Wind-Up (Doll) Wednesday

Or is that "blow up doll"?

And are we talking about the kind you buy at the kinky adult store, or the kind that does this to virtually every bank, pension fund and insurance company in the land?



The latter became a real possibility yesterday when a motion filed by Merrill Lynch was ruled on in "Merrill .v. XLCA, 08-cv-2893", and found that Merrill was entitled to the protection that it had purchased from XL Capital.

Otherwise known as a CDS, or Credit Default Swap.

This opens the door for XL Capital to be forced to pay $3.1 billion in coverage on those swaps.

By the way, XL Capital (NYSE: SCA) currently trades at 52 cents/share as of Tuesday afternoon, and has a market cap of $34 million, with balance sheet cash of $480 million, according to Yahoo Finance's statistics page.

From that quick cursory look this is almost certain to bankrupt the company immediately.

Thereby making all of the other swaps that they wrote worthless.

Thereby causing all of the credit instruments that they wrapped to immediately trade at their underlying credit quality, whatever that might be.

Care to bet that this is the only one like this out there?

Sold to you!

Now that we have a nice legal record that this path of attack works there will be literally thousands more lawsuits exactly like this aimed at all of the credit insurers.

In my opinion they're all done.

Every one of them.

Its over.

(As an aside, whether investors will try to pry back together the legal divorce/spinoff of the SCA IPO and attack the XL "spinner" (NYSE:XL) is an open question. However, at present, they do not appear to be in imminent danger.)

Now the question to ask yourself as an investor is this - what percentage of the instruments held in public companies in "Level 2" and especially in "Level 3" are being valued based on these "wraps", and what is their intrinsic value without the wrap?

If you don't know and haven't seen an honest and complete answer from the financial company you own or have an obligation through (e.g. insurance companies with annuities, policies, common stock in any financial firm, etc) you damn well better find out or just assume that all of these "assets" are at best junk paper and at worst may be zeros!

Let's add to the fun. Notice the TNX lately? Its way up - 2.68% today, to a yield of 4.099%. Guess what this does to mortgage rates? That's right - it increases them, and if you look at Bankrate you'll find that they are absolutely shooting the moon - a 30 year FHA loan is now pushing if not at 7%.

A move from 6% to 7% on a 30 year fixed rate cuts the affordability of a house by 10% for the buyer, which means it cuts the value of every home in the nation by that same 10% immediately.

Just what the housing market needs, right? To make things worse the yield curve is flattening which reduces the "vig" that lenders can earn by borrowing short and lending long, thereby putting even more pressure (upward) on long money prices.

Mortgage prices are going up right into the weakest housing market since The Depression.

Depressed yet? It gets better. The Real Estate crooners are claiming that there was an increase in home sales last month. True. What they didn't tell you is that a lot of those sales were foreclosures, and that bona-fide resales by private parties decreased even further. What's worse is that one foreclosure auction sale in a given subdivision whacks $50,000 or more off the value of every home in the neighborhood, thereby further depressing sales.

Don't look for support of a thesis that homebuilding (and selling) will turn next year. None of the ratings agencies will back you on that call; Fitch and Moody's both lowered ratings on several builders claiming that there will remain a drag well into next year.

We are nowhere near the end of this cycle as the inventory that is held by the banks is still not being puked up into the market faster than the new foreclosures come in!

Until that happens we cannot reach a bottom in prices nor will actual sales by voluntary sellers become the base of market activity - a necessary condition before Real Estate can turn.

This thesis, by the way, is the "base case" that everyone within both political parties and The Fed are using in their policy-setting deliberations! I don't know what people in the political parties and other policy-making arms of the government are smoking, but its definitely illegal.

How anyone with more than two firing neurons could think that a cycle that is typically 14-16 years in length can possibly turn in three or four is beyond me. But that is precisely what people's "base case" assumptions are.

They're nuts. All of them. McCain, Obama, Bernanke, Bush.

Berspankme claims that "the danger of substantial downturn has faded." Do you believe him? How many previous acts of either lying or just flatly being wrong does one get before your credibility is shot? "Subprime will not affect the broader economy", remember?

The SEC is apparently feeling some heat and getting tired of the nonsense with the ratings shopping game, threatening to add a "suffix" to asset-backed debt ratings:

"The U.S. Securities and Exchange Commission may recommend this week that Moody's Investors Service, Standard & Poor's and Fitch Ratings include a new designation to the scale created by John Moody in 1909, according to people familiar with the plans. The changes may force investors to reassess the way they gauge the risk of securities backed by mortgages, student and auto loans and credit cards, said one of the people, who declined to be named before the announcement. The action could force banks to add capital to guard against losses or curb lending. "

Now let me see if I get this right.

Adding a "letter" to a rating suddenly causes people to add capital or curb lending.

You didn't read my Counterfeiting Ticker yesterday, did you?

Do so.

This additional "risk capital" and "reserves" have absolutely nothing to do with the addition of a letter. They have everything to do with the fact that counterfeiting now appears to be gathering a bad name for itself, and when exposed suddenly people start to see the risk that was always there in the first place but was intentionally hidden from them.

Of course the banks are opposed to these proposed rules. Is that supposed to be a surprise?

Counterfeiting is only profitable so long as you can convincingly pass off your fakes as real; ergo, anything that threatens to shine the bright light of truth on the matter will be vehemently opposed.

Oh, and you know those ads that say "Talk to Chuck"? Well, apparently some people did, and bought one of their bond funds that invested in subprime assets. You know what happened, right? Now there is a lawsuit, and a possible settlement. Guess what - the prospectus allegedly said it was only "marginally riskier than cash." Pull the other finger please.

Nor are they alone. Seems that Fidelity got in on this act too, and is also being sued, for basically the same reason (although Fidelity is promising to fight like hell, and not settle). Go figure.

You know why they call 'em BROKErs, right? Is it because if you listen to them instead of doing your homework you have a decent chance of winding up exactly that?

The lesson in this one, just like those who have found themselves handcuffed in Auction-rate securities, again, touted as "about as safe as cash"?

Do your own homework and make your own decisions with your money; do not rely on what you are told by a broker or banker.

Or else.

Oh, in news unrelated to the market, but which drew a cheer from me today, three US Internet Service Providers said they will cut off access to certain Usenet newsgroups carrying child pornography after being pressured by the NY Attorney General.

Its about damn time.

Folks, this particular issue is one that I crusaded on the entire time I ran MCSNet and I have maintained an active stance on it since. These are not random pictures of kids being abused that "pop up anywhere." They are very specific areas that are named for exactly the content they contain, such as "alt.binaries.pictures.pre-teen.fucking", and contain exactly that.

I have never argued that an ISP should proactively screen content in someone's email, for example, or on their personal web page. But when you have a group that by its very name is expected to contain blatantly illegal material, it does, and then you are notified of it by law enforcement you can't legitimately claim you didn't know and there was nothing you could do about it!

Congratulations to Mr. Cuomo's office for this agreement and may it be the first of many. While getting this crap off The Internet will never be completely accomplished, denying these creeps the means of anonymous and simple mass distribution is an important step forward for our children and long overdue.

Sometimes the good guys do win, even if it takes a while.

PS: Lehman. Anyone else think they're a zero? The market sure does.