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.
21..That was an excellant video on the housing crash and in such simplist terms anyone can understand it. Oddly enough just changing their vocabulary makes this all the more deceptive.
Enormous amounts in derivatives were based on mortgages for real estate—houses. It appears that the author omitted that.
bookmark
What Cooked The World’s Economy?
http://www.freerepublic.com/focus/f-news/2209313/posts
And...
Here’s the link for the evidence in the information from the “Bank for International Settlements,” as mentioned in the full version of the excerpted article linked above.
http://www.bis.org/publ/otc_hy0805.pdf
...and a quote from it.
“The over-the-counter (OTC) derivatives market showed relatively steady growth in the second half of 2007, amid the turmoil in global financial markets. Notional amounts of all categories of OTC contracts rose by 15% to $596 trillion at the end of December (Table 1), following a 24% increase in the first half of the year.1”
The simplest derivatives are options, the basic ones being puts and calls.
A put is a contract which gives the buyer of the put the right to sell a certain asset (e.g. a certain number of shares of XYZ corp., and oz. of gold, . . .) at a fixed price to the seller of the put at any time during the term of the contract (American version) or at the ending date of the contract (British version).
A call is a contract which gives the buyer of the call the right to buy a certain asset at a fixed price from the seller of the call (again at any time ruing the term of the contract or at the ending date of the contract).
A straddle is a contract that combines a put and a call (with different prices) on the same asset.
Puts were traditionally used to hedge downside risk when buying on margin (i.e. on credit), and calls to hedge risk of price rises when short-selling (selling borrowed assets).
Of course there are more exotic derivatives like credit default swaps in which one party pays the other for the right to sell some asset (usually a loan or portfolio of loans) at an agreed to price if some specified bad thing happens. (The “bad thing” is most often the borrower defaulting on the loan, but it could be something else.) The seller of the CDS either believes the bad thing won’t happen, or that even if it does the asset will be worth acquiring at the agreed price, or some probabilistic combination of the two, while the buyer is worried about the bad thing happening and thinks the asset won’t be worth holding onto if it does, and is willing to pay something to hedge against the bad thing happening and being stuck with the asset.
Anyone with a brokerage account can trade in options and maybe more exotic derivatives as well. Generally the only mutual funds that use derivatives much are hedge funds (hence the name).
That’s about all I know on the subject.
Derivatives aren't "borrowings".
($16T went out for bank interest payment bailouts on derivative bond losses 2008-2010).
Huh? Derivative bond losses? Are you talking about derivatives or bonds?
The $1.5Quadrillion of world-wide derivatives, say at 1% interest due each year
They aren't debt, why would interest be due?
I’m not sure how it’s calculated for other derivatives, but the notional value of a call is the value of the stock (at current marke price) which the purchaser of the call has a right to buy at a fixed price, while the notional value of an interest rate exchange is the underlying principal amount.
Quite frankly, it seems adding up the notional values of derivatives is quite meaningless, and the huge sum doesn’t forebode anything. It’s rather like adding up the maximum possible payouts of all outstanding insurance policies of all types, then running around worrying that the sky is falling because the insurance companies don’t have anywhere near that amount in assets.
Quit making sense. You have to PANIC!!!
Thank you. It's too bad the author or OP didn't explain it.
Derivatives are long shot odds. I get $1 million for $1 investment if Michigan Sate beats Wisconsin on a Hail Mary pass with no time left in the game. Oh wait that just happened!!!
Those are not the complex CDS derivatives that have the world banking system in peril. Those and futures are simple derivatives that are traded publicly out in the open
Went a great gun show today. Not as crowded as the ones right after Obama’s election, but much more crowded than the ones of the past year or so.
Vendors were saying AR-15s weren’t moving much anymore. Shotguns and other old standby SHTF stuff was moving briskly, though.
I have more confidence in the rapture predictions than in anything from this lame blog.
Remember Bush’s first two Secretaries of the Treasury were non Wall Street corporate types who quietly pushed for financial reforms. Both were pushed out and ultimately replaced by Hank Paulson, CEO of Goldman Sachs, the ultimate financial insider. Bush also appointed Ben Bernanke to the Chairman of the Federal Reserve.
The Republicans are as much enablers of crony Wall Street capitalism as the Democrats. The Wall Street banks have increased their stranglehold over the economy since Bill Clinton appointed Robert Rubin (also Goldman Sachs) to the Secretary of the Treasury position.
True economic reform will require breaking up the Wall Street banking cartel and once again separating investment banking from retail banking. Neither party is currently favoring this type of reform because both parties are owned by Wall Street.
The Feds need to outlaw national banks and return the control to each of the individual 50 states! No bank is allowed to cross state lines, nor is any bank allowed to hold any interest in other state banks. Very drastic I know, but probably too late for what is inevitably coming. America is doomed!
Concerning state govts controlling commercial banks, that’s what we had for 70 years? It worked well and then the bankster lobby which had Greenspan in their pocket bought off politicians of both Parties and repealed the law that kept banks small enough to fail.
The repeal gave them carte blanche to do anything including profiting from our taxes and Fed Reserve. Bill Clinton, Phil Gramm and his wife got rich and about 10 years later we were all screwed.
If OWS is pushing an end to TBTF and states’ rights I’m for it.
You’ve made this very understandable. Well, I had to look up “notional,” but the student has to do at least a little homework.
From your explanation, this article appears to be a little over-the-top.
Thank you for taking the time to explain.
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