Monday Apr 27, 2009

Have you been watching the TED spread?

A picture is worth a 1000 words and it certainly resonates with the economic global meltdown this past year.  A red flag indicator on the economy is the TED spread.  This metric is an indicator of perrceived credit risk in the economy.  The TED spread tracks the difference between interest rates of interbank loans and short term T-Bills (government debt).  The difference is measured in basis points (bps). Unlike the economic recessions of the past, this spread skyrocketed universally across the globe rather than in specific countries.  Historical averages are usually below 50 bps so when the TED spread went over 450 bps in the Fall of 2008 there was no surprise what was happening in the world stock markets.  Click here to see a TED spread quote from Bloomberg.

While the TED spread has dropped in the first part of 2009, there certainly needs to be additional closure of the spread in order to get back to historical averages. This will only happen, in my opinion, when credit flows normally once again.  There has been too many mixed messages on banks lending again (but to whom???) and being able to assign value on toxic assets that the banks are holding.  Until these two items can be cleared out, the one common solution for both is attracting private investors.

Consumer and private investor confidence is at an all time lowGovernment loans and stimulus packages globally all factor into where and what to invest.  Where have all the risk takers gone?  I certainly don't have the stomach to hedge in the current securites environment.  Even governments have retreated to purchasing safe, secure debt for investments so who can blame the private investors to be in a you lead and then I'll follow strategy.

Events got pretty scary last October when the TED spread peaked.  A money market fund defaulted, consumers were running on banks and many financial institution capitalizations were evaporating.  You could literally hear value being sucked out of the market and retreating to liquid assets.  Where did it all go?  It's like we had full balloons in a closed room and suddenly the balloons are all empty... but there is still the same amount of air in the room.  We just cannot find the air to blow the balloons back up again.  Reports have indicated that world banks have written off ~$900B (U.S. dollars) in toxic assets but there remains ~$3.1B still working its way through the system.  The TED spread will be watching...

This is where consumer confidence plays a huge factor. 

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Wednesday Oct 15, 2008

Have you ever heard of Credit Default Swaps?

Have you had enough yet of all the discussions, opinions, suggestions, agendas and lunacy regarding the stock market?  I've been watching for a while what is the ultimate effect of credit default swaps (CDS).  It is rumored that there are approximately trillions (U.S. dollars) worth of these puppies lurking out there.  That is no typo, yes trillions not billions worth of these unregulated contracts between a buyer and seller.  Some estimates put CDS liability up to $60 trillion U.S. dollars.  Basically CDS are insurance contracts if a credit instrument (e.g. bonds) defaults.  They cannot technically be called insurance because they are unregulated.  Since they are unregulated there is no requirement to report or track these instruments.  That's sounds a little broken you would think.

A good example is Lehman Brothers.  Lehman's bonds recently have traded for less than $.20 (U.S. dollars).  That means the seller of CDS on these bonds are liable to payoff the other $.80 (U.S. dollars).  These payoffs are going to absolutely impact negatively the institutions that issued the CDS. Instruments such as the CDS have complex probability mathematics behind them.  Created by intellects who went to work on Wall Street. Definitely something I'd personally stay away.  The derivative market is clearly not for the faint of heart. Trouble has been brewing for a while as reporting has disclosed.  The cascading effect across the world was obvious.  I don't know how some could say that this was a U.S. economy only problem.  Markets and investors worldwide are ultimately linked as a result of technology.  Investment options are available to almost anyone, anywhere via the access of a computer.  In my opinion the complex automated trading algorithms of buy .vs sell in the market do not take into account the variable of human fear.  How does a computer program stop a run on the bank without human intervention? That is intervention coordinated with complaint on a global level.   Would love to know where money is flowing to and where it is flowing from...  I'd guess it is flowing to banks where governments are insuring deposits and from banks where there is none.    Have we thought through the long term effects yet?  Truly fascinating.


The blog of Bob Porras - Vice President, Data, Availability, Scalability & HPC for Sun Microsystems, Inc.


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