Easy Al Greenspan has stepped out of his cave and opened his big fat mouth again. This time, Al felt it necessary to propose that the United States of America have specific “laws that authorize the Treasury to use taxpayer money to counter systemic financial breakdowns transparently and directly.”
Where to start…I mean, Alan Greenspan is a socialistic, Keynesian Loving, politician pleasing, power and greed driven **explicit delete, explicit delete**, piece of **explicit delete**. To think that this guy was a self proclaimed libertarian.

It’s really ironic that Easy Al even has the audacity to comment on the current mess we are facing in today’s financial markets. It was his bubble blowing and encouragement/praise of the exotic financial instruments that got us in this mess in the first place. He is the mad scientist behind this credit crunch Frankenstein.

Bail Out Blue Prints

Readers of mine, I’m sure that you understand why I’m in rare form this fall day. More recent readers, you are in for a treat. As a REAL libertarian who understands the simple advantages to free market economics, the bail out of Fannie Mae and Freddie Mac is enough to make me pull my hair out.
Yes, we all saw it coming, but the Federal Reserve has finally confirmed the inevitability and bailed out the failing GSEs. Some of the specifics of the deal include an immediate $2 billion in injected money. Regulators have said that they don’t plan to invest more than $200 billion, all of which are TAXPAYER’S dollars, but that is not an official cap…just an estimate. All in all, we are looking at what will eventually be easily the biggest bail out in our history.

The CEO’s of Fannie and Freddie, Dan Mudd and Richard Syron, got canned. It is reported that since 2003, these guys have earned an approximate $26 million in cash and stock options, and they are expected to receive another $23 million in severance packages. I stand by my view that if we’ve learned one thing during this credit crunch, it’s that the best job in the world is apparently a failed CEO.

Monetary Authority or GSE?

Let’s take a slightly deeper look at the finance details of this bail out. The first question that pops up is what will the $200 billion be used for? Some of it will be used to buy Fannie and Freddie equity shares in order to sure up finances.

The majority of is will be used to buy up mortgage backed securities…oh boy. Just last Friday, I read some interesting reports. The Federal Reserve has approximately $500 billion in mortgage backed securities on its balance sheets. The overwhelming majority of which were undertaken as collateral via the discount window.

Let’s not forget that less than 12 months ago, only the highest rated debt, such as U.S. Treasuries, were accepted as collateral via the discount window. It’s funny how the rules can be bent or broken when they are of an inconvenience. I wonder where Wall St. would be today if they still had those assets on their books?

Anyways, the same report also showed that mortgage backed securities now makes up over half of the Fed’s balance sheet. Please note, all of these numbers are prior to the Fannie/Freddie bail out, but what’s it really matter. If all the Fed’s assets go to zero, they can just reprint another half trillion dollars in order to ‘sure up’ their own ‘balance sheets.’
Bail Out Aftermath

I know I can be sarcastic and even narcissistic when I discuss these matters, but I am under no intention of downplaying the severity of the consequences of the Federal Reserve’s actions. We must understand our predicament, and the path that policy makers have set to navigate these rough times.
We must understand that, even with this bailout, there are still some serious questions to be answered. The most serious issue in the near term being, what happens to the $1.46 trillion dollars of credit default swaps…yes that trillion with a ‘T’. Credit default swaps are in a sense default insurance on a company’s debt.

When a company defaults, and this is being called a default by the International Swaps and Derivatives Association, the swaps are triggered and must be paid. What we don’t necessarily know is who will be footing the bill on that one. I got a feeling it won’t be long until we find out.
I would like to mention here that I’ve been discussing for a long time that the credit woes wouldn’t subside until the credit derivatives market is thrown under the bus. There are many interested individuals, who don’t do what I do for a job, that have had a difficult time understand the notion behind this, and for good reason.

This is a perfect example of what happens when credit derivatives are actually triggered. Please note that the credit derivatives market is completely unregulated from an accounting stand point, and is also several hundred trillion dollars in size. The sheer size is ever so slightly easier to grasp given the $1.46 trillion that was triggered on just two GSEs.

This is also the reason I believe that if the credit crunch was a baseball game, we would probably be throwing out the opening pitch right now. We still have a long way to go. I personally am very curious to see how the financial market absorbs this near $1.5 trillion in payments, but how will financial markets absorb $50 or $100 trillion in triggered swaps?

Snowballing Credit Woes

This will probably open the eyes of a lot of people, and we will start to hear more about the stress in the credit derivatives market going forward.

But what does this mean for policy makers? Put it this way, there are many companies, more than we even know about, who are on the margin barely hanging onto their ability to roll over their short term debt. I’m talking about the auto makers, airlines, and definitely many others. What if a 25 or 50 basis point rise in interest rates, orchestrated by an official raise in the Federal Funds Rate or otherwise, makes these companies non-solvent because they can’t roll over their short term liabilities anymore?

It would mean another massive default, and another couple trillion dollars worth of credit default swaps triggered. That could easily put another Wall Street or other investment firm out of business if they bit off more than they can chew, which would then in turn mean more CDS’s triggered.

It’s easy to see, and scary to think about how this sort of thing could snow ball. Believe me when I say that Bernanke and Paulson know this, and they will do everything in their power to prevent just that from happening. That is the exact reason that I believe the next interest rate move by the Federal Reserve will not be up, but instead will be a cut. With that in mind, I have to more words for you…got gold?

Nicholas Jones
Analyst, Oxbury Research

P.S. It’s probably easy to see that I believe this to be one of the most important issues going forward. The credit derivatives market is the big daddy of them all. Given that, I have done extensive research, and the results are alarming. Unfortunately, we don’t have the time to delve into the details and take a look at what the consequences might look like in this post. This is definitely something that will begin to creep into the main stream media going forward, and I will, without doubt be sharing my more detailed thoughts on this topic with you in the near future.