Foreign central banks are looking for any opportunity to dump their stockpiles of dollars in a manner that doesn't disrupt their economies or the global financial system.

Bulletins from the Titanic -


On Monday, Asian stock markets took another beating, on fears that the
credit squeeze which began in the United States will continue to
worsen in the months ahead. Every index from Tokyo to Sidney fell
sharply continuing the "self-reinforcing" cycle of losses started last
week on Wall Street. The Nikkei 225 average fell 3.3 per cent, India's
Sensex 2.9 per cent, Taiwan's 3.5 per cent, and Hong Kong's Hang Seng
slumped 4.5 per cent. The subprime tsunami is presently headed towards
downtown Manhattan, where nervous traders are already hunkered-down in
the trenches---ashen and wide-eyed.

Amid the deluge of bad news over the weekend; one story towers above
all the others. The yen gained 1.5 per cent against the dollar. (9 per
cent year-over-year) That means that Wall Street's biggest swindle,
the carry trade, is finally unwinding. The over-levered hedge funds
will now be forced to sell their positions quickly before the interest-
rate window shuts and they're stuck with humongous bets they cannot
cover. The faltering yen is the grease that lubricates the guillotine.
$1 trillion in low interest loans--which keeps the trading whirring
along in US markets--is about to get a haircut. Cheap Japanese credit
is the hidden flywheel in Hedgistan's main-cylinder. Once it is
removed, the industry will seize up and clank to a halt. Fund managers
can forget about the vacation rental in the Hamptons. It'll be sloppy
Joes and Schlitz Malt-liquor on Coney Island from here on out.

Over the weekend Deutsche Bank announced that losses from
"securitized" subprime mortgages were likely to reach $400 billion.
The news sparked a sell-off in the Asian markets where investors have
become increasingly eager to pare down their holdings of US equities
and dollar-backed assets. Overnight, the greenback has become the
leper at the birthday party; everyone is steering clear for fear of
contagion. Foreign central banks are looking for any opportunity to
dump their stockpiles of dollars in a manner that doesn't disrupt
their economies or the global financial system. Their intentions may
be prudent-even honorable-but it won't forestall the inevitable blow-
off of US dollars that is likely to commence as soon as the financial
giants reveal the real size of their losses. New regulations have been
put in place that will require the banks to provide "market prices"
for their assets. This will expose the degree to which they are under-
capitalized. When word gets out that the banking system is underwater;
there'll be a run on the dollar.

On Sunday, the AFP reported that the Group of Seven richest nations
(G7) is considering direct "intervention" in the dollar's decline to
prevent a "disorderly correction".

"It is not too early contemplating the risk of coordinated
interventions by the G7," said Stephen Jen and Charles St-Arnaud of
investment bank Morgan Stanley. "History shows that multilateral,
coordinated interventions have been key in establishing turning points
in multi-year trends in major currencies in the past three decades."
On Thursday, Treasury Secretary Hank Paulson, full fathom five under
the waves on the poop deck of the Titanic communicated through speaker
tube the news that "A strong dollar is in our nation's interest and
should be based on economic fundamentals."

According to Bloomberg News: "More than $350 billion of collateralized
debt obligations comprising asset-backed securities may become
'distressed' because of credit rating downgrades."

What's clear is that the situation is getting worse, not better.
Honesty must at least be considered as one of many options, although
the Treasury Dept avoids that choice like the plague. Eventually, the
public will have to be told about what is going on. Last week, the
Financial Times reported: "In recent days, investors have been
presented with a stream of high-profile signs that sentiment in the
financial world is deteriorating. However, deep in one esoteric corner
of finance, another, little-known set of numbers is provoking growing
concern. So-called correlation - a concept that shows how slices of
complex pools of credit derivatives trade relative to each other - has
been moving in unusual ways 'What we are seeing in the synthetic
[derivative] markets is that there is a serious fear of systemic
risk,' says Michael Hampden-Turner, credit strategist at Citigroup.
'This is not just about price correlation within the collateralized
debt obligation market, but about a potential rise in default
correlation and asset correlation.' Until recently, traders often
tended to assume that there was relatively little correlation between
different chunks of debt, because they thought that the biggest risk
to the world was idiosyncratic in nature - meaning that while one
company, say, might suddenly default, it was unlikely that numerous
companies would default at the same time. However, some regulators
have been warning for some time that in times of stress correlation
does not always behave as traders might expect."

The multi-trillion dollar derivatives industry-which has never been
tested in down-market conditions---is now moving sideways. No one
really knows what this means except that the most opaque and volatile
debt-instruments are now threatening to unravel, triggering a cascade
of unanticipated defaults and a colossal loss of market
capitalization. Credit default swaps (CDS) are rarely thrashed out in
market commentary. They are counterparty options which provide hedging
against the prospect of default. They are, in fact, a financial
equivalent of the San Andreas faultline which is quivering menacingly
as foreclosures mount and mortgage-backed bonds continue to implode.
As the Financial Times suggests, the shock waves should be sweeping
through the Wall Street trading pits in the very near future.

There are also new developments on the sale of "marked to model" CDOs-
the red-haired stepchild of the new structured finance paradigm. "The
trustee of a $1.5 billion collateralized debt obligation managed by
State Street Global Advisors has started selling assets, apparently
starting a process of liquidation," Standard and Poor's said. The sale
is a red flag for the other holders of $1.5 trillion of CDOs who've
been waiting for market conditions to change before they try to sell
their mortgage-backed bonds. The liquidation will assign a "market
price" to these complex structured investment vehicles. If the price
at auction is mere pennies on the dollar, then the banks, pension
funds, and insurance companies will have write down their losses or
add to their reserves to cover their weakening assets. Simply put, the
State Street sale could turn out to be doomsday for a number of under-
capitalized investment banks. Their revenues are already down; this
would be the last stake to the heart.

Finally, Greg Noland, at Prudent reports on the "looming
disaster" at Fannie Mae where, the best-known Government Sponsored
Entity (GSE) has entered into the current housing slump with a "Book
of Business of mortgages, MBS and other credit guarantees of $2.7
trillion" which is backed by a measly "$39.9 billion of Shareholder's

That's all?

As Noland concludes, "A devastating housing bust will bankrupt the
mortgage insurers, while the solvency of their derivatives
counterparties going forward will be in doubt in any number of
scenarios. The GSEs are now integrally linked to what I expect to be
Credit insurance's and "structured finance's" astonishing downfall."

The only thing looking up are oil futures. And they'll be denominated
in euros soon enough.

Mike Whitney lives in Washington state. He can be reached at:


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