In large part, financial derivatives caused the meltdown of the world financial system. Do you know what a derivative is? If you found a derivative on your doorstep, would you recognize it? Do you think your local banker knows what a derivative is well enough to describe it to you? Could your financial advisor educate you to where you could truly understand them? Do you think Alan Greenspan understood derivatives when he had a chance to do something about them? Do you think anyone in the world really and truly understands derivatives? The answer to all these questions is a resounding NO! So, do we need them to survive? Does our economy need them? The answer to that may not be so clear cut.
A derivative is an investment for the sake of investment with pretty much nothing behind it, basically a gamble. A derivative is an investment in another investment. Many derivatives are based on another derivative which very likely is based on yet another derivative, on and on. It’s not at all unlike those Russian dolls, one doll inside another inside another, sometimes dozens, even hundreds deep. Derivatives are about as useful as Russian dolls too.
Why we may need derivatives at all and why you don’t hear many national leaders calling for their elimination is that our entire economy has become a Ponzi scheme based on the banking sector that is little more than the worlds largest casino now largely reliant on these bogus securities. If we tried to undo the Ponzi scheme overnight, calamity would ensue, and of course already had. The calamity we saw in 2008 is just the tip of the iceberg.
The total value of all derivatives as of 2007 was around $516 trillion. The gross domestic product of the US economy is about $15 trillion. The size of the derivatives market shot up from $100 trillion to $516 trillion in just five years leaving little doubt that there was anything at all underpinning the sector. It’s not as if the value of all assets upon which such investments are based shot up by 500% in five years, it’s just the most massive con ever perpetrated on mankind.
I mentioned Alan Greenspan and the fact that even he, arguably the number one economist in the world, didn’t understand derivatives much better than you or I. Over ten years ago, the danger of these investments was brought to his attention, and he had to do battle with Brooksley Born who tried to regulate them in order to allow derivatives to spiral out of control. Had Mr. Greenspan had a clue as to how dangerous and fraudulent these investment vehicles were, perhaps he’d have at least given the American public fair warning as to what he was going to allow the banks to do to us all. He knowingly allowed what happened in 2008 to happen. He’d seen the effects of derivatives gone bad when one of the wealthiest counties in the United States, Orange County, California; declared bankruptcy, mostly from derivatives . This was the late 1990 when derivatives were about $25 trillion. As far back as 1993 derivatives cost Proctor and Gamble big as well, and took down Long Term Capital Management (LTCM), a trillion dollar hedge fund, over ten years ago. Even today, derivatives are completely unregulated and are still the scariest thing in our economy.
So, do derivates have a positive side? Only if you happen to be the guy peddling the damn things and perhaps if you get in and out before the bubble bursts. Its a scam, period. I won’t venture to say that you’d be better off at your local casino, but you can understand what your odds are there and there is far more regulation over any casino compared to Wall Street. One report states that even Alan Greenspan stated that he had no interest in preventing fraud on Wall Street, that he’d leave self-regulation to the industry and the market. In other words, he’d allow investors to get burned so they’d know enough not to invest a second time. The main problem with this theory is that now that he and Larry Summers and the other heavy hitters that for the most part are still calling the shots have allowed our entire economy to be mostly based on the false value and false usefulness of the investment banks. Once upon a time these banks were the means of funding industry, now its a shell game, hiding the decent investments based on something concrete amongst a sea of faux investment, derivatives. You and I and sophisticated investors and bankers and government officials and just about anyone in the world had no idea how solid any investment is. You may think investing in a blue chip stock might be a sound investment, yet as we’ve already found, solid companies get sucked into some of the $516 trillion dollars worth of crap, potentially killing a healthy company and your investment. It happened to governments all over the world, it happened to blue chip companies, and it harmed tens of millions of investors of all sizes. There is no transparency in this business, the banks and brokerages dealing in these things know they are screwing their investors and are quite proud that we are all such suckers and that government is so incredibly corrupt and compliant.
So what are we to do? Who knows? The banking sector won’t allow Washington to protect us, our economy needs investment and most people need to do something with their savings other than watch inflation erode its value. I guess what we need to do is simply wait for the inevitable to happen, the Ponzi scheme to go bust and a new system of investing to emerge. It will be painful, but so far nobody has a better plan.
There is another significant problem exposed by derivatives. We have all assumed that the guy running the asylum know what they are doing, yet they don’t. They understand more than you and I, to be sure, but they are either corrupt or simply do not have the ability to control the monster they created. Dr. Frankenstein knew enough to assemble body parts, but he had no idea as to how to deal with the create he had created. So too is the problem faced by all of Wall Street and the Federal government, and worse yet, they are concentrating their efforts on how to take thier profits before this whole nasty mess collapses, and it will collapse. It must.
Look at the guys running the show. At one time Bernie Maddoff was the chairman of the NASDAC stock exchange. Doesn’t that say it all? Robert Rubin, a key Clinton era player, key to the complete deregulation of Wall Street and a top play at Citibank at the time the government was required to hand over $100 billion to keep them afloat. What does that say about the brains making the rules. We should all be scared, very scared. Maddoff wasn’t an anomaly, its just that he was caught. He wasn’t primarily involved with derivatives, but he was indicative of the lack of oversight and the fact that the people we revere and place in high positions are like the king with no clothes, we simply choose to ignore what are own senses are telling us. By 2007, the derivatives market shot up to $595 trillion, then to $684 trillion in June of 2008 and back down to $592 trillion at the end of 2008. Be scared, very scared. This crisis isn’t over.