geauga illuminati: April 2009

Wednesday, April 1, 2009

COMMENT HERE

the purpose of this post is to allow for any general comments or suggestions underneath by visitors to this blog...i'd like to make this a little more interactive, so be free with your opinions...(not sure, but you may have to sign into blogger to comment) ....if an answer seems neccessary, ill try to respond...rj

A short story...The Chrysler Bankrupcy

why couldnt chrysler work out a solution short of bankruptcy with its creditors? it was because chrysler's credit default swap holders had a perverse incentive to root for bankruptcy. briefly, a CDS basically is an unregulated insurance policy on debt (ie, bonds) that pays off if the creditor defaults...the holders of any CDS are ususally themselves bondholders in any distressed company...there’s no limit to the amount of exposure one can take in CDS contracts referencing a particular credit, more than the actual debt involved, so it can be profitable to load up on CDS and then buy just enough of the actual bonds so that you can force a bankruptcy...the bettor loses on the bonds he owns, but gains far more on the CDS that pay off as a result...
theres further explanation of credit derivatives & naked CDSs in the comments & articles below...

Public-Private Investment Partnership is a Scam

Insiders can easily game the system created by Geithner and Summers, costing taxpayers up to a trillion dollars or more. Here's how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders. Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total. Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large. http://www.alternet.org/workplace/135532/the_geithner-summers_plan%3A_even_worse_than_we_thought/?page=entire
this gaming of the PPIP doesnt even have to be done in the obvious fashion above...the holders of the toxic assets can use a similar scheme to buy each others toxic waste & leave the taxpayers holding the bag...the execs at Goldman Sachs, who had input into designing the plan, are probably licking their chops...

Derivative markets: An understandable explanation

HEIDI'S BAR
Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Heidi's drink now pay later marketing strategy and as a result, increasing numbers of customers flood into Heidi's bar and soon she has the largest sale volume for any bar in Detroit. By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively. A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide. Naive investors don't really understand the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation's leading brokerage houses. One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. Heidi demands payment from her alcoholic patrons, but being unemployed they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy. DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The decreased bond asset value destroys the banks liquidity and prevents it from issuing new loans. The suppliers of Heidi's bar, having granted her generous payment extensions and having invested in the securities are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers. The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed middle-class non-drinkers.
Finally an explanation we understand.
(anonymous)

my take: the only part missing to this explanation is that some financial institutions also started selling insurance on those Drinkbonds, promising that if they defaulted, they would be swapped for US treasury securities...these insurance securities were unregulated, and a "naked" casino-like market developed betting on them, that was a hundredfold the value of the underlying bonds, and financial institutions that had no part of the original bond transaction were selling & buying these swaps, as if all your neighbors took out fire insurance on your house, and all hoped to collect in full if it burned down...thus a whole zoo of these exotic instruments & counterparty agreements was spawned from those Drinkbonds; for more info, see "Recipe for Disaster" & links for size of derivatives bubble & CDSs below...

geauga illuminati

Wednesday, April 1, 2009

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A short story...The Chrysler Bankrupcy

Public-Private Investment Partnership is a Scam

Derivative markets: An understandable explanation

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