The Market Ticker - Other Voices

MUST WATCH: Glenn Beck And The Dollar Carry

nospam@example.com (Karl Denninger) — Wed, 18 Nov 2009 09:58:38 -0500

Love him or hate him, he got this one almost competely right, and explained it in terms anyone can understand.

TAKE THE TIME TO VIEW THIS EVEN IF YOU HATE GLENN BECK AND FOX NEWS. IT'S IMPORTANT.

Gerald Celente... Audio Link

nospam@example.com (Karl Denninger) — Tue, 17 Nov 2009 17:06:22 -0500

You should be able to play directly from this Ticker; if not, click the original link, which is from Kingworld News.

Original Link is here:

Janet's Insight On Acquittals....

nospam@example.com (Karl Denninger) — Wed, 11 Nov 2009 15:32:00 -0500

Ralph Cioffi and Matthew Tannin, former hedge fund managers and co-heads of Bear Stearns Asset Management, were acquitted yesterday (November 10) of all six counts in their fraud trial” U.S. v. Cioffi, 08-CR-00415, U.S. District Court for the Eastern District of New York (Brooklyn).

You may reprint the following with non exclusive permission provided you include the cover art and the following tag line: “Excerpted with permission from the publisher, John Wiley & Sons, from Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street , by Janet Tavakoli. © 2009 by Janet Tavakoli.”

I worked at Bear Stearns in the late 1980s and remembered amiable newcomer Ralph Cioffi to be Bear Stearns’ most talented and successful salesman of mortgage-backed securities. He was usually even tempered, always hard working, and thoughtful. I headed marketing for the quantitative group run by both Stanley Diller, one of the original Wall Street “quants,” and Ed Rappa (now CEO of R.W. Pressprich & Co, Inc.), a managing partner. Ralph was a popular salesman with my colleagues and a heavy user of our quantitative research. In gratitude for analytical work that helped him make sales, Ralph presented our group with an $800 portable bond calculator purchased out of his own pocket. When I was lured away from Bear Stearns by Goldman Sachs, Ralph Cioffi tried to persuade me to stay, matching the offer. Around 20 years had passed and since then we occasionally stayed in touch, but we were not close friends.

Among other hedge funds, Bear Stearns Asset Management (BSAM) managed the Bear Stearns High Grade Structured Credit Strategies fund. By August 2006, the fund had a couple of years of double-digit returns. BSAM launched the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage fund taking advantage of the first fund’s “success.”

Both funds managed by BSAM included CDO and CDO-squared tranches backed in part by subprime loans and other securitizations (collateralized loan obligations) backed by corporate loans and leveraged corporate loans. In August 2006 when BSAM was setting up the Enhanced Leverage fund, other hedge fund managers (like John Paulson), shorted subprime-backed investments.

Investors in the two funds managed by BSAM had been getting double digit annualized returns on high-grade debt at a time when treasuries were yielding less than 5 percent. In fixed income investments, that usually means investors are taking risk.

Ralph seemed to have similar views to mine on CPDOs, the leveraged product that I had said did not deserve a AAA rating. Ralph told me he thought the AAA rating could “lull the unsophisticated investor to sleep,” and that for the purposes of his hedge funds, if he liked an investment-grade-rated trade he could have the same trade without paying fees and: “easily lever up … fifteen times.” To paraphrase Warren Buffett, if the price of your investments drops, leverage will compound your misery.

On May 9, 2007, Matt Goldstein called and asked me if I had a chance to look at the registration statement for a new initial public stock offering (IPO) called Everquest Financial, Ltd (Everquest). Everquest is a private company formed in September 2006, and the registration statement was a required filing in preparation for its going public. The shares were held by private equity investors, but the IPO would make shares available to the general public.

Everquest was jointly managed by Bear Stearns Asset Management Inc, and Stone Tower Debt Advisors LLC, an affiliate of Stone Tower Capital LLC. I was curious, but I was swamped. I told him no, I was very busy and had not even had a chance to glance at it. He called again asking if I had seen it, and again I said no, “Go away.” The next morning I ignored Matt’s voice mails, but finally took his call the afternoon of Thursday May 10 telling him that I still had not looked at the registration statement and had no plans to do so that day. My first call on the morning of Friday, May 11, 2007, was again from Matt Goldstein. He thought the IPO might be important.

I went to the SEC’s website, and as I scanned the document I thought to myself: Has Bear Stearns Asset Management completely lost its mind? There is a difference between being clever and being intelligent. As I printed out the document to read it more thoroughly, I put aside the rest of my work and said: “Matt, you are right; this is important.” I was surprised to read that funds managed by BSAM invested in the unrated first loss risk (equity) of CDOs. In my view, the underlying assets were neither suitable nor appropriate investments for the retail market. I did not have time for a thorough review, so I picked a CDO investment underwritten by Citigroup in March 2007 bearing in mind that if the Everquest IPO came to market, some of the proceeds would pay down Citigroup’s $200 million credit line. Everquest held the “first loss” risk, usually the riskiest of all of the CDO tranches (unless you do a “constellation” type deal with CDO hawala), and it was obvious to me that even the investors in the supposedly safe AAA tranches were in trouble. Time proved my concerns warranted, since the CDO triggered an event of default in February 2008, at which time Standard & Poor’s downgraded even the original safest AAA tranche to junk.

The equity is the investment with the most leverage, the highest nominal return, and is the most difficult to accurately price. The CDO equity investments were from CDOs underwritten by UBS, Citigroup, Merrill, and other investment banks.

Based on what I read, Everquest’s original assets had significant exposure to subprime mortgage loans, and the document disclosed it, “a substantial majority of the [asset-backed] CDOs in which we hold equity have invested primarily in [residential mortgage-backed securities] backed by collateral pools of subprime residential mortgages.” Based on my rough estimates, it was as high as 40 percent to 50 percent.

I explained my concerns to Matt in a general way. Among other concerns: (1) money from the IPO would pay down Everquest’s $200 million line of credit to Citigroup; (2) the loan helped Everquest buy some of its assets including CDOs and a CDO-squared from two hedge funds managed by BSAM, namely the Bear Stearns High-Grade Structured Credit Strategies Fund that had been founded in 2003 and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund (“Enhanced Leverage Fund”) launched in August 2006; and (3) the assets appeared to include substantial subprime exposure.

Matt Goldstein posted his story on Business Week’s site later that day. Initially it was called: The Everquest IPO: Buyer Beware, but after protests from Bear Stearns Asset Management, Business Week changed the title to Bear Stearns’ Subprime IPO. I hardly think that pleased Bear Stearns more.

Ralph Cioffi contacted me about the Business Week article. He said that dozens of IPOs like Everquest had been done—mostly offshore so as not to deal with the SEC. According to Ralph, BSAM’s hedge funds and Stone Tower’s private equity funds would own about 70 percent of Everquest stock shares (equity), and they had no plans to sell “a single share at the IPO date.” They planned to use the IPO proceeds to pay down the Citigroup credit line and possibly buy out unaffiliated private equity investors.

I responded that verbal assurances that there are no plans to sell a share at the IPO date are meaningless. Publicly traded shares can be sold anytime. But even if the funds kept their controlling shares, it was not good news. Retail investors would have only a minority interest which would be a disadvantage if they had a dispute with the managers.

Ralph claimed that subprime was “actually a very small percent of Everquest’s assets.” He reasoned that on a market value basis the exposure to subprime was actually negative because Everquest hedged its risk. Technically, Ralph might have been correct—but the registration statement for the Everquest IPO itself suggested otherwise: “The hedges will not cover all of our exposure to [securitizations] backed primarily by subprime mortgage loans.”

It is fine to talk about net exposure (left over after you protect yourself with a hedge), but one usually also discusses the gross exposure (of the assets you originally bought). Hedges cost money, so they can reduce returns.

Ralph Cioffi said CDO equity is “freely traded and easily managed.” I countered that CDO equity may be easy for Ralph to value, but investment banks and forensic departments of accounting firms told me they have trouble doing it. I told him that if this were a CDO private placement, it would have to be sold to sophisticated investors and meet suitability requirements, but since it is in a corporation, it can be issued as an initial public offering (IPO) to the general public. It seemed to be a way around SEC regulations for fixed income securities, and it was not suitable for retail investors in my view.

Ralph said he would talk to his lawyers about changing the IPO’s registration statement to add a line about third party valuations. We seemed to be talking at cross purposes, since the registration statement already said that third party valuation would occur at the time of underwriting. The problem with that was that the assumptions for pricing would be provided by a conflicted manager, and assumptions are critical in determining value. Moreover, on an ongoing basis, one had to rely on a conflicted management’s assumptions for pricing.

Ralph did not seem to want to end the discussion, so I asked him if there was something he wanted me to do. He said it would be great if I issued a comment saying I was quoted “out of context,” that my being quoted in Business Week lent credibility to the article and was not helping me, and that I would be “better served” writing my own commentary. I ignored what I perceived to be a thinly veiled threat. I told him that if he wanted me to write a commentary, I would do a thorough job of raising all of the objections I had just raised with him. Ralph seemed unhappy but my thinking he was a hedge fund manager from Night of the Living Dead was the least of his problems.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

More Goldman From Janet

nospam@example.com (Karl Denninger) — Tue, 10 Nov 2009 09:24:00 -0500

Hmmmm..... now this is interesting.... offered without comment... (ed)

Goldman’s Undisclosed Role in AIG’s Distress (pdf)

TSF – Opinion Commentary – November 10, 2009 (last of a series)

By Janet Tavakoli

Goldman wasn’t the only contributor to the systemic risk that nearly toppled the global financial markets, but it was the key contributor to the systemic risk posed by AIG’s near bankruptcy. When it came to the credit derivatives American International Group, Inc. (AIG) was required to mark-to-market, Goldman was the 800-pound gorilla. Calls for billions of dollars in collateral pushed AIG to the edge of disaster. The entire financial system was imperiled, and Goldman Sachs would have been exposed to billions in devastating losses.

A Goldman spokesman told me its involvement in AIG’s trades was only as an “intermediary,” but that isn’t even close to the full story. Goldman underwrote some of the CDOs comprising the underlying risk of the protection Goldman bought from AIG. Goldman also underwrote many of the (tranches of) CDOs owned by some of AIG’s other trading counterparties.

Even if all of Goldman’s CDOs had been pristine, it poisoned its own well by elsewhere issuing deals like GSAMP Trust 2006-S3 that—along with dodgy deals issued by other financial institutions—eroded market trust in this entire asset class and drove down prices.

By September 2008, Goldman had approximately $20 billion in transactions with AIG. Goldman was AIG’s largest counterparty, and its trades made up one-third of AIG's approximately $62.1 billion in transactions requiring market prices. Societe Generale (SocGen) was AIG’s next largest counterparty with $18.7 billion. SocGen, Calyon, Bank of Montreal, and Wachovia bought several (tranches) of Goldman’s CDOs and hedged them with AIG.

END OF EXCERPT (click above for pdf of entire commentary)

Janet Tavakoli: More Goldman (ed: Tee Hee)

nospam@example.com (Karl Denninger) — Thu, 05 Nov 2009 14:33:00 -0500

From Janet this afternoon.....

I apologize to Goldman Sachs’ CFO David Viniar. He did not lie when he said that Goldman’s direct credit exposure with AIG was hedged in the event AIG collapsed. He only addressed direct AIG credit risk.1 On September 16, 2008, he may merely have been unimaginative about risk to Goldman as a result of AIG’s potential bankruptcy partly brought on by stress created by billions in collateral payments already made—and the billions in additional collateral owed—to Goldman Sachs (and other CDS counterparties). Systemic risk is a matter of public interest. Viniar apparently did not intentionally give the impression that Goldman was disinterested when it came to AIG’s bailout.

Read the rest at http://www.tavakolistructuredfinance.com/GS2.pdf - it's good.

Is it getting warm up there in NY this time of year?

(*chuckle*)

Goldman Sachs: Reasonable Doubt

nospam@example.com (Karl Denninger) — Mon, 02 Nov 2009 09:03:25 -0500

Goldman Sachs: Reasonable Doubt (pdf)

TSF Opinion Commentary - November 2, 2009

By Janet Tavakoli

In August 2007, I publicly challenged the fact that AIG took no write-downs whatsoever for its credit default swaps on underlying mortgage related “super senior” positions. I used the example of its aggregate $19.2 billion in credit default swaps on super senior positions backed by BBB-rated tranches of residential mortgage backed securities. I spoke with Warren Buffett, but only about what I had already told the Wall Street Journal (Dear Mr. Buffett Pp. 164-165, 246).

I met with Jamie Dimon, CEO of JPMorgan Chase, adding that the difference was material. JPMorgan Chase’s credit derivatives positions exceeded those of all other U.S. banks combined at the time. JPMorgan was not a participant in the problematic deals, and it was not a recipient of AIG’s settlement payments, but stability in the credit derivatives markets was an important issue. Dimon was dismissive of my concerns. In August of 2007, a potential implosion of AIG was too horrible to contemplate.

Unbeknownst to me, in July 2007, Goldman Sachs and AIG began a prolonged battle over prices and collateral payments for pre-2006 vintage deals on which Goldman had bought protection.

Fraud Audit

Was the risk that Goldman hedged with AIG as bad as Goldman Sachs Alternative Mortgage Products’ GSAMP Trust 2006-S3? Any risk manager worth their salt would have reasonable doubt about this deal and conduct a fraud audit. A fraud audit doesn’t mean you are accusing anyone of fraud, only that the audit will be thorough, because there are indications of grave problems. If there is fraud, however, the audit should be rigorous enough to uncover it.

If the aggregate $19.2 billion CDS position were derived from BBB rated tranches similar to one from GSAMP Trust 2006-3, the supposedly super safe “super senior” tranche would be worth zero. Every underlying BBB tranche would have permanent value destruction and zero value. AIG would owe a credit default swap payment for the full amount $19.2 billion. Since there is doubt about the collateral of every deal of this ilk, super senior tranches of mezzanine CDOs in the secondary market are currently valued at zero.

No wonder Goldman Sachs bought protection from AIG on mortgage backed deals—and then bought protection on AIG. Goldman may not have contributed to the aggregate $19.2 billion position, but this mezzanine super senior risk was visible to all of AIG’s counterparties.

Sophisticated counterparties like AIG are supposed to protect themselves, and have little chance for recovering damages. But now the American taxpayer has stepped in to make payments for AIG. U.S. taxpayers have a right to recover money paid out for derivatives on deals that include phony collateral.

Maiden Lane III now owns the underlying CDOs for AIG’s cancelled credit default swaps. One can now investigate them—and all of the underlying collateral.

The government’s 100% payout to AIG’s counterparties was a gift, and the negotiations were done in secret. The monoline insurers were in a similar situation with a variety of deals from a variety of counterparties. (Structured Finance Pp. 405-427) For example, in 2008, Citigroup Inc. accepted about 60 cents on the dollar from New York-based bond insurer Ambac Financial Group Inc. to retire protection on a $1.4 billion CDO. Ambac said the underlying “super senior” was worth about zero, and the protection payment would otherwise have been near the full $1.4 billion. Citigroup got a relatively huge payout, since other “high grade” deals have been settled for as low as ten cents on the dollar.

The irony is that Goldman Sachs may not have been involved in the worst of the deals, but its officers had unusually high profile in AIG’s damage control. Goldman’s deals with AIG may have all been completely proper, but deals like GSAMP Trust 2006-3 indicate that Goldman should not be exempt from the general fraud audit of mortgage securitizations that all of the former investment banks [Lehman, Bear Stearns, Morgan Stanley, Goldman Sachs, Merrill Lynch, and some foreign banks going business in the U.S. (DMB Pp. 97-107.)] should undergo.

END OF EXCERPT – Click on pdf file above to continue reading.

Tavakoli’s book on the global meltdown: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

Janet Tavakoli: Warren Buffett's Wall Street War

nospam@example.com (Karl Denninger) — Tue, 20 Oct 2009 09:31:27 -0400

Posted exactly as received.... (KD)

JT Note: It’s time to impose WW II’s 95% excess profits tax.

Warren Buffett’s Wall Street War (link to pdf)

TSF’s Dark Comedy Commentary – October 20, 2009

By Janet Tavakoli

In a January 2009 interview with NBC’s Tom Brokaw, Warren Buffett criticized leveraging “to the sky,” and creating “phony instruments [RMBSs, CDOs, et al.] that fool other people so you stick money in your pocket.” In 2002, he claimed over-the-counter derivatives are “financial weapons of mass destruction”¹and participants who account for them have “enormous incentives to cheat.” ²

Warren Buffett, the blogosphere’s “Oracle of Omaha,” often chastises the financial community. If you cost him money, he’s liable to write an expose. He posts annual shareholder letters on a low-tech website and seems to labor under the assumption that rational people eagerly read his blog. Congress and regulators are dismissive of Buffett’s hyperbolic rhetoric; it is fit only for a banana republic.

In 2003, Buffett wrote of the manufactured housing industry’s “business model centered on the ability…to unload terrible loans on naïve lenders…The consequence has been huge numbers of repossessions and pitifully low recoverie[s].” ³ Buffett alleged that the manufactured housing industry’s consumer financing practices were “atrocious,”⁴ and securitizations provided the money to fuel the financing.

Berkshire Hathaway’s investment in the distressed junk debt of Oakwood Homes lost money after the designer and manufacturer of modular homes went bankrupt in 2002. Buffett claimed “Oakwood participated fully in the insanity.” ⁵

Warren Buffett’s diatribe suggested that most of the manufactured housing industry was involved along with several Wall Street firms that underwrote the securitizations. Using money from new investors to pay returns to old investors in unsupportable investments is called a Ponzi scheme.

Oakwood’s loans to purchasers of manufactured homes were made possible by a line of credit from Credit Suisse First Boston (Credit Suisse). The credit line was similar to a credit card except that Oakwood had to put up the home loans as collateral. Credit Suisse earned fees for the loans and further fees when it packaged (securitized) Oakwood’s loans. Credit Suisse (the old investor) bought the securitized loans and then sold them to new so-called sophisticated investors.

Sales of manufactured homes declined. Loan delinquencies (late payments) and repossessions rose. Oakwood Homes had crushing debt and falling income for at least three years before it filed for bankruptcy in November 2002. But securitizations had temporarily inflated the bubble for the collapsing enterprise. A June 2008 court opinion said Oakwood’s aggressive lending practices led to the high number of repossessions and a debt load that Oakwood could not support. Oakwood’s liquidator said the transactions it did with Credit Suisse were “value destroying.”⁶

Someone should have muzzled Warren Buffett back in 2003. The Slumbering Esquires’ Club might have believed Buffett’s preposterous theory that after private securitizations became popular, the “industry’s conduct went from bad to worse.”⁷ Buffett’s wacky warnings could have jeopardized Wall Street’s subsequent mortgage lending securitization Ponzi scheme.

The SEC might have investigated Lehman Brothers’ questionable shenanigans, especially after it was held liable in 2003 by a California jury for allegedly helping FAMCO cheat borrowers. The SEC might have looked into the unsavory practices at Goldman Sachs Alternative Mortgage Products, Bear Stearns, Merrill Lynch or the entire private securitization industry, and their mortgage lending subsidiaries.

While the SEC slept inside a collapsing debt bubble, the Omaha conspiracy theorist spooked Goldman Sachs into believing it needed his money. In the fall of 2008, Buffett closed a deal for $5 billion in Goldman Sachs’s preferred stock paying a 10% annual dividend. Goldman even gave Buffett warrants to buy $5 billion in common stock at a price of $115 anytime before October 1, 2013. [The Fed let Goldman buy back its warrants for chump change.⁹] Buffett’s warrants are now about $3 billion in-the-money and worth much more—a sweetener for his crispy calamari.

Hank Paulson, Ben Bernanke, and Tim Geithner¹⁰ ignored the historic ravings of the most successful living investor, and fueled some of the bombers piloted by Wall Street before finance’s Pearl Harbor. After they used taxpayer money to save the system and enriched the culpable with no strings attached, Buffett said “it could have turned out a lot differently,” and called each of them a four-letter word. The label was undeserved.

Four-letter words aside, Warren Buffett raised a good point. It could have—and should have—turned out a lot differently. But it’s not too late. Buffett called the crisis an economic Pearl Harbor and said that “Wall Street owes the American people one at this point.”⁸ During World War II, we imposed an excess profits tax. We should impose a 95% excess profits tax—or windfall profits tax—on certain financial institutions (including Goldman Sachs) enriching themselves with ongoing low-cost Fed funding and debt guarantees.

Adapted from Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street (Wiley 2009) by Janet Tavakoli

Disclosure: Janet Tavakoli is an investor in Berkshire Hathaway Inc.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based consulting firm to financial institutions and institutional investors. She is the author of a book on the cause global financial meltdown: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

She is also the author of Credit Derivatives & Synthetic Structures (Wiley, 1998, 2001), Collateralized Debt Obligations & Structured Finance (Wiley, 2003), Structured Finance & Collateralized Debt Obligations (Wiley, September 2008).

Notes:

1 Berkshire Hathaway Inc. 2002 Annual Report, 15.

2 Ibid., 13.

3 Berkshire Hathaway Inc. 2003 Annual Report, 5.

4 Ibid.

5 Ibid.

6 OHC Liquidation Trust, et.al v. Credit Suisse First Boston et al., U.S. Bankruptcy Court, Delaware. Civil Action No. 07-799 JJF (Chapter 11 Case No. 02-13396) Memorandum Opinion June 9, 2008. (Partial Summary Judgment)

7 Ibid. [1]

8 Warren Buffett on ABC’s Good Morning America, July 9, 2009.

9 The Treasury got a paltry 23% return on its $10 billion investment in preferred shares and warrants in Goldman Sachs. The Fed accepted only $1.1 billion for warrants that had more than nine years to run during a quarter when Goldman Sachs was awash in cash and profits and would report record earnings made possible only by taxpayer intervention. The Fed gave up the right to buy 12.2 million shares of Goldman for $122.9 per share. [As of Oct 16, the warrants were in-the-money by around $750 million and would have been worth much more with just over nine years to the original October 26, 2018 expiration date.] This does not include ongoing near zero-cost funding, relaxation of accounting terms, temporary protected status as a bank holding company (guarding against a run on Goldman) before switching its status to a protected financial holding company on August 14, 2009 [The Treasury may designate it a Tier 1 Financial Holding Company], and issuance of $25.15 billion (as of June 2009) unsecured FDIC guaranteed debt [GS is allowed $35 billion outstanding prior to Oct. 31, 2009. Goldman’s first issuance was for $5 billion of 3.35% maturing in 2012 on November 25, 2008; at the time its stand-alone debt traded at 8.25% for a comparable maturity].

10 In the fall of 2008, Henry (“Hank”) Paulson was Treasury Secretary (Paulson was formerly CEO of Goldman Sachs), Ben Bernanke was (and currently is) the Chairman of the Federal Reserve, and current Treasury Secretary Timothy Geithner was the Chairman of the New York Fed. [Geithner was succeeded by Stephen Friedman as Chairman of the NY Fed. Friedman was a former Goldman Sachs co-chairman and owned shares of Goldman Sachs and was a member of Goldman’s board while he held his influential Fed position, a conflict of interest and a violation of Fed policy. Friedman resigned the Fed position in May 2009.]

Janet Tavakoli: China Defaults

nospam@example.com (Karl Denninger) — Wed, 07 Oct 2009 08:49:00 -0400

Sent to me and reposted; I am opening a new category called "other voices" for articles such as this, and will use it from time to time. Anything in here is, obviously, from people other than myself :)

China Defaults, Currency Basket Threatens Dollar

TSF – October 6, 2009

By Janet Tavakoli

Robert Fisk exposed revived discussions by the Gulf States, China, France, Japan, Brazil, and Russia to replace the dollar as the benchmark oil trading currency with a basket of currencies including gold within 10 years. This proposal is not new and discussions have been ongoing for decades. But other extraordinary moves in the capital markets suggest we should take this threat to the dollar’s position very seriously. For example, China has $2.3 trillion in currency reserves (about 70% in dollars), and China knows how to get its way.

In November 2008, Chinese banks said they would no longer play by our rules. Top tier banks (Bank of China and Industrial and Commercial Bank of China) reneged on derivatives contracts. They failed to come up with billions in collateral on dollar/yen FX trades, which were out of the money after the yen’s October appreciation. This should have been headline news in every financial newspaper, but it wasn’t.

Chinese banks defaulted. They may have been partially motivated by U.S. malfeasance in the capital markets that caused losses in Asia. The U.S. squandered its credibility and our cover-ups have done nothing to restore it.

Most credit support annex agreements would say that closing out these trades would be an event of default, and then the cross default on all the trades would kick in with the same counterparty. But the credit of the Chinese banks was better than many of their counterparties. Everyone was forced to renegotiate contracts with the Chinese banks.

From the perspective of the derivatives markets, this is earth shattering. What would have happened if AIG had done the same thing? (Hey, Goldman, UBS, and others…you want your collateral? Well…Stuff It!)

At the end of August 2009, China signaled that state owned oil consumers: Air China, COSCO, and China Eastern could default on money-losing commodities derivatives contracts.

If we had been paying attention, the U.S. should have done everything in its power to correct our mistakes, clean up the mess in our financial system—instead of sweeping it under the carpet—and turned our efforts to maintaining the credibility of the capital markets and the credibility of the dollar.