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Posts tagged ‘derivatives’

Boom Goes The Dynamite: The Crashing Price Of Oil Is Going To Rip The Global Economy To Shreds

f you were waiting for a “black swan event” to come along and devastate the global economy, you don’t have to wait any longer.  As I write this, the price of U.S. oil is sitting at $45.76 a barrel.  It has fallen by more than 60 dollars a barrel since June.  There is only one other time in history when we have seen anything like this happen before.  That was in 2008, just prior to the worst financial crisis since the Great Depression.  But following the financial crisis of 2008, the price of oil rebounded fairly rapidly.  As you will see below, there are very strong reasons to believe that it will not happen this time.  And the longer the price of oil stays this low, the worse our problems are going to get.  At a price of less than $50 a barrel, it is just a matter of time before we see a huge wave of energy company bankruptcies, massive job losses, a junk bond crash followed by a stock market crash, and a crisis in commodity derivatives unlike anything that we have ever seen before.  So let’s hope that a very unlikely miracle happens and the price of oil rebounds substantially in the months ahead.  Because if not, the price of oil is going to absolutely rip the global economy to shreds.

What amazes me is that there are still many economic “experts” in the mainstream media that are proclaiming that the collapse in the price of oil is going to be a good thing for the U.S. economy.

The only precedent that we can compare the current crash to is the oil price collapse of 2008.  You can see both crashes on the chart below…

Boom Goes The Dynamite: The Crashing Price Of Oil Is Going To Rip The Global Economy To Shreds.

Understanding Credit default swaps

In the first video clip toward the end you heard we the taxpayers were taking over approximately 14,000,000,000:00 Billion worth of Derivatives or (CDS) from Anglo Irish Bank  alone!

(I personally believe that that figure to be near the 100,000,000:00 mark)

But most people do not know or understand what exactly these Derivatives are let alone understand them .So in the 2nd video clip you can get a crash course on the basics of CDS.

But the bottom line is Brian Cowen and Brian Lenihan could not possible know what they needed to know before taking on such obligations and there lies’ the crocks of the Irish financial meltdown.

Politicans, experts at waffling are making decision on complex financial instruments, that I have being studying for the last 12 years and still do not fully understand, but I know that they are like financial nuclear bombs and are best Instruments that should be avoided at all costs. They are unregulated and you are buying a pig and a poke.

Here is what Warren Buffet had to say about these unregulated financial tools .

In fielding a question about derivatives, which he once referred to as “financial weapons of mass destruction,” Mr. Buffett told shareholders that he expects derivatives and borrowing, or leverage, would inevitably end in huge losses for many financial participants.

“The introduction of derivatives has totally made any regulation of margin requirements a joke,” said Mr. Buffett, referring to the U.S. government’s rules limiting the amount of borrowed money an investor can apply to each trade. “I believe we may not know where exactly the danger begins and at what point it becomes a super danger. We don’t know when it will end precisely, but…at some point some very unpleasant things will happen in markets.”

Mr. Buffett has expressed similar bearish sentiments about derivatives in previous meetings and in his widely read annual letters to shareholders. He had first-hand experience with the difficulties of derivatives after Berkshire acquired General Re, the reinsurance company, in the late 1990s, and spent several years unwinding its derivatives portfolio at a loss to reduce the subsidiary’s exposure to risk. He noted, however, that Berkshire currently has several dozen derivatives positions — such as futures and options contracts on stock indexes and foreign currencies — and added that “derivatives aren’t evil.”

Charlie Munger, Berkshire’s 83-year-old vice-chairman and Mr. Buffett’s droll sidekick during the six-hour annual meeting, said that the accounting of derivatives contributed to the risks they pose to the financial markets.

“The accounting being deficient enormously contributes to the risk,” said Munger, lamenting that executives and shareholders were getting paid on “profits that don’t exist.”

Mr. Buffett noted that existing accounting conventions allow parties involved in derivative transactions to value the same contract differently, leading to an inadequate or incomplete picture of the contract’s risk. “I will guarantee you, if you add up the marks on both side, they don’t add up to zero,” Mr. Buffett said, referring to the accounting of a single derivative contract.

Exacerbating the problem of derivatives and leverage is the short-term trading mentality and high turnover in the stock and bond markets, Mr. Buffett and Mr. Munger added. “There is an electronic herd of people around the world managing an amazing amount of money” who make decisions based on minute-by-minute stimuli, said Mr. Buffett, adding, “I think it’s a fool’s game.”

Source http://seekingalpha.com/article/34606-buffett-on-derivatives-a-fool-s-game

So what has Cowen and Lenihan gotten us into ?

18 months later!

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Ireland’s leading academics recommend ‘Nationalising banks is the best option’

Date: 17 Apr 2009

The following commentary has been written by a group of Ireland’s leading academic economists, including faculty from UCD Smurfit School: John Cotter, associate professor of finance, Don Bredin, senior lecturer in finance, Elaine Hutson, lecturer in finance and Cal Muckley, lecturer in finance

Published:  Irish Times

Twenty of Ireland’s leading academic economists argue that the Government has got it badly wrong. Nama is not the way to clean up the banking mess created by the property bubble: temporary but full-blooded nationalisation of the banks is the only way

OVER THE last number of months extraordinary changes have occurred in the Irish banking and financial scene. We believe that we are now at a critical stage in Irish economic history and that it is crucial that the Government take the right course of action to deal with the problems in our banking sector.

The banking system is widely perceived to have seized in terms of lending, and whether correct or not this perception needs to be addressed. We believe that the correct action to take now is nationalisation of the banking system, or at least that part of it that is of systemic importance.

We do not make this recommendation from any ideological position. In normal circumstances, none of us would recommend a nationalised banking system. However, these are far from normal times and we believe that in the current circumstances, nationalisation has become the best option open to the Government.

Furthermore, we explicitly recommend nationalisation only as a temporary measure. Once cleaned up, recapitalised, reorganised with new managerial structures, and potentially rebranded, we recommend that the banks be returned to private ownership.

In introducing its proposals for the National Asset Management Agency (Nama), Government Ministers and Peter Bacon, the consultant who recommended this plan to the Government, have stressed that they see their current plan as likely to produce a superior outcome to nationalisation (though they concede that majority State ownership may be required).

We disagree strongly. We see nationalisation as being the inevitable consequence of a required recapitalisation of the banks done on terms that are fair for the taxpayer.

We can summarise our arguments in favour of nationalisation, and against the Government’s current approach of limited recapitalisation and the introduction of an asset management agency, under four headings. We consider that nationalisation will better protect taxpayers’ interests, produce a more efficient and longer lasting solution to our banking problems, be more transparent in relation to pricing of distressed assets, and be far more likely to produce a banking system free from the toxic reputation that our current financial institutions have deservedly earned.

PROTECTING THE TAXPAYER

Our banks have made an enormous quantity of bad loans, mainly to property developers, and realisation of these losses will see a substantial erosion of their capital base. International financial regulations require that banks maintain certain levels of capital to be allowed to stay in business.

In addition, as the recession mounts, so too will bad debts in consumer and other commercial loans, and so our banks need outside capital investment to make up the losses on these loans. The highest grade, and most desirable, form of capital is ordinary share capital, and in the current circumstances the Irish Government is the only conceivable investor willing to provide this capital.

The Government has put forward Nama as a vehicle to take these bad loans off the banks at a discounted rate. To the extent that the realisation of losses on these loans erodes the capital position of the banks, the Government has indicated that it is willing to supply equity capital in return for shares.

Crucially, however, the Government’s current descriptions of the range of outcomes from this process suggest that they are badly underestimating the scale of losses at our banks, and as such may end up substantially overpaying for bad assets.

Take our two leading banks, AIB and Bank of Ireland. Analysts have repeatedly estimated the extent of bad loans at these banks to be of the order of at least €20 billion. Losses of this sort would wipe out virtually the entire €27 billion of Tier 1 capital of these banks. This means that if the Government purchases these loans at fair market value, it will end up having to provide funds to replenish fully the equity capital of these banks and, in consequence, would end up with essentially full ownership of these banks.

There is thus a fundamental internal contradiction in the Government’s current position. The Government is claiming that it can simultaneously: (a) purchase the bad loans at a discount reflecting their true market value; (b) keep the banks well or adequately capitalised; and (c) keep them out of State ownership.

These three outcomes are simply mutually incompatible, and we are greatly concerned that the Nama process may operate to maintain the appearance that all three objectives have been achieved by failing to meet the first requirement. This would arise if Nama purchases the bad loans at a discount – but still well above market value.

With €90 billion in loans to be purchased, the consequences to the taxpayer of overpaying for bad assets by 10 to 30 per cent are truly appalling. To put these figures in perspective, the effect in a full year of the Budget measures taken last week was to save the exchequer €5 billion.

Peter Bacon and others have argued in recent days that the question of who owns the banks does not matter, because the ownership structure does not change the underlying size of loan losses. Frankly, this is argumentation by distraction.

Nobody is claiming that nationalisation changes the underlying loan losses on the bank balance sheets. However, what it does change is who owns the equity and also who has first claim on any increase in value in the new banks after they have been recapitalised. If nationalised, the taxpayer stands to get a return on their equity investment after the banks have been sold into private hands in a few years’ time, and this would substantially reduce the underlying cost to the taxpayer.

Furthermore, nationalisation offers an opportunity, should the Government see such a need, to share directly with the taxpayers the upside in restoring banking sector health. Such an opportunity could involve a voucher-style reprivatisation of the banks and could be used to provide economic stimulus at a time of scarce resources, at no new cost to the exchequer.

A MORE LASTING SOLUTION

With the Nama process charged with meeting the three mutually contradictory objectives above, it is also possible that objective (b), recapitalising, will not be fully met. In other words, a Government that needs to be seen to purchase the bad assets at a reasonable discount and that does not want to take too high an ownership share may end up skimping on the size of the recapitalisation programme. Thus, rather than create fully healthy banks capable of functioning without help from the State, this process may continue to leave us with zombie banks that still require the State-sponsored life-support machine that is the liability guarantee.

However, once nationalised and with the promise of future returns for the State, the incentive for the Government will be to create well-capitalised healthy banks that can be privatised and allowed to operate independently from the State, as quickly as possible. We believe that full nationalisation now will end up getting the State out of its involvement in the banking business faster than the current approach being taken by the Government.

In contrast, a circumstance where a drip-feed of recapitalisations is required would be the worst of all possible outcomes.

TRANSPARENCY

Peter Bacon and Government Ministers have stressed that it is necessary to keep the banks out of public hands so that the process is a transparent one.

The truth is exactly the opposite.

Every additional euro that the State pays for bad assets is an additional euro for the current bank capital holders and one euro less of valuable equity investment for the State. For this reason, the process by which Nama purchases the bad assets is going to be an extremely controversial one. Already, analysts are citing ranges from 15 per cent to 50 per cent as appropriate for the discount on these loans.

However the Government decides to price these assets, whether it be via accountancy firms, auctioneers or economic consultants, the process is going to have an element of arbitrariness to it and is unlikely to be one that will be widely seen as fair and transparent.

By contrast, nationalisation per se requires no such controversial asset-pricing process. Nationalisation can still involve a Nama, if the Government believes that reprivatisation of the banks would proceed best if certain of the most toxic and compromised assets have to be taken off the bank books altogether rather than just written down to market price.

However, the valuation process in this case would cease to be controversial, as the Government would own both the Nama and the banks, so the price would hardly matter. The Swedish bad bank experience (widely mis-reported in this country) involved an asset valuation board that set the price for assets transferred from nationalised banks, but the process was not a controversial one.

A related argument that Government officials have made against nationalisation is that it would remove the stock market listing and market monitoring function, rendering opaque the quality of the State-owned banks. However, the experience of recent years is one that would have to cast doubt on the ability of markets to effectively monitor financial institutions.

TOXIC REPUTATIONS

The Government’s plans seem likely to keep in place the current management at our biggest banks.

For instance, the smaller discounts on bad loans being cited would, if paid, likely allow Bank of Ireland to maintain its recent levels of equity capital without taking more funds from the Government than the €3.5 billion it has already taken (in return for preference shares which give an option for a 25 per cent State share.)

This type of incremental change will do little to restore the battered reputation of Irish banking. It would be difficult to avoid claims of crony capitalism and golden circles were billions of State monies to be placed into the banks with minimal changes in their governance structure.

Nationalisation provides the opportunity for a fresh start for Irish banking. The State should run the temporarily nationalised banks as independent semi-State operations headed by highly independent boards of senior figures of the utmost integrity. Executives for these banks should be sourced through an international search, and remunerated accordingly.

These executive boards should be charged with a clear mandate to improve risk management practices, restore the brand image of Irish banking and finance, and return the banks to private ownership in a reasonably short time frame, for as high a stock price as possible.

This would certainly see substantial changes in senior management and board members in these banks, and allow for a rebuilding of the reputational capital of these institutions.

To conclude, we consider that the Government’s approach of limited recapitalisation supplemented by Nama represents only a partial solution to our banking problems, and one that is unlikely to protect the taxpayer. A nationalised banking system with a mandate to restructure and reprivatise would be a preferable approach at this time.

List of signatories

This commentary has been written by a group of Ireland’s leading academic economists, several of whom have analysed and commented on the banking and financial crisis on these pages and elsewhere over the past year. They are:

Karl Whelan, professor of economics, dept of economics, UCD; John Cotter, associate professor of finance, Smurfit School, UCD; Don Bredin, senior lecturer in finance, Smurfit School, UCD; Elaine Hutson, lecturer in finance, Smurfit School, UCD; Cal Muckley, lecturer in finance, Smurfit School, UCD; Shane Whelan, senior lecturer in actuarial studies, school of mathematics, UCD; Kevin O’Rourke, professor of economics, Trinity College Dublin; Frank Barry, professor of international business and development, school of business, Trinity College Dublin; Pearse Colbert, professor of accounting, school of business, Trinity College Dublin; Brian Lucey, associate professor of finance, school of business, Trinity College Dublin; Patrick McCabe, senior lecturer in accounting, school of business, Trinity College Dublin; Alex Sevic, lecturer in finance, school of business, Trinity College Dublin; Constantin Gurdgiev, lecturer in finance, school of business, Trinity College Dublin; Valerio Poti, lecturer in finance, DCU business school; Jennifer Berrill, lecturer in finance, DCU business school; Ciarán Mac an Bhaird, lecturer in finance, Fiontar, DCU; Gregory Connor, professor of finance, department of economics, finance and accounting, NUI Maynooth; Rowena Pecchenino, professor of economics, department of economics, finance and accounting, NUI Maynooth; James Deegan, professor of economics, Kemmy School of Business, Limerick; and Cormac Ó Gráda, professor of economics, UCD

source http://www.smurfitschool.ie/aboutsmurfit/news/newsarchive/title,31429,en.html

Comment:

It’s hard to believe but it is now 18 months since these academic economists called for the government to do what I would have thought was the most obvious route to go regarding the Banking crises

18 months later we see these people were right all along!

On the 01.10.2010 the Irish government has effectively nationalized 85% of the banking system and has wasted billions by not taking the advice of these leading academic economists. In fact it has emerged the two Brian’s have wasted millions on advice from international firms like Morgan Stanley only then to ignore it

In the video clip above we hear about Derivatives and a possible 14,000,000,000:00 exposure

For  the last 18 months I have consistently tried to expose  these losses and I must now conclude that 14 billion is far short of the eventual figure, baring in mind what has emerged since the video was first shown across our TV screens

I suspect that the eventual figure is many times this figure and could be up to 100,000,000,000:00

This Derivative market has collapsed with the bankruptcy of AIG in the US

and there is no sure way in valuing these particular financial toxic tools

there is no market so there is no value !

Last Friday in the irish Times I picked up this article and it appears we are taking on another 200 billion in Bank debts??Doc132010  (last paragraph) are these the derivate losses I am talking about?

The banks are continuing to hide these huge losses and the government is colluding with the banks with this fraud!

We are saddled with an obviously incompetent corrupt Government hell-bent on clinging to power at all , and any cost to the Irish people. We as a people must stand up and challenge these economic terrorists any way we can. It’s time the people had their say

We need a general election.

NAMA and its derivative trading

NAMA and its first Quarterly accounts  ACCOUNTS NAMA    PDF Doc  
I have been warning for the last 18 months that the Banks were hiding losses in their derivative trades .I then showed that NAMA was also intending to deal in derivatives.
I have not had any luck getting any comments from any of the political parties (including the Labour party)
I now feel vindicated as the first public accounts from NAMA clearly show losses stemming from
Derivative trades of which they are holding approx 16 Billion euro worth!
So now we know that NAMA are also dealing in Derivatives and are doing no better that the banks were
I predict a total loss in all of this kind of trading activity!
Cowen and Lenihan should be taken out and S*** for this fraud on the Irish people

Derivatives ???


NEW YORK (Reuters) – Warren Buffett’s Berkshire Hathaway Inc said fourth-quarter profit surged, helped by derivatives bets tied to global stock markets, though operating profit fell 40 percent as the weakened economy weighed on several businesses.

Profit rose for a third straight quarter, and full-year profit increased 61 percent, as Berkshire rebounded from perhaps its worst year since Buffett took over in 1965.

“I was quite impressed with the results,” said Vahan Janjigian, author of the book “Even Buffett Isn’t Perfect.”

“It is clearly suffering from the economic recession we have been in, but compared with most other companies involved in similar businesses, it is doing quite well,” he added.

In his annual letter to Berkshire shareholders, Buffett admitted that Berkshire’s ability to outperform that benchmark “has shrunk dramatically,” and that “our future advantage, if any, will be a small fraction of our historical edge.”

Net worth per share, which measures assets minus liabilities and is a key metric for Buffett, rose 19.8 percent, compared with a 9.6 percent drop a year earlier.

Still that lagged a 26.5 percent gain including dividends for the Standard & Poor’s 500, the first time it trailed since 2004. Berkshire’s net worth per share is up 20.3 percent annually since 1965, while the S&P 500 is up 9.3 percent. Total book value rose to $131.1 billion from $109.27 billion.

full story link

http://www.reuters.com/article/idUSTRE61Q1IF20100227?loomia_ow=t0:s0:a49:g43:r5:c0.100000:b31169752:z0

Have helped warren buffet to come in with substantial profits as fourth-quarter profits surged, helped by derivatives bets tied to global stock markets, though operating profit fell 40 percent as the weakened economy weighed on several businesses.
Profit rose for a third straight quarter, and full-year profit increased 61 percent, as Berkshire rebounded from perhaps its worst year since Buffett took over in 1965.

 

Derivatives have been the driving force for the enormous profits enjoyed by the major banks in the US in the last quarter as well

Now we see even Buffet is using them!

But on real economic activity nothing doing we are still in the dole drums and the only way the banks are going to give an encore with regards to their profits going forward is to keep using even bigger and riskier Derivatives bets

In other words “Gambling” all over again!

They will have to engineer another bubble and the stock market in the obvious choice so expect a massive turn in the markets soon

Place your bets here now!

Wall St. Helped to Mask Debt Fuelling Europe’s Crisis

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting.

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

It had worked before. In 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means.

Athens did not pursue the latest Goldman proposal, but with Greece groaning under the weight of its debts and with its richer neighbors vowing to come to its aid, the deals over the last decade are raising questions about Wall Street’s role in the world’s latest financial drama.

As in the American subprime crisis and the implosion of the American International Group, financial derivatives played a role in the run-up of Greek debt. Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere.

In dozens of deals across the Continent, banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Greece, for example, traded away the rights to airport fees and lottery proceeds in years to come.

Critics say that such deals, because they are not recorded as loans, mislead investors and regulators about the depth of a country’s liabilities.

Some of the Greek deals were named after figures in Greek mythology. One of them, for instance, was called Aeolos, after the god of the winds.

The crisis in Greece poses the most significant challenge yet to Europe’s common currency, the euro, and the Continent’s goal of economic unity. The country is, in the argot of banking, too big to be allowed to fail. Greece owes the world $300 billion, and major banks are on the hook for much of that debt. A default would reverberate around the globe.

A spokeswoman for the Greek finance ministry said the government had met with many banks in recent months and had not committed to any bank’s offers. All debt financings “are conducted in an effort of transparency,” she said. Goldman and JPMorgan declined to comment.

While Wall Street’s handiwork in Europe has received little attention on this side of the Atlantic, it has been sharply criticized in Greece and in magazines like Der Spiegel in Germany.

“Politicians want to pass the ball forward, and if a banker can show them a way to pass a problem to the future, they will fall for it,” said Gikas A. Hardouvelis, an economist and former government official who helped write a recent report on Greece’s accounting policies.

Wall Street did not create Europe’s debt problem. But bankers enabled Greece and others to borrow beyond their means, in deals that were perfectly legal. Few rules govern how nations can borrow the money they need for expenses like the military and health care. The market for sovereign debt — the Wall Street term for loans to governments — is as unfettered as it is vast.

“If a government wants to cheat, it can cheat,” said Garry Schinasi, a veteran of the International Monetary Fund’s capital markets surveillance unit, which monitors vulnerability in global capital markets.

Banks eagerly exploited what was, for them, a highly lucrative symbiosis with free-spending governments. While Greece did not take advantage of Goldman’s proposal in November 2009, it had paid the bank about $300 million in fees for arranging the 2001 transaction, according to several bankers familiar with the deal.

Such derivatives, which are not openly documented or disclosed, add to the uncertainty over how deep the troubles go in Greece and which other governments might have used similar off-balance sheet accounting.

The tide of fear is now washing over other economically troubled countries on the periphery of Europe, making it more expensive for Italy, Spain and Portugal to borrow.

For all the benefits of uniting Europe with one currency, the birth of the euro came with an original sin: countries like Italy and Greece entered the monetary union with bigger deficits than the ones permitted under the treaty that created the currency. Rather than raise taxes or reduce spending, however, these governments artificially reduced their deficits with derivatives.

Derivatives do not have to be sinister. The 2001 transaction involved a type of derivative known as a swap. One such instrument, called an interest-rate swap, can help companies and countries cope with swings in their borrowing costs by exchanging fixed-rate payments for floating-rate ones, or vice versa. Another kind, a currency swap, can minimize the impact of volatile foreign exchange rates.

But with the help of JPMorgan, Italy was able to do more than that. Despite persistently high deficits, a 1996 derivative helped bring Italy’s budget into line by swapping currency with JPMorgan at a favorable exchange rate, effectively putting more money in the government’s hands. In return, Italy committed to future payments that were not booked as liabilities.

“Derivatives are a very useful instrument,” said Gustavo Piga, an economics professor who wrote a report for the Council on Foreign Relations on the Italian transaction. “They just become bad if they’re used to window-dress accounts.”

In Greece, the financial wizardry went even further. In what amounted to a garage sale on a national scale, Greek officials essentially mortgaged the country’s airports and highways to raise much-needed money.

Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics.

These kinds of deals have been controversial within government circles for years. As far back as 2000, European finance ministers fiercely debated whether derivative deals used for creative accounting should be disclosed.

The answer was no. But in 2002, accounting disclosure was required for many entities like Aeolos and Ariadne that did not appear on nations’ balance sheets, prompting governments to restate such deals as loans rather than sales.

Still, as recently as 2008, Eurostat, the European Union‘s statistics agency, reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”

While such accounting gimmicks may be beneficial in the short run, over time they can prove disastrous.

George Alogoskoufis, who became Greece’s finance minister in a political party shift after the Goldman deal, criticized the transaction in the Parliament in 2005. The deal, Mr. Alogoskoufis argued, would saddle the government with big payments to Goldman until 2019.

Mr. Alogoskoufis, who stepped down a year ago, said in an e-mail message last week that Goldman later agreed to reconfigure the deal “to restore its good will with the republic.” He said the new design was better for Greece than the old one.

In 2005, Goldman sold the interest rate swap to the National Bank of Greece, the country’s largest bank, according to two people briefed on the transaction.

In 2008, Goldman helped the bank put the swap into a legal entity called Titlos. But the bank retained the bonds that Titlos issued, according to Dealogic, a financial research firm, for use as collateral to borrow even more from the European Central Bank.

Edward Manchester, a senior vice president at the Moody’s credit rating agency, said the deal would ultimately be a money-loser for Greece because of its long-term payment obligations.

Referring to the Titlos swap with the government of Greece, he said: “This swap is always going to be unprofitable for the Greek government.”

source  http://www.nytimes.com/2010/02/14/business/global/14debt.html?pagewanted=2

The Derivatives bubble

 

 


 

Derivatives have grew into a massive bubble, some USD
1,144 Trillion
by 2007. The new derivatives bubble was fuelled by five key economic and political trends:

  1. Sarbanes-Oxley increased corporate disclosures and government oversight
  2. Federal Reserve’s cheap money policies created the subprime-housing boom
  3. War budgets burdened the U.S. Treasury and future entitlements programs
  4. Trade deficits with China and others destroyed the value of the U.S. dollar
  5. Oil and commodity rich nations demanding equity payments rather than debt

In short, despite Buffett’s clear warnings,”
in my view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

That warning was in Buffett’s 2002 letter to Berkshire shareholders. He saw a future that many others chose to ignore. On Buffett’s mind also was His acquisition of General Re four years earlier, about the time the Long-Term Capital Management hedge fund almost killed the global monetary system. How? This is crucial: LTCM nearly killed the system with a relatively small $5 billion trading loss. Peanuts compared with the hundreds of billions of dollars of subprime-credit write-offs now making Wall Street’s big shots look like amateurs. Buffett tried to sell off Gen Re’s derivatives group. No buyers. Unwinding it was costly, but led to his warning that derivatives are a “financial weapon of mass destruction.”


A massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession. In five years comes from the most recent survey by the Bank of International Settlements, the world’s clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier’s window at a racetrack or casino, where you’d place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.

To grasp how significant this bubble is let’s look at these numbers

U.S. annual gross domestic product is about $15 trillion

  • U.S. money supply is also about $15 trillion
  • Current proposed U.S. federal budget is $3 trillion
    • U.S. government’s maximum legal debt is $9 trillion
    • U.S. mutual fund companies manage about $12 trillion
    • World’s GDPs for all nations is approximately $50 trillion
    • Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
    • Total value of the world’s real estate is estimated at about $75 trillion
    • Total value of world’s stock and bond markets is more than $100 trillion
    • BIS valuation of world’s derivatives back in 2002 was about $100 trillion
    • BIS 2007 valuation of the world’s derivatives is now a whopping $516 trillion

Moreover, the folks at http://www.bis.org/statistics/derstats.htm
BIS tell me their estimate of $516 trillion only includes “transactions in which a major private dealer (bank) is involved on at least one side of the transaction,” but doesn’t include private deals between two “non-reporting entities.” They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average.

Also, keep in mind that while the $516Trillion “notional” value (maximum in case of a meltdown) of the deals is a good measure of the market’s size, the 2007 BIS study notes that the $11 trillion “gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets.”


The fact is, derivatives have become the world’s biggest “black market,” exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations. And in today’s slowdown, plus a volatile global market, Wall Street knows derivatives remain a lucrative business.

Recently Pimco’s bond fund king Bill Gross said “What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.” In short, not only Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America’s leaders can’t “figure out” the world’s USD .1,144 Trillion $ derivatives.(see below)

BIS is primarily a records-keeper, a toothless tiger that merely collects data giving a legitimacy and false sense of security to this chaotic “shadow banking system” that has become the world’s biggest “black market?”

Here are some of the types of derivatives that are out there.

Have you ever heard of them?

Chances are your local bank manager hasn’t either!

But I bet his Head office has a few slick traders that are trading these on a Daly bases and I’m

Pretty sure that they must be in it up to their necks!

  • Foreign exchange contracts
  • Listed credit derivatives
  • OTC ( over the counter)
  • Forwards and forex swaps
  •  Currency swaps
  • Options on Interest rate contracts
  • Forward rate agreements
  • Interest rate swaps
  • Options on
    Equity-linked contracts
  • Forwards and swaps
  • Options on Gold & Other commodities
  • Credit default swaps
  • Single-name instruments
  • Multi-name instruments
  • Unallocated instruments
  • CDS (credit default swaps)
    CDSs are derivatives whose cost is determined using financial models and by arbitrage relationships with other credit market instruments such as loans and bonds from the same ‘Reference Entity’ to which the CDS contract refers

     

  • ABS (asset-backed securities)
  • MBS (mortgage-backed securities)
  • OTC derivatives
  • Futures

    To name but a few!

  •  According to various distinguished sources including the Bank for International Settlements (BIS) in Basel, Switzerland — the central bankers’ bank — the amount of outstanding derivatives worldwide as of December 2007 crossed USD 1.144 Quadrillion, ie, USD 1,144 Trillion. The main categories of the USD 1.144 Quadrillion derivatives market were the following:

  • 1. Listed credit derivatives stood at USD 548 trillion;

    2. The Over-The-Counter (OTC) derivatives stood in notional or face value at USD 596 trillion and included:

    a. Interest Rate Derivatives at about USD 393+ trillion;

    b. Credit Default Swaps at about USD 58+ trillion;

    c. Foreign Exchange Derivatives at about USD 56+ trillion;

    d. Commodity Derivatives at about USD 9 trillion;

    e. Equity Linked Derivatives at about USD 8.5 trillion; and

    f. Unallocated Derivatives at about USD 71+ trillion.

 

For a more indebt information on the latest actual derivative figures please follow this link

It makes very interesting reading

Link  http://www.bis.org/statistics/derstats.htm

Source http://www.elliottwavetechnology.com

Tom Foremski at http://www.siliconvalleywatcher.com/mt/archives/2008/10/the_size_of_der.php

Russian-Roulette

 

Let’s consider a well publicized recent sale of Russian gold bullion to itself:

I noticed this article to-day by Rob Kirby

And it is a very worrying development indeed!


Russia sells gold to itself

December 14, 2009 3:47pm by Emma Saunders

The Russian central bank data table appended below is the World Gold Council. It states that Russia possesses 607 [actually, now officially 640 tonnes with the addition of the recent 30-ish tonne purchase from itself] metric tonnes of gold bullion.
will spend $1bn next week, buying 30 metric tons of gold from Gokhran, the state repository. Gokhran had planned to sell 20-50 MT on the open market, but cancelled after news of the sale leaked. The sale would have helped plug Russia’s budget deficit, and, apparently, purchase some diamonds from state-run miner Alrosa….

Does this not strike you as being odd?

In case you missed it, Russia announced that they are selling gold to THEMSELVES!?!?

The source of the gold

The revelation that Russia is “selling gold to itself” and lack of acknowledgment that Gokhran exists – is a MAJOR omission by the World Gold Council in their aggregate gold bullion data.


++Additionally, the World Gold Council also reports that as of October 2009, gold exchange-traded funds held 1,750 tonnes of gold for private and institutional investors.

The World Gold Council’s data keeper is GFMS Ltd. The GFMS web site makes the following claim:

GFMS is the world’s foremost precious metals consultancy, specializing in research into the global gold, silver, platinum and palladium markets.

GFMS is based in London, UK, but has representation in Australia, India, China, Germany, France, Spain and Russia, and a vast range of contacts and associates across the world.

Our research team of fifteen full-time analysts comprises qualified and experienced economists and geologists; while two consultants contribute insights on important regional markets.

Executive Chairman Philip Klapwijk and CEO Paul Walker appear regularly at international conferences and seminars, and their articles have been widely published. All analysts travel regularly and extensively to stay in touch with GFMS’ unrivalled network of contacts and sources of information around the world.

With 15 full-time analysts, two consultants and “representation” in Russia – how is that GFMS [and by extension the World Gold Council] can omit such a large hoard as stored at Gokhran and materially misreport the nature of Russian gold reserves? They didn’t even mention the existence of Gokhran in a footnote.

Gold professionals who have been inside Gokhran [Russian] State bullion depositories have provided me with personal accounts of this bullion depository. They report scenes reminiscent of the movie Gold Finger – on steroids – literally countless metric tonnes of neatly stacked gold bullion.

So, a better question might be, what else – regarding GOLD – has GFMS and the World Gold Council not reported or omitted?

Getting A Beat On Where the World’s Physical Gold Is Stored

It is generally accepted that for the entirety of mankind’s existence on this planet – the earth’s crust has yielded roughly 160 thousand metric tonnes of gold. The World Gold Council / GFMS identifies where roughly 32 thousand tonnes of that total are located.

We might add to what’s listed above, the following:

“No one knows exactly how much gold has been passed from generation to generation and is now stashed in safe deposit boxes across India. But bullion analysts estimate Indian families are sitting on about 15,000 tonnes of gold worth more than $US550 billion ($A600 billion).”

Then, if we conservatively assume that the rest of the world has as much as India stored away in safe deposit boxes – that’s another 15,000 metric tonnes.

Therefore by using reported World Gold Council / GFMS data plus some very conservative assumptions, we can approximately account for 62,000 metric tonnes of the world’s roughly 160,000 metric tonnes ever mined.

By the process of elimination and adjusting for the 62 thousand metric tonnes referenced above, there is a residual 98 thousand metric tonnes of physical gold bullion; the location of which cannot be readily identified.

The very nature of World Gold Council / GFMS data may be characterized as being static and don’t tend to change much year-over-year. This demonstrates that the owners of gold bullion DO NOT GENERALLY
TRADE THEIR PHYSICAL STASHES
– they sit on them!

The Conundrum That “IS” the London Bullion Market Association [LBMA]

The LBMA is considered to be the world’s foremost physical gold market. Here is their data on the number of ounces of gold “transferred” DAILY – by month, year-over-year – from Nov. 08 – Nov. 09:

Month Millions of Ounces Transferred / Day
Dec 08 17.5
Jan 09 18.8
Feb 09 23.8
Mar 09 22.2
Apr 09 20.5
May 09 21.9
Jun 09 20.5
Jul 09 17.7
Aug 09 16.4
Sep 09 20.6
Oct 09 20.8
Nov 09 21.5
Total 242.2

There are 22 business days per month, so the LBMA claims to have traded 151,046 metric tonnes of gold in the most recent 12 month period.

242.2
x
22 = 5,328 million physical ozs or 151,046 metric tonnes

The LBMA reports that they have “transferred” or traded 151,046 metric tonnes of gold – a commodity that when folks possess it, they are demonstrably inclined NOT TO trade it. Using another bench mark, annual global mine production is in the neighborhood of 2,500 metric tonnes. The LBMA claims to have sold last year’s global mine supply over 60 times in 12 months.

The LBMA claims to do this year-in, year-out.

This implies that ANY LBMA physical gold stocks are HIGHLY LEVERAGED through trade in paper gold

London is but one exchange where gold trades. Others include N.Y., Tokyo, Dubai, Bombay and different points in China. Don’t forget, physical ounces traded on ANY of these exchanges are additional ounces that London cannot be trading.

The reality is that every physical ounce of gold reported to be in the vaults of the LBMA and exchanges in general, is sold tens and perhaps more than a hundred times over in paper form. This paper selling suppresses what would otherwise be the freemarket gold price.

The Russians are known to be very shrewd and calculating. It makes one wonder whether the Russian announcement of a sale of gold bullion – TO THEMSELVES – might not have been a “tell” signaling their intention to not only withhold physical metal from the market and ensure that paper promises of delivery of real metal are honored.

Could it be that the Russians are really signaling that the assignment of false, arbitrary values [using futures / derivatives] to finite resources will no longer be tolerated?

If so, the real leverage is in owning physical gold bullion – not the paper promises.

The Elephant In The Room

More Pieces of the Puzzle 

by Rob Kirby | August 4, 2009


This following article was an address by Rob Kirby at the Gold Anti-Trust Action Committee Inc., GATA Goes to Washington — Anybody Seen Our Gold?, at the Hyatt Regency Crystal City Hotel, Arlington, Virginia, Saturday, April 19, 2008. The original address has been updated and added to since new information has come to light.

My name is Rob Kirby – proprietor of Kirbyanalytics.com, proud GATA supporter and frequent contributor to Bill Murphy’s LeMetropolecafe.com. I would like to extend a warm welcome to GATA delegates from all over the world to Washington, D.C.

I’d like to delve into the numbers, or math, showing how J.P. Morgan’s derivatives book cannot be ‘hedged’.

As per their call reports filed with the Comptroller of the Currency’s Office, we know J.P. Morgan’s derivatives book grew by a cancerous 12 Trillion from June 07 to Sept. 07. The OCC’s Quarterly Derivatives Report serves as the public’s only peek into the opaque and murky world of derivatives-flim-flammery.

Flim Flammery is the understatement of the century. In fact, dealer notionals have EXPLODED parabolic-ally in recent years while END USER demand has been static and virtually non-existent.

 

J.P. Morgan’s derivatives book is epitomized by the chart above; it clearly serves no observable or commercially productive purpose, it’s pyramidal in structure and its elephant-sized interest rates derivative composition exerts pressure on the global interest rate complex.

Let’s look at the composition of their book:

 

We’re shown that 65 %, or, 61.5 Trillion of the total is IRS [on page 22 of 32].

Hedging Mechanics of Interest Rate Swaps > 3 yrs. Duration

Interest rate swaps > 3 yrs. in duration customarily trade as a “spread” – expressed in basis points – over the current yield of a corresponding benchmark government bond. That is to say, for example, 5 year interest rate swaps [IRS] might be quoted in the market place as 80 – 85 over. This means that the 5 yr. swap is “bid” at 80 basis points over the 5 yr. government bond yield and it is “offered” at 85 basis points over the 5 year government bond yield. Let’s assume that 5 year government bonds are yielding 1.90 % and the two counterparties in question consummate a trade for 25 million notional at a spread of 84 basis points over. Here are the mechanics of what happens: The payer of fixed rate pays [1.90 % + 84 basis points =] 2.74 % annually on 25 million for 5 years. The other side of the trade – the floating rate payer – pays 3 month Libor on 25 million notional, reset quarterly – typically compounding successive floating rate payments at successive 3 month Libor rates so that actual cash exchanges are settled “net” annually. To ensure that the trade remains a “true spread trade” [and not a naked spec. on rates] and to confirm that 1.90 % is a true measure of where current 5 year government bond yields really are – the payer of the fixed rate actually buys 25 million worth of physical 5 year government bonds – at a price exactly equal to 1.90 % – from the receiver of the fixed rate at the front end of the trade. So, in this regard, we can say that 25 million IRS traded on a spread basis creates a “need” for 25 million worth of 5 year government bonds – because it has a 5 year bond trade of 25 million embedded in it.

  • Interest rate swaps of duration < 3 years are typically hedged with strips of 3 month Eurodollar futures instead of government bonds.

In recent years the Chicago Mercantile Exchange [or CME] has developed an interest rate swap – futures based hedging product for the 5 and 10 year terms. I acknowledge the existence of these products but due to their 200k contract size and amounts traded, as reported in archived CME volume data, they do not materially impact the numbers in this presentation.

As demonstrated, Interest Rate Swaps create demand for bonds because bond trades are implicitly embedded in these transactions. Without end user demand for the product – trading for “trading sake” creates ARTIFICIAL demand for bonds. This manipulates rates lower than they otherwise would be.

I learned these basics – first hand – over 15 years as a broker in Capital Markets. My largest client at that time was Citibank Canada – who pioneered these instruments for Citibank worldwide. For the bulk of the 1980’s, Citibank Canada was the largest interest rate derivatives player in the world.

Here’s the breakdown of 12 Trillion in derivatives growth in 3 months:

 

65 % of 12 Trillion, or, 7.8 Trillion of it is Interest Rate Swaps

35 % of 7.8 Trillion, or, 2.73 Trillion requires bond hedges

2.73 Trillion / 66 days per quarter = 41.4 billion in bonds per day

Here’s the math showing that 35 % of interest rate swaps require bond hedges:

 

So, in the latest quarter it took 41.4 billion in bonds per day JUST TO SATISFY HEDGING OF THE GROWTH in their SWAP BOOK.

The existing book minus the growth, or 80 Trillion, – 52 Trillion of that is IRS. 65 % of the 52 Trillion figure – 33.8 Trillion – matures in 3 yrs. or less with the lion’s share of that in under1 year as you can see here:

 

Assume a conservative average maturity of 18 months [6 quarters] then one sixth of 33.8 Trillion, or 5.63 Trillion worth of Swaps roll off and need to be replaced every 3 months.

35 % of 5.63 Trillion, or 2 Trillion, required bond hedges to keep the book static.
 
2 Trillion / 66 days = another 30.3 billion bonds required per day.

So, In Aggregate: J.P. Morgan required more than 71.7 billion worth of bonds each business day – from Jun. 30 to Sept. 30 / 07 – JUST FOR THEIR SWAP BOOK – if it is hedged.

Some, like the OCC themselves, might argue that ‘netting’ – or balancing short against long internally within J.P. Morgan’s book – reduces the amount of bonds required to hedge. Over time netting would have some effect – but “netting” generally occurs at day’s end. This math does not even work intra-day:

According to the U.S. Treasury:

“During the July – September 2007 quarter, Treasury borrowed $105 billion of net marketable debt….”

J.P. Morgan is but one of 20 primary dealers of U.S. treasury securities.

50 % of all Treasury Securities auctioned over this period were 2 yr., 20 yr, or 30 yr. – so they were not used to hedge swaps. This leaves a balance of around 50 billion bonds suitable for hedges.

Treasury also tells us foreign participation in U.S. bond auctions typically tops 20 %. So you’re now left with 40 Billion in “net new” U.S. Treasury Securities – suitable for hedges – to distribute among all domestic players for an entire quarter. The growth component of J.P. Morgan’s book alone, if it’s hedged, requires more than 1.4 billion more than this amount every day!

Bonds required to hedge the growth in Morgan’s Swap book are 1.4 billion more in one day than what is mathematically available to the entire domestic bond market for a whole quarter?

This interest rate swap book is not hedged. J.P. Morgan is the FED.

 

If you believe the yeomen’s work of John Williams of Shadow Gov’t Stats – this helps explain how we get bogus inflation reports from officialdom in the 2 % range when in reality it is running “double-digits”.

Historically, bond vigilantes would have spotted the ruse and sold bonds raising rates of interest to levels commensurate with real inflation rates at 10 % plus the historic premium of 250 points or 12 – 14 % nominal market rates.

If you’re wondering where the bond vigilantes have gone:

They have all lost their jobs. Long ago, the last of the true bond vigilantes sold bonds – intuitively correct I would argue – not realizing that J.P. Morgan’s Swap Book was a “black hole” of stealth artificial demand. They lost their shirts along with their jobs.

Nowadays – bond traders who have chosen to remain employed – resemble trained monkeys and play the game the way their masters intend them to:

 

Monetary authorities have long been pursuing expansionary monetary policies while attempting to cloak their actions by suppressing rising interest rates and other natural market reactions.

This has completely perverted our whole banking and monetary system.

This is why false values have been assigned to a host of financial instruments.

This explains why the gold price has been suppressed. It’s another canary in the coal mine that was vigorously and nefariously silenced.

If you’re wondering why J.P. Morgan never seems to get caught up in any sort of hideous mark-to-market losses concerning their derivatives or hedge book – consider that back in the spring of 2006, Business Week’s Dawn Kopecki reported,

“President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye.”

So do any of you think that J.P. Morgan gets a pass? I would suggest to you that if they had not – our whole financial system would already have collapsed in a heap.

You see folks; hubris has been cast upon us in an attempt to have us believe that wealth is really created on a printing press and on trading desks in N.Y. at J.P. Morgan or Goldman Sachs.

Remember, real wealth really comes from the earth – like gold – just as it always has.

 

 

Copyright © 2009 Rob Kirby
Editorial Archive

 

contact information

Rob Kirby | Kirby Analytics | Toronto, Ontario, Canada | Email | Website

The opinions of FSU contributors do not necessarily reflect those of Financial Sense.or machholz

 

 

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