股海一粟的博客
投资是一门艺术，投资是一所永远的学校。股海一粟第一次接触到股票还是在1988年，那时候上海只有老八股，没有正规的交易所。。。那一年股海一粟只有10岁。
正文
All three major indices managed to post a modest gain. Like last Friday, sectors were traded in a split fashion throughout the day. Financials were again weak following news that AIG may need to make substantial write-downs due to decreasing values in its credit derivatives. The one-trillion dollar question on Wall Street these days is really how many more write-downs related to the sub-prime issue are going to occur to the financial industry. I certainly don’t know the exact number. But from various comments and published reports, it is possible to make an educated guess and I will have a try here.
The official estimation from the Fed was between $100 billion and $150 billion. This certainly seems too optimistic considering the total write-downs in the financial industry are already topping $140 billion. Wall Street firms including Bear Stearns thought that $250 billion might be a more reasonable estimate and if that’s the case, then it means we are more than half way done with the sub-prime crisis. Over the weekend, German Finance Minster Peer Steinbrueck estimated during the G-7 meeting that the worldwide write-downs will eventually reach $400 billion. If Mr Steinbrueck is right, it means that we are just a little over one third done with the crisis and there will be much more to come in the next few quarters. But this is not the worst scenario yet. On top of the already widely-known sub-prime mess, there is another ticking time-bomb that just started to emerge: credit derivatives (mostly CDS – Credit Default Swap and CDOs – Collateralized Debt Obligation) and this is the monster that caused Dow component AIG to post its worst daily performance in 20 years.
According to PIMCO’s Bill Gross, the total outstanding CDS is around 45 trillion and historically the default rate is around 1.25%, so about $500 billion of these CDS insurance contracts will be in default. And if we use a recovery rate of 50%(a normal also conservative estimate), it will equal to a loss of $250 billion. However, during the past few years the bonds under insurance are changing dramatically, from less risky such as municipals and investment grade corporate bonds to highly risky such as corporate junk bonds and SIVs in the mortgage area. If we instead use a 2.25% default rate (100 bps above the historical average) and still keep the 50% recovery rate, then the total default will be around $500 billion, which can easily dwarf the capital held by the bond insurers. In other words, if the bond insurers cannot absorb the potential loss, then banks will have no choice but to make further write-downs. And if this scenario turns out to be the case, we may have many more $140 billion write-downs to come. Certainly not a good thing to happen!
The official estimation from the Fed was between $100 billion and $150 billion. This certainly seems too optimistic considering the total write-downs in the financial industry are already topping $140 billion. Wall Street firms including Bear Stearns thought that $250 billion might be a more reasonable estimate and if that’s the case, then it means we are more than half way done with the sub-prime crisis. Over the weekend, German Finance Minster Peer Steinbrueck estimated during the G-7 meeting that the worldwide write-downs will eventually reach $400 billion. If Mr Steinbrueck is right, it means that we are just a little over one third done with the crisis and there will be much more to come in the next few quarters. But this is not the worst scenario yet. On top of the already widely-known sub-prime mess, there is another ticking time-bomb that just started to emerge: credit derivatives (mostly CDS – Credit Default Swap and CDOs – Collateralized Debt Obligation) and this is the monster that caused Dow component AIG to post its worst daily performance in 20 years.
According to PIMCO’s Bill Gross, the total outstanding CDS is around 45 trillion and historically the default rate is around 1.25%, so about $500 billion of these CDS insurance contracts will be in default. And if we use a recovery rate of 50%(a normal also conservative estimate), it will equal to a loss of $250 billion. However, during the past few years the bonds under insurance are changing dramatically, from less risky such as municipals and investment grade corporate bonds to highly risky such as corporate junk bonds and SIVs in the mortgage area. If we instead use a 2.25% default rate (100 bps above the historical average) and still keep the 50% recovery rate, then the total default will be around $500 billion, which can easily dwarf the capital held by the bond insurers. In other words, if the bond insurers cannot absorb the potential loss, then banks will have no choice but to make further write-downs. And if this scenario turns out to be the case, we may have many more $140 billion write-downs to come. Certainly not a good thing to happen!
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