First, a quick news scan:
- Dubai Debt Delays Revive Fear of Financial Crisis
- US Markets Bracing for Selloff on Dubai Debt Worries
- Stocks Fall as Treasuries, Yen, Swaps Rise on Dubai Attempt to Delay Debt
- Yen Strengthens to 14-Year High, Prompting Speculation Japan to Intervene
- Fujii Says Japan May Contact U.S., Europe After Yen's Jump to 14-Year High
- Abu Dhabi Commercial Bank Is Said to Be Owed $1.9 Billion by Dubai World
- Treasuries Jump on Demand for Safer Assets After Dubai Asks to Delay Debt
- Sony, Toyota, Japanese Exporters Brace for `Breaking Point' as Yen Surges
- Japan's Hirano Says Rapid Currency Moves Are `Undesirable' as Yen Rallies (you betcha, reference the JPM links which highlight interest rate and currency exposure for JPM below)
My regular readers should remember my warnings on the currency trade risks (Japan's Hirano can testify), and interest rate derivative concentrations (let's see what happens to the counterparty daisy chain if Dubai defaults): "The Next Step in the Bank Implosion Cycle???". As excerpted:
Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.
Click to expand!
High dependency on Forex and interest rate contracts
Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.
In terms of absolute dollar exposure, JP Morgan has the largest exposure towards both Interest rate and Forex contracts with notional value of interest rate contracts at $64.6 trillion and Forex contracts at $6.2 trillion exposing itself to volatile changes in both interest rates and currency movements (non-subscribers should reference An Independent Look into JP Morgan, while subscribers should reference JPM Report (Subscription-only) Final - Professional, and JPM Forensic Report (Subscription-only) Final- Retail). However, Goldman Sachs with interest rate contracts to total assets at 318.x and Forex contracts to total assets at 11.2x has the largest relative exposure (see Goldman Sachs Q2 2009 Pre-announcement opinion, Goldman Sachs Stress Test Professional, Goldman Sachs Stress Test Retail). As subscribers can see from the afore-linked analysis, Goldman is trading at an extreme premium from a risk adjusted book value perspective.
Let's not forget about the other subjects in today's news as market and US futures approach the 4% loss mark for the day. In Dubai, word has it that if creditors reject proposals to postpone near-term debt obligations until May 2010, the Dubai government could be forced to hold a fire sale of its international real estate. In order to avoid what is probably inevitable (that real estate is probably being carried on the books at the same outrageous premium that US REITs and banks are carrying their real estate at), Dubai World is asking for a reprieve from their lenders. In other parts of the world, I am sure the Japanese multinational corporations are pressuring the government to intervene on behalf of weakening the currency.
All of the events above have the propensity to inject volatility into the carry trade and currency/interest rate derivatives market, which I have written about in the past. We are talking trillions of dollars of risk, essentially unhedged (or hedged between a small handful of counterparties with very high correlations and related exposures, as I said, essentially, unhedged). If one catches a big default, it will daisy chain, causing the others to hog capital and liquidity (as if they weren't doing this already), thus exacerbating what is going to be a monumental problem for commercial REITs and US RMBS, consumer and small business debt, and mortgages stateside.
Let's go over some of those I told ya' so's, but before we do I just want all to know that this might not even be the catalyst to bring us back to respecting fundamentals. Dubai World is by far not the only player that binged on debt during the bubble to dabble in overpriced, rapidly depreciation assets. Reality will start rearing its (now rather ugly) head in many other places throughout the globe and sooner (or later) it will pop up in a place that causes this big, globally central bank coordinated charade to come tumbling down (Dubai Shows Limits of Government Rescues, Roubini’s Das Says). It may be this (black) Friday, next (black) Monday, or some other day in the future. All I know is that there are still hundreds of billions of dollars of losses in the system that have been ignored as risky asset prices have partied like it was 1999. After all, it is not as if Dubai World was the only one binging at the free credit punch bowl, where they??? Now, back to some of those I told you so's...
- As the markets climb on top of one big, incestuous pool of concentrated risk...
- Any objective review shows that the big banks are simply too big for the safety of this country
- Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
following is a Must Read for those that think the big US banks will be
immune to contagion and shocks born across the pond in interest rate
and currency markets: An Independent Look into JP Morgan. This contains the "public preview" document (JPM Public Excerpt of Forensic Analysis Subscription), which is free to download.
- JPM Report (Subscription-only) Final - Professional
- JPM Forensic Report (Subscription-only) Final- Retail
- Bad CRE, Rotten Home Loans, and the End of US Banking Prominence?: Balance sheet recessions combined with real and financial asset bubbles within a bubble sustained by "extend and pretend" policies, will literally bring an end to banking dominance withing entire nations. Those who don't believe me should take a closer look at the Japanese experience and ask yourselves just how many Japanese banks are left in the Global top 20. Here's a hint, they dominated 90% a couple of decades ago.
- Now That the Im pairments Are Starting, Will Anyone Bother to Look into How Realistic They Are?: Ignore those asset impairments if you wish, sooner or later someone is going to want their money back, if not Dubai Worlds' creditors then somebody else. All of a sudden, the covers get snatched off and we see naked bodies...
- You've Been Bamboozled, Hoodwinked and Lied To! Here's the Proof. What Are You Going to Do About It?: Hey, the government lied to you about the stability of those banks in the stress tests. Here's the evidence...
- At What Point Does Accounting Gimmickery Become an Outright Lie? Let's Ask PNC
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 - JP Morgan
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - BAC (the bank
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 4 - Wells Fargo
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 5 - PNC Bank
I will be releasing some very interesting research to subscribers along with public excerpts today and Monday. Posting will be very light today(except for one research report) due to the holidays, but I will be following the markets closely and may comment.
Note: Subscribers may want to dust off that HSBC (one of the largest lenders to Dubai World) report from last year. Although it is over a year old, it has some informative macro coverage (pro report) and reminds all of how much credit and real estate exposure HSBC really has. It's a good chance their Asia and credit derivative exposure may follow the path of Dubai World. If their stock doesn't tank too much, I will revisit the situation.