighting by hedging against it using credit derivatives. A bank could thus own a security rated BBB (implied risk weighting: 100%) but using sufficient hedging -with, for example, AIG - treat the security as if it was rated AAA (implied risk weighting: 20%).

As noted, it wasn’t just Europe cashing in on this trick. Wall Street banks were huge players. Take Merrill Lynch, for example. Merrill virtually wrote its massive, $40bn+ billion subprime CDO out of regulatory existance using a negative basis trade - the fancy phrase that describes buying a security, and then using a hedge to offset its regulatory capital impact (while still skimming the spread of the bond yield over the hedge payments).



The difference between Europe’s banks and America’s in regard to the regulatory arbitrage trade is that by and large, European banks hedged with more reliable counterparties. Wall Street tended to use the monolines.


As the monolines went down, a lot of Wall Street’s banks saw their negative basis trades unwind.

With - it should be noted - the exception of one big player: Goldman Sachs. In an article in the NYTimes last week, it was stated that Goldman had hedges on around $20bn of securities with AIG:

Although it was not widely known, Goldman, a Wall Street stalwart that had seemed immune to its rivals’ woes, was A.I.G.’s largest trading partner, according to six people close to the insurer who requested anonymity because of confidentiality agreements.

So the US decision to bailout AIG might have saved Europe’s banks - but it had a much more direct aim of saving Goldman too.




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This is in breaking because it is URGENT that we get the word out to every citizen in this country about not only what is happening but why it is happening. Karl, your latest video (and tireless work on this) is awesome, but you left out the most important part: WHY is this administration absolutely desperate to buy $700 billion in toxic foreign debt *right now* before any more time passes? Understanding this is the key that unlocks the truth for everyone. I'm beseeching all of you here, please use this thread to explore, explain and enunciate clearly the REASONS this atrocity is being forced upon us. Substantiating hyperlinks are VERY helpful, please. We need to understand WHY this is happening.


The short version seems to be not only are all the banks insolvent, the country itself is insolvent. The fiat money system is about to fail. This could well result in not only GDII, but total World War as well.


Here is, from what I can tell, what is really behind the Paulson Plan:


1) The government's fiscal year ended yesterday

2) The interest on the national debt this year is going to be about $1 trillion dollars

3) The Treasury is about $700 billion short of being able to pay the interest

4) The Paulson Plan purchases about $700 billion in toxic foreign assets

5) The foreign banks and investors then will take that money and purchase US Treasuries

6) The USA does not default on its debt immediately, as is about to happen (financial Armageddon)

7) Foreign countries are threatening "panic selling of US debt": http://www.bloomberg.com/apps/news?pid=n....

8) Paulson/Bush will veto any Bill that does not have this provision


As others here have put it, this is the mother of all margin calls on US debt.


Quoting directly from a poster on another forum who has been referenced here in at least two threads:


"The whole point of this $700 billion 'gift' to the primary dealers is to keep the US Treasury bubble from bursting. Even at today's ridiculous artificially low Treasury yields, the interest on the Federal Debt is over $400 billion per year. This year's budget deficit was around $400 Billion. With next year's budget deficit expected to approach or maybe exceed $1 TRILLION, they will need to have the primary dealers be able to absorb an ADDITIONAL $600-$700 Billion. Do you think they plucked that $700 Billion figure out of thin air? Paulson's plan is to give the primary dealers $700 billion of balance sheet relief with the understanding that they replace DOLLAR FOR DOLLAR the toxic mortgage securities they offload to the Taxpayer with newly issued US Treasuries. This whole thing is about lining up financing for next year's HUMUNGOUS Federal Budget Deficit in advance. The $700 Billion "gift" allows the primary dealers to handle $600-$700 Billlion more in expected 2009 Treasury issuance than they were able to do this year. They were able to handle $400+ Billion this year, so with $700 Billion of "help", they should be able to absorb the $1 Trillion next year. This how you go about financing (or at least try to) a $1 trillion budget deficit without printing. The real reason for this "bailout" is not that complicated and does not require any Tin Foil at all. Can you imagine Paulson and Bernanke telling a Congressional Committee that they expect the economy to completely tank next year and that the budget deficit is going to approach or exceed $1 Trillion? And by the way we need you to help the Primary Dealers out with $700 Billion in balance sheet relief at taxpayer expense so that they can help us finance it. No. They can't do that. So this is what we get. Vague references to "financial meltdown". It's not like they are out-and-out lying. Failed Treasury auctions will not produce pleasant consequences for anyone in the US. My point is that this "bailout" is not part of some Wall Street conspiracy to loot the US Treasury and taxpayer. Sorry to spoil everybody's fun. Rather, it is how the Treasury gets prepared to finance next year's gigantic budget deficit without printing money. I have said before that I am sure that the Chinese have already made "the phone call". The one where they say "You start printing and we start selling.""


Here are the primary dealers: BNP Paribas Securities Corp., Bank of America Securities LLC, Barclays Capital Inc., Cantor Fitzgerald & Co., Citigroup Global Markets Inc., Credit Suisse Securities LLC, Daiwa Securities, America Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co., RBS Greenwich Capital, HSBC Securities Inc., J. P. Morgan Securities Inc., Merrill Lynch Government Securities Inc., Mizuho Securities USA Inc., Morgan Stanley & Co. Incorporated, UBS Securities LLC


These primary dealers (PDs) all have hopelessly impaired balance sheets (they are insolvent) and as a result Treasury auctions are on the brink of total failure. And if Treasury auctions fail...


Financial Armageddon.


Put in it's simplest form, the Emperor has no clothes.


Please, fellow Market Ticker members, and especially please Karl, comment on this and help shape it into something powerful that can be used to help get the word out TODAY.


We cannot let our country fall into the abyss, and we cannot let our Constitution be destroyed by the abrogation of the separation of powers. WE MUST STEER THIS AS CITIZENS IN EVERY WAY POSSIBLE TO ENABLE AND ENACT A SUSTAINABLE OUTCOME!


Any clarifications, corrections and amplifications in this presentation of the crisis would be very helpful. Thanks.

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Very Scary.

A thought I had while reading it:-

My understanding is, in the US, the Fed buying US treasuries *is* "printing money"?

So the Fed buying worthless paper off the dealers and then the dealers buying US Treasuries, that sounds a lot like printing money too.

I think the Chinese might figure that one out. (If the article above is correct)

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Some interesting pieces in yesterday's FT:


"Settlement day approaches for derivatives"

The "auction season" starts tomorrow, when the International Swaps and Derivatives Association has scheduled an auction for Tembec, a Canadian forest products company. This is followed by Fannie Mae and Freddie Mac auctions on October 6. Then, Lehman is settled on October 10, and Washington Mutual is scheduled for October 23.




More depth:

"A new formula?"

Efforts are also under way to force more trading activity on to electronic exchanges, in an effort to cut paper-based backlogs. In another effort to cut bottlenecks, traders are also "tearing up" contracts - essentially removing old deals that cancel each other out in economic terms. The CDS market recently saw its first ever decline in total trades outstanding because tens of trillions of dollars of contracts had been torn up.



(apolgies if already posted)

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Something fishy is definitely going on at UBS



Olivant in touch with Lehman to protect UBS stake

Wed Oct 1, 2008 12:39am EDT


ZURICH, Oct 1 (Reuters) - Activist investor Olivant said on Monday it was in contact with the administrators of collapsed bank Lehman Brothers to secure its 2.78 percent stake in Swiss bank UBS, which the fund holds through Lehman.


Olivant, the investment company of former UBS CEO Luqman Arnold, made headlines earlier this year when it clashed with UBS's new management and openly called for a separation of the Swiss bank's troubled investment banking business from its money-generating wealth management arm.



Olivant staff 'devastated' over suicide

Updated 14.44 Sun Sep 28 2008


Staff at a private equity firm are said to be devastated at the apparent credit crunch-linked suicide of one of their senior colleagues.


Olivant's chief operating officer, Kirk Stephenson, 47, died on Thursday morning after the married father-of-one threw himself in front of a commuter train near Taplow station in Buckinghamshire, police said.


Luqman Arnold, chief executive of Olivant, said: "Everyone at Olivant has been devastated by the news of Kirk's death."


Mr Arnold, former boss of UBS investment bank and Abbey National plc, added: "Our thoughts and prayers are with Kirk's wife and family."



UBS seen announcing more writedowns this week.


ZURICH, Sept 29 (Reuters) - Swiss bank UBS is expected to announce fresh writedowns before its Oct. 2 shareholder meeting but may try to present this as a turning point as the writedowns will be smaller than in previous quarters, analysts say.



UBS to Cut 1,900 Investment Bank, Equities, Fixed Income Jobs


Oct. 1 (Bloomberg) -- UBS AG, the European bank with the biggest losses from the credit crisis, may announce plans to eliminate about 1,900 jobs in its investment banking, equities, and fixed income units at its Oct. 2 shareholder meeting, two people with knowledge of the matter said.



Swiss banks 'well capitalised' - Government

Tuesday, 30 September 2008 15:01


Switzerland's two biggest banks UBS and Credit Suisse are 'well capitalised' and there is no reason for the government to intervene in their operations, a finance ministry spokeswoman said today.


'UBS and Credit Suisse are well capitalised institutions; state intervention is not necessary,' the spokeswoman said.

and now:

Zurichers Say UBS `Won't Go Bankrupt' Like Swissair


Oct. 2 (Bloomberg) -- Hartmuth Wetzel stood in front of UBS AG's headquarters in Zurich, watching a flat-panel screen through a window for signs of a rebound in the Swiss bank's shares.

``UBS won't go bankrupt,'' said the 65-year-old industry consultant, who was debating the financial crisis in a crowd of mostly middle-aged men nervous about the fate of Switzerland's largest bank. Wetzel said the stock had already fallen too much for him to sell it, and besides, he has his cash in the bank. ``That's my hope.''




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pesto's latest:




Smack smack - we're dead


* Robert Peston

* 2 Oct 08, 09:05 AM


If the patient is the financial economy, here's a smattering of the latest worrying symptoms.


1) National Savings has been overwhelmed by calls from anxious savers wanting to lend their money to HM Treasury rather than keep it in a high street bank. And there's also been such a rush to place deposits in taxpayer-owned Northern Rock that it's had to suspend its more attractive products and is turning money away.


Bank of Ireland2) There's been a flight by some British savers to the safety of Irish banks, where deposits are 100% protected by a government guarantee. And here's an odd thing. Yesterday Ulster Bank, a subsidiary of Royal Bank of Scotland, was given 100% deposit protection by the Irish government, on the same basis as the independent Irish banks. So it's now safer for both wholesale and retail depositors to put their money into Ulster Bank than into RBS's NatWest subsidiary in the UK.


3) Austrian, South African and US mints are working 24/7 but still unable to press enough gold coins to meet soaring demand.


4) As I disclosed on the Ten O'Clock News last night, British banks urged the chancellor and the governor of the Bank of England at a hastily arranged meeting on Tuesday to please please let them swap their car loans, their loans to companies, their commercial property loans for cash from the Bank of England - because of their deep concern that wholesale funds are draining from the system. The banks felt they received a sympathetic hearing from the chancellor and a relatively hostile one from the governor. The banks fear, perhaps guiltily, that Mervyn King's understandable desire to see them spanked for their past sins and deterred from repeating their errors could turn out to be a capital punishment (smack! - no more banks).


5) Those same banks told the chancellor that their real vulnerability isn't the instability of retail savings, of the fear that the likes of you and me will move our modest amounts of cash. What really worries them is that huge wholesale deposits made by professional money managers are harder and harder to retain. And what the banks warned is that the Treasury may find itself having to follow the example of the Irish by guaranteeing retail and wholesale deposits (though the Treasury is reluctant to do this, because of how it would automatically lead to a ballooning of the national debt).


And now for the complicated and scary stuff. Today is the beginning of "auction season", when the International Swaps and Derivatives Association starts a series of auctions to settle who pays what to whom on a plethora of credit derivative contracts relating to businesses that have gone into default.


It's settlement time on those humungous insurance policies for corporate debt, called credit default swaps, which I've mentioned to you as being another potentially lethal flaw in the financial economy.


Lehman Brothers building, New YorkIn the coming three weeks, payouts of hundreds of billions of dollars may be made - or at least demanded - to cover losses arising from the defaults on the debt of Fannie Mae, Freddie Mac, Lehman and Washington Mutual.


Sandy Chen, the analyst at Panmure who's been a smart predictor of credit-crunch accidents, estimates that payments on Lehman's battered bonds could be as much as $350bn.


Now the problem here is that for every beneficiary of these payments, there's an underwriter - those who provided the CDS insurance - which has to find the cash. And, as I've pointed out, this was a largely unregulated market, so the great fear in markets is that some underwriters have insufficient capital and will simply collapse when the claims are made.


That in turn would hurt financial institutions expecting to be paid out on their CDS contracts and damage others with separate exposure to the collapsed businesses. The shock to the system could be very severe.


To compound the current anxiety about all this, the CDS market is so opaque that it's impossible to know right now who is holding the radioactive baby.


This gigantic CDS mess has contributed to the seizing up of money markets in recent weeks, the tendency of all banks and financial institutions to hoard cash - because no-one knows who or what may be vulnerable during the CDS auction season.


That, as if you needed telling, is just one more reason why the US $700bn bank bail-out is no panacea, even if we should be relieved that it has passed its first Congressional hurdle.


The financial weather ahead remains stormy and unpredictable.


PS. The most significant British corporate announcement today was that Marks & Spencer is slashing capital spending, It was planning to spend up to £900m this year on improving stores, its supply chain and computer systems. That's being reduced to £700m - and next year it'll be slashed to £400m.


In other words, M&S will be placing far fewer orders than planned with other businesses - which will have a damaging impact on their profits and on the prospects for their employees.


That's a graphic illustration of how the horrors of the financial economy are infecting the real economy.



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If anyone thinks Lie-bor is just allowed to fluctuate freely, he must be kidding himself.


I read no bank is lending to another. Why is Lie-bor not at 20%-40% then? Maybe because it just can't be allowed to? :o



Libor, set by 16 banks in a daily survey by the British Bankers' Association at about noon in London, is used to set rates on $360 trillion of financial products worldwide, from home loans to derivatives.


``There are a lot of bids but no offers,'' said Pang Meng Yam, a money-market dealer at KBC Bank NV in Singapore. ``There's no lending, most money markets are frozen and the discrepancy between the benchmark rates and the actual trading rates are getting wider.''

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If anyone thinks Lie-bor is just allowed to fluctuate freely, he must be kidding himself.


I read no bank is lending to another. Why is Lie-bor not at 20%-40% then? Maybe because it just can't be allowed to? :o



Have you noticed that the Hong-Kong anchorwoman on Bloomberg pronounces it Lie-bor? Just last night I was watching and thinking it was more accurate.

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Breakdown Approaches Climax


Jim Willie CB

Jim Willie CB is the editor of the "Hat Trick Letter"

Oct 2, 2008



The bond crisis is absolute, broad, deep, and all-inclusive, enough to kill the USTreasurys after it kills the US banking system.


the USFed instructing them to perhaps be ready for a one-week universal shut-down of the banking system,


One should remember that debt solutions accomplish nothing in providing remedy for debt abuse and damage inflicted by broken debt contraptions.


The USGovt swallowed two really big ugly hairy hungry tapeworms, that will possibly each cost an extra $1 trillion in unplanned expenses.

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Not sure if this has been posted, BBC are saying Wells Fargo is taking over Wachovia




The US bank Wells Fargo is to buy its troubled rival Wachovia in a $15.1bn (£8.5bn) deal, after Wachovia ditched a deal with Citigroup.

Wachovia had provisionally agreed a $2.16bn US government-backed rescue with Citigroup.


Wells Fargo's purchase of Wachovia will create one of the biggest US banks.



Wells Fargo, based in San Francisco and considered one of the strongest banks amid the market turmoil, said that the deal requires no assistance from the Federal Deposit Insurance Corporation or any other government agency. It will raise up to $20 billion by issuing new shares, primarily common stock.

By acquiring Wachovia, Wells Fargo will now gain the big retail banking network it has long sought. Though it has long been well-regarded by bank analysts and observers — and counts Warren E. Buffett as one of its largest shareholders — the firm has not had a significant presence east of the Mississippi.


Wells Fargo said Monday that it would mark Wachovia’s assets down to fair value, a potential sticking point for other banks because of the charges that would incur. A big-enough capital-raising campaign would alleviate pressure on Wells Fargo.



Edit found additional link


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The system is blowing up NOW.



Kaupthing: fears grow over financial strength

Major broking clients of Kaupthing have transferred derivative positions to other brokers this morning.


By Richard Fletcher and Amy Wilson

Last Updated: 12:39PM BST 03 Oct 2008


A number of London brokers reported that Kaupthing clients had moved positions held via Contract for Differences (CFD) after the Icelandic bank significantly increased the margin that clients had to put up.


"They have told clients they want to deleverage," said one London stock broker who has seen a number of clients transfer positions from Kaupthing. "It's great for me. I'm doing loads of business this morning, but you do wonder what is going on over there".


The move has increased the markets fears about the financial strength of Kaupthing, one of Iceland's largest banks, which is reported to be in talks with the Icelandic government.


The cost of insuring against Kaupthing defaulting on its debt jumped 1105.4 basis points to 3,306.


Kaupthing is the major backer of several British investors including Robert Tchenguiz, who has significant stakes in supermarket chain Sainsbury and pub operator Mitchells & Butlers.

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The system is blowing up NOW.


The cost of insuring against Kaupthing defaulting on its debt jumped 1105.4 basis points to 3,306.



Wasn’t Bear Sterns around 700-800 when it popped?

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I love the headline :D




How do you say “This sucker is going down” in Icelandic?


Whispers, unanswered telephone calls, stone-walling, firm “no comments”… Something was up in Iceland on Friday.

The immediate focus was Kaupthing - one of Iceland’s two largest banks. The price of its CDS has now spiked through 2500bp, suggesting the credit markets believe default is imminent. Sources suggest emergency talks are now underway between Kaupthing and the Icelandic authorities.




But this is a run on a country’s financial system, not just one institution. The collapse of the Icelandic krona continued apace, threatening to hit 156 against the Euro on Friday.

And, behind the scenes, some furious finger-pointing is underway. The snap nationalisation of the third largest Icelandic bank, Giltnir, has led to accusations that the central bank, the Sedlabanki, has intensified the crisis by drawing attention to severe liquidity problems affecting all the country’s banks. Rival brokerages in London say most trading lines to Kaupthing and its main rival Landsbanki, were cut earlier in September.

Some sort of statement from the Sedlabanki is awaited.

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What makes you think that this can't happen to GBP?



Offshore Icelandic crown trade ceases - traders

Fri Oct 3, 2008 8:30am EDT


LONDON, Oct 3 (Reuters) - Offshore trading in Iceland's crown currency had dried up by Friday as fears mounted over its high leveraged banking sector following the partial nationalisation of local lender Glitnir, traders said.


According to Icelandic central bank data, the euro was quoted at 156.18 crowns, up 0.32 percent on the day, with contributions seen mainly from domestic banks.


But offshore dealers said the euro had been trading about 7 percent higher at between 162-167 crowns.


One trader said the euro was quoted as high as 170 against the crown.


"There is an onshore/offshore market developing for the currency. The local dealers are dealing at one level, slightly below the international banks," said Elisabeth Gruie, currency strategist at BNP Paribas in London.


"We're still quoting it, but at very small amounts below 1 million euros as we're settling small amounts for some clients," she said, adding that the divergence in trade began on Thursday morning.


"No one is updating the prices at the moment," a Copenhagen-based trader said.


"The banking sector is falling apart in Iceland. If that happens it threatens the entire economy."

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I guess Iceland will either end up on the Fed's balance sheet, or the ECB's. (Yes, I mean the whole country: everything toxic in Iceland, including sulphur hot spots. :) )

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Money-Market Rates Climb to Records, BOE Relaxes Funding Rules


The London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars increased to 4.33 percent, the most since January, the British Bankers' Association said. The corresponding rate for euros climbed to 5.33 percent, an all-time high. The Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record and Asian bank rates climbed to the highest levels in at least nine months.


Libor, set before noon in London every day after a survey conducted by the British Bankers' Association on the cost of dollars, euros and eight other currencies, determines prices for financial contracts valued at $393 trillion as of Dec. 31, influencing consumer interest rates on everything from home loans to credit cards. ...



Posted On: Thursday, October 02, 2008, 12:08:00 PM EST


A Modern Day Weimar


Author: Jim Sinclair



Dear Extend Family,


Unless the LIBOR rate drops sharply we are facing a planetary financial crisis next week.


For God's sake protect yourself.


Gold and gold related items will be the only true storehouses of wealth. The bailout bill is powerless to reverse what is now happening.


This is a modern day Weimar happening right before our eyes.


Respectfully yours,


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