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Thursday, February 11, 2010

PSW: The Fed / CDS Development

Phil at Phil's Stock World wrote an article this morning that deals with the Greece bailout, new Fed CDS Developments, and some housing related news. The second one is of major interest because it dwarfs the other two in potential impact.

The Greece bailout is small potatoes in comparison. I am not being flip (not overly so at least), because these small potatoes will become large potatoes in the not-too-distant future. The progression would be something like Dubai -> Greece -> Portugal -> Italy -> Spain -> Ireland. Fears over sovereign debt grows in one economy and then spreads to the next larger one. In fact, I fully expect that Greece will be bailed out, and no it is not a good thing. It is moral hazard kicked into a higher gear, because then the pressure is off the next most susceptible economy to change its ways because it will expect to get bailed out.... which of course it will. Which spreads the risk to the next large economy (hence the progression). The latest issue of The Economist had a much smarter plan regarding the IMF handling the default, but nobody wants that.... well politicians don't want that, so moral hazard it is. But at least until the systemic risk spreads a little more, the Greece Default issue is not the major economic news.

On the other had, something I have been hearing very little about has a much bigger potential impact: The new Fed CDS policy. If you are interested, read on below.

Here is the Full article - Bailout? Greece Don’t Need No Stinking Bailout!



Speaking of strong banks - Our beloved Fed is now backstopping $25Tn in Credit Default Swaps with, of course, YOUR MONEY.  You were obligated this week as the Fed approved an application by the Depository Trust & Clearing Corporation to operate "the Trade Information Warehouse (Warehouse) for over the-counter (OTC) credit derivatives."  The new Fed-endorsed organization will settle CDS obligations in all currencies and process credit events. It will also include all OTC credit derivatives traded worldwide, and will be regulated by the Fed and the NY State Banking Department and will be overseen by other US and International regulators


As Zero Hedge points out: "What all this implies is that basis spreads will likely compress very shortly, once counterparty risk becomes a thing of the past and all systemic risk in the biggest derivative market out there (ex IR swaps) is fully backstopped by the Federal Reserve. It will also guarantee the DTCC monopoly status when it comes to CDS trading as nobody will desire to transact and/or clear elsewhere. We shudder to think if the Fed grants DTCC with exclusive status for IR and FX swaps as well, and the associated $600 trillion notional outstanding." Oh come on, what can go wrong?

By eliminating step 3 entirely, the Fed/DTCC entity becomes the Freddie Mac of the CDS world and hedge funds are free to run out and write all sorts of nonsense papers knowing they have a rich sucker who will buy it all - no questions asked (except by Congress about 12 months AFTER it all falls apart). Yes, it’s your tax dollars at work or, rather, all the tax dollars you are likely to pay as a nation for the next decade now obligated to keep the CDS scam going rather than forcing it to scale back by simply NOT supporting it when it fails.

Speaking of kicking an explosive can down the road - CitiMortgage (C) announced that they will let some delinquent borrowers remain in their homes without making mortgage payments for six months if they voluntarily transfer ownership to the bank. "We are concerned that if there is a foreclosure glut at some point in the cycle it would have to have a negative impact on house prices, and Citi’s pilot program should help prevent a build-up in foreclosed homes," said Sanjiv Das, the chief executive of CitiMortgage.

The CitiMortgage pilot program provides incentives for more borrowers to use a procedure known as a "deed in lieu of foreclosure," in which the borrower voluntarily transfers ownership of the home to the lender, which then cancels the mortgage debt. Aside from letting such people stay in the homes for six months, CitiMortgage says it will give them at least $1,000 to cover relocation costs, an incentive sometimes dubbed "cash for keys."

Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP, estimates 7.1 million of the 7.9 million households behind on their mortgage payments will lose their homes to foreclosure if nothing is done to improve current loan-modification programs. She believes banks should put much more emphasis on loan modifications that reduce the principal for people who are deeply under water. 315,716 brand new foreclosure notices were sent out in January, up 15% from last January, according to RealtyTrac. That’s a rate of 1 in 34 homes over the year. In Nevada, it was on in 95 homes, but that was for January ALONE - divide that by 12 and it’s one in 8 for the year.
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