Defaulting banks - where will it stop?

[Jan Klimkowski]

So, the giant CDS mystery continues, with D-Day scheduled for next week.

Are we facing the proverbial black swan event that will cause major global financial institutions to fail, and sovereign states to default - like frenzied lemmings knocking each other over the cliff?

Or was the whole CDS edifice a giant banker's swindle - which will end with a whimper (instead of a bang), and the sound of mad, cackling, laughter from offstage financiers? Aka crooks and fraudsters.

Ticker Forum's Denninger explores the two options - each entirely unpalatable in their implications.

The Fraudacity Of American Finance

I just had to coin a new word.

Audacity + Fraud = Fraudacity.

John Mack yesterday in a CNBC interview said that the capital deployed by Treasury into the banks was going to rebuild their capital ratios - not be lent out. In other words, they intend to hoard it.

This means, bluntly, that not one nickel of benefit will be seen by Main Street, despite claims by Paulson, Bush and others that this bailout is necessary for "Main Street, not Wall Street."

Liars.

Never mind that Bloomberg is reporting that the so-called "executive compensation limits" that Paulson is touting mean little or nothing:

"Oct. 15 (Bloomberg) -- Goldman Sachs Group Inc.'s Lloyd Blankfein, whose $70.3 million paycheck made him Wall Street's most highly compensated chief executive officer last year, could still earn tens of millions annually under the bank-rescue plan run by his former boss, Treasury Secretary Henry Paulson."

Very nice. So the taxpayers hand out billions and the executives still rake it in.

Where is the accountability?

CNBC's Fast Money finally started talking about the outright fraud and lies last night. Dylan Ratigan was absolutely on fire about the fact that Paulson was in fact one of the executives lobbying hard for removal of leverage limits in 2004, just two years before he took the position at Treasury (and cashed out $500 million in Goldman Sachs stock tax free.)

I and a few others have been peppering the media with this, and finally, someone woke up to the fact that the very same people who made this mess now want we the taxpayers to pay for cleaning it up - after they ran off with all your money!

Never mind that its unlikely to work.

Nor does it stop there. AIG continues to draw on their "credit line" with The Fed. Inquiring minds want to know a few things here, chief among them being why suddenly is there $80 billion of hard money required in a business that is "fundamentally sound" in excess of cash flow, and where that requirement did not previously exist.

I'm suspicious as hell on this one guys, and my suspicion generally points in the direction of Lehman's Credit-Default Swaps.

The claim by the DTCC and ISDA is that the total "actual exposure" is somewhere in the area of $6-8 billion once all the contracts have netted out.

Let's examine this, because it leads to only two possibilities, both of which are extremely uncomfortable.

First, if the claims are correct: Then the entire CDS game is one gigantic high-finance version of "pick pocket."

That is, you come to me for a CDS on Lehman. I charge you $100,000. Then I immediately go find someone who will sell me the same contract for $90,000. I have now "picked your pocket" to the tune of $10,000, and (theoretically anyway) I have no risk. This continues until the last sucker says "no mas!" on a cheaper price, at which point that particular chain of CDS come to a close, until the next buyer shows up.

If this is the essence of the CDS game then the entire scheme and the dealers' insistence on keeping these things off a public exchange is an artifice with intent to defraud. Why? Because by keeping bid/ask and O/I hidden these banks are able to continue to play this game of "steal from the guy you sell to by obscuring the price"; indeed, that is the essence of the trade! This market doesn't exist to make a market or to set a price for risk, it instead serves as nothing other than a high-finance looting operation with everyone putting in the maximum effort to obscure market facts so as to be able to maximally exploit the customer!

Why do I make this charge? Because there were allegedly $600 billion worth of contracts written on Lehman. If only 1% of that turns into real money needing to be paid out, and recovery on the bonds was literally under 10 cents, then the actual "notional at risk" was $540 billion. As a result we have almost none of the market being used either to insure actual bonds or to place bets on the firm's demise (or health) - essentially the entire CDS marketplace exists to do exactly one thing - steal from the buyers of this "protection"!

If I ran a place that was called a "Tavern" but 99% of the people who were there in fact came to deal cocaine, and only 1% of the people purchased drinks and food to be consumed in my "establishment" I'd be instantaneously raided and shut down by the cops, and with good reason. I would be operating a criminal enterprise - despite calling what I'm doing "serving food and adult beverages", in point of fact I was providing cover and concealment to a highly-illegal enterprise that was engaged in a prohibited activity. Ditto if my alleged "Tavern" was in fact cover for a bookmaking operation and again, 99% of my "activity" was in fact illegal sports betting while 1% was the sale of alcohol and food.

If the ISDA and DTCC claims are correct this is the fraud of the century and every bank and institution involved in it needs to come under immediate federal indictment.

The other possibility is more ominous - ISDA and DTCC are lying, and in fact there are hundreds of billions of dollars in real claims that need to be paid off next week.

The latter explanation happens to (inconveniently) fit with AIG suddenly needing $80 billion worth of actual money. See, AIG's derivatives desk is known to have written CDS on damn near anything or anyone in considerable size. It was a very profitable part of the operation while the music continued to play, but now it has imploded on them, as all overly-leveraged schemes eventually do.

If this explanation is correct then we have a whole different set of problems. In that case the obvious question is whether OTS was complicit in allowing a regulated institution's wholly-owned subsidiary with recourse to the parent to lever up to a degree that vastly exceeded any reasonable standard of prudence under banking and insurance regulations. The implication there is that we had willful and intentional refusal to enforce banking and insurance regulations on both a state and federal level, because AIG was in fact a regulated entity - this was no hedge fund!

The latter scenario also leads one to question whether the $80 billion drawn thus far is in fact going to pay off hedge funds who made bets on Lehman's collapse! If so then this is a further outrage, in that these firms bought these "swaps" from an entity that was insolvent at the outset of writing them, and the idea of the government stepping in to protect hedge funds from bets they made with a firm they knew didn't have the capital to pay is beyond outrageous, not to mention a raw fleecing of the taxpayer to cover the bets of an illegal and under capitalized casino that was enabled and powered by willfully-blind regulators!

Either way we've got a problem with the only real question being exactly who has been lying to whom, where we need to point the Federal Prosecutors, and from whom we should seek to disgorge the ill-gotten gains with Civil RICO (Racketeering) lawsuits.

There's more fraudacity to explore, but this should give the prosecutors plenty to start with.

Do you think we can find one or two somewhere in this country that aren't actually in bed with the fraudsters?

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