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Banks are hoarding cash to prepare for CDS pay-outs

 
Me114
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10/07/2008 08:04 AM
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Banks are hoarding cash to prepare for CDS pay-outs
Banks are hoarding cash to prepare for CDS pay-outs

[link to www.ft.com]

Banks prepare for CDS pay-outs

By Aline van Duyn in New York and Hal Weitzman in Chicago

Published: October 7 2008 03:00 | Last updated: October 7 2008 03:00

Banks are hoarding cash in expectation of pay-outs on up to $400bn (£230bn) of defaulted credit derivatives linked to Lehman Brothers and other institutions, according to analysts and -dealers.

This added pressure on the frozen financial system comes as officials prepare to meet participants in the so-far unregulated $54,000bn credit derivatives market to speed up plans for the creation of a central clearing house.

The Federal Reserve will meet dealers, investors and exchange executives in New York on Tuesday. Although big dealers had committed to setting up a central counterparty by the end of the year, urgency has increased in light of the collapse of banks around the world and as company bankruptcies loom.

"The New York Fed will hold a meeting [today] with a small number of banks and buyside firms to discuss the progress being made toward the creation of a central counterparty for credit default swaps," said a Fed official, adding that this would "help reduce systemic risk associated with counterparty credit exposure and improve how the failure of a major participant would be addressed".

Credit default swaps, a form of insurance against bond defaults, are the most common type of credit derivative. The default of up to $500bn in derivative contracts linked to Fannie Mae and Freddie Mac was settled on Monday, the biggest such exercise ever carried out.

The Fannie and Freddie CDS settled at between 91.5 and 99.9 cents on the dollar, reflecting the fact its underlying debt is not in default after the mortgage groups were seized by the US government. The seizure did trigger defaults on derivatives, however.

The next test will be the unwinding of CDS linked to Lehman, which filed for bankruptcy three weeks ago. Michael Hampden-Turner, a credit strategist at Citi, estimates that there could be $400bn of credit derivatives referenced to Lehman.

These contracts will be settled on Friday, and with the recovery value on Lehman bonds currently estimated at about 10 cents on the dollar, the pay-out by banks and other sellers of credit protection on Lehman could reach a gross $360bn.

The Fed meeting is expected to include executives from exchanges such as the CME Group and Intercontinental Exchange, which are vying with The Clearing Corporation, a consortium of investment banks and dealers that has vowed to establish a central counterparty clearing house by the end of the year.

The Financial Times Limited 2008

see link
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Me114 (OP)

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10/07/2008 08:08 AM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
by bearking
NEW 10/6/2008 11:15:02 PM
$400B payout due Fri for Lehman CDS?

posted on Tickerforum

"We think one of the key drivers has been the tremendous potential demand for cash from counterparties, related to the CDS (credit default swap) payouts on the recent major credit events. To recap, the FNM/FRE CDS settlement auction happens today (6 October), the LEH auction on 10 October (Friday), and WaMu on 23 October. In these settlement auctions, the reference price for the underlying bonds will be set, thus determining the payout levels."

"… We think that the CDS payouts related to these credit events will put tremendous strains on the financial counterparties that had written those CDS. We broadly estimate there could be US$50bn of payouts related to FNM/FRE CDS, and US$400bn of payouts related to LEH CDS. We think it highly likely that many counterparties, particularly hedge funds, will not be able to raise the cash to meet their ends of these bargains."

"What will this mean? More failures amongst hedge funds, insurance companies and banks, and - given that CDS are largely OTC, meaning that there is limited visibility beyond the immediate counterparty - a lack of trust that translates into money markets remaining effectively shut. And whichever measure of financial stress/lack of liquidity is used - LIBOR-BaseRate gap, TED spread etc - it will remain at elevated levels as long as markets are worried about possible failures of counterparties (or counterparties' counterparties)."
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Anonymous Coward
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10/07/2008 08:33 AM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
so if the financials make it through to Friday, then we still have a possible meltdown on that date?

10/10
Anonymous Coward
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10/07/2008 08:36 AM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
Thank you OP. This helps put in perspective.
Anonymous Coward
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10/07/2008 08:37 AM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
so if the financials make it through to Friday, then we still have a possible meltdown on that date?

10/10
 Quoting: Anonymous Coward 170917


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Me114 (OP)

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10/07/2008 08:49 AM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
the unwinding is happening!
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Anonymous Coward
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10/07/2008 08:52 AM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
I have been getting the evil eye from my local bank tellers as i go in each week to pull out more and more cash!
Me114 (OP)

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Re: Banks are hoarding cash to prepare for CDS pay-outs
Release Date: October 7, 2008
For release at 9:00 a.m. EDT

The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve's existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.
:ura:

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Me114 (OP)

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10/07/2008 12:12 PM
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Re: Banks are hoarding cash to prepare for CDS pay-outs
see link for more and the charts

02 October 2008
The Dollar Rally and Deflationary Imbalances in the US Dollar Holdings of Overseas Banks

[link to jessescrossroadscafe.blogspot.com]

Dollar Assets and Liabilities in the International Banking System

In reading the Assets and Liabilities reports of the Bank for International Settlements (BIS), we have been examining the holdings of the reporting banks with respect to the changes in US dollar denominated assets and liabilities.

The Eurodollar had been a component of M3 and was discontinued by the Fed in 2006.


When a multinational company deposits US dollar receipts from an export business in their domestic banks those deposits are frequently held in dollars. Think of it as a short term Certificate of Deposit denominated in US dollars.

Overseas banks may take those customer dollar deposits (liabilities) and place them in dollar assets such as CDO tranches and interest yielding debt instruments which are held as dollar assets on their books.

If those dollar assets decline because of a financial event as we are seeing today, the depositors may choose to withdraw their dollar deposit from the bank as they mature.

This places the bank in an awkward position since the corresponding assets have deteriorated in value, but the nominal value of the certificate of deposit liability remains the same with the requisite interest accrual.

As a result, a demand for dollars can be generated in the foreign country that is artificial but very real in terms of day to day banking operations.

This is the 'artificial dollar short' and monetary deflation about which so many have spoken. It is specific to Europe in this case because the ECB cannot print dollars, it can only obtain them from the Federal Reserve.

It has more of the characteristics of a supply disruption or a liquidity crunch in that demand is temporarily exceeding supply because of an exogenous event.

The central banks arrange swap operations, such as between the Fed and the ECB, to exchange Euros and Dollars to maintain the liquidity of their domestic operations.

If handled inefficiently or under event duress this could have the effect of creating a short term currency imbalance, increasing the cost of euro-dollar swaps, and driving the 'price' of the dollar higher in the short term, and perhaps quite sharply if the event is of sufficient magnitude.

As the imbalances are resolved the 'fundamentals' should reassert and relative values among currencies revert to the mean.

But in the short term a significant amount of dislocation and distress could occur in the arbitrage and banking markets.

We believe that we are in such an occasion now, as the European banks had been slow to markdown their degraded US assets, and had relied on swaps written by companies such as AIG which have failed, leaving the banks a day late and literally 'a dollar short.'

The resulting sharp rally in the US dollar is therefore likely to be an anomaly which will correct, and perhaps quite sharply, once the effect of the short term imbalances dissipates.

We do not have access to a Bloomberg terminal but would speculate that EUR.USD swaps have risen higher recently as the withdrawal pressures in the European banking system increased. This has little to nothing to do with the relative prospects for the fundamentals, but are what we like to refer to as 'the technical trade.' Real enough to the trader, but transitory.

Have you missed the exquisite irony that it was the US banks that sold the foul debt assets to the overseas banks that are now driving the demand for US dollars. And the US banks are quite possibly squeezing their foreign countrparts in the process?

We wonder if the ECB and other Central Banks agree with this and therefore understand that decreasing the value of the US dollar relative to their currency might be an effective policy response to some liquidity problems in their domestic banking system.

They may already be attempting to accomplish this, given the recent increases in the Fed swaplines with their foreign central bank counterparts. But they may also be getting squeezed by some multinational trading banks and funds.

Although we have been discussing this using the Euro as an example, the situation would apply to any national banking system which has been long deteriorating US debt and the monetary dollar fruits of the US current account deficit and their own mercantilism.

Don't confidence men generally rely on the gullibility and greed of their marks? We doubt the economic hit men are missing this opportunity to profit from a position of relative advantage.

No wonder some nations are complaining that they need a new basis for international trade not based on the dollar.

"It's good to be the King."

Posted by Jesse at 8:00 PM
:ura:

Sweet Thoughts!
I Unknown Depths of Love, You.
What Happens Next Loves me.
Help me Jesus, Life will let me know.
Living is Effortless Normal
God Inside, Outside, Everywhere, Forever!
homepage [link to heartdaughter.com]

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