Feb 19, 2008

Finance for the stout hearted - the invisible elephant

The invisible elephant it’s not polite to mention

(Only to be found under many layers of technical chat from the happy talkers of Goldman Sachs)
That oil is priced in dollars (technically referred to as the fact that the US dollar is a “petrocurrency,” in fact the only petrocurrency) has been called by economists “like having a mint in your backyard.” The US can in practice print as many billion dollars as it likes, and pump these into the pool of “Outside the country dollars, internationally held dollars,” technically known as M3, which the US government decided to make secret a few months ago.

Since any country that buys or sells oil, which includes pretty much all countries on earth, must keep on hand a large pile of US dollars in order to be able to buy oil, or received for selling it, even the billions of dollars pumped into the world pool of US dollars by Mr. Bernanke’s printing press doesn’t have much more effect than Thor’s attempt to drain the drinking horn presented to him in the hall of the ice giants, not knowing that the other end of the drinking horn had been placed in the ocean.

“…You want foreigners to buy your worthless debt but not your brands or your technology? Well, why don't you look around for another group of suckers instead?”… Chan Akya – Dear Dinosaurs (http://www.atimes.com/atimes/Global_Economy/IJ20Dj01.html)

THE BEAR'S LAIR Level 3 storm about to hit Wall Street By Martin Hutchinson


There's a mystery on Wall Street. Merrill Lynch wrote off $8.4 billion in its subprime mortgage business, a figure revised up from $4.9 billion, yet Goldman Sachs reported an excellent quarter and didn't feel the need for any write-offs. The real secret of the difference is likely to be in the details of their accounting, and in particular in the murky world, shortly to be revealed, of their "Level3" asset portfolios…

…From November 15, we will have a new tool for figuring out how much toxic waste is in investment banks' balance sheets. The new US accounting rule SFAS157 requires banks to divide their tradable assets into three "levels" according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks' own models.

Goldman Sachs has disclosed its Level 3 assets, two quarters before it would be compelled to do so in the period ending February 29, 2008. Their total was $72 billion, which at first sight looks reasonable because it is only 8% of total assets. However the problem becomes more serious when you realize that $72 billion is twice Goldman's capital of $36 billion. In an extreme situation therefore, Goldman's entire existence rests on the value of its Level 3 assets…

…There has been no rush to disclose Level 3 assets in advance of the first quarter in which it becomes compulsory, probably that ending in February or March 2008. Figures that have been disclosed show Lehman with $22 billion in Level 3 assets, 100% of capital, Bear Stearns with $20 billion, 155% of capital, and J P Morgan Chase with about $60 billion, 50% of capital. However those figures are almost certainly low; the border between Level 2 and Level 3 is a fuzzy one and it is unquestionably in the interest of banks to classify as many of their assets as possible as Level 2, where analysts won't worry about them, rather than Level 3, where analyst concern is likely.

The reason analysts should worry is that not only are Level 3 assets subject to eccentric valuation by the institution holding them, but the ability to write up their value in good times and get paid bonuses based on their capital uplift brings a temptation that few on Wall Street appear capable of resisting. Both Goldman Sachs and Merrill Lynch are reported to have made profits of more than $1 billion on their holdings of Level 3 assets in the first half of 2007, for example, profits on which bonuses will no doubt be paid at the end of their fiscal years. Given that we have had five good years on Wall Street, years in which nobody has known the amount of Level 3 assets on banks' balance sheets... it would not be surprising if many banks' Level 3 assets had become seriously overstated, even without any downturn having occurred…

THE ROAD TO HYPERINFLATION - Fed helpless in its own crisis By Henry C K Liu


For the insurers to maintain the necessary triple-A rating, their capital reserve would have to be repeatedly increased along with the premium they charge. There will soon come a time when insurance premium will be so high as to deter bond investors. Already, the annual cost of insuring $10 million of debt against Bear Stearns defaulting has risen from $40,000 in January 2007 to $234,000 by January of 2008. To buy credit default insurance on $10 million of debt issued by Countrywide, the big sub prime mortgage lender, an investor must as of January 11, 2008 pay $3 million up front and $500,000 annually. A month ago, the same protection could be bought at $776,000 annually with no upfront payment.

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