Dow Drops 504 points

[kgoerz]

Originally Posted by nmap

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

This is why I only invest in Land, The price of Dirt never go's down.

[Pete]

Looks like the road is a bit more rocky in Russia.

http://www.bloomberg.com/apps/news?p...efer=worldwide

Second day they closed the markets early.

[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

[nmap]

Originally Posted by Team Sergeant

This will not be a national problem; this financial crisis will effect the entire globe.

Just my .02

TS

Words of wisdom, and well worth reflection.

Today, gold was up $90 an ounce to $870 per ounce. Meanwhile, the Dow has broken important support levels.

The next thing to look for is a run on the dollar; one indicator is an extended increase in the price of gold and other commodities. The next one to watch is the price of bonds. If bonds start going lower, and interest rates higher, then we could be in for some challenging times.

One problem is that the U.S. dollar is the world's reserve currency. We have, in essence, had a very large line of credit that never had to be repaid, all at zero interest. If faith in the dollar cracks among foreign nations, then the value as compared with other currencies will decline - probably a lot. We, the U.S., will wind up paying much higher interest rates to finance our deficits.

There are indications that consumer discretionary spending may be in for a move downward too. But this must surely affect the entire world - from China and Mexico, and many other places as well. Our consumers will suffer distress, purchase less - and thus draw other nations into recession as well.

Kgoerz may do very, very well with his land. Perhaps refugees from Wall Street will offer to work for room and board. (That was an attempt at humor, by the way).

[Sweetbriar]

How will T-bills do? I put my retirement into them years ago and never got around to putting them back in the market. Growth is always slow, but I was waiting for a correction in the economy....

[nmap]

Originally Posted by Sweetbriar

How will T-bills do? I put my retirement into them years ago and never got around to putting them back in the market. Growth is always slow, but I was waiting for a correction in the economy....

T-bills are the short term variety, with a maturity of a year or less. They should be fine - one of the best and safest places to be, in my opinion. Even if interest rates go up, the new issue each year provides an improved yield.

Longer term bonds may be more problematic. Their long term nature makes them go down quite a lot if interest rates go up significantly.

Short, safe, and liquid are good goals - and you have all three with T-bills.

[echoes]

Originally Posted by kgoerz

This is why I only invest in Land, The price of Dirt never go's down.

Sir,

That's what my uncle, (and grandpa before him,) would say.

Have to admit, am not too happy at my tax dollars being spent to "bail out" yet another financial institution.

Yet, I will really have a problem if the CEO's DO walk with their multi-million dollar retirement pack's, and the rest of the employees are left holding the bag. Am all for big-business, but think that if my tax dollars are bailing out their poor decision making...it just 'aint right.

Just my humble .02

Holly

Originally Posted by greenberetTFS

echoes,

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

GB TFS

Indeed Sir! The Col. certainly has a way with words!

[Team Sergeant]

Cascading effect...... I don't see an end in sight, I do hope those at the helm of this crisis have cool heads.




Clobbered: Dow Plummets 449 on Credit Fears

Credit fears swept Wall Street on Wednesday, pushing the blue chips to their second epic selloff of the week and overshadowing the Fed's emergency takeover of insurance giant American International Group.

Today's Market

The Dow Jones Industrial Average slid 449.36 points, or 4.06% to 10609.66, the Standard & Poor’s 500 dropped 57.22 points, or 4.71%, to 1156.38 and the Nasdaq Composite lost 109.05 points, or 4.94%, to 2098.85. The FOX 50 fell 36.83 points, or 4.21%, to 838.16.

The losses pushed the Dow to its lowest level since November 2005 and the broad S&P 500 to a reading unseen since May 2005.

“Just because the government gave an $85 billion life preserver to AIG doesn’t mean everything is fine. If anything, there is more concern. There are significant credit market fears," said Michael James, senior equities trader at Wedbush Morgan Securities.

http://www.foxbusiness.com/story/mar...l-aig-bailout/

[Red Flag 1]

nmap,

Thanks!

I feel we are a nation living on credit/debt...over extended, and praying to not be caught too short.
Folks have already been caught short on housing loans; they were "approved". Is there another shoe?

Lord I hope we have this right!

Jim

[CoLawman]

Nmap,
Thanks for the reply. Troubling times indeed. It is times like this that I am thankful that I have secure employment. I just never knew I would be doing this job while using a walker!

I need to get on meds or seek counselling as I still have this compulsion to "Buy".

[Pete]

Futures and now we have short selling and then you have naked short-selling.

Why do I get the impression that there are a bunch of people playing the money game that don't have any real money or things?

[Razor]

Dow rises 410, S&P up 50, NASDAQ up 100 at close of market today.

[Penn]

nmap, Is it correct to assume that this article on the governments action, forestalls a world wide depression, caused by the bad bets in the mortgage markets? And is it also true, that the sub prime mortgage market that was created is linked to the Feds willingness to lend banks money without oversight on their balance sheets? If they are both true, is it correct to assume that by creating this new agency, the Government is, in essence, buying out the debt via a guarantee on the American economy and taxpayer?
If these assumptions’ are correct; how then are those who made their bets in this market held responsible. Secondly, would not the Government take possession of the assets as well as the debt? And would the debt be sold off, a la Milkins junk bonds, which create a new market? And the hard assets, would they be sold?
Or, are we, the American people, guaranteeing a bad portfolio with no hard assets and nothing to recover or sell?

http://www.bloomberg.com/apps/news?p...B.Y&refer=home

[bravo22b]

Disclaimer: I am not a finance guy, nor have I ever played one on TV.

My (admittedly limited) understanding of how this might work is that the government would agree to buy assets from these financial institutions that are illiquid because it impossible to put a value on them. If we are talking about the government buying these packages of securitized mortgages, or CDO's (Collateralized Debt Obligation), then the government is indeed buying something that has a hard asset behind it, namely somebody's house. That of course raises a lot of questions about what exactly the government is going to do with all this real estate.

If the government buys these assets, it does a couple of things. One, it gets the assets that are bought off the books of the financial institution. Second, it sets a price for these assets that the financial institutions can then use to assign a value to similar assets that they still hold on their books. This may help them from suffering the type of overnight under-capitalization that seems to be causing all these firms to go belly up.

What seems to be a further, if not well reported, problem is that the paperwork for some of these CDO's is missing. In other words, let's say a given CDO consists of the mortgage debt of 10,000 houses. The person that owns that CDO theoretically should have or have access to the titles for each and every one of those 10,000 houses to prove that they, in fact, own the mortgage. It seems that a lot of this paperwork is lost or did not follow the CDO when it was sold, and maybe even re-sold, several times. So the firms that own these CDO's may not even be able to prove that they actually own the mortgage, preventing them from foreclosing and/or re-selling the property.

It will be interesting to see how this all shakes out. Bill Gross from PIMCO suggested ( I think tongue-in-cheek) that the government buy up millions of houses and then bulldoze them to reduce the over-inventory of houses for sale, thus correcting a large part of the real estate problem in one fell swoop. Maybe he was kidding, but what will happen if the government suddenly finds itself owning millions of homes that may or may not have been foreclosed on, and that they may or may not have title to? Could be interesting.

[ZonieDiver]

Biography
An unremarkable civilian with a background in securities brokerage and computer science.

Nmap,

I think you need to consider changing part of the above description. Your analysis is always succinct and enlightening. You simplify very complex problems excellently. There is nothing "unremarkable" about those abilities. If you don't teach about this subject at a university or community college, you may wish to consider it. Thanks for all your time.