THE COMING DERIVATIVES CRISIS-MAYBE

Parshah Lech-Lecha - Genesis 12:1-17:27 OCT 30-NOV 5,11
http://israndjer.blogspot.com/2010/10/parshah-lech-lecha-genesis-121-1727.html

The Coming Derivatives Crisis That Could Destroy The Entire Global Financial System-The Economic Collapse Thursday, October 20, 2011

Most people have no idea that Wall Street has become a gigantic financial casino. The big Wall Street banks are making tens of billions of dollars a year in the derivatives market, and nobody in the financial community wants the party to end.
[FINANCIAL]-The word derivatives sounds complicated and technical, but understanding them is really not that hard. A derivative is essentially a fancy way of saying that a bet has been made. Originally, these bets were designed to hedge risk, but today the derivatives market has mushroomed into a mountain of speculation unlike anything the world has ever seen before. Estimates of the notional value of the worldwide derivatives market go from $600 trillion all the way up to $1.5 quadrillion. Keep in mind that the GDP of the entire world is only somewhere in the neighborhood of $65 trillion. The danger to the global financial system posed by derivatives is so great that Warren Buffet once called them financial weapons of mass destruction. For now, the financial powers that be are trying to keep the casino rolling, but it is inevitable that at some point this entire mess is going to come crashing down. When it does, we are going to be facing a derivatives crisis that really could destroy the entire global financial system.Most people don’t talk much about derivatives because they simply do not understand them.Perhaps a couple of definitions would be helpful.

The following is how a recent Bloomberg article defined derivatives….Derivatives are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in the weather or interest rates.The key word there is speculation. Today the folks down on Wall Street are speculating on just about anything that you can imagine.

The following is how Investopedia defines derivatives….A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.A derivative has no underlying value of its own. A derivative is essentially a side bet. Usually these side bets are highly leveraged.At this point, making side bets has totally gotten out of control in the financial world. Side bets are being made on just about anything you can possibly imagine, and the major Wall Street banks are making a ton of money from it. This system is almost entirely unregulated and it is totally dominated by the big international banks.Over the past couple of decades, the derivatives market has multiplied in size. Everything is going to be fine as long as the system stays in balance. But once it gets out of balance we could witness a string of financial crashes that no government on earth will be able to fix.The amount of money that we are talking about is absolutely staggering. Graham Summers of Phoenix Capital Research estimates that the notional value of the global derivatives market is $1.4 quadrillion, and in an article for Seeking Alpha he tried to put that number into perspective….If you add up the value of every stock on the planet, the entire market capitalization would be about $36 trillion. If you do the same process for bonds, you’d get a market capitalization of roughly $72 trillion.The notional value of the derivative market is roughly $1.4 QUADRILLION.

I realize that number sounds like something out of Looney tunes, so I’ll try to put it into perspective.$1.4 Quadrillion is roughly:
-40 TIMES THE WORLD’S STOCK MARKET.
-10 TIMES the value of EVERY STOCK & EVERY BOND ON THE PLANET.
-23 TIMES WORLD GDP.

It is hard to fathom how much money a quadrillion is.If you started counting right now at one dollar per second, it would take 32 million years to count to one quadrillion dollars.Yes, the boys and girls down on Wall Street have gotten completely and totally out of control.In an excellent article that he did on derivatives, Webster Tarpley described the pivotal role that derivatives now play in the global financial system….Far from being some arcane or marginal activity, financial derivatives have come to represent the principal business of the financier oligarchy in Wall Street, the City of London, Frankfurt, and other money centers. A concerted effort has been made by politicians and the news media to hide and camouflage the central role played by derivative speculation in the economic disasters of recent years. Journalists and public relations types have done everything possible to avoid even mentioning derivatives, coining phrases like toxic assets,exotic instruments,and – most notably – troubled assets, as in Troubled Assets Relief Program or TARP, aka the monstrous $800 billion bailout of Wall Street speculators which was enacted in October 2008 with the support of Bush, Henry Paulson, John McCain, Sarah Palin, and the Obama Democrats.Most people do not realize this, but derivatives were at the center of the financial crisis of 2008.They will almost certainly be at the center of the next financial crisis as well.For many, alarm bells went off the other day when it was revealed that Bank of America has moved a big chunk of derivatives from its failing Merrill Lynch investment banking unit to its depository arm.So what does that mean?

An article posted on The Daily Bail the other day explained that it means that U.S. taxpayers could end up holding the bag….This means that the investment bank’s European derivatives exposure is now backstopped by U.S. taxpayers. Bank of America didn’t get regulatory approval to do this, they just did it at the request of frightened counterparties. Now the Fed and the FDIC are fighting as to whether this was sound. The Fed wants to give relief to the bank holding company, which is under heavy pressure.This is a direct transfer of risk to the taxpayer done by the bank without approval by regulators and without public input.So did you hear about this on the news? Probably not.Today, the notional value of all the derivatives held by Bank of America comes to approximately $75 trillion.JPMorgan Chase is holding derivatives with a notional value of about $79 trillion.It is hard to even conceive of such figures.Right now, the banks with the most exposure to derivatives are JPMorgan Chase, Bank of America, Goldman Sachs, Citigroup, Wells Fargo and HSBC Bank USA.Morgan Stanley also has tremendous exposure to derivatives.You may have noticed that these are some of the too big to fail banks.The biggest U.S. banks continue to grow and they continue to get even more power.Back in 2002, the top 10 U.S. banks controlled 55 percent of all U.S. banking assets. Today, the top 10 U.S. banks control 77 percent of all U.S. banking assets.These banks have gotten so big and so powerful that if they collapsed our entire financial system would implode.You would have thought that we would have learned our lesson back in 2008 and would have done something about this, but instead we have allowed the too big to bail banks to become bigger than ever.

And they pretty much do whatever they want.A while back, the New York Times published an article entitled A Secretive Banking Elite Rules Trading in Derivatives. That article exposed the steel-fisted control that the too big to fail banks exert over the trading of derivatives. Just consider the following excerpt from the article….On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan.The men share a common goal: to protect the interests of big banks in the vast market for derivatives, 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.So what institutions are represented at these meetings? Well, according to the New York Times, the following banks are involved: JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup.Why do those same five names seem to keep popping up time after time? Sadly, these five banks keep pouring money into the campaigns of politicians that supported the bailouts in 2008 and that they know will bail them out again when the next financial crisis strikes.Those that defend the wild derivatives trading that is going on today claim that Wall Street has accounted for all of the risks and they assume that the issuing banks will always be able to cover all of the derivative contracts that they write.But that is a faulty assumption. Just look at AIG back in 2008. When the housing market collapsed AIG was on the wrong end of a massive number of derivative contracts and it would have gone bust without gigantic bailouts from the federal government. If the bailouts of AIG had not happened, Goldman Sachs and a whole lot of other people would have been left standing there with a whole bunch of worthless paper.It is inevitable that the same thing is going to happen again. Except next time it may be on a much grander scale.When the house goes bust, everybody loses. The governments of the world could step in and try to bail everyone out, but the reality is that when the derivatives market comes totally crashing down there won’t be any government on earth with enough money to put it back together again.A horrible derivatives crisis is coming.It is only a matter of time.Stay alert for any mention of the word derivatives or the term derivatives crisis in the news. When the derivatives crisis arrives, things will start falling apart very rapidly.

Citigroup to Pay Millions to Close Fraud Complaint
By EDWARD WYATT Published: October 19, 2011

WASHINGTON — As the housing market began its collapse, Wall Street firms and sophisticated investors searched for ways to profit. Some of them found an easy method: Stuff a portfolio with risky mortgage-related investments, sell it to unsuspecting customers and bet against it.Citigroup on Wednesday agreed to pay $285 million to settle a civil complaint by the Securities and Exchange Commission that it had defrauded investors who bought just such a deal. The transaction involved a $1 billion portfolio of mortgage-related investments, many of which were handpicked for the portfolio by Citigroup without telling investors of its role or that it had made bets that the investments would fall in value.In the four years since the housing market began its steady descent, securities regulators have settled only two cases related to the financial crisis for a larger sum of money. This is also the third case brought by the S.E.C. accusing a major Wall Street institution of misleading customers about who was putting together a security and about their motive. Goldman Sachs and JPMorgan Chase & Company both settled similar cases last year.The settlement will refund investors with interest and include a $95 million fine — a relative pittance for a giant like Citigroup. On Monday, the company reported that in the third quarter alone it earned profits of $3.8 billion on revenue of $20.8 billion. The settlement may also have trouble getting approval from Jed S. Rakoff, the federal district judge in New York who must ultimately sign off on the fine and who has taken a hard line on S.E.C. settlements.

Neither the S.E.C. nor the Justice Department would say whether the case raised questions about whether Citigroup had been involved in any criminal wrongdoing. But the case highlights a growing frustration felt by foreclosed homeowners, investors and Wall Street protesters alike that few, if any, senior banking executives have faced criminal charges for losses growing out of the financial crisis.Citigroup has settled one case stemming from the crisis. Last year, it agreed to pay $75 million to settle federal claims that it hid from investors vast holdings of subprime mortgage investments that were losing value during the crisis and that ultimately prompted the federal government to rescue the bank.The securities laws demand that investors receive more care and candor than Citigroup provided to investors in the security, said Robert Khuzami, director of the S.E.C.’s enforcement division, referring to Wednesday’s action. Investors were not informed that Citigroup had decided to bet against them and had helped to choose the assets that would determine who won or lost.The complex amalgamation of investments known as Class V Funding III produced $126 million in profits for Citigroup’s brokerage subsidiary, and another $34 million in fees for putting it together. All of that, including interest and the $95 million fine, will now be going back to the investors; the government will not receive anything.In a statement, Citigroup noted that the S.E.C. did not charge it with intentional or reckless misconduct. Rather, it settled charges that its actions were negligent and misleading to investors. Despite its profits on the current deal, over all Citigroup lost tens of billions of dollars on its holdings of mortgage-related investments.We are pleased to put this matter behind us and are focused on contributing to the economic recovery, serving our clients and growing responsibly, the company said in a statement. Since the crisis, we have bolstered our financial strength, overhauled the risk management function, significantly reduced risk on the balance sheet and returned to the basics of banking.

The S.E.C. on Wednesday also brought a case against Credit Suisse, which played a smaller role in the transaction, and against one individual at each company. But those individuals were midlevel employees in each company’s investment and trading departments; no senior executives at either company were charged.Credit Suisse, which managed the portfolio of mortgage bonds that served as collateral for the deal, agreed to pay $2.5 million, half of it in penalties, to settle the case. The company declined to comment.Samir H. Bhatt, 37, a former portfolio manager at Credit Suisse, also agreed to settle, paying no fine but agreeing to a six-month suspension from association with any investment adviser.Only Brian H. Stoker, 40, a former Citigroup employee who was primarily responsible for putting together the deal, has decided to fight the S.E.C.’s case. He left Citigroup in 2008.There is no basis for the S.E.C. to blame Brian Stoker for these alleged disclosure violations, said Fraser L. Hunter Jr., a lawyer at WilmerHale who is representing Mr. Stoker.He was not responsible for any alleged wrongdoing — he did not control or trade the position, did not prepare the disclosures and did not select the assets. We will vigorously defend this lawsuit.Mr. Stoker joined Citigroup at the height of the housing boom in 2005, and worked as a director on the structured product desk. His job tasks were largely behind the scenes, crunching numbers and assembling deals like Class V Funding III.After the deal closed on Feb. 28, 2007, more than 80 percent of the portfolio was downgraded by credit ratings agencies in less than nine months. The security declared an event of default on Nov. 19, 2007, and investors soon lost hundreds of millions of dollars, the S.E.C. said, while Citigroup gained.

Among the losers was Ambac of New York, which insured financial instruments and was the largest investor in the deal, according to the S.E.C. Ambac’s role in the transaction was to assume the credit risk associated with a $500 million portion of the portfolio. When the value of the portfolio fell, Ambac had to make payments to those who had bet against the bonds, as Citigroup had.In part because of losses tied to the financial crisis, Ambac filed for bankruptcy last year.Criminal prosecutions related to the financial crisis have been few. Two former Credit Suisse brokers were sentenced to jail in their roles for misleading clients about purchases and thus inflating their sales commissions. Six executives at a mortgage company, Taylor, Bean & Whitaker, have pleaded guilty in a scheme to issue false mortgages to obtain federal mortgage money and bank bailout funds. Lee B. Farkas, a former chairman of Taylor Bean, was sentenced to 30 years in prison for his role in the case, which resulted in the demise of Colonial Bank of Montgomery, Ala.Those crimes started long before the financial crisis. A prosecution of two former executives of Bear Stearns, the failed investment bank, ended in acquittals.Eric Dash contributed reporting from New York.