Hot Topics and Recent Rants

European "SuperBanks" Leveraged 60:1?!

Swiss Banking Secrecy Dead? Think Again!

The "Golden Indicator"

Events

Total Wealth Symposium

The Fairmont Southampton Hotel & Resort Southampton, Bermuda April 26 - 29, 2009

The "Crash" Gauge:

How Financial Weapons of Mass Destruction Became
the Last, Best Indicator in a Global Disaster

Also in this Issue:

• The Coming Lawsuit Tsunami
  
• Swiss Government Goes on the Offensive

Dear A-Letter Reader,

In 1997, an elite group of bankers and mathematicians known as the "JP Morgan Mafia" embarked on a special, hush-hush sort of mission.

They were looking to create an instrument that could separate a loan's risk of defaulting from the loan itself. In doing so, they'd be able to bypass regulations on their minimum capital requirements and ramp up the profits.

They succeeded. And in a hushed, back room of JP Morgan, the Credit Default Swap (CDS) was born.
 

"Blind" Insurance

You can think of a CDS as insurance for a loan.

Typically this loan is a bond, and "Credit Default" is a pre-determined action - like bankruptcy or nationalization - which triggers the insurer's responsibility to pay the buyer a pre-determined amount...usually the value of the loan.

But it's not your average insurance policy. Rather, it's more like "Blind" Insurance.

Blind because it's not regulated. Blind because you can sell a Credit Default Swap without the necessary capital to ever make your buyer whole in the event of default. And blind because you don't even need to own the underlying asset - the loan being "insured" - to buy or sell credit default swaps...making it a superb means for speculation.

But back to the regulation for a moment, because it's a key wrinkle in the story.

CDSs stepped out of the shadow of any regulatory structure with the "Commodities and Futures Modernization Act of 2000." If you're one of our business-history junkies, then that particular piece of legislation probably rings a bell.

Because it was that same act that gave us the "Enron Loophole," which took specific types of energy trading outside the regulatory authorities' reach. In fact, Enron Corporate Lobbyists even drafted that portion of the bill...and it set the stage for the abysmal failure of privatized utilities in California, leading to Enron's eventual demise.

Talk about foreshadowing.

Anyway, after the Act was passed into law, the market for CDSs simply exploded. With some US$900 Billion in total contracts before the act, there were trillions of dollars in CDS contracts by 2003...and then the market expanded 10 times over between then and 2007.

And we don't have to tell you why.

Every financial institution in the world was running with the pedal-to-the-metal, piling on questionable subprime mortgages in an all-out race to bring in the most fees...all the while offsetting their risk with these "Blind" insurance contracts. Citigroup - to use a relevant example - currently has some US$93 Billion in derivatives assets and US$103 Billion in derivatives liabilities...many of which are CDSs.
 

But the Swaps Don't Lie
 

But a funny thing happened on the way to the crash.

You see, regardless of what instrument people are trading - Credit Default Swaps, stocks, beanie babies or antiques - if there are enough people trading enough of a given instrument, you end up with a marketplace.

And unlike the convoluted world of representative democracy - where people might vote for any number of tangible or intangible reasons - people are voting with their dollars in the marketplace. And they're only voting with one thing in mind; making money instead of losing it.

So the Credit Default Swap market is taking on a new role. It's becoming the "Crash" Gauge. The bellwether for the catastrophic event of a default. Since CDS contracts skyrocket in value around the event of a default, it makes sense that the markets will pay more for a CDS if the underlying investment - the loan - seems poised for a default.

And due to today's turbulent economic times, this "Crash" Gauge is becoming a crucial element of how analysts, bankers and businessmen get the job done. HSBC's analysts tipped their hand in a review of the world's currencies...

"...We could have quite easily given CDS spreads a higher weight, which we believe is a key driver of the FX market at the present time..."

Indeed, according to Bloomberg, the Bank of Tokyo Mitsubishi UFJ Ltd. already has a team of analysts whose sole purpose is to monitor CDS rates as they pertain to FX rates. And the results have so far been very interesting...

"The pound traded at a negative correlation of 94 percent in the past year against U.K. debt swaps," meaning that as CDS contracts rose in value, the pound almost always fell, "showing the currency is weakening as credit perceptions worsen."

And in light of the abysmal and unbelievable failure of ratings agencies, this free-market effect is one of the few sober tools that investors have for evaluating the rapidly changing standing of the world's major governments and corporations.

And while the high-end of Sovereign debtors - from triple-A rated to single-A rated - was safe from last year's round of credit downgrades, the CDS market is telling a different story, "It is registering concern and uncertainty about what's happening fiscally and the potential challenges governments are facing."

How to Arm Yourself with the "Crash" Gauge

It's becoming increasingly clear that CDSs will play an extremely important role as this crisis unfolds. But despite their disastrous potential as "Weapons of Financial Mass Destruction," (something the Sovereign Society explains in detail here) the free and open nature of the market for Credit Default Swaps puts a small but noticeable silver lining on an immense storm cloud.

In this age of political damage control, Bernanke's "war of the words," and failed ratings agencies, the CDS market provides one of the few clear gauges for market sentiment that's available to individual investors.

If you want to put a "Crash" Gauge on your market dashboard - something we suggest for every investor - then take a look at www.markit.com. This site is recommended by our Investment Director, Eric Roseman, and it's the info source that various parties use to mark their CDS assets to market. You can also set up a "Google Alert," to e-mail you news items containing the words "Credit Default Swap."

But we'd like to end with a warning.

The fact that the CDS market has become so large and liquid that it's now an accurate measure of market sentiment is...well, it's troubling to say the least. Remember that these are "Blind" insurance contracts.

For example you, dear reader, may have sold some US$100 Billion in Credit Default "insurance" against a personal wealth of just US$1 Million dollars (granted, you'd likely have to be a financial institution for that to be so). But if so, you would not only be introducing a systemic risk for those parties whose risk you "absorbed," but you'd also be helping to lull the markets into a false sense of security.

Should the world's governments fail in their efforts to carefully control default events, Credit Default Swaps could be the catalyst that brings the global financial system to its knees. So while the CDS markets could offer some prudent insight into "Mr. Market's" views on the potential for default, you should be fully aware of the devastating potential of these "Blind" Insurance contracts.

(Get the full story on Credit Default Swaps here)

2-10x Your Money on the Greatest De-leveraging Since 1929.
 

Not only are we facing a financial crisis, we are also facing a banking, credit, food, energy and a commodity crisis. Last year we saw $10 trillion wiped off global stock exchanges in just a month. And now the next demon derivative is about to whip down Wall Street and wipe a further $20 trillion off global exchanges, spinning the world into what might end up being a global deflationary collapse. But this one investment will soar 2-10-fold as the world comes undone.

The Coming Lawsuit Tsunami [Part I]

Just when you thought it couldn't get any worse...

"It's bad enough to be in the middle of a global financial panic that could be worse than the Great Depression," says Wealth Preservation & Tax Consultant Mark Nestmann, "But if you're an American, even if you manage to avoid investment losses, you could be wiped out by the coming 'lawsuit tsunami.'"

"People sue because they're angry, desperate, or think they can get some easy money from a deep pocket. And in a depression, there's plenty of anger and desperation. Here's a preview of what you can expect on the lawsuit front in the next few months:

• A blizzard of litigation against anyone with even a remote connection to Wall Street. Worldwide, US$60 trillion or so of wealth has disappeared in the last year; perhaps US$15 trillion in the USA alone. Investors are suing investment advisors, money managers, credit rating agencies and anyone else they can think of. Those who avoided losses aren't necessarily safe. For instance, investors who get out of Ponzi schemes before they blow up can be sued by those who didn't. Think of it as spreading the wealth around...or at least what's left of it.
  
   
• A huge increase in litigation related to food safety. If your business has anything to do with food, you better call a lawyer. Recent deaths caused by ingesting salmonella-contaminated food will lead to a crackdown on food producers, distributors, retailers and restaurants. Victims of poisoning, or their families, will sue anyone even remotely connected to the food industry. Opportunists suffering from nothing worse than indigestion will want a slice of the pie, too.
  
   
• A proliferation of lawsuits by the disabled. Under the federal Americans with Disabilities Act, you must do what is "readily achievable" to make your business accessible to disabled customers. You must also make reasonable provisions to accommodate disabled employees (including, incredibly, employees that suffer from schizophrenia and other serious mental illnesses). Under some state laws, you must do even more. California is especially inviting to litigants like Jarek Molski, a paraplegic who has filed more than 400 lawsuits against California businesses alleging discrimination. In that state, your business can lose a lawsuit if there is any discrimination or distinction in the way it provides goods or services to the able-bodied and disabled. Even If you fully comply with the ADA - but only the ADA - a disabled litigant can win damages against your California business.
  
   
• A big jump in "abandoned property" lawsuits forcing owners of vacant homes to maintain them, or risk losing them. As U.S. real estate prices collapse, thousands of vacant homes have been abandoned by their owners. Some are boarded up; others are occupied by the homeless, drug dealers, gang members, and prostitutes. If you own a building that you fail to maintain, the sheriff can seize it and sell it to anyone who will occupy the property and have enough income or cash to maintain it. If that's not enough, the Supreme Court has upheld the right of local and state governments to use "eminent domain" laws to seize private property. Developers in cahoots with local governments can then demolish whatever buildings are on the property, and in their place build sports stadiums, universities or anything else deemed to increase the property's economic value.

"But just to be sure trial lawyers are gainfully employed, the Obama administration has introduced legislation that, if enacted, will invite a frenzy of litigation against employers. I suspect that includes a lot of people who read this blog. Just what we need in these hard times! Especially since the single largest predictor in the long-term growth trend of employment-related case filings is the national unemployment rate."

"In my next A-Letter post, I'll give you a rundown of what Obama has in mind to punish employers, and present some suggestions to deal with the rising lawsuit tsunami. But in the meantime, here's some food for thought:

"In 2007, the Pacific Research Institute published a landmark analysis of the total costs to the U.S. economy, both direct and indirect, of lawsuits aimed at giving an injured party compensation for damages. Such "tort" lawsuits, according to PRI, cost us all US$865 billion in 2006. In terms of U.S. GDP, that's a hidden 13% tax on everything you earn (or if you'd rather, a hidden 8% consumption tax). The annual "tort tax" for a family of four is US$9,827."

"Small potatoes, I suppose, compared to the cost of the various bailouts Congress is considering, but if Obama gets his way, the tort tax will be a lot higher in years to come."

"I hope you have a good asset protection plan in order. If you don't, I'll describe some of the first steps you should consider in my next A-Letter post."