Dow Drops 504 points

[echoes]

For some Americans, today has not been a good one due to this drop. It reminds me of the Friday after 9-11, when the Market re-opened.
Can remember holding my breath that day...it was a very long day... Have just read that todays drop is the worst since that day.

http://www.marketwatch.com/

September 15, 2008 4:44 P.M.ET

BULLETIN

Blue chips drop 500

It's the worst day for the Dow industrials in seven years, and Wall Street is in full tilt after Lehman Brothers fails to find a buyer but Merrill Lynch does. Stocks slump and bonds jump.

[Jack Moroney (RIP)]

While I am sure that this too will pass with a long and painful recovery, what bothers me most about this is not the dent in my investments as much as the total lack of accountability for those that were instrumental in precipitating the events that led to this day of reckoning. While this is not the end of life as we know it, it certainly is another indication that those in positions of power, as well as those of us that put them and keep them in power, need to pluck their heads out of their collective fourth points of contact and get this right. We are truly at a breaking point the in US's ability to secure its national interests at home and abroad-and for that you can thank our self-serving politicians.

[kgoerz]

Originally Posted by Jack Moroney

While I am sure that this too will pass with a long and painful recovery, what bothers me most about this is not the dent in my investments as much as the total lack of accountability for those that were instrumental in precipitating the events that led to this day of reckoning. While this is not the end of life as we know it, it certainly is another indication that those in positions of power, as well as those of us that put them and keep them in power, need to pluck their heads out of their collective fourth points of contact and get this right. We are truly at a breaking point the in US's ability to secure its national interests at home and abroad-and for that you can thank our self-serving politicians.

But the Dims say we are on the Highway of Hope, if we get off on the Exit Ramp of prosperity that leads to the side road to change. Whatever that means

[nmap]

The underlying problem is the derivatives market. As Lehman is liquidated, its securities must be sold to someone at some price. When that happens, we have a new, recent price for those securities.

However, a number of banks have their capital invested in such things. When the trade occurs, the banks must adjust their capital numbers - perhaps below minimum levels. Thus, there is a cascading effect.

The real excitement now is in AIG. They're looking for $75 billion after a credit downgrade. Will they survive? I certainly wouldn't buy their bonds, much less their stock.

This feeds back into the housing market. We had a robust housing market, partly due to freely available mortgage money. It is unlikely that anyone will touch new "creative" mortgage securities for quite awhile. Hence, perhaps less money for new mortgages - thus putting downward pressure on house prices. Will people keep paying the mortgage on a house that isn't worth nearly what they paid for it? Hmm.

By the way - the credit default swap (CDS) market is around $60 trillion dollars. (Yes, trillion with a "T"). It is unregulated, uncontrolled, and unreported. In essence, someone, somewhere guarantees that a debt instrument will be repaid. The lack of transparency in such a large market is problematic.

[Penn]

nmap, Thanks for the PM. Can you elaborate on the CDS market?

[nmap]

Originally Posted by Penn

Can you elaborate on the CDS market?

I'm glad to, Chef Penn.

Let's suppose someone wishes to purchase some bonds - say, $10 million dollars worth - but they want a guarantee that the bonds will fulfill their payments. They could pay a premium - usually, a small premium - and someone, somewhere guarantees that the bond will meet its terms. It is also possible to trade the CDS, so the person making the guarantee can sell it to someone else. One problem is that no one knows who is actually obligated.

As an example, someone might have guaranteed that an XYZ bond would not default. They then found someone to trade this with, perhaps making a profit. That person (or company, more likely) did the same. This may have happened many times - say, five times. Now, if XYZ does default, a bond holder would go to the original person making the guarantee. This person would point to the next person down the line, and so forth. This works just fine if the person at the end can perform - but - what if they cannot? They refuse to pay or default. You can see the end result. It all goes to court. And if the failure is large, their may be bankruptcies all around.

Add in another problem. The CDS market was highly leveraged - as I understand it, 20 to 1. A small series of defaults results in a large, bad outcome.

Here's an example of the price action, from todays WSJ:

On Monday, many of AIG's bonds traded at levels more reflective of junk bonds that are on the verge of default. Some of the bonds traded at less than 50 cents on the dollar, having fallen from more than 80 cents last week. In the market for derivatives contracts that provide protection against debt defaults, investors were agreeing to pay $2.5 million upfront plus $500,000 annually to hedge against a default of $10 million in AIG's debt over five years, according to data provider CMA DataVision. The cost is so high because sellers of the protection want to be adequately compensated for taking on the risk.

Key point: If a bank owns an AIG bond, and wants to buy insurance, it will cost $2.5 million dollars, plus $500,000 per year to guarantee $10,000,000 in debt over 5 years.

To put this in perspective, to guarantee U.S. Treasury bonds would cost about $25,000 for $10,000,000. By the way, that's up from $21,500 on Friday. So if you had made the guarantee on Friday, you would lose $3,500 if you liquidated it today. That's volatility. Now - if you had only put up about $1,500, you would have lost all your money plus another $2,000. LINK (Saying this another way - in this example, you would promise to pay $10,000,000 to a person buying insurance if the treasury bond defaulted. They would pay you $25,000 for doing this. If you suppose the default wouldn't happen, it's like free money. If the default does happen, there is a problem.)

AIG made a lot of these guarantees - but as overall fear in the credit markets increase, the cost to offset a guarantee goes up. Here is a link to some AIG-specific details: LINK

This goes to the bailout or not question. Bailouts are a problem. But not bailing them out can create lots of other problems.

Another link might be of interest... LINK

[echoes]

Originally Posted by Jack Moroney

While I am sure that this too will pass with a long and painful recovery, what bothers me most about this is not the dent in my investments as much as the total lack of accountability for those that were instrumental in precipitating the events that led to this day of reckoning. While this is not the end of life as we know it, it certainly is another indication that those in positions of power, as well as those of us that put them and keep them in power, need to pluck their heads out of their collective fourth points of contact and get this right. We are truly at a breaking point the in US's ability to secure its national interests at home and abroad-and for that you can thank our self-serving politicians.

Col. Sir,

You have very eloquently put so many Americans thoughts into words, indeed.

The only thing I enjoy reading as much as your posts, are posts about guns. Go figure?

Holly

[greenberetTFS]

Originally Posted by echoes

Col. Sir,

You have very eloquently put so many Americans thoughts into words, indeed.

The only thing I enjoy reading as much as your posts, are posts about guns. Go figure?

Holly

echoes,

I sincerely agree with you, JM really does an excellent job on this post....

GB TFS