Dear CIGAs,

If you listened carefully there was much to be heard at today's Fed testimony.

The primary reason for funding the Bear/JPM deal was to prevent Chapter 11 for Bear. In Chapter 11 Bear would be released from its liabilities with residual assets distributed.

That would mean that the specific performance obligations required of Bear on the structured products they were principle to (their inventory) would no longer be obligatory as that is a liability discharged.

That would mean not only the $30 billion going publicly up in smoke, but the entire web of obligations written against them would also go up with it.

That smoke would take the form of a financially nuclear mushroom cloud. It is estimated that thousands of counter-parties would be engulfed in that mushroom cloud of financial destruction.

No major investment bank, insurance company or other financial entity which has major commitments in the OTC derivative market will be allowed to go Chapter 11. This will cost the Fed huge amounts of money - well beyond what you have seen so far.

The Fed balance sheet will become garbage on the asset side with growing and in most cases undetermined liabilities. Central banks cannot go broke as they have a blank check they can use to print all the funds required. What a central bank can do is DESTROY THE CURRENCY they represent. The tool for that destruction is a combination of inflation and balance sheet deterioration, the path we are now clearly on.

There is so much more to come that there is no respite here.

Gold is headed to $1650 and the US dollar to .5200 on the USDX.

Note the currency from the Weimar Republic: (Click image to enlarge in PDF format)

Review of the Testimony:

1. Soros was quoted today (not in this meeting) as predicting the next major problem emanating from the companies that have issued credit default derivatives (swaps) so far beyond their capacity to perform (45 trillion US dollars worth according to the WSJ) that it borders on comical. I wholly concur, but believe this is already in place, albeit just starting. A downgrade of the credit worthiness character of the issuers (credit default swaps) bonds would trigger an opening of the flood gates. Not downgrading those bonds will end the existence of the credit rating firms via civil litigation. AAA credit rating for entities with trillions of dollars of guarantees with now modest capitalization stretches the imagination of any financial Pollyanna.
2. The subject of the action of a bankruptcy judge as it applies to OTC derivatives was opened. It got slammed shut fast by the Fed, saying this was not a relevant subject as no bankruptcy occurred.
3. It was stated that the Federal Reserve assumed the risk of the derivatives at the point to which Bear Stearns had marked them to model on the day of the transaction. The question that remains is what was the mark to model that Bear Stearns in fact has marked their position as counterpart to SIVs?
4. The question was asked of the Federal Reserve when they knew that Bear Stearns was in trouble. The answer was that they know Bear Stearns faced Bankruptcy one day before the transaction weekend. It was made clear that the Fed was not the supervisor of Bear. Actually, no one was in the situation of OTC derivatives and their valuation supported by the Fed in their commentary on regulations and derivatives on many occasions. There is a distinct difference between when you know an entity is in trouble to knowing that they are going to have to file Chapter 11.
5. As always, the problem being examined is directed at the mortgages themselves. The structure of the OTC derivative market, its lack of regulations, Fed blessing of no regulations and all other characteristics is not in the scope of discussion.
6. This is the beginning of a politicized discussion of the valuation by computer models as asked by Mr. Tester. The question is who valued Bear’s portfolio and the answer is of course Bear. If you were using a voice analyzer, I believe the answer to the question, “Are Bear’s derivatives worth $29 billion?” would show the Chairman begin stuttering. The question to follow this is why did JP Morgan require a $29 billion guarantee if the items had a good value of $29 Billion? The answer again would be stuttering. The answer to the question “What does highly rated mean?” is “No firm guarantee.”
7. It became clear that the reason Bear could not file chapter 11 is that would legally result in assuring the counter party of the special performance contract that must perform ( Bear - the loser) would never perform, making the entire web of OTC derivatives issued against those instruments BANKRUPT. This is why JPM would not take on more than the first billion with the Fed, now the performing party on the balance of the $29 billion. This is the real heart of the situation.
8. Questions were asked of the Fed regarding how they would stand in civil litigation over the transactions formulated by the Fed. My comment is good luck suing the government (or quasi government) organization. That question is quite relevant where Bear, JPM, Credit rating companies and all those involved in OTC derivatives are concerned. What has not occurred to the investment banks, insurance companies, retirement funds and all those entities trying to maximize interest via guaranteed debt and derivatives thereupon, litigation will. Will the Fed assume the litigation losses for protection of the financial entity if it threatens chapter 11? The answer is probably YES.

Let’s review the key points for Gold now:

1. $887.50 give or take.
2. $900
3. $961
4. $1024