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Fun With Bloomberg


Many of the fine contributors to MV have outlined the risk involved with and their fear of derivatives - those leveraged financial obligations derived from some underlying financial instrument. That fear is a function of many factors not least of which is the undisclosed nature of those risks: their size and who is really exposed.

Fitch, the credit-rating shop, announced the results of a survey they performed estimating the size of the global credit derivatives (financial contracts tied to debt obligations) as worth more than $1.8 trillion, up 40% from their March estimate. The global market for all derivatives is something like $128 trillion (notional amount) so this may not seem much in comparison. But credit-derivatives are the fastest growing part of the derivatives marker, so they bear watching. As well, here's the other important part: knowing who's involved on each side of the transaction. The most common trading partners for these credit derivatives are JP Morgan, Merrill, Deutsche, Morgan Stanley, and Credit Suisse. The companies with the underlying credit risk that come up most often in the contracts? France Telecom, Ford, GM, DaimlerChrysler, and GE.

One of the reasons I bring this up is that I saw this headline across my Bloomberg around the same time I saw the Federal Reserve data about the big three automakers' May credit terms. They were also released yesterday. Not surprisingly, the portfolio of credit that the big three have extended to consumers to buy and finance cars is at record levels. Total maturity of the portfolio is 60.7 months (vs. 60.1 in April), a new record. Loan to value ratio: 97.3% vs. 97% in April and the highest in history. Financing rates (the interest rate on the auto loan portfolio): 2.4% vs. 2.5% in April and the second lowest is history.

Net/net, the big three are extending some of the easiest credit terms to consumers to buy their cars ever. What do they have to show for it? Declining unit sales run rates, some of the seasonally highest inventory levels in years, and ever-lengthening replacement cycles on the cars they actually are selling. This alone would be bad: bad for the big three in terms of profitability and bad for the consumers that bought cars they might not be able to pay off or find a buyer for should the need arise. The risk involved, if it stopped with the buyer and seller of the cars, would be material but not critical.

But here's the real kicker: the risk associated with the big three's decision to keep unit sales going at all costs by "stuffing the channel" and financing their customer's purchases is not limited to just the buyers and sellers of cars. No, the risk involved with this particularly bad business decision is now multiplied via the credit derivatives that represent these portfolios and spread out across the financial system. Insurance companies, hedge funds, pensions; all have direct or tangential exposure. So the next time someone you know buys an SUV they can ill afford, you can't just shake your head and wonder at their financial irresponsibility. Whether you like it or not, you're exposed to the financial risk they represent to GM, or to Ford, or to Chrysler.

Hard to believe? It was only a scant few years ago that the top five list of issuers in the credit-derivatives market included WorldCom and Enron.
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