Friday, 27 November 2009 00:00

Markets Gap Down 3 pct., Sovereign Nations Nearing Default or Firesale, Can't Say I Didn't Warn You

First, a quick news scan:

My regular readers should remember my warnings on the currency trade risks (Japan's Hirano can testify), and interest rate derivative concentrations (let's see what happens to the counterparty daisy chain if Dubai defaults): "The Next Step in the Bank Implosion Cycle???". As excerpted:

Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!


High dependency on Forex and interest rate contracts

Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.

In terms of absolute dollar exposure, JP Morgan has the largest exposure towards both Interest rate and Forex contracts with notional value of interest rate contracts at $64.6 trillion and Forex contracts at $6.2 trillion exposing itself to volatile changes in both interest rates and currency movements (non-subscribers should reference An Independent Look into JP Morgan, while subscribers should referenceFile Icon JPM Report (Subscription-only) Final - Professional, and File Icon JPM Forensic Report (Subscription-only) Final- Retail). However, Goldman Sachs with interest rate contracts to total assets at 318.x and Forex contracts to total assets at 11.2x has the largest relative exposure (see Goldman Sachs Q2 2009 Pre-announcement opinion Goldman Sachs Q2 2009 Pre-announcement opinion 2009-07-13 00:08:57 920.92 Kb, Goldman Sachs Stress Test Professional Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb, Goldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb,). As subscribers can see from the afore-linked analysis, Goldman is trading at an extreme premium from a risk adjusted book value perspective.


Let's not forget about the other subjects in today's news as market and US futures approach the 4% loss mark for the day. In Dubai, word has it that if creditors reject proposals to postpone near-term debt obligations until May 2010, the Dubai government could be forced to hold a fire sale of its international real estate. In order to avoid what is probably inevitable (that real estate is probably being carried on the books at the same outrageous premium that US REITs and banks are carrying their real estate at), Dubai World is asking for a reprieve from their lenders. In other parts of the world, I am sure the Japanese multinational corporations are pressuring the government to intervene on behalf of weakening the currency.

All of the events above have the propensity to inject volatility into the carry trade and currency/interest rate derivatives market, which I have written about in the past. We are talking trillions of dollars of risk, essentially unhedged (or hedged between a small handful of counterparties with very high correlations and related exposures, as I said, essentially, unhedged). If one catches a big default, it will daisy chain, causing the others to hog capital and liquidity (as if they weren't doing this already), thus exacerbating what is going to be a monumental problem for commercial REITs and US RMBS, consumer and small business debt, and mortgages stateside.

Let's go over some of those I told ya' so's, but before we do I just want all to know that this might not even be the catalyst to bring us back to respecting fundamentals. Dubai World is by far not the only player that binged on debt during the bubble to dabble in overpriced, rapidly depreciation assets. Reality will start rearing its (now rather ugly) head in many other places throughout the globe and sooner (or later) it will pop up in a place that causes this big, globally central bank coordinated charade to come tumbling down (Dubai Shows Limits of Government Rescues, Roubini’s Das Says). It may be this (black) Friday, next (black) Monday, or some other day in the future. All I know is that there are still hundreds of billions of dollars of losses in the system that have been ignored as risky asset prices have partied like it was 1999. After all, it is not as if Dubai World was the only one binging at the free credit punch bowl, where they??? Now, back to some of those I told you so's...

The following is a Must Read for those that think the big US banks will be immune to contagion and shocks born across the pond in interest rate and currency markets: An Independent Look into JP Morgan. This contains the "public preview" document (JPM Public Excerpt of Forensic Analysis SubscriptionJPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb), which is free to download.

  1. If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?
  2. If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 - JP Morgan
  3. If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - BAC (the bank
  4. If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 4 - Wells Fargo
  5. If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 5 - PNC Bank

I will be releasing some very interesting research to subscribers along with public excerpts today and Monday. Posting will be very light today(except for one research report) due to the holidays, but I will be following the markets closely and may comment.

Last modified on Friday, 27 November 2009 00:00


  • Comment Link Reggie Middleton Tuesday, 01 December 2009 13:20 posted by Reggie Middleton

    I definitely hear where you're coming from. The only problem is the danger of jumping on the momentum driven bandwagon. You reaaly never know when it will crash. Since fundamentals have been thrown to the wind, the only thing that keeps prices up is that some is paying a higher price than the other guy. No metric to drive the price, no way to guage the extent.

    As for their not being another crash, logic dictates that won't be true, but logic has not prevailed lately, has it?

    What will precipitate a drop or crash is when someone defaults big time. The risk in Dubai is not their debt problems, but the risk of those problems exposing the fairy tale that is counterparty risk and hedging among a closed circle. It is real. If Dubai get's away without paying, how about all of the other nations/sovereigns that binged? Ireland? Spain? Nearly all of eastern europe!

  • Comment Link none Tuesday, 01 December 2009 13:10 posted by none

    fed up with this rally. Yes, countries will be driven to bankruptcy eventually but it's still a couple of years away at least. Canada still has a housing bubble and lineups for new yet-to-be-built condos.

  • Comment Link none Tuesday, 01 December 2009 13:08 posted by none

    Looks like Japan has stepped in to kick the can down the road until the New Year.

    I don't believe there will be a serious market drop from here on in. I thought there would be all summer and fall but there is always some new bailout available from somewhere. Look at oil prices too - the will NOT go below 75% for more than a few hours. Nevermind the CNBC BS about it being worries about Dubai 'easing' account for this rally - it's f***ing Japan. The next round it'll be the ECB or Germany again, or China. It will not stop.

  • Comment Link Anthony Harrison Tuesday, 01 December 2009 07:39 posted by Anthony Harrison

    As state-owned investment conglomerate Dubai World announced its plans to restructure debt (a phrase widely abused by many US companies to obliquely say that they are unable to pay debt), the jitters were felt in US real estate. Dubai World directly and indirectly (through Nakheel and Istithmar World) has significant exposure in several well-known properties in US commercial real estate market such as $ 8.5 bn CityCenter project with MGM Mirage, Mandarin Oriental & W hotels in New York and Fontainebleau Miami Beach resort.
    Last month delinquencies on U.S. commercial real estate loans (CMBS) reached 4.8%, more than six times the year earlier level which has already exposed the so called recovery. In addition, Dubai World may be forced to sell some of its US properties at distressed prices, which would further drive down prices of not only commercial but also residential real estate. Further, while U.S. banks don’t have significant direct exposure, Big UK banks, such as Standard Chartered, Royal Bank of Scotland and Barclays are much more exposed to Dubai World. But in a world of integrated financial system, it’s hard to pin point that who bears the ultimate default risk.

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