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The Next Derivatives Bloodbath: Insurance and Auto Makers
George Washington’s Blog
Sunday, Oct 12, 2008
This essay is about future derivatives problems. But before we look to the future, let’s recap what happened yesterday, to gain some perspective.
Post-Game Analysis on Lehman
As the Washington Post writes today about yesterday’s auction of some $400 billion dollars in credit default swaps for Lehman:
‘If we see defaults from the standpoint that protection sellers don’t pay up, then we’re going to have a huge problem in the market,’ Telpner said. ‘But we don’t have any explicit evidence indicating that sellers ultimately are not going to be able to pay the amounts owed to buyers.’
And the Sunday Times writes today:
“The valuation leaves the insurers of the debt a bill of about $365 billion. It is not clear whether the insurers, which are required to settle the bill in the next two weeks, will be able to pay – a development that could further undermine increasingly stressed capital markets.”
Will the “insurers” of Lehman’s CDS be able to pay up? The big bank insurers to the Lehman swaps have been hoarding cash, and so can presumably pay.
The bigger question is whether the hedge funds – such as Citadel – will be able to pay up or will go belly up. The next couple of weeks will tell.
But even if no companies are wiped out by their Lehman CDS obligations, it is clear that yesterday was, indeed, a traumatic day for the world economy. As today’s Sunday Times article put it:
“Lehman’s corporate debt default promises to increase the stress across global credit markets. Sean Egan, of the Egan-Jones ratings agency, said: ‘This is a killer. Lehman said a month ago that it was in terrific shape and now you can’t even get ten cents on the dollar for its debt.
(Article continues below)
‘It underscores the deep structural flaws in our financial system, knocks confidence in the financial markets and raises the cost of capital. It also demonstrates that we are experiencing not only a crisis of confidence, but a crisis.’”
Next Up: Automakers
The next phase of the derivatives wipeout will hit insurance companies and auto makers.
Initially, Standard and Poor’s is saying that GM and Ford may very well go bankrupt.
As of 2004, “GM was among the five companies most frequently included in credit-derivatives contracts in 2004, along with Ford Motor Co., France Telecom SA, DaimlerChrysler AG and Deutsche Telekom AG, Fitch said.”billions of dollars in GM credit default swaps traded per day. Fitch’s noted that “GM CDS are the second most included named in synthetic collateralized debt obligations (CDOs), behind Ford, as disclosed in several Fitch analyses of the CDS market.”
Indeed, according to Fitch’s, as of 2004 and 2005, there were perhaps
On October 3rd, Bloomberg wrote:
General Motors Corp. saw its credit default swaps rise to a record after the automaker said Sept. 19 it was going to draw down the remainder of a $4.5 billion revolving credit line to preserve cash because of the instability in the financial markets. Detroit-based GM, the largest U.S. carmaker, has lost almost $70 billion since 2004.
As of June of this year, “The cost to insure GM’s debt with credit default swaps rose to 33.5 percent upfront . . . plus annual payments of 500 basis points” and “Ford saw its credit default swap spread increased to 30.5 percent upfront, plus 500 basis points annually“.
According to financial advisor Mike “Mish” Shedlock, there are appromixately one trillion dollars of credit default swaps for GM.
If GM goes bust, there would be huge credit default swap liability. While I have seen no estimates of the current amount of Ford CDS, it is probably also quite high, given that it was one of the most common CDS issued in 2004.
Insurance
The insurance companies are also getting hit hard by CDS.
The October 3rd Bloomberg article states:
“The cost to protect against default by Hartford, Prudential Financial Inc. and MetLife Inc. soared to records and shares fell yesterday on speculation that turmoil in financial markets may be spreading to insurance companies.”
As an article at Naked Capitalism explains:
First it was banks and securities firms, and now the focus of worry has widened to include insurance companies. Reader John referred us to a Reuters article that MetLife credit default swaps are now trading on an upfront basis, which means buyers of protection against the default of MetLife bonds must make an upfront payment as well as agreeing to periodic fees. Only companies seen as being in serious risk of failure trade on an upfront basis. Another story shows similar pricing of XL Capital CDS.
Concerns about MetLife became serious when the company announced it was writing down its investment portfolio and withdrew its 2008 earnings forecast.
From Reuters:
Metlife Inc’s credit default swaps on began trading on an upfront basis on Thursday, indicating perceptions that its credit quality is considered distressed.
The cost to insure Metlife’s debt rose to around 10.5 percent the sum insured as an upfront sum, or $1.05 million to insure $10 million in debt for five years, in addition to annual premiums of 5 percent, according to Markit Intraday.
The swaps had closed on Wednesday at a spread of around 717 basis points, or $717,00 per year for five years to insure $10 million in debt, according to Markit.
The second Reuters story:
Credit default swaps on XL Capital Ltd [an insurance copmany] began trading on an upfront basis on Thursday, and its stock price plunged more than 37 percent.
The cost to insure XL’s debt rose to around 12.5 percent the sum insured as an upfront sum, or $1.25 million to insure $10 million in debt for five years, in addition to annual premiums of 5 percent, according to Phoenix Partners Group….
The swaps had opened at a spread of around 750 basis points, or $750,00 per year for five years to insure $10 million in debt, according to Phoenix.
Instead of being the end of the derivatives bloodbath, Lehman was probably just the beginning.
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13 Responses to “The Next Derivatives Bloodbath: Insurance and Auto Makers”
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October 12th, 2008 at 9:23 am
What’s truly important here is whether or not Obama “palled around with terrorists”…because McCain “knows how to fix the economy”…if we’re not careful, we could loose (I mean “lose”) sight of the truly important matters in this country. Don’t be distracted by this so-called “financial meltdown”…afterall, Obama and McCain acted in a bi-partisan manner to get the $700 billion passed…this showed “true leadership” by both of them…because “doing nothing is not an option”…what would you rather have?? A “tax-and-spend liberal” as President or a “borrow-and-spend conservative” as President?? The choice is yours…whatever you do, “don’t waste your vote” on a 3rd party candidate!! This election is too important to do that. Remember what happened in 2000 with Nader? Wouldn’t want that to happen again!!
October 12th, 2008 at 12:05 pm
Dan,
Your lack of insight is typical of the average American voter. Since Obama has none of the attributes of being a classic liberal and McCain is the polar opposite of what a conservative is, I wonder which candidates you are talking about?
Obama is a big government, anti-Constitutional globalist and McCain happens to be nearly identical, you just need to throw in a little extra Neo-conservatism when it comes to foreign policy.
The financial meltdown is hardly a distraction. It is the culmination of bad monetary policy and the simple fact the owners of the private company known as the Federal Reserve and various members of the Bilderberg Group have seized control of our country. Corrupt politicans such as Obama and McCain are not viable choices for any Patriotic American citizen.
Neo-liberals (aka progressives) and neo-conservatives have the same political agenda. A true conservative choice would be Ron Paul, Bob Barr or Chuck Baldwin. Voting for a third party candidate is what every American needs to do in order to restore this nation (politically speaking). We have no hope if an ignorant public continues to vote for the likes of McCain and Obama.
October 12th, 2008 at 1:34 pm
The “Bilderberg” siezeure of the U.S.A. was ensured in 1000b.c. in Egypt. We are the inheritors of a frustrating and confusing world. I love venting MY frustrations on this site after 2 cups coffee. The people who write here are so thoughtful.
October 12th, 2008 at 4:40 pm
TIME to stop this.
Do you bleed GOLD?
c
c
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http://illuminatimatrix.wordpr.....symbolism/
x
x
x
Me neither.
z
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z
October 12th, 2008 at 4:46 pm
this is by far the most devastating aspect of this whole crisis the so called quadzillion dallar death star the explosion of which will create a financial black hole …..
October 12th, 2008 at 5:40 pm
Sorry dan but in my opinion voting for either one of those brain dead morons is a wasted vote from the way i see things. Voting for the lesser of two evils still sends this country down the wrong path even if it is at a slightly slower pace. Any time you exercise your constitutional rights including the right to vote, especially with something you believe in regardless of the popularity is never “wasted”.
October 12th, 2008 at 7:09 pm
Amen Dave #2!! Nothing else to comment!!
October 12th, 2008 at 8:19 pm
Dave and Dan:
I hate to bring this to the attention to everyone, but most of the public is ignorant, and there is no hope during this election process. sorry we are screwed, and there ain’t nothing we can do at this time. The plan has been in place for more then a 1000 bc, and it started in Sumer, who was you could say the founding civilization who started Egypt.
it all came from Sumer, the bloodlines and all.
We all know the Elites control both sides of the game, so they win. They control the banks, media, Military, major corporations, and all the rest, and they control those who run the government.
We are small in numbers, and right now we really do not stand a chance. Sure people are waking up but it is too late.
So start getting people aware, start training troops, build suply areas, stock up on arms, and create a strong underground. The only way we are going to win this is to go along, be good sheep, and fight from inside of the belly of the beast.
October 12th, 2008 at 9:10 pm
Look on the bright side folks, these events are going to make for sensational blockbuster gangster movies. I wonder who will play the part of the disreputable Insurance Company operating out of some backstreet laundry, who insures Lehman for $365 BILLION? and has just fourteen days to pay up? A comedy classic! in the making.
October 12th, 2008 at 9:30 pm
The more you read about high finance and the criminal’s involved with all their fancy words like CDS’s derrivatives etc etc., it’s all a giant ponzi scheme, swaping invisible nonexistent credits, there is no money…they just print these green papers. Its a sick joke.
October 12th, 2008 at 9:36 pm
That’s going to be crazy when insurance and auto companies go under.
October 13th, 2008 at 12:50 am
It makes perfect sense, if there are no more cars, who needs car insurance.
October 13th, 2008 at 10:18 am
AJ is cornholing your wife, Butch. She loves it. He’s cornholing against the New World Order! Cornholing for Jesus! Amen!!