What IS the Recommended Daily Allowance of Moral Fiber?

The $55 trillion (TRILLION!) credit derivatives market faces its first reckoning day today as $360 billion worth of contracts on now-defaulted Lehman Brothers derivatives are due to be settled. Here's another example of a juicy piece of genuine news that was not reported in the mainstream media since the 10 October default-swap auction put swap payouts at 90 cents on the dollar (very generous of us taxpayers). So thanks to Telegraph.co.uk, we have the following:

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3224615/Markets-hold-breath-as-360bn-Lehman-swaps-unwind.html

These derivatives were, of course, very risky to begin with, so companies sold 'swaps' as a kind of 'hedge' in case the 'instruments' ever became 'worthless.' Naturally I type this, quite literally, tongue-in-cheek. Sellers wanted buyers to think they had stop-loss-like protection, but the sellers couldn't call it that. So they chose an appropriately useless and irrelevant moniker: swaps. If they had sold 'insurance,' then the product would have been subject to regulation and oversight under all sorts of inconvenient laws which require, among other things, that a percentage of insurance monies collected be put up for safe keeping in the event that payouts were necessary to satisfy future claims. But the amount they needed to keep on hand for swaps was $0.00. Hell, they could have used the name 'Skuzzlebutts' or 'Giant Indians' instead of swaps if they felt like it. The concept would have been no less morally, ethically, or financially bankrupt.

So here we are again with another lesson in moral fiber and the consequences of not having any. The derivatives bombed, the buyers wanted the swaps they bought as a safety net to kick-in, but there was just one small problem. There was no money to pay claims. No money anywhere. Buyers paid for protection and there wasn't any. Zilch.

The American taxpayers effectively own the company that must now pony-up. Today is that day. The day of the first 'small' wave of Lehman Derivative credit swap payouts. Monday's nice 400 point gain on the Dow will probably be erased (and then some) if I'm right; any market behaving rationally would rightly dive to the floor. But rationality is the exact opposite of what we're seeing now... the market's signals are all messed up. Paulson and Bernanke's interference amounts to rescuing those who have done wrong and ignoring those who made the right choices. The market does not grok such nonsense; the market's mentality is like the HAL 9000 computer in Arthur C. Clarke's novel and movie 2001: A Space Odyssey; lie to it, and it becomes confused and neurotic. This manifests in exotic and irrational reactions to previously straightforward scenarios. Then, regardless of whether you're an investor or an astronaut, the end result is FUBAR!

Anna Schwartz co-authored "A Monetary History of the United States" with Milton Friedman in 1964. Her body is frail but her mind is immaculate. She believes that Paulson and Bernanke's actions are prolonging the crisis because of those mixed signals formerly noted. She believes nothing is too big to fail because the quicker it fails the more quickly the market can deal with it, and begin to mend itself.

It takes real guts to let a large, powerful institution go down. But the alternative -- the current credit freeze -- is worse, Ms. Schwartz argues.
"I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you. They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant.
-Anna Swartz as interviewed by Brian Carney, WSJ, 10/18/08

http://online.wsj.com/article/SB122428279231046053.html?mod=special_page_campaign2008_mostpop

Some analysts believe today's swap redemption will be a non-event, that the auction took care of any worries. Heck, the government's paying for it, so who cares?? If there's nothing to worry about then maybe we'll have another pass-the-champagne feast like yesterday's +413-point romp on the happy little tire swing. If not, well, then we won't. But in addition to today's Lehman derivatives settlements, a whole slew of corporate earnings reports are due out this week, so if these don't get us then it's likely that the new Era of Frugality, or the big wave of hedge fund sales that loom large on the horizon, or the rising tide of Alt-A and A-rated mortgage paper defaults, or the Big Kahuna... the inevitable credit card Day of Wreckoning (sic), (which Bank of America's Ken Lewis refers to as "a damn disaster") will.

God said He'd never flood the world again, but said nothing about the financial markets. The market is no more than a big idea anyway. Lest we forget, the whole concept of value and worth are products of our imagination that do not even exist in three-dimensional space -- just like Skuzzlebutts and Giant Indians. So no need to get excited if your 401k lost $200,000 in the last six weeks; the money was never really there to begin with. Let that thought dance on your prefrontal cortex a while. Regardless...

Happy Lehman Derivative Swap Payout Day, America! You earned it!