It is the Mother of All Bubbles...the Hindenburg of derivatives...
- From: periodistalibre@xxxxxxx
- Date: 14 Sep 2006 16:13:32 -0700
A bubble!
Twenty years ago, the total notional sum of derivatives in the entire
world was close to zero. At least that is the impression you get from
looking at a chart showing the growth of derivatives in the years
since.
theFrom nothing, the global supply of derivatives has risen faster than
NASDAQ...faster than oil...faster even than prices of Mayfair
apartments.
Other market bubbles were soap bubbles compared to the Hindenburg of
derivatives, which the latest estimates judge to be worth some $236
Trillion - or about eight times the GDP of the entire planet. In other
words, derivatives make up a bubble larger than the old globe itself.
What a jolly time to be alive. There in front of us is the fattest,
juiciest bubble that has ever existed. If only we had a long sharp pin
in
our hand!
But what are these derivatives, readers might want to know.
They are debt. Packages of debt. Bundles of debt. Piles of debt. Rocky
Mountains of debt.
Debt that is stuffed into hedge fund portfolios as an investment. Debt
that is laid away at insurance companies and pension funds...as an
asset.
Debt that is traded, extended, extruded, pressed, bolted, wrung out and
wadded up. It is debt for all seasons...all people... all times and
place...it is Urbi and Orbi Debt...
There. We have given you the technical description of it. What follows
is
an answer to the question: what do all these bubbled up derivatives
really
mean?
Derivative contracts are sometimes so difficult to understand that it
takes teams of dusty mathematicians to keep an eye on them. That gives
financial institutions comfort, but it shouldn't. Long Term Capital
Management of Greenwich, Connecticut had two Nobel Prize winners among
its
quants when it managed to blow itself up after placing a few bad bets.
Why? Because behind the arcane complexity of derivative contracts are
the
simple-minded human beings who are at any moment in only one of two
positions: long or short. Every contract is a bet. And every bet can go
either way.
You might think that this means the whole shebang is a zero-sum
proposition. Let them blow up, you might say; the longs and the shorts
will offset each other. For every winner there will be a loser...and
for
every half dozen fools separated from his money there will be a new
billionaire with peculiar art in a monstrous mansion in Greenwich.
Alas, that is not the whole story. Derivatives are not a zero-sum
game...but a game in which the actual odds themselves follow long
patterns
of boom and bust. There are, for example, trillions of dollars worth of
securities whose value is derived from the housing market. Fast-talking
lenders write adjustable-rate, payment optional mortgages for
slow-witted
homeowners. Then, they sell the contracts on...whence they are packaged
with thousands of others into a mortgage-backed security (MBS). The
mortgage backed security is backed by a mortgage. But who backs the
mortgage? That would be those sad sacks you read about in the papers,
who
stretched too far to buy too much house with an ARM far too long and
too
complicated for them to grasp.
Most of the time, and especially during the long bull market in housing
-
roughly equal to the bull market in credit derivatives - the payers are
ready and able to pay. Sometimes they are not. When they are not...the
security of mortgage-backed securities disappears.
America's average mortgage payer has not had a real wage increase in 34
years. Instead, he has become upwardly mobile by proxy... piggy-backing
on
the shiny surfaces of bubbles...in credit...in debt...in housing. But
there must come a day when the bubbles take a bath...when the poor
homeowner must find another money-tree or miss his mortgage payment.
And
when he misses, what a hit he will take. And that will be the day all
the
bubbles blow up at once - including the mother of them all, the bubble
in
derivatives.
By Bill Bonner*
*Bill Bonner, founder of Agora Financial one of the world's largest
financial publishing
businesses, two-time bestselling author and the creative force behind
the
Daily Reckoning
.
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