Tuesday, December 29, 2009

Got 190K on you for a derivatives bailout? Thought not.

Remember recently we discussed how the money to pay interest and processing fees is never created at any point during the credit/loan process? The effects of all that fiat money circulating through the economy have created another impossible scenario: the impossibility of meeting all the derivative investments out there. Recall also the discussion about "black swans," unforeseen events that shock or scare people and shake up markets (for example, a 9/11 type event). A "black swan" that hits the derivatives market would either completely crash the US economic system or put us all on the hook for another huge bailout - just what we don't need.

Silicon Valley Watcher
The Size of Derivatives Bubble = $190K Per Person on Planet
By Tom Foremski - October 16, 2008

...According to various distinguished sources including the Bank for International Settlements (BIS) in Basel, Switzerland -- the central bankers' bank -- the amount of outstanding derivatives worldwide as of December 2007 crossed USD 1.144 Quadrillion, ie, USD 1,144 Trillion. The main categories of the USD 1.144 Quadrillion derivatives market were the following:

1. Listed credit derivatives stood at USD 548 trillion;

2. The Over-The-Counter (OTC) derivatives stood in notional or face value at USD 596 trillion and included:

a. Interest Rate Derivatives at about USD 393+ trillion;

b. Credit Default Swaps at about USD 58+ trillion;

c. Foreign Exchange Derivatives at about USD 56+ trillion;

d. Commodity Derivatives at about USD 9 trillion;

e. Equity Linked Derivatives at about USD 8.5 trillion; and

f. Unallocated Derivatives at about USD 71+ trillion...

...Whilst outstanding derivatives are notional amounts until they are crystallised, actual exposure is measured by the net credit equivalent...Also, the notional value becomes real value when either counterparty to the OTC derivative goes bankrupt. This means that no large OTC derivative house can be allowed to go broke without falling into the arms of another...Let us think about the invisible USD 1.144 quadrillion equation with black swan variables -- ie, 1,144 trillion dollars in terms of outstanding derivatives, global Gross Domestic Product (GDP), real estate, world stock and bond markets coupled with unknown unknowns or "Black Swans". What would be the relative positioning of USD 1.144 quadrillion for outstanding derivatives, ie, what is their scale:

1. The entire GDP of the US is about USD 14 trillion.

2. The entire US money supply is also about USD 15 trillion.

3. The GDP of the entire world is USD 50 trillion. USD 1,144 trillion is 22 times the GDP of the whole world.

4. The real estate of the entire world is valued at about USD 75 trillion.

5. The world stock and bond markets are valued at about USD 100 trillion.

6. The big banks alone own about USD 140 trillion in derivatives.

7. Bear Stearns had USD 13+ trillion in derivatives and went bankrupt in March. Freddie Mac, Fannie Mae, Lehman Brothers and AIG have all 'collapsed' because of complex securities and derivatives exposures in September.

8. The population of the whole planet is about 6 billion people. So the derivatives market alone represents about USD 190,000 per person on the planet.

...Derivatives are securities whose value depends on the underlying value of other basic securities and associated risks. Derivatives have exploded in use over the past two decades. We cannot even properly define many classes of derivatives because they are highly complex instruments and come in many shapes, sizes, colours and flavours and display different characteristics under different market conditions.

Derivatives are unregulated, not traded on any public exchange, without universal standards, dealt with by private agreement, not transparent, have no open bid/ask market, are unguaranteed, have no central clearing house, and are just not really tangible...

When derivatives unravel significantly the entire world economy would be at peril, given the relatively smaller scale of the world economy by comparison. The derivatives market collapse could make the housing and stock market collapses look incidental...


Isn't it time we stopped letting investment firms make up debt out of the thin blue air and count it as real money? They don't pay it back - we do! Hello? Obama? How about some trails for these fat cat CEOs instead of bailouts? When ordinary people "sell" something that doesn't exist, it's called fraud - why is it called "investing" when these guys do it?

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