With the current economic crisis which seems to be spreading across the world we are dealing with far more than a "subprime" crisis, or an attempt to "quarantine "toxic debt." There is a much bigger avalanche waiting to come tumbling down. Namely the derivatives market now estimated to be over $1 quadrillion (that is 1,000 trillion) in global derivatives holdings. That makes the current $700 billion bailout look like less than a drop in a very large bucket.
As the long predicted crash started unfolding, I have been nagged by a long sequence of events that seem to be culminating at the current moment. There have been significant structural changes in the U.S. and elsewhere that have impacted both labor markets, and capital. In terms of labor markets (also known as workers) the transitions have been stark. In the United States we have watched the long term decimation of the manufacturing sector and a transition to a "service" economy. I remember the concerns in the 1980's about the transformation of the U.S. economy from a production economy to a consumer economy. This trend was accelerated with broad implementation of corporate-driven globalization and formalized by the passage of NAFTA (North American Free Trade Act) and the rewriting of GATT (General Agreement on Tariffs and Trade).
These two international trade agreements were structured along similar philosophies. Namely the removing of "boundaries" to trade, and enhancing the "boundaries" around workforces. Those boundaries were national boundaries and national sovereignty. We saw the exportation of U.S. job (outsourcing and off-shoring) accelerate. We also started seeing the merger mania of the 1980s which have continued to the present. In fact, they are a prominent feature of the current crisis.
Other nations, in a competitive and revolving fashion, became the cheap, exploitable labor force for a global economy. China, maximizing on its single most abundant resource (people) successfully positioned itself as the cheap workforce for global corporations searching to always maximize profit. (Now they too import even cheaper labor).
All along this path towards removal of boundaries, there has been increasing financial and investment penetration in an increasingly intertwined global financial market.
Facilitating what might be framed as an integration of financial and corporate markets, the U.S. (and other nations) have engaged in almost three decades of deregulation and the removal of other boundaries and barriers - particularly in the "financial" areas. Insurance companies become investment marketers, banks become investment bankers, banks cash in on the lucrative credit market, credit card companies start offering mortgage financing. Functions and institutions that once had high barriers between them with regulation and oversight, became increasingly deregulated and shadowy. They pushed for, and got passed, barriers against predatory lending - like those pesky bankruptcy laws.
I can't help but thinking that (in part) we are seeing the "jobless recovery" of the 2001 recession coming home to roost. Lots of folks wrote about the jobless recovery including myself (What Jobs? What Recovery?) and even Ben Bernake (The Jobless Recovery). Most of us, myself included, focused on the restructuring of the economy at that time as a major component of what was going on. However, it was also clear that money was flowing from somewhere into the financial markets. Wall Street was recovering - the people (and workers) were not. This money flowing around was symptomatic of the liberalization of investment restrictions which was a major feature of international globalization.
Unfortunately while there was money being brought into the market, much of it was "little people's" money (i.e. money from state and corporate retirement funds). The little people's money provided grease for much bigger financial fish, and "derivatives" took a whole new life and growth spurt.
Derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The main types of derivatives are futures, forwards, options, and swaps.
The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a wide range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), residential mortgages, commercial real estate loans, bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) -- see inflation derivatives -- or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs. Unregulated Credit derivatives have become an increasingly large part of the derivative market.
Until recently, most people had never even heard of derivatives; but in terms of money traded, these investments represent the biggest financial market in the world. Derivatives are financial instruments that have no intrinsic value but derive their value from something else. Basically, they are just bets. You can "hedge your bet" that something you own will go up by placing a side bet that it will go down. "Hedge funds" hedge bets in the derivatives market. Bets can be placed on anything, from the price of tea in China to the movements of specific markets.
"The point everyone misses," wrote economist Robert Chapman a decade ago, "is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing."1 They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services. In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling. But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve "risk management." Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked. But the cost was an increase in risk to the financial system as a whole.2
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars - that's 1,000 trillion dollars.3 How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don't have, and that is where the huge increase in risk comes in.
Credit default swaps (CDS) are the most widely traded form of credit derivative. CDS are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the "protection buyer" gets a large payoff from the "protection seller" if the company defaults within a certain period of time, while the "protection seller" collects periodic payments from the "protection buyer" for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes. In one blogger's example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling "protection" on a risky BBB junk bond. The premiums are "free" money - free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.
I have no idea how any government can fix this because so much of this "money" wasn't really there at all. What was there as you said was money that was supposed to be retirement money of all the little people. That was the smoke that allowed things to look rosey in years past. If this plays out the way I think it will what is coming will make the great depression look like a little dip
by
Pat Dazis (1 articles, 0 quicklinks, 0 diaries, 23 comments)
on Tuesday, October 7, 2008 at 1:38:29 PM
I agree that the people are likely to take a bath on this debacle, and that the economic situation could get way worse than a so called "simple recession." We have some fundamental flaws in my opinion.
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Rowan Wolf (80 articles, 0 quicklinks, 2 diaries, 106 comments)
on Tuesday, October 7, 2008 at 2:29:25 PM
It is my understanding that CDSs are the "insurance" purchased by Party A when they bet against Party B over junk bonds issued by Company C. If party A wins the bet and Party B can't cover the bet, Company Z that issued CDS pays. Many Party Bs are in trouble and won't pay, so the CDS kicks in. Quickly Company Z discovers they are responsible to cover billions in losses even though the CDS brought in only pennies.
My humble opinions about the crisis is this:
The original Wall Street firms were Partnerships. The owner/managers were constrained by personal risk. When they went Corporate, the new stockholder/owners were handed the risk and management conducted themselves as though they were still Partners but without the downside of risk. This new model was additionally exploited to transfer risk to investor/customers while the companies collected transaction fees. Collecting fees is not scalable from a fixed asset base. Increasing the number of types of securities, increasing leverage and conducting transactions at the speed of light gave the illusion of scalability and increased profitability given the same asset base, but did not add real value to the economy and infrastructure, it mostly created more risk.
The synthetics are the way they increased the number of securities associated with a single asset. A hundred bets could be made against the performance of one asset. Six hundred fees or more could be collected for making, trading and unwinding the bets and insuring the bets.
The old owner Robber Barons invested in infrastructure to make their millions, and the Country and the citizens benefited. It wasn't completely balanced because there was exploitation. Regardless, we all benefited.
The new management Robber Barons invest in derivatives, vapor securities that do not benefit the economy or the infrastructue. In fact, the financial sector extracts capital from the economy. Prosperity was an illusion, a leveraged sleight of hand. Debt replaced added value earnings as a means of increasing the standard of living. Our capital base shrunk as money moved from Main Street to Wall Street.
by
Bernard (0 articles, 0 quicklinks, 0 diaries, 57 comments)
on Tuesday, October 7, 2008 at 2:43:13 PM
Laws have been tweaked over the years to permit all of this nonsense. The people who work in the industries that generate wealth from thin air as if it were gold from straw for the most part have done nothing wrong, looked at purely as a legal question. Consequently, it is those industries themselves, and the way in which they have come to be operated, which are at issue. We can now see that practices accepted as legal and honorable from the perspective of the individual are actually toxic from the perspective of society at large. Had I the means, I would opt to declare certain industries and practices to be forbidden, and help those who had worked in those fields to find employment in jobs that were actually helpful to society, just as people with any other outdated skillset are expected to do.
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I write pointed political and business short stories at klurgsheld.wordpress.com
by
P. Orin Zack (3 articles, 0 quicklinks, 2 diaries, 15 comments)
on Tuesday, October 7, 2008 at 2:44:49 PM
Thanks for the excellent and believable analysis of what is going on. It seems to me that one might make a useful analogy: the so-called Great Depression was a bomb that went off in 1929, a typical 'traditional' bomb. What is going off now is a nuclear device, by comparison.
I circulate an email-based newsletter to a small closed group (120), and hope it is okay to reprint your article. With full attribution, of course. Let me know if that's a problem (irvthom1@comcast.net)
by
Irvthom (7 articles, 2 quicklinks, 2 diaries, 88 comments)
on Tuesday, October 7, 2008 at 3:32:01 PM
I thought I was the only one wondering how in earth there can be a thousand trillion dollars worth of "derivitive" deals "out there." I've asked friends, but no one seemed to know any more than I.
Thanks for your excellent work on this murky subject. I understand much more than I did before, but the concepts are nebulous, to be sure.
I'm struck by the vaporous quality of these so-called "financial instruments."
Committing to monstrous amounts of exposure with relatively minimal assets somehow became fashionably astute. We little people would be burdened with the archaic notion that risk must be backed up by adequate assets, but these economic visionaries, these arcane geniuses of obscene calculus had discovered economic valhalla.
Those that questioned the deep insight of these economic astronauts were chided for being against Americanism and the Blessed Free Market.
Given the exponential magnitude of their irresponsibility, their stunning selfishness, and their astronomical greed, I disagree with those who claim this mega-orgy of gambling is legal. If there isn't some way in which laws were fundamentally broken, then appropriate laws must be crafted and applied retroactively. Major players and so-called leaders who made this system possible should be put on trial.
Additionally, the superstructure of this gambling cult must be studied, understood deeply, well documented, and then dismantled for the good of humankind.
by
Lover of Truth (0 articles, 0 quicklinks, 0 diaries, 26 comments)
on Wednesday, October 8, 2008 at 1:29:15 AM
I don't even want to read your article, RW. I will say that I almost bought gold when it was less than $400 an ounce about a year ago. I own outright a small house in a reactionary suburb of Oakland-San Francisco. And I've been saying for about a week to anyone who would listen: "If the DOW holds below 10,000. look the f*** out!"
by
GLloyd Rowsey (48 articles, 3 quicklinks, 26 diaries, 338 comments)
on Wednesday, October 8, 2008 at 6:45:07 AM
ITS MORE LIKE ONE WORLD ORDER COMING HOME TO ROOST
IF YOU CONTROL THE MONEY OF A COUNTRY YOU CONTROL THAT COUNTRY, NOW THE PLAN, AND THE AGENDA OF THE FOURTH BARON ROUTHSCHILD AND COMPANY, THE FEDERAL RESERVE, PAULISON, BEN, BUSH THE CLINTONS, CFR, THE TC, BUILDERBURGS, AND EVEN OUR NEXT HAND PICK PRESIDENT OBAMA, ETC. NOW THEY ARE AT THEIR LAST PHASE OF THEIR AGENDA CONTROL THE MONEY OF THE WORLD AND YOU CONTROL THE WORLD, THE NEW WORLD ORDER IS HERE., STAY TUNED THIS IS JUST THE BEGINNING, WITH THE MONEY COMES CONTROL OF THE FOOD SUPPLY, THE WATER SUPPLY, AND POPULATION CONTROL AT THEIR PLEASURE. THIS HAS BEEN PLANED, AND WHO THE HELL IS GOING TO STOP THESE INBREAD MADMEN, ROYALS. WHO HAS THE PLAN, AND WHERE CAN I GET COPY.
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rich racer (0 articles, 0 quicklinks, 0 diaries, 229 comments)
on Wednesday, October 8, 2008 at 6:54:33 AM
You really don't have to do much more than go to WRH (the October 6 line-up) to see a vast and comprehensive collection of information and perspectives on how bad it really is. Keep in mind that it's worse than any of what you are reading because everything is interdependent in the global financial scheme. Keep in mind that the major players are mostly psychopaths who have nothing but self-interest in mind and that nothing is less likely to solve an interdependent crisis than unbridled self-interest.
The interdependent financial crisis is also interdependent with the geo-political situation and every conflict that is occurring at this time. The interdependent financial crisis is also hot-linked to energy, housing and food. All of these things are interdependent. Think of the world of phenomenal reality as being like a spider's web or a suspension bridge. I'll leave you to ponder the possibilities.
As the crisis deepens, the people's assets, borrowing and buying habits are altered; paranoia becomes rampant. Things constrict. Then, that which the banks and corporations rely on in order to conduct their business suddenly go missing or is greatly reduced. You do the math. The stock market is about confidence. Confidence is a funny thing. It can make a lie a valuable commodity and ratchet its value far above what it essentially is and it can maintain that value for... who knows how long? This can be done as long as confidence fuels the faith and imagination of the people. That's in free fall right now.
What happens when corporations rule government policy? The possibility of false flag terror attacks, sudden critical shortages and war becomes immanent. It is hard to imagine any other alternative. This is how they operate. This is how they have operated for as long as they have operated.
What is the solution? First you have to look at the problem itself and how the problem got to where it is. We're in a 'breaking eggs to make omelets' situation where certain individuals must be apprehended and jailed or eliminated entirely. This is a realpolitick look at things. I'm not advocating anything. I'm talking about what's there. You can't solve the problem of the troll under the bridge as long as the troll remains under the bridge. It may be that you can drive the troll away. You can maroon the troll. You can imprison the troll and you can kill the troll. You have to do something about the troll or your problem continues. You cannot go to the troll for the solution to the problem of the troll; as is presently the process being employed.
I'm not going to mince words here. In many cases you need to employ the Ceausescu solution. The reason this is necessary is because the troll will not stop acting like a troll for as long as the troll remains. Trolls do not magically transform into elves. Trolls do not possess a conscience that would allow for rehabilitation. Trolls are trolls. Some people think they are cute. I do not.
Alternatively you can strip the troll of all of his/her assets and imprison or exile them to a place from which they cannot return. You can forbid them the opportunity to operate in their former sphere of activity ever again. Unfortunately... you have a problem. The problem is that the trolls are the ones making the laws that enforce and constrain troll behavior. The trolls are the ones enforcing the law. The trolls are the ones reporting and shaping the news. The only way to deal with trolls is to call in the exterminator the same way you would for any pest infestation. You may want to use a humane trap so that you can ferry them to the shark encircled island. You may want to merely contain them. However you approach it you have to do something that renders the trolls harmless; one way or the other.
Sometimes justice has to be employed in a direct and powerful way. Consider that the trolls never had a moment's hesitation or doubt about destroying the lives of others; causing wars and want and all of the ills that trolls cause. Trolls are not human. Trolls don't care. The end justifies the means and only the needs of trolls are ever considered.
The indecently rich must be stripped of all of their assets and put out on the street. The politician trolls must be driven from office. The corporation trolls must be run off. The media trolls must be silenced. Parasite trolls and parasite nations have to be cut off completely from any and all influence in the host country or they will (and are) bleed you white. Parasites do not engage in symbiosis. Parasites are not beneficial to the host body.
This is clear simple fact. Banker trolls must be bankrupted and all trolls must be defined and treated as trolls.
Sooner or later a housecleaning is going to be in order or you lose the house. Sooner or later the trolls will destroy the world in which you live because that is their modus operandi. That is how they do business. Should you allow your own destruction so as not to offend the trolls? That is for you to decide.
Everybody knows who the trolls are. Who are the people who have amassed great wealth at your expense? Who are the people creating the wars for personal profit? Who are the politicians and religious leaders who are servants of these trolls? Who are the media operatives who feed the lies that justify the looting and pillaging? Who are the storm-troopers enforcing the will of the trolls against the well being of the populace? One should take a look at the conditions that existed in France prior to the revolution and what followed after and be mindful that all too often when the tables are turned the same people are still sitting there.
Do I think you can pull this off? You can't pull this off if you don't deal with your own inner troll first. You can't solve a problem if you can't see to what extent you are part of it. And you can't use kid gloves to solve a troll problem. You can't reason with trolls and you can't ever trust a troll to be reasonable and quit their evil ways. Hey, they're trolls.
Trolls caused these problems and one of the ways they did this was by getting you to accept that troll behavior is acceptable. It's not. Troll behavior never works out to the advantage of everyone else. A troll infestation can not be eliminated by leaving the solution in the hands of the trolls. They'll throw a few of their number under the train and go right on with business as usual. Troll behavior has to be looked at as shameful and reprehensible and it must be universally condemned. Trolls have to be named and shamed. Trolls have to be rendered impotent by whatever means necessary or you might as well take your own life because they're going to do it anyway- or worse and they won't be so kind in the deed as you would be yourself. A massive awakening must take place and when it does it won't be hard to see what's what. Luckily... and I say that with no small amount of irony... a massive awakening is going to take place whether you like it or not. It's taking place now. It needs to be hard and lasting or nothing is going to change.
You've got a front row seat to life in interesting times. Sooner or later you are going to realize that the real power has and always does reside in 'the people'. Until you stop employing trolls to look after your affairs you are going to be neck deep in troll shit and they are going to serve it to you warm for dinner.
This polemic, like all of my dissertations is only so many words. Circumstances are another thing. When you injure your body you feel it. Unfortunately it is not so when someone else is injured. But we are all interdependent too, whether we see it or not. Everyone's death and suffering really does diminish and affect you too.
by
rich racer (0 articles, 0 quicklinks, 0 diaries, 229 comments)
on Saturday, October 11, 2008 at 4:43:11 AM
17 comments
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