Posted: Wed Jan 26, 2005 10:23 pm Post subject: Financial derivatives--Meltdown
I was asked to post some information about financial derivatives on another thread, and thought it may be useful to a lot of you, if you don't know much about them. After all, you may be starting to actually relax about the future, and we can't have that!!
The danger lies in the fact that derivatives aren't regulated properly. Banks can wrap their mortgages this way and sell them to bagholders who hand them off to other bagholders.
Think Fanny Mae and Freddy Mac.
From BBC:
" Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers ... which can trigger serious systemic problems "
Warren Buffett
Derivatives also pose a dangerous incentive for false accounting, Mr Buffett says.
The profits and losses from derivates deals are booked straight away, even though no actual money changes hand. In many cases the real costs hit companies only many years later.
This can result in nasty accounting errors. Some of them spring from "honest" optimism. But others are the result of "huge-scale fraud", and Mr Buffett points to the US energy market, which relied for most of its deals on derivatives trading and resulted in the collapse of Enron.
Berkshire Hathaway, the investment group led by Mr Buffett, is pulling out of the market, closing down the derivatives trading subsidiary it bought as part of a huge reinsurance company a few years ago.
In his letter Mr Buffett compares the derivatives business to "hell... easy to enter and almost impossible to exit", and predicts that it will take years to unwind the complex deals struck by its subsidiary General Re Securities
"The larger suspension of disbelief is expressed by the people who buy, own, and trade the $1.37 trillion in securities issued by Fannie Mae. At every possible turn, the government and Fannie Mae executives take pains to note that the government does not in any way, shape, or form, guarantee the debt Fannie Mae issues to the public.
To which bond investors and traders, a bunch of guys not known for blind faith, say: Riiiight."
Some time back, I read that derivatives were the $100 trillion timebomb. Then it was $200 trillion. Last I heard, they have ballooned to $300 trillion.
At what point will it blow?
Watch the TNX, i.e. the U.S. Ten-Year Treasury Notes Index. From what I gather, a large amount of these derivatives are essentially bets on interest rates, and the 10-year mid-term bonds are one of the best indicators of rates across the board, being in between the short-term ones (1-yr, 2-yr, 5-yr) and the long term ones (30-year).
TNX is now around 4.2%, not such a big problem (yet). When it rises above 4.5%, people will start to scream. TSHTF should happen if/when it breaks beyond 5% to 6%.
Once you figure out what TNX is, and what its implications are, I bet you will start watching it too. _________________ Live quotes - crude oil, gold and currencies
http://www.post1.net/lowem/page/livequotes
I'm not going to name names or name banks on this post, but I will tell you that I have personal knowledge about the holdings of the derivatives holdings at a major bank. A major bank. A major and very respected bank.
A very close and personal friend of mine landed a job at this bank at a certain trading desk. He realized after about two years that their entire derivatives model overvalued their portfolio by 20-25%. I can't remember which it was at this point, but this was in 1997-1998. He told me about this at that time. I asked him why he didn't tell his management about this problem. He told me that he had a $200K bonus riding on the profitability of his department. If he told them about the problem, he could kiss $200K g/bye. Therefore, he buried it. We then hit the local White Castle, got six double cheeseburgers and a grape Nehi each, and laughed about it in the parking lot.
I had no idea the importance of that conversation.
And yes, I paid for my own damn sliders.
He tried to talk me out of the Glock 19 I ended up buying. He thought the S&W 686 was a much better gun-owning experience. "You don't get to polish it and clean it and all that crap. The Glock is the Jeep Wrangler of guns. It's the burger and fries of guns. It's the Bruce Springsteen of guns. WTF do you want with that crap?"
Well the derivatives market has two sides. On the one side you have the financial institutions, on the other side you have the consumers.
The financial institutions can play this game forever, the consumers can't. The only thing which has kept this market going is the ongoing interest rate decreases. Despite the increases of the federal rates interest rates for e.g. mortgages have been falling. This obviously can't go on forever.
At a certain point the consumers will reach a limit on what they are able to (and willing to) consume. That will be the tipping point for the derivative markets.
Joined: Sep 29, 2004 Posts: 2330 Location: Pennsylvania, USA
Posted: Thu Jan 27, 2005 8:30 am Post subject:
Ayoob_Reloaded wrote:
I'm not going to name names or name banks on this post, but I will tell you that I have personal knowledge about the holdings of the derivatives holdings at a major bank. A major bank. A major and very respected bank.
A very close and personal friend of mine landed a job at this bank at a certain trading desk. He realized after about two years that their entire derivatives model overvalued their portfolio by 20-25%. I can't remember which it was at this point, but this was in 1997-1998. He told me about this at that time. I asked him why he didn't tell his management about this problem. He told me that he had a $200K bonus riding on the profitability of his department. If he told them about the problem, he could kiss $200K g/bye. Therefore, he buried it. We then hit the local White Castle, got six double cheeseburgers and a grape Nehi each, and laughed about it in the parking lot.
I had no idea the importance of that conversation.
And yes, I paid for my own damn sliders.
He tried to talk me out of the Glock 19 I ended up buying. He thought the S&W 686 was a much better gun-owning experience. "You don't get to polish it and clean it and all that crap. The Glock is the Jeep Wrangler of guns. It's the burger and fries of guns. It's the Bruce Springsteen of guns. WTF do you want with that crap?"
Interesting post. You guys really know how to put away the burgers. I'm with your friend regarding the Glock. Unless you're a solder or a cop, a handgun is like a wristwatch. A Casio will get the job done, but a Hamilton Ventura much more sexy.
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