No. of Recommendations: 2
Absolutely fantastic write-up Deej. While I mostly agree with that great write-up, allow me to play devil's advocate.

I don't know about the rest of investors currently in the market, but my biggest fears in this investing environment in not future negative growth, unemployment, overvaluation relative to future earnings, or even the clogged credit system, or corporate bond yields peaking (signaling future bond defaults).

My biggest fears are the effects of all this on the Credit Default Swap market (the Trillion dollar elephant in the room), which could have a domino effect the likes of which we have never seen before. This type of derivative wasn't around during the Great Depression, over even the 1982-83 recession. I'm sure many realize by now how severe these instruments can be.

If one firm fails (and hence defaults on its bonds), it could take down 5 other firms that sold insurance on that company's bonds (too cheaply, with a large notional exposure). And those 5 firms can cause the defaults of 10 more firms who were selling insurance on some of those 5 companies' bonds.

The big risk is the obvious domino effect this could have as more corporate bonds default, causing more corporate bonds to default. (Which according to current corporate yields, and well respected investors, will be a very large number).

The good news is the gov. is now guaranteeing bank debt.

However, banks weren't the only ones involved in CDSs. I predict many insurance companies (which the gov. is currently not guaranteeing the debt of) will fall, as most have sold thier bond default insurance way too cheaply.

CDSs are sold not only on financial institutions' debt, but company stalwarts like GE as well. All these financial institutions have so much exposure to corporate America's (and the rest of the world's) corporate and mortgage bond defaults, that it could cause a large portion of corporate americal to dissapear in a short time frame.

And then once the CDSs explode, this leaves all of the other counterparty risks on the table that those institutions were exposed to failing to meet their obligations. (Like currency and commodity hedging that other companies depend on).

Its all pretty scary stuff. I don't mean to scare people, but the panic is not without merit. What gives me great relief is that the U.S. government IS NOW aware of the significance of the problem (and plans to somehow quickly regulate it) and how it can effect nearly every financial institution in corporate america. It doesn't hurt that the smartest, and perhaps most ethical and respected, investor on the planet is bullish on America and equities.

Don't get me wrong...I am invested in U.S. equities as well as corporate bonds and cash, but I'm fully aware of the VERY significant risks ahead, even at historically VERY cheap fundamentals.

I wonder if the average investor is aware yet of just how significant the CDS market is? This is my fear. That they haven't priced this in yet, b/c they aren't aware of THIS somewhat complex problem and how big and intertwined it is, and are only focusing on much lower earnings and very high unemployment.

Regards,

Frank
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