This is an excellent snapshot of the current situation. From Martin Weiss:

WHY THE FINANCIAL SYSTEM IS IN JEOPARDY

Why are central banks around the world pouring massive amounts of fresh new cash into their markets?

Is the global economy suddenly contracting? No.
Are the world’s largest banks suddenly going broke? No.
So what’s prompted these governments to pour out so much money so soon?

Pure and simple, they’re afraid the mortgage meltdown in the United States could trigger massive failures in the international financial system.

Just look at what almost happened back in 1998 when Russia defaulted on its debts and the hedge fund, Long Term Capital Management, collapsed. Banks recoiled in horror. Stock and bond markets nosedived. And the world’s financial system came perilously close to the brink.

In the November 2006 issue of Weiss’ Safe Money Report, he laid out a scenario of how this was likely to happen again and in a bigger way. Weiss explained how a mortgage market collapse would lead to a credit crunch, and how a credit crunch could threaten the financial system.

“We pledged to monitor the situation and to alert you when we felt it was becoming an immediate danger. Now, that time has come.”

The dangers are undeniable

Total “notional” value of all derivatives outstanding in the world is now a mind-boggling $415 trillion, over eight times the GDP of the entire world economy … twenty times the total value of all U.S. stocks … and fifty times all the Treasury debts of the United States Government.

Any unexpected disruption in this $415-trillion market could throw the world’s financial markets into turmoil … bankrupt hundreds of hedge funds … wipe out the profits of big-name financial institutions … sabotage the investments of pension funds … and scramble the portfolios of millions of average investors.

In 1998, the last time the derivatives market nearly blew up, there were $80 trillion in derivatives outstanding worldwide, according to the BIS.

Today, total derivatives outstanding have expanded to $415 trillion, which is over FIVE times more than in 1998. From 2005 to 2006 alone, outstandings surged by 39.5%, which was TEN times faster than the growth in the global economy.

If the risks were spread among thousands of institutions, each with plenty of capital to back up its bets, this derivatives balloon might not be such a threat. But…

• The U.S. Government’s Office of the Comptroller of the Currency (OCC) reports that, in the United States …
  Just FIVE banks control 97.1% of the derivatives in the entire U.S. banking system.

• Among these five banks, none has the capital to cover its net credit risk, the primary measure the OCC uses to evaluate the risks these banks are taking in their derivatives trading.

In 1998, JPMorgan Chase, the world’s largest player in the derivatives market, had $3.80 in credit risk for each dollar of capital. Now, the OCC reports that JPMorgan Chase has a whopping $7.99 in credit risk per dollar of capital, more than double its 1998 risk level. JPM is the single largest player in the derivatives market, and is taking the most risk of all: EIGHT times its entire capital, according to the OCC’s data.

HSBC, was barely a player in the derivatives market back in 1998. Today, HSBC has $5.65 in credit risk per dollar of capital!

Citibank had credit risk of $2.03 per dollar of capital in 1998; it’s grown to $4.60 today.

Bank of America, America’s largest bank, is up to its eyeballs, risking over FOUR times its capital: 90 cents on the dollar in 1998; $2.88 today.

Wachovia: Just 18 cents on the dollar in 1998; $1.56 today. That’s more at stake than its entire capital.

Scant Oversight or Control

Based on data compiled (but no longer published) by the OCC, less than 9% of the derivatives held by U.S. banks are traded on regulated exchanges.

The remaining 91% are strictly one-on-one contracts, handled over the counter, outside the domain of regulated exchanges.

This mean that each party is ultimately responsible for monitoring the credit and trustworthiness of each counterparty. They’re on their own, which leads to the conclusion that …

Even Some of the Biggest Winners
Could Wind Up Among the Losers

Right now, everyone is worried about the big losers:

• Hedge funds that poured too much money into bad mortgages …

• Banks that financed the hedge funds, and …

• Investors that own the bank shares.

There’s no question that many of these are in grave danger as a result of the mortgage meltdown.

Most people don’t seem to realize that even some of the biggest winners could wind up among the losers

Say, for example, that you’re running a mortgage company and you’ve got a big stake in the subprime mortgage market. Say you’re getting hammered with one massive loss after another. So one morning, you wake up in a cold sweat and say: “I can’t take this any more! If this continues, it’s going to wipe me out! I’ve got to buy some protection. I’ve got to place some bets on the opposite side!”

Like thousands of others in recent weeks, you rush to buy “credit default swaps” — in your case, special bets that are designed to go UP in value when your borrowers default.

You figure it’s good insurance. Plus, as is the usual practice, in order to avoid putting up a lot of capital, you finance most of your new bets with short-term loans.

Finally, you figure you can sleep nights. If the mortgage market calms down, you anticipate that your regular operations will stabilize. Conversely, if the mortgage meltdown worsens, the profits likely on your new bets should help offset your losses. Either way, you’re covered … or so you think.

Now … here comes the hidden nightmare: Long before you start cashing in your chips, you’re shocked to learn that the other guy — the one on the losing side of the bet, has run out of capital! He’s broke. And he won’t pay you a single penny.

Bottom line: – Even though you’re on the winning side of the trade, you still lose. You lose on your regular mortgage operations. AND you lose on the new trade.

You run out of capital just like the others caught in the mortgage meltdown. And, just like the others, you default on your bank loans.

The crux of the problem: – If you were trading on an established exchange, the other guy’s default would be primarily the exchange’s problem — not yours.

It would be their responsibility to make sure the market participants have enough capital to back up their bets. It would be their job to go after anyone who doesn’t meet his obligations.

But unfortunately, the exchange has very little to do with your transaction!

Remember: 91% of U.S. derivatives are strictly one-on-one contracts, handled over the counter, outside the domain of regulated exchanges.

In other words, it’s between you and the other guy: If he pays up, fine. But if he stiffs you, tough luck!

• Now you see why there’s so much concern in high places about the credit risk America’s five biggest banks are taking?

• Now you see why central banks all over the world are dishing out such huge amounts of cash all of a sudden?

Their great fears:

1. A chain reaction of defaults that no government or exchange authority could control.

2. Huge losses at major international banks.

3. Massive convulsions in the world economy.

How to Protect Yourself can be found here:

http://www.financialsense.com/editorials/weiss/2007/0813.html

Another “Must Read”. Article excerpts from Hayman Capital investment manager. Provides background on “Ponzi” finance scheme that lined pockets of Wall Street professionals while Main Street (especially in the minority sector) became shut out and in the cold.

Dallas-based Hayman Capital Partners LP is up more than 240% this year, with a 60% gain in July alone. Hayman has earned its bragging rights. Care to know why?

Excerpted from Investor Letter, by J. Kyle Bass – Managing Partner at Hayman Capital, Dallas Dtd: 7/30/07

”Last week, I spent some time in the “Inland Empire” of California on a diligence trip to survey the actual damage. As many of you already know, 55% of all Subprime loans were made in California and Florida.

Let me start by saying it is MUCH WORSE than even I thought it could be. I met with various mortgage lenders, originators, economists, and capital markets professionals. The overriding theme that I got from them was that “Everyone committed fraud and everyone is responsible for the problem”. They told me that they believe that 90% of all Subprime loans that were made contained some kind of fraud. Either borrowers lied about their incomes or mortgage brokers fudged numbers on the applications to make them pass muster with the needed ratios in order to get loans approved. They also said that of the borrower frauds, 50% of applicants overstated their income by MORE THAN 50%”

The Greatest “Bait and Switch” of ALL TIME

I recently spent some time with a senior executive in the structured product marketing group (Collateralized Debt Obligations, Collateralized Loan Obligations, Etc.) of one of the largest brokerage firms in the world. This individual proceeded to tell me how and why the Subprime Mezzanine CDO business existed.

Subprime Mezzanine CDOs are 10-20X levered vehicles that contain only the BBB and BBB- tranches of Subprime debt. He told me that the “real money” (US insurance companies, pension funds, etc) accounts had stopped purchasing mezzanine tranches of US Subprime debt in late 2003 and that they needed a mechanism that could enable them to “mark up” these loans, package them opaquely, and EXPORT THE NEWLY PACKAGED RISK TO UNWITTING BUYERS IN ASIA AND CENTRAL EUROPE!

He told me with a straight face that these CDOs were the only way to get rid of the riskiest tranches of Subprime debt. Interestingly enough, these buyers (mainland Chinese Banks, the Chinese Government, Taiwanese banks, Korean banks, German banks, French banks, UK banks) possess the “excess” pools of liquidity around the globe. These pools are basically derived from two sources: 1) massive trade surpluses with the US in USD, 2) petrodollar recyclers.

These two pools of excess capital are US dollar denominated and have had a virtually insatiable demand for US dollar denominated debt…until now. They have had orders on the various desks of Wall St. to buy any US debt rated “AAA” by the rating agencies in the US.

How do BBB and BBB-tranches become AAA?

Through the alchemy of Mezzanine-CDOs. With the help of the ratings agencies the Mezzanine CDO managers collect a series of BBB and BBB- tranches and repackage them with a cascading cash waterfall so that the top tiers are paid out first on all the tranches – thus allowing them to be rated AAA. Well, when you lever ONLY mezzanine tranches of Subprime RMBS 10-20X, POOF…you magically have 80% of the structure rated “AAA” by the ratings agencies, despite the underlying collateral being a collection of BBB and BBB- rated assets… This will go down as one of the biggest financial illusions the world has EVER seen. These institutions have these investments marked at PAR or 100 cents on the dollar for the most part.

Now that the underlying collateral has begun to be downgraded, it is only a matter of time (weeks, days, or maybe just hours) before the ratings agencies (or what is left of them) downgrade the actual tranches of these various CDO structures. When they are downgraded, these foreign buyers will most likely have to sell them due to the fact that they are only permitted to own “super-senior” risk in the US.

I predict that these tranches of mezzanine CDOs will fetch bids of around 10 cents on the dollar. The ensuing HORROR SHOW will be worth the price of admission and some popcorn. Consequently, when I hear people like Kudlow on CNBC tell their viewers that the Subprime problem is “contained”, I can hardly bear to watch.”

link to full letter (pdf) fomat:

http://www.dealbreaker.com/images/pdf/HaymanJuly07.pdf

There was a time when Bob Chapman was at the top of my list for penetrating commentary, telling it like it is. But when he became embroiled in a reputed kick-back scheme, I and many others witnessed, only in passing, his rather stellar fall from grace. Seemingly undaunted, Chapman has in my opinion mounted a noble effort in terms of staging his comeback to respectability. Of course, not all would agree.

In the following, I excerpted portions from his mid-week letter. True to form, I think he tells it like it is.

I’ve become rather stunned by recent developments in the capital markets. As others have noted, we are indeed witness to a rare sequence of events in our economic history. Images come to mind of a fire breaking out in some hugely populated edifice. The fire marshals, in an attempt to restore calm and order, pronounce that the outbreak is contained. However, the blaze ultimately resumes in force, threatening the lives of all the building’s residents.

I suppose one could even relate current events to the demolition of the twin towers, only this time its the derivatives and structured credit complex that is threatening collapse, thus wiping out all floors from the top down. I’ve never seen anything like this in my entire life; moreover, who can say with any confidence what will be the final outcome?

Chapman, as I began, says it about as good as I’ve read anywhere.

The Elitist Thieves & Market Manipulators

“We have seen the Treasury and the Fed in the markets day after day, sometimes in arrogant indifference as to whether anyone sees what they are doing. Since August 1st their participation has been a classic of indifference.

We do not know exactly how much money and credit the ECB spewed out the past week, but we do know 94 lenders had requested reserves increases. How much of the $130 billion was relent we do not know and we’ll have to wait a month or more to find out. In the US market we now know that the Fed injected $140 billion, but we do not know how much was relent. Again we won’t have those figures until later. What we do know is that the Fed bought, immediately monetizing, $38 billion in mortgage backed securities CDOs. On Friday, the GSE’s were refused permission to increase capital by $70 billion and to raise their guarantees on jumbo loans from $417,000. The GSE’s at least won’t be used to bail out the system.

Restoration of Confidence, The Mammoth Job Ahead

The mammoth job is to restore confidence and that is going to be very difficult because the system came apart at the seams. We have seen a massive run against credit markets and we still have no idea how bad the damage really is.

Contagion, contrary to the protestations of charlatans Paulson and Bernanke, has engulfed the entire financial system. It has fully engulfed the heart of structured finance, the CDO market, asset-backed securities, the repo market, credit derivatives, structured products and even money market funds.

The huge pressure on these markets and rates has put upward thrust to interest rates, as Wall Street demands lower rates to help bail them out. We could still face a collapse probably led by commercial paper. The central banks have to restore trust. Banks and other lenders have to be convinced that market pricing is real not just the result of central banks making $1.7 trillion available.

Equally important is that the rating system is reliable. Even bankers are not convinced that central bankers know what they are doing

Can they really make the world a credit society? The perception that liquidity could be taken for granted under virtually all circumstances was false. That has just been proven. These structured products have totally distorted the marketplace in much the same way derivatives have. This crisis has been a long time coming.

Behind all these problems is “Greenspan’s Folly.” The unbelievably low interest rates, pressure on lenders to lend and the complete abdication of any sane guidelines. The GSE’s were made to function as Sir Alan and the politicians wanted them to function to keep them in office and to perpetuate prosperity.

When this exercise in insanity began in 2004 we predicted exactly this outcome. Fannie Mae and Freddie Mac were the foundation for the Ponzi scheme initiated by the Fed and carried out by lenders, bankers and Wall Street. Bankers and Wall Street got richer as money flooded into these GSEs and eventually the public got left holding the bag. Funding GSEs allowed the bubble to form. It allowed housing consumption by those who never should have been able to buy homes.

Massive Abuse of Financial Power

The housing, Fed, GSE, banker, CDO fiasco was massive abuse of financial power. Never in financial history were so many AAA and AA securities created that in actuality were junk. We do hope thousands sue all three rating agencies. The result of all this chicanery is that the system now is in the reversal process of dehedging. We see less liquidity and the highly disruptive reversal of speculative flows from mortgage-related instruments, along with the very real risk of mortgage and credit collapse. That means higher real interest rates, lower bonds and stocks, and higher gold and silver prices.

This time they’ve “taken the financial system to the edge”

Risk is being re-priced at a much higher cost level. We are told from their lofty heights by Wall Street and the Fed that this is a liquidity issue not a solvency issue. Well, we have news for the elitists and that is what you have done this time is take the financial system to the edge via mortgage-related instruments and derivatives, and we risk a credit collapse, because of your greed. There are trillions in top-rated securities that are simply junk. They are impaired and when all is said and done 50% of those instruments are going to go bad. What the operating parties have done is create the greatest abuse of leverage ever.

Wall Street lied and the rating agencies swore to it, as the Fed and the Treasury nodded their heads in approval

These investment vehicles were risky and inappropriate for most investment vehicles, such as pensions, and for leveraging. Wait until the credit-derivative market collapses, you will then see more thunder and lightening.

Who’ll clean up that unregulated mess?

The central banks will slow the process of de-leveraging and the exit from credit instruments that will incur grievous financial losses. They’ll be lots of bankruptcies. It is very important to note that market misperceptions with respect to risk and liquidity have been exposed. We will see the unmasking of serious flaws in assumptions by black box models in leveraged strategies across various securities markets. We have spoken of this often.

We saw it with LTCM and few lessons were learned. Probability is a hoax. Go to any roulette wheel and you will fast find out. Confidence is gone, just as the yen carry trade is about to end. You will now see a tidal wave of hedge fund withdrawals; probably 50% will go out of business over the next few years.

The funds that made this all possible came from central banks.

They made it happen, they made it possible. Not only did they fund it – they encouraged it. They have created a mess that could take down the financial system.

As we have state over and over, it is not suitable or prudent for pension plans to venture into hedge funds, which we believe is a dark high-stakes corner of the investment world. Going to non-traditional investments to generate the annual returns necessary to meet obligations to retirees is wrong.

We expect a lower stock market and if we are correct, the 8% or more returns expected for pension funds won’t be there to meet the requirements of the flood of baby boomers on the way to retirement. In addition, a number of funds have failed and we expect more will as cheap high risk funds dry up.

The underlying concept behind hedge funds is high risk, high return, and the concept behind pension funds is little risk and guaranteed return. The two concepts are incompatible. The approach can be deadly.

How can an investment manager invest in hedge funds when they are virtually unregulated?

Often the contents of a hedge fund are arcane and difficult if not impossible to value. We refer you to the events of the past three weeks and the inability to value or sell CDOs of which hedge funds are loaded with due to high return and for their use as collateral. This is borne out by the recent collapse and bankruptcy of Bear Stearns’ two CDO hedge funds. One fund borrowed 5 times its capital and the other 15 times and this is typical. This is not the place for pension funds.

Regulators have been concerned, but Wall Street’s power is such that nothing has been done to reign in these funds. We could now as a result of that inaction be witnessing some very nasty losses.

Just 20 years ago we would have never imagined that pension funds would be allowed to take such risks.

The average hedge fund has returned 7.7% this year, lower than the 9% on the S&P 500 index, and now that we’ve had a large correction in markets, the average return could easily be in the minus column.

These pension fund managers are buying into these funds that are unpredictable, very risky and lack transparency. Would our sane pension manager buy into something where assets values were the result of a computer model? The answer unfortunately is yes. Is it really prudent to pay fund management 20% plus fees? We don’t think so.

link: http://news.goldseek.com/InternationalForecaster
/1187276460.php