..so even I can understand it…..Bill,
I missed this article from Bloomberg when it was posted on June 27. You have to like the description of derivatives and how the price of derivatives is determined!
QUOTE
www.bloomberg.com/apps/news?pid=20601039&sid=aMbY7RGPEqQo&refer=home
The most stunning aspect of the demise of two hedge funds belonging to Bear Stearns Cos. is the almost total absence of transparency surrounding the bailout.
The debacle may finally provoke regulators, who have long suspected that buying derivatives is akin to running through a fireworks factory with a lighted blowtorch in each hand.
Their focus is likely to fall on how to assign prices to complex derivatives, created by cooking together different flavors of securities whose values are driven by other assets such as stocks, bonds or mortgages.
The efforts by Bear Stearns’s creditors to extricate themselves from their investments have laid bare one of the derivatives market’s dirty little secrets — prices are mostly generated by a confidence trick.
As long as all of the participants keep a straight face when agreeing on a particular value for a security, that’s the price. As soon as someone starts giggling, however, the jig is up, and the bookkeepers might have to confess to a new, lower price.
END
Mark Gilbert has presented this problem in a light-hearted way but the issue is the most serious one on the planet today. It is naïve to think of the $500 Trillion derivatives market as a sideshow, where some silly prices are agreed for obligations that no one has the creditworthiness to back. This is not just an ugly, non-malignant tumor that can be conveniently cut off. This massive financial activity that bets on the outcome of the pricing of the underlying assets has corrupted the system such that those who would be responsible for paying out orders of magnitude more money than they have if the bets go against them are sucked into a black hole of moral and ethical destitution as they have no other choice but to manipulate the price of the underlying assets to prevent financial ruin.
How can a “$500 Trillion dollar anything” not require regulation as Greenspan vehemently preached. The propaganda perpetrated by the FED is that derivatives are magical financial vehicles that allow risk to be efficiently distributed. Risk of what? It is meant to be the risk of unexpected price changes of the underlying assets that is being spread around. But if the entities who are assuming the risk are not able to pay there is no spread of risk, there is just an illusion of the spread of risk, as Bear Stearns has just discovered.
Derivatives may be complex instruments but the concept is simple. They are insurance contracts against something happening. For example, an interest rate derivative is an insurance policy against interest rates going up beyond a certain level. If they do there is a pay-out to the derivative holder. If not, the derivative expires and the holder has paid an insurance premium for nothing. But the real difference with derivatives from insurance is that insurance is usually for very rare events like a house burning down, or a car being stolen. But derivatives are for protection against mundane things happening like interest rates going up, or the gold price going up, or the stock market going down. These are not catastrophic risks that happen infrequently, they WILL happen at some point in time. What is more if a payout event is triggered, unlike when a house burns down, there will not be just a handful of claims on any one day, payouts will be due in the trillions of dollars on the same day. It is the financial equivalent of a hurricane Katrina hitting every US city on the same day!
Instead of stopping this idiotic sham business from growing to galactic proportions, all the authorities, and all the banks, and all the major financial institutions around the world have heralded it as the best thing since sliced bread. But now all these players are complicit in the crime. They are all on the hook. The stakes are now too high. They must manipulate the underlying assets on a daily basis to prevent triggering the payout of a major derivative event.
Derivatives are a bet against volatility. Guess what has happened? Surprise, surprise! Volatility has vanished. The VIX looks like an ECG when the patient has died! Gold has an unofficial $6 rule. The DOW is not allowed to drop more than 200 points and it must rally the following day. Interest rates must not rise, if they do the FED must issue more of their now secret M3, ship it offshore to the Caribbean and pretend that an unknown foreign bank is buying US Treasuries like crazy.
Loading ...
