OTC Hockey Stick Problems Of The Derivatives Beast
May 7, 2008
Elaine Meinel Supkis
Once again, I will try to approach the biggest financial monster on earth, bar none: the Derivatives Beast. This bizarre creature was born the day the dollar was devalued and began its swift death when Nixon completely cut the ties between our paper IOUs and gold. 'Let the markets set the relative value of everything against the dollar. Let all things vacillate wildly as speculators and traders bet against the rise and fall of all things vis a vis all currencies in the world. And gold will cease to be a money and will now be a commodity just like wheat or oil!' And so, the trade problems and insecure financial problems began to grow and accumulate until we now have a hysterically big monster, the Derivatives Beast, that expresses INSECURITY in all systems. And It has grown to such vast size, it is bigger than all of the value of the entire planet earth! So we shall go back in history to examine the birth and growth of this Beast.
First, the news from today: Fannie Mae loses $2.2B in 1Q, warns of severe weakness
Fannie Mae reported losses of $2.2 billion in the first quarter and the nation's largest buyer of home loans said Tuesday it would cut its dividend and raise $6 billion in new capital, with expectations that the housing slump will persist into next year.Home prices fell faster in the first quarter than Fannie Mae had expected, the government-sponsored company said, and it will open a $4 billion share offering immediately, with the remainder being offered in the "very near future."
Following the stock sale, Fannie Mae's federal regulator, the Office of Federal Housing Enterprise Oversight, will cut the capital surplus cushion the company has to maintain by 5 percentage points to 15 percent, with another five-point cut in September, provided there is "no material adverse change" in the company's regulatory compliance.
The G7 banking system and all its parts and pieces continues to fly apart. As the entire edifice collapses with a roar of dust and falling building parts, the people who refused to raise interest rates to reflect the real rate of inflation for over a decade now, stand around, pretending to be clueless. Like termites eating away in the dark, inflation has reduced the foundations and beams of our banking system, silently and with great stealth. Now, it is obvious to any outside observers that the entire system is dying. Inflation is raging out of control nearly everywhere on earth and internally, within the banking system, it is running at a rate faster than Zimbabwe's amazing inflation rate.
This internal inflation is expressed in the nature of the Derivatives Beast. This is a very young creature born of the dying banking system of the US and European empires. Post-WWII, the classic banking system based more or less on the holdings of US gold at Fort Knox continued in all its many forms. The price of gold was controlled by the US Treasury working with the private bankers in the Federal Reserve. We actually had reserves back then, relative to the size of the money supply! And it was gold.
Back to today's news: Fannie Mae is going bankrupt. As the housing collapse gathers steam, Fannie Mae's portfolio of DEBTS loses intrinsic value. If a homeowner can't pay the debts, the house is increasingly worthless as a store of value. It can't be auctioned off for nearly as much as the debts owed. To fix this, there was an emergency meeting of the wizards. They said, 'Hey, if we decree that there is NO NEED FOR RESERVES, Fannie Mae can continue to grow!'
So they made the reserves vanish. Our nation did this to our currency under Nixon. If the reserves never matter, it doesn't matter if the equity base or assets collapse in value or vanish! 0% reserves means INFINTE LENDING POWER! The magic of lending is, one can make the money appear from out of nowhere. Just sign the dotted line and voila! Money is cranked out and put into the system. This is what we call 'money growth'. Since the planet Earth is a limited physical system with limited resources, the new money ends up chasing these limited physical goods. It is used to bid up the price of everything the money holders want to bid up. Art work, houses, food, fuel: you name it, it can be bid upwards!
When infinite money based on 0% reserves exists, it creates money faster and faster and we call this 'inflation'. Then there is the other nasty void: 0% interest rates and 0% pay down of principal on a loan. Japan has experimented with this concept for the last 15 years! Amazing! Their export economy ballooned. They became the world's #1 export economy and the upper classes in Japan got very, very rich and Japanese companies not only colonized Asia but the US itself, building factories all over the world and destroyed the dominance of US corporations overseas. Japan's FOREX reserves shot upwards at a mad rate while keeping the yen weak. A contradictory monetary policy. Any time one sets lending at 0%/0%/0%, this leads to INFINITY in money creation! There is no restraints at all! None. Japan does have one thing the US banking system doesn't have: reserves. The FOREX reserves are set at 10% growth per year so they are a 0%/0%/10% system. The US is heading towards a fatal 0%/0%/0% system. This, by the way, is the definition of bankruptcy. We can't pay anything for anything. We are looking straight down into the Dark Pit of Hell here. So, Fannie Mae has gotten permission to go there for infinite lending power.
Fannie Mae Wins Cheers Despite Loss
But investors celebrated anyway, bidding up the stock 9 percent, to close at $30.81.Their optimism stemmed from the belief that Fannie Mae was in a position to pick and choose among the best and safest loans currently in the marketplace. The company, which buys mortgages from banks and other lenders, announced it would raise $6 billion in new funds to purchase additional loans and shore up a listing balance sheet.
“As the market recovers, we will be a prime beneficiary,” Fannie Mae’s president, Daniel C. Mudd, said in a conference call with analysts Tuesday morning. When the housing market finally stabilizes, the company will “feast” on the mortgages it is currently buying, he added.
Wall Street yesterday went hog wild. Oh boy! Infinite lending with NO RESTRAINTS! Wow! A miracle from the wizards to our wallets. Not only has the Fed decreed they will drop interest rates to 0% to keep the 'economy' going, lenders won't have to have any reserves and they can still 'buy' and hold more and more loans even if these go bankrupt after only one or two years and virtually none of the interest, much less, principal are paid off! But the money created by these loans will be launched. For the full amount of the lending will appear on ledgers of banks and businesses. This is why it causes inflation.
I could sit at home and write loans to the entire planet if I had this magical 0%/0%/0% system. If everyone qualifies for this system, why, we will all be trillionaires. Like in Zimbabwe or the Weimar Republic.
U.S. April Business Bankruptcy Filings Increase 49%
And American businesses are going bankrupt. A total zero system would save them. They could borrow forever at 0% and thus, never worry about paying off debts. One simply accumulates debt. As our government has been steadily doing since Nixon severed the gold/dollar connection.
Now we can talk about the Derivatives Beast! I keep struggling to understand It. Thinking about it not as a rational system set up by sober people wishing to protect our economy, if we look at it as a creation of instability, misspending of funds, wild overspending, shortages of commodities and a madcap desire to have some sort of 0%/0%/0% system with the inflation hidden somehow, this magical Beast is the result of years of scheming and playing tricks so infinite money could be created in the dark where no one could see it or understand it. Once we view this Beast as an invisible entity from the Outer Darkness, we can see its true nature. Which is very much an expression of the power of the demonic death wish forces over on the Other Side of Reality and Life.
I have a box of very old Mad Magazines. This cartoon is from an issue in 1975. Inflation was just beginning to take off. It was nowhere near its peak. But every other cartoon was about inflation! It certainly was on everyone's mind. There even was a blank box representing the severing of gold from the dollar. It said, $0 value.
This cartoon is important for it cuts to the truth of what is going on! EASY CREDIT is destroying America's government and our joint powers! NOT high interest rates. Easy credit! Mad Magazine's cartoonist was a genius. Clark and Jacob's cartoon sums up the situation perfectly and incidentally, set the stage for Volcker to raise interest rates rapidly to kill this inflation! Indeed, when I saw the cartoon, a lightbulb flashed in my head. I saw this cartoon long, long ago! And absorbed it and it became part of my worldview! This is probably one of the reasons why I have written often in the past, 'Easy credit always leads to bankruptcy!' Isn't this funny? Bravo to a comic book for hitting the nail right on the head.
We want easy credit for the simple reason, we can buy to our heart's content and not worry about paying it back. But of course, as the price of what we want begins to climb steeply, we need more and more credit to buy things. A Picasso painting in 1960 was worth far less than a million dollars. Now, it is auctioned for a hundred million and this is pure, unadulterated inflation. Money has to seek some place to park itself and bidding up things is the best way to deal with easy credit. This is why the value of housing shoots up if credit is set at below the rate of inflation. And this increases inflation since the dollars must inflate the value of assets being use to gain easy credit! This is Oroboros, the snake that eats its own tail.
Below is a graph from the Chicago Board of Trade showing how the interest rate swap game which began less than 20 years ago, is a classic 'hockey stick' chart heading rapidly to infinity. Any system that has this appearance on a graph is going to blow up or die. Nothing except for maybe the Universe itself and probably not even that, can go upwards in a hockey stick graph sort of way! THIS IS IMPOSSIBLE. Generally, speaking, when anyone sees ANYTHING IN CREATION doing this, they must either stop it from continuing or run for cover. For death and doom will rapidly stalk onstage and take over. A hockey stick graph is a clear indication we are looking into the maw of Death itself. This is the door to the Outer Darkness. It is fatal. I can't be more stark about this: IT MEANS GRAVE DANGER.
Of course, when the CBOT published this chart...and they have refused to update it since 2005, I updated it....they thought this was a nifty thing! Look! It is growing rapidly! Why, we should encourage this further!
This is why we need regulators who say, 'There is no way in hell we will allow this to happen. Back off or we shall arrest you.' Alas, fools run our systems and when they see a hockey stick graph, they are childishly overjoyed and scheme to make it go even faster and higher! They love infinity and hope to attain total wealth and absolute power of the Pharoahs to build giant pyramids and then bury themselves inside with all their loot and live for eternity with the gods while laughing at the humans outside the pyramids of power.
I looked for more information about derivatives since we have to understand this monster much better. Here is a good web page with a sane summary about it:
A derivative is a risk-shifting agreement, the value of which is derived from the value of an underlying asset. The underlying asset could be a physical commodity, an interest rate, a company’s stock, a stock index, a currency, or virtually any other tradable instrument upon which two parties can agree.
Once upon a time, derivatives could only be on a select few physical objects that could be seized by the entity upon whom the risk of default concerning paying off debts was settled. If a debtor wants to evade responsiblity, they could sell their exposure to bankruptcy to someone who would collect fees plus be able to own the ultimate property. But this wasn't very profitable. Because when someone goes bankrupt, usually, as we see in the news this year, a host of people go bankrupt and there are fewer buyers of physical things. So the value of the underlying object drops! This was fixed by our wizards so it doesn't matter.
Namely, all things are very variable in ultimate value. So the juggling of this risk has become a growth industry as the ONLY point is to EVADE RESPONSIBILITY for paying off loans parked on things that are collapsing in value! Isn't that funny? The only response to falling value of things is for the banking system and the markets to inflate the value like crazy so all the complex buck-passing doesn't have to shrink! This is why they much prefer raging inflation rather than Volcker's sensible solutions!
And why should ANYONE wish to evade responsibility for risk? Only cheaters, dead beats, con artists and criminals want this! THIS IS PURE EVIL! We struggle to teach our children to be responsible! We tell them, 'You did this, you clean it up, you pay for the window you broke,' etc. Instead, we have an army of spoiled brats who have schemed with each other to evade responsibility for things breaking down. This also reminds me of my sisters who, until I saved up my own money working as a teenager, we three shared the same car. They NEVER put in gas or checked the oil. I did. So my costs for this damn car were through the roof while their costs dwindled happily. Complaining to my parents did no good so I bought a wreck, rebuilt it and drove that for 10 years. Sold it for $600 eventually.
Responsibility is important. It means planning ahead. 9 out of 10 times, I would turn the key in our joint car to be horrified to see the gas gage at zero gallons. We lived 8 miles from the nearest gas station! So I had to plan ahead and keep gasoline in a can at home! At my own expense, of course. Heh. Now we all see why I am so uptight about all this! The risk of being stuck on a dirt road miles from help thanks to my sisters was MY problem, not theirs. They would wait until I filled the tank and then run off with the car yet again. By the way, I moved out of the family home when only 16. My parents gave me premature legal rights via a lawyer I talked into giving me this wonderful piece of paper that said, I was my own boss, not my parents! Thank you, ACLU!
Back to shoveling off all risk to other parties who then sold it off to yet other parties who did this again and again, causing the 'value' of derivatives to shoot upwards like crazy:
How do privately negotiated (OTC) derivatives differ from futures?First, the terms of a futures contract—including delivery places and dates, volume, technical specifications, and trading and credit procedures—are standardized for each type of contract. For swaps, the same characteristics are subject to negotiation by the parties to the contracts. Second, futures contracts are always traded on an exchange, while swaps are traded on a bilateral basis. Third, those who engage in futures transactions assume exposure to default by the exchange’s clearinghouse; for OTC derivatives, the exposure is to default by the counterparty. Fourth, credit risk mitigation measures, such as regular mark-to-market and margining, are automatically required for futures but optional for swaps.
Finally, futures are generally subject to a single regulatory regime in one jurisdiction, while swaps—although usually transacted by regulated firms—are transacted across jurisdictional boundaries and are primarily governed by the contractual relations between the parties. Various products, including futures contracts and exchange-traded options, fall within the generic category of futures, but all have the common characteristics described above. The definitions that follow refer exclusively to privately negotiated (OTC) derivatives.
This is very, very important: OTC derivatives are NOT REGULATED. And being swaps rather than futures, the responsibility is no longer direct. It is diffuse. The Chicago exchange wanted to make money supervising these unregulated, bizarre buck-passing scams so they took some responsibility in setting it up and regulating it themselves...with the intention of driving them all to infinity! Here is the ultimate scam: interest rate swaps. Remember: the guys playing this game are creating inflation both in the daylight and in the dark! These swaps are directly creating inflation even as they supposedly hedge against the powers of inflation.
More derivative information:
Interest rate swaps:An interest rate swap is an agreement to exchange interest rate cash flows, calculated on a notional principal amount, at specified intervals (payment dates) during the life of the agreement. Each party’s payment obligation is computed using a different interest rate. In an interest rate swap, the notional principal is never exchanged. Although there are no standardized swaps, a plain vanilla swap typically refers to a generic interest rate swap in which one party pays a fixed rate and one party pays a floating rate (usually Libor).
The dealer’s view on interest rates does not matter. When the dealer assumes a client’s risk, the dealer typically lays off—that is, hedges—that risk with an offsetting transaction. Suppose, for example, a dealer enters into a swap in which the client pays a fixed rate to the dealer and the dealer pays a floating rate to the client. The dealer could hedge the risk by entering into an offsetting swap with another client or dealer. Or, it could take a Treasury security position with interest rate exposure that offsets the swap. Or, it could take an offsetting futures position. Over the entire portfolio some risks might be uncovered at various times—which is essential to the existence of a liquid market—but such risks are carefully monitored and controlled by dealers.
See? Isn't this funny as hell? OK: the guy taking up the risk of the guy paying an interest rate on a huge pile of loans immediately turns around and PASSES IT OFF. Everyone is 'hedging' off of the same loan pile. But as they pass this around, they all try to milk it for loot! Since it is directly connected to the infinite money machine in the Cave of Death, they have discovered that no one can tabulate the addition of price as they bid with each other over these hedges of risks of default. All is well and all parties make a lot of loot this way until one thing happens: the first party defaults. The risk has to be paid! So the second party defaults. It is DOUBLED and passed on to the next guy! He dies and the next has a hockey stick situation. He is hammered by this, too! Etc.
Um, we are seeing this as the entire banking system in the West collapses. They are in hysterics to have governments fix this by propping up the value of the underlying assets and loans and preventing Bear Stearns from going bankrupt, just for one glaring example. This is why they are screaming, 'There is BLOOD IN THE STREETS!' as they wail for the government to save them with what?
Zero percent rate loans with zero percent down as reserves and never paying off the balance! See? Isn't this absolutely simple to understand?
But there is more!
A credit derivative is a privately negotiated agreement that explicitly shifts credit risk from one party to the other.For a buyer of an option, the amount at risk is generally the value (premium) of the option at default. For the seller of an option, there is no credit exposure.
Options differ from insurance in that options do not require one party to suffer an actual loss for payment to occur. In addition, the owner of an option need not have an insurable interest—such as ownership in the underlying asset—in the option.
This interest rate swap meet is fun! The guy holding all the risk does NOT hold the underlying asset so he doesn't have to worry about it even existing. If it vanishes, he just does what? HAHAHA. And the seller of this stupid derivative is also off the hook! He, too, is not in charge of the underlying asset. So who is?
HAHAHA. NO ONE! Well, except for the entire planet earth. This is how we get huge inflation with dropping value of assets! This is the bizarre system that sets up 'stagflation' which can only be broken by high interest rates and the arrest of all these con artists who destroyed the classic banking/trading systems. And this means stopping wild spending by governments and individuals. Savers must rule the economic realm, not spend thrifts!
Here is a thumbnail history from the Chicago Board of Trade's web page: 1848
On April 3, 1848, the Chicago Board of Trade (CBOT) was officially founded by 83 merchants at 101 South Water Street. Thomas Dyer is elected the first president of the CBOT.
1849-50
"To arrive" contracts come into use for future delivery of flour, timothy seed and hay.
1851
The earliest "forward" contract for 3,000 bushels of corn is recorded. Forward contracts gain popularity among merchants and processors.
1861
The Civil War begins. CBOT finances formation of three regiments and an artillery battery for the Union Army. CBOT adopts gold coin as its standard of value.
1865
CBOT formalizes grain trading by developing standardized agreements called "futures contracts." CBOT also begins requiring performance bonds called "margin" to be posted by buyers and sellers in its grain markets.
1877
Futures trading becomes more formalized and "speculators" enter the picture.
1916
War grinds on; corn reaches $1.05 per bushel, highest since Civil War.
1917-20
War makes the market unstable; wheat trades at $3.25 per bushel, highest ever paid for a future delivery.
Grain trade and railroads nationalized during and for a period after the end of World War I on November 11, 1918.
1940
During World War II, Paris falls to the German army and open wheat futures shrink 37 million bushels in six days of liquidation and prices decline.
1969
CBOT begins trade in first non-grain product, with a Silver futures contract.
1974
CBOT starts trade in 3 Kilo Gold futures on December 31.
1979
CBOT begins trade in 100 troy oz Gold futures on February 20.
1982
CBOT launches first options on futures contract, for U.S. Treasury Bond futures on October 1.
1988
Fed Fund futures begin trading May 3.
2001
Chicago's four financial exchanges close on Wednesday, September 12 in recognition of the tragic events of September 11.
CBOT launches 10-Year Interest Rate Swap futures.
2006
On September 26, Singapore Exchange and Chicago Board of Trade commenced the first day of trade for the Joint Asian Derivatives Exchange (JADE). JADE a market division of SGX Derivatives Trading Ltd., launched its debut in commodities futures trading with TSR 20 Rubber futures contract.
2007
On February 5, 2007, the CBOT launched the electronically-traded DJUSRE Index futures contract designed to allow market participants to capitalize on changes in the real estate sector of the stock market.
CBOT Holdings, Inc. announced its best year in company history, with revenue of $169.3 million for the fourth quarter 2006 on January 31, 2007.
See how the trade in goods morphed? It became increasingly disassociated from its reality. Note also the huge impact wars have on prices. In WWI, we supplied Europe with both food and lending. In WWII, we lost market share due to Germany and Japan locking us out of our markets and we gave away food to all our allies. And had rationing at home. Today, we are at war, we are not giving away food, we are giving away useless dollars dropping in value so our allies can buy food but this drives up the value of food commodities: another cycle that is dangerous in the extreme. Look at how the CBOT also jumped with both feet into the real estate shark tank! They thought they were jumping into another hockey stick graph situation of infinite wealth. Right when it began to collapse into chaos. And that year the exchange made record profits! Whoopee. Better than 1929.
CBOT Interest Rate Swap Futures: Enhanced Solutions for Risk Management
Chicago Board of Trade 5-year and 10-year Interest Rate Swap futures reduce the operational and regulatory risk created by increasing volumes of outstanding OTC interest rate derivatives.At the end of 1990, the outstanding notional amount of OTC U.S. dollar interest rate swaps was similar in size to U.S. Treasury debt, with both just above $2 trillion. Fifteen years later, however, the outstanding notional amount of OTC swaps exceeded $50 trillion, or roughly 12 times that of the U.S. Treasury debt $4.1 trillion.
CBOT Swap futures reduce the heavy administrative costs of trading plain vanilla swap exposure. All outstanding trades in Swap futures aggregate into a single line item. Moreover, the guarantee of the CBOT clearing services provider mitigates credit risk by serving as the ultimate counterparty to all trades, making CBOT Swap futures comparable to the strongest credits in the OTC market.
CBOT Swap futures employ an internal rate of return formula to express the fixed rate of a forward starting swap as the price of a 6% coupon bond. Upon expiration the contract is cash-settled to the appropriate ISDA® (International Swaps and Derivatives Association, Inc.) benchmark rate. This rate is determined by a survey of swap dealers polled at 10:00 a.m.Chicago time, and posted at 10:30 a.m. Chicago time on the Reuters ISDAFIX3 page.
The $100,000 nominal size of each contract signifies the notional par value of an interest rate swap that exchanges semiannual fixed-rate payments for floating-rate payments. The fixed payments are based on a 6% annual rate, and the floating payments are based on 3-month LIBOR (London Interbank Offered Rate).
Here is the companion cartoon from Mad Magazine. It shows how Congress has collapsed when we went into economic distress in 1975.
Evading REGULATORY risks has been so costly, it has created a monster that is hundred of TRILLIONS of dollars in size. Think about that. The volume has to increase rapidly in order to diffuse risk to as many people as possible. But none of these people want to PAY for this risk when bankruptcies pop up. Note how banks are dealing with this: they ask the central banks to make a few trillion in Funny Money™ bail outs.
With the CBOT’s clearing services provider functioning as the ultimate counterparty to all transactions, swap futures allow uniform multilateral netting of credit risk. For many market participants, this entails fewer and lower regulatory barriers than the bilateral netting and/or collateralization agreements found in the OTC swap markets.In order to trade CBOT products, market participants must have a brokerage agreement with a CBOT clearing member; transactions then clear between the clearing member and the CBOT clearing services provider, offering a layer of protection that not only guarantees customer credit, but also gives anonymity to the end user.
So a flock of anonymous people operating entirely in the dark are using the Chicago Board of Trade to evade government and banking regulations and powers? HAHAHA. So naked, they are! When a government agent read this laudatory claim of anonymous evasions of the government, did the SEC raid the CBOT? HAHAHA. Nope. No one called for investigations and stopping this crazy and obviously illicit scheme. Instead, the pirates using this system have bribed all our politicians except for possibly Kucinich and Ron Paul, to keep this game going.
And here is the Mad Magazine cartoon about the other interested party to all these crimes:
The media owners prevented both Kucinich and Ron Paul from addressing any and all of these issues. The Cone of Silence was dropped on both men. Ron raised enough money despite this, most of it online, that he was able to yell long enough and his followers yelled loud enough for a tiny bit of this information to make the news a very tiny bit. But note how the Wright story was hammered ruthlessly into everyone's brains. This is the shouting power of the media which mercifully, backfired! Thank god.
But they still won't let Ron Paul or any of us appear in the news. Volcker barely manages to get a word or two in edgewise. At least Greenspan is being driven back into the dark shadows from whence he came.
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