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The Coming Derivatives Crisis That Could Destroy The Entire Global Financial System
Michael summarizes the situation with derivatives. I've gotten several questions about derivatives and how they affect the world's financial well-being - and as I've mentioned in comments - finance is not my field - but I think this article is very helpful. Please add any input you may have about this big tangled web that seems destined to eventually collapse (minus heroic efforts on the part of governments to keep it alive). ~ Ilene
The Coming Derivatives Crisis That Could Destroy The Entire Global Financial SystemCourtesy of Michael Snyder of Economic Collapse
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.
p.s. See also: Karl Denninger's take on the 2008 meltdown.
Tying It All Together (For Tom And Others On The Right)
http://market-ticker.org/akcs-www?post=196348
and
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Interesting. I just had that same conversation with a friend. Obama encouraging a revolution, and he wants troops back home? While Iran and Turkey are going to "cambodiaize" the Kurds? Nice to see he "stands up for democracy" unless it happens to conflict with his campaign pledge....
Don't forget we have THOUSANDS of foreign troops here in the US "training"....they will do the job that many US troops will be too horrified to do! That was the plan all along!
We continuously hear the propaganda meme that people are afraid to borrow from the banks --- but the truth is that banks have been refusing to loan at record numbers.
The bankers want to spend all their free government money in speculation across the markets and foreign investment.
Therefore, in a period of record low interest rates, when housing prices have fallen considerably, few can buy at this time.
A recent United Nations economic report on food prices explained that investment in commodity speculation (speculation on foodstuffs, etc.) has increased from $13 billion in 2003 to $260 billion by 2008, a 2,000 percent increase.
Now that may appear to be a large increase, but it dramatically under reports the increase when one understands that the amount has been leveraged to a great extent; a conservative estimate would be from 10,000% to 50,000% leveraging on that $260 billion in commodities speculation --- thanks to securitized financial instruments, credit derivatives, and further manipulated with the use of credit default swaps (CDS), another category of credit derivatives. (CDSes are often referred to as “unregulated insurance” -- if they were regulated, they’d be outlawed! This is what they mean by “shadow banking.”)
Another recent report, this time by the Commodity Futures Trading Commission (USA) explained that 95% of commodity futures trades was pure speculation, not for purposes of hedging, or spreading risk, as the Wall Street bankers are forever claiming.
So we can extrapolate that massive and unwarranted speculation in food pricing (commodity futures) is a formidable cost driver – resulting in much human turmoil and tragedy while accomplishing nothing of value – except increasing the wealth of the speculators.
Of course, the same situation has been concurrently taking place in oil and energy markets, precious metals markets (gold, silver, etc.) and the healthcare sector, all affecting prices.
So to understand the massive roiling of international and national markets, using phantom money and funds, is to understand the enormous detrimental and destructive forces on people’s lives which is decidedly anti-progress in human affairs.
Understanding the connections and linkages allows one to better grasp seemingly unrelated world events: the cornering of the chocolate market awhile back, then a few months later serious political troubles erupt in the major chocolate-producing country, Ivory Coast (Africa), thus causing upheavals in chocolate (futures trading) market prices.
Behind the scenes one sees money flows between certain financial groups to certain countries’ rulers (the Ivory Coast, in this case) – and a few people are enriched, while many die and many other innocent lives are destroyed in the process.
Now we have been told another propaganda meme – that this global economic meltdown resulted from a slight mortgage default rate a few years back – a preposterous notion, given that had there been zero defaults the same meltdown would have occurred – it is unsustainable for the banksters to continue selling $100 to $1,000 worth of debt for every $1 of debt on hand – a relatively recent occurrence, all made possible by relatively recent changes in laws, regulations and legislation --- in other words, absolute corruption.
This is exactly how Wall Streeters made their billions – selling endless debt which they now tell us is our fault and our problem!
When Warren Buffett publicly denounces credit derivatives as “financial weapons of mass destruction” – then later spreads his money among congress to ensure these weapons continue to exist and proliferate – he is playing the American public in the same manner as the Robber Barons once did.
When Warren Buffett publicly proclaims that the super-rich should pay taxes also, while his company is in arrears for billions of unpaid taxes, he is playing the American public in the same manner as the Robber Barons once did.
Perhaps the time has finally arrived that the people are tired of being played for fools?
IOTW, when we see George Schwartz, 'scuse me, Soros, buying up agricultural land, we know something vast and terrible is in the offing.
http://en.wikipedia.org/wiki/Shadow_banking_system
'Could' bring down the entire system and 'only a matter of time' don't go together. What is it?
Only a matter of time before it crumbles, and the crash could take down the system.
The dervivatives market is the surplus fiat market. There's not enough being earned to buy the products that would be created by investing all of this money in actual production. So the banks gamble with it instead.
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apparently everything financial and everything associated with it is just a crime and i'm supposed be concerned by a potential collapse? and nearly everyone is guilty of perpetrating and promoting these crimes. ok. i really don't know if i can live with that, but, ok. La Ricotta - Orson Welles http://www.youtube.com/watch?v=j_od3BxJ2W0&feature=related
No, but control fraud and other types of financial fraud are indeed crimes, and when 1,000 banksters were found guilty of felony convictions after the S&L debacle, that was from 10,000 criminal referrals from William Black's SEC (at that time).
And those crooks are but a drop in the bucket compared to today.
Today can only be compared to the ultra-leveraged run, beginning in the early 1920s, lasting 7 years until it caused the Great Crash of 1929!
At the present, the repeat of that ultra-leveraged run began around 2000, with the meltdown occurring mid-2007, and nothing was been done to circumvent a reoccurrence.
Back in 1933, securitizations were officially ended. Today, they have yet to be touched (note recent spate of articles about the over $1 trillion in securitized student loans).
No, but control fraud and other types of financial fraud are indeed crimes, and when 1,000 banksters were found guilty of felony convictions after the S&L debacle, that was from 10,000 criminal referrals from William Black's SEC (at that time).
And those crooks are but a drop in the bucket compared to today.
Today can only be compared to the ultra-leveraged run, beginning in the early 1920s, lasting 7 years until it caused the Great Crash of 1929!
At the present, the repeat of that ultra-leveraged run began around 2000, with the meltdown occurring mid-2007, and nothing was been done to circumvent a reoccurrence.
Back in 1933, securitizations were officially ended. Today, they have yet to be touched (note recent spate of articles about the over $1 trillion in securitized student loans).
When i explain derivatives to somebody i explain it simply through this:
I take a cup of coffee or water, tell them this symbolises your savings in the banks. The bank take those savings and sell to whatever you want to call it times one hundred. And now we are nearing the time that everybody wants their cup of coffee... All 100 of them.
So what do you think would happen at a coffeshop where 100 people ordered and payed for their coffee and only 1 gets his coffee and nobody else does. And what if the one who does happen to get his coffee turns out to be the owner of the placel who's wearing a tshirt saying: no refunds.
Unless they're synthetic deriviatives, then infinity is the limit.
Day by day tangible silver and gold metal coins seem to be the only path to storing wealth. It takes up a lot less room than farm land. You can't eat gold, but you can't eat dollars or dirt either.
When does the string break? Its the quadrillion dollar question.
That sounds more like fractional reserve banking than deirvative bets.
Exactly. Derivatives are side bets. For example, bets on what happens to the one guy who gets the coffee - does he end up dead, does he share the coffee, or does he spill it and no one gets anything. How do you want to bet?
The reason ir sounds the same is 'cus both are ponzi schemes
I don't know why the default of the financial system is an issue for the 99% of the world population. It kills the fiat ponzi and all those who live off it. What's to stop the world choosing new leaders, declaring a total reset, allowing those who are ruined to take care off themselves, declaring all debt irrelevant and then starting essentailly from scratch; A NEW ECONOMY A NEW FINANCIAL ARCHITECTURE ALL REGULATED TO AVOID PAST FOLLY.
It can be done, it will be done. By taking away their power we can avoid the unnecessary bloodshed associated with THEM wielding power to burn the 99% debt slaves in their own interest.
The earlier entire geographical and national segments of the world economy break away from this essentially american financial ponzi the better. Make all these bets illegal as they as purely speculative, naked derivative leveraged plays, that take money out of real economy. Starve the beast. As it will die faster. The US oligarchy is unable to fight it as is evident by the trading mentality of some of those who crib about WS shenanigans here on ZH, all the while feeding the beast and themselves. Road to financial hell.
"essentially american financial ponzi "
"American" finance is a mere condom for the City of London crew.
What, so Goldman Sachs, J P Morgan, Bank of America etc etc are all British banks? Yeah, right. Grow up.
DavidC
A total reset would be nice, but we may not be able to put humpty dumpty back together again. We could be entering the Dark Ages part ll. Widespread anarchy and warring tribes.
Thus the whole reason why ZHers have been promoting Ag & Au for the past 4+ years.
Humpty Dumpty won't be put back together and only silver/gold will see you thru the part II of the Dark Ages.
Metals to love and own: Ag, Au, & Pb
Semper Peratus.
Paratus.
"Widespread anarchy and warring tribes."
Leading to Congressional gridlock and two equivalent tribal children in a murder-suicide party pact to steal their patrimony for each his own.
http://campaign.r20.constantcontact.com/render?llr=nid4i7n6&v=001zHmPEHN...
The inflation is currently sitting quietly in short term bonds, puts, and any other low risk short term asset. Meanwhile Bernanker is preaching about buying MBS, to force investors to take more risks. WTF MBS are high risk, re. Primex. Wait till the DJIA hit 3000, then you may see gold start to climb to 10k.
Hair-fucking-cut, got physical?
vast majority of those derivatives are forex swaps with very tiny risk in aggregate(other than counter party risk - but that is different) If one party goes busto on a 100million currency swap they arent on hook for 100 mil, just the movement in the underlying. most of those int rate/forex swaps net out to a few hundred k in either direction
ie quadrillion is very misleading. my own research suggest 260 trillion is about the total real financial claims of oecd - still nothing to sneeze at.
Thats assuming you, or indeed anyone else understands them properly. Considering recent history, I would err on side of nobody has a fucking scooby doo of the implications and total outstanding value.
While it is true that there are lots of currency swaps and you are right about them. The idea that most derivatives are only notional value is misleading. If a bank puts a CDO on the asset side of its balance sheet then insures it with a CDS, the bank is allowed to carry it at full market value even if the CDO blows up because the insurance is still there. Now if the CDS goes too, the bank has to carry the full market value as a loss down to its retained earnings. That is the real danger in my view.
Hope this helps,
Hey there, it's been over three frigging years since they discontinued mark-to-market.....
And the FASB isn't totally to blame, it was Kanjorsky and Congress that FORCED them to change to mark-to-fiction.
DavidC
If everyone were using derivatives in a responsible fashion, then in theory they could all be unwound with no major problems. But you just know that some players are using them for speculation and making dangerous one-sided, unhedged bets. And even if only a small proportion of the total is speculation, it could easily lead to trillions of losses for someone. For example, I've read reports that Dexia was mainly done in by a single unhedged bet on German interest rates that cost it 86B.
We know that someone is sitting on major losses for Greek CDS when Greece defaults. But no one knows who the bagholders will be. So it shuts down the entire financial system because no one can be sure that their counterparties are solvent.
Derivatives have absolutely no place in the consumer banking system!
"But you just know that some players are using them for speculation ..."
According to recent CFTC study (that's Commodity Futures Trading Commission, with too many neocons aboard, BTW), 95% of all commodity futures trades are speculation, NOT HEDGING, i.e., not spreading the mythical so-called "risk."
SOS, there sweetums!
There is a reason that Geithner and TPTB lobbied hard and successfully to ensure that a market clearing mechanism for derivatives never became a reality...to do so meant that the cartel made of the big banks would be broken as derivatives would be priced on an open market. With a transparent market smaller players could now get in the game. The end result: derivatives would be priced at 'real' prices and most would go down drastically in value, and, with increased competition from new market entrants, profitability would go down as well. In th end it would wreck the current hugely profitable derivative game...kind of like how the drug cartels would be wrecked if we legalized cocaine and pot. In any event, this would probably lead to the failure of the TBTF banks and the domino destruction of the financial system and world as we know it. We can say thank you to Timmy for saving the world ar we can prosecute him fro protecting one of the biggest criminal racket's the world has ever seen. Seeing how it's all going to blow up eventually, I vote for the latter...let's clean house of the criminals and start with a clean slate while we have something left.
ie quadrillion is very misleading. my own research suggest 260 trillion is about the total real financial claims of oecd -
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All based on about 70% value is what a few knowledgeable people believe-which could be as much as 3-400 trillion in losses at this point-but as the collateral (mostly mortgages based on house prices) falls out from under the so called original value-the leverage gearing winds negative-thus increasing the amount of losses-
umm....no. (to the 300 trilion of losses) that is silliness. (though if our entire financial/currency system gets reset from zero I suppose there could be ~$260 trillion of 'losses', if thats what you meant0
Well that make me feel better. Got physical?
evrey thing will be fine for the bankers,[ only the lonely] will be destroy. the poor will be poorer,the rich will be richer.if we can make thru dec, everthing will be alright i know.who needs derivatives when you can rig the market.---
the rich will be richer until they are bubba's bitch
And then his dinner....
"A horrible derivatives crisis is coming"
At the rate we're going, we are likely to see Jesus or the Twelfth Imam arrive first.
These banks have gotten so big and so powerful that if they collapsed our entire financial system would implode.
**************
That would be the best thing that could happen and it should have been allowed to happen in 08-instead we created special accounting rules and hid the garbage paper from Bank balance sheets-
These things sit marked to the dollar in MMMF's/Pension funds and major Corporate balance sheets all over the world-
Share and Bond holders should have been wiped out-Banks should have failed and lost everything-
Governments should have nationalized the Banks and printed the money to make only the depositors whole-
The Market wants to clear and it eventually will and when the Market is held back like it is and when it does decide to price-it will and it will appear to be very erratic and random in it's unwind-but the Market knows exactly what needs to be done and it never loses-ever-
"Governments should have nationalized the Banks and printed the money to make only the depositors whole..." That was my conclusion. Here's two other good articles with Karl Denninger explaining his take on the 2008 meltdown.
Tying It All Together (For Tom And Others On The Right)
http://market-ticker.org/akcs-www?post=196348
and
In Explanation Of The Last Paragraph
http://market-ticker.org/akcs-www?post=196363
Great blog post, Lady Ilene.
The most salient suggestion I've yet heard:
Nationalize the Federal Reserve, at least the top ten banks, and immediately enact a financial transaction tax.
America had one from 1914 to 1966, and it was almost doubled by FDR during WWII, and President Kennedy spoke of raising it shortly before his assassination (and also ending that oil depletion allowance).
Whomever bears the blame for ending it during the Johnson Administration screwed us royally, just like Jimmy Carter screwed us by ending the federal anti-usury laws when he signed that Depository Institutions Deregulation and Monetary Control Act of 1980, and Reagan-Bush-Clinton-Bush-Obama continue screwing us royally.
It's either Bernie Sanders, Byron Dorgan, Russ Feingold, Dennis Kucinich, Peter Defazio, Marcy Kaptur time --- and I ain't talking about any beer labels here!
Yes!! Finally, some real demands - those 99%ers are really misidirected, misinformed and misled and need to get a clue. (Kudos to WB7 to calling it 99.99% - it might even be 99.999%). The two key demands with the first finally getting some media coverage, although outright lies if you listen to MSM or NPR and misinformed or ignored if you listen to the lame left Pacifica.
While Ron Paul seems to be the best choice and I would vote for him today, I would much rather see a primary challenge to the Wall Street puppet we have now and maybe, just maybe confront the constant lies we hear each day. primaryobamanow dot com
Yes!! Finally, some real demands - those 99%ers are really misidirected, misinformed and misled and need to get a clue. (Kudos to WB7 to calling it 99.99% - it might even be 99.999%). The two key demands with the first finally getting some media coverage, although outright lies if you listen to MSM or NPR and misinformed or ignored if you listen to the lame left Pacifica.
While Ron Paul seems to be the best choice and I would vote for him today, I would much rather see a primary challenge to the Wall Street puppet we have now and maybe, just maybe confront the constant lies we hear each day. primaryobamanow dot com
Ilene-thanks for the links-
Denniger is correct on this-another Derivative savvy person is John Hussman who also laid out a similar road map-
The end result is never in question-the question is-how much will they be able to skim from taxpayers before it all collapses-
When the same crooks end up with all the available money in a Deflationary depression-they are right back on top as always-
Just saw this... (From NPR)
What If We Paid Off the Debt? The Secret Government Report
Maybe that's why the idiot brigades thought we needed to make sure there was no way we'd ever run out of debt... and so decided to let Derivatives go nuts!
Nothing quite like economic "professionals"!
that referred to the situation facing Clinton in 2000 when the US had had successive years of balanced/surplus budgets etc. Debt was relatively small then....That's an ice age away in terms of financial bubble formation. Those days are gone for USA.
The 'Myth': http://www.craigsteiner.us/articles/16
oh you mean when Clinton asked Rubin to look at the books and they changed around a couple zeros and found a couple hundred billion.
Government accounting is pure fantasy. Lots of money goes out but very little is actually accounted for on real books. Our real national debt prodably surpassed $100 trillion already.