Surfed Into This Summary of the Current Global Economic Crisis

I surfed into this summary of a global capital markets. I'd never heard of the Market Oracle before it turned up in the search yesterday. it seems like a really good summer to me but I'd like the opinion of somebody who'd heard of the market Oracle newsletter or someone more up to date on current crazy set up of the international credit markets. Its long and think with charts so if no one reads it I'll understand. The title is based off Warren Buffett's quote about the credit default swaps.


Credit Default Swaps Weapons of Financial Mass Destruction
http://marketoracle.co.uk/Article6695.html
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Many financial companies are on the hook for risky credit-default swaps, or private contracts that let firms bet in a completely unregulated market, on whether a borrower is going to default. When a bond default occurs, one party pays off the other for the principal amount. However, in an unregulated market, no one knows which bank issued these swaps. For OTC contacts, buyers of insurance rely on the counterparty to make good on their promises. Ominously, c redit-default swaps have mushroomed to $55 trillion today, up from $144 billion a decade ago.

In contrast to the clandestine world of OTC trading, the Chicago Board of Trade launched a cash-settled and highly transparent credit default swap contract in June 2007, with the ticker “CX,” tracking the top-50 North American Investment Grade Bond Index. Hedge funds were particularly fond of selling these CDS contracts, when corporate defaults were at record lows over the past few years. That made selling CDS contracts a very profitable endeavor.

However, with the meltdown in the S&P financial sector, XLF, the CDS insurance for top investment grade companies at the CBoT has risen 50% in the past four weeks to around $363,000 per contract, reflecting the heightened risks from a sharp downturn in the US and global economy. Elsewhere, average high-grade corporate bond spreads hit an all-time high of 510 basis points over Treasuries this week, while junk spreads reached a record 1,300 basis points. Worse yet, the cost to insure $10 million of Morgan Stanley's 5-year bonds is $1.9 million plus $500,000 a year.

AIG, formerly the world's largest insurance company, had written credit-default swaps on more than $446 billion in credit assets, including mortgage securities, corporate loans and complex structured products. Last year, when sub-prime mortgage delinquencies triggered default swaps that AIG had insured, the firm was forced to book large write-downs. That spooked investors, who reacted by dumping its shares, and made it impossible for AIG to raise the capital it needed to survive. Without a Fed rescue for AIG, the CDS nuclear bomb would have exploded.

The New York Fed is aiming to rein-in the nuclear CDS market, by establishing a centralized credit default swap market with the Chicago Mercantile Exchange and London 's Intercontinental Exchange. The LEH bankruptcy has revived calls to move CDS trading onto an exchange trading floor, to remove the system risk posed by a counterparty failure, provide greater price transparency and offer simpler, more standardized settlement of contracts when an issuer defaults.

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<snip>...In addition, global speculators borrowed $1.2 trillion worth of Japanese yen, in order to buy higher yielding currencies, commodities, and stocks held abroad.

The “yen carry” trade is profitable while the US-dollar is climbing higher against the yen, and speculative appetites are juiced-up in the global stock markets. But the highly leveraged carry trade goes sour quickly, when the US-dollar is tumbling against the yen. Carry traders are quick to dump their speculative positions in foreign stock markets, when the yen is climbing, to avoid bruising foreign currency losses. When carry traders rush for the exits at the same time, the herd effect can create an avalanche of panic sales on global stock markets.

Over the past several years, carry traders inflated several emerging stock markets to astronomical heights, and also boosted more mature stock markets in the developed economies. But the unwinding of “yen carry” trades is a very destructive force to global stock markets, much like the Libor credit freeze, or the nuclear CDS time-bomb. The Dow Jones industrials have lost 1,600 points over the past five sessions, the biggest cumulative point loss on record for the blue-chip index. Along the way, the US-dollar plunged 5% against the Japanese yen.
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I read something about a lot of banks borrowing yen and parking it in Icelandic banks, because Iceland's bank paid high interest and the interest charged on the yen has hovered between 0.25% and 0.50% since the Japanese bubble burst in 1990. But I didn't realize it was that big a problem.