Jubilee Prosperity

Derivatives, Ticking Time Bombs

AIG, BAC, BRK/A, C, FNM, FRE, GE, GM, GS, JPM, WFC and government were all hit hard by derivatives, what Warren Buffett called weapons of mass financial destruction.

http://www.marketwatch.com/news/story/derivatives-new-ticking-time-bomb/story.aspx?guid=%7BB9E54A5D%2D4796%2D4D0D%2DAC9E%2DD9124B59D436%7D&dist=msr_3

Derivatives may be convertibles, futures, loans, options, warrants or complicated bets leveraged up to 100 to 1. Derivatives were the tail wagging the dog up and down in volatile credit, currency, energy, food, materials and mortgage markets.

A minor move against a highly levered position can suddenly wipe out capital and net worth, as Barings, Long Term Capital Management, Merrill, Sumitomo and many others found.

Respect for the risk of derivatives did not deter Mr Buffett’s Berkshire Hathaway company from $37 billion in derivative losses causing a 77% decline in profits.

BRK/A fell 51% from 151,650 to 74,100.

With bullish bets on the S&P 500 between 2017 and 2027, BRK may profit from Mr Buffett’s derivative bets on the stock market after his demise.

http://www.reuters.com/article/ousiv/idUSTRE4AK6XX20081121

As of June 2008 there were $684 trillion in global derivatives outstanding, according to the Bank for International Settlements in my family hometown. This liability dwarfs the world economy over eleven times.

Most derivatives were hidden, off-balance sheet, over-the-counter, private bank-to-bank leveraged contracts with questionable pricing models. Often these derivatives, in credit, equities, foreign exchange, gold, interest rates and mortgages, appeared to be the tail wagging the dog.

http://www.bis.org/statistics/otcder/dt1920a.pdf

In many cases, net derivative credit risk is greater than the capital of the financial institution. In Q2 2008, HSBC derivative risk was 595% of capital, JPM 430%, C 258%, BAC 195%, and WB 57%. We may learn more about AXP, GS, MS and Raymond James if they become reporting banks eligible for Federal Reserve transfusions.

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This entry was posted on Monday, April 6th, 2009 at 12:28 am and is filed under Prosperity. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.