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Reflections of the Fed Cut, SoGen Rogue Trader


Last weeks cut by the fed of 75 bps was a surprise. The So Gen Panic selling and unwinding proved to be part of the reason. But this sort of action proves that more icebergs lie underneath the financial waters.

The monoline insurance companies like Ambac and MBIA are in worse shape than most realize, the counter-party risk in the $45 trillion Credit Default Swap market is much worse than we realize, and the exposure by various banks to their problems is much larger than currently understood. The Fed understands this, and realizes that they have been behind the curve but need to catch up.

Quoting from a recent note from Michael Lewitt:

" 'MBIA's total exposure to bonds backed by mortgages and CDOs was disclosed to be $30.6 billion, including $8.14 billion of holdings of CDO-squareds (CDOs that own other CDOs, or mortgages piled on top of mortgage



MBIA was being priced as a weak CCC-rated credit when it issued its bonds last week; it is now being priced for a bankruptcy. MBIA's stock, which traded just under $68 per share last October, dropped another $3.50 this morning to under $10.00 per share.

'The bond insurers' business model is irreparably broken. In HCM's view, it will be all but impossible for these companies to raise capital at economic levels for the foreseeable future and certainly in enough time to work out of their current difficulties. The performance of MBIA's 14 percent bond issue will prove to have been the death knell for this business. The market needs to come to the realization that the so-called insurance that these companies were offering is not going to be there if it is needed. The fact that these companies were rated AAA in the first place will remain one of the great puzzles of modern finance for years to come.'
MBIA is still rated AAA. Ratings downgrades are just a matter of time. Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital. Barclays' estimates are based on banks holding as much as 75% of the $820 billion of structured securities guaranteed by bond insurers. (Source: Bloomberg)

As the downgrades on various mortgage assets and the CDOs continue to increase, the ability of the monolines to deal with the problems is going to come under increasing question. The losses at major banks could be much worse than $122 billion if they are downgraded to the same junk level that ACA was.

And that is just the credit default swaps (CDSs) from the monolines. What about the trillions that are guaranteed by banks and hedge funds? There are a total of $45 trillion CDSs outstanding.

if we get another 50-basis-point cut, then it means the Fed is responding to concerns about the credit crisis. And we will get another cut the next meeting and the next until we get down to 2% or below.

A 50-basis-point cut takes the rate to 3%. It they had cut the rate by 1.25% next week, the market would have collapsed. And it is not just the Fed that is concerned. Add to all this Europe is Dropping again.

ONE story of Profit from the Subprime Meltdown


Jeff Greene Buys 'Palazzo,' Scores $500 Million Gain; Erotica and Bowling Lanes. Well as thousands are loosing their homes across the country, there is one man who decided to bet the current crisis would unfold.

As Johnathan Karp of the Wall Street Journal reports; Relaxing at his 40,000-square-foot mansion, Palazzo di Amore, Jeff Greene reflects on a stellar 12-month run. He snatched the estate out of receivership for $35 million in a bidding war. He got married in a spectacular wedding here with boxer Mike Tyson as his best man. And he is up more than half a billion dollars on a bet that the housing market would crater.

He may have lost a friend in the process: John Paulson, a hedge-fund manager who devised what proved to be a wildly profitable strategy for betting against risky mortgages.

It was the spring of 2006, and Mr. Paulson, seeking investors for a new fund, gave Mr. Greene a peek at his plan. Mr. Greene didn't wait for the fund to open. He beat his friend to the punch by doing the same complex mortgage-market trade on his own.

"He never told me: 'Don't do it,'" Mr. Greene says. Mr. Paulson won't discuss the matter.

"Jeff lives on the edge. He made a fortune, lost a fortune and made it back," says Fred Sands, a Los Angeles real-estate developer who got to know him through late-night parties Mr. Greene threw at his Malibu and Hollywood Hills homes. The latter pad is known for its pillow-lined penthouse den, the Moroccan room. His soirees attracted an eclectic crowd, from Paris Hilton to Mr. Tyson.

For the artwork in Mr. Greene's new Beverly Hills mansion, money is one motif. A dark metal rendering of a dollar bill hangs over the bar.

Eroticism is another. In the east wing are two huge erotic paintings that Mr. Greene waited to hang until after his September wedding there.

The September wedding at his estate was Mr. Greene's first, and he pulled out all the stops. Guests sat beside a long reflecting pool, wandered marbled halls snacking on hors d'oeuvres, dined around the fountain in the motor court and boogied on a revolving dance floor in the 24-car garage. In late December, the party moved to Mr. Greene's yacht off the Caribbean island of St. Barts.

Yet two years ago, an undercurrent of concern about the economy had begun to trouble him. Recalling the pain of losing his first fortune, he consulted a range of smart people in search of a way to hedge his bets. One was Mr. Paulson, whom he'd met decades earlier in New York's Hamptons, the same playground of the affluent where he later met Ms. Chan.

Mr. Paulson was convinced the market for risky "subprime" home loans would implode. He outlined a sophisticated securities trade he was crafting for a new hedge fund. It involved derivatives -- contracts whose value shifts with some other asset's value -- and would need an investment bank's participation. The bank would have to be convinced that a mere individual, as opposed to an institution, qualified to be a counterparty in such a transaction. Mr. Greene says he asked Mr. Paulson, "Can I do this trade myself?" and was told, "You'll never get approved."

Banks did turn Mr. Greene down at first. But after he produced enough paperwork, Merrill Lynch & Co. and J.P. Morgan Chase & Co. agreed. He was the first individual either bank had approved for this type of trade, involving what's called an asset-backed credit-default swap, say people familiar with the matter.

Mr. Greene dived into the riskiest type of the trade by betting on derivatives backed by a single pool of subprime mortgages. He says he analyzed lots of mortgage bundles before placing his bets. But, belying the financial sophistication he aims to project, he adds: "A lot of this stuff is anyone's guess."

Mr. Greene says his positions rose only a little until the spring of 2007, when troubles at a lender rattled the market. In recent months, he has cashed out some positions, locking in $72 million in profit, according to financial records. As of early this month, his positions at Merrill Lynch and J.P. Morgan were up about $466 million combined. Because the market for the riskiest derivatives is thin, Mr. Greene says, he is waiting for better pricing before he sells more.

His hedge-fund friend, Mr. Paulson, didn't want other investors duplicating his trades. "When I mentioned to him that I had already done some of this on my own, he kind of was surprised and seemed to be upset," Mr. Greene says, adding that Mr. Paulson didn't allow him into his new fund.

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