The Derivatives Market is Unwinding!
Posted June 5th, 2008 by doctor011
output
A couple of months ago, a financial analyst who sells derivatives told me that fears about a meltdown in the derivatives market were unfounded.
Yesterday, he told me - with a very worried look - "THE DERIVATIVES MARKET IS UNWINDING!"
What does this mean? What are derivatives and why should you care if the market is unwinding?
Well, it turns out that the reason that Bear Stearns was about to go belly-up before JP Morgan bought it is that it had held trillions of dollars in derivatives, which were about to go south. (The reason that JP Morgan was so eager to buy Bear Stearns is that it was on the other side of these derivative contracts -- if Bear Stearns had gone under, JP Morgan would have taken a huge hit. But the way the derivative agreements were drafted, a purchase by JP Morgan canceled the derivative contracts, so that JP Morgan didn't experience huge losses. That is probably why the Fed was so eager to broker - and fund - the shotgun marriage. JP Morgan is a much larger player, and if Bear's failure had caused the derivatives hit to JP Morgan, it probably would have rippled out to the whole financial system and potentially caused an instant depression).
In addition, the subprime prime loan crisis is intimately connected to the unwinding of the derivatives market. Specifically, loans were repackaged into derivatives called collateralized debt obligations (or "CDO's") and sold to both big and regional banks and investment companies worldwide. The CDO's were highly-leveraged -- many times the amount of the actual loans. When the subprime loan crisis hit, the high leverage magnified the fallout, and huge sums of CDO derivatives became essentially worthless.
Do you remember when wealthy Orange County, California, went bankrupt in 1994? Yup, that was because it had invested in bad derivatives.
And, according to a recent article by one of the world's top derivative insiders, the market for credit default swap ("CDS") derivatives is also unraveling.
And reported just today, Lehman Brothers is now on the edge, due to exposure to derivatives.
Derivatives are the Elephant in the Living Room
The subprime mortgage crisis is bad, and is hurting many people, and slowing the economy. High oil and food prices are bad, and are hurting many people, and bringing down the economy. But -- according to top insiders -- derivatives are the elephant in the room . . . the single largest threat to the U.S. and world economy.
One reason is that, according to Paul Volcker, the former chairman of the Federal Reserve, the entire modern financial system is based upon derivatives, and the financial system today is entirely different from the traditional American or global financial system because derivatives - a relatively new concept - now underly the entire fabric of the financial system. In short, many of the people who know the most about derivatives say that the current system is a house of cards built upon derivatives.
And yet banks and financial houses have hidden their derivatives exposure off the balance sheets. No wonder almost no one understands derivatives:
"Not only [world's richest man] Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't 'figure out'" the derivatives market.
Indeed, the government may have actively helped to hide the the derivatives mess since at least 2006. For example, according to Business Week:
"President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations."
Former fed chairman Alan Greenspan has been a huge booster for and defender of derivatives for many years. Did you know that the same guy that pushed subprime loans has also aggressively pushed derivatives since at least 2001?
And the other regulatory agencies and Congress have taken a totally hands-off approach towards derivatives.
How Big a Problem?
How big is the derivatives market? Worldwide, it is $516 trillion dollar. The derivatives market dwarfs the real market for goods and services, and acts likes an unregulated black market.
As one writer put it:
"It’s all smoke and mirrors. The financial system has decoupled from the productive elements of the economy and is now beginning to show disturbing signs of instability."
And its not just the U.S. Derivatives salesmen have sold these babies all over the world. Because banks, financial institutions and governments world-wide have bought significant derivatives, the fall out will not be limited solely to the U.S. See this and this.
If the derivatives market is truly unwinding, as my investment advisor friend and some of the top industry insiders say, we could be in for a very bumpy ride.
For further information on derivatives, see these articles:
http://www.prudentbear.co...
http://www.marketoracle.c...
http://www.marketoracle.c...
http://www.marketoracle.c...
http://www.globalresearch...
http://www.telegraph.co.u...
http://www.nytimes.com/20...
http://www.nytimes.com/20...
http://www.nytimes.com/20...
http://money.cnn.com/2008...
http://www.ft.com/cms/s/0...
http://www.occ.treas.gov/...
http://news.moneycentral....
http://www.telegraph.co.u...
Posted by George Washington at 12:01 PM
http://georgewashington2....
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The problem isn't only taxes.
Like I said before, if I produce something on my property, I don't even have a problem with paying taxes, preferably to a local government, as long as I can pay with the products I produce. If I have to go out and exchange it first for money and then pay the taxes I am at the mercy of the money makers, whether it be dollars made of paper, gold or silver. I shouldn't have to go through that idiocracy.
grant
Goodmorning!
I am sure that the government has food stored, and as you say, probably not enough. How long do you think food will last in case of a massive drought, a few years? I doubt that it would pass a year, not to feed everyone. Yet in Africa, much of which has fertile land, the population is encourage more to look for diamonds, precious stones or gold, even have wars over these items, and yet very little is invested in agriculture. Another point you make is that some food is stored and controlled by the government, not the individual. I don't see many private food storage facilities or banks. There is no such thing as freedom if a person can't produce enough food themselves on their own land, and this because the government has the authority to take away land from small farmers if they don't pay property taxes or income taxes. Consider that one of the side affects of the policies of the government, I am careful not to say objective, has been for people to leave the rural areas, where they produced their own food and in many cases preserved it for future use. Today most of the population has been driven to cities in search of the all mighty dollar which has lead to a welfare state. We need look no futher than nature to know as animals our main goal should be to store food, bees, ants even squirrels. We have been educated that money, including gold and silver have real value, but personally I don't see the attraction.
Time for Breakfast.
grant
Major problem.
You have identified a major problem in our country. The government has the power to take away your property if you don't pay your taxes.
I live in a very diverse area and often talk to people that are from all over the world. I was talking to a lady from the Philippines and she was complaining about how high the house tax is here. She said she still has a house and a plantation in the Philippines and pays approximately $50 a year for the property. She has people living and working on the plantation. It actually is producing money.
Something is wrong when a farmer can produce enough food to feed his family, but gets the farm taken away because of the taxes.
This was just posted
on www.jsmineset.com
Jim Sinclair’s Commentary
You think the credit default derivative companies can perform on the obligation when those obligations become demands? Bernanke can easily speed along those demands if he thinks that he can play Hawk without consequences.
For your information (From Wikipedia):
Risks
Risks involving credit derivatives are a concern among regulators of financial markets. The US Federal Reserve issued several statements in the Fall of 2005 about these risks, and highlighted the growing backlog of confirmations for credit derivatives trades. These backlogs pose risks to the market (both in theory and in all likelihood), and they exacerbate other risks in the financial system. One challenge in regulating these and other derivatives is that the people who know most about them also typically have a vested incentive in encouraging their growth and lack of regulation. (The incentive may be indirect, e.g., academics have not only consulting incentives, but also incentives in keeping open doors for research.)
Credit default swaps can be used to manage credit risk without necessitating the sale of the underlying cash bond. Owners of a corporate bond can protect themselves from default risk by purchasing a credit default swap on that reference entity.
For example, a pension fund owns $10 million worth of a five-year bond issued by Risky Corporation. In order to manage the risk of losing money if Risky Corporation defaults on its debt, the pension fund buys a CDS from Derivative Bank in a notional amount of $10 million that trades at 200 basis points. In return for this credit protection, the pension fund pays 2% of 10 million ($200,000) in quarterly installments of $50,000 to Derivative Bank. If Risky Corporation does not default on its bond payments, the pension fund makes quarterly payments to Derivative Bank for 5 years and receives its $10 million loan back after 5 years from the Risky Corporation. Though the protection payments reduce investment returns for the pension fund, its risk of loss in a default scenario is eliminated. If Risky Corporation defaults on its debt 3 years into the CDS contract, the pension fund would stop paying the quarterly premium, and Derivative Bank would ensure that the pension fund is refunded for its loss of $10 million (either by taking physical delivery of the defaulted bond for $10 million or by cash settling the difference between par and recovery value of the bond). Another scenario would be if Risky Corporation's credit profile improved dramatically or it is acquired by a stronger company after 3 years, the pension fund could effectively cancel or reduce its original CDS position by selling the remaining two years of credit protection in the market.
nice post lysa... I read
nice post lysa... I read sinclair everyday.. good advice from him!
as for me and my home, we shall worship the LORD
Some really boring reading
If you need a reason to get to sleep...try visiting the Bank for International Settlements site. These guys keep track of all the derivatives and list them categorically.
http://www.bis.org/statis...
Just in case you have not watched this...
Results for [THE MONEY MASTERS] @ Google Video®
http://video.google.com/v...
Some people used a stick of wood to represent money, known as the "Tally Stick", it was used for a very long time. I bought the DVD but you can watch it at Google Video®. It has short clips but the whole thing is 215 min.
Derivatives & Lehman
Many are on these forums for reasons other than economics. For those interested in deeper, reasoned, forward-looking insight into the markets, I can recommend nothing higher than this site by Mish Shedlock:
http://globaleconomicanal...
March 25 and April 2, more than two months before the current headlines on Lehman:
http://globaleconomicanal...
http://globaleconomicanal...
Author's view on Ron Paul (June 2007):
http://globaleconomicanal...
Another source of independent financial analysis, regarding Lehman on March 28:
http://boombustblog.com/c...
Corn can be packaged and stored for many many years.
Wouldn't be a major problem with our modern technology to store corn. Of course I am just using corn as an example, it could include a whole range of grains, beans, or other seeds. And it wouldn't have to be controlled by a Federal banking system, it could just as well be local community banking unions.
Market regulation is not the answer
It's never the answer. Companies or investors who overdelve into derivatives are exposing themselves to undue risk...and I for one believe that's their problem.
It's similar to buying on margin...in which many investors of the late 1920's basically were borrowing against their net worth to generate huge profits off small stock market moves...when they moved down, not only was their investment wiped out, but due to the margin buying, everything they owned was lost.
This is rampant greed in effect, and investors and companies who have tempered their risk in derivatives with solid investments will shine all the brighter. They're going to be able to buy up insolvent companies for pennies on the dollar...JP Morgan got Bear Stearns at an absolute bargain, and now they'll pick through the company, take what they like and dump the rest like junk.
Sometimes you have to let hard lessons be learned, and this one may very well hurt...but you can't protect people from themselves.
Priorities.
It would probably make a few people go on a diet, pass on the second or third taco, so they could put away a few kernals for a rainy day. Would probably have an affect on population growth as a couple would think twice about spending their corn and instead by a condom. All joking aside, I just look at the world situation and I don't have the answers, but when I think that we have guards and every thinkable technology protecting banks nowadays to protect paper, or all the money that is spent to protect Fort Knox and other reserves of gold that just sits there, serving no purpose and yet we have very little world food reserves stored away, my minds trys to find a solution. Seems to me it should be the other way around, food should be put at a level of value above gold and silver. Am I wrong?
Well goodnight I have to sleep now.
grant
http://www.dailypaul.com/...
http://www.dailypaul.com/...
as for me and my home, we shall worship the LORD
There is no gold in Ft. Knox.
Don't believe me? Have a look and see when the last audit was last due and contact your government representative and ask him/her why it wasn't done.
Also, ask him/her the government's definition of "deep storage gold.
Also the government does have food stored (not enough I'm sure). Some of it just spent 15 days sitting on ships off the coast of Myanmar only to return "back to base" (a relief effort you paid for).
Food is valued above metal. However, your idealism, in my opinion, clouds the realities of using a perishable product as a long-term medium of exchange.
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
JP Morgan is Also Partly Behind the Run-up of Oil Prices
because of their unregulated futures speculation. Of course, they aren't the only one manipulating, but they absolutely contribute to detriment of our well being.
http://www.globalresearch...
These slimebags and company have to go if we every want piece of mind in America.
Store what has real value.
Your correct, not everyone has acreage to plant corn, but as I wrote before, not everyone has a gold or silver mine either, in fact I imagine even less people than have acreage. So it does kind of put the wealth into only a few hands as they would be able to mine for it and control the flow of gold into the system. Also mining companies do have stock piles of gold and silver already as well as mineral rights. Now gold and silver certainly could be used as a vehicle for exchange, since you could go to the bank, deposit corn and get a silver or gold piece to trade with, or corn certificates to trade with or electronic corn credits. In this way something of real value is stored, since not everyone values gold or silver, but food, usually is universally accepted.
.
double post
if you left it to the banks to take care of
then there would be more corn credits than actual corn.
aaaahahha... so very
aaaahahha... so very true!
as for me and my home, we shall worship the LORD
I don't understand your logic.
If you can hold corn, why can't you hold gold or silver.
Why do you need a whole mine?
Also, corn is perishable. It is also subject to the vagaries of weather and drought and takes up an enormous amount of space. What is the volume of dried corn needed to make a pound of flour? Where are all the vaults big enough, secure enough, and numerous enough located?
Also, if you study "money" this has been tried before and left behind in favor of gold, and more commonly, silver.
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
we posted exactly at the same time
another example of how great minds think alike ;-)
the problem is is that food
the problem is is that food is consumed... why would someone eat his wealth and lose his wealth?? food is a commodity.. gold and silver is money with gold and silver I can buy all the corn I want!
as for me and my home, we shall worship the LORD
Gold and silver would still have value.
Nothing would prevent you from keeping Gold or silver as products to sell, I am just suggesting that having bank vaults full of corn have real value. As we see banks nowadays are full of paper, have high security, probably air condition and perfect for storing kernals. I mean as you say what if we have a drought, well in that case, if there is no corn, can't imagine much else growing either. A person could make a deposit. Another could borrow kernels and pay interest on what they produced. Sure there would be inflation, but it would stimulate people to produce and save food, something of real value. Just an idea, and I believe it has been done before if you look to the bible as history. Seven years of abundance and Seven years of drought. Or something like that.
grant
but not everyone has acreage
but not everyone has acreage or can afford acreage to plant corn etc.. thats why people who live in the cities us dollars now to pay the farmer to do so! but when dollars are useless with no value what will that city dweller use? as a farmer i would gladly take gold or silver coin and sell my beef! the time is coming when they won't take paper money.. the farmer may trade a bottle of JD for a few stakes but Gold and Silver have always been money and always will be money! it comes down to the division of labor!
Forgive My Ignorance
What exactly are derivatives? I have heard the term bandied about, but I have never heard exactly what they are.
In very basic terms
A derivative is kinda like gambling on the market in a sense.
The most basic derivative which has been around forever is a future contract...where I grow corn, and in February I sell a future 5000 bushels of corn for a agreed upon price to an investor. I'm secure in that I know what price to expect for my corn when I cut it, and he's secure in knowing that he'll get corn come harvest time. He has essentially gambled on the price transferring the price risk from me to him.
It has gone from this simple type of bet to very complicated and widespread betting. These bets have gotten pretty creative over the past few years and have been traded extensively. This is a very uncontrolled market and is spread worldwide, and the scope of it isn't fully understood by even the most competant market observer. Warren Buffett himself admits to not fully understanding it.
This market is huge...more than half a quadrillion dollars, but even the largest meltdown imaginable won't produce that much loss. The BIS (Bank for International Settlements) has estimated the total risk in the entire derivative market to be around 15 trillion dollars worldwide.
If this market is truly unwinding, many companies and investors are going to be overexposed to a lot of undue risk, and a meltdown can push the planet into recession.
The good news is that the bad news is out on derivatives...many companies are scrambling to balance their risk, which is lowering the value of said derivatives because they look pretty bad on a balance sheet.
Thank you
I did as was suggested and searched on Google, but this explanation helped bring it all into focus.
derivatives are not showing
derivatives are not showing up on the balance sheets tho!
as for me and my home, we shall worship the LORD
In most basic terms, and as
In most basic terms, and as I understand it, derivatives are investments which are derived from other investments.
Another way to put it - investments which are sold, repackaged and sold again - over & over & over.
Google
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
GREEDisBAD
is trying to make you think. James West, June 4th in his article titled Global Financial Meltdown Ahead (can be read at gold-eagle.com) "But the big kicker that is going to make the recession a global depression is the sudden slowdown in growth in India and China." He quotes the BBC report saying "Growth is expected to continue to slow this year, but will remain higher than most other economies in the world".
He ends with this
But it’s a nervous eye watching the data today on my part. If the Asian juggernaut has exhausted its momentum, all the gold, silver, oil and metals stocks in the world won’t feed a planet torn by food riots and civil warfare
The recent food riots have been caused by UN ineptness,
World Bank corruption, dictatorships, and currency debasement (caused by governments).
When Saigon fell, those with a gold coin got on the boats to Hong Kong. Those that had nothing stayed behind. Many were executed.
I'll hang on to my gold coin.
If my friend prefers corn in his vault, that's his choice.
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
Try high food prices
Try inflation
and what is bought as a
and what is bought as a hedge against inflation??
as for me and my home, we shall worship the LORD
Like I said, currency debasement.
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
Either you die of starvation or,
Corn becomes more valuable and you trade an ounce of corn for an ounce of gold.
Or since you would have corn in savings at a bank you could go an make a withdrawl.
grant
You didn't answer my question (below).
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
real Real Value.
The only problem with Gold or Silver as the basis for money is what if you don't have a mine? Seems like a few people in charge of production can control the money just as easily. Of course modern farmers probably want corn or beans to become money, since they can control the production of these as well, wouldn't have been the case years ago. However one advantage to having corn as money is you can eat it, and it would make a lot more sense to store food in a bank then gold or silver. I understand that gold and silver are great for using as money, but even bible bugs can point to where gold and silver will become worthless someday and man will work for a cup of grain.
ok lets put it this way.. I
ok lets put it this way.. I own a Ranch and raise 50 head of black angus beef critters.. I would with a doubt.. take 1 oz. gold coins for my calfs! I can then trade that gold coinn for what ever else I need... now paper dollars are the governments promise! and the governments promise isn't worth crap.. the dollar has devalued 97% since 1913. also.. as a farmer I can growm my own corn etc.. I would take the gold hands down! the problem you have is the division of labor! some farm, some build, some sell seeds etc.. every one can not be a farmer/builder/banker/doctor/whatever all the time.. all trades need to be able to trade something for services... and that payment needs to be prompt.. precious metals fill that void.. unless I could trade 20 ears of corn to my dentist to get a cavity filled.. what if the dentist didn't want corn, then i bet he would take a 1/10th ounce gold eagle!
as for me and my home, we shall worship the LORD
the mine can't control the
the mine can't control the billions of ounces of gold already in circulation!
as for me and my home, we shall worship the LORD
What do you use in a drought when there is no corn?
What do you do if your corn becomes moldy or is eaten by vermin?
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
Spray some silver
Spray some silver (colloidal) on the moldy parts. That should take care of it... ;-)
"derivatives market" is an oxymoron
There IS NO market for these credit default derivatives, they are over-the-counter transactions and that is why they are unwinding. They have no market values and always were fraudulent in nature. Market value might as well be zero.
A very good post on a subject that does not get the
in-depth public attention that it deserves. It's a subject that you will not hear discussed by the knee-jerk bulls.
Yes, you are 100% correct...
If someone had not stepped in, our nation, and the world would have felt the collapse immediately. Try as they may to stop this collapse it will eventually happen, we are prolonging this situation by bailing these banks out, but it will eventually come crashing down, just like the Roman Empire.
We need this to happen, and start fresh with a currency that is backed by something. I believe it will happen, and the sooner the better. I do not wish anything bad on anyone or any nation, but we as Americans can no longer support the global elite, and their agenda.
You are 100% correct doctor011.
This junk paper is the nuclear bomb of the financial market. JP Morgan is the Fed's "bank" and was covering its @ss just like you said.
Bear Stearns was a warning shot over the bow. What is coming (helped along by Bush & Co,) has never been seen before.
May you live in interesting times, says the Chinese proverb.
___________
Lisa C.
http://www.women4ronpaul....
"Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all."
-Dale Carnegie
They print their own monopoly money
and their still so stupid they lose it all and have to bail each other out. I'm a dumb old red neck but you let me be banker in monopoly and I'll win every time and they call the working man stupid. They can't even hold on to their play money its no wonder they stash all the gold away. I would end up with it all cause to have a house built in real life they have to give it to me. Well at least until after the election when they tag everyone with a Real ID and they start to sanction people for not doing their work for them for free. Then they can lock all their play money up with the gold. Won't be a need for either of those when you have free labor. Pretty sad when your so stupid and lazy the only way you can make money is through slavery. Man I bet if I was there slave I could end up with all their money. They won't want me as a slave I'll be stealing from them left and right. "Honey have you seen the silver ware"? "I don't know where it is darlin have you seen my wallet"? "Why won't this sink work what happen to the copper pipe where did that copper pipe go"? "Honey where are are the twins their late for cheerleading practice where could they be"?
Hee hee...
Now I don't care who you are - that was dang funny!
Yours in Liberty,
Shovel
Thanks. Bookmarked this. :)
Thanks. Bookmarked this. :)
Excellent piece
Now the big question: The Fed can't bail everybody out, so when do dominos start dropping (because all of the these deals are packaged and held BETWEEN these investment banks. Or could they??? If the Fed literally printed its way out of this, the American citizen would foot the bill in the form of higher inflation and eventually a dollar collapse. This is truly the underpinnings of depression. Pack up the supplies and prepare to look at life in a whole new way. Tell me I am wrong, PLEASE!
Excellent post. Thanks for the information.
Greed and elitism always leads to a downfall. Unfortunately, the people who get hurt are the innocent.