Tuesday, November 01, 2011

Melt Down In The Works

According to Zero Hedge our financial system is on the brink of a collapse bigger than the one that happened in 2008. This all comes about because the risks the banks are taking internationally are accounted as if the financial system is going to work properly and cover them. But what if the system can't cover?

A little over a month ago, Zero Hedge started an avalanche in the financial sector, and an unprecedented defense thereof by the "independent" financial media and conflicted sell side, by being simply the messenger in pointing out that the gross exposure of one Morgan Stanley to the French banking sector is $39 billion. The firestorm of protests, which naturally focused on the messenger, and not the message, attempted to refute the claims that Morgan Stanley (and many others) are overexposed to Europe (both banks and countries) by stating that gross is not net, and that when one nets out "hedges" the real exposure is far, far lower. The logic is that bilateral netting, as the principle behind this argument is called, should always work - no matter the market, and that counterparty risk, especially when it comes to hedges, should always be ignored because banks will always honor their own derivative exposure. Obviously that this failed massively when AIG had to be bailed out, to preserve precisely the tortured and failed logic of bilateral netting was completely ignored, after all things will never get that bad again, right? Well, wrong. Because the argument here is precisely what the exposure is when the chain of netting breaks, when one or more counterparties go under (such as MF Global for example, which filed bankruptcy precisely due to its hedged (?) European exposure - luckily MF was not in the business of writing CDS on European banks or else all hell would be breaking loose right now). So little by little the story was forgotten: after all when everyone says gross is not net, contrary to what history shows us all too often, everyone must be right. Today it is time to refresh this story, as none other than Bloomberg pulls the scab right off and while confirming our observations, also goes further: yes, banks are not only massively exposed to Europe, but they are in essence misrepresenting this exposure to the public by a factor of well over ten!
For all intents and purposes Greece is gone. Terrible to be sure but barely manageable. But what happens when Italy goes? Or Ireland, or Spain, or Portugal, or all of them plus others? Like China.


Cross Posted at Classical Values


Kalpesh said...

Yeah!!! i agree with the statement that Now the story has changed and banks are not only massively exposed to Europe, but they are in essence misrepresenting this exposure to the public by a factor of well over ten! but i was came to know about this first when i was in lincoln technical institute by one of my professor.

M. Simon said...


That is such a clever bit of spam that I'm leaving it up.