TICK TOCK Derivatives: The $600 Trillion Time Bomb That’s (Still!) Set to Explode


Instead of attacking the problem, regulators have let it spiral out of control, and the result is a $600 trillion time bomb called the derivatives market says Keith Fitz-Gerald, Chief Investment Strategist of Money Morning

The world’s gross domestic product (GDP) is only about $65 trillion, or roughly 10.83% of the worldwide value of the global derivatives market, according to The Economist. So there is literally not enough money on the planet to backstop the banks trading these things if they run into trouble.

Think I’m exaggerating?

The notional value of the world’s derivatives actually is estimated at more than $600 trillion. Notional value, of course, is the total value of a leveraged position’s assets. This distinction is necessary because when you’re talking about leveraged assets like options and derivatives, a little bit of money can control a disproportionately large position that may be as much as 5, 10, 30, or, in extreme cases, 100 times greater than investments that could be funded only in cash instruments.

Imagine the fallout from a $600 trillion explosion if several banks went down at once. It would eclipse the collapse of Lehman Brothers in no uncertain terms.

A governmental default would panic already anxious investors, causing a run on several major European banks in an effort to recover their deposits. That would, in turn, cause several banks to literally run out of money and declare bankruptcy.

Short-term borrowing costs would skyrocket and liquidity would evaporate. That would cause a ricochet across the Atlantic as the institutions themselves then panic and try to recover their own capital by withdrawing liquidity by any means possible.

And that’s why banks are hoarding cash instead of lending it.

The major banks know there is no way they can collateralize the potential daisy chain failure that Greece represents. So they’re doing everything they can to stockpile cash and keep their trading under wraps and away from public scrutiny.

There are three main points to remember here:

1) There is not enough capital on hand to cover the possible losses associated with the default of a single counterparty  let alone multiple failures.

2) That means banks with large derivatives exposure have to risk even more money to generate the incremental returns needed to cover the bets they’ve already made.       

3) And the fact that Wall Street believes it has the risks under control practically guarantees that it doesn’t.

Many people have read about this problem, and have seen even higher numbers quoted..as high as 1.4 QUADRILLION (1,400 Trillion), but believe all the risk is taken care of through offsetting actions, much as options and futures are a zero sum net game.

This may be true, although it’s hard to quantify because vast portions of the derivative market are not regulated, tracked or listed the way other financial data is so we simply don’t know, although big players can be assumed to be hedging this sort of risk.

THE REAL PROBLEM, according to experts, is the fact that while 

 the “net exposure” is manageable, what is NOT manageable is “counterparty risk,” as Lehman and AIG showed. What happens if another major player can’t meet obligations (certainly a high probability in this day and age)?  One counterparty default snowballs into systemic default.

Derivatives are not tangibles, but rather sales of future cash flow. Hence there are several counter-parties. Most notable and the real threat is the insurance bought to limit exposure risk. Lehman was in the insurance business of the mortgage CDO sector. When the shtf, Lehman lacked the cash and access to cash to cover the settlements for loss.

Herein is the problem. If the settlement for loss can’t be covered by the derivitive insurer, the losses go straight to the bank’s bottom line. Stock and bond-holders of the insurer are wiped out. Same for those with shares in the bank that is counting on the settlement.

Chain reaction. In and of itself, this is good. Higher risk means higher potential for profits and loss. The insurance on derivatives was meant to reduce risks and insure profits. Good luck with that.

The problem is the fear factor among the depositors. They will run on the bank and wipe out what little remains on deposit. The majority of money deposited is already loaned out. In a strangled economy, the potential for default on the loans is high. The deposits are insured by FDIC and the loan is insured by a counter-party already tapped out. FDIC will have to call on Treasury and Fed to roll the presses.

“Fact of life, you can only pile feces so high before it falls over. The real problem is each derivitive has too many counter-parties completely dependant upon each other to make good. Good luck with that.”

Jim Sinclair, the great gold and currency trader has remarked that all of this is “too stupid to be stupid”.  Concerned citizens who have pondered the complete failure of authorities to contain this ticking bomb could be excused for viewing all this as a well-planned chess game being played by global elite -perhaps a plan to take a giant leap forward by pushing the economy over the edge to advance widely shared goals of centralized world government and a global currency under complete central bank cartel control:

“I think we are all missing the point here. The big picture is to collapse the currencies, write off all debts and introduce a new form of universal monetary instrument. When there is blood in the streets and chaos reigns we will accept what is offered to us.

“All of this stuff has been prepared and rehearse of that you can be sure. Think B.I.S.  The persons running this show have been doing a sensational job in making it all come to pass. Why else would the financial institutions and governments participate in such wild and crazy borrowing and debt? Push it over a cliff and start fresh with complete control. I believe that Henry Kissinger is one of the principal architects of this long drawn out death (yes he is still operating in the shadows of the US government). As Henry once said (think 911 and war on terror):

‘Today Americans would be outraged if U.N. troops entered Los Angeles to restore order; tomorrow they will be grateful! This is especially true if they were told there was an outside threat from beyond whether real or promulgated, that threatened our very existence. It is then that all peoples of the world will pledge with world leaders to deliver them from this evil. The one thing every man fears is the unknown. When presented with this scenario, individual rights will be willingly relinquished for the guarantee of their well being granted to them by their world government.’

A well planned chess board,  epic failure to govern, or a global game of musical chairs so profitable that neither government nor Wall St. mega-bank wants to end it?

Either way, in the words of Serge in one of my favorite films, Chocolat, “SOMSING MUST BE DONE”!


About Surfing The New Normal

A blog dedicated to exploring new ways of thinking that lead to success in business and in life, & creating the person you really want to be. We apologize in advance for anyone we inadvertently or purposely offend and would like to take this opportunity to emphasize the importance of keeping a good sense-of-humor and an open mind. Enjoy. "You have to be able to risk your identity for a bigger future than the present you are living." ~Fernando Flores "I am actually a paranoid in reverse. I suspect that people are secretly plotting to make me happy." ~J. D. Salinger "You have to create your life. You have to carve it, like a sculpture." -William Shatner "The only reason they come to see me is that I know that life is great- and they know I know it." ~Clark Gable
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