Derivatives & The Blob

I was flipping channels over the Thanksgiving holiday and stumbled upon the movie classic, "The Blob".  I had forgotten that this 1958 horror classic starred Steve McQueen.  I remember as a kid that this was the ultimate scary movie.  "The blob eats you alive!".

Reading an article on Bloomberg last night regarding financial derivatives reminded me of The Blob.  It just oozes along devouring everything in its path.  In the end, they froze The Blob and sent it to the Arctic for a permanent freeze.  How are we going to "freeze" these instruments that Buffet described as "weapons of mass destruction"?

"Global derivatives trading in over- the-counter and exchange-traded futures and options will represent a $700 trillion market with $3.7 quadrillion in annual turnover by the end of this year, research company TABB Group said.  Rules to have central clearing for over-the-counter trading would require additional collateral of as much as $2.2 trillion, Westborough, Massachusetts-based TABB said in a statement on its website, citing a report it completed at the request of the World Federation of Exchanges."
Source: Bloomberg

"The 'derivative monster' still lurks in these financial waters. Every contraction cycle needs a culprit. Derivatives will be the blame for this one."
Random Roving, July 3, 2010
 
"Puplava's risk comments are targeted at the significant amount of derivatives in the world.  His argument is that the risk can NOT be taken out. Many on Wall Street believe that great mathematical models can remove the risk. For a more thorough understanding of the crisis evolving...."             http://www.financialsense.com/series2/rogue.htm

Random Roving, March 27, 2003 (email era)

The Delusional Benefactors

"Mass delusion is always encouraged by those who benefit most from the mass delusion. David Lereah has admitted that he lied about the housing bubble because he was employed by realtors. Realtors made millions in commissions. Appraisers made millions in fees by inflating appraisals. Mortgage brokers made millions by encouraging people to lie on mortgage applications. Wall Street whores made billions by creating toxic packages of mortgages and selling them to Irish nuns, old ladies and clueless municipal administrators. The ratings agencies made hundreds of millions in fees for slapping AAA ratings on toxic derivatives. Politicians got rich from political “contributions” from Fannie Mae, Freddie Mac, Wall Street, and the NAR. Any reasonable human being could look at the chart above and see that this would end badly, but Americans wanted to be deluded. They choose to believe. The housing market has now been falling for five years, with another five years to go. Ben Bernanke has reduced interest rates to zero. I wonder how that will work out."
James Quinn, TheBurningPlatform.com

The Derivative Monster

The "derivative monster" still lurks in these financial waters.  I just finished Michael Lewis' latest bestseller, "The Big Short", which chronicles the details behind the mortgage meltdown.  At the core of the crisis were collateralized debt obligations (CDOs) a form of derivatives.  I still think that derivatives will be the core of the major meltdown that still lies ahead.  The reason is that a small "bet" can control a significant amount of dollars.  It has been reported that $700 TRILLION of derivatives exist worldwide. These options have way too much leverage.

I'm confident on the "what", but the "when" is very unknown.  This financial casino can only keep the gamblers at the table for so much longer.

Weiss Research's team just released this in a report:
-Fact: The U.S. derivatives that helped cause the last debt crisis are merely being shifted around like deck chairs on the Titanic.
-Fact: Nothing whatsoever is being done about the derivatives monster overseas, which is more than TWICE as big.
-Fact: Most important, despite months of debate and thousands of pages of legislation, the two biggest risk-mongers of all — the Treasury and the Fed — didn't even get a slap on the wrist. They got more power.

Every contraction cycle needs a culprit.  Derivatives will be the blame for this one.

"Jim Puplava posted a great article on the banks last year...especially focused on those with large derivative positions. JPM Chase has an incredible derivative position."
Random Roving, August 18, 2002 (pre-blog email days)

The wild ride continues!!
"In February this year he ranted every week on his radio show about 'naked short selling', 'credit default swaps', and 'derivatives'. I was originally unfamiliar with these terms and was amazed last week when they became front page news."
Random Roving, September 30, 2008

"We've just seen the beginning of the derivative implosion. Remember, Warren called them 'weapons of mass destruction'."
Random Roving, January 1, 2010

Aristotle & The Story of Thales

"Aristotle described the story of Thales, a poor philosopher from Miletus who developed a 'financial device, which involves a principle of universal application.' Thales used his skill in forecasting and predicted that the olive harvest would be exceptionally good the next autumn. Confident in his prediction, he made agreements with local olive-press owners to deposit his money with them to guarantee him exclusive use of their olive presses when the harvest was ready. Thales successfully negotiated low prices because the harvest was in the future and no one knew whether the harvest would be plentiful or poor and because the olive-press owners were willing to hedge against the possibility of a poor yield. When the harvest-time came, and many presses were wanted all at once and of a sudden, he let them out at any rate he pleased, and made a large quantity of money."
Source: Wikipedia

Now you understand today's financial markets.

Sierpinski's Triangle and The U.S. States

In February 2009, I made a post referencing Sierpinski's Triangle for a theory on the fractal nature of this calamity. The New York Times reports today about "the state of the States":

"California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay. And states are responding in sometimes desperate ways, raising concerns that they, too, could face a debt crisis. New Hampshire was recently ordered by its State Supreme Court to put back $110 million that it took from a medical malpractice insurance pool to balance its budget. Colorado tried, so far unsuccessfully, to grab a $500 million surplus from Pinnacol Assurance, a state workers’ compensation insurer that was privatized in 2002. It wanted the money for its university system and seems likely to get a lesser amount, perhaps $200 million. Connecticut has tried to issue its own accounting rules. Hawaii has inaugurated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by June 15. And many states have balanced their budgets with federal health care dollars that Congress has not yet appropriated."

The entire article:
http://www.nytimes.com/2010/03/30/business/economy/30states.html

Credit Derivatives

Artimus turned me onto this source. Here's their recent publication on credit derivatives.

"Was the collapse of the subprime mortgage derivatives market a disaster - or merely the warning for something far worse? In today's reading we will take a look at a much larger potential danger to investors, that of credit derivatives, as introduced
below:"

"The credit derivatives market is roughly 30 times the size of the subprime mortgage market - and potentially even more at risk in the coming years. In the previous article, The Subprime Crisis Is Just Starting, we explored the roots of the subprime crisis, demonstrated how mortgage securitizations work, and then used this knowledge to show why 2008 could be a much more dangerous year for the subprime mortgage markets - and the global financial system - than 2007. In this article, we show how the same fundamental - and quite human - motivations that created the subprime market crisis also imperil the $35 trillion global credit derivatives market."

"Unfortunately, as of June 6, 2008, and after the writing of the main article, the credit derivatives danger became much more real, to the tune of $1.7 trillion of bad news coming a step closer to financial institution balance sheets, in just one day. This update has been added to the end of the article, as part of five pages of information for Turning Inflation Into Wealth readers, that was not available in the public investor education website version of the article."

The full report:
http://mortgagesecretpower.com/Readings/1007/cTWENTYONEgh.pdf

A prior post on the topic:
http://randomroving.blogspot.com/2003/03/puplavas-view-on-derivatives.html