Fannie, Freddie CDS auction timeline

www.reuters.com
(visit the link for the full news article)


Related News Links:
money.cnn.com


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Mod Edit: Fixed title to reflect original headline
Mod Edit: Breaking News Forum Submission Guidelines – Please Review This Link.


[edit on 4/10/2008 by Badge01]

On Monday, October 6th, what may be the biggest test of our financial system to date will take place. Credit Default Swaps are in question here, and these little-known, hard-to-understand, shadowy investment vehicles can potentially wreak more havoc than subprime mortgages ever did.

Credit Default Swaps, or CDS, are, in simple terms, a type of insurance against default on a debt. This is sort of similar to the type of insurance you get for your car, though CDS are unregulated and privately traded between companies with very little public reporting of the money involved. It's like a cross between car insurance and a side bet one might make with a friend - "I'll bet ya a hundred bucks you won't eat this bloated, festering rat that's currently stinking up my basement!"

In the case of financial markets, a bank holding a bloated, festering rat of risky debt (something like a huge stack of subprime mortgages, perhaps) would take out a private contract with another company whereupon the bank would pay the "Insurer" a percentage of their bad debt per year in exchange for a promise that the "Insurer" will make a large payment to the bank if the bad debt defaults. This, in theory, would help the bank mitigate their losses if/when the loans default. Much like you pay a quarterly premium to your car insurer in exchange for the promise that they will buy you a new car if yours is destroyed by a falling piano, a bank pays that premium into a CDS with the promise that the "Insurer" will offset part or all of any defaulted debt the bank may face in the future.

That seems harmless enough on the surface, doesn't it? Most of us do something kinda similar with car and health insurance.

Things start to get difficult, though. Imagine if your neighbor could issue an insurance policy on your car as well. Let's say he thinks you're an excellent driver and that you would never get into an accident. He starts taking CDS contracts from others in your neighborhood where they pay him a premium and he promises to buy them all new cars if you destroy yours. For a few years, your neighbor would be raking in the dough. If you never destroy your car, he'll have made a ton of money from all these people betting that you're NOT a good driver. But, imagine one evening you decide to take a joyride after imbibing a quart of moonshine and wind up turning your local movie theater into a drive-in - all the sudden your neighbor is on the hook to buy all these other neighbors new cars because you went and crashed yours!

Replace "cars" with "toxic debt" and "neighbor" with "random speculator" and you've got the dark side of Credit Default Swaps.

The even darker side? The current estimate of the value of the CDS contracts out now - nearly $55 TRILLION.

Now that I've explained that, let's look at what is going to happen on Monday. A series of auctions will take place to determine the exact dollar amount of loss in the failure of Fannie and Freddie. Once that dollar amount is established, the "Insurers" holding the Credit Default Swap contracts must pay up, and they are most certainly expected to have to pay out in the BILLIONS. Private "Insurers" aside, the publicly traded banks that "insured" Fannie and Freddie's debts in this manner will be looking at a huge outflow of cash.

Let's say Bank X is currently on shaky ground in the current economic environment. Their customers have been withdrawing money and closing accounts, they have lost money due to their own dealings in toxic mortgages, and their stock value has declined drastically in the past month. On top of all that, Bank X is the "Insurer" in many CDS contracts.
On Monday, Bank X will find out how much they owe on Fannie and Freddie's defaulted debt, and they'll have to pay up.

If Bank X cannot cover the "insurance" payouts on these Credit Default Swaps, Bank X will become insolvent and either file for bankruptcy or be seized by the Fed.

It's unknown how many "Bank Xes" there are right now, but analysis indicates there are a good number.

Even if Bank X makes it through Fannie and Freddie, Lehman's CDS auctions will happen on 10/10 and WaMu auctions on 10/23. As Bank X fails, its CDS auction will be scheduled, driving Bank Y into failure.

It's like a line of dominoes. One falls, more will fall behind it.

It should be clear later in the day Monday which banks, if any, will face potential insolvency due to their CDS obligations. On Tuesday, 10/7, we could see the stock markets respond accordingly.

Don't clear out your bank accounts, but it's not a bad idea to have a few days' worth of cash on hand next week. It appears like we could possibly face a bumpy, bumpy ride.

www.reuters.com
(visit the link for the full news article)

[edit on 10/4/2008 by anachryon]


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Mod Edit: Title


[edit on 4/10/2008 by Badge01]

Could it be more dire?

Its almost as if the enemy is hastening his pace. Perhaps not quite as assured of success as they would like. Or perhaps, just wanting to use tactical speed - 'shock and awe'... it's part of their playbook, that much is sure.

Wow thanks for the post I didnt realize this was Monday they were doing this. Monday is supposed to be a big day according to Reinhardt so who knows this might be what crashes our market. Ill be paying full attention...

Just checked futures and Asia. Asia is down arount 3.5% all around, and US futures are down pretty good too. Hearing something about a rate cut in Oz and a possible co-ordinated FCB rate cut.

I keep thinking we've heard the worst we can hear, then more poo like this comes up.

Be sure to read the CNN story linked in the first post - it's two pages long but well worth the read.


A lot of companies with names we've never heard before will probably fall this week, and it's possible some names we do recognize will fall as well.

Darn it! I just found out that 60 Minutes covered the CDS market on tonight's program, as well as a general summary of what got us to the mess we're in today. I'm hearing this was a well produced show, fairly hard hitting, and frankly kind of scary to watch.



Did anyone catch the show??

This thread needs a good bump, everyone needs to bump this thread for at least the next 24 hrs.
This thread is the basis for so many of the other threads that have been started in the last 2 weeks about this next week of predictions. This thread is the proof that so many need, it is slapping you in the face. Prepare NOW!

Thank you anachryon for posting this information and then putting it into layman's terms.
I have been wondering about this situation based on rumors floating around but I never really understood what it all meant.
I understand now and I do feel that this will be the catalyst for a complete collapse.
Look friends, it will not hurt you to just be prepared. I am not saying raid your accounts but do take out a couple hundred so you have cash on hand. Go fill up your gas tanks, buy some extra groceries, make sure you have the things you need to get through 7 days without access to a bank.
If nothing happens then you have a full tank, some groceries and some cash and all is well with the world.
I hope, pray and wish that nothing does happen but we will be prepared just in case.

Wish we could change the title of this thread so more people would be interested.
Maybe you should make a prediction anachyron.

reply to post by SEEWHATUDO

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Thank you for your kind words, I really appreciate them. And I'm pleased to hear that I was able to put this in "layman's terms" - that was my goal with the extremely long post, but the thread got so little attention I thought I'd failed. *wry smile*

I've been trying to express the seriousness of the CDS market, but usually I'm met with anything from confused looks to outright disbelief. I've been told it's all just "speculation." But what can ya do, y'know? It's a huge issue with potentially more debt than anyone could ever pay back...kind of like the USA's debt as things look now. I guess I'll just keep plugging on 'til more major implosions happen...then maybe people will understand the potential scope.

I hope everyone is wrong about the CDS market. I hope it's overblown. I hope that firestorm doesn't actually happen, because it's pretty horrible to think about what it means when those contracts come due.


EDIT: The title of the thread is what it's gotta be for this forum, even with my original research. I think it'd be double-dipping if I started another in the non-news forum so I won't go there.

[edit on 10/5/2008 by anachryon]

i don't know how i missed the auction date - tomorrow, geez..

I haven't heard a word about how/if this auction is going. Markets worldwide are down pretty hard with halts to trading in various places. US markets are down around 200 at open but not fully open yet.

Kind of a bump I know, but if anyone hears anything about the CDS auction please post pronto.

Results for the four auctions will be published here:

www.creditfixings.com...

Here's the preliminary results, folks:

I'm not sure what all those number mean. What is "Inside Market Midpoint". Can someone explain? I also looked at the Final Results of the Quebecor Auction. Did Lehman Brothers end up buying their own debt?

So if I understand this correctly, the "Open Interest" is what they'd like to get and the Adjustment amounts are the highest bids so far ? Is this a correct read ? Sorry, layman here

edit: - Just reread the first few posts again - doh. So now I'm guessing the "Open Interest" is what said institution might have to pay out and adjustment amounts are what will actually need to be paid out ?

Excuse my lack of understanding, but this is the kind of c*** that shouldn't be allowed. Little more than financial horseraces.

[edit on 6-10-2008 by maudeeb]

Can someone explain this a little more? I get that net open is what they need to sell, and adjustments are what they are being offered? Sorry, not a number person here. Thanks

Can someone please explain these numbers line by line. I don't understand what I am looking at and can't make sound decisions with limited information. I never thought I would have to be this saavy. I would appreciate any info anyone can give that doesn't make my head spin even further. Thank you.

Here's a decent initial breakdown:



The recovery amount on this auction is higher than many others. Most repays I've seen have been around 50% or lower - this is right around 93%.

What this means is that a bunch of banks placed bids on what they would conceivably pay for Fannie/Freddie debt. In this case the banks said they would pay around $.92-.94 on the dollar for the debt, feeling that they can recover nearly the entire amount. In simple terms: if Fannie/Freddie had $100,000 in debt (to use a small number), a bunch of big banks said they felt they could recover $92k-94k. Obviously the final debt numbers are much larger than this, but that's a good starting point.

This is not terrible news for financial markets, in general. It means that the CDS payouts will not be as high as many feared.

BUT - I have my doubts as to the validity of these valuations. Is a $100k house still worth as much as $94,000, and will a bank be able to find a buyer for said house? I'm not so sure.

We don't know which "Insurers" owe how much money yet. The "Insurers" have until October 15th to pony up whatever they owe, so we should start getting an idea in the next few days what exactly we're looking at.


Remember, Lehman Bros' auction is Friday, 10/10. Right now it is believed that the recovery amount for Lehman will be MUCH lower, as will the recovery for AIG. This means that the "Insurers" for Lehman and AIG debts will have to make much larger payouts than they would for the same dollar amount of debt as Fannie/Freddie.

Thank you very much. I don't know about where you live but in Ohio a house that was worth 100,000 a yr. ago is worth about 85,000 now. So if they believe they will get 94 to 96 cents on a dollar they are wrong. Not here.