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April 19, 2013

What Are Derivatives and Why Do They Imperil the U.S. Economy?

By Richard Clark

We should not have allowed these banks to get so large that they could use our deposited money to make trillions of dollars of reckless bets. But we stood by and let it happen. Our legislators are virtually owned by the big banks and were afraid to bight the hand that feeds them. Now these banks have grown so important to, and integrated within, our overall economy, that their dissolution or insolvency would wreck us.


(Article changed on April 19, 2013 at 20:54)

(Article changed on April 19, 2013 at 13:27)

The claim is that when financial markets in the United States next crash, so will the U.S. economy.   Remember what happened back in 2008:   The financial markets crashed, the credit markets froze up, and suddenly the economy went into cardiac arrest.   And there are very few things that could cause the financial markets to crash harder or farther than a derivatives panic.  

Sadly, however, most Americans don't yet understand what derivatives are.   Unlike stocks and bonds, a derivative is not an investment in anything tangible.   Rather, a derivative is a bet on the future value or performance of something else.   Just like you can go to Las Vegas and bet on who will win the football games this weekend, bankers on Wall Street make trillions of dollars of bets about how interest rates will perform in the future and about what credit instruments are likely to default.   And they do it in secret, in that no public record is kept of their bets.

In other words, without most people even knowing it, Wall Street has been transformed into a gigantic casino where people are betting on just about anything you can imagine.   This works fine as long as a) there are not any wild swings in the economy, and b) risk is managed with strict discipline.   But as we have seen, there have been times in recent years when derivatives have caused massive problems.   For example, recall why the largest insurance company in the world, AIG, crashed back in 2008, requiring a huge government bailout.   It was because huge numbers of their derivatives went bad.   To be specific, a great many banks and other institutions purchased, from AIG, a kind of insurance policy called a credit default swap, which is essentially an agreement or contract that guarantees that if a particular investment of these banks went belly up -- in this case a mortgage backed security -- AIG would compensate these banks for their loss.   In other words, AIG was betting that these mortgaged backed securities (MBSs) would hold up just fine while they collected thousands of payments each month, from these banks, while the banks that purchased this insurance from AIG were betting that the MBSs might very well not hold their value, and they wanted to be covered just in case they actually did not.   The problem that then arose was that the housing bubble popped and housing values began to plummet nationwide.   This meant that mortgage backed securities, which (once again) were essentially packages of mortgages that people, institutions and especially banks, had invested in, were rapidly losing value, with many of them soon becoming worthless, assuming the status of junk bonds.

When this happened, all the banks that had purchased this special insurance from AIG, wanted to collect on the "policies' they had purchased, i.e. they wanted to collect on these (derivative) bets.   But AIG had nowhere near the funds necessary to pay off all these claims, and so the US government, i.e. we taxpayers, had to bail them out. 

Why not just let AIG and the big banks fail?   You know the answer:   They were "too big to fail."   Which means that these banks, and AIG, were so completely integrated, invested in, and otherwise mixed in, with the larger economy, that if they failed, so would the larger economy. 

Bad derivative trades (i.e. betting) also caused the failure of MF Global, as well as the $6-billion loss that JPMorgan Chase recently suffered because of derivatives betting that went bad, and it made headlines all over the world.  

And now the claim is that all of those incidents were just warm-up acts for the inevitable derivatives panic that will destroy global financial markets.   It is said that this largest casino in history is going to go "bust" and that the economic fallout from the resulting financial crash will be absolutely horrific.   This is the reason why Warren Buffett refers to derivatives as "financial weapons of mass destruction."  

Nobody really knows the total value of all the derivatives (bets) that are floating around out there, but estimates place their total value at anywhere from 600 trillion dollars all the way up to several thousand trillion dollars.   By comparison, the global GDP is somewhere around 70 trillion dollars (for an entire year).   So we are talking about an amount of money, invested in bets that might very well go bad, that is absolutely mind blowing.  

The obvious question, then, is:   Can banks and other financial institutions really survive such gambling and investment losses without severely damaging the rest of the economy?   And considering that America's five biggest banks have almost $9 trillion in assets, which is more than half the size of the U.S. economy, with much of it bet on (or invested in) derivatives, one would have to guess that the answer is no, i.e. that the larger economy could not survive such massive gambling losses by the biggest banks.   For, according to the federal government, the four largest U.S. banks account for 93% of the total banking industry notional amounts of derivatives, and 81% of the derivatives industry's net current credit exposure.   ("Credit exposure" means, of course, that if the bets go bad, the banks will take it in the shorts.)    Therefore, if a widespread derivatives crisis were to cause these top banks to crash and burn, it would almost certainly cause the entire U.S. economy to crash and burn as well.   So just remember what we saw back in 2008.   What is coming could very well be far worse.

It would have been really nice if we had not allowed these banks to get so large and if we had not allowed them to use our depositor's money to make trillions of dollars of reckless bets.   But we essentially stood by and let it happen.   Our legislators are virtually owned by the big banks and so they were afraid to bite the hand that feeds them.   Now these banks have grown to be so important to, and integrated within, our overall economic system, that their dissolution or insolvency would also destroy the U.S. economy.   It's kind of like when cancer becomes so advanced that killing the cancer would also kill the patient.   That is essentially the situation that we are facing with these banks.

It would be hard to overstate the recklessness of these banks, so let's present some numbers that are absolutely jaw-dropping.  According to the Comptroller of the Currency, four of our largest U.S. banks are walking a tightrope of risk, leverage and debt when it comes to their gambling with derivatives.   Just check out how "exposed" they are.   (One example is provided below.   Click here to see more, and read the rest of the article from which the above synopsis was taken.)

JPMorgan Chase:   Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars) 

Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)


Economics professor and former Wall Street insider Michael Hudson says that banking since World War I has been more and more focused on loading down the economy with debt rather than what he thinks should be the business of banks, which is financing economic growth and production.   Hudson says that banks should be public, government-run enterprises lending money only on economic merit, and that derivatives betting should remain private in separate institutions.   Watch the video at this site by clicking on the second video link there, if the first one doesn't work. 

Uncannily, Thomas Jefferson seems to have foreseen all this more than 200 years ago:

"The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution.   If the American People allow private banks to control the issuance of their currency, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered."

  -- Thomas Jefferson

This quote, in the opinion of financial adviser Greg McCoach of the Wealth Daily organization, sums up the ghastly situation that has come to pass, which will soon, he says, engulf everyone -- not just the people whose personal savings accounts in Cyprus have recently been stolen by banksters.

Thomas Jefferson fully understood what banksters would create for all of us if they were left unchecked to their own devices.   And in fact they have been allowed to do exactly that, by way of the politicians they have essentially bought, and now control.   Because of this, banksters are now treated as a special class of citizens that can literally do no wrong.   Anything they do is forgiven and papered over.

This is how a country devolves from being a nation of laws, with liberty and justice for all, into a nation ruled by men with absolute control, who gradually, through their own greed and self-centeredness, and purely for their own benefit, make a world of wonder into a world of abject misery for growing numbers of others.


Over the last few years, political and financial leaders in Europe and the United States have implemented policies, regulations, and bailouts costing global taxpayers trillions of dollars, and it's all been with the promise that these measures would lead to economic growth and recovery.   But that turns out to have been a pack of lies.   We have been royally tricked.

We've seen it time and time again over the last five years:   Governments overstepping their authority and punishing their citizens -- because of the actions of elite banking conglomerates, dirty politicians, and bought-off regulators.

Unfortunately, what has happened in Iceland, Greece, Ireland, Hungary, Argentina, Spain, and Portugal in the last five years could very well be just the beginning of far worse consequences elsewhere, soon to wreak havoc throughout the US and the entire world.

 The game plan moving forward is the same rape and pillage routine, in the name of purported recovery and stability, but on a much grander scale, worldwide.   Today we're seeing it in Cyprus, where Eurozone financiers have threatened to not only rob the populace of their personal savings, but shut off access to bank accounts indefinitely.   And, as we've seen, the people are having none of it.   Hopefully they fight back and win the day, but this bankster robbery will soon become commonplace in multiple locations throughout the world.

What happened in Europe a few weeks ago is yet further proof that nothing they've done has fixed the underlying fundamental problems surrounding the events that led to the crash of 2008.

The Cyprus situation is just a trial balloon the banksters are sending out to see how much they can get away with -- knowing they must and will eventually implement these sorts of policies in many other places.

For those who don't believe the bought-and-paid-for stooges of their government are prepared to take extreme measures that may include the seizing of retirement accounts, cash savings, or even gold (as FDR did in 1933), look no further than Cyprus, the latest recipient of bank bailouts.   The European Union has made the determination that the people of Cyprus are now responsible for the hundreds of billions of dollars in bad bets made by their government and bank financiers, and they are moving to confiscate money directly from the bank accounts of every person who has savings in the country.

In a recent King World News interview, former Assistant Secretary of the U.S. Treasury, Dr. Paul Craig Roberts, talked about the crisis in Cyprus, warning that "banks are now moving to enslave humanity."   Roberts went on to say, "You see, this crisis is being used by the EU bureaucracy in Brussels to destroy the financial sovereignty of the individual countries.   That's what this is all about.   They are saying, 'We can't trust you with the euro because you create too much debt.   So we're going to decide your budget, your tax policies, and your spending policies."   And we're going to take your money as required.

Jean-Claude Trichet, the former head of the European Central Bank, made this clear in all of his public speeches, that this is where things are headed.   So what you see is that the whole bailout is to be made at the expense of the public.   The purpose is to destroy the sovereignty of the individual members, and to concentrate power in Brussels and in the private banks.

But it's the same here in the U.S.  

Who actually runs the U.S. Treasury?   Who actually runs our financial regulatory agencies?   Who actually runs the Fed?   The ghastly truth is:   All of the executives of the banks that are 'too big to fail' run these agencies!   Let's not fool ourselves any longer.  

In other words, the various CEOs who got the banks in trouble are now running economic policy in the United States.   That's essentially what's happening in Europe as well.

So what's Next? 

The world is about to witness another round of derivatives horror -- but on a much broader scale than last time.   The powers-that-be (i.e. the banksters) and their bought-and-paid-for politicians fully understand what they must now deal with regarding failing derivatives.

How is it that people don't understand the connection between this situation and all the desperate measures we are currently seeing within our own government here in the United States?   For example, ask yourself why the U.S. government would start purchasing massive amounts of hollow-point ammo rounds in addition to large purchases of assault rifles and armored vehicles for several government agencies like the Department of Homeland Security and the Social Security Administration?!   Anyone familiar with hollow-point rounds understands that these rounds are designed to kill people quickly and easily -- and not for training purposes, as the government says.   Why would you waste money buying hollow points, which cost significantly more than target rounds, if you are buying these rounds for training purposes?   Such purchases makes absolutely no sense, unless these government agencies have motives other than the ones to which they admit.


According to this enlightening article written recently by Michael Snyder called, "The Coming Derivatives Panic that Will Destroy Global Financial Markets":

"On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan.   These men share a common goal:   to protect the interests of big banks in the vast derivatives market, one of the most profitable -- and controversial -- fields in finance.

"They also share a common secret:   The details of their meetings, even their identities, have been strictly confidential."

According to Snyder, the following large banks are represented at these meetings:   JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America, and Citigroup.   So, when the casino finally goes "bust," you will know who to blame.   Without a doubt, says Snyder, a derivatives panic is coming.   It will cause the financial markets to crash.   Several of the "too big to fail" banks will likely crash and burn and require bailouts.   As a result of all this, credit markets will once again become paralyzed by fear and will freeze up.   So, we will once again see the U.S. economy go into cardiac arrest -- only this time it will not be as easy to fix.

Everything points to another financial derivatives collapse that these elitist banking scum will use as an excuse, and as a device, to take whatever more they damn well please from us.  

And don't forget what the banksters got away with last time: 

Blogger and cartoonist Ted Rall points out that the Office of the Comptroller of the Currency and the Federal Reserve released the details of the settlement between the Obama Administration and the big banks over the recent illegal-foreclosure scandal.   

Citibank, JPMorgan Chase, Bank of America, Wells Fargo and other major home mortgage lenders foreclosed upon and evicted millions of homeowners between the start of the housing collapse in 2007 and 2011.   Millions of families became homeless, including 2.3 million children.   The vast majority of these Americans are still struggling;   many fell into poverty from which they will never escape.   

But it turns out that the banks had no legal right to evict these people .   Disgusting, amazing, yet true.   In many cases, the banks didn't have basic paperwork, like the original deed to the house.   They resorted to "robo-signing" boiler room operations to churn out falsified and forged eviction papers.   In others cases, people could have kept their homes if they'd been allowed to refinance, which is their right under federal law, but the banks illegally and underhandedly refused to allow them to do this, giving them the runaround, repeatedly asking for the same paperwork the homeowners had already sent in, until it was too late to avoid foreclosure proceedings.   Soldiers fighting in Afghanistan and Iraq, protected from foreclosure under U.S. law, came home to find their homes having been sold at auction.   In other cases, banks even repossessed homes where the homeowner had never even missed a mortgage payment.   

The details: 

*  Even though the owners qualified for federal loan modifications, the banks seized 1.1 million homes, making 1.1 million families homeless . . after the loans were approved for refinancing.   Since the average foreclosed home was worth $191,000 , the banks (banksters) essentially stole $210-billion-worth of homes!   Under the "landmark settlement," these wrongfully evicted Americans will receive a measly $300 to $500 each, the value of a modest night out at a nice restaurant in Manhattan (amounting to two-tenths of 1% of their average housing loss). 

*  900,000 borrowers who were entitled to refinancing under Obama's Make Home Affordable program were denied help and lost their homes.   Their federally granted compensation:   $400 to $600 each. 

*  420,000 homeowners who lost their homes while the banks intentionally dithered and "lost" their paperwork get $400 to $800 each. 

*  28,000 families who were entitled to protection against foreclosure under federal bankruptcy law, but got thrown out of their homes anyway, get $3,750 to $62,500 each. 

*  1,100 soldiers entitled to protection against foreclosure because of their military status get $125,000 each. 

*  53 families who weren't late on their mortgages, never missed a payment, but got thrown out anyway, get $125,000 each.

See more of this story here .  


Submitters Bio:

Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've always been more interested in political economics and what's going on behind the scenes in politics, than in mechanical engineering, and because of that I've rarely worked more than 8 months a year, devoting much of the rest of the year to reading and writing about that which interests me most.