Bank Exposure To Bad Hedges and Counterpary Risk Is Still Quite Relevant: A 10% Decline in Derivatives Books Can Cut up to 50%+ Out Of Bank’s Equity

One of my interns made an interesting observation after going over
the Feds recent data dump of bailout info.  It reads as follows:

Some quick observations from the data on MBS purchases:

– 8558/10007 MBS purchases by the Fed were done at par or a premium.  These are only agency MBS too.

- A majority of the Maiden Lane holdings were agency MBS

- It looks like the safety net put
under AIG was done to protect the agencies.  If all those agency
guaranteed MBS had to be liquidated, all that AAA paper would have gone
down as the biggest sucker bet in the modern history of financial
markets

- I have yet to find any equity
collateral data for BAC, C, and AIG.  AIG is what is important here
though, because I have no doubt they are writing some of these CDS on
European sovereigns, and I’m sure they are undercapitalized yet again,
which means if they pledged equity to the Fed, that could destroy a part
of the balance sheet and simultaneously blow up the CDS market since
none of the sellers are capitalized adequately.  I’m digressing, but I
bet CDS will get moved to an exchange, because there are going to be a
lot of buyers (both hedgers and speculators) who get burnt by
undercapitalized counterparties.

There is a sharp drawdown coming in both MBS and sovereign CDS land
if the accounting numbers and the institutional investment sheeple get
even a whiff of reality. I am working on the Spain haircut numbers (and
yes, Spain will have to restructure in some form or fashion, be it
maturity extension, coupon reduction, haircut – or a combination of the
three) and anyone who has read my work has seen the housing numbers and
opinion – as well as my historical accuracy. For those who have not been
reading me or don’t subscribe, there’s a related reading list at the
bottom of this post, such as

1. The
   3rd Quarter in Review, and More Importantly How the Shadow Inventory
   System in the US is Disguising the Equivalent of a Dozen Ambac
   Bankruptcies! Wednesday, November 10th, 2010
2. Banks,
   Monolines, and Ratings Agencies As The Three Card Monte (Wall)Street
   Hustlers! Its a Sucker’s Bet, Who’s Going to Fall for it in QE2? Tuesday, November 9th, 2010

On that note, here is a snapshot the results of our digging into the monoline exposure.

I have harped on counterparty exposure between banks for years now.
It is not as if we haven’t learned that I was correct with the effective
demise of Bear Stearns and Lehman Brothers (see offset towards bottom
of this post), or what should have been the effective demise of AIG.
Yet, concentration risk is greater than ever.

I bring attention to it in regards to JP Morgan on both my blog and CNBC… Click to expand

I posted on the topic near ad nauseum…

• A Step by Step Guide to Exactly How Much Derivatives Risk Each of the 5 Big Banks Actually Have, and How It Could All Go Boom! Monday, October 25th, 2010
• Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!! Friday, October 22nd, 2010

And I even present plenty of anecdotal and empirical evidence in the
public domain. I don’t expect anyone to be sore if (actually, when) I
way “I told you so” for the 5th time in as many quarters.

As you can see, a 2 % decline in gross derivative values can chop
certain bank’s balance sheet equity in half. Of course, they are
perfectly hedged and such an even could never come to fore –
particularly with the strength of the collateral behind all of those MBS
and the fiscal certainty (of default) in Euroland.

After all, hedges work well, right Bear Stearns Lehman, Countrywide
and AIG investors? ‘Nuff yapping done, I now present A Complete and
Comprehensive Rundown of US Big Bank Exposure to Monoline Risk. This is available to all paying subscribers (click here to subscribe). It is recommended that the following related subscription items be reviewed as well…

Related Subscription Content

• Morgan Stanley Exposure to monolines
• BSC and MS Ambac-MBIA Insured Model
• Foreclosures & Shadow Inventory
• Shadow Inventory

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I included this sidebar for those of you who have not followed me in the past. You can save some time and just review Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?, but this is probably a lot more entertaining! I took the time to pour through my blog’s archives, and…

Hey, Big Wall Street Bank Execs Always Tell the Truth When They’re in Trouble, RIIIIGHT???? After all, they are all hedged and all of that massive derivative risk is offset through counterparties!!! Here’s more of Alan Schwartz lying on TV in March of 2008

Meredith Whitney downgraded Bear Stearns today Friday, March 14th, 2008: “Yep, she did it. The ratings agencies are considering a downgrade. I thought it was a joke when I first heard it. Let’s just imagine that I used these wise sources as an info source to make my money! The ratings agencies and sell sides are jokes that I can no longer laugh at.”

It’s a good thing no one listened to that damn blogger who has the gall to charge money for his research and opinion. We had to listen to him bitch and moan for 2 months before… Is this the Breaking of the Bear? (January 2008)” Bear Stearns is in Real trouble Bear Stearns will soon be, if not already, in a fight for its life… the biggest issues don’t seem all that prevalent in the media though. Bear Stearns is in a real financial bind due to the assets that it specialized in, and it is not in it by itself, either. For some reason, the Street consistently underestimates the severity of this real estate crash. If you look throughout my blog, it appears as if I have an outstanding track record. I would love to take the credit as superior intelligence, but the reality of the matter is that I just respect the severity of the current housing downturn – something that it appears many analysts, pundits, speculators, and investors have yet to do with aplomb. With a primary value driver linked to the biggest drag on the US economy for the last century or so, Bear Stearn’s excessive reliance on highly “modeled” and real asset/mortgage backed products in its portfolio may potentially be its undoing. This is exacerbated significantly by leverage, lack of transparency, and products that are relatively illiquid, even when the mortgage days were good.” Notice how the worse case scenario is economic insolvency – as in less than ZERO! Book Value, Schmook Value – How Marking to Market Will Break the Bear’s Back …  I can say that when I do watch it I hear a lot of perma-bulls stating that this and that stock is cheap because it is trading at or below its book value. They then go on to quote the historical significance of this event, yada, yada, yada. This is then picked up by a bunch of other individual investors, media pundits and other “professionals,” and it appears that rampant buying ensues. I don’t know how much of it is momentum trading versus actual investors really believing they are buying on the fundamentals, but the buying pressure is certainly there. They then lose their money as the stock they thought was cheap, actually gets a lot cheaper, bringing their investment down the crapper with it. What happened in this scenario? These investors bought accounting numbers instead of true economic book value. Anything outside of simple widget manufacturers are bound to have some twists and turns to ascertain actual book value, actual marketable book value that is. This is what the investor is interested in, the ECONOMIC market value of book, not what the accounting ledger says. After all, you are paying economic dollars to buy this book value in the market, so you want to be able to ascertain marketable book value, I hope it sounds simplistic, because the premise behind it is quite simple – How much is this stuff really worth?. The implementation may be a different matter, though. I set out to ascertain the true book value of Bear Stearns, and the following is the path that I took. Then he had the nerve to come back with Bear Stearn’s Bear Market – revisited Friday, February 22nd, 2008

So, who was right? The Bust that Broke the Bear’s Back? Monday, March 10th, 2008: My ruminations on Bear Stearns look to come into their own… It looks as if the prudent should start debating the ability of Bear Stearns to remain a going concern Thursday, March 13th, 2008 Despite the Federal Reserve’s efforts Wall Street fears a big US bank is in trouble Thursday, March 13th, 2008: While I can’t know for sure which IB it may be, my studies tell me it is either the Bear with the Broken Back or the Riskiest Bank on the Street, and that’s where I’m concentrating my bets… From the London Business Times: Global stock markets may have cheered the US Federal Reserve yesterday, but on Wall Street the Fed’s unprecedented move to pump $280 billion (£140 billion) into global markets was seen as a sure sign that at least one financial institution was struggling to survive. The name on most people’s lips was Bear Stearns. [Hey, it pays to read the boombustblog.com. ...] “The only reason the Fed would do this is if they knew one or more of their primary dealers actually wasn’t flush with cash and needed funds in a hurry,” Simon Maughan, an analyst with MF Global in London, said. Bear Stearn’s new CEO states unequivocally that his balance sheet hasn’t changed since November and that they have $17 billion of cushion. [He did not outright say that they were in good shape though. My concern was looking forward. They are a significant counterparty risk (along with Morgan Stanley) and they have significant illiquid level 2 and 3 assets as a percentage of tangible equity. In addition, 17 billion is not much considering the leverage and amount of illiquid assets held by this bank.] And what happens after the fact? Yes, I can turn bullish as well… Joe Lewis on the Bear Stearns buyout Monday, March 17th, 2008: The problem with the deal is that it is too low, and too favorable for Morgan. It is literally guaranteed to drive angst from the other side. Whenever you do a deal, you always make sure the other side gets to walk away with something.  If you don’t you always risk the deal falling though unnecessarily. $2 is a slap in the face to employees who have lost a life savings and have the power to block the deal. At the very least, by the building at market price and get the company for free! BSC calls are almost free and the JP Morgan Deal is not signed in stone Monday, March 17th, 2008 This is going to be an exciting, and scary morning Monday, March 17th, 2008 As I anticipated, Bear Stearns is not a done deal Tuesday, March 18th, 2008

Reggie Turns Bearish on Lehman in February, before anyone had a clue!!! Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 Web chatter on Lehman Brothers Sunday, March 16th, 2008: It would appear that Lehman’s hedges are paying off for them. The have the most CMBS and RMBS as a percent of tangible equity on the street following BSC. The question is, “Can they monetize those hedges?” I’m curious to see how the options on Lehman will be priced tomorrow. I really don’t have enough. Goes to show you how stingy I am. I bought them before Lehman was on anybody’s radar and I was still to cheap to gorge. Now, all of the alarms have sounded and I’ll have to pay up to participate or go in short. There is too much attention focused on Lehman right now. I just got this email on Lehman from my clearing desk Monday, March 17th, 2008 by Reggie Middleton Like I said above, it’s not as if upper management of these Wall Street banks would ever mislead us, RIGHT???? Erin Callan, CFO of Lehman Brothers Lying giving an interview on TV in March and again in June of 2008. Even if the big Wall Street banks would lie to us, we have expert analysts at hot shot, white shoe firms such as Goldman Sachs, who of course not only are “Doing God’s Work” but also happen to be the smartest of the smart and the “bestest” of the best, RIIIGHT!!!??? Below we have both Erin from Lehman AND Goldman lying on TV in a single screen shot. Ain’t a picture worth a thousand words??? We even had the inscrutable Meredith Whitney say “To suggest that Lehman Brothers is going out of business is a real stretch!” (She OBVIOUSLY DOESN’T READ THE BOOMBUST) as well as Erin Callan, the CFO of this big Wall Street bank on TV lying interviewing again… But that damn blogger guy Reggie Middleton put his “put parade”short combo on Lehman right about that time, and had all of these additional negative things to say… Lehman stock, rumors and anti-rumors that support the rumors Friday, March 28th, 2008 It appears that I should have dug deeper into Lehman! May 2008: I never got a chance to perform a full forensic analysis of Lehman, but did put a fair size short on them a few months back due to their “smoke and mirrors” PR (oops), I mean financial reporting. There were just too many inconsistencies, and too much exposure. I was familiar with the game that some I banks play, for I did get a chance to do a deep dive on Morgan Stanley, and did not like what I found. As usual, I am significantly short those companies that I issue negative reports on, MS and LEH included. I urge all who have an economic interest in these companies to read through the PDF’s below and my MS updated report linked later on in this post. In January, it was worth reviewing “Is this the Breaking of the Bear?”, for just two months later we all know what happened. I came across this speech by David Eihorn and he has clearly delineated not only all of the financial shenanigans that I mentioned in my blog, but a few more as well. Very well articulated and researched. So, who was right? The Ivy league, ivory tower boys doing God’s work or that blogger with the smart ass mouth from Brooklyn? Please click the graph to enlarge to print quality size.

Learn more about BoomBustBlog here: Who is Reggie Middleton!!!

Recommended free reading:

Reggie Middleton on Financial Survival Radio: Important Little Details Left Out of the Case-Shiller Home Price Index Saturday, October 30th, 2010

The Truth Goes Viral, Pt 1: Housing Prices, Economic Sales and the State of Depression

Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!

Those
Who Blindly Follow Housing Prices Without Taking Other Metrics Into
Consideration Are Missing the Housing Depression of the New
Millennium

Pay Attention to the National Association of Realtors and Their Chief Marketing Agent At Your Own Risk!

The
Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks
Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf
2008!

JP
Morgan’s 3rd Quarter Earnigns Analysis and a Chronological Reminder
of Just How Wrong Brand Name Banks, Analysts, CEOs & Pundits Can
Be When They Say XYZ Bank Can Never Go Out of Business!!! Sunday, October 17th, 2010

Comments

[StockInsanity]

I for one would like to figure out how to force banks to market their book to market again...hasn't the market stabilized enough to raise the sham that is "mark to model" ? Americans and the rest of the world are living in a dream world, where they think everyone is overcapitalized, PEs are "Cheap" and the global growth story rolls on...when in the meantime America and other countries in Europe are insolvent, the banks are insolvent, and we slave away for dollars that the FED prints billions of without thinking twice.

[KTV Escort]

RM, one of the sharpest minds on the planet.

[Eternal Student]

The Bank exposure analysis is very well done. It's truly unfortunate that no one else is doing this. Well, not unfortunate for RM, of course. But for the broader society. Makes you wonder what some financial types are doing to earn their excessive salaries.

[Widowmaker]

Bend over and I'll show you the excessive salary structure.

[Widowmaker]

It's all lies among thieves, Reggie.  Even white boys got to shout.

[Vampyroteuthis ...]

Baby got back!

[moneymutt]

Saw this on front page of Huff Post and thought of you and your chart of the Economic Republic of JP Morgan, apparently Simon Johnson has a similar concern

http://www.huffingtonpost.com/simon-johnson/jamie-dimon-becoming-too-_b_791518.html

[trillionaire]

Love your posts, nice to see you are getting some air time.

[New Revolution]

That's easy.   Close out the Federal Reserve.    Who do you think is keeping their owners alive.   Right, its the central bank in America that the 2B2F's own.    Now, you didn't really think the Federal Reserve Bank was working for America, did you?    And I don't think the 'god's work' they're doing has much to do with the Judeo-Christian God that most people think of when the phrase is used.   But to answer your question, this is how you force reality on the 2B2F's.    Then you put them through a pre-package bankruptcy just like they did for General Motors.    The FED is replaced with a Suffolk style publicly owned and traded with open meetings with public votes (2/5ths US Govt owned) and on a true gold standard backed by our Governments gold @ $6000 to $8500/troy ounce.    Say it can't be done?    Watch U.S.

[egdeh orez]

Reggie, how does it feel like to be a bear in this market in the past 1.5 years?  How does it feel to be a fundamental investor when fundamentals haven't mattered in the past 1.5 years?  I find it very heart wrenching.  Eventually, the markets will return to its fundamentals... but 1.5 years is a really fucking long and lonely time.

[dnarby]

What are you talking about?  The fundamentals on precious metals are fabulous!

[Robslob]

Move your money to small local banks with little exposure to all this crap?

[Vampyroteuthis ...]

Reggie, your analysis is good (little long though). The question I have is what will force JPM and the other TBTF to accept reality when the Fed and the gov't backstops them on an indefinite time period? How can we force market reality?

[kaiserhoff]

That, Grasshopper, is the Holy Grail.  Most on ZH would say buy precious metals, and withdraw from the system to the greatest possible extent.  Make small, but permanent changes in your own life, to help starve the beast.  That may or may not help.

I think this dies from a swarm.  In a few months, at most, hundreds of municipalities, counties, and school districts will admit they are broke.  What will Ben von Numbnuts do about that?

[Vampyroteuthis ...]

I think history will repeat with a common trigger. Lehman collapsed because it was too big to easily bailout and the political desire to do so was lacking after Bear Sterns, AIG and the Freddie/Frannie debacles. It comes down to which entity is lurking out there that is too big to rescue?