How about shorting financial institutions?

[Juggernaut118]

Short the ones that are highly leveraged with derivatives.
http://www.gold-eagle.com/editorials_04/chuhran112604.html

[GeorgeF]

"highly leveraged with derivatives"
Which are those?

[laserboy]

Fannie Mae and Freddie Mac. They use derivatives to hedge against fluctuating interest rates and to help them cook their books. They got completely hosed by declining interest rates the past few years and have like $20 billion in unrealized losses.

And, oh by the way, they hold TRILLIONS in debt and their business model revolves around buying bad loans from mortgage lenders at the peak of the real estate bubble.

[Scuba Chuck]

JP Morgan

As a professional, I don't recommend shorting for anybody. Even the 'pros' I know, usually don't short, and when they do, kick themselves for knowing better. Shorting is for traders who work on the exchange...

JP Morgan has an enormous short commodities derivatives market. This is not necessarily a very known topic. I heard about it through one of my bond managers who manages about $100 billion of A rated bonds or higher. They won't touch JP Morgan's bonds (even though rated A) due to this derivatives risk.

In fact there is rumors that a large move in gold could put JP Morgan into bankruptcy. How do you like them apples?

I invest to help me keep my money. To gamble, I play poker.

[laserboy]

SEC: Fannie Mae Violated Accounting Rules (http://biz.yahoo.com/ap/041216/fannie_mae_2.html)

I can't wait for this house of cards to fall.

[adios]

On this $9 billion paper loss, the immediate problem is that FNM used hedge accounting inappropriately.

My understanding of hedge accounting is that the mark-to-market losses/gains in the derivative used to hedge (probably interest rate swaps in the FNM case) can be netted against gains/losses to the underlying asset. In order to use hedge accounting there is a threshold of correlation between price movements in the derivative used to hedge the underlying asset. I read somewhere where it was something like 92.5%. Now since FNM was ruled to not be in compliance with the hedge accounting criteria, they have to run the mark-to-market losses in the derivatives used to hedge the underlying asset through the income statement while not recognizing the corresponding gain in the underlying asset.

I'm assuming these were pay fixed, receive floating swaps. In a decreasing rate environment these are mark-to-mark losses, unless you get hedge accounting treatment and net them against the underlying asset. As time moves on the loss will probably converge to $0. At least that's my take but this points to a second problem with FNM, their strategy for hedgeing isn't all that transparent, at least not to me. In general FNM tryings to synthetically (I think thats the right word) match the funding for a loan with the loan's duration and this results in the utilization of derivative instruments (as almost all lenders do that I know of). Basically it's deferring interest rate risk with is problematic when borrowing short and lending long (the carry trade) which lenders do to capture the spread between short term and long term rates. I've never been particularly bullish on FNM but I do like certain MREITs but I bought some FNM yesterday playing it for a short term bounce thinking the bad news is out. FNM debt paper acted well yesterday from what I read in the WSJ as well.

[laserboy]

I won't pretend to understand all of that (reading about derivatives hurts my brain). But it seems to me that derivatives used as intended, to hedge against interest rate risk in this case, should be a lot simpler than that. To have your derivative portfolio escalate to the point where even Warren Buffett can't figure out what you're trying to do is madness.

What are they? A mortgage lender? Or some kind of professional gambling outfit?

[adios]

[ QUOTE ]
I won't pretend to understand all of that (reading about derivatives hurts my brain). But it seems to me that derivatives used as intended, to hedge against interest rate risk in this case, should be a lot simpler than that. To have your derivative portfolio escalate to the point where even Warren Buffett can't figure out what you're trying to do is madness.

What are they? A mortgage lender? Or some kind of professional gambling outfit?

[/ QUOTE ]

Perhaps they'll become more transparent as the CEO and CFO were ousted last nigh. Stock got another bounce. I've posted about FNM before and the derivative markets. As long as there's someone on both sides of the derivative trade and they're solvent it shouldn't be a problem. The key question to me is the solvency of the players ie are there standards and regulations for this? I don't know for sure.

[laserboy]

One of the key concerns regarding Fannie Mae is that they operate under a different set of standards than traditional mortgage lenders. For instance, whereas banks typically operate under a fractional reserve system where their loans are backed by a certain amount of cash reserves, Fannie Mae operates under no such restrictions since they are not a "bank" and are free to use corporate debt instead.

Again I am not an expert on derivatives, but if ever there was a company where solvency was an issue, I would think Fannie Mae would be it. Their debt to equity ratio is 35 to 1 for goodness sake. Do they know what they are doing? The fact that they lost $9 billion and tried to sweep it under the rug does not inspire a great deal of confidence in me.

[Dan Mezick]

You might consider what Social Security reform would do to financial markets if suddenly, every working US citizen was expected to invest a portion of Social Security benefit funds.

What would the likely effect of all this new money be, on said financial institutions??

They'd likely benefit tremendously.