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Friday, January 18, 2008

Has the Black Swan Landed on U.S. Financial System?

Items of interest:

Nathan Nicholas Taleb: The Black Swan at amazon.comNathan Nicholas Taleb's best selling book, The Black Swan: The Impact of the Highly Improbable, was discussed here at TJN a couple of months ago.

The issue of a financial meltdown, or a black swan event, is now certainly on the minds of many people, who have seen their IRA's, 401k's and other investments get slaughtered over the last several months.

Did Alan Greenspan engineer a house of financial cards that is about to collapse or will the financial system find its footing here very soon?

Stay tuned.

What is a credit default swapIs this the next shoe to drop?

Wall Street Journal [subscription required]:
Default Fears Unnerve Markets -- The turmoil on Wall Street is beginning to rock a foundation of the financial system: the ability of institutions to make good on their many trades with one another.

Today, a struggling bond insurer, ACA Financial Guaranty Corp., will ask its trading partners for more time as it scrambles to unwind more than $60 billion of insurance contracts it sold to financial firms but can't fully pay off, according to people familiar with the matter. The contracts were intended to protect Wall Street firms from losses on mortgage securities and other debt they own.

The problem is that the insurer [...]
The Big Picture:
Counter-Party Risk -- Get used to hearing that phrase: Counter-Party Risk.

You will be hearing a lot of it in the coming year. Its one of the reasons I disagree with my friend Doug Kass about any bottom in Financials.

Consider this small concern: Given the enormous amount of hedging that was done by Investment Banks (Merrill, Morgan Stanley, JPM, Citi, etc.) if the monoline insurers fail, well, then you are no longer hedged. So while some people are arguing that the write downs are now over, I am not quite so sure.

And that's before we get to the issues of defaults which have yet to occur. These are problems in the near future, and they are likely to cause an ongoing set of dislocations. Hence, why I expect the financial sector bottom will be a long tedious process. [...]
Jim Jubak / MSN Money:
The next banking crisis on the way -- Write-downs for high-risk, high-yield corporate debt, known as 'junk,' could dwarf losses in the mortgage mess. And that's when this financial crisis will finally hit bottom. [...]
The Big Picture:
Beginning or the End? -- Markets have been in what I call the "orderly whackage phase" over the past few weeks.

Off of the top, there's been some damage done:
  • The Dow is down nearly 2,000 points or ~13% from the October highs.
  • The S&P500, from its recent high of 1565, has given up almost 15%.
  • The Nasdaq has shed 470 points from 2859, or nearly 17% lower.
  • The Russell 2000 is down ~20%.
And thats before the disorderly whackage phase begins. [...]
The Five Dumbest Things on Wall Street This Week -- Al Greenspan still thinks there's a 50/50 chance the U.S. could avoid recession, but there's only a 10% chance of that.

The former Fed chief told The Wall Street Journal this week that if the economy isn't already in recession, it probably will be soon, noting that the odds are "not overwhelming but they are marginally in that direction." [...]

Greenspan, who has long been a housing market guru, was warned about rampant chicanery in the home lending business by the late Fed governor Ed Gramlich as early as 2001, according to The New York Times, but he declined to take action. Instead, he adopted the Bush Administration's lingo, referring to exotic subprime loan products designed to hoodwink unsophisticated, low-income borrowers as a form of "financial innovation." Now, the self-proclaimed conservative is calling for a government bailout for borrowers.

All this brings to mind the words of Hank Rearden, the hero in "Atlas Shrugged," the great novel authored by Greenspan's muse, Ayn Rand.

"I work for nothing but my own profit -- which I make by selling a product they need to men who are willing and able to buy it," said Rearden, adding later, "I am proud of every penny that I have earned in this manner." [...]
comment: Don't say you weren't warned about Easy Al's financial binge.


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