Inspiring Confidence

Conventional wisdom has it this morning that stocks are at the start of a rebound.  And for all I know, that’s true; technician types say the market is way oversold.

But minefields abound.  For starters, the derivatives exposure of the biggest banks exploded during the last quarter of 2008.

“Citibank, Bank of America, HSBC Bank USA, Wells Fargo Bank and J.P. Morgan Chase reported that their ‘current’ net loss risks from derivatives — insurance-like bets tied to a loan or other underlying asset — surged to $587 billion as of Dec. 31,” according to McClatchy Newspapers. “Buried in end-of-the-year regulatory reports that McClatchy has reviewed, the figures reflect a jump of 49 percent in just 90 days.”

Oh, and those numbers don’t yet account for the derivatives risk that BofA took on by acquiring Merrill Lynch, because that deal closed January 1.

“Because of the trading in derivatives,” says McClatchy, “corporate bankruptcies could cause a chain reaction that deprives the banks of hundreds of billions of dollars in insurance they bought on risky debt or forces them to shell out huge sums to cover debt they guaranteed.”

In other words, the credit-default swap monster still looms large out there.  “Trading in credit-default contracts has sparked investor fears because they are bought and sold in a murky, private market that is largely out of the reach of federal regulators. No one, except those holding the instruments, knows who owes what to whom. Not even banks and insurers can accurately calculate their risks.”

Doesn’t exactly inspire confidence, does it?

Which brings us to the matter of credit-default swap king AIG.  We now learn that AIG scored its fourth bailout “by telling regulators the company’s collapse could cripple money-market funds, force European banks to raise capital, cause competing life insurers to fail and wipe out the taxpayers’ stake in the firm,” according to a memo dated February 26 and obtained by Bloomberg.

Knowing this, what are we to make of Ben Bernanke’s statement to Congress last week — after he no doubt read the memo — that, “If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG.  AIG exploited a huge gap in the regulatory system, there was no oversight of the financial- products division, this was a hedge fund basically that was attached to a large and stable insurance company.”

Of course, Bernanke himself had oversight of the banks that lent money to AIG’s financial products division.  But he was MIA.  And as long as he wants to draw the hedge fund comparison, it’s worth pointing out that hedge funds are likewise unregulated, but Bernanke has oversight of the banks that lent them money too.  And again he was MIA.

Doesn’t exactly inspire confidence, does it?

And on top of all that, Tim Geithner says it’ll be a few more weeks before we know more details about his bank “rescue” plan.  During which time there will endless leaks and trial balloons to see what might stick to the wall and what might not.

No matter.  The Dow’s up 122 points as I write, and we might well be at the start of a rally.  A bear-market rally, but a rally nonetheless.

More telling of the longer term picture is a forecast from UBS that sees $2500 gold “as some hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks,” according to the Financial Times.

Yup, that sounds more like it.