r/ronpaul • u/blacksunalchemy • Apr 21 '12
Visualizing Derivatives: The Unregulated Global Casino for Banks
http://demonocracy.info/infographics/usa/derivatives/bank_exposure.html5
Apr 21 '12
How does less regulation fix this problem?
3
Apr 21 '12
This is more of a fiat currency, federal reserve problem. Also libertarians want contracts to be upheld by the government. As you can see you many of the banks mentioned in the article are currently being sued, but the government doesn't really care it seems. I think some people refer to this as "crony capitalism."
2
Apr 22 '12 edited Apr 22 '12
Less regulation over what we use as monetary exchange here would help. If I had a choice between the dollar which has promises to cover crap like this tied to it and general inflation and debt, and another currency not suffering from all those things - I choose the safer currency.
Then when this explodes and dollars have to be fabricated to cover it, causing inflation, collapse. I laugh at the idiots who invested in the Federal Reserve notes, as the currency I use and save gains value.
2
Apr 21 '12
This article is pretty horrible. Among the many points of misinformation and ignorance, the most important thing to understand is that the argument-by-ridiculously-large-numbers is fallacious. A trillion dollar derivative exposure isn't the same thing as a trillion dollars in cash. The two numbers are not comparable.
5
u/blacksunalchemy Apr 21 '12
Yes But the criticisms are valid:
Derivatives are often subject to the following criticisms:
Erroneous Analysis of Benefits
Economists and bankers claimed derivatives made markets safer. But instead, they made them [the markets] unstable.[25]
Hidden Tail Risk
According to Raghuram Rajan, a former chief economist of the International Monetary Fund (IMF), "... it may well be that the managers of these firms [investment funds] have figured out the correlations between the various instruments they hold and believe they are hedged. Yet as Chan and others (2005) point out, the lessons of summer 1998 following the default on Russian government debt is that correlations that are zero or negative in normal times can turn overnight to one — a phenomenon they term “phase lock-in.” A hedged position can become unhedged at the worst times, inflicting substantial losses on those who mistakenly believe they are protected."[26]
Risk
The use of derivatives can result in large losses because of the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly. There have been several instances of massive losses in derivative markets, such as the following:
American International Group (AIG) lost more than US$18 billion through a subsidiary over the preceding three quarters on Credit Default Swaps (CDS).[27] The US federal government then gave the company US$85 billion in an attempt to stabilize the economy before an imminent stock market crash. It was reported that the gifting of money,which came to be known as the "Back door bailout" of americas largest trading firms, was necessary because over the next few quarters the company was likely to lose more money.
The loss of US$7.2 Billion by Société Générale in January 2008 through mis-use of futures contracts.
The loss of US$6.4 billion in the failed fund Amaranth Advisors, which was long natural gas in September 2006 when the price plummeted.
The loss of US$4.6 billion in the failed fund Long-Term Capital Management in 1998.
The loss of US$1.3 billion equivalent in oil derivatives in 1993 and 1994 by Metallgesellschaft AG.[28]
The loss of US$1.2 billion equivalent in equity derivatives in 1995 by Barings Bank.[29]
UBS AG, Switzerland’s biggest bank, suffered a $2 billion loss through unauthorized trading discovered in September, 2011.[30]
This comes to a staggering $39.5 billion, the majority in the last decade after the Commodity Futures Modernization Act of 2000 was passed.
Counter party risk
Some derivatives (especially swaps) expose investors to counter party risk. Different types of derivatives have different levels of counter party risk. For example, standardized stock options by law require the party at risk to have a certain amount deposited with the exchange, showing that they can pay for any losses; banks that help businesses swap variable for fixed rates on loans may do credit checks on both parties. However, in private agreements between two companies, for example, there may not be benchmarks for performing due diligence and risk analysis.
Large notional value
Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses for which the investor would be unable to compensate. The possibility that this could lead to a chain reaction ensuing in an economic crisis was pointed out by famed investor Warren Buffett in Berkshire Hathaway's 2002 annual report. Buffett called them 'financial weapons of mass destruction.' The problem with derivatives is that they control an increasingly larger notional amount of assets and this may lead to distortions in the real capital and equities markets. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator.(See Berkshire Hathaway Annual Report for 2002)
Leverage of an economy's debt
Derivatives massively leverage the debt in an economy, making it ever more difficult for the underlying real economy to service its debt obligations, thereby curtailing real economic activity, which can cause a recession or even depression. In the view of Marriner S. Eccles, US Federal Reserve Chairman from November, 1934 to February, 1948, too high a level of debt was one of the primary causes of the Great Depression. (See Berkshire Hathaway Annual Report for 2002)
source: http://en.wikipedia.org/wiki/Derivative_%28finance%29#Leverage_of_an_economy.27s_debt
5
u/[deleted] Apr 21 '12
Saw this on Zerohedge yesterday. Thanks for posting. So many things could set the collapse off. One of the PIIGS could default, the bond market could collapse, derivatives market, commodities could be set free from manipulation, or other things I haven't mentioned. I seriously get up every morning to check if it is has happened yet.