Posted on 09/15/2008 8:08:51 AM PDT by TigerLikesRooster
Wall Street crisis: Is this the death knell for derivatives?
On page 62 of last year's accounts, under the heading "off balance sheet arrangements" Lehman had derivative contracts with a face value of $738bn
Nils Pratley
guardian.co.uk, Monday September 15 2008 09:18 BST
If this is the death of Wall Street as we know it, the tombstone will read: killed by complexity.
Derivatives in their baffling modern forms – collateralised debt obligations, credit default swaps and so on – lie at the heart of the failure of Lehman, Bear Stearns, Fannie and Freddie, and even our own Northern Rock.
The philosophy that underpins the growth of derivatives is the idea that risk can be transferred to institutions more able to take the strain. In theory, it's a terrific scheme – the weak can get rid of risks they can't handle, and the financial system should be stronger as a result.
The practice is very different, as Warren Buffett worked out years ago. His 2002 letter to his Berkshire Hathaway shareholders made headlines by condemning derivatives as "financial weapons of mass destruction". The passage comprised only a couple of pages of the lengthy letter but read it again today - it is the best guide to understanding how Wall Street has arrived at today's mess.
Here is Buffett on General Re Securities, a derivatives dealer that Berkshire inherited with its purchase of insurer General Re. "At year-end (after ten months of winding down its operation) it had 14,384 contracts outstanding, involving 672 counterparties around the world. Each contract has a plus or minus value derived from one or more reference items, including some of mind-boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have widely varying opinions."
Now consider Lehman Brothers balance sheet.
(Excerpt) Read more at guardian.co.uk ...
Ping!
One can only hope. While there are some legitimate types of derivatives, and some legitimate uses of those types of deriviatives for hedging or diversification, the great bulk of them are voodoo garbage. What’s worse, most of the trading in them is being done by cocky young kids who are aren’t really being supervised at all (SocGen’s Jerome Kerviel, being the perfect example). Most of these kids have never been through a serious market disruption, and even if they have, it was when their personal net worth consisted of virtually nothing, and they had no real responsibility at all at their jobs, so they had no personal financial or employment impact.
(I guess I should update that to include credit derivatives, but it doesn't look like that market's going to be of much size for a while. ;-)
IF enough of the big players walk away with enough money, and pass the crisis on to the taxpayer, then they’ll be back. Unless of course we wise up and regulate.
......Most of these kids have never been through a serious market disruption,....
The sight this morning on Fox and Friends of their young colleagues leaving Lehman carrying cardboard boxes should prove to be a sobering event
What this tells me is that the 1,000 or so multi-millionares running this comapny aren’t worth the bonuses they’ve received for the past decades.
Wall Street has become more about smoke, mirrors, sales than purdent financial advice and proper investing techniques.
Credit derivatives are fine when used responsibly. But in the hands of children (i.e., Stan Neal, Chuck Prince, Bobby Rubin, Dick Fuld, Franklin Raines), they are solely instruments for self-enrichment.
Remember the Black October of 1997? That is when Goldman Sachs, Firm of Robert Rubin and Jon corzine, was bailed out with Cash from Clinton because of there over investing within the Mexico Market, after the Peso tanked?
Funny how this never comes up. I was a clerk at the Board of the Trade at the time, it was much worse than today.
The derivatives market is about $455T.
At some point, all that on-books money must be converted to a more liquid form.
At the extreme other end of the money specturm, there is only about $1.5T practical cash available.
A 300-to-1 virtual-to-real money ratio is unsustainable; something’s gonna break and someone’s gonna lose a LOT of money.
But the next round of derivatives traders are in college right now. These young professionals leaving Lehman carrying boxes and having no employment prospects aren’t their colleagues, and it’s doubtful the college kids are watching this. The ones who are even aware of it are thinking it’s a one-time event that has nothing to do with their own brilliant and prosperous futures. Most are probably just focusing on keg parties, interspersed with occasional bouts of cramming.
The net value of the derivatives market is zero.
Why don't we raise taxes on the rich, rather than putting them out of work?
I encourage anyone with the slightest interest in the financial derivatives mess to use the link in the Guardian story to the pdf of Berkshire Hathaway’s 2002 report.
Buffet’s mini-treatise is on pages 13 through 15 of the report and is such a clear and succinct treatment of the problem that I have printed it out for future use in explaining derivatives to friends and family.
I ain’t no Buffet lover, but that three pages is pure gold.
no.
fire BAD!
fire BAD!
The big stock market meltdown seems to have fizzled. Anybody here ever been through a business cycle before? I feel like I’m in a playpen.
I think it’s easy point the finger squarely at derivatives, almost too easy. The base assets were garbage (junk mortgages) and so no matter where you put them on your books, you’re still trading garbage and eventually it’s going to stink.
At the end of the day Fuld’s arrogance is what tanked Lehman Bros., and I bet that a good portion of their 4.5 billion increase in net profit had a lot to do with writing away all of this junk paper. He received a 22 million dollar bonus this year, I bet you that check is cashed and invested somewhere else.
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