Friday, March 7, 2014

Derivatives- What of it Warren?

I mean we even lost 400 million 
Derivatives typically have a large notional value.  As such, there is the danger that their use could result in losses for which the investor (Bank) would be unable to compensate.  So many vehicles riding on one underlying where the vehicles reach escape velocity, far outperforming the original value of the financial product through leveraging and the huge dependencies on counterparties.     

The possibility that this could lead to a chain reaction ensuing in an economic crisis was pointed out by famed investor Warren Buffett called them 'financial weapons of mass destruction.'  A potential problem with derivatives is that they comprise an increasingly larger notional amount of assets which may lead to distortions in the underlying capital and equities markets themselves.

If the sale on these were called on as a whole, the spread on the leveraging could not be covered, the original product is distorted, lesser value if any.  That's a very large number 700 Trillion $dollars$ and that was in 2011, were above that now.  It's known that the Banks can only cover part of the spread, hell that sounds like a Bookie! 

There have been several instances of massive losses in derivative markets, such as the following:

Two former JP Morgan Chase & Co. (JPM) employees were charged by federal prosecutors with attempting to conceal trading losses at the largest U.S. bank last year as part of a probe of its US$6.2 billion loss on derivatives bets, story became to be known as the The London Whale.

From Wikipedia:
American International Group (AIG) lost more than US$18 billion through a subsidiary over the preceding three-quarters on credit default swaps (CDSs). The United States Federal Reserve Bank announced the creation of a secured credit facility of up to US$85 billion, to prevent the company's collapse by enabling AIG to meet its obligations to deliver additional collateral to its credit default swap trading partners.

The loss of US$7.2 Billion by Société Générale in January 2008 through misuse of futures contracts.

The loss of US$6.4 billion in the failed fund Amaranth Advisors, which was long natural gas in September 2006 when the price plummeted.

The loss of US$4.6 billion in the failed fund Long-Term Capital Management in 1998.

The loss of US$1.3 billion equivalent in oil derivatives in 1993 and 1994 by Metallgesellschaft AG.

The loss of US$1.2 billion equivalent in equity derivatives in 1995 by Barings Bank.

The loss of UBS AG, Switzerland's biggest bank, suffered a US$2 billion loss through unauthorized trading discovered in September 2011.

This comes to a staggering US$46.9 billion, the majority in the last decade after the Commodity Futures Modernization Act of 2000 was passed.

What of it Warren?

Bill George

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