Wednesday, December 2, 2009


Remember how the derivative market helped get our financial institutions into trouble, and then helped collapse our economy? Well, after handing over trillions of dollars in taxpayer guarantees, loans, and credits to cover the derivative losses of our financial institutions derivatives are making a comeback.

After watching the value of derivative contracts drop to a little over $100 trillion at the end of 2008, our failed financial institutions are writing more derivative contracts than ever. According to the FDIC the total value of derivative contracts has now reached about $135 trillion. To give you an idea of what this means $135 trillion represents almost 10 times what America will buy and sell this year (2009 GDP Forecast for America = $14.26 trillion).

Check out this derivative graph (click on all the graphs to enlarge):

For those of you still having trouble with the concept of a derivative let me make this simple. They are contracts that derive their value from something that hasn't happened yet. I know, I know ... it's still kind of fuzzy. So, think of a scalper who buys tickets and creates a game package.

For example, scalpers who gamble and buy tickets and then rent hotel rooms for this year's Super Bowl are now hoping that the undefeated Colts and undefeated Saints continue the pace all the way to the Big Game. Every football fan will want to be there. But what if things sour for the Colts and the Saints? Let's say that the Houston Texans and the Carolina Panthers somehow stumble their way into the Big Game as 9-7 teams. Guess what? You're probably looking at a loss. You're especially in big trouble if you purchased lots of tickets and rented lots of rooms. But you're really REALLY screwed if you made purchases or made payouts with the anticipated profits from an undefeated Colts-Saints Super Bowl.

In the real world this is what happens when you spend money (make bets) on products (game tickets) that "derive" their value from events that must happen (Colts-Saints going undefeated all the way to the Super Bowl) for a payout.

But big finanical institutions and commerical banks don't live in the real world. They live in an Alice in Wonderland Economy, courtesy of you and me. They have learned that they don't have to worry about being criminally stupid. The American taxpayer will bail them out, with no penalty to alter behavior.

Must be nice.

Today the same commercial banks that helped bring this economic mess upon us are making bets on the direction of interest rate contracts and foreign currencies, once again anticipating big payouts. So what are they banking on, you ask? A couple of things. Here we see they're betting on $188 trillion in foreign currencies and future interest rates.

Let me say this again. Rather than try and make money by lending to small business and entrepreneurs who will create jobs our biggest commerical banks are upping the ante and making trillion dollar bets on the direction of interest rates and other currencies. And they're able to do this because Tim Geithner, Ben Bernanke, and Hank Paulson did not pushing for penalties and new guidelines for our bailed out financial incompetents when we handed them their cash.

As a final insult to the American taxpayer, who financed the banking bailout - and who are now struggling to pay the bills - commerical banks have cut back on consumer credit. They've cut over a trillion dollars in credit card lines over the past year.  Check this graph out ...

Worse - as if it could get worse - among the "derivative contracts" that our financial titans are betting on include the mortgage and credit card debt that you and I are now paying. In a few words, they are betting that you and I will keep paying our bills. They have turned our debt into "debt contracts" that they've bundled together (as CDOs) and sold to one another. They are now betting that we will pay no matter how much they raise interest rates (which they are confident about, in part, because of the 2005 bankruptcy law changes).

So, this is what we have: (1) You provide the reliable and secure debt contracts with your steady mortgage and credit card payments; (2) You provide the taxpayer money to guarantee bailouts on the stupid bets our financial institutions make; and (3) The banks continue betting like the greedy drunken fools that they are with no penalty for past stupidity. What could possibly go wrong?

There's more. Much more. So check out this FDIC site on "Commercial Bank Graphs and Data Points." It's not pretty.

- Mark

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