| Quadrillion? That's a number only astronomers | | | | According to the article, Bear Stearns held a |
| use, right? You know...as in the North Star is "just" | | | | jaw-dropping $13.4 trillion in derivatives, which is |
| a couple of quadrillion miles away? | | | | "greater than the U.S. national income." So where |
| But, ominously enough, Earth's economists are | | | | did all those derivatives go? Well, this time |
| actually starting to use the number, too. No, not | | | | anyway, JP Morgan was encouraged to step in to |
| to discuss the amount of dollars out there (though | | | | add Bear's derivatives to its own $77 trillion |
| it might feel like the Fed just pumped a quadrillion | | | | portfolio, giving the financial giant a grand total of |
| greenbacks into the economy). The Bank of | | | | $90 trillion in these wobbly investments. |
| International Settlements recently reported that | | | | Which begs the question, why didn't we just let |
| the amount of outstanding derivatives has now | | | | Bear Stearns-$13 trillion in derivatives and all-go |
| reached the $1.14 quadrillion mark ($548 Trillion in | | | | belly up? Wouldn't that have taught the nation a |
| listed credit derivatives plus $596 trillion in notional | | | | valuable lesson and given Wall Street a |
| [or face value] OTC derivatives). | | | | long-deserved wake-up call? "Twenty years ago |
| Whether you're an astronomer or an economist, | | | | the Fed would have let Bear Stearns go bust," |
| that's an awfully big number. In case you need a | | | | said credit specialist William Sels. "Now it is too |
| mega-number refresher course, million is followed | | | | interlinked to fail." |
| by billion which is followed by trillion which is | | | | Which means that a Bear Stearns collapse today |
| followed by quadrillion (and, okay, quintillion and | | | | could be the first falling domino in a collapsing |
| sextillion follow that). Yes, it takes a thousand | | | | domino configuration tomorrow. Derivatives really |
| trillion to make up one quadrillion, and, sadly, that's | | | | are all interlinked. So expect the Fed to move |
| where we now find ourselves with this whole | | | | with SWAT-like velocity to rescue any bank |
| derivative mess. | | | | struggling with its derivative load. |
| Leverage Madness | | | | But what happens when even that's not enough? |
| Derivatives, as you may know, are essentially | | | | Surviving the Coming Derivatives Collapse |
| unregulated, high-risk credit bets. Unlike the | | | | Eventually, shockingly, something will go wrong. |
| earnest farmer who might employ a futures | | | | Some bank will slip up, some mathematician will |
| contract to hedge the price of the beans he's | | | | miscalculate or the Fed just won't react fast |
| worked so hard to grow, many banking | | | | enough next time, and the whole $1.4 quadrillion |
| institutions now use futures, forwards, options, | | | | derivative complex will simply "go Chernobyl." Only |
| swaps, swaptions, caps, collars and floors-the | | | | it might not be $1.4 quadrillion by then. It might be |
| whole wacky inventory of leverage devices-to | | | | a whole lot more. |
| bet the hell out of virtually anything. | | | | What would be the aftermath? |
| What drives derivatives, at their very roots (if | | | | Whatever happened, it wouldn't be pretty. |
| you can somehow get back that far), are base | | | | Referring to the Bear Stearns emergency, James |
| assets that get leveraged to a demented degree. | | | | Melcher, a well-known hedge fund manager, said, |
| Martin Mayer writing for the Brookings Institute, | | | | "There was a risk of a total meltdown at the |
| said, "the receiver of the payments on these | | | | beginning of last week. I don't think most people |
| loans or securities has bought the securities for | | | | have any idea how bad this chain could have |
| the duration of the swap on 95% margin, even | | | | been." |
| though the law says nobody can buy securities | | | | The New York Times was even more pointed: "If |
| without putting up half the price." | | | | the Fed hadn't acted this morning and Bear |
| Extrapolated, $1.14 quadrillion in assets "owned" on | | | | (Stearns) did default on its obligations, then that |
| something like 95% margin has to be one of the | | | | could have triggered a widespread panic and |
| scariest phenomena in economic history. | | | | potentially a collapse of the financial system." |
| Mathematicians and academics are supposedly the | | | | Yes...the Times said that. |
| air traffic controllers of the derivative complex, | | | | But there's too much leverage, too much money, |
| keeping everything neatly hedged, up-to-date and | | | | too much greed and too many shenanigans |
| safe. But a quadrillion-plus of these highly | | | | involved here to believe this story will have a |
| leveraged investments is like multiplying America's | | | | happy ending. So, as soon as you can, you really |
| fleet of airplanes a million-fold...while not bothering | | | | need to buy some "derivative-collapse insurance." |
| to boost the number of air traffic controllers. The | | | | You need to buy gold. |
| potential for financial disaster here is simply | | | | Think of gold-this beautiful, glittery precious |
| overwhelming. | | | | metal-as its own monetary system, an honorable |
| "Financial Weapons of Mass Destruction" | | | | investment divorced from the old-boy paper |
| So warned Warren Buffet of derivatives six | | | | money network that has bred so many nasty |
| years ago. | | | | derivative beasts. Should the worst happen, gold |
| "We view them as time bombs, both for the | | | | would represent the only financial sanity around; |
| parties that deal in them and the economic | | | | investors not mangled by a derivative collapse |
| system," is how the Oracle of Omaha put it. | | | | would flock to the precious metal if only to wait |
| That time bomb almost went off in March 2008 | | | | things out. |
| with the Bear Stearns debacle. The title of an | | | | If you just rolled your eyes, Google Bear Stearns |
| article by noted analyst Ambrose | | | | to see just how close we all came. Then go |
| Evans-Prichard-"Fed's rescue halted a derivatives | | | | ahead and look into gold...before we start |
| Chernobyl"-says virtually everything you need to | | | | wondering just how much $1 quintillion in |
| know. | | | | derivatives is. |