Best of the Week
Most Popular
1.Ukraine Preface, the Emerging Dynamics Of Petro-Yuan Standard - Jim_Willie_CB
2. Speculations Reversed - Gold Price Stealth Rally 2014 - Peter_Schiff
3.Bubbleberg News Drivel Masquerading as Financial Reporting - David A. Stockman
4.Nationwide UK House Prices 9.5% Inflation, Housing Market on Steroids, Help to Buy Anniversary - Nadeem_Walayat
5.How to Profit from Palladium Huge Price Surge… - Peter Krauth
6.UK Home Solar Panel Installations Good or Bad for House Buying and Selling? - Nadeem_Walayat
7.Global Gold Manipulation Update - MAP Wave Analysis - Marc_Horn
8.Ukraine Capital Controls and 200% Inflation But Still In Better Shape Than US! - Jeff_Berwick
9.The Rise of a Euro-Chino-Russian Superpower - Stephan Bogner
10.Across Europe Secession Movements Intensify - BATR
Last 72 Hrs
Glaring Q.E. Failure Spotted - Money Velocity Is Falling Rapidly - 16th Apr 14
High-Frequency Insider Trading - 16th Apr 14
Gold Prices 2014: Do What Goldman Does, Not What It Says - 16th Apr 14
These CEOs Will Make Investors Rich - 16th Apr 14
Climate Change, Central Banking And The Faustian Bargain - 16th Apr 14
Every Central Bank for Itself - 16th Apr 14
Social Security, U.S. Treasury Stealing Every Last Penny From Americans - 16th Apr 14
Ukraine Falling to Economic Warfare and Its Own Missteps - 16th Apr 14
Silver and Gold Miners Still Disappoint - 16th Apr 14
Silver, Gold, and What Could Go Wrong - 15th Apr 14
How I Intend to Survive the Meltdown of America - 15th Apr 14
France Wakes Up To The Multicultural Multi-Threat - 15th Apr 14
The Real Purpose Of QE - It’s Not Employment - 15th Apr 14
Peak Coal - 15th Apr 14
Flash Crash, Rigged Markets - What’s the Frequency Zenith? - 15th Apr 14
Forecasting U.S. GDP Growth: A Look at WSJ Economists’ Collective Crystal Ball - 15th Apr 14
Stock Market - Is Something Nasty About to Happen? - 15th Apr 14
How to Trade Your Way To Freedom - 15th Apr 14
Understanding (and Ignoring) the Media Bandwagon Against Gold - 15th Apr 14
When Stock Market Bubble Crashes, Take Refuge in Gold Stocks - 15th Apr 14
Bitcoin Price Strong Appreciation to Be Followed by Declines? - 14th Apr 14
Greece, Turkey, We're Shuffling The Cards on Our Europe Investing Play - 14th Apr 14
Silver Price Ultimate Rally: When Paper Assets Collapse - 14th Apr 14
Get Your Share of an Extra Trillion Euros Money Printing - 14th Apr 14
Fourth Reversals in The Gold and Silver Charts - 14th Apr 14
Stock Market Nearing Rally in a Downtrend - 14th Apr 14
London House Prices Bubble, Debt Slavery, Crimea 2.0 - Russia Ukraine Annexation - 14th Apr 14
Four Horsemen - Top Economists Explain the Source of Our Economic Crisis - Video - 13th Apr 14
Peak Oil And Global Warming – A Question Of Culture - 13th Apr 14
The Global Banking Game Is Rigged, and the FDIC Is Suing - 13th Apr 14
College Degree Earnings Propaganda - 13th Apr 14 - Andrew Syrios
Stock Market Potential Diagonal Triangle Pattern Forming - 12th Apr 14
Ukraine Crisis – Military Flash Drive Thinking - 12th Apr 14
Gold And Silver – 2014 Coud Be A Yawner; Be Prepared For A Surprise - 12th Apr 14
Gold Preparing to Launch as U.S. Dollar Drops to Key Support - 12th Apr 14
Manipulated Stocks Markets And The Empty Bag - 12th Apr 14
Stock Market - It’s Not Time to Panic… It’s Time to Buy - 12th Apr 14
Doctor Doom on the Fiat Money Empire Coming Financial Crisis - 12th Apr 14
Sheffield, Rotherham Roma Benefits Plague, Ch5 Documentary Gypsies on Benefits & Proud - 11th Apr 14
This Bitcoin Price Rally Might Be a Fake One - 11th Apr 14
GDX Gold Stocks Benchmark - 11th Apr 14
Silver Price Finally Outperforms – How Bullish Is That? - 11th Apr 14
Limits to Employment Participation, and Societal Change - 11th Apr 14
US Moves To Restrict Travelers Taking International Flights - 11th Apr 14
Bill Gross to El-Erian: 'Come on, Mohamed, Tell Us Why' You Resigned PIMCO - 11th Apr 14
British Pound GBP/USD - Double Top or Further Rally? - 11th Apr 14
Don't Miss the Boat on Big Biotech Catalysts: Keith Markey - 11th Apr 14
Russia Invaded Crimea and These US Energy Companies Made a Killing - 11th Apr 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Derivatives the Greatest Scam in the History of the World

Politics / Credit Crisis 2009 Jul 06, 2009 - 12:49 AM GMT

By: LewRockwell

Politics

Best Financial Markets Analysis ArticleChris Clancy writes: This essay is a story about insurance, or rather, a story about a type of insurance policy which underwent a mutation. This mutation was not spontaneous – it was engineered. It was one of the biggest scams ever perpetrated.


Paradoxically, the problem was that it worked too well and just got too big.

I hope you stay with the story until its denouement. Maybe you’ll be gobsmacked. If it moves you to go out and start looking for suitable lamposts – then it’s understandable.

When a business makes a loan to another party it can insure against the risk of default. This would be prudent behaviour if the lender had concerns about the borrower not repaying everything which was due.

Insurance companies, like all industries, work to a set of fundamental principles. Two of their most fundamental principles are indemnity and insurable interest.

Indemnity simply means that no-one should "profit" from making an insurance claim. Instead, the money received should be enough to restore you financially to the position you were in before the reason for making the claim occurred.

Insurable interest means that you cannot insure something unless you have a legitimate interest in protecting yourself against something bad happening to that thing. So, for example, you can insure your car or the life of your spouse. You cannot, however, insure the car or the spouse of a complete stranger since your only incentive would be the hope that something bad happens to either or both. In fact, you would have a very strong motive for making sure that something bad actually does happen to either or both!

What has the above got to do with the present mess?

Everything unfortunately.

Understanding the gravity of the situation we are now in means getting to grips with the dreaded "D" word – and I don’t mean "Depression" – I mean "DERIVATIVES"! Few understand them. The following quote refers to Gordon Brown:

"He … made the extraordinary confession that as Chancellor he 'didn't know a lot about' sub-prime mortgages – a key banking practice that sparked the economic collapse."

Mention of the ‘D’ word is usually enough to turn most people off instantly – therefore in what follows I have attempted to keep it as brief and clear as I can and to avoid mentioning this heinous word. Instead I’ll refer to them as Gherkins, Sprouts and Bananas.

The current crisis was started by cheap money being kept cheap for too long. It found its way into the housing market where things escalated as a result of government encouragement for lenders to make bad loans. The lenders who made the bad loans didn’t care since they could sell them on to someone else.

The buyers of these loans didn’t care either since they knew the government would bail them out if they got into trouble. These loans were then securitised; in other words, they were divided up into securities (financial instruments) called "Gherkins" and then sold on to the financial industry.

The financial industry then employed very clever people to mix these securities up in all sorts of permutations and combinations. By the time they had finished splicing and dicing, mixing and matching a new generation of financial instrument had emerged – these were called "Sprouts."

Why did they do this?

It was done to hide the fact that many of these securities were based on bad loans. As such they could only attract a "junk" credit rating which made them more difficult to sell on. By combining them with good loans in incredibly complicated mathematical models, using all sorts of weird and wonderful statistical techniques, this new generation of financial instruments could all attract a triple-A credit rating. Obviously this made these things highly marketable.

Sprouts were sold in vast quantities all over the world. The buyers simply looked at the credit rating. They didn’t know how these things were constructed. They didn’t realize that the models were flawed – Austrian economics tells us again and again that predictions involving human action cannot be reduced to mathematical formulae. (If you’re into self-abuse and really want to put yourself through it go here for a simplified example of how to create a Sprout – and more).

Let’s return to the world of insurance.

Organizations which had purchased Sprouts in huge quantities wanted to reduce their risk. Companies like AIG, for example, offered them insurance policies. In return for regular monthly premiums they could insure against their Sprouts going bad. This was quite legitimate since they had an insurable interest – they owned what they were insuring – and would be rightly indemnified in the event of default.

What happened next was that the insurance policies themselves were then securitised and another generation of financial instruments emerged called "Bananas."

These things have been loosely described as "insurance policies." Nothing could be further from the truth! These things had nothing whatever to do with indemnity and insurable interest. The buyers of Bananas were given the mysterious title of "counterparties." Nobody actually knows who they are.

What was their incentive in purchasing Bananas?

Put simply, Bananas were a bet in which the die was loaded in favour of the gambler, or counterparty. They were betting on the failure of bad loans which were purchased and then re-packaged into Sprouts and then sold on! For those in on the scam there was simply no reason to buy Bananas unless they were confident that the sub-prime market would collapse – which it did. They then claimed on their "insurance" policies.

No. Don’t reach for the bottle just yet. You’ll need a clear head for what comes next. Because it actually gets worse.

Just to recap. The housing food chain spawned three types of financial life form – Gherkins (Mortgage Backed Securities), Sprouts (Collateralised Debt Obligations) and Bananas (Credit Default Swaps).

In this must-read article by James Lieber (which I hope you pass on to as many people as possible) he argues that it was Bananas which turned what should have been a recession into a depression – that the failure of the sub-prime market and its concomitant Gherkins and Sprouts by themselves would not have landed us where we are now.

Why?

Because the amount of money which is still out there waiting to be claimed on Bananas is mind-boggling!

How did it become so large?

The answer is the word "replication." One Sprout could be "insured" time and time again. This is why the thing became so large.

Lieber, writing in Jan. 2009, estimated that the Banana liability was in the region of $600 trillion. In fact, Ellen Brown, writing in Sep. 2008, put total trade in Gherkins, Sprouts and Bananas in excess of $1,000 trillion. The latter is called a quadzillion. If so then we’ve made it – not billions or trillions any more – now we’re into quadzillions!

And just where has all this bailout money paid to financial institutions gone? There’s no way of telling because the Fed’s not saying. How much has gone straight into the pockets of the counterparties, whoever or whatever they are?

I pray HR 1207 makes it all the way. Maybe it will yield up the truth about what has been going on – the fact that it didn’t just happen – it was quite deliberate. And let’s be clear, as Lieber points out in his article, it simply could not have been done without collusion between major players.

Is there a way out of this nightmare? Well, call me an optimist, but there must be. If people can devise a system whereby a tiny elite run the world on money created out of thin air, and get away with it, then surely we have the wit to devise a method of neutralising or cancelling these things – of evaporating them into thin air!

Then go after the counterparties who have already received money and prize every stinking penny from their filthy money-grubbing fingers.

This is no conspiracy theory – it’s fact. See here and here for two articles recently published on LRC – laugh or cry, it’s up to you – but we’ve all been conned, scammed, stiffed or any other word you can think of – yet again.

The greatest scam in history has littered the world with banana skins. There’s a lot more slipping and sliding to go before we emerge from this one – if we ever do – and in one piece at that!

Chris Clancy [send him mail] is Associate Professor of Financial Accounting at Zhongnan University of Economics and Law in Wuhan, Hubei Province, People's Republic of China.

    http://www.lewrockwell.com

    © 2009 Copyright Chris Clancy / LewRockwell.com - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014