GORDON T LONG
THE LEVERAGE ASSOCIATED WITH ³AAA´ ASSETS
I could not have stated it any clearer than JimSinclair at jsmineset.com: ³People are seriouslyunderestimating how much liquidity in the globalfinancial world is dependent on a solvent BP. BPextends credit ± through trading and finance. Theyextend the amounts, quality and duration of credit abank could only dream of. You should think about thefinancial muscle behind a company with 100+ yearsof proven oil and gas reserves. Think about that incomparison to a bank with few tangible assets. Thenthink about what happens if BP goes under. This is nobank. With proven reserves and wells in the ground,equity in fields all over the planet, in terms of creditquality and credit provision ± nothing can match anoil major. God only knows how many assets aroundthe planet are dependent on credit and financeextended from BP. It is likely to dwarf any bankingentity in multiples«. The price tag and resultant knock-on effects of a BP failure could easily be equal to that of aLehman, if not more. It is surely, at the very least, Enron x10.´ From a historical context, some may not be aware that the infamous House of Rothschild at the height of theirbanking powermoved into Energy & Oil. Also, John D. Rockefellerquickly realizedhis globally expanding Standard
Oil was more a bank, consolidating his financial empire under a banking structure which resulted in the ChaseManhattan Bank (the basis of Citigroup). As long as an energy giant can manage its cash flows throughout thevolatility of price fluctuations, it becomes a money and credit generating machine. It can borrow with AAA yieldsanywhere on the curve and lend to less credit worthy entities at attractive spreads. These lending differentials helpfuel the $430T Interest Rate Swap OTC market. BP has been able to spin off $20B of earnings for the last 5 yearsand $15B in cash last year.
All of this suddenly comes to an end if its credit rating is significantly impaired. Butwhat could possibly cause this to happen? It would take a black swan event. An outlier. A fat tail.Sound familiar? Heard this discussion before?The Gulf Oil Disaster may be the fat tail to end all fat tails and shows the exposure behind the entire risk models of the vast majority of derivatives algorithm models. To suggest that BP would need to take impairments north of $20B would have seemed out of the realm of possibilities less than 90 days ago. Now, if it is contained to only$20B, it would be considered a blessing. Fitch dropped BP¶s credit rating an unprecedented 6 notches onJune 15
from AA to BBB which followed June 3rd's AA+ to AA cut. This is what happens when a fat tail occurs and it hasonly just begun.
CONTAGION HAS BEGUN
Though few are talking openly, it doesn¶t mean large amounts of money aren¶t aggressively repositioning. Thisrepositioning is effectively de-leveraging and is consequentially a liquidity drain. This comes as US M3 has gone