The Bank of International Settlements, which seems to be the only institution that tracks the derivatives market, has recently reported that global outstanding derivatives have reached 1.14 quadrillion dollars: $548 Trillion in listed credit derivatives plus $596 trillion in notional/OTC derivatives.
Yes, that is Quadrillion. One and 15 zeroes!
A Gold-Eagle article sheds some light on the mess:
Derivatives, as you may know, are essentially unregulated, high-risk credit bets. Unlike the earnest farmer who might employ a futures contract to hedge the price of the beans heâ€™s worked so hard to grow, many of todayâ€™s institutions use futures, forwards, options, swaps, swaptions, caps, collars and floorsâ€”any kind of leverage device they can cook upâ€”to bet the hell out of virtually anything.
What drives derivatives, at their very roots (if you can somehow get back that far), are base assets that get leveraged to a demented degree. Martin Mayer writing for the Brookings Institute, said, â€œthe receiver of the payments on these loans or securities has bought the securities for the duration of the swap on 95% margin, even though the law says nobody can buy securities without putting up half the price.â€
It takes one thousand Trillion to make a Quadrillion. And despite calls for more regulation from such mandarins of the finance world as George Soros, it seems that the value (and consequently the risk) of this â€˜derivatives time-bombâ€™ is exponentially increasing. As Bershire Hathawayâ€™s 2002 Annual Report stated:
â€œCharlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system,â€
That time bomb almost went off in March 2008 with the Bear Stearns debacle. The title of an article by noted analyst Ambrose Evans-Prichardâ€”â€œFedâ€™s rescue halted a derivatives Chernobylâ€â€”says virtually everything you need to know.
According to the article, Bear Stearns held a jaw-dropping $13.4 trillion in derivatives, which is â€œgreater than the U.S. national income.â€ So where did it all go? Well, this time anyway, JP Morgan was encouraged to step in to add Bearâ€™s derivatives to its own $77 trillion portfolio, giving the financial giant a grand total of $90 trillion in spooky derivatives.
Which begs the question, why didnâ€™t we just let Bear Stearnsâ€”$13 trillion in derivatives and allâ€”go belly up? Wouldnâ€™t that have taught the nation a lesson and given Wall Street a long-deserved wake-up call? â€œTwenty years ago the Fed would have let Bear Stearns go bust,â€ said credit specialist Willian Sels. â€œNow it is too interlinked to fail.â€
The Gold Blog