Saturday, October 20, 2007

Superfund Strong Arm and a Game of Chicken

As the terribly entertaining drama of the banks exposure to mortgage related losses unfolds, a clearer picture is beginning to emerge on how the big banks intend to get through the crisis. The plan appears to make moves on two fronts.
Strong Arming
Friday afternoons are really the place to be as far as news in the future, as most announcements are timed for the late afternoon before a weekend in an effort to not draw attention. This past Friday we see this:
SIV fund support grows with PIMCO, Fidelity: Draghi
By Francesca Landini
WASHINGTON (Reuters) - Support for a so-called super SIV fund designed to ease the stress of the subprime meltdown appeared to grow on Friday as a top global finance official said two giant investment funds had thrown their weight behind the endeavor.
Fund giants PIMCO and Fidelity have joined the so-called super SIV fund set up by three big U.S. banks, boosting confidence in the plan, Bank of Italy Governor Mario Draghi said at the close of a meeting of finance officials from the Group of Seven rich industrialized nations.
Draghi said U.S. Treasury Secretary Henry Paulson had discussed the fund with officials attending the meeting of central bankers and finance ministers from the United States, Canada, Italy, France, Germany, Britain and Japan.
"Paulson has done a short briefing on the SIV fund," Draghi told journalists. "PIMCO and Fidelity have joined."

Full article:

So what we see here is the Superfund for SIV's is making sure to collect as many big name players as possible. One may conclude the fund is trying to make itself seem credible by including solid names across many nations. I think their intent is a bit different. The plan is to make it impossible for any sale of assets related to the SIV's to happen without approval of the cluster of banks in the Superfund. In this way, price discovery of the assets can be forestalled indefinitely, the exact stated purpose of the fund. By making agreements with all the major players, the Superfund intends to strong arm (not those ARMS!) any entity from unloading the crap paper they hold. This is a key point. I was thinking that a way for a competing bank to crush the competition would require that the bank not hold any of the assets in question. That bank could then buy a reasonable amount, and sell it on the open market,probably at a significant discount to what the assigned price is. Then that bank could short the big holders of the paper as the new price is now known by the sale, and they make a huge killing. A complete lock-up of those assets will keep that from happening. It is a form of price control, and it is a great move by the banks.

A Game of Chicken
The well known game of chicken is defined on Wikipedia as:
The game of Chicken, also known as the Hawk-Dove game, is an influential model of conflict for two players in game theory. The principle of the game is that while each player prefers not to yield to the other, the outcome where neither player yields is the worst possible one for both players. The name "Chicken" has its origins in a game in which two drivers drive towards each other on a collision course: one must swerve, or both may die in the crash, but if one driver swerves but the other does not, s/he will be called a "chicken"; this terminology is most prevalent in the political science and economics.

Right now we are looking at a systemic banking crisis. The FED had to cut rates in a hurry, the discount window was open for business, Hank Paulson is running around on TV, in interviews, at any conference anywhere pushing the SIV Superfund. All these things are very rare and disquieting. The banks second front in their "War on Insolvency" is a game of chicken played against the FED, the US government, and the US taxpayer.
First I want to present an analogy that I think captures exactly what is going on. Imagine a criminal has committed terrible crimes in the process of being a drug dealer. The Police and FBI have him nailed to the wall on several murder charges. The criminal's lawyer, in a closed door hearing, presents evidence that the firearm or firearms used in the crimes were guns that were seized by the police and/or FBI in other raids elsewhere. The guns were supposed to be melted down and destroyed. The serial numbers of the firearms used by the criminal match those of guns supposedly destroyed. For the case to move on, the police/FBI have to admit the guns were sold from their possession for profit. This would cause serious repercussions indeed. Instead, the police/FBI accept the defense that the guns technically do not exist, and the criminal goes free.

Now before you try to assign who in the current mess is the FBI or the criminal, that is not the point of the analogy. The point is the disclosure of the gun sales would seriously hurt the perception that the authorities are to be trusted. This could cause problems in the public belief system. That is the take home point.

The banks want, and in effect are demanding a bailout in the form of:
  • Interest rate cuts, probably down to the 2-3% area in the next 6 months
  • A free hand to make the SIV Superfund as closed to the free market as possible
  • Solvency guaranteed for Countrywide, Fannie Mae, etc
  • Cash infusions form the central banks worldwide

If they do not have these things, a blow up or meltdown of a major bank may cause a serious change in the public belief system as it relates to the banking system. Most people are unaware of the nuances of a Fiat currency, and most people (luckily!) have no idea about fractional reserve banking. If major banks have major issues, most people will be absolutely shocked to find their money is as good as gone. That is the threat the banks are using right now. Perception is reality, and the banks are banking that a bailout will be coming and kept quiet or else the curtain will be pulled back, and the wizard is exposed.

Mish at his site has an excellent post as it relates to how your money is not actually at the bank at all (Warning: do not read if you are easily unsettled):

Going forward, the tricky balance is going to be for the prices of real estate to correctly crash downwards, but the banks somehow able to withstand the beating. It is certainly going to be interesting to see it all play out. Remember, an animal hurt and cornered is very dangerous, and I do not think the banks like looking like total fools right now. They have several cards yet to play, and the game of chicken is on.

On a lighter note, check out this tune from a great film, "Streets of Fire". Diane Lane is a great actress:

Have a good night.


Anonymous said...


I found this on Mish's site:
3) Gold is risky.

3A) Typically the above statement is made in passing as if other things are not risky. But step back for a moment consider the debacle in housing. Some houses in bubble areas like Florida.....

Yeah.... No crap! A salary of $50K/year here (which is good money) couldn't buy(properly service the debt) the average median quarter of a million dollar home. That was unless you were an idiot. Seriously I knew something was out of wack when 4 bedroom homes with zero lot lines could actually get bought at those prices. What makes me mad as hell is that bubble priced my hard working ass out of anything acceptable. Even shacks here started fetching mad crazy stupid prices. Long story short is I continued to rent because I couldn't afford to be a bone head and get in beyond my means... When the shiza hitz the fan so help me great creator I will not be affected in any way. Ever see a funny movie where people are all milling around outside in what appears to be a bright and sunny day? Well there I am in the crowd with my umbrella up, wearing a poncho, a pair of fishing waders and sitting in a small canoe, getting laughed at constantly. Well guess what? Out of no where it starts to rain... no wait it starts to pour.... hard. Everyone is getting soaked and then it floods. Some people manage to climb the one and only tree within miles. Most people are screaming I can't swim...I CANT SWIM! As the water level rises and almost all people go under I pull out my trusty oar made out of gold and paddle away. (Wearing a shit eating grin because the tree just go struck by lightning)

Keep up the good work!


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