Chapter 28 - Why Are Derivatives Dangerous?

 I very strongly suggested that you websearch: "why are derivatives dangerous".

Stig Dragholm

"Speculation of the world using "casino money" via derivatives is ten times greater than the world production - it is completely and utterly raving mad!" [287]

Webster Tarpley

"Derivatives represent the worst usury, on the largest scale, in history. Trying to float over $200 trillion of financial paper on the basis of a mere $10 trillion or less of commodity production is the most insane exercise in usury that humankind has ever attempted. As we have seen, this colossal folly is doomed to fail." [280]

Alan Kohler - 2012

"Almost all financial derivatives trading adds nothing but risk to the world and should be banned. It won't be, but that doesn't mean the debate is academic.

But is there any reason to allow financial derivatives at all? In my interview with him this morning, New York hedge fund manager James Rickards says they should simply be banned because the benefits are illusory and the effect is that risk is created out of thin air and then multiplied.

That's what happened in 2008 and, says Rickards, the problem is worse now: "The derivatives books are larger. If we had a problem then, we have a bigger problem now. This will collapse again if we don't do something about it.

Most derivatives trading involves swaps or contracts for difference, where two people bet on movements in an underlying asset or income flow without actually trading in it. It's a bit like betting on flies crawling up a wall, without having to buy the flies.

In fact, derivatives caused the 2008 global financial crisis because banks and investment banks vastly multiplied the leverage on their balance sheets by betting through derivatives and then losing control. Since then the amount of derivatives outstanding has actually grown, and now stands at more than $700 trillion.

Let's be clear: basically we're talking about a casino where the gamblers are banks. And banks aren't just any old punters: they also take deposits and lend money, underpinning the financial system on which society rests.

As with all casinos, someone always loses their shirt occasionally - LTCM in 1998 (US$4.6 billion), UBS in 2011 ($2 billion), AIG 2008 ($18 billion), Barings in 1995 ($1.2 billion), Societe Generale in 2008 (7.2 billion), and so on.

If derivatives can't be banned, then perhaps banks should just be stopped from trading them and putting their capital at risk. Oh wait a minute, they used to be - it was called Glass-Steagall, but that was repealed." [281]

Adele Ferguson - The Australian. 18 October 2008

"In 2002, legendary investor Warren Buffett warned that derivatives were time bombs and 'financial weapons of mass destruction' that could harm not only their buyers and sellers, but the whole economic system.

Instead of heeding this oracle's warnings, financial institutions rejoiced in these ticking bombs, which have now blown up, leading to estimates that the global banking system will lose up to $1.4 trillion before the crisis is over.

The world financial system is leveraged beyond comprehension. It is estimated that between $US500 trillion ($732 trillion) and $US700 trillion worth of derivatives are outstanding.

Compare this with the total economic activity (GDP) of the world, which is about $US50 trillion, and even a 5 per cent drop in the value of the derivatives is beyond the rescue capability of the world's central banks, according to financial author Bert Dohmen....

The latest Reserve Bank Bulletin reveals that Australian banks have more than $13 trillion in off-balance-sheet derivative exposures, compared with $5.4 trillion six years ago. If just 1 per cent of these blew up because third parties at the other end got into trouble, the whole shareholder wealth would be wiped out and the banks could be broke.

As total bank assets are $2.3 trillion, why do Australia's banks have exposure to $13 trillion of derivatives positions? All banks hedge to reduce risk, but this is a great deal of hedging.

To put it in perspective, Australia's GDP is about $1.3 trillion, our pool of investment fund assets is $1.2 trillion and the freely floated market capitalisation of the stock market is $1 trillion." [282]

Warren Buffet 2002

"I view derivatives as time bombs, both for the parties that deal in them and the economic system.

Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. For example, if you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction, with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration, running sometimes to twenty or more years, and their value is often tied to several variables. ...

Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others." [283]

Why Are Derivatives Dangerous?

"Only a handful of firms represent a massive portion of the total derivatives traded in the world. This means that if one of them went bankrupt, it could lead to a chain reaction effect that could cause all the others to fail. This would wipe out the entire financial system.

The failure of Lehman Brothers on 15 September 2008 nearly caused this to happen during the Credit Crisis and would have succeeded had it not been for the extraordinary intervention by the Federal Reserve, Treasury, FDIC,and other government agencies." [284]

Richard Clark 2010

"Thanks to very generous campaign contributions from these big banks, congressional 'reform' plans for credit default swaps are full of loopholes, guaranteeing that another derivatives-fueled financial crisis awaits us. And the banks can certainly afford to be generous when carrying out this kind of bribery where astounding amounts of monetary value are in play: According to the Bank for International Settlements, credit default swaps with a face value of $36 trillion were outstanding in the second quarter of 2009." [285]

Jeff Nielson

"Warren Buffett once described derivatives as 'financial weapons of mass destruction' - and for a very good reason. While U.S. 'unfunded liabilities' are larger than the entire global economy, the derivatives market is 20 times larger than the entire global economy - at an astonishing $1 quadrillion. Yes, you heard me correctly - $1 quadrillion! And get this - this derivative market is totally unregulated. It is totally lacking in transparency, meaning that all we know about this $1 quadrillion mountain of banker-paper is what the bankers tell us.

The collapse of U.S. economy is a certainty - only the manner of the economic collapse has yet to be determined. In time the global derivatives bubble will produce the same result which has occurred to every other currency not backed by gold throughout history: those currencies, our 'money', will become worthless." [286]

Not To Worry.

Not to worry. The TV tells us that everything is ok.

Just checking.

Have you done that websearch for me?

 This websearch is important: "why are derivatives dangerous".

[280] Webster Tarpley's book 'Surviving The Cataclysm'

[281] retrieved 2014

[282] retrieved 2015-04-20

[283] Excerpts from the Berkshire Hathaway annual report for 2002 retrieved 2015-04-20

[284] retrieved 2015-04-20

[285] retrieved 2015-04-20

[286] Jeff Nielson of in a speech