The Worst is yet to come….The Alt-A / Credit Default Swap Crisis….

Junkdrawer

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Tue Feb-24-09 10:24 AM
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The Worst is yet to come….The Alt-A / Credit Default Swap Crisis….

Some weird happened. It seems that our biggest banks, investment houses and insurance companies woke up one fine day 10 years or so ago and decided they were actually London betting houses.

And they didn’t make millions or billions of dollars of bets. No, they made HUNDREDS OF TRILLIONS OF DOLLARS of bets.

How the hell did this happen? Well, let’s put it this way: Suppose I told you that an event was 99.999 % sure to happen 3 years from now and that you could legally bet on it, backed by the nation’s largest banks and insurance companies, and that the bet would pay off 100 to 1. Would you place the bet?

And, on the other side of the betting window, if I told you that if you constructed a bet that would attract billions of dollars of wagers, but wouldn’t pay off for several years; I’d give you a $50 million bonus that wouldn’t be taken back no matter how much would be lost when the wager came due. Would you construct the bet? Oh, now you might think that you have the moral fiber to resist such a temptation, but it doesn’t matter. Just about every decision maker in High Finance said “Yes! Yes, I’ll take those bets!”

So here we are. The bets were called Credit Default Swaps (CDS) and a large portion of them were made against so-called Alt-A mortgages. In case you haven’t been following the story, The “Alt-A Mortgage Crisis” is the upscale, time-release version of the Sub Prime mortgage crisis we just suffered through. I say “upscale, time-release” because the loan amounts were much larger and included teaser interest rates for the first several years of the loans that made them affordable until the rates reset. The biggest part of the resets are due latter this year:

And it wasn’t just one bet per mortgage. With the repeal of Glass-Steagall Act, hundreds or thousands of bets could be made against each mortgage and by parties that had no relationship to the mortgage. Hence the “London betting house” analogy. That’s why the numbers are so astronomical.

So, what can be done? Well…

1.) We do nothing and watch the nation’s largest banks and insurance companies go bankrupt. Lehman Brothers on steroids.

2.) We try to make the bets good. How we can make tens or hundreds of trillions of dollars of bets good is anyone’s guess.

3.) We step in and make sure that almost no Alt-A loan goes bad. BTW: I think that’s in the “Economic Stimulus Bill”. But even with more favorable rates, I’m not sure people won’t default – they still have real-estate taxes and utility bills on houses they could never afford.

4.) We could nationalize the banks and insurance companies after declaring all their current CDS contracts null and void. That should prove interesting to all the foreign bettors who currently fund our deficits.

Finally, what I find interesting is that so little of all the above is talked about openly in the press. Oh, we hear a lot about "The Sub Prime Crisis", but only a little about CDS and Alt-A. I’m guessing the thought is that if the full extent of the horror were known, people would retreat to their basements with stockpiles of canned goods and ammunition. Looking at the stock market for the past few weeks, I’m not sure that hasn’t already happened.