I believe the credit deflation is still very much in play.
Kudos to whoever brought up the image of the derivative bubble in a comment.

Of course this isn’t the only credit bubble. I could bring up all sorts of egregious financial instruments that are credit based and in trouble, from CDOs, to Option ARMs. But basically, this obscene amount of credit leads us no room to do anything but deflate, else be forced to never ending credit expansion that ultimately will be unsustainable, and cause us to have decades of rebuilding. And the ironic thing is derivatives are originally designed to allow people the ability to reduce risk.
As in any exchange, one side usually gains, while the other loses.
While all the banks have people who are defaulting on their loan, all those exposed who sell the credit default swaps expecting payment must give it up a much larger amount in the event that there is a default.

According to wikipedia:
A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the “buyer” pays periodic payments to the “seller” in exchange for the right to a payoff if there is a default[1] or “credit event”[citation needed] in respect of a third party or “reference entity”.

In the event of default in the reference entity:

the buyer typically delivers the defaulted asset to the seller for a payment of the par value. This is known as “physical settlement”.
Or the seller pays the buyer the difference between the par value and the market price of a specified debt obligation. This is known as “cash settlement”.

Normally selling these derivatives seems like a good idea for the banker, to collect payment from. If the loan was given out responsibly, even if the borrower defaults, the banks keeps the collateral deposit, and gets to obtain the property and sell it at an auction, even if it isn’t a sell at the auction, there are plenty of people willing to collect, and the bank can then use that amount to pay off the default credit swap buyer.

But these are certainly not “normal” times. And the markets that were going up for so long eventually come down.
You see, the problem comes when there is an overwhelming amount of bad loans done irresponsibly, and an overwhelming amount of defaults, and the banks are so overloaded with properties, coupled with the obscene amount of leverage of shareholder money and bad mortgages that they simply don’ have a choice but to lose money.
I remember watching some report on fast money about a man that used to work for Bear Sterns and retired, and when he left, he loaded up on credit default swaps and made a fortune.
Unfortunately it’s difficult for you and I to get access to these credit default swaps.

So What is one to do during this credit unwinding?
Enter FairFax Financial (FFH)
If you believe that there will be more defaults, Fairfax Financial Holdings Limited (USA) [[FFH]] , is one financial, that during this crisis, you can profit from.
Do not buy it right now. It’s over bought right now, but do your due dilligence on this one add it to your watchlist, and keep an eye on it, and when it comes down to reasonable prices, you may want to consider buying it.
Then again, you will have to be paying a lot of attention to how the government is handling everything with their bailing out, and nationalizing mortgage, and everything else, and how government intervention will effect the credit default swaps.
But his potentially could be one that you buy when the financial sector is being beaten down, because the worse the financials get, the more money FFH will make, and since they’re tied to financials, they’ll also bennefit from a rally.

In the meantime, I also love buying [[SRS]] as shorting the real estate market is another great way to play the credit unwinding.

Short Auto- I think the “no credit? no problem?” commercials are dead. The 0% APR, please oh please buy a car that costs more than you can afford, and we’ll give you a special deal before we launch the interest rates up are dead. Even creative financing, and even basic regular car loans will be rare. Auto is going down. I have felt this way for awhile, and have been against F and GM, with a small hedge in TM. But I am out of those names. You may consider buying TM stock and puts on it. But I will look for some new names to really short, starting with those that FLY and RC have mentioned. Right now I don’t have a specific name of choice.

Berkshire Hathaway. This is a long term play, but is still a great credit play, even though it’s one that’s more bullish. Long term, A company that has an excellent balance sheet, tons of cash and can continue to grow without the use of credit is exactly what you want during a credit crunch. Although I expect things to continue to be bad and perhaps collapse dramatically if there’s not a solution to this credit deflation, You can’t deny the fact that the vix is high, market sentiment is low, and everything else that Chivas said in this post.

SKF- This just seems mandatory if you’re investing in a couple financials, but I really don’t know enough about the governments intentions, and the bond makers and what’s going to really happen here to want to own a large position, but my gut says SKF is still a good play. However, rather than go this direction, I decided to grab a strangle on the XLF due to me not knowing what the government has in mind.

Transports- Commodities are getting killed, because of this credit deflation. Joey-farmer who is leveraged out his ass is getting shitcanned. When the price of coal gets shit canned, people don’t want to pay a shitload to ship it, because they won’t make as much from it. so the prices on shippers and transports go down. As the credit unwinds, Transports are getting hit. Not to mention institutions are unloading shares of everything. Right now the opportunity is to buy puts on these. as everyone unloads until it’s “not cool to sell transports anymore” then you can start selling off some puts, and then as it drops more, perhaps grab some stock in the transports against your puts.

I also don’t mind for value hunters to go out and buy stocks, provided they do so with protective puts. Something like FCX, NOV, DRYS, etc may be undervalued, but it’s getting killed right now. If you want to slowly start buying, buy 100 shares for every protective put, or better yet, play a slight bias to the downside, and buy 80 shares for every 1 put. Now the stock tanks, you sell the put, keep the stock and use the profit to buy another 80-100 shares at a lower price, and buy a couple of puts with a later expiration, and lower strike price, and continue. Or you can purchase a LEAP option call, and buy short term puts until the market turns around. You can also buy a bear put spread against your stock. If you have a price that you think the stock simply won’t go below, in addition to buying the put you can sell a put at a lower strike price to lower your break even point, and collect the premium.

One last word of advice. Be quick and informed. These markets, things can change in an instant. Be willing and ready to adapt if you must… Read all of IBC, as well as the other sites that I won’t name, but I’m sure there’s plenty of links on the right hand side of Fly’s blog of plenty of informative blogs. If you’re quick and informed, you can figure shit out on the run and bank some coin.

 

Update: Here’s a good article about FairFax