Are we in an economic crisis? Oh, you bet.
But there is another failure on the immediate horizon that most of you probably don't know about. The OCC. Options Clearing Corporation. Next Friday is options expiration, and the DOW has dropped from 11,388.44 to 8,579.19 or >25% since the last options expiration (September 19th). Think about how many naked puts there are out there. There will be a lot of people scrambling to cover their losses. And who receives that money and passes it on?
Who ensures that every buyer has a seller? The OCC.
Fast Forward to the Tuesday after Options Expiration when all trades must be finalized. Something like $3T of value has disappeared since the last options expiration. Where will people get money to cover THAT?
What, if anything, will/can Paulson do to see that the market goes UP by next Friday. Because they MUST assure that the market goes up by Friday. Will we even have a market if it does not?
Second problem. Tomorrow is the CDS unwind for Lehman. Some $500B is going to be bandied around as various people have to cover one part or another of this huge deal. And it isn't clear that all of that money actually exists. Can you say "Naked CDS?"
Aside: What is a Naked Option?
Answer: An option that was sold by someone who did not own the underlying asset.
Question: You mean people were selling things they didn't own?
Answer: You betcha! (selling short is a form of this, but the CDS instruments were far, far worse than short selling stocks.)
Prior to thinking about the great unwind for the Lehman leveraging, I had anticipated another day of DOWN. 8,000 on the DOW kind of down. Now, I have to wonder as the Fed and the US Treasury simply cannot afford to have the Lehman transaction fail to completely take place. Nor can it afford to have various note holders default.
I still think 8,000 at some point during the day will happen, but now we're at a fork in the road:
- The Fed intervenes and the market goes up. The day ends in the green. A short squeeze begins, fueling a rise in the market that lasts days or weeks, possibly into the Obama Administration. Also solving the first problem mentioned above.
Might be a very interesting time to buy calls in stocks that have been undeservingly beaten up. I might buy some Apple Options. (Note: I'm already an Apple stockholder.) Or not. Maybe Alcoa instead.
- Devastation on WallStreet. The market closes down. Potentially way down. Paulson has to step in this weekend and will nationalize a number of institutions. Probably a rule saying that short selling is forbidden and options sales can only take place on an up-tick might occur. Could be worse than that, even. He might hand Goldman Sachs $500B and say "buy stuff." They then become the US National Bank. No telling if this intervention will work, but if it does not then HELLO 1933.
I might add at this point that we'll cease to have a financial system in this country. It would take an FDR-style set of public works projects to keep people employed and fed. And expect a lot of extra zeros to appear on your dollar bills unless someone decides to increase interest rates to try to defend the dollar while doing the Keynesian thing of pumping money into the economy through public works. It would behoove us for those public works to be the infrastructure of the 21st century, including green power, but GWB still have control of this ship until January 20th. Woe and Devastation.
Yesterday, Gordon Brown, the former Chancellor of the Exchequer and now Prime Minister of England decided to backstop the LIBOR (interbank loan rates) with £50 billion of equity. They are attempting to fix the LIBOR to a lower number than the current effective 4.75%(dollar)-5.39%(euro)-6.28%(pound) rates. If these central banks are successful in their attempts to fix LIBOR at 2%-3% and become the overnight lenders of choice, then there is some hope that other independent banks will be forced to also lower their rates. But if yesterday is any indication, that will not happen. The banks are simply not lending money to each other and there is the 'Fear and Panic' side of the credit crunch. It has not ended.
Now comes the fun part. Paulson will be doing stuff this weekend. Iceland just lost its bank. Nationalization is the last remaining "cure" and I fully expect it to be applied wholesale.
Will any of it work? Beats me. I'm an engineer, not an economist.
Tuesday will be the transaction completion date for all of the Lehman CDS transactions from tomorrow. There will be an immense number of margin calls (and there probably already are from today that haven't reached people yet in the mail).
That one is bound to hurt. If scenario #1 (short squeeze) is going on and the market is up, it might be a nice day on WallStreet. If scenario #2 is going on, then people will be jumping out of buildings.
NEXT FRIDAY - OPTIONS EXPIRATION
Either we're up a lot and the naked puts have real limits on their losses or I think the whole system just flames out.
I really don't know.
And, even if Paulson is successful in staving off a total disaster by next Friday (and we should have a good indication by the end of THIS Friday whether they're trying or not), we still have the credit crunch waiting in the wings, not to mention the mortgages that people cannot afford to pay.
Oh, and the high price of energy.
So today, Friday October 10th, is a very big day.
And now I need Bonddad or Jerome á Paris to talk me down.