Posted on 10/22/2011 4:55:46 PM PDT by dennisw
Most people have no idea that Wall Street has become a gigantic financial casino. The big Wall Street banks are making tens of billions of dollars a year in the derivatives market, and nobody in the financial community wants the party to end. The word "derivatives" sounds complicated and technical, but understanding them is really not that hard. A derivative is essentially a fancy way of saying that a bet has been made. Originally, these bets were designed to hedge risk, but today the derivatives market has mushroomed into a mountain of speculation unlike anything the world has ever seen before. Estimates of the notional value of the worldwide derivatives market go from $600 trillion all the way up to $1.5 quadrillion. Keep in mind that the GDP of the entire world is only somewhere in the neighborhood of $65 trillion. The danger to the global financial system posed by derivatives is so great that Warren Buffet once called them "financial weapons of mass destruction". For now, the financial powers that be are trying to keep the casino rolling, but it is inevitable that at some point this entire mess is going to come crashing down. When it does, we are going to be facing a derivatives crisis that really could destroy the entire global financial system.
Most people don't talk much about derivatives because they simply do not understand them.
Perhaps a couple of definitions would be helpful.
The following is how a recent Bloomberg article defined derivatives....
Derivatives are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in the weather or interest rates.
The key word there is "speculation". Today the folks down on Wall Street are speculating on just about anything that you can imagine.
The following is how Investopedia defines derivatives....
A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.
A derivative has no underlying value of its own. A derivative is essentially a side bet. Usually these side bets are highly leveraged.
At this point, making side bets has totally gotten out of control in the financial world. Side bets are being made on just about anything you can possibly imagine, and the major Wall Street banks are making a ton of money from it. This system is almost entirely unregulated and it is totally dominated by the big international banks.
Over the past couple of decades, the derivatives market has multiplied in size. Everything is going to be fine as long as the system stays in balance. But once it gets out of balance we could witness a string of financial crashes that no government on earth will be able to fix.
The amount of money that we are talking about is absolutely staggering. Graham Summers of Phoenix Capital Research estimates that the notional value of the global derivatives market is $1.4 quadrillion, and in an article for Seeking Alpha he tried to put that number into perspective....
If you add up the value of every stock on the planet, the entire market capitalization would be about $36 trillion. If you do the same process for bonds, you’d get a market capitalization of roughly $72 trillion.
The notional value of the derivative market is roughly $1.4 QUADRILLION.
I realize that number sounds like something out of Looney tunes, so I’ll try to put it into perspective.
$1.4 Quadrillion is roughly:
-40 TIMES THE WORLD’S STOCK MARKET.
-10 TIMES the value of EVERY STOCK & EVERY BOND ON THE PLANET.
-23 TIMES WORLD GDP.
It is hard to fathom how much money a quadrillion is.
If you started counting right now at one dollar per second, it would take 32 million years to count to one quadrillion dollars.
Yes, the boys and girls down on Wall Street have gotten completely and totally out of control.
In an excellent article that he did on derivatives, Webster Tarpley described the pivotal role that derivatives now play in the global financial system....
Far from being some arcane or marginal activity, financial derivatives have come to represent the principal business of the financier oligarchy in Wall Street, the City of London, Frankfurt, and other money centers. A concerted effort has been made by politicians and the news media to hide and camouflage the central role played by derivative speculation in the economic disasters of recent years. Journalists and public relations types have done everything possible to avoid even mentioning derivatives, coining phrases like “toxic assets,” “exotic instruments,” and – most notably – “troubled assets,” as in Troubled Assets Relief Program or TARP, aka the monstrous $800 billion bailout of Wall Street speculators which was enacted in October 2008 with the support of Bush, Henry Paulson, John McCain, Sarah Palin, and the Obama Democrats.
Most people do not realize this, but derivatives were at the center of the financial crisis of 2008.
They will almost certainly be at the center of the next financial crisis as well.
For many, alarm bells went off the other day when it was revealed that Bank of America has moved a big chunk of derivatives from its failing Merrill Lynch investment banking unit to its depository arm.
So what does that mean?
An article posted on The Daily Bail the other day explained that it means that U.S. taxpayers could end up holding the bag....
This means that the investment bank's European derivatives exposure is now backstopped by U.S. taxpayers. Bank of America didn't get regulatory approval to do this, they just did it at the request of frightened counterparties. Now the Fed and the FDIC are fighting as to whether this was sound. The Fed wants to "give relief" to the bank holding company, which is under heavy pressure.
This is a direct transfer of risk to the taxpayer done by the bank without approval by regulators and without public input.
So did you hear about this on the news?
Probably not.
Today, the notional value of all the derivatives held by Bank of America comes to approximately $75 trillion.
JPMorgan Chase is holding derivatives with a notional value of about $79 trillion.
It is hard to even conceive of such figures.
Right now, the banks with the most exposure to derivatives are JPMorgan Chase, Bank of America, Goldman Sachs, Citigroup, Wells Fargo and HSBC Bank USA.
Morgan Stanley also has tremendous exposure to derivatives.
You may have noticed that these are some of the "too big to fail" banks.
The biggest U.S. banks continue to grow and they continue to get even more power.
Back in 2002, the top 10 U.S. banks controlled 55 percent of all U.S. banking assets. Today, the top 10 U.S. banks control 77 percent of all U.S. banking assets.
These banks have gotten so big and so powerful that if they collapsed our entire financial system would implode.
You would have thought that we would have learned our lesson back in 2008 and would have done something about this, but instead we have allowed the "too big to bail" banks to become bigger than ever.
And they pretty much do whatever they want.
A while back, the New York Times published an article entitled "A Secretive Banking Elite Rules Trading in Derivatives". That article exposed the steel-fisted control that the "too big to fail" banks exert over the trading of derivatives. Just consider the following excerpt from the article....
On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan.
The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential.
So what institutions are represented at these meetings?
Well, according to the New York Times, the following banks are involved: JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup.
Why do those same five names seem to keep popping up time after time?
Sadly, these five banks keep pouring money into the campaigns of politicians that supported the bailouts in 2008 and that they know will bail them out again when the next financial crisis strikes.
Those that defend the wild derivatives trading that is going on today claim that Wall Street has accounted for all of the risks and they assume that the issuing banks will always be able to cover all of the derivative contracts that they write.
But that is a faulty assumption. Just look at AIG back in 2008. When the housing market collapsed AIG was on the wrong end of a massive number of derivative contracts and it would have gone "bust" without gigantic bailouts from the federal government. If the bailouts of AIG had not happened, Goldman Sachs and a whole lot of other people would have been left standing there with a whole bunch of worthless paper.
It is inevitable that the same thing is going to happen again. Except next time it may be on a much grander scale.
When "the house" goes "bust", everybody loses. The governments of the world could step in and try to bail everyone out, but the reality is that when the derivatives market comes totally crashing down there won't be any government on earth with enough money to put it back together again.
A horrible derivatives crisis is coming.
It is only a matter of time.
Stay alert for any mention of the word "derivatives" or the term "derivatives crisis" in the news. When the derivatives crisis arrives, things will start falling apart very rapidly.
One additional problem is that derivatives and their additionally piled on insurance policies are growing, and the bankers and investment houses wish to add even more derivatives not seeing that there must be an end point.
Maybe because the long term is too dark to contemplate?
You have to dissect the multi-trillion dollar figures thrown around. 80% of this total exposure is in the form of plain vanilla Interest Rate Swaps.
In a vanilla Interest Rate Swap, the 2 parties involved in a transaction are only exchanging fixed interest payments for floating interest payments on an agreed-upon notional. It is not the notional itself that is being exchanged. Please place these huge figures in their proper perspective
For example: 2 parties may engage in a Swap transaction on a $100million notional amount. They are not exchanging the entire $100million. They are only exchanging interest payments on that $100 million on a monthly, quarterly, semi-annual or annual basis (whatever they agree to), so the true exposure is nowhere near the $100 million notional amount of the swap. If a bank on one side of the transaction goes under, the other side hasn’t lost $100million, or anywhere close to it.
That being said, things are not looking too stable. It is very likely that at least one European bank will fail, which could set off a chain reaction in the US with some of our big banks which are hanging by a thread.
Derivatives are more complex than just ‘side bets’ and they have an important role to play in the world of finance and international banking. They allow firms to hedge exposure to obligations such as interest payments, and project financing costs just to name a few uses. Yes, there is an element of speculation involved, but the market is very liquid and there are regular bilateral netting and portfolio compression cycles that take place. These are processes by which offsetting trades are effectively “torn up” thereby removing them from the balance sheet of the banks involved in the transactions. Too much to elaborate upon here, but these compression cycles occur regularly and every big bank with derivatives exposure participates. Think of these cycles as maintenance, in which the deadwood and underbrush are removed in order to prevent a potential forest fire.
The term 'derivative' is pretty broad. Everything from a listed option on a stock or a future can be considered a 'derivative' because its value is derived from an underlying asset.
The derivatives as described in this article are primarily Interest Rate Swaps which are traded "Over The Counter" or directly between the two parties. They are not listed on an exchange, nor are they something that individual investors or mutual funds would trade or have any exposure to.
In a vanilla Interest Rate Swap, the 2 parties involved in a transaction are only exchanging fixed interest payments for floating interest payments on an agreed-upon notional. It is not the notional itself that is being exchanged. Please place these huge figures in their proper perspective
For example: 2 parties may engage in a Swap transaction on a $100million notional amount. They are not exchanging the entire $100million. They are only exchanging interest payments on that $100 million on a monthly, quarterly, semi-annual or annual basis (whatever they agree to), so the true exposure is nowhere near the $100 million notional amount of the swap. If a bank on one side of the transaction goes under, the other side hasn't lost $100million or anywhere close to it.
Under Dodd-Frank, banks will be forced to have these products centrally cleared, meaning that each side of a transaction will face a clearing house instead of facing another bank directly. In essence; each bank will have to post collateral based on the value of the derivative contracts to which they have exposure. This collateral will (in theory) protect the counterparties of those transactions if a bank were to default.
>>>In a nutshell, a derivative is a financial insurance policy. They are typically cheap because they reflect the (typically very low) probability of the insured condition coming to pass. Derivatives are typically used as hedges to other bets.<<<
Maybe at one time they were used as hedges (to insure your own liability), but not anymore. Now you get Soros types betting on the failure of the dollar and then going about every way he can to destroy the American market.
I heard it described as like being able to buy fire insurance on your neighbor’s house. Because you don’t have a stake in the house not burning down (i.e., ownership), you have no reason to care if it does burn down, and maybe you even leave some gasoline and matches nearby, in hopes of someone doing your dirty work for you.
Furthermore, since every one of your neighbors can buy fire insurance on your house, the payout, if your house does burn down, isn’t the value of the house, but the value of your house times the number of derivatives sold on it.
Derivatives should be outlawed if you don’t have a vested interest in the underlying product.
Thanks for inserting some sanity into this discussion. To elaborate further:
To those that want to ban all derivatives:
When a farmer pre-sells his crops, that is a derivative
If you own stock options on your employer, that is a derivative
If I want to insure a loan I am making I buy a CDS, a Credit Default Swap from an insurer. If that insurer decides to sell that exposure to another insurer that doubles the NOTIONAL VALUE outstanding but it does not increase the amount at risk.
For example, I lend US Steel $100 million. I buy a CDS from Goldman for $500,000. They turn around a insure their risk with JP Morgan for the same amount. The CDS’s total NOTIONAL VALUE is now $200 million, but there is ONLY $100 million at risk.
Take these total derivative numbers with a grain of salt. Much of it is an offset of another position.
$75 trillion... notational
assuming 100 : 1 risk, that means roughly $750 billion exposure. assuming offsetting bets, the minimum exposure would be $375 - 750 billion.
let them fail
the small banks will buy the assets... and become the new big banks, but with less risky practices
of course, these people are all lefties... their intention is to collapse the system. therefore I expect their failure and the 0bama group to bail them out.. with our money... jacking up the debt even higher
which means... they will continue printing more dollars, diminishing the dollar further
expect gold to continue to rise (as well as all commodities with inherent value)
Those are derivatives.
Mark
If the derivatives can’t be paid off, it won’t be because of the derivatives, it will be because bad government policy in the EU, US, China, and Japan crashed the world economy. Absent a systematic economic failure caused by out of control government, derivatives markets will be of no particular concern.
I would wager that the government parasites will cause the world economy to collapse and will then try to blame it on derivatives, markets, banks, global warming, and, of course, Bush.
The derivatives market creates massive fantasy (not real) wealth which becomes concentrated in a few hands and then it is used as a claim on real wealth (real property, portions of paychecks, ban savings, pensions etc of people both living now and yet unborn) through bailouts and various ‘stimulus’ schemes.
Those claims are being made now and will have repercussions for many generations. Here is but one example.
A Huge Housing Bargain — but Not for You
http://www.thestreet.com/story/11224917/1/a-huge-housing-bargain—but-not-for-you.html
The back door bailout of BOA is another example. If they are made whole through FDIC, what, if any, do you think will be left over to cover depositor losses?
Dangerous times.
2009 : (BANK OF AMERICA ANNOUNCES IT HAS “SUSPENDED CURRENT COMMITMENTS” TO ITS CORPORATE PARTNER ACORN & WILL NOT ENTER INTO ANY FURTHER AGREEMENTS WITH ACORN OR ITS AFFILIATES)
NOVEMBER 30, 2010 : () -——Wikileaks Next Document Drop Will Probably Target Bank Of America, YAHOO Finance ^ | TUE November 30, 2010 | Katya Wachtel
NOVEMBER 30, 2010 : ()New York Attorney General Andrew Cuomo’s office refused to share some information with SEC lawyers...... -———Report: BofA First Got Favorable Deal From SEC On Merrill Settlement
By David Benoit
Of DOW JONES NEWSWIRES
“Looking at several posts about B of A recently, it makes me wonder...is B of A the designated fall guy?”
Bank of America is most definitely the designated fall guy. Before the 2008 financial crisis Charlotte, NC was emerging as a major financial center which threatened the stranglehold the New York Wall Street banks and the New York Federal Reserve have over the US financial system. Two things happened during the financial crisis. First the Federal Reserve chose the save Citibank, Goldman Sachs and JP Morgan and sacrifice Wachovia, the second largest Charlotte bank.
Second step, Bank of America on its own was going to survive so Bernanke and Paulson forced Bank of America to buy Merrill Lynch. Since then New York state (Cuomo as attorney general), the SEC, the Federal Reserve, the mainstream media, and the Treasury Department have hounded Bank of America in an effort to further weaken it. Note that Bank of America picked up most of its derivative exposure due to the Merrill Lynch acquisition, not due to its own actions prior to the big bailout.
Now Bank of America will be brought down and its good assets divided among the New York banks after the taxpayers cover the bad debt. Wall Street will once again have monopoly control over the US financial system and Charlotte will see its unemployment rate skyrocket with thousands of unemployed bankers having no place to go.
As an aside Wells Fargo is probably avoiding the Bank of America treatment this time around because it is headquartered in San Francisco, Pelosi’s hometown. However, Pelosi is in her 70’s so in a few years when she retires the Wall Street boys will find a way to bring down Wells. We cannot have competition in the financial sector in this country.
If we really wanted to reform the financial system we would separate investment banking from commercial banking again and we would break up the big New York banks. Instead we live in a world where what’s good for Goldman, JP Morgan, and Citibank is good for America!
SEPTEMBER 2, 2009 : (REPORT : HASSAN NEMAZEE {FUNDRAISER OF KERRY, HILLARY CLINTON , OBAMA & OTHER DEMOCRATS -—see IRAN} WAS CHARGED LAST WEEK ON BANK FRAUD; HE DEFRAUDED AT LEAST THREE BANKS {see CITIBANK, BANK OF AMERICA CORP, & HSBC HOLDINGS})
Still difficult grasping these numbers, the defy immagination....32 millions years just to count them!
So why not outlaw them? Sounds like a huge Ponzi scheme to me? or is it there is no will in high places to do so?
http://www.youtube.com/watch?v=5Z9eOZpRVuQ
Here is a clip of two British guys doing a comedy sketch on the housing crash. But I think they do a pretty accurate job on describing it in a simple way that an idiot like me can understand. I’ll need to search if they have on on derivatives. But is almost sounds similar.
Paraphrased excerpt:
“So the mortgage seller gives a poor black man in Alabama a mortgage. That mortgage gets combined with other risky mortgages from other poor black men in Alabama. It is then sold as a package as an investment to say somebody in Japan.
They in turn sell it to others, and so on.”
AND YOU MAKE MONEY ON THE SALE?
“Well of course, you don’t expect me to work for free?! And every time it is resold someone takes a cut.”
AND WHY DO PEOPLE BUY THESE FUNDS?
“Because they have good names. No - not the names and reputations of the banks. But good names. Like “High Value Enhanced Capital Managed Fund”
OH - HIGH IS GOOD!
“Yes, a very good name. Better than having ‘poor black man’s mortgage’ in the name somewhere.”
They also talk about the bailouts, etc.
“Maybe because the long term is too dark to contemplate?”
Or maybe because if they “fail” - the government will just bail them out again because they are to big to fail.
Quant ping!
Since then New York state (Cuomo as attorney general), the SEC, the Federal Reserve, the mainstream media, and the Treasury Department have hounded Bank of America in an effort to further weaken it.
Note that Bank of America picked up most of its derivative exposure due to the Merrill Lynch acquisition, not due to its own actions prior to the big bailout.
Now Bank of America will be brought down and its good assets divided among the New York banks after the taxpayers cover the bad debt.
I remember this going down when the crap began hitting the fan.....Paulson and Bernanke were the "pressure" men of the hour... people in the know were furious.
Does anybody know what notional means?
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