Wednesday, September 24, 2008

Bait & Switch: Blame it on Fannie

The current Republican myth is that mortgage giants sucked the credit lubrication from America's economic engine. That's odd, as Fannie Mae and Freddie Mac were taken over on September 7, backed by the full faith and credit of Uncle Sam. Investors and the stock market cheered the action.

How did that oil intervention not work? The financial house of cards collapsed September 18, the day Morgan Stanley's credit default swaps soared to $900,000 for one year's peace of mind on $10 million of their debt. That's 9 times last summer's $100,000 amount, already considered junk status. September 19th, the Treasury Chief declared emergency and an intent to meet with Congressional leaders. That meeting took the oxygen out of the room.

Paulson & Bernake stated in their Senate Banking testimony that credit derivatives were critical to America’s financial system but didn’t have the infrastructure to deliver on their promises. Normally, when you sell something and fail to deliver, it's called fraud.

Lehman held $740 billion in derivative investments when it failed. While not all were credit derivatives, this off balance sheet area provided the greatest risk to Lehman Brothers. Goldman and Morgan Stanley hold alot more risky derivative instruments, in the trillions.

Goldman Sachs held $2 trillion in derivatives as of November 20, 2007, (page 148 of their latest annual report). That is the firm's maximum payout amount. Morgan Stanley had $7.1 trillion in derivatives, (page 147 of Morgan's report).

They also package and sell such instruments. This comes from Goldman's latest 10-K:

Credit Products. We offer to and trade for our clients a broad array of credit and credit-linked products all over the world, including credit derivatives, investment-grade corporate securities, high-yield securities, bank and secured loans (origination and trading), municipal securities, and emerging market and distressed debt. For example, we enter, as principal, into complex structured transactions designed to meet client needs.

In addition, we provide credit through bridge and other loan facilities to a broad range of clients. Commitments that are extended for contingent acquisition financing are often intended to be short-term in nature, as borrowers often seek to replace them with other funding sources. As part of our ongoing credit origination activities, we may seek to reduce our credit risk on commitments by syndicating all or substantial portions of commitments to other investors or, upon funding, by securitizing the positions through investment vehicles sold to other investors. Underwriting fees from syndications of these commitments are recorded in debt underwriting in our Investment Banking segment.

This is the linkage (as referred to by President Bush) that seized up last week. The bailout was caused by a huge gaseous backup in unregulated financial instruments. Uncle Sam intends to manage its discharge. It is clearly intended to save the wealth of the rich.

Fannie and Freddie were already saved when overpriced credit derivatives started backing up Goldman’s colon, putting severe pressure on its rectum. Thus, they called their ex-CEO for some relief. Uncle Sam stands ready with cases of Gas-X and money to buy $700 billion of crappy corporate credit.

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