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September 17, 2008
SouthAmerica: Last February I posted the following on this thread and since the meltdown is underway - here is some info about the derivatives market.
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02-19-08 07:52 AM
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February 18, 2008
SouthAmerica: I have been writing in the last few years about the subject of economic depressions and that we are due for another major economic depression like in the 1930âs and also that one of the major triggers for this new depression would be the collapse of the global DERIVATIVES market.
If I had to guess what the history books are going to say in the future when they try to figure out what was under the foundations that triggered the first great depression of the 21st Century â The headlines probably are going to say that the US financial markets were able to create the biggest financial scam in global financial history. The global financial system was taken for a ride when the US financial markets blew a super-bubble in the DERIVATIVES market that surpassed US$ 50 trillion dollars.
After that market collapsed a close analysis showed that its structure looked more like a great scam than anything else; built with sophisticated mathematical equations that even the geniuses and the experts that created that mess had a hard time understanding it.
That market started with financial instruments that made sense, then greed and pure stupidity took over and the market grew into a gigantic super-bubble that eventually started spinning completely out of control creating the biggest financial meltdown in global financial history.
By the way, last Friday Paul Krugmanâs column on The New York Times âA Crisis of Faithâ raised many questions about the US financial system as well.
And he said: âMore important, however, is the way the ever-widening financial crisis has shaken investorsâ faith in the whole system. People no longer trust assurances that fancy financial instruments will function the way theyâre supposed to â after all, they know what happened to people who thought their subprime-backed securities were safe, AAA-rated investmentsâ¦And loss of trust can be a self-fulfilling prophecy.
He ended his column by saying: ââ¦And the financial contagion is still spreading. What market is next?"
We donât have to look further than the DERIVATIVES market to get some clues to be able to answer his question.
On Sunday The New York Times published a front page story that shows that another Economic Crash like in 1929 it is a very real possibility and the seeds for such an event might have been planted already. This time the economic meltdown can be even worse that in the Great Depression of the 1930âs. You can find some clues about a system that is at the edge of the abyss on the article: âArcane Market Is Next to Face Big Credit Testâ
You can read the entire article at:
âArcane Market Is Next to Face Big Credit Testâ
By Gretchen Morgenson
February 17, 2008 - Front Page Story
The New York Times
Source:
http://www.nytimes.com/2008/02/17/b...enson"&st=nyt
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Here I am quoting from that article, and I am also making some comments along the way:
Before I start quoting from that article The New York Times â the article also had a chart with the following information:
The chart said: âIn the Shadow of an Unregulated Marketâ â The value of the credit default insurance market is now much larger than the domestic stock market, mortgage securities market, and United States Treasuries market as follows:
Credit Default Insurance Market = US$ 45.5 trillion.
U.S. Stock Market = US$ 21.9 trillion.
Mortgage Security Market = US$ 7.1 trillion.
U.S. Treasuries Market = US$ 4.4 trillion.
NYT: âFew Americans have heard of credit default swaps, arcane financial instruments invented by Wall Street about a decade ago. But if the economy keeps slowing, credit default swaps, like subprime mortgages, may become a household term.
Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companiesâ finances.
Like a homeownerâs policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.
The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion â roughly twice the size of the entire United States stock market.
No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated.
But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity.â
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SouthAmerica: This is just another example of how incompetent the Bush administration has been since January 2001.
A financial market grows from $ 1 trillion to $ 46 trillion US dollars over a period of 7 years and it did not raise a red flag that such a market might need some government regulation to keep it honest and from spinning out of control at some point in the future.
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NYT: ââ¦Placing accurate values on these contracts is just one of the uncertainties facing the big banks, insurance companies and hedge funds that create and trade these instruments.
In a credit default swap, two parties enter a private contract in which the buyer of protection agrees to pay the seller premiums over a set period of time; the seller pays only if a particular credit crisis occurs, like a default. These instruments can be sold, on either end of the contract, by the insurer or the insured.
But during the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold.
As investors who have purchased such swaps try to cash them in, they may have trouble tracking down who is supposed to pay their claims.
âThis is just a giant insurance industry that is underregulated and not very well reserved for and does not have very good standards as a result,â said Michael A. J. Farrell, chief executive of Annaly Capital Management in New York. âI think unregulated markets that overshadow, in terms of size, the regulated ones are a real question mark.â
Because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim.â
In late 2005, at the urging of the Federal Reserve Bank of New York, market participants agreed to advise their trading partners in a swap when they assigned contracts to others. But it is unclear how closely participants adhere to this practice.
It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim.
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SouthAmerica: And this is supposed to be the most sophisticated financial market in the world â Can you imagine what they would be doing if they were not so sophisticated?
There is a book called: âGreat Financial Scandalsâ by Sam Jaffa, the book describes from the world's first notable financial debacle, the South Sea Bubble scandal of the seventeenth century, through to the Boesky, Guinness, BCCI, Barings and New Era scandals of more recent times, Sam Jaffa weaves a rich and startling web of the deceitful depths to which men and women will sink in search of fast - and big - bucks.
Americans love sophisticated financial innovations, and here is another example an American financial innovation that took a lot of people for a ride.
A Ponzi Scheme - Named after Carl Ponzi, who collected $9.8 million from 10,550 people ( including ¾ of the Boston Police Force ) and then paid out $7.8 million in just 8 months in 1920 Boston by offering profits of 50% every 45 days.
A swindle of this nature, referred to as a "bubble" for the hundreds of years it has existed and now referred to as a "Ponzi scheme" is basically an investment fraud where investors are enticed with the promise of extremely high returns or dividends over a very short period of time.
This shorter period between payouts and high rate of return is required to create the impetus for the frenzy that is to follow as word leaks out, and is soon verified, by numerous sources. The truly experienced con will balance these two factors (payout period and promised rate of return) against the expected duration of the operation so as to maximize his take while still maintaining some semblance of credibility.
In the true sense of borrowing from Peter to pay Paul, ponzi schemes are a simple fraud whereby initial investors are paid exceptional dividends as interest cheques from the deposits of a growing number of new investors.
"Profits" to investors are not created by the success of the underlying business venture but instead are derived fraudulently from the capital contributions of other investors.
A few people invest in the scheme, then as news of the offer spreads, more investors are drawn in. Usually there is no actual investment involved, contrary to your understanding, just money being shipped in from new investors to the earlier ones.
Source:
http://www.elitetrader.com/vb/showthread.php?s=&postid=1797463&highlight=swaps#post1797463
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