On US Financial Crisis, USD700 Billion Last Ditch Rescue and Bailout, Derivatives and Toxic Waste

Fiat MoneyThe USA is in a financial crisis and nobody will deny it this time. Unlike back in 2007 when the government denies the recession and the crisis altogether, figuring that a couple of billion here and there would prop up the financial sector enough to survive the storm and none would be the wiser. Today the US government is debating pumping in a huge US$700 billion into the financial system as a final ditch bailout plan. That is a huge amount of money, and not the government’s money, but the people’s money. The US government is now desperate enough to cough up the retirement fund for the whole of US to plug the current leak – chief among the stars this round is none other than Freddie Mae and Freddie Mac. The idea of sinking all the citizens hard earned cash (and future) is terrifying to say the least.

The question is, would the US$700 billion plug the financial leak for good and allow the economy and public confidence to recover. Or will it be the final card that the US Fed has to play on the table. What is next? Or more importantly, will there be another Freddie Mac and Mae after (and if) this hole is plugged. For the US Fed may not have enough cash to bail out another round of sinking ships. The US economy is sinking, the question is just how fast and how far will it need to sink before resurfacing.
How the heck did this mess ever started? I believe it is human greed – pure and simple. The greed of the few (and powerful and rich) have dragged the whole nation into it’s mess.

And how big a mess is it? Let’s put some perspective into the big picture.

The current crisis off course started with the default of the sub-prime loans. But since each loan has the house as a collateral, it should not have been that devastating. The sub-prime crisis have revealed to the public the delicate and dangerous world of derivatives trading. Basically, derivatives are investment products which are derived off the house loans themselves – divided up and repackaged and sold off as valid investment vehicles. Basically a single house loan can spawn tens of derivative investment products. Essentially money has been created out of thin air. These ‘created’ monies are only vaguely traceable to the original house loan that it was derived from. Some investors called some of these derivatives toxic waste.

How big is the derivative market in US? According to the QCC Bank Derivatives Report for the 3rd quarter of 2004, the notional value of derivatives held by US banks are at a record of US$84.2 Trillion! This amount is divided among the top banks in USA (shown only for the top few banks):

JPMorgan Chase US$ 36.8 Trillion
Bank of America US$ 14.8 Trillion
Citibank US$ 11.1 Trillion
Wachovia Bank National Assn US$  2.3  Trillion
HSBC Bank USA US$  1.3  Trillion
Bank One National Assn US$  1.2  Trillion
Bank of New York US$ 561 Billion
Wells Fargo Bank US$ 557 Billion

They key interesting detail about the table above is that for the case of JPMorgan Chase, while the exposure is at US$36.8 Trillion, assets are only at US$628 Billion which works out to about US$58 of derivative per dollar of asset. Credit exposure to Risk Based Capital Ratio is 844%! The other banks have exposure that are similar in nature.

Should the top 3 banks become illiquid or default, the entire US and the worlds financial system would collapse. That is the fire that the Fed is trying to extinguish with not enough water.

With only US$700 billion at hand, the Fed can only play a confidence game. They are hoping that the capital injection of such huge amount would bring sanity back into the bankers and confidence back to the investors. The caveat is that after this injection, the economy must improve or at least sustain. If for example; people continue to lose jobs because companies fold and the spending and investment power of the US continue to diminish and the recession is prolonged, the US financial system would be on it’s knees from this point forward.

I see this as a last ditch effort by the Fed and I can only pray that the gamble would proof to be successful for I cannot even begin to imagine if otherwise.

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