Thursday, 26 November 2009 19:00

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

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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 KbGoldman 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.

Read 8173 times Last modified on Friday, 27 November 2009 01:16
Reggie Middleton

Resident Contrarian Badass at BoomBustBlog (you can call me Editor-in-Chief)...

Disruptor-in-Chief at, where we're ushering the P2P Economy.
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