Commentary - 02/17/2008

Credit Default Swap Tsunami - One Level Deeper

On February 11th, Mish's Global Economic Trend Analysis published an excellent commentary entitled Credit Default Swap Tsunami Approaches. As Ed Steer commented in the February 16th Casey's Daily Resource "A clearer picture of the upcoming collapse could not be painted," and I certainly agree with that statement. But I'd like to take that report one level deeper. There's more going on than just citing company names. There are inter-related Institutional Major Holders of these companies that few consider in evaluating what's really happening here.

First, the main topic of Mish's focus was the article "AIG Falls on Concern Losses May Have Been Understated.

American International Group Inc., the world's largest insurer by assets, fell the most in 20 years in New York trading after its auditor found faulty accounting may have understated losses on some holdings.

So-called credit-default swaps issued by AIG, which protect fixed-income investors against losses, declined by $4.88 billion in value in October and November, four times more than previously disclosed, the company said today in a regulatory filing. AIG's auditors found ``material weakness'' in its accounting for the contracts, and the firm doesn't know what they were worth at the end of 2007, the filing said.

Well, that's certainly interesting at this point in time. It was only two years this month that AIG was looking at a $1.5 billion dollar fine for problems in accounting, as reported in TheStreet article " AIG Reportedly Nearing Record Fine".
American International Group is likely to pay a record-setting $1.5 billion fine to settle a lengthy regulatory investigation into the giant insurer's accounting practices, published reports say. A settlement between AIG and regulators could be announced as early as this week, according to The Wall Street Journal and The New York Times.
So I guess we have a track record here. But digging deeper, here are the Major Holders of American International Group, Inc., with less than one percent controlling almost 28% of the shares.

But let's consider Mish's next comment, but this time be sure to click on the links provided to see just who are the Major Holders of these companies and how they're inter-related.

"Companies like Citigroup, AIG, Merrill Lynch, Lehman, Morgan Stanley, might think they are hedged. If so they are only fooling themselves. Just what is a guarantee from someone like MBIA, Ambac, or Madame Merriweather's Mudhut Malaysia worth? The answer is nothing.
To me, it looks like the problem is even bigger due to the inter-relationships of Major Holders in all these companies. I cannot help but wonder what's really going on here behind closed doors. Are they going to gang up and let everybody else left holding the losses? I do not know! But there is plenty more to consider. Here's an example that Mish points out:
Consider GM. The market cap of GM is $15 billion or so. There are about $1 trillion in credit default swaps bet on the success or failure of GM. It is virtually impossible for this to be hedged because there is not $1 trillion in GM bonds available as collateral.

The credit swaps on MBIA, Ambac, and the homebuilders trade deep into junk, some priced outright for default. Is there any wonder Moody's, Fitch, and the Standard & Poors are reluctant to downgrade MBIA and Ambac? The ratings assigned to Ambac and MBIA are a joke.

Does it not seem to you that there are self-serving inter-relationships of Major Holders between ALL of these companies? You have to remember that according to SEC documents, these Institutional Holders can vote ALL their shares as one, and dispose of ALL these share at their pleasure. Now that's POWER!

One more wild card in all these inter-relationships is Warren Buffett. If you take a look at the Major Holders of Moody's, one of three rating agencies, who do we find as the largest single Major Holder? Berkshire Hathaway! Bloomberg ran an article yesterday entitled "MBIA, Ambac Rescue May Be Set Before Ratings Are Cut.

Dinallo reached out to billionaire investor Warren Buffett to value the mortgage business of Ambac, MBIA and FGIC. Buffett this week said he offered to take over $800 billion of the municipal debt guaranteed by the companies for about $9 billion.

Buffett's plan would allow the insured bonds to retain their AAA rating, and leave Ambac and MBIA with guarantees on mortgage securities and other debt responsible for the companies' losses.

Considering the size of Buffett's holdings in Moody's, this seems to me like one hell of a lot of inside information on everything that going on. Taking the cream and dumping the rest. It's interesting how regulators treat Buffett, as in this story Buffett On The Prowl
Rumors had been swirling since May that Berkshire was building a stake in Kraft Foods. Shares of companies often rise when Berkshire discloses investment stakes. Regulators sometimes let Berkshire delay disclosures so investors cannot try to copy Buffett before he is finished buying.
Well, we need to get back to Mish's story. The next quote is:
The dollar has been rallying lately, which is contrary to what you might think, but what if the US actually is the best house in a bad neighborhood? Could the dollar rally against the Euro as the problems at European banks like Union Bank of Switzerland, Societe Generale, Deutsche Bank (DB), Barclay’s (BCS) and Credit Suisse (CS) surface day after day? Every day it seems, a new financing is announced by a major bank (lately by the likes of Citi, PNC, and Wachovia just to name a few) in order to ‘shore up capital’.
Again, the inter-relationships are exposed here. Now for the next group:
If you think the banks are a mess, try taking a quick look at the balance sheets of companies like Lehman and Bear Stearns. These companies have balance sheets that are literally 40 times their shareholder equity.
Seems like the same Institutional Holders are involved every large corporation, no matter what the company does for a living. Down home, we say "Everyone has their nose in everyone else's business." Now that's REAL POWER! This must be the reason that:
Sometimes The Dragon Wins

© 2008 by Edward Ulysses Cate
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