The Magnificent Seven and the Public Private Partnership

by Rob Kirby, Kirby Analytics. April 6, 2009

So how big is the credit derivatives market anyway? According to Reuters, the credit derivatives market is 55 Trillion in size at Oct. 7, 2008:

…AIG sold protection to banks on pools of risky mortgages and other assets in the $55 trillion credit derivatives market…

Now, let’s take a look at where the bulk of these derivatives are held,

Source: Comptroller of the Currency

According to sworn testimony given by AIG chief Liddy, we know that insurer AIG currently possesses about 1.6 Trillion worth of credit derivatives [down from about 2.6 Trillion].

…“Although we have wound down more than $1 trillion in the portfolio of AIG Financial Products – the unit that is at the root of our financial problems – that portfolio remains very large – $1.6 trillion – and it continues to contain substantial risk. The financial downside for taxpayers is potentially very large and very real, and that’s why we’re winding this business down…

So, the top six banking institutions that report to the OCC along with AIG [The Magnificent Seven] comprised approximately 18.5 Trillion worth [33.5%] of an industry reported to be 55 trillion in aggregate. The Federal Reserve’s proxy bank, J.P. Morgan Chase, possessed 8.39 Trillion worth of these derivatives or 15.25% of the global total of outstanding notional.

So folks, what do you suppose the odds are that the Federal Reserve’s proxy bank – J.P. Morgan, the most dominant player in this space - had more than a few trades on its books where AIG was their counterparty?

Pretty good odds, ehh?

So, how does that fit with Mr. Bernanke’s sworn testimony of March 3, 2009 before law makers on Capitol Hill,

“Bernanke dropped his typical reserve and told the members of the committee that he was livid with the way that AIG had been run.

"Nothing makes me more angry," Bernanke said.

"I don't think there's a single episode in this entire 18 months that has made me more angry," Bernanke said.

"AIG exploited a huge gap in the regulatory system; there was no oversight of the financial products division. This was a hedge fund basically that was attached to a large and stable insurance company, made huge numbers of irresponsible bets, took huge losses. There was no regulatory oversight because there was a gap in the system," he said.

Bernanke said the government had no choice and had to rescue AIG.”

Ladies and gentlemen, if Mr. Bernanke was “so angry” with AIG’s behavior, why did he not speak out or take corrective action sooner? Are we to believe that the Federal Reserve’s proxy bank was doing HUGE business with AIG and at the same time the Federal Reserve was unaware that this was happening? Bernanke claims that AIG was run like a hedge fund when the Fed’s bank - J.P. Morgan Chase – has an 87.36 TRILLION derivatives book? How about Goldman Sach’s – formerly an investment bank with 30+ TRILLION in derivatives with a crucial Capital Ratio of 1056? If Mr. Bernanke is so concerned about major institutions acting like hedge funds, why doesn’t he start by reeling in the risk taking behavior of the institutions under his own perview?

Source: Comptroller of the Currency

If the Chairman of the Federal Reserve was “angry” with the goings-on at AIG, wouldn’t they be discussing them to avert systemic financial repercussions? Does it not appear that these two individuals are familiar with each other?

Former Fed Chairman Alan Greenspan pictured with
AIG chief Maurice Greenberg

Last week the White House issued a statement that they remained optimistic that GM could be restructured without the need of a bankruptcy filing.

White House optimistic GM can avoid bankruptcy

WASHINGTON (Reuters) – President Barack Obama's administration remains optimistic that General Motors Corp can restructure without going to bankruptcy court, a senior administration official said on Wednesday.

The official reiterated the White House's position, however, that "targeted use of the bankruptcy code" could be employed if necessary.

"We remain optimistic that significant re-structuring can be executed without the use of the bankruptcy code," the official told Reuters.

Whether or not General Motors, or a host of other companies or sovereign entities for that matter, are forced into bankruptcy may very well be determined by the potential gains which might accrue to some financial players stand to make from their credit derivatives bets:

Entity	Derivatives Outstanding	Market Value or Public Debt	Difference
BANK OF AMERICA CORPORATION	118,689,745,334	31,558,840,000	87,130,905,334
GMAC LLC	83,556,419,908	4,690,000	83,551,729,908
MORGAN STANLEY	84,271,180,804	24,186,940,000	60,084,240,804
DEUTSCHE BANK AKTIENGESELLSCHAFT	71,011,177,628	18,510,000,000	52,501,177,628
CITIGROUP INC.	61,875,137,002	12,760,000,000	49,115,137,002
AMERICAN INTERNATIONAL GROUP (AIG)	47,393,950,401	2,230,000,000	45,163,950,401
GENERAL MOTORS CORPORATION	43,373,996,836	1,540,000,000	41,833,996,836
CENTEX CORPORATION	41,027,349,092	856,760,000	40,170,589,092
LENNAR CORPORATION	40,426,782,677	1,260,000,000	39,166,782,677
AMBAC ASSURANCE CORPORATION	36,835,358,941	189,580,000	36,645,778,941
PULTE HOMES, INC.	38,364,111,999	2,460,000,000	35,904,111,999
FORD MOTOR COMPANY	39,618,004,718	5,030,000,000	34,588,004,718
THE GOLDMAN SACHS GROUP, INC.	80,849,691,288	46,624,340,000	34,225,351,288
BARCLAYS BANK PLC	44,579,007,183	11,160,000,000	33,419,007,183
WHIRLPOOL CORPORATION	32,665,900,751	1,850,000,000	30,815,900,751
CBS CORPORATION	32,484,932,800	2,600,000,000	29,884,932,800
SOUTHWEST AIRLINES CO.	33,766,673,423	4,090,000,000	29,676,673,423
TOLL BROTHERS, INC.	27,532,256,817	2,590,000,000	24,942,256,817
SPRINT NEXTEL CORPORATION	33,852,494,934	10,230,000,000	23,622,494,934
AUTOZONE, INC.	31,489,303,582	8,700,000,000	22,789,303,582
D.R. HORTON, INC.	19,889,587,401	2,540,000,000	17,349,587,401
ALCOA INC.	20,554,123,223	4,620,000,000	15,934,123,223
AMERICAN EXPRESS COMPANY	28,098,626,953	13,970,000,000	14,128,626,953
K. HOVNANIAN ENTERPRISES, INC.	9,458,710,459	70,220,000	9,388,490,459
AETNA INC.	15,056,041,259	9,720,000,000	5,336,041,259
TIME WARNER INC.	33,530,285,093	29,240,000,000	4,290,285,093
WELLS FARGO & COMPANY	47,902,948,043	58,060,000,000	-10,157,051,957
JPMORGAN CHASE &CO.	61,250,536,812	86,770,000,000	-25,519,463,188
RUSSIAN FEDERATION	102,631,256,656	151,000,000,000	-48,368,743,344
ABBOTT LABORATORIES	5,273,779,532	68,720,000,000	-63,446,220,468
REPUBLIC OF TURKEY	169,668,377,905	243,747,000,000	-74,078,622,095
REPUBLIC OF ITALY	157,609,796,730	248,773,000,000	-91,163,203,270
BERKSHIRE HATHAWAY INC.	18,409,990,929	126,860,000,000	-108,450,009,071
UNITED MEXICAN STATES	76,677,172,011	320,334,000,000	-243,656,827,989
FEDERATIVE REPUBLIC OF BRAZIL	113,249,393,554	814,000,000,000	-700,750,606,446

Derivatives outstanding is data made available by the Depository Trust and Clearing Corporation for publicly traded credit default contracts. Market value is for public companies generally in early March 2009; public debt is for countries generally from year-end 2008. Difference is author’s calculation. The average derivatives outstanding for entities with positive differences are 22 times the value of the entity (excluding GMAC as an outlier with a multiplier of 17,816).

For those of you have heard the cliché, “someone is worth more dead than they are alive”, take heed. All of the companies highlighted in bold red in the table above have more credit default insurance contracts written on them than their market capitalizations – some by factors of 40+. Bankruptcy filings make these outstanding derivatives bets payable.

If, as and when any of these behemoths declare bankruptcy, we are likely to see the losing side of these bets socialized with still more debt through the auspices of TARP, TALF or whatever alphabet acronym the disingenuous Federal Reserve happens to be flogging at the time.

The proceeds from the winning half of these bets will, no doubt, accrue privately to selected members of the Magnificent Seven – and we’ll all be reminded that this in the public good.

Today’s Market

Overseas equities began the week on a positive note with Japan’s Nikkei Index adding 108 points to 8,857. North American markets didn’t fare as well with the DOW slipping 41.70 to 7,975.90, the NASDAQ losing 15.16 to 1,606.71 and the S & P off 7.00 to 835.50. NYMEX crude oil futures fell 1.16 to 51.35 per barrel.

On foreign exchange markets the U.S. Dollar Index gained .80 to 84.73.

In the interest rate complex the benchmark 5 yr. government bond finished the day at 1.90% while the 10 yr. bond finished at 2.94%.

Precious metals were bombed with COMEX gold futures ending the day down 25.50 at 869.30 per ounce while COMEX silver futures lost .66 to finish at 12.14 per ounce. The XAU Index gave up 4.61 to 122.95 and the HUI Index lost 13.74 to close at 293.70.

On tap for tomorrow, at 2:00 p.m. Feb. Consumer Credit data is due – expected -1.5B vs. prior +1.8B.

Wishing you all pleasant evening and happy investing!

Rob Kirby

© 2009 Rob Kirby

Contact Information

Rob Kirby | Proprietor, Kirby Analytics Newsletter - Proprietary Macroeconomic Research
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