The Inevitable Derivative Meltdown 18 comments
an article to
-
Font Size:
-
Print
- TweetThis
Economics: The social science that deals with the production, distribution, and consumption of goods and services and with the theory and management of economies or economic systems.
Apocalypse: Great or total devastation; doom: the apocalypse of nuclear war. A prophetic disclosure; a revelation.
Armageddon: The scene of a final battle between the forces of good and evil, prophesied to occur at the end of the world. A decisive or catastrophic conflict.
The Precipice
The world stands today at the brink of an economic precipice unlike anything it has ever faced in the entire history of mankind. Circumstances are already in place which will propel a leap into the chasm pushed by the greed of men in positions of power and influence; men in financial institutions determined to squeeze every last dime of profit from their financial trading activities; men that have devised new ways to manipulate the financial systems to their benefit so they may profit ever more greatly. These events will cause the collapse of entire financial institutions, the cessation of global economic activity, and the total debasement of all nations' currencies, leading to a world of anarchy and chaos too horrible to contemplate. It is not a question of "If" this collapse will occur, it is only a question of "When." The outcome of such a collapse will create an environment like nothing experienced before in human history.
A singularly certain outcome will be the failure of paper money to function as an instrument of exchange. In its place, hard metals with intrinsic value, such as gold and silver, will once again, as they did centuries ago, provide the basis of value for commercial and personal financial transactions. Once the collapse begins, none of the world's financial institutions or central banks will be able to slow it, never mind stop it. Because of the instantaneous and interconnected nature of global financial trading and communication systems, and also due to the extremely risky nature of existing financial instruments, economic and financial collapse will be nearly instantaneous. Unrecognized for what it is until it is too late to intervene, the unraveling of the intertwined global financial infrastructure will occur regardless of any attempted interventions. Such actions will be futile, unable to accomplish the intended result of arresting the financial calamity. Such an event is scary, frightening and completely unimaginable.
Nonetheless, it will occur. It is beyond our control. It will be a product of the system that has been built as a house of cards. The triggering event will be either the collapse of a hedge fund, a large scale corporate bankruptcy which will cause bond defaults and defaults of associated derivative instruments, or the failure of a large bank or bond house which in turn will cause massive illiquidity among counterparties in derivatives trading. This sequence of events has already started, and on December 26, 2007, the day after Christmas, no single individual can predict where such events will take us and what the end game scenario will be. We can only wait and watch.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Joseph L. Sha...
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
There are good reasons why people such as Mr. Ruggiero may feel uneasy in the midst of what seems like financial chaos. I might point out that doom-'n-gloom books have been around for many decades in many forms, often written by reputable authors. I recall "Blood in the Streets" and a host of others that predicted hyperinflation and economic collapse years ago. However, the doomsday scenario has not come to pass, and it's worthwhile to ask oneself why, when the probabilities are often in favor of it.
First, let's make an assumption that explains the way much of the world works: an operational imperative for the "how," without worrying about the "why." Here it is: Everything happens so that the rich can get much richer. Once you accept this, all else follows, and it all makes sense.
Within the convoluted web of mortage-backed securities and derivatives, one thing has become abundantly clear. There may be losers in this game, but the losers are not the banks. Let's work it through.
The Fed is a for-profit, private bank which to my knowledge has never been publicly audited. It doesn't like to lose money, and it doesn't want its colleague banks to lose money, either. The fact that the Fed sometimes operates in the interests of the U.S. economy is tangential to its drive for profit, regardless of the cost to the average American (through inflation or other economic artifacts which the Fed can affect).
When talking about the huge potential and actual losses from real estate derivatives, keep in mind that these derivatives have been generating double digit percentage gains for nearly a decade on several trillion dollars of leveraged money. The loss of a few billion dollars is barely a blip on the screen in comparison.
The real tragedy is that the big losses are probably not being taken by the banks, but rather by the "end users" of the derivatives, such as pension funds, college endowments and others whose greed for a little extra return led them to put their eggs in a rotten basket. I may be wrong on this, however, and apologize if I have seemed unsympathetic to banks which have fallen on hard times as a result of their awful investments.
But I'm getting off track. Let's assume that the interlocking financial derivative transactions are indeed a house of cards. Then they are a house of cards where each card is quarter-inch plate steel. They may look flimsy, but they are solid.
The U.S. has spent almost a trillion dollars on the war in Iraq. Regardless of whether one is for or against this war, this level of spending shows that we are quite capable of coming up with a trillion dollars out of nowhere to do something with, and the economy hasn't tanked as a consequence. Indeed, since the Iraq war began, our economic strength has been robust. It would seem that there is plenty of money available to provide liquidity for the banks. We just have to print it, and the Fed can do that in various ways.
Since banks have methods for masking losses -- so I've heard -- such as putting worthless assets into "on sale" status and carrying them on the books at full face value; or "selling" worthless assets at full face value, but with off-books "puts" attached that require buyback later at the same price; we really don't know what kind of awful financial shape large banks are in, especially those that aren't publicly traded. On the other hand, we don't know how much wealth banks have been earning and arranging to shield off books over the past decade, which could be substantial. What we do know is that the banks are irked because they are not making as much money as the used to, and bailouts make for happy banks, a happy Fed, and happy rich people. So that is what will happen.
Let's think about the "butterfly" effect, also related to positive feedback nonlinearities called reflexivity by George Soros, who may have taken that nomenclature from the 20th century scientific philosopher Alfred Korzybski. This effect says that there are nonlinearities which are unpredictably self-reinforcing, so that small causes can lead to huge effects. This is undoubtedly true in "undamped" systems which don't have offsetting negative feedback to calm the waters. However, the banking system, unlike an ocean where an underground earthquake can cause a disastrous tsunami, has plenty of ability to apply negative feedback wherever it wants. Therefore, the thought that a small transaction could lead inevitably to an avalanche is not quite accurate. It is accurate to say that reverse leverage is painful, but as long as the presses keep printing money to keep the leverage in place, the house of steel cards continues to withstand the hurricanes. It worked for the LTCM bailout years ago, and it can work again, particularly since financial institutions are much wealthier now than they were a few decades ago.
Ask yourself, where has all the money gone over the past half century? Not the money that goes around in circles in our economy, but the money that gets taken out as the "house cut" by the Fed, organized crime, and the super rich. Consider GNP totalled over the past 50 years, and you'll see that it's quite a bit. Much of the production consists of services, which do not retain value, and of depreciating assets such as automobiles. But some of it consists of sales of income-producing assets, such as valuable real estate, large corporations, transportation systems, utilities, etc. I believe that over the course of the last half century, "ownership" of a substantial portion of the U.S. has been amassed by relatively few entitites. For instance, we know from public reports that hundreds of billions of dollars per year are taken out of the economy through various forms of organized crime. That money goes to buy things, and not all of the things are fast boats and small planes. The money also might buy banks, agri-business and influence in corporate America (and perhaps on Capitol Hill, but let's not go there).
It's not impossible that there has evolved in this country, as in others, a significant group of super rich people. They are not like Bill Gates, who for reasons of his own decided against founding a dynasty with his wealth by legally funneling it offshore into trusts or holding companies or other entities sufficiently at arms length to legally avoid taxes on subsequent profits (which Howard Hughes did, I have heard, with his Hughes Medical Foundation, after getting Congress to pass the law that let him do it). Instead, Bill Gates gives his money to charity. However, not all super rich people have this perspective. Some are perfectly content to place their assets in legal hibernation until some descendent shows the promise of leadership and takes the helm of the flagship. There are many fictionalized stories of how this works in the Orient, and indeed that culture has a far longer view than we do concerning the wielding of financial power. But again, this has been a long digression, so we return to the point.
The point is that the super rich, the banks and the federal governments of the developed world are not, in this modern era, going to sit idly by and watch the winnings of their cronies evaporate. The person in the White House may not have obligations to floundering local governments, whose budgets are being slashed as real estate prices fall, but s/he has definite obligations to the military industrial complex, the large oil companies and the many other players who put him/her in office. Those folks don't like to lose money, and they might even get nasty about it if they start to. We have never heard the full story of why Ross Perot pulled out of the presidential race some years back. Rumor had it that there were threats made. I wouldn't doubt it, because he wasn't necessarily a "team player." Corporate America likes "team players;" and for the super rich, having a president with that perspective is indispensable.
So, we see that the combined weight of the wealthy and powerful is set against a global meltdown. I believe this weight is quite sufficient to prevent any looming financial disaster, however probable it might seem.
The only scenario to be cautious of, in my view, is the one in which the super rich have already placed their bets on the short side. That is, they would make more money on their puts and short sales than they would lose in asset value decline during a global depression. One must also factor in the money they would gain from buying back in at the bottom, so it's not a straightforward calculation. My conclusion is that a global depression isn't worth it to those who, through their inaction, could refrain from preventing it.
Therefore, the positive action will be forthcoming, whether in the form of loans from Dubai or Central Bank liquidity or government bailouts or jawboning to stop ARM resets. The global system will continue to lurch forward, as it has since World War II, with the rich getting much, much richer, and with the quality of life eroding for the middle class. In the U.S. of today, with our vast technological and medical breakthroughs, it is lamentable that it takes two parents working full time to make ends meet in a modest way. It's going to get a lot worse for the middle class, regardless of which way the economy goes, because we are gradually selling out our country and our future, but the voters don't have the time or wherewithall to change this, or even to understand it.
Therefore, I cannot agree with doomsday scenarios, even though they may have a sound scientific basis, because the game is rigged. The probabilities are not as they seem, and the most likely scenario is not the one that will occur. Just as the prices of stocks often fluctuate wildly for no good reason, due to "market" forces at work behind the scenes, similarly our economy will prevail -- and it certainly will prevail in an election year.
to refi these losers. The bottom line, Paulson and Repub-owned Fed are forestalling the inevitable. All this infusion to banks globally is to roll over bonds on their books by yrend, without disclosing the values, next year, we will see.
This is the old scare tactic, speak in apocalyptic terms but yield no specifics.
Ruggiero runs a private equity firm specializing in the raising of capital. I was thinking of commissioning a boat, but now I think I need an ark. Do you think he can help me get financing and investors interested in a nice ark?
Ruggiero's alleged profession is the raising of capital, which is money based.
Check out the pics, when Germany inflation was so bad, a days pay, was carried in a wheel barrels, hope we dont leave those images to our grandkids!!!!!!!!!!