If you think the health care debate is a big brouhaha, its nothing compared to the behind the scenes battle over government regulation of derivatives.
On the government side we have a proposal that would require the most standard derivatives to be processed through a clearinghouse, whose members would make good on any default. This is the way the commodity markets operate. For "nonstandardized contracts," banks would have to put up more capital or margin.
On the other side of the table are the big five banks: JPMorgan Chase & Co. (NYSE: JPM), Goldman Sachs (NYSE: GS), Bank of America (NYSE: BAC), Morgan Stanley (NYSE: MS), and Citigroup Inc. (NYSE C).
The stakes in this game are unbelievable and beyond any means of understanding. We are talking about a $592 trillion dollar market ...
The big five banks hold 95% of the $291 trillion in notional derivatives value of the country's 25 largest bank holding companies.
Banks have been using their power to control the derivatives market "under the table." This example will show why placing trades on a clearinghouse would limit their "free money." Here's how it works: According to Bloomberg, "When a company or investor wants to enter into a swap, the bank checks internal pricing sources to determine the cost of making the opposite trade with another bank, which would enable to eliminate any exposure on the trade. Armed with that information, it then offers a higher swap price to the client, allowing the bank to pocket a profit. The prices are measured in basis points, each of which is .01percentage points.
The big five banks have made $35 billion from derivatives trades, including interest rate and CDSs and cash instruments such as treasuries and corporate bonds.
Who will win this poker game? If ever there is an issue that goes to the very core of our financial meltdown, this is it. Make no mistake. How this is resolved will set the course of our financial markets for this and future generations.
Do you believe that the government has the power and the will to follow through on these proposals?
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Reader Comments (Page 1 of 1)
9-01-2009 @ 5:10PM
Iridium said...
I would ask: Who let the derivative market get to $592 trillion in the first place?
How do you essentially create $592 trillion in debt swaps and get away with it?
The CDS should have never been invented. Shame on JP Morgan for creating the concept. I don;t think many people realize that the Credit Default swap was crated in 1997. It isn't an old market tool. It only took on greater importance after the Commodity Futures Modernization Act in 2000. That damn piece of legislation needs to be taken back.
The CDS was created as an insurance policy for banks as a way to protect against the loss of money owed to them in the case of an outright default of a business they lent money to. Within a few short years over $50 trillion in contracts were sold. 3-4 times the value of the entire GDP of the United States was insured against. How could there ever be that much loss? It is impossible.
After the CFMA institutional traders like Goldman Sachs began to speculate in CDS. They made billions underwriting the swaps and coudl make billions more holding swap contracts if the other institutions default. This risk play drove the derivative market to $592 trillion in less than 10 years.
I would bet good money that the 5 big banks hold multiple CDS contracts on every small bank in America. For every small bank that defaults one of the big banks makes billions since they are owed the money written into the swap contract. My bet is that the majority of these are held by Chase and Goldman. That is why Chase absorbed JP Morgan. To get thier hands on JP's CDS book.
If there was a total outright collapse there would be no way to ever repay the derivative contracts. It would be one giant "double default" scenario. The CDS buyer will have no avenue for repayment and will lose the entire value paid for the contract.
This still doesn't get to the root problem of the derivative market. Speculators swap contracts daily to pocket the difference from CDS spreads. It is all fake money. The money never existed since it is just an IOU in case of default. The fake money generated through speculation was then funneled into the broader market creating the massive bubble. Every CDS just created another CDS.
The massive speculation the CFMA of 2000 created gave us Enron, $147 barrel oil, the financial collapse, and $592 trillion worth of outstanding insurance contracts that must be paid in the case of a total collapse.
THIS INSANITY MUST STOP!!!!!! THE STOCK MARKET IS A TOTAL SCAM !!!!!!
9-01-2009 @ 5:55PM
clikdawg said...
Um, er ... the "health care debate bru-ha-ha" is specifically designed to keep our minds off the continuing transfer of wealth into fewer and fewer hands: While we shout "Less Filling!" and "Tastes Great!" at each other over Bam-Bam's "everybody's-covered-and-it-will-actually-SAVE-money" bit of flim-flam, those little electronic digits are whirring like you don' wanna know as your present (and your children's future) dollars are being passed moment-by-moment into the tender keeping of The Big Boys, who know JUST what they wanna do with the proceeds of the theft.
Rule of Thumb #499: Whatever they want us fighting amongst ourselves about at any given moment is definitely NOT what we need to be paying close attention to -- the art of modern governance is contained in the three words, "Misdirection, misdirection, misdirection" ...
9-02-2009 @ 2:18AM
al coholic said...
Whenever I post on Blogging Stocks I feel confident that as a reasonably intelligent person I can usually at least understand the issue being debated.
In this case I just don't get it. Except for greed is there any legitimate reason these CDS's should exist? What would happen if they were outlawed? We obviously managed to have a financial system before they were created.
I'm not sure I even know what the hell derivatives are.