The Hoard Mentality

We know that a whole lot of the big financial players, mostly those that are licensed as banks (which now includes Morgan Stanley and Goldman Sachs), took advantage of their ability to borrow cheap money at the Federal Reserve discount rate (as the Fed was cutting rates and making money even cheaper) – a rate drop that was intended to trickle cash into the small business/consumer credit markets, and shore up payrolls and receivable financing. We know these big money guys bought Treasury bills (government paper) instead, thus hoarding the cash. Why?

Some think that all this hoarding was to have a cash reserve to bottom feed on the remnants of a crashed stock market, but their own stock was tanking as well and they did not use their hoarded cash to buy back their own stock at steep crashed-market discounts. There’s something happening, maybe, that most folks aren't thinking about?

Remember a blog a few weeks ago when I discussed the “credit default swap” (CDS) instrument –where a lender who is worried about the creditworthiness of a borrowing corporation can pay out some of the interest upside – through a tradable CDS – in exchange for “default-insurance” from a solvent party able to stand behind the loan? In other words, the issuer of the default insurance is paid a chunk of the interest payments (big money when you do a lot of this) – i.e., the lender is literally paying a piece of the interest being generated to this CDS issuer… as long as the borrower is making interest payments. If the borrower defaults, the lender calls on the issuer of the CDS to make good on the defaulted loan.

As long as you don't have lots of defaults, and those CDS instruments are generating real money, they trade like diamonds. But who were those borrowers? There is currently an estimated $55 trillion in CDSs still out in the world market. This CDS paper covered loans to companies like Bear Stearns, Lehman Bros., AIG, to name a few, although the vast pool of guaranteed companies have not defaulted and probably won't default (we hope!).

Although there is no real way to know exactly who owes what and who is covering how much of which risk, it seems that the very financial companies that took the default risk (issued the CDS paper), earning the big bucks from the CDS payments, are the same companies that are borrowing all that money from the Fed and hoarding the borrowings. Here is how today’s thedeal.com described the issue: “Fear that settlements of Lehman Brothers Holdings Inc.'s credit default swaps could unhinge markets are looking to be unfounded as the final day to settle them winds to a close [today]. It's been unclear exactly since [that] investment bank filed for bankruptcy on Sept. 15 what the total [default] exposure would be, as estimates ranged from $6 billion all the way up to $400 billion in swaps.

“A few weeks ago, there were major concerns that exposure could be in the hundreds of billions. But in a statement last week, the Depository Trust & Clearing Corp., which clears most [CDS] trades in the over-the-counter market, estimated that ‘net funds transfers from net sellers of protection to net buyers of protection are expected to be in the $6 billion range,’ which seems to have tamped down much of the fear.”

“But with markets still jittery, there was speculation that banks and other sellers of CDSs were hoarding their cash in order to pay out on losses of slightly more than 91% on Lehman contracts.” So it’s simple terror that motivated the hoarding, and perhaps as the lack of a stampede suggests that perhaps some of that hoarded money can slide down to the companies that need receivable loans to guarantee their payrolls. I might suggest to the Department of the Treasury that they use “cattle prods” if necessary. We're dying down here!

I’m Peter Dekom, and I approve this message.