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The Horrific Derivatives Bubble That Could Destroy Entire World Financial System

Stock-Markets / Derivatives Aug 09, 2010 - 03:29 PM GMT

By: Pravda

Stock-Markets Best Financial Markets Analysis ArticleMichael Snyder writes: Today there is a horrific derivatives bubble that threatens to destroy not only the U.S. economy but the entire world financial system as well, but unfortunately the vast majority of people do not understand it. When you say the word "derivatives" to most Americans, they have no idea what you are talking about. In fact, even most members of the U.S. Congress don't really seem to understand them. But you don't have to get into all the technicalities to understand the bigger picture.


Basically, derivatives are financial instruments whose value depends upon or is derived from the price of something else. A derivative has no underlying value of its own. It is essentially a side bet. Originally, derivatives were mostly used to hedge risk and to offset the possibility of taking losses. But today it has gone way, way beyond that. Today the world financial system has become a gigantic casino where insanely large bets are made on anything and everything that you can possibly imagine.

The derivatives market is almost entirely unregulated and in recent years it has ballooned to such enormous proportions that it is almost hard to believe. Today, the worldwide derivatives market is approximately 20 times the size of the entire global economy.

Because derivatives are so unregulated, nobody knows for certain exactly what the total value of all the derivatives worldwide is, but low estimates put it around 600 trillion dollars and high estimates put it at around 1.5 quadrillion dollars.

Do you know how large one quadrillion is?

Counting at one dollar per second, it would take 32 million years to count to one quadrillion.

If you want to attempt it, you might want to get started right now.

To put that in perspective, the gross domestic product of the United States is only about 14 trillion dollars.

In fact, the total market cap of all major global stock markets is only about 30 trillion dollars.

So when you are talking about 1.5 quadrillion dollars, you are talking about an amount of money that is almost inconceivable.

So what is going to happen when this insanely large derivatives bubble pops?

Well, the truth is that the danger that we face from derivatives is so great that Warren Buffet has called them "financial weapons of mass destruction".

Unfortunately, he is not exaggerating.

It would be hard to understate the financial devastation that we could potentially be facing.

A number of years back, French President Jacques Chirac referred to derivatives as "financial AIDS".

The reality is that when this bubble pops there won't be enough money in the entire world to fix it.

But ignorance is bliss, and most people simply do not understand these complex financial instruments enough to be worried about them.

Unfortunately, just because most of us do not understand the danger does not mean that the danger has been eliminated.

In a recent column, Dr. Jerome Corsi of WorldNetDaily noted that even many institutional investors have gotten sucked into investing in derivatives without even understanding the incredible risk they were facing....

A key problem with derivatives is that in the attempt to reduce costs or prevent losses, institutional investors typically accepted complex risks that carried little-understood liabilities widely disproportionate to any potential savings the derivatives contract may have initially obtained.

The hedge-fund and derivatives markets are so highly complex and technical that even many top economists and investment-banking professionals don't fully understand them.

Moreover, both the hedge-fund and the derivatives markets are almost totally unregulated, either by the U.S. government or by any other government worldwide.

Most Americans don't realize it, but derivatives played a major role in the financial crisis of 2007 and 2008.

Do you remember how AIG was constantly in the news for a while there?

Well, they weren't in financial trouble because they had written a bunch of bad insurance policies.

What had happened is that a subsidiary of AIG had lost more than $18 billion on Credit Default Swaps (derivatives) it had written, and additional losses from derivatives were on the way which could have caused the complete collapse of the insurance giant.

So the U.S. government stepped in and bailed them out - all at U.S. taxpayer expense of course.

But the AIG incident was actually quite small compared to what could be coming. The derivatives market has become so monolithic that even a relatively minor imbalance in the global economy could set off a chain reaction that would have devastating consequences.

In his recent article on derivatives, Webster Tarpley described the central role that derivatives now play in our 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.

But wasn't the financial reform law that Congress just passed supposed to fix all this?

Well, the truth is that you simply cannot "fix" a 1.5 quadrillion dollar problem, but yes, the financial reform law was supposed to put some new restrictions on derivatives.

And initially, there were some somewhat significant reforms contained in the bill. But after the vast horde of Wall Street lobbyists in Washington got done doing their thing, the derivatives reforms were almost completely and totally neutered.

So the rampant casino gambling continues and everybody on Wall Street is happy.

For now.

One day some event will happen which will cause a sudden shift in world financial markets and trillions of dollars of losses in derivatives will create a tsunami that will bring the entire house of cards down.

All of the money in the world will not be enough to bail out the financial system when that day arrives.

The truth is that we should have never allowed world financial markets to become a giant casino.

But we did.

Soon enough we will all pay the price, and when that disastrous day comes, most Americans will still not understand what is happening.

Michael Snyder

The Economic Collapse

Pravda.ru

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.

Pravda Archive

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


Comments

Shelby Moore
09 Aug 10, 23:15
Truth is

"The truth is that we should have never allowed world financial markets to become a giant casino."

Truth is that derivatives were demanded by the masses, because it was the only mathematical way (market response) to sustain their desired stealing from each other:

http://www.marketoracle.co.uk/Article21650.html

http://www.marketoracle.co.uk/Article20263.html

So please don't get off on the "lack of regulation" lie:

http://www.marketoracle.co.uk/Article21538.html#comment93592

Signing off. Thanks Nadeem for letting me air my views. I doubt I have changed any one's mind or been any thing other than a complete waste of my time, except for fine tuning my own understanding.


L. Million
10 Aug 10, 08:22
Truth is not what it seems

Shelby - I follow your posts and appreciate your insight. I'm just a layman trying to understand what has happened and what to expect so I can prepare. People like me are listening. Keep up the fight!


Nadeem_Walayat
10 Aug 10, 11:04
Truth is ?

Shelby

Your welcome, though voicing your thoughts on a repository for human thought can never be deemed as a waste of time.

Best.

NW


Shelby Moore
10 Aug 10, 21:32
re: Truth Houdini

Thank you for feedback. We need more writers with correct logic:

http://www.marketoracle.co.uk/Article21741.html#comment93663

(see my comment which will follow the one linked above)

Mathematically those who only rely on their physical senses (measuring or sampling), can easily be fooled by magic of mis-direction (i.e. "noise" or "aliasing error"). This is actually a mathematical fact stated in the fundamental theorem of measurement, call the Shannon-Nyquist Theorem.

http://goldwetrust.up-with.com/knowledge-f9/book-ultimate-truth-chapter-1-science-is-never-certain-t148.htm#3159

My technical debate above at Wikipedia illuminates that even scientists fail to remember the fundamental truths. You need to read all the way to the end of the discussion at Wikipedia to see I was correct.


David G. DiLucca
20 Aug 10, 11:24
Controlling derivatives

The stock market is conrolled by the large institutions that buy and sell about 74% of daily transactions. How can individuals control that? Same thig for derivatives and bailouts for large institutions, since they own Washington polititians, from the top down; how can individuls stop their actions? Even Warren Buffet cannot stop.... so what is the solution? We read about the consequences every day, yet the solutions remain academic.


Randall
20 Aug 10, 16:13
Derivatives

I'm with Shelby on this one. Few "Americans" are free from guilt on this issue (not just Ami's, look at Europe).

As long as the "gimme" mentality holds sway, theft will be the norm, and sudden collapse just around the next corner.


Shelby Moore
20 Aug 10, 21:12
Usury = gimmie -> derivatives = timebomb

http://www.marketoracle.co.uk/Article21925.html#comment93957

Thanks.


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