The Preposterous Notion
of ‘Fixing’ the Derivatives Market and Other Follies.
Revised. Orginally published 4.23.2010
Abstract: Our current government believes, or so they say, that they can
fix financial and economic problems with policy and oversight, mostly using
taxation. Some eight centuries of research show that this is actually a proposal
that flies in the face of veracity. Government decisions hatched in the Obama
administration appear to be based almost
entirely on partisan policies where the entire political game is contingent upon searching for new ways to restrain
capitalism while acquiring as much of
the wealth from this source as possible. The general thrust is to equalize
income for the masses even if it requires a total destruction of the capitalist
structure of a given economy. This is based on the old, tired Marxist notion of
redistribution of wealth. This essay investigates the methods used to
nationalize General Motors and the current political attack on Goldman Sachs
and then concludes with the stark financial realities of the existing
derivatives market. The notion that some
government can control a $600 trillion derivatives market is so far divorced from realism that we must be both amused and
fearful that they will attempt something in the near future toward this
objective. Government meddling into markets always yields the same result:
higher taxes or prices and less efficiency. Shortages almost always follow an episode of
government perturbation of the free markets. We need to realize that the
derivatives market is comprised of millions of willing buyers and sellers.
Buyers think they are buying something of value. Who is our government to
question that? Whenever we build something there suddenly appears a pack of
howling populist or Marxist radicals clustering around to tax it or destroy the
process and replace it with government. I don’t see any important exceptions to
this rule in our current government officials. Our elected officials, speaking for the most
part now to those in power, are incompetent and greedy radicals that will say
or do anything to get at our money.
Our society seems to tolerate politicos who dominate
certain sectors of our society and generally attempt, in their words, to offer
a stable system of laws, the running and regulation of banks, currency and
other benefits. Most of the success in politics is grounded by some form of
naiveté, and like-minded misplaced trust from the politically uneducated masses
and is based on broad promises to the lower classes. Most governments tend to
be of the authoritarian type where orders are handed out by some central
committee or a close ensemble of trusted cadres that surrounds some dictator or
satrap and the citizens are expected to eagerly comply with orders. It is
apparently a sorry attribute in human behavior to wish for somebody to hold
tightly to your collar and guide you through the rough elements of life. Governments
can grow in size and power according to several mechanisms such as protracted
war, famine, regulation of commerce, imperialism, religious conflicts, conquests
and other factors and resist truncation at all costs. The new recompense for
unreasonable expansion in the size of government will be debt and defaults.[1]
Singular events that perturb the society such as financial crises are
particularly interesting in that they seem to be easily converted into dynamic wellsprings
of new and bigger government. The public grovels and twists their hats in the
presence of their devoted leaders while begging for relief from some problem;
they get only promises. The general observation is that when a financial crisis
occurs and the currency or other important economic vector turns down then such events
signal a change in political direction from left to right [or the converse] is
indicated by the votes from angry and disappointed people who respond to this
effect. George Bush was chased out of office and his party decimated from the
2007 financial crisis which he handled very poorly. As for the voters, “prosperity
is right around the corner” they are promised. Or in our current political
maelstrom the notion that “I have a plan to fix the economy” encourages change
from either or both contestants. When
times turn hard the voters tend to vote for the opposition in frustration and
ignorance, two attributes which characterize most of our citizens.
The voters tend to bend according to
personalities and not fact-based realities of the economy; they are easily
controlled and their views strongly influenced if we watch the approval rating
polls after some speech. Peasant societies, in which the bottom level people in
that system have much in common with our current voters, are universal in our
long recorded histories and are seemingly best controlled by feudal or
authoritarian systems. The necessary jobs are simple and fairly easily
regulated in peasant societies and are not skill intensive. Unemployment was
rarely a problem. Those who couldn’t cope merely starved and were no longer a
problem. Feudal lords and overseers could control vast amounts of land, water
and food with little force. The workforce was mostly immobile and tended to
regenerate itself limited only by the food supply and certain diseases. The
feudal system of Europe lasted more than a
millennium and was very stable in terms of the resident populations being
controlled by their lords and ladies. That control and stability has faded
away. Some of our biggest nations, such as the US U.K.
The advent of the Industrial Revolution, which eliminated
the feudal system, placed the new powers in the hands of individuals who could
generate wealth from business operations in stark contrast to the earlier
wealth-transfer systems that used inheritance and land control to pass along
power structures, land and wealth to the next generation. Here, capitalism[2]
advanced rather abruptly, as measured in social time units such as generations,
and became the dominant creator of power and influence because the ability to make
money transitioned from a small collection of heirs to a broad segment of the
society who produced a few entrepreneurs. Thus, a new pyramid was created with
entrepreneurs seated a the very top of the pyramid.[3]
The first offspring, the main vector in continuing on with wealth and power of
many nobles, were not able to compete in the free markets with others of lower
birth in an arena where cognitive skills were worth more than mere family
tartans and standards. Much of their workforce migrated to the cities in quest
of money, fun and drink and left landed nobles to their own fate. Thus power in
the form of money and capital displaced the previous leadership and land models
and pushed the emphasis in new directions.
Clever individuals no longer need authoritarian overseers. They could now
do their best without constraints. There
was, then, virtually no limit to how much wealth and power could be accumulated
by those individuals with industry, essential cognitive skills and some luck. The
system had changed forever.
The accumulation of wealth in the hands of a few
is always an economic, military and political problem, but reasonably no more
of a problem that was extant in the feudal system. It is currently more of a problem when those
few are the politicians who ostensible replaced the nobility.[4]
Sometimes this balance appeared to get out of hand and certain governments
needed to control business and extract taxes to spread around the profits and
address some needs of society that could not be fixed in the feudal system. After all, there was new and abundant wealth
being created from capitalism. Socialism in some form or another was an attempt
to control the distribution of the wealth of capitalism and make it more
equitable or to pretend to provide the nonexistent ‘equality’ to all.[5]
This effort failed, as we should have
expected, and the politicians shifted
the political emphasis to equal ‘outcomes’ rather than the pure ‘equality’
theorem that is rendered impossible by the natural distribution of cognitive
skills. People are clearly not equal. The process of controlling the
capitalists led to some fateful interactions frequently resulting in the
disintegration of whole business sectors or portions of governments. It is fair
to say that there must be some level of cooperation between the capitalists,
usually few in number, and politicians with even fewer attributes in advanced
business skills, and this interaction is both necessary and sufficient to
stabilize the society. Capitalism is what drives our world economy. Attempts to
stamp out capitalism have summarily failed[6]
and resulted in famine and economic disasters wherever attempted. The hybrid
forms of capitalism—socialism controlling businesses such as Nazism, Peronism,[7]
and Marxism in the form of modern
Communism as practiced in the People’s Republic and elsewhere have produced
somewhat satisfactory results as long as government does not interfere too much
in the practice of commerce. China Cuba North Korea Arabia .
Thus a criminal, loser or racist might attain a higher station in the political
world even though he or she may have the California California
Suffice it to say that governments and
capitalists interact in complex ways and those ways frequently determine the
economic fate of a given society. This topic of complex ways must sooner or
later be defined in terms of the stability of the economy and more particularly
in terms of financial crises. Governments cannot seem to properly balance tax
revenues and spending.[15]
There is apparently no potential political power in a balanced budget. A
reading of two recent books: Ascent of Money[16] by Niall Ferguson’ and the newer book This Time is Different: Eight Centuries
of Financial Folly by Carmen M. Reinhart and Kenneth Rogoff show, very
clearly, that the vast majority of governments cannot manage finances with any long
term competence. They make enormous mistakes as outlined by 1957 book: War
and Aftermath 1914-1929 by Pierre Renouvin[17]
that offers us a critical but objective scrutiny of the political and military actions
of various government agencies starting in the 1890s and leading up to August
1914 where most world stock markets suddenly shut down for months; this history
is enlightening. By 1916 most governments had spent all they had and were
wildly printing money to fund the Great War.[18]
We achieved 51 million deaths out of that adventure and enough hate and
discontent to set up the next world war for 31 million more to pay the ultimate
price. This is government operating in full bloom and proves that diplomacy can
recurrently solve no problems. Failed governments have no discernable
history in the political sense.
We can talk about peace and such, but every year
we find military action and economic pressures being applied in many places on
this globe. Even Obama bombs villages in two places in the Middle
East despite his seeming aversion to war. The ethic that should
prevent wars proposed by many is absent in nearly all governments. We must
finally admit that we are never going to agree on what peace and stability
means on this planet and be content to dealing with lesser crises. War is
expensive and this relevant fact brings
us back to the perpetual occurrences of financial crises:
We had a depression in 2007 that was, in my view[19],
temporarily stalled from its downward plunge by massive interaction by the US
Federal Reserve and Treasury that resulted in essentially doubling our money
supply [M2] in a few weeks. We wasted a
trillion dollars on war for no apparent gain and much more in worthless social
programs and the legacy of these efforts surged directly into our debt. Our
government now prints unbelievable amounts of money and all of that pile slithers
directly into the national debt now approaching 14 trillion dollars. Our soaring debt will rekindle this depressionary
fire in the next few years.[20]
We are bankrupt.
Several things must be made clear about this attempted
salvage of our economy in the 2007 Depression: [1] It was an experiment never
attempted on such a massive scale and [2] much of it was guess work at the time
as the politicians had scant time to analyze what was happening and [3] the
aftermath of this process generated new political opportunities to expand
government and control over certain markets. We are now hopelessly mired in debt and trying
to spend our way to prosperity using more debt.[21]
There is no way we can grow out of 14 trillion in debt with deficits exceeding
a trillion dollar every year on a GDP
of only 14 trillion unless we debase our currency. We are on the path to economic destruction.
The first thrust after any catastrophe is to put
new laws into place that will ‘fix’ the problem and ‘prevent’ it from happing
again. World War 1 was the Great War that would end all wars. This nostrum has
never worked in the past because we continue to have such financial catastrophes
and government has been in place with ostensibly their fingers on the levers of
the money machines for the last 5000 years without any convincing evidence that
they are doing anything other than grabbing power or guessing what to do next. They
are incompetent.
A recent and noisy example of how government can
‘fix’ a problem is the nationalization of General Motors.[22]
What happened was actually very simple: the unions forced concessions on job
security, pay, benefits and retirement from the company over many decades that
brought its labor costs up to unacceptable and noncompetitive levels and the
company then lost money on every car they made on average so the corporation
failed. This attracted political attention and the Obama organization decided
to fix the problem by nationalizing the company. This conforms to my theory of
‘spreading around the wealth.’[23]
GM was swamped by $80 billion in debt and was going bankrupt. Our current Neo-Marxist liberal/radical
government now blends fascism[24][25][26]
with socialism in an attempt to redistribute
the wealth and they applied this in fact as we saw in the GM and Chrysler
bailouts where bond holders and stock holders were wiped out [a 70% haircut in
the parlance for the bond holders] and the shrunken remains given to the unions
while the management was replaced by orders from the White House.[27]
The unions retained some 17% of the company [for what?? Political reciprocity??]
and the US Canada
This project is now viewed as a
positive interaction by the government in ‘fixing’ a problem with a
corporation. The ugly fact is that they
were $80 billion in debt and could never make that up by selling cars. At a 10%
profit margin per car, it would have meant sales of $800 billion to get that
back by selling 26,666,666 autos,
about double the US US
As the celebrations over this feat
subside we now turn to how we can ‘fix’ the derivatives markets and ‘prevent
the taxpayer from being stuck’ with another financial disaster. Our government
can do that they say.
The
immense size of the derivative market, currently running $596 trillion[28],
is daunting. It turns out interest rate contracts [$145.0 trillion] and foreign
exchange contracts [$18.2 trillion] constitute 90% of the contracts in this
market in the US
Leverage
in banks is debt-driven[31]
so the bank capital reserve limits the upper bound of how high this can go and
for an 8% capital-to-debt ratio it becomes simply 1/0.08 or 12.5 max. This is
peanuts compared to how the government set up securitized mortgages. We can complain
about numerous massive government
failures such as the Great Society, HUD, War on Poverty, and the phony Community Communist Reinvestment Act[32][33]that allowed the liberals to buy votes by offering
‘affordable housing’ to deadbeats and illegal aliens and abruptly ended with an
asset bubble. This process is ongoing. This real estate bubble brought down Bear Stearns [34]
who conjured up a leverage of 35.5 to 1 with their total debt almost equal
to our GDP [13.4 trillion[35]].
Fannie Mae and Freddie Mac probably hold $3-7 trillion of bad debt known as
toxic assets. Such bubbles are a natural part of our economic system and have
been happening almost yearly for the past 5000 years. All it takes for a bubble
to form is an unreasonable demand for some good or service that pushes prices
to levels way above the asset base. The
bubble is a free market correction to the supply and demand schedules. We are
doubtless bulling another bubble with the push toward alternative “green”
energy machines that only add cost to an existing asset.[36]
We read fluff like this
from liberal politicians on derivatives:
"Ultimately, we were not able to reach comprehensive consensus that will
fill in dangerous gaps while allowing companies to safely use derivatives to hedge their risks," Reed
[Sen from Rhode Island e.d.] said in a
statement. "I am hopeful that there will be bipartisan support for
bringing derivatives out into the open, regulating trades and ensuring that
regulators have the tools to keep up with new innovations in the system."[37]--
Senators divided over
rules on the derivatives market. [Emphasis is mine in
all quotes.]
If
we thought GM had a tough frog march back to financial security we have to stand
aghast at the notion that our government can fix this derivatives market. Since
there is little or no capital behind some 600 trillion in derivatives we can
ask if they could be restricted to a leverage of only 100 whereby somebody
would post capital of 6 trillion dollars.
According to a leading expert on international financial affairs:
“Unless this capital [for investment in this context] is
forthcoming, a clutch of countries will prove unable to roll over their debts
at a bearable cost. Those that cannot print money to tide them through, either
because they no longer have a national currency (Ireland East Europe ), run the biggest
risk of default.”[38]--The capital well is running dry and some
economies will wither. The world is running out of capital. We cannot take
it for granted that the global bond markets will prove deep enough to fund the $6
trillion or so needed for the Obama fiscal package, US-European bank
bail-outs, and ballooning deficits almost everywhere.”--By Ambrose Evans-Pritchard 26 Apr 2009 [Emphasis is mine in all
quotes.]
Our GDP
is only 14.3 and ¼ of the world’s GDP
so where could we get 6 more to hold leverage down to only 100, three times higher
than what was able to sink Bear Stearns at 35.5?? The world GDP is only about 4 x 14 or 30 trillion. Governments
fail to acknowledge that this market is a free market with thousands or
millions of willing buyers and sellers. This is a classic free market.
So, to sum up: all this smacking about leverage
and risk by politicians is misplaced. Our system runs on leverage and debt
because credit is money! Debt fuels growth and future profits and more growth. Risk
management saves capital and protects assets and financial instruments. There
is no way to back derivatives with
capital and guarantee no future financial crisis any more than there is a way
to prevent a run on any bank. There
is no way to back up the banks other than the printing presses running full
tilt as we saw in late 2007. This position is not being made clear to the
voters: government cannot possible do what they claim.
Our politicians have financial and economic advisors
and are not as stupid as they first appear. The only purpose of any government
intervention into capitalism is to gain power and collect more taxes to build
up their power base. The 2007 Depression was a grand opportunity to hike
spending and bloat government and the Goldman Sachs case is a prime example.
The case against Goldman is flimsy and the target of the investigation
[Paulson] is not even named in any indictment. The interesting fact that
Goldman’s employees gave Obama a million dollars in campaign contributions
[that he will not pay back] leads us to assume that this is a crass grunt and
grab intermezzo for Washington
Goldman is the best of the best and can best any
rules or regulations that our politicians can put up. They can move their
operation to Singapore Hong Kong where there is a more receptive
business environment at any time and prosper. Politicians either don’t
understand leverage and how it works to expand the money supply and its
function in investments or they do not. If Goldman is cut up and trashed the
remnants will simply reassemble someplace else and continue on with investments
as they did with the fine people at Bear Stearns that needed new jobs. The US Asia is
growing under this mechanism and can now provide what the US JEC .[39]
The reason was capitalism and Wall Street ingenuity. This makes the politicians
look like bigger fools and uglier criminals than we might expect.
Now, let’s do some rational thinking about the
derivatives market. Firstly, how much did we lose when some of our investment
banks went down? That was 10 trillion at best and another 5 for Europe . So, what was the net effect of the existing
market? We lost 15/600? A mere 2.5% of the market!?? Now, we push further on
the Stone of Reason to see what lies beneath and ask: what can our government
do about this risk? Put up a few trillion here and there in capital backing?
No. There is no money to do this. Missing from the equation here is the data
that might show that the derivatives market actually prevented some loses fr0m
the financial meltdown on Wall Street. This market exists for a reason and
because so many people buy products from this market we probably err greatly to
summarily condemn this financial instrument or tax it to death.
The effect of government interference in markets
is always the same: higher costs and a series of distortions. We seem to want
to depend upon politicians who are only radical, racist-based chum chuckers[40]
or outright criminals[41]
or pervert enablers[42] for help and advice on this issue. They
profess to know the solutions to this problem. What solution can they offer?
Why, they can get tax money to buy more political power.
The effect of government intrusion into such
markets that address the important attribute of risk aversion is that the
cost of buying risk insurance will soar thus fewer municipalities and
pension funds will buy fewer contracts and the risk of damage from defaults and
varying exchange rates will rise. That is an unnecessary cost and is
inefficient.
Thus, you
will be paying incompetents to tax you to make the risks in business and the
currency exchange world increase. That sounds like the
old politics we know and vote for. The new radicals like Bertha Lewis of ACORN
fame, noisy propagandists like Joe Klein of Time[43],
Andy Stern of the vicious street-gang and head bashing SEIU union and their
Communist allies and other chum chuckers are trolling for money and power. They try to play on the propagandist’s
favorite themes: fear, corporate greed and racism. They attempt to show that
the Tea Party people are Nazi thugs who want to round people up people of color
and send them to internment camps and other crass lies.[44]
And, notice that Democrats like Joe Biden, Hillary Clinton, and Harry Reid sit
idly by and make no comments or corrections to these lies and their
preposterous statements. These senators are just slugs stuck in the cracks of
the Washington
All these people want is the control over your
money and future and they will get if we don’t chuck these parasites out in
November. All they have is your money. And,
you don’t have enough to satisfy the far left. They will attempt to grab it all
if they can. Lenin is still their patron saint.
rycK [a 5th generation Californian
in exile]
[1] The US
[2] The Pyramidal Theory of
Capitalism Explained in Simple Terms.http://rycksrationalizations.blogtownhall.com/2010/01/07/the_pyramidal_theory_of_capitalism_explained_in_simple_terms.thtml
[3] The Pyramidal Theory of Capitalism
Explained in Simple Terms.http://rycksrationalizations.blogtownhall.com/2010/01/07/the_pyramidal_theory_of_capitalism_explained_in_simple_terms.thtml
[4] USSR Cuba
[5] The Futile Attempt of
Forcing Equality Among the Masses.
[6] Russian Revolution, Chinese revolution,
Cuban revolution, etc.
[8] California
[9] The Road to Social
Success, Peace and Justice: California
[10] As Predicted: California
[11] Copulating
with Coprolites: The Unveiled Mechanism of Governance by Progressive Liberalism
in California
[12] The Proud March of the Financial Lepers: Greece California
[13] California Becomes the National Leper like Greece
[14] Or perhaps dootifully, a new word derived from dooty: Belligerent
Ignorance, Phony Economics and the Clunker Crusaders: Washington
[15] Inefficiency in California Greece
[16] The Ascent of Money: A Financial History
of the World (Hardcover) by Niall Ferguson (Author) http://www.amazon.com/Ascent-Money-Financial-History-World/dp/1594201927
Review:
“The number one lesson from this book is this:
financial
systems collapse all the time. It happens in every era in every
geography — which highlights why it shouldn’t be such a surprise that our own
system is under serious strain right now.” http://john.jubjubs.net/2009/04/03/the-ascent-of-money-by-niall-ferguson/
[17] : War
and Aftermath 1914-1929 by Pierre Renouvin
[18] Extracted from a previous blog: Maximizing Both Tax Revenues and Economic Growth: The
Folly of Government and the Generation of Phony Numbers and Class Warfare
[19] Maximizing Both Tax Revenues and Economic Growth: The
Folly of Government and the Generation of Phony Numbers and Class Warfare
[20] Deflation and Defaults:
The Path Downward from Debt and Excessive Spending.
[21] Krugman Offers an Essay
on Misdirecting Political Power. We can Control the Banks and prevent the Next
Crises, but No Details, Just give us Power.
[23] The Phony Quest for
More Jobs--A Prediction: Obama will Just Create and Transfer Debt for Jobs
Funding.
[24] Muzzling the Media:
Fascism Looms Tall in Chicago
[25] The New York Times
Wants More Control Over Private Equity Firms. More Fascism on Order
[26] Our Economy is
Collapsing. The Liberals will Now Institute Some Kind of Neo- Fascism or
Socialism or Some New Blend to Maintain Power.
[27] The Phony Quest for
More Jobs--A Prediction: Obama will Just Create and Transfer Debt for Jobs
Funding.
[29] Government theft of citizen’s wealth by
debasing the currency or manipulating currency exchange rates.
[30] The Bubble that will Burst Higher than all Previous
Bubbles: Depression Looms as the Dollar Crashes.
[32] “Bear Stearns made the first public securitization of Community Reinvestment
Act (CRA ) loans started in 1997.[6] Editorialists in some American
newspapers[7][8] and US Congressman Ron Paul[9] say the CRA
loans were lent to otherwise un-credit-worthy consumers in the name of ending
discrimination, although an analysis of actual lending patterns does not
generally support this conclusion.[10][11][12]
On June 22, 2007,
Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail
out" one of its funds, the Bear Stearns High-Grade Structured Credit Fund,
while negotiating with other banks to loan money against collateral to another
fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund.[13] The funds were invested in thinly
traded collateralized
debt obligations (CDOs)
found to be worth less than their mark-to-market value. Merrill Lynch seized $850 million worth of the
underlying collateral but only was able to auction $100 million of them. The
incident sparked concern of contagion as Bear Stearns might be forced to
liquidate its CDOs, prompting a mark-down of similar assets in other portfolios.[14][15] Richard
A. Marin, a senior executive at Bear Stearns Asset Management
responsible for the two hedge funds, was replaced on June 29 by Jeffrey
B. Lane, a former Vice Chairman of rival investment bank, Lehman Brothers.[16]
[34]By
my count, the Federal Reserve has already extended something on the order of $455 billion in loans collateralized by some of
these same troubled assets, namely $125 billion in repos, $150 billion in the
term auction facility, $50 billion in "other loans", $30 billion from
the Bear Stearns deal, and $100 billion in "other Federal Reserve
assets". That $455 billion total does not include this week's$85 billion loan to AIG, nor the $180 billion in reciprocal currency swap lines. http://www.econbrowser.com/archives/2008/09/paulson_bailout.html
[35] $13.40 trillion in derivative financial
instruments, of which $1.85 trillion were listed futures and option contracts.
In addition, Bear Stearns was carrying more than $28 billion in 'level 3' assets [ dog
droppings] on its books at the end of fiscal 2007 versus a net equity position
of only $11.1 billion. This $11.1 billion supported $395 billion in assets,[4]which
means a leverage ratio of 35.5 to 1. This highly
leveraged balance sheet, consisting of many illiquid and potentially worthless
assets, led to the rapid diminution of investor and lender confidence, which
finally evaporated as Bear was forced to call the New York Federal Reserve to
stave off the looming cascade of counterparty risk which would
ensue from forced liquidation.”[35]
[36] The Bursting of the GanGreen Bubble.
[38] The capital well is running dry and some economies will wither
The world is running out of capital. We cannot
take it for granted that the global bond markets will prove deep enough to fund
the $6 trillion or so needed for the Obama fiscal package, US-European bank
bail-outs, and ballooning deficits almost everywhere.-- By Ambrose Evans-Pritchard
Last Updated: 8:49AM BST 26 Apr 2009 http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/5220118/The-capital-well-is-running-dry-and-some-economies-will-wither.html
Last Updated: 8:49AM BST 26 Apr 2009 http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/5220118/The-capital-well-is-running-dry-and-some-economies-will-wither.html
[39] Presidents Roosevelt, Johnson and
Carter.
[40] Barrack Obama : O’Bozo
the Clown and His Lying Neo-Marxist Droolers Ruin the Economy and Put Criminals
into Power.
[41] The Clintons, Chris Dodd and other
senators.
[42] Bill Clinton and Barney Frank
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