Derivatives exposures is worth $190K/human being on Earth

The global derivatives market exposure is worth $1.144 QUADRILLION. That's $190,000 for every human being on Earth. Something tells me that most of those derivatives ain't worth the hard-drive sectors they're stored on.
Whilst outstanding derivatives are notional amounts until they are crystallised, actual exposure is measured by the net credit equivalent. This is normally a lower figure unless many variables plot a locus in the wrong direction simultaneously. This could be because of catastrophic unpredictable events, ie, "Black Swans", such as cascades of bankruptcies and nationalisations, when the net exposure can balloon and become considerably larger or indeed because some extremely dislocating geo-political or geo-physical events take place simultaneously. Also, the notional value becomes real value when either counterparty to the OTC derivative goes bankrupt. This means that no large OTC derivative house can be allowed to go broke without falling into the arms of another. Whatever funds within reason are required to rescue failing international investment banks, deposit banks and financial entities ought to be provided on a case by case basis. This is the asymmetric nature of derivatives and here lies the potential for systemic risk to the global economic system and financial markets if nothing is done.
The Size of Derivatives Bubble = $190K Per Person on Planet (Thanks @staceyhebert!)


  1. That sounds really scary, but I really don’t understand at least 3/4 of this post*, and I get the feeling that it’s something that I should understand.

    Now I’m going to spend the next hour or two figuring out what “derivatives exposures” are.

    *Note that I don’t own a home, my 401k is less than 1yr old, and the only other savings I have are in a plain-old savings account. I’m also at least 40yrs away from retirement.

  2. Sorry, distracted/delighted by the blink tag. Most of these exposures are resold many times and hence appear much worse than they really are. Otherwise Leaman hedges would probably have taken every penny of US$ currency alone when it failed. That said there are huge outstanding leveraged bets out there sold as hedges against an impossible series of events with no ability to cover the downside if everything went wrong. Unfortunately the impossible is happening as we speak.

  3. I think that’s the first justified use of the blink tag in the history of the Internet. Well done.

  4. Although I do wish to address the criticisms to this that Noen raised, but this appears to be an excellent example of where the Austrian Business Cycle Theory holds true:

    According to the theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas that would not attract investment if the money supply remained stable. A correction or “credit crunch” – commonly called a “recession” or “bust” – occurs when credit creation cannot be sustained. Then the money supply suddenly and sharply contracts when markets finally “clear”, causing resources to be reallocated back towards more efficient uses.

    Or, as Steve Liesman said today on Meet The Press:

    David Gregory: Steve, final question of the–was what was wrong in the financial system, was it knowable, was it discoverable?
    Steve Liesman: Yes, it was. It was way too much excess. Here’s, here’s the, here’s the easy thing you could have known: Any time capital chases investments, you know you’re in for a hard fall. It should be investment ideas that are looking for money. That’s the normal way of the world. This was all backwards, it was the other way around, and that was how you could have known we were headed for a hard fall.

    Back to the credit cycle (i.e. boom-bust cycle):

    Under the current fiat monetary system, a central bank creates new money when it lends to member banks, and this money is multipled many times over through the money creation process of the private banks. This new bank-created money enters the loan market and provides a lower rate of interest than that which would prevail if the money supply were stable.

    This credit creation makes it appear as if the supply of “saved funds” ready for investment has increased, for the effect is the same: the supply of funds for investment purposes increases, and the interest rate is lowered. Borrowers, in short, are misled by the bank inflation into believing that the supply of saved funds (the pool of “deferred” funds ready to be invested) is greater than it really is. When the pool of “saved funds” increases, entrepreneurs invest in “longer process of production,” i.e., the capital structure is lengthened, especially in the “higher orders”, most remote from the consumer. Borrowers take their newly acquired funds and bid up the prices of capital and other producers’ goods, stimulating a shift of investment from consumer goods to capital goods industries. The preference by entrepreneurs for longer term investments can be shown graphically by using any discounted cash flow model. Essentially lower interest rates increase the relative value of cash flows that come in the future. When modelling an investment opportunity, if interest rates are artificially low, entrepreneurs are led to believe the income they will receive in the future is sufficient to cover their near term investment costs. In simple terms, investments that would not make sense with a 10% cost of funds become feasible with a prevailing interest rate of 5% (and may become compelling for many entrepreneurs with a prevailing interest rate of 2%).
    Because the debasement of the means of exchange is universal, many entrepreneurs can make the same mistake at the same time (i.e. many believe investment funds are really available for long term projects when in fact the pool of available funds has come from credit creation – not “real” savings out of the existing money supply). As they are all competing for the same pool of capital and market share, some entrepreneurs begin to borrow simply to avoid being “overrun” by other entrepreneurs who may take advantage of the lower interest rates to invest in more up-to-date capital infrastructure. A tendency towards over-investment and speculative borrowing in this “artificial” low interest rate environment is therefore almost inevitable.
    This new money then percolates downward from the business borrowers to the factors of production: to the landowners and capital owners who sold assets to the newly indebted entrepreneurs, and then to the other factors of production in wages, rent, and interest. Austrian economists conclude that, since time preferences have not changed, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. In other words, depositors will tend to remove cash from the banking system and spend it (not save it), banks will then ask their borrowers for payment and interest rates and credit conditions will deteriorate.

    Capital goods industries will find that their investments have been in error; that what they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production will have turned out to be wasteful, and the malinvestment must be liquidated.[20] In other words, the particular types of investments made during the monetary boom were inappropriate and “wrong” from the perspective of the long-term financial sustainability of the market because the price signals stimulating the investment were distorted by fractional reserve banking’s recursive lending “ballooning” the pricing structure in various capital markets.

    The boom then, is actually a period of wasteful malinvestment, a “false boom” where the particular kinds of investments undertaken during the period of fiat money expansion are revealed to lead nowhere but to insolvency and unsustainability. It is the time when errors are made, when speculative borrowing has driven up prices for assets and capital to unsustainable levels, due to low interest rates “artificially” increasing the money supply and triggering an unsustainable injection of fiat money “funds” available for investment into the system, thereby tampering with the complex pricing mechanism of the free market. “Real” savings would have required higher interest rates to encourage depositors to save their money in term deposits to invest in longer term projects under a stable money supply. The artificial stimulus caused by bank-created credit causes a generalised speculative investment bubble, not justified by the long-term structure of the market.

    The “crisis” (or “credit crunch”) arrives when the consumers come to reestablish their desired allocation of saving and consumption at prevailing interest rates. The “recession” or “depression” is actually the process by which the economy adjusts to the wastes and errors of the monetary boom, and reestablishes efficient service of sustainable consumer desires.

  5. so at a time when American hegemony was about to collapse from eight years of kleptocracy and imbecile foreign policy, like a great, soiled white knight, a global economic catastrophe brings the whole planet crashing down across the board – thereby ensuring that all nations keep their relative positions of power.

  6. Hmm. Interesting. I just checked this out in four browsers – IE7 (because it’s the renderer for my RSS feed reader), Opera, Firefox and Chrome. The only one that has blinking is Firefox.

    But as faras the article itself goes, the short version, as I understand it, is this:

    “The banks can’t ever be allowed to collapse, no matter what stupid/criminal behavior they have done, because if they do the world economy will go right along with them, and it’ll make the depression look shiny and happy.”

  7. I for one am just amazed that:
    A. Someone remembers the flash tag
    B. The flash tag is still supported in modern browsers. (I’m using Camino by the way)

    For a second, I assumed that maybe a flash or gif file was used.

  8. This *is the thing* I don’t get. I really, really, thought that the lessons were learned and the problem gone with LTCM’s implosion back in the nineties. Silly me. And, since these things are working out to be the devil’s tool, why isn’t congress holding hearings continuously on derivatives and the problems they are creating?

    Another thing, if some of these instruments are so problematic (which they are), and serve nothing more than to fuel a “bonus handout” at the end of the year to a wall street bank, why can’t cangress pass a law saying that these contracts are not enforceable for the collateral (no pun intended) damage that they create to the rest of us? Especially when the parties making the contracts are not directly related to the generated liabilities i.e. why people call it a “bet”. I still can’t fathom why the plug isn’t being pulled on that *right now*. Maybe someone can enlighten me.

    BTW, Nova had an excellent show on the LTCM collapse called the “Trillion Dollar Bet.”

  9. Ford Prefect: I just found this sales brochure on the floor. It says, “The Universe can be yours for a mere five quilliard Altairian dollars.”
    Arthur Dent: Cheap?
    Ford Prefect: A quilliard is a whole page full of noughts with a one at the beginning.

  10. Global per capita GDP is $8.2K according to the World Bank, so that means we all owe 23 years of labor to the banks. Or something.

  11. Global per capita GDP is $8.2K according to the World Bank, so that means we all owe 23 years of labor to the banks. Or something.

    Or that the size of the phantom wealth (i.e. house of cards) is 23-fold the size of the real wealth in existence.

    This is why media pundits and television economists focus on “confidence” — like Wile E. Coyote running off the edge of a cliff, but who doesn’t fall until he looks down and realizes his predicament. “Just don’t look down!” cry the Keynesians.

    “Just keep the music going and no one will realize there aren’t enough chairs!”

    c.f. The Emperor’s New Clothes

  12. Wow, I thought the blink tag had been deprecated. The continued existence of blink dwarfs the financial crisis in its ability to inspire terror. But it is funny.

  13. 1. No blinkee in Safari either.

    2. Anybody remember the MARQUEE tag? I actually used it on a commercial site once.

    3. Kleptocracy is my new favourite word.

    4. Of course it was foreseen. Regan tried to tell us that all that accumulating wealth would “trickle down”. Instead it resulted in a few very rich people investing in loans to many ordinary working people. Over time, the rich got progressively richer, and had to find new ways to invest their money. Hence, derivatives. Then derivatives of derivatives. Then derivatives of derivatives of derivatives. Good thing none of that money was ever real.

  14. No, no, no! It’s all the fault of ACORN, Barney Frank, and poor people having the gall to want their own house.

    At least, that’s what the people on FOX News say over and over. And when have they been wrong?

  15. At least, that’s what the people on FOX News say over and over. And when have they been wrong?

    According to them, never. ;)

    Though, I’m also tired of people saying this began with housing, when in reality it began with artificially cheap credit that caused people to buy that housing. (i.e. malinvestment in a housing bubble, as equity for credit in still further malinvestments)

  16. The thing that I have the most trouble understanding about the economy is that it isn’t a closed system; money isn’t conserved. If the derivatives market contracts to a ‘mere’ $100 trillion, where did that extra quadrillion dollars go? Nowhere! It’s just gone.

  17. Nemryn, that money never existed at all.

    Money is essentially a promise to pay in real-world value. A banknote is really a coupon redeemable for goods and services. The value lies in the goods and services, not in the money.

    Derivative contracts are money based on value that was outrageously overstated. There was some small value backing them, but nowhere near enough to cover everyone’s expectations if everyone tried to cash in at once.

  18. I’m not sure if I feel smarter for having read through all of this, or just more depressed.

  19. Unusual Suspect: that’s kinda what I mean. The money exists only theoretically, but the contract-holders still loan it out, or use it as collateral, or whatever it is they do with it, as if it were real.

  20. > Nemryn, that money never existed at all.

    I think this is key. Who exactly would we be paying to make up this debt? The folks who bet on returns for their investments, a return that was always in the future and did not exist yet.

    This is a naive idea, but why not just wipe it clean and start at zero? Forgive all debts, everywhere. What you have in material goods and property rights is what you’ve got, and go from there.

    All we really have is our savings (non-invested ones, at any rate) and our means of material production; everything else is moonshine. We have six billion pairs of hands and 24 hours in a day. If we can feed and clothe and shelter ourselves, we are just fine.

  21. @12, I’ve been wondering this myself. I think this is how it works (think of it as the cancerous expansion of derivatives):

    1. Bob starts writing $100k derivatives contracts on my house not burning down. He writes 1000 of these contracts to various folks who each pay him $100 in fees for the “insurance”.

    2. Half of these contracts just sit out there. Virtual notional value of $50M – cancel these contracts and the only bad thing that happens is that 500 people wasted their hundred bucks.

    3. But the other half have been used to buy real money. Some have been used as collateral for debt (say you get $1k in debt using your $100k derivative as collateral). Others have been sliced and diced, mixed with other derivatives and resold as risk-hedges. For, say $1k. This is $5M of real money that has been tied to the underlying derivatives.

    4. Lets not talk about folks who then use that $1k to leverage-up their positions by borrowing 20X or 30X on their “de-risked” derivative baskets.

    So if I cancel all of these contracts, suddenly $5M of debt has no more collateral to support it and has to be paid back. In reality we are going through that right now – as some of these derivative cards are turned up nil and the underlying debt has to be paid. But if we cancel them then we have to do it all at once. Boom.

    So if you cancel all of these

  22. Takuan,
    while it is fun to blame Bush/Cheny for the mess, they own only part of it, especially the stimulus/war post 9-11. If you see an M-3 chart for the post war period until it was discontinued it shows the irresponsible leverage hockey stick really starting in about 1995 deep Clinton territory after they were frightened by the republican takeover of the senate/house and focused even harder on “It’s the Economy, Stupid”. Also relaxing most of the safety systems and rules was done under both Clinton and Bush.

    Never be fooled, United Statsians and their duopoly system leaves them with little choice but deciding which crook will be robbing them.

    Also, to be fair there is a shallow M-3 up-angle in Regan 80’s too.

  23. nope, since there are STILL those in the camp that brought us all the Grand Old Depression that openly try to blame Obama for the current fiscal mess, no quarter for them at all. Eight long years to admit the problem and do something and they chose theft and mass murder. No pity,no mercy. Only justice.

  24. That’s apparently the price the OverLord Masters of the planet have set as the ‘notional’ value for each SERF on this planet. Our governments are all busy assuming this debt in guise of “saving” the fat cats.

    So if you don’t understand the buzzword laden blurb, see if you can understand this:

    Each individual on this planet will be held responsible for $190,000 of this debt which will be collected in form of TAXES … with COMPOUND INTEREST.

    Welcome to the New World Order, dear Sheeple!

  25. #29 is right. Now governments are being put on the spot to provide cash to cover the brokers’ fictions. Otherwise people who bought those contracts would be out of luck, which would be horribly unfair, right? Who are they? Investors, many of whom are brokers themselves, and all of whom went along with the inflated prices, inflating them more in the process. Where is the government getting the cash from? Average taxpayers, many of whom admittedly are investors because of their pensions. Still, there’s no doubt that real money is going to pay fictional debts and that the net direction of the money is from people really making it to people who really made it up. (How could everyone on Earth possibly have racked up $190K in debt? How many bad mortages are there really, and what is the true value of those homes?)

    I cannot see any surefire way to stop these sidebets on the real economy, but I also do not see why governments should assist sidebets.

  26. Im with Manitssa128,

    Why do farmers and gas station attendants owe car loan payments to bankers who just got to sit around and magically create their loans from nothing?

    Why are traders, who in reality trade absolutely nothing, buying yachts while tent cities reminiscent of hoovervilles are springing up all across the country?

    The people who produce real value in out economy should be paid accordingly. It’s the biggest collective heist in human history and we “proles” don’t even see it.

    Moreover, the media has us so focused on what went wrong, what it is in the first place, and who needs to go to jail; that we don’t even realize its the system in general that needs the changing.

    Let the rich make off with their money, lets find a system backed by real value. i.e. or

    I’m all for putting energy into something useful, not putting people in jail.

  27. @32 I have been struggling for a way to express that idea for weeks now – 6 billion pairs of hands and 24 hours in a day. Or to put it another way:

    ” Our workers are no less productive than when this crisis began. Our minds are no less inventive, our goods and services no less needed than they were last week or last month or last year. Our capacity remains undiminished. ”

    This idea, this take on it must win the day. There are things to be built, like this From AC to DC: Going green with supergrids

  28. The whole thing has the same level of magical thinking as when priests told the farmers in Mesopotamia to worship their gods and give all their sheaves of wheat over to the priest-rulers. Now, just like then, the peasants are told by their priest-economist-politician classes that the issues at stake are far too complicated and otherworldly for mere peasants to understand. So just keep your head down, work hard, and hand over that food. Let us hold and distribute your products.

    How is anything really different today? Until we unequivocally see this class as the criminal warrior parasites they are, until we demand a true, democratic rule of law, what else will we do but prostrate ourselves before them?

    At least there are regulations on the books to handle this situation. Not just civil laws but criminal ones. This is felony material. The derivatives should be covered under the RICO act– and the bankers and trades involved should be locked up with the mobsters for running illegal betting operations.

    It is a fundamental error of perspective to attach a $ sign to the problem. It keeps us floating, unaware, in the gnostic world of priests and war-gods. Once we see it is truly a political problem, an issue of distribution and criminal activity, the problem and the solution are inverted.

    If a gambling ring couldn’t get the losers to pay up, they couldn’t go to the government and demand the taxpayers pay for the losers! The DA would just arrest them all and say their “contracts” for betting are meaningless and legally unenforceable.

    Perhaps if these bankers and traders just start trying to collect on their derivatives in person with mafia goons fighting it out in corporate offices, we’d all finally get the point and the criminal nature of this nonsense, as well as the legal remedies to solve it, would become obvious to all.

  29. The more complicated derivatives, as far as I can tell, are chips in a gambling game — worth absolutely nothing by themselves, and redeemable only by selling them to someone else who wants to play the game.

    That works only as long as people still want to get into the game, and as long as everyone is playing by the same rules.

    Some of the _simpler_ ones, I’m told, are occasionally useful if you want to hedge your bets on the real stocks/commodities futures/whatever.

    But the advice I’ve gotten has been “Derivitives — even simple ones like options — are a game run by pros for the pros. Remember the rule for any gambling game: If you look around the table and don’t see the sucker, you’re the sucker. If you aren’t willing to work as hard as the experts, don’t even think about trying to beat them.”

  30. #40 – And that is just the issue. While the wealthy are talking up “Atlas Shrugged” and speaking of pulling a John Gault, most of the Wealthy aren’t actually doing anything to begin with. Most of these executives are the do nothings that Ayn Rand writes about in the first place.

  31. Uniquack @ 42 – That’s the best rabble rousing I’ve seen in a good while. Got any solid strategy to go along with your theory? I’m listening.

  32. ‘Movable Type’ is the name of the CMS guys. It’s not meant to be taken literally. Anyway…
    Nobody ‘blames’ Obama for the mess. Everyone is just impatient for him to fix it. Real blame can start to be affixed to Obama’s ‘trusted confidant’, former Texas Republican Senator Phil Gramm. He’s the principle architect of the Gramm-Leach-Bliley Act, that repealed the part of the Glass-Steagall Act that kept banks out of the investment and insurance business. That set the stage for all the stupidity that led up to the current crisis.
    Also, there are few if any ‘laws’ on the books that regulate this part of the financial markets. Combine that with a Federal Reserve that gave approval to investment companies to be leveraged at 35:1 and an SEC that couldn’t find a Ponzi scheme as big as Maddoff’s for nearly ten years -even when someone was waving a red flag in their face- and the stage is set for a disaster of epic proportions.
    If heads should roll, start with Gramm, Leach, and Bliley. Find out who put them up to that stupidity and how they benefited from it. Then start chopping at the former administration for letting it continue unabated for all those years.

  33. @33. Mantissa128, who said:

    “This is a naive idea, but why not just wipe it clean and start at zero? Forgive all debts, everywhere. What you have in material goods and property rights is what you’ve got, and go from there.”

    Try to convince the Chinese, to whom we owe about $1.3 trillion US, to “wipe it clean.”

    Try to convince the bank that holds my mortgage (a perfectly good one, but one I still owe a couple-a-ten thou on). Oh. Wait. Your plan lets them have my house, since they hold the property rights. Do I get any of the money back that I paid?

    Try to convince the bank that holds the note on my car that it’s my car.

    Try to convince the umpty-ump colleges to whom are owed billions in student loans. Sure. Forgive the debt. Then your professors can make do with 1/10th the salary.

    The Year of Jubilee, they call it.


  34. the little people who lost all never bet on complicated derivatives. They were lied to overtly, or by omission.

  35. In related news, there are trillions in outstanding lottery tickets. Every time a person buys a lottery ticket, the state is potentially obligated to pay millions of dollars. It’s only a matter of time before everyone wins the lottery at once and the state is required to pay out millions to each of millions of lottery players.

  36. I thought about writing a bit on how derivatives can be valued but I decided I’d rather be a bit optimistic.

    Always look on the bright siiide of life ::whistles::

    At least your non-paper assets might be worth something sometime in your life time.

    In an absolute worst case situation, we can always revert to a pure barter economy and not honor these contracts. Currencies will be devalued, trade will become inconvenient but the world won’t end and the people who used their money to buy useful things like books, educations and influence will benefit the most.

    Or the rest of the world can suck it and we elites can all live in some sort of a Logan’s Run sexdome where you kill anyone with thoughts or who gets too old. Perhaps it could be located near a sacred river that runs through caverns measureless to man down to a sunless sea. That appeals to me. But it might be a bit of a pipe dream.

    Or an HG Wells situation wouldn’t be too bad with Morlocks and the Eloi. That wouldn’t be as cool cuz I wouldn’t really want to be either of them. I suppose it reflects reality, though. We’ll all be most likely be eaten by something subterranean at some point.

    Suffice to say, science fiction rocks!

  37. It’s long past time that even the most intellectually deficient people realized that bullshit isn’t a product – and bullshit is all that the current crop of completely amoral and incompetent “corporate leaders” and our worthless politicians have to sell.

  38. I have heard that the Inuit had a way of dealing with Narcissistic Personality Types, people who’s selfishness threatened everyone’s survival in the Arctic environment.

    Their solution was that the flaming asshole should have a little accident. “Oops! You slipped and fell into icy waters and sank like a rock. Pity. We’ll be sure to care for your children.”

    I’d like to revive this quaint custom.

  39. The value of derivatives has nothing to do with the value of whatever they are derived from.

    The best way to think of it is like giant craps game:
    The pot contains all the bets on how the dice will roll.
    The value of the pot has nothing to do with the value of the dice – a pair of six sided dice cost a few cents, yet people can gamble away their life savings on one roll.

    So the “derivatives worth 190K$/person” statement is equal to saying “roll of dice worth 100$”.
    If all one was after was a set of dice to roll, that could be had cheaply.
    Derivatives isn’t a form of ownership, it’s a form of gambling.

  40. I am going to concur with many others:

    This is the one and only time in the history of the Internet where the blink and marquee tags were ever justified.

  41. @50 Andyhavens, I did say it was a naive idea.

    But think about it. You never owned your car. You wanted to use it now, instead of having to save for it first. Ditto for your house, although arguably there would be no practical way to save for it first. I think this is why inheritance and family used to be something important.

    Will the Chinese be unable to feed, shelter, or clothe themselves if they don’t receive value for that 1.3 trillion? (Mind you, they’re having enough trouble as it is.) That “1.3 trillion” is a promise, and you can’t eat promises.

    And the poor colleges – how on earth do the professors and TA’s and janitors eat and shelter themselves… with the promise of a future payback?

    Debt financing is inherently unreal. It is a promise whose primary purpose is to motivate people to do something here and now. My point is that we can do the something here and now without the promise. We did it for 50,000+ years before the little clay spheres in Mesopotamia came about.

  42. Thing is a derivative has a winning side and a losing side. Guess who has to pay out?

    Someone buys in on one side as a monthly premium that said bad thing is or is not going to happen; it all depends on the underlying collateral and what you think is or is not going to happen.

    In the end though, someone pays out the derivative. Why do you think AIG is FUCKED? They probably have 200 trillion in derivatives right now that are “due”.

    That’s going to eventually be a crapton of money that has to paid back one way or another, or just outright abolished.

    Something tells me the next 100 generations of taxpayers will bear the brunt of it in the end…

  43. So, what if the G20 or G8 or whomever declared ALL derivatives null and void? Since everyone is apparently cross-leveraged with everyone else – why not just wipe it all away? Sure, some companies might disappear – and they probably deserve it.

    I realize this is a poorly thought out pipe dream, but this real/phony multi quadrillion exposure is just nonsense. And it’s killing the planet.

  44. The solution is simple: give bankruptcy judges “cramdown” power on derivatives contracts.

    All parties get: nothing; please pay the court clerk on the way out, with cash or a certified check.

  45. I have heard that the Inuit had a way of dealing with Narcissistic Personality Types, people who’s selfishness threatened everyone’s survival in the Arctic environment. Their solution was that the flaming asshole should have a little accident. “Oops! You slipped and fell into icy waters and sank like a rock. Pity. We’ll be sure to care for your children.” I’d like to revive this quaint custom.

    Sounds like you’re thinking of the Jacobins and the Reign of Terror.

    “Oh, there’s no justice like angry-mob justice.”

  46. #50 and #66, you don’t have to forgive *all* debt to wipe out derivatives contracts. #70 proposes a more nuanced approach. And certainly law refuses to recognize all kinds of contracts, it would be trivial to simply render all derivatives contracts (or even a discrete subset) null and void.

    The real question is the collateral consequences. But given the scope of this thing we might just have to take that plunge.

  47. Bankruptcy judges already have the power to void a derivative instrument. In bankruptcy, all of the debtors assets are pooled and all creditors are lined up, with secured creditors getting first crack at the assets, with the unsecured creditors getting what’s left. All pending claims are suspended, so that all creditors are put in the same boat. Following bankruptcy, all debts are discharged (with some exceptions that are not applicable to this discussion).

    There are two kinds of bankruptcy: liquidation (all assets are sold in an effort to maximize dollars to creditors) or reorganization (debts are restructured so that debtor can remain as an operating business). If a company wants to avoid its obligations to pay out under a derivative instrument, it must simply seek bankruptcy protection. It can choose to do so as a reorganization, allowing the company to continue to do business afterwards.

    The problem here is that, if you believe the powers that be, companies like AIG are “too big to fail.” In other words, AIG will not avail itself of bankruptcy protection. Instead, the taxpayers keep fronting money with the expressly stated goal of AIG avoiding bankruptcy.

  48. Numbers like this remind me of the money that music execs claim to be losing as a result of piracy or the value of drugs the cops claim to have impounded.

    Surely part of the problem with derivatives is that a notional value gets attached to them that they don’t deserve. If we buy in to what they tell us they’re worth then we join in the lie.

  49. Hey Ridl,

    I’d say history is not pointing in an optimistic direction and yet I feel optimistic. Rarely have there been times and places in which this fundamental issue has been dealt with very well. Usually just different factions of the warrior-priests battle it out and make the peasants their pawns.

    However, I think the Internet and other social changes have made the possibility of a breakthrough greater than any time in history, even as it also heralds far greater potential for control over the population.

    We face something new: the thermodynamic limits of capitalism/industrialism and acquisition-based economics. In previous eras, including during the early history of the US and up through the mid-late 20th century, there were always new, easily conquered lands to acquire through various physical and fictive means of violence that acted as a steam valve on civilizations that became too top-heavy with inequalities. The world is full now like a tinderbox and violence on the scales necessary to achieve strategically useful acquisitions is MAD. Fictive means will persist. Watch the financial war developing between China and the US.

    The industrial system we have now is simply failing physically. The financial frenzy of speculation was simply a fictive attempt to maintain modes of acquisition-based living for another decade. Why should millions of Chinese want to work 18 hour days so millions of Americans can have their tech and receive only pieces of paper in return? Expanding energy flows could temporarily justify it by making it seem they were benefiting from the arrangement. Now, in a peak oil state, the energy and other resources dwindle and the unequal nature of this situation is clear. As a result, we start seeing the unfolding of the derivatives and other “contracts” that maintained our country’s resource and value flows with nothing but promises. Truly, Wall Street is a greater purveyor of fiction to the world than Hollywood.

    Only those who can’t recognize our civilization in its current mode of behavior is fundamentally impaired by the intercession of physical realities– of energy flows in vs. energy out– will try to maintain, prop up the past. As Thomas Kuhn noted, revolutions (in science and elsewhere) occur when the paradigm shifts in enough people.

    The best we can do at this point is to engage in reasoned communication with our fellow citizens (in the most inclusive meaning of that term) about the limits of the old paradigm and the new/truly-ancient paradigms is key. Use available media and immediate conversation in person. Have faith in strange attractors and the way changes occur in chaotic, nonlinear systems. Politically, judge what causes to join and efforts to make on the basis of whether it is supportive of the world you’d like to see or still trying to prop up the old world. I think it is better to lead oneself and each other with one’s ideals than follow a specific plan. We don’t know what the future will exactly look like or how to get to something that seems “good,” but we might be attracted towards a reasonable place, and help birth a realignment if we just remember to remain perceptive of our ideals.

  50. Surely part of the problem with derivatives is that a notional value gets attached to them that they don’t deserve. If we buy in to what they tell us they’re worth then we join in the lie.

    Just like those “toxic assets”? i.e. assets that banks just don’t feel like selling at their current market value. (Because the market knows they’re fucking worthless.) But taxpayors, via the government, are going to buy them for the bank’s asking price, while politicians feed us bullshit about “maybe someday they’ll be worth something and we’ll all make money from this”.

    Actually, the next tactic coming out of the Washington D.C. is to let these banks keep the “toxic assets” on the books and instead make it legal for these banks to cook their books Enron-style!

    A Republican and a Democrat have proposed a new bill (H.R. 1349) to create a Federal Accounting Oversight Board to do things exactly the way the Feds think they should be done in the financial markets.

    How’s that for bipartisanship! Or as the late George Carlin said, “Bipartisan usually means that a larger-than-usual deception is being carried out.”

    This legislation if passed, has the potential to vest within the executive branch of our government, the ability to re-write the accounting rules midstream. It is one more way in which politicians and bureaucrats can change financial reporting standards to hide the terrible effects of government intrusion.

    For example, in this current economic bust cycle, imagine that at the top, when the bubble begins to burst, the mark to market rules, which had allowed financial companies to inflate their assets, now were “suspended” for a time. Even though the market for these assets is dropping, the companies then keep their assets over-valued, thereby hiding the fact that they are insolvent. This will ultimately fraudulently fool more people into putting more money into, what would amount to at that point, a giant ponzi scheme, allowing the politically connected to get their money out while the non-politically connected investors shovel more money into a hole, before they realize they’ve just lost it all. Meanwhile, before the collapse, the then current administration will claim everything is fine. Once a new administration comes into power, and the place falls apart, the media and public will blindly blame the new guy. Whoever that would be, republican or democrat. We’ll have hearings, a big political fight, blame the ‘free market’ (as if one actually existed) and then propose more gov’t intrustion to fix the problem. That intrusion and regulation will ultimately benefit the few well connected at the expense of everyone else.

    I’m sure there are a great many other scenarios that corrupt politicians and beaurocrats would be able to invent in the future to enrich their crony friends.

    Keep in mind about mark to market (and more importantly, mark to model):

    As the practice of marking to market caught on in corporations and banks, some of them seem to have discovered that this was a tempting way to commit accounting fraud, especially when the market price could not be objectively determined (because there was no real day-to-day market available or the asset value was derived from other traded commodities, such as crude oil futures), so assets were being ‘marked to model’ in a hypothetical or synthetic manner using estimated valuations derived from financial modeling, and sometimes marked in a manipulative way to achieve spurious valuations. See Enron and the Enron scandal.

  51. @66 Mantissa128 – Are you seriously suggesting we just go back to hunting and gathering? We just hold cash even?

    The financial system, and debt, has enabled us to get to the level of wealth and standard of living that we are at today. Because are over-exposed to debt today doesnt mean we wipe debt out all together, ffs. Every single business in the world required debt, even just really short term term, to operate. On its principles, debt is an amazing thing. Why shouldnt we allowed to do things now?

    Everyone here’s an expert – but this is a fucking joke. So much ignorance.

  52. What a wonderfully misleading article. Things are, indeed, incredibly screwed-up, but this article misses the point massively, and more dangerously lets readers think they now understand better.

    The gross notionals are highly irrelevant. The amount a derivative pays out is its notional times the mathematical formula which defines it. For most products, this formula is a few percent. Then, there’s collateralization and netting. Collateralization being lending me stuff to cover the mark-to-market value, so I’m not out if you go bust, and netting being making sure that if you go bust, owing me money, everything I owe you is wiped clean too. Between them, they tidy up a lot of (but obviously not all) the nastier parts of derivatives exposure.

    Then, as pointed out above, a lot of these deals are just moving the exposure around, rather than creating new exposure.

    So, my uninformed guess would place the total meaningful amount of derivatives exposure going on to a few tens of trillions. This is still bad enough, given that the losses so far have been a trillion or two, but bringing up this quadrillion thing is stupid and distracting.

  53. Okay, this stuff is hella complicated, and yeah, it does seem like it’s hella complicated mostly just to stretch the information gap between financial professionals and the rest of us, but I’m gonna try to explain it in simple terms. The ridiculous make-believe nature of it and the obvious inequity and irresponsibility of it all we can leave for another day, but for right now, let’s look at how this stuff works, and why the 1.144 quadrillion dollars of the total derivatives market doesn’t just disappear.

    Let’s look at one of the largest derivatives markets listed in the article– Interest Rate Derivatives. Basically what you’ve got here is a scenario where two companies will trade interest payments according to what they think the market will do. So say you’re a bank and you’ve lent out adjustable-rate mortgages totaling $10 million, earning 3% over the cost of money (the fed). You have a sneaking suspicion that the market is about to shift, and that the fed will subsequently drop the cost of money from its hypothetical current rate of 2%, so you want to convert that adjustable rate income into a fixed rate while you can still get a fixed rate income in exchange at its current rate of 5%. So you write a derivatives contract for $10 million. The company you’re dealing with gives you payments at a fixed rate of 5%, and you give them payments at an adjustable rate of 3% over the fed.

    So although there is then a contract for $10 million dollars, there has been no transfer of funds or ownership or even an agreement to pay $10 million dollars– it’s basically just the gap between the two interest rates that they are agreeing to pay. Financial companies frequently use this stuff to diversify their holdings and reduce their exposure to more volatile markets. It’s essentially a bunch of rich people making tiny little bets (by percentage) on the future movement of really astoundingly huge sums of money. We don’t worry about the quadrillion-dollar size of the market– the size isn’t really a problem, because derivatives trading at this sort of scale is a game about cash flow, not assets. The actual assets are the $75 trillion in real estate and the $100 trillion in stock markets and the $15 trillion in dollars etc. None of that is directly affected by the derivatives trading game, though the interconnected nature of the current setup means that everything touches everything and we really can talk about the fate of the economy as a whole.

    So let’s talk about what happens when your bets have gone badly, and why this might possibly lead to widespread economic collapse. Say you made some bad decisions about the likely rate of default on a whole mess of loans which you ponied up as interest-bearing assets in credit default swap derivatives, perhaps several times. Now you’re on the hook not for the cost of the mortgage, but the payments that you get from the mortgages, which you have to keep making even though the higher rate of default has made this highly unprofitable. Because you chose poorly in the expectation of continued growth, your cash flow does not match your obligations, and you have to sell assets to cover those obligations. When this is an isolated occurrence, or in regard to the current situation, when the amount you are wrong by is great enough and common enough, the end situation is that those assets drop in value, which means you have even less income moving forward since you have to sell assets at a loss just to cover your position.

    This is not to be confused with Collateralized Debt Obligations, which are a different thing than credit default swaps. The details get a little sticky, and I’m not gonna get into it. Regardless, the reason for the banking bailout is that if we don’t cover the ongoing losses, the bank has to file for bankruptcy protection. If that happens, the frenzied selloff of assets in combination with the failure of existing contractual obligations jeopardizes the entire industry. Letting Lehman and Bear Stearns go was a big mistake from the perspective of keeping the financial sector afloat.

    Should we really bother to keep it afloat? Well, that’s a different question for another day.

  54. You lose a dollar, you lose a quadrillion. You still have nothing. Ergo…

    There is nothing to worry about…

    You lose your job, you lose your house, you lose…

    If we had been as fiscally irresponsible as these jerks (even in a minor way) we would have lost our jobs… Oh, we did and are.

  55. #82 Grimnir, I understood everything until … if we don’t cover the ongoing losses, the bank has to file for bankruptcy protection. If that happens, the frenzied selloff of assets in combination with the failure of existing contractual obligations jeopardizes the entire industry.

    You went too fast there.

  56. @80 Evawes, sprinkling your argument with the f-bomb does not improve it.

    I’m not suggesting abandoning cash or going to a barter system. I raised the idea of debt financing as a problem to think about, not a plan of action. As other posters have suggested, tackling derivatives is a better solution.

    I still maintain that debt financing is inherently problematic. Its weakness lies in exchanging something real in the here and now with a promise. There is a difference between tangible savings and the kind of wealth on paper that you describe.

    There is no end to how deeply we can mortgage the future, and that’s the core problem. As Peter Schiff has said for years, we have too much consumption and borrowing, and not enough production and savings. The former results in something tangible here and now, and the latter in a bill at the end of the month we counted on being able to pay.

    Why is defaulting on debt – like bankruptcy and loan consolidation – a crazier idea than pouring trillions of dollars into meeting this imaginary quadrillion-dollar payback promise?

  57. The financial system, and debt, has enabled us to get to the level of wealth and standard of living that we are at today. Because are over-exposed to debt today doesnt mean we wipe debt out all together, ffs. Every single business in the world required debt, even just really short term term, to operate. On its principles, debt is an amazing thing. Why shouldnt we allowed to do things now?

    If you read my earlier post about the Business Cycle, the difference here is between lending/borrowing based on “saved funds” or “differed funds” (aka investment), and lending/borrowing based on merely expanding the money supply.

    This is exemplified in the juxtaposition between a natural interest rate (determined dynamically between borrowers and lenders) and the mandated interest rate by central banks such as the Federal Reserve.

    The Fed’s interest rates are well below what a stable money system would communicate the current supply of savings to be, particularly now that the Fed’s rate is effectively 0%.

    Debt isn’t the problem; but using official edicts to dupe everyone into believing that debt be easier to have than the market can actually bear is the problem.

    I still maintain that debt financing is inherently problematic. Its weakness lies in exchanging something real in the here and now with a promise. There is a difference between tangible savings and the kind of wealth on paper that you describe.

    Which is why natural interest rates are based on time preference — the measure of how much of a premium you are willing to pay to have something now rather than save up to buy it later.

    Artificially low interest rates from the central banks, particularly as trickled down into credit card debt (while, in parallel, causing inflation), has severely biased everyone into buying everything on debt now (because the price of doing so isn’t just cheap, it’s cheaper than trying to save a currency that’s losing value over time!)

    “causing capital resources to be misallocated into areas that would not attract investment if the money supply remained stable” is called “stimulating aggregate demand” (or “unlocking hidden demand”) by Keynesians.

    In other words, buying now what you would have deferred until later, because you wouldn’t think you could afford it now. Cheap credit makes people believe they can afford it now, even though nothing has actually changed about the actual supply of goods and services.

  58. thanks for the gopher link… I didn’t realise Firefox functioned for gopher… and I’d forgotten the delights… now to see if it supports archie and veronica… :)

  59. There is no end to how deeply we can mortgage the future, and that’s the core problem. As Peter Schiff has said for years, we have too much consumption and borrowing, and not enough production and savings. The former results in something tangible here and now, and the latter in a bill at the end of the month we counted on being able to pay.

    Why the Meltdown Should Have Surprised No One
    by Peter Schiff

    * In 2007, pundits scoffing accurate predictions about the economy (“Peter Schiff was right”)

  60. @ Uniquack – Thanks. Good. Nicely put.

    @ Grimnir – I didn’t get a headache from that. I think maybe I could now explain these things in my own words now without being too wrong. Thank you. I do agree you went a bit too fast at the end – wouldn’t a well-restructured company be worth more than a company bleeding out? Shouldn’t restructured bankruptcy sometimes be good for investment?

  61. … why is it that the commenters on the Consumerist article seem to have a clue while the commenters here whine about the blink tag or blather on in complete ignorance of the topic just transfixed by the number?

  62. Zeke –

    An insightful and interesting question. Thank you for your helpful contribution. Without you, how would we know how badly we suck?

    Way to raise the level of discourse.

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