by Andrew Freiburghouse
The home loan that has become the poster child for mortgage finance excess and error, the so-called "Option ARM," is starting to wedge its way back into the home refinance news cycle. Fiv
e-year Option Adjustable Rate Mortgages taken out in 2005, that is, are due to reset in 2010.
An Option ARM loan customarily begins with a low teaser rate for a fixed period of time, in this case five years, but the borrower has an "option" to either pay the full payment or a lower payment. The difference between the full payment and the lower payment, if the full is not paid, is added onto the mortgage balance.
"Negative amortization," it's called.
How Many 5-Year Option ARMs Will Re-Set in 2010?
It's hard to get perfect statistics on how many Option ARMs are out there, because banks were not required to report this product specifically. According to BusinessWeek, approximately 1.3 billion borrowers took out approximately $389 billion in Option ARM home loans during 2004 and 2005.
According to Fitch Ratings, up to 80 percent of Option ARM borrowers only pay the minimum payment. Added, then, to the overall decline of the housing market, is the negative amortization problem.
The batch of 5-year Option ARMs taken out in 2005 includes hundreds of thousands of severely underwater homeowners.
The Time to Refinance that Option ARM Is Now or Soon
Mortgage refinance rates remain low and, although refinancing is still not easy, credit appears to have eased at least somewhat. If there ever was a time to refinance that Option ARM, that time is now or soon.
Now or soon because the housing market appears to be stabilizing, with house prices rising over the past few months. Rising house prices, combined with government insistence that banks at least try to refi struggling borrowers, must be counted as the best hope for those wishing to refinance out of Option ARM mortgages. Conventional refinance deals are not usually possible due to loan-to-value concerns.
Refinance at Any Cost? Not Necessarily
Definitely, borrowers with Option ARMs due to reset in 2010 must be actively looking at refinance options. However, that does not necessarily mean such borrowers should refinance at any price.
No doubt, dealing with a troubled home loan can be a frightening experience, but borrowers must still strive to be rational about what's best to do in this situation. Certainly it's not worth refinancing out of one unaffordable loan into another unaffordable loan, for example.
Finding an honest, competent mortgage pro to help with these complexities is a wise choice in these trying refinance times.
About Author:
Andrew Freiburghouse is a writer and businessman. He has worked as a magazine reporter, tax preparer, screenwriter, copywriter, and loan officer. He graduated from Santa Clara University in 1999 with a B.A. in English. Andrew was born and raised in the City of Los Angeles.
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Saturday, October 31, 2009
Friday, October 30, 2009
Obama lifts ban on HIV / AIDS emmigrants and entry to US
WASHINGTON (Reuters) - President Barack Obama announced on Friday that a 22-year-old ban on allowing people infected with the AIDS virus into the United States will be lifted on Monday.
Obama made the announcement in signing an extension of the Ryan White HIV/AIDS Treatment Act, which provides for education, prevention and treatment programs for U.S. HIV patients
. immigrants
Obama said the ban was imposed 22 years ago when visitors to the United States were treated as a threat.
"We lead the world when it comes to helping stem the AIDS pandemic -- yet we are one of only a dozen countries that still bar people from HIV from entering our own country," he said.
"If we want to be the global leader in combating HIV/AIDS, we need to act like it," he said.
He said on Monday his administration will publish a final rule that eliminates the travel ban effective just after the first of 2010.
The AIDS virus infects 33 million people globally and around a million in the United States.
(Reporting by Steve Holland, editing by Jackie Frank)
Obama made the announcement in signing an extension of the Ryan White HIV/AIDS Treatment Act, which provides for education, prevention and treatment programs for U.S. HIV patients
. immigrants
Obama said the ban was imposed 22 years ago when visitors to the United States were treated as a threat.
"We lead the world when it comes to helping stem the AIDS pandemic -- yet we are one of only a dozen countries that still bar people from HIV from entering our own country," he said.
"If we want to be the global leader in combating HIV/AIDS, we need to act like it," he said.
He said on Monday his administration will publish a final rule that eliminates the travel ban effective just after the first of 2010.
The AIDS virus infects 33 million people globally and around a million in the United States.
(Reporting by Steve Holland, editing by Jackie Frank)
Thursday, October 29, 2009
Why the Goldman Sachs-AIG Story Won’t Go Away: Bloomberg
I'm glad to see that there are concerned individuals that will keep digging into the relationship that Goldman Sachs has to the US government, especially the Treasury. This is a nice follow up piece to several posts on this subject that I've made here over the last year. My thanks to Jonathan Weil and to Bloomberg.com. / GB
Commentary by Jonathan Weil
Oct. 29 (Bloomberg) -- How did so much taxpayer money end up in the coffers of American International Group Inc.’s too- big-to-fail customers? The more we find out, the more it becomes obvious we still don’t know the half of it.
It’s the story that won’t go away: Was last year’s federal rescue of AIG a back-door bailout for the likes of Goldman Sachs Group Inc., Societe Generale SA, Deutsche Bank AG, Merrill Lynch & Co. and other large banks? And who exactly were the regulators trying to protect when they seized control of the insurance giant in September 2008? The banks? Or the rest of us?
To believe AIG’s disclosures, you’d have thought its executives decided on their own last year to pay 100 cents on the dollar to the various banks that had bought $62 billion of credit-default swaps from the company. Now, thanks to an Oct. 27 story by Bloomberg News reporters Richard Teitelbaum and Hugh Son, we know otherwise.
It turns out the decision to make the banks whole wasn’t AIG’s. It was made by the Federal Reserve Bank of New York, back when its president was the current U.S. Treasury secretary, Timothy Geithner, and its chairman was Goldman Sachs director Stephen Friedman. (Friedman resigned from the New York Fed in May, after the Wall Street Journal reported he had bought more than 50,000 shares of Goldman stock following AIG’s takeover.)
Before AIG was seized, its executives had been negotiating for months with the banks, trying to get them to accept discounts of as much as 40 cents on the dollar, Bloomberg reported, citing people familiar with the matter.
Taking Over
Then, late in the week of Nov. 3, the New York Fed took over the negotiations with the banks from AIG, together with the Treasury Department (at the time run by former Goldman boss Henry Paulson) and Chairman Ben Bernanke’s Federal Reserve Board. Less than a week later, the New York Fed instructed AIG to pay the counterparties in full, Bloomberg reported.
Judging by the result, you might think Geithner’s team was on the banks’ side, rather than AIG’s.
AIG wound up paying $32.5 billion to retire the swaps, $13 billion more than if it had paid, say, 60 cents on the dollar. The New York Fed also arranged to pay the banks $29.6 billion for collateralized-debt obligations backed by subprime mortgages and other loans, a tad less than half their face value. (The swaps were side bets by the banks that rose in value as the CDOs fell.)
It probably made sense for the counterparties to reject AIG’s initial settlement offers. They had their own investors to look after. And once the government took control of AIG, it couldn’t credibly threaten to force the company into bankruptcy proceedings. The premise of the government’s seizure, after all, was that AIG was too big to fail.
Rush to Pay
But why the rush to pay the banks in full once Geithner’s team took over the talks? The public has never gotten satisfactory answers, notwithstanding that the government’s commitment to AIG now stands at about $182 billion.
In a story published yesterday in response to Bloomberg’s scoop, the New York Fed’s general counsel, Thomas Baxter, told the Washington Post that officials were racing to prevent AIG’s collapse and didn’t have time for protracted negotiations with each creditor. That won’t put to rest suspicions that regulators used AIG as a slush fund to shield some of the banks from losses, using taxpayer money.
Nor has anyone from AIG or the government explained why there was such a hurry to buy the CDOs. While the banks supposedly received market prices, that deal has since turned sour for taxpayers. The value of the securities, now held by a Fed-run entity called Maiden Lane III, was down by about $7 billion as of June 30, according to the New York Fed.
The public might get some answers soon. Next month, the inspector general for the government’s Troubled Asset Relief Program, Neil Barofsky, is scheduled to release a report on whether AIG overpaid the banks, and the extent to which the counterparties’ own financial problems may have been at issue.
Goldman Sachs Untouched
Goldman, for one, has long said it wouldn’t have incurred any material losses even if AIG had gone under.
“We limited our overall credit exposure to AIG through a combination of collateral and market hedges,” Goldman’s chief financial officer, David Viniar, said in March. “There would have been no credit losses if AIG had failed.”
Then again, Viniar is the same guy who this month made the ridiculous claim that Goldman doesn’t have a too-big-to-fail guarantee from the government. Goldman has refused to identify who the counterparties were on the other side of its hedges, rendering Viniar’s statement in March unverifiable.
Even if Goldman was fully hedged, it’s reasonable to assume that not all the other banks were. We shouldn’t have to guess anymore, though. It’s long past time for the government to start telling us the whole truth about what happened at AIG.
We’ve had too many secrets in this financial crisis already.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
Click on “Send Comment” in the sidebar display to send a letter to the editor.
To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net
Last Updated: October 28, 2009 21:00 EDT
Commentary by Jonathan Weil
Oct. 29 (Bloomberg) -- How did so much taxpayer money end up in the coffers of American International Group Inc.’s too- big-to-fail customers? The more we find out, the more it becomes obvious we still don’t know the half of it.
It’s the story that won’t go away: Was last year’s federal rescue of AIG a back-door bailout for the likes of Goldman Sachs Group Inc., Societe Generale SA, Deutsche Bank AG, Merrill Lynch & Co. and other large banks? And who exactly were the regulators trying to protect when they seized control of the insurance giant in September 2008? The banks? Or the rest of us?
To believe AIG’s disclosures, you’d have thought its executives decided on their own last year to pay 100 cents on the dollar to the various banks that had bought $62 billion of credit-default swaps from the company. Now, thanks to an Oct. 27 story by Bloomberg News reporters Richard Teitelbaum and Hugh Son, we know otherwise.
It turns out the decision to make the banks whole wasn’t AIG’s. It was made by the Federal Reserve Bank of New York, back when its president was the current U.S. Treasury secretary, Timothy Geithner, and its chairman was Goldman Sachs director Stephen Friedman. (Friedman resigned from the New York Fed in May, after the Wall Street Journal reported he had bought more than 50,000 shares of Goldman stock following AIG’s takeover.)
Before AIG was seized, its executives had been negotiating for months with the banks, trying to get them to accept discounts of as much as 40 cents on the dollar, Bloomberg reported, citing people familiar with the matter.
Taking Over
Then, late in the week of Nov. 3, the New York Fed took over the negotiations with the banks from AIG, together with the Treasury Department (at the time run by former Goldman boss Henry Paulson) and Chairman Ben Bernanke’s Federal Reserve Board. Less than a week later, the New York Fed instructed AIG to pay the counterparties in full, Bloomberg reported.
Judging by the result, you might think Geithner’s team was on the banks’ side, rather than AIG’s.
AIG wound up paying $32.5 billion to retire the swaps, $13 billion more than if it had paid, say, 60 cents on the dollar. The New York Fed also arranged to pay the banks $29.6 billion for collateralized-debt obligations backed by subprime mortgages and other loans, a tad less than half their face value. (The swaps were side bets by the banks that rose in value as the CDOs fell.)
It probably made sense for the counterparties to reject AIG’s initial settlement offers. They had their own investors to look after. And once the government took control of AIG, it couldn’t credibly threaten to force the company into bankruptcy proceedings. The premise of the government’s seizure, after all, was that AIG was too big to fail.
Rush to Pay
But why the rush to pay the banks in full once Geithner’s team took over the talks? The public has never gotten satisfactory answers, notwithstanding that the government’s commitment to AIG now stands at about $182 billion.
In a story published yesterday in response to Bloomberg’s scoop, the New York Fed’s general counsel, Thomas Baxter, told the Washington Post that officials were racing to prevent AIG’s collapse and didn’t have time for protracted negotiations with each creditor. That won’t put to rest suspicions that regulators used AIG as a slush fund to shield some of the banks from losses, using taxpayer money.
Nor has anyone from AIG or the government explained why there was such a hurry to buy the CDOs. While the banks supposedly received market prices, that deal has since turned sour for taxpayers. The value of the securities, now held by a Fed-run entity called Maiden Lane III, was down by about $7 billion as of June 30, according to the New York Fed.
The public might get some answers soon. Next month, the inspector general for the government’s Troubled Asset Relief Program, Neil Barofsky, is scheduled to release a report on whether AIG overpaid the banks, and the extent to which the counterparties’ own financial problems may have been at issue.
Goldman Sachs Untouched
Goldman, for one, has long said it wouldn’t have incurred any material losses even if AIG had gone under.
“We limited our overall credit exposure to AIG through a combination of collateral and market hedges,” Goldman’s chief financial officer, David Viniar, said in March. “There would have been no credit losses if AIG had failed.”
Then again, Viniar is the same guy who this month made the ridiculous claim that Goldman doesn’t have a too-big-to-fail guarantee from the government. Goldman has refused to identify who the counterparties were on the other side of its hedges, rendering Viniar’s statement in March unverifiable.
Even if Goldman was fully hedged, it’s reasonable to assume that not all the other banks were. We shouldn’t have to guess anymore, though. It’s long past time for the government to start telling us the whole truth about what happened at AIG.
We’ve had too many secrets in this financial crisis already.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
Click on “Send Comment” in the sidebar display to send a letter to the editor.
To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net
Last Updated: October 28, 2009 21:00 EDT
Sunday, October 25, 2009
Be afraid! A year after AIG, derivatives remain big risk
12.10.09
The global financial crisis has introduced ordinary people to the extraordinary and arcane world of “derivative product” — a gigantic system of commercial bets in financial markets where the total outstanding amount of derivatives adds up to a mere $600 trillion (some 10 times the value of global production).
The City is one of the leading centres of this trading activity.
Volatile equity and currency markets caused problems with exotic option “accumulators” and now numerous investors and corporations are hunkered down with their lawyers hoping to litigate their way out of significant losses on “hedges” pleading such familiar defences as “I did not understand the risks” or “I was misled about the risks by the bank”.
If you thought this would lead regulators such as the Financial Services Authority, the Bank of England and America's Federal Reserve to tame the wild beast of derivatives, then you would be wrong. History tells us that there will be cosmetic changes to the functioning of the market but business as usual will resume in the not too distant future.
Previous episodes of derivative problems — portfolio insurance in 1987 and long-term capital management in 1998 — never led to changes in fundamental issues such as using derivatives for speculation, mis-selling instruments to less-sophisticated market participants and excessive complexity.
The industry and its key lobby group, the International Swaps & Derivatives Association, are well-practised in the art of playing the regulatory game.
Derivatives, it will be argued, are so complicated that only derivative traders themselves can properly “regulate” them. The new centralised counterparty to reduce the risk of a major dealer failing is only for “standardised” derivatives and already there are impassioned debates about what is meant by “standard derivatives”.
On 17 September, the chief executive of the derivatives association, Robert Pickel, told the House Agriculture Committee in America: “Not all standardised contracts can be cleared,” because even if they have standardised economic terms, many derivatives contracts will be “difficult if not impossible to clear” since the counterparty depends on liquidity, trading volume and daily pricing. This would, Pickel said, make “it difficult for a clearing house to calculate collateral requirements consistent with prudent risk management.”
Dan Budofsky, a partner at legal firm Davis Polk & Wardwell, who testified on behalf of the Securities Industry and Financial Markets Association, agreed that “it may be more appropriate for products that trade less frequently to trade over-the-counter”. The industry will argue for self-regulation, which is about as close to regulation as self-importance is to importance.
The reasons for policy inaction are complex. Derivatives do perform important risk-transfer functions within modern capital markets — their Dr Jekyll side — and Pickel eloquently made the point that standardisation and the centralised counterparty “would undercut [derivatives'] very purpose: the ability to customise risk-management solutions to meet the needs of end-users”.
But derivatives also have a Mr Hyde side: they are used to speculate, keep dealings off-balance sheet and out of sight, increase leverage, arbitrage regulatory and tax rules and manufacture exotic risk cocktails.
What industry participants will not acknowledge is that the Dr Jekyll side of derivative trading has taken second place to the Mr Hyde side.
For companies, the ability to use derivative trading to supplement traditional earnings, which are under increased pressure, is irresistible.
The complexity of modern derivatives has little to do with risk transfer and everything to do with profits.
As new products are immediately copied by competitors, traders must “innovate” to maintain revenue by increasing volumes or creating new structures.
Complexity delays competition, prevents clients from unbundling products and generally reduces transparency. Frequently, the models used to price, hedge and determine the profitability also manage to confuse managers and controllers within banks themselves allowing traders to book large fictitious “profits” that their bonuses are based on.
The scary part is that regulators on both sides of the Atlantic seem unable to marshal the knowledge, skill, gumption, political will and backbone to be able to implement the changes that are called for.
Warren Buffet once described bankers in the following terms: “Wall Street never voluntarily abandons a highly profitable field. Years ago … a fellow on Wall Street was talking about the evils of drugs.
“He ranted on for between 15 and 20 minutes to a small crowd and then asked, Do you have any questions?' An investment banker instantly shot his hand up and said: Could you tell me who makes the needles?'”
Derivatives and debt are the needles of finance and bankers will continue to supply them to all the Dr Jekylls and Mr Hydes alike for the foreseeable future as long as there is money to be made in the trade.
Taxpayers should just start saving for the future losses that they will have cover to bail out the banks at a time to be arranged in the future.
* Satyajit Das is a risk consultant and the author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall)
Saturday, October 24, 2009
THE ROLE OF DERIVATIVES
During the recent financial crises, you may have heard some talk about the role of derivatives. These mysterious financial instruments are understood by practically nobody. Not by those who sell them and not by those who buy them. Yet the survival of banking system and, ironically, the destruction of our entire economy may be the result of their trading. The following brief essay by Chris Temple gives us a basic understanding of derivatives and an explanation of their importance. / GB
THE ROLE OF DERIVATIVES
The issue of derivatives is one which has received occasional mention in the mainstream media. Derivatives have also received more widespread attention among certain pundits purporting to know a thing or two about economics; the trouble here, though, is we hear little more than hysterical ravings about how derivatives are about to cause the end of the world. Little in the way of helpful or explanatory information is offered by these types to explain exactly what derivatives are, how they work, and what the benefits (and dangers) are to the economy.
Two preliminary things here, before I defer to a more qualified expert than I. First, we can simplify things by defining this important term. The root word of derivative is derive. Derivatives are financial instruments which are derived from some underlying commodity or asset. Most all of you have heard of an option before; this is a financial instrument giving you the option to buy or sell a certain security at a certain price, and by a certain date. Technically, an option itself is a derivative, as it is derived from and dependent on the fate of an underlying asset. So, if you keep this in mind, you’ll have an easier time in general understanding derivatives as just what they are; sophisticated "bets" on the fate of underlying stocks, bonds, interest rate levels, currencies, commodities and such.
The second thing to understand about derivatives is that their use has been critical to the continued life of our fractional reserve banking/credit system, and to the broader economy. All of you have read at least one version of my "signature" essay entitled Understanding the Game. In it, I explain how, over time, it has become necessary for the financial system to create ever more intricate--and inherently risky--devices to "create" wealth. Through the multiplication of these derivative contracts, as you’ll read in a moment, prices for many of the underlying assets have been artificially increased. This new "wealth" has served as the basis for ever more credit creation, merger deals and other means for keeping the rubber band stretching even more.
The trouble is, as even Fed Chairman Alan Greenspan (generally a fan of derivatives) has implied before, the wonderful wealth-creating attributes of derivatives could reverse one day. These very same instruments that have been responsible for the creation of trillions of dollars worth of enhanced values of underlying assets could indeed end up being indiscriminate destroyers of capital, were they to "unwind" in a significant way. This happened with Long Term Capital Management, a hedge fund collapse that nearly brought down the entire system. It happened with Enron; but regulators were on top of things sufficiently ahead of time to limit, for now, the ripple effects. They might not be so lucky next time.
For those of you who want to take the time to study the derivative issue further, I would strongly suggest visiting www.econstrat.com, which is the web site for the Derivatives Study Center. In scouring the Web myself for the most understandable explanations to pass along to you, the commentaries and "primer" by the Center’s Randall Dodd truly stood out.
In his "Derivatives Primer," Dodd--after discussing how these kinds of contracts in a broad sense aren’t exactly new--discusses the risks inherent in derivatives:
"The first danger posed by derivatives comes from the leverage they provide to both hedgers and speculators," he writes. "Derivatives allow investors to take a large price position in the market while committing only a small amount of capital--thus the use of their capital is leveraged. . ."
Back to the Long Term Capital story: some of you remember that this hedge fund had raised approximately $3 billion from investors. Yet, when LTCM blew up, it had "notional" (presumed face) value of derivatives of an astounding $1.4 trillion. This happened because LTCM milked derivative contracts’ ability to create artificial wealth for all they were worth. In the process--and this is one of the inflationary components of what derivatives do--the placing/creating of all these fancy "bets" skewed the values of underlying assets considerably.
Many of you know that if all of a sudden there is unusually large activity, let’s say, in the options for XYZ Company, the share price of that same company will be affected. If a number of options are suddenly being either created or bought betting that XYZ is going up, then the share price of the stock itself will usually go up, as investors think that "somebody knows something good is going to happen." Yet, this might not really be true; and it could be nothing more than the (at its core) unnatural effect of these kinds of derivative activity that give XYZ a falsely inflated value, and give investors similarly wrong expectations.
Using the LTCM example above, you can imagine the magnitude even now of still-inflated values in the financial markets courtesy of derivatives.
In his Primer, Dodd also bemoans the fact that further risks are presented due to the fact that many derivatives traded Over the Counter are mysterious. They are not regulated, nor is there much information available as to their quantity and character. Recently, Sen. Dianne Feinstein (D-CA) attempted to get legislation acted upon which would regulate these, the very same types of deals, it should be remembered, were engaged in by Enron. However, everyone from Fed Chairman Greenspan to Wall Street turned on the lobbying offensive, and her move was defeated. Thus, even after all the hand-wringing over Enron, it appears that the majority of legislators are perfectly willing to allow this ticking time bomb to exist.
Finishing up the commentary section of his primer, Dodd states, "In sum, the enormous derivatives markets are both useful and dangerous. Current methods of regulating these markets are not adequate to assure that the markets are safe and sound and that disruptions from these markets do not spill over into the broad economy."
No doubt this is an understatement; and the fact that Alan Greenspan, for his part, is unwilling to see this huge inflationary mechanism regulated--in spite of the risks--underscores just how unable he is without derivatives to keep the overall credit bubble and the dollar from deflating much further.
by Chris Temple / NationalInvestor.com
THE ROLE OF DERIVATIVES
The issue of derivatives is one which has received occasional mention in the mainstream media. Derivatives have also received more widespread attention among certain pundits purporting to know a thing or two about economics; the trouble here, though, is we hear little more than hysterical ravings about how derivatives are about to cause the end of the world. Little in the way of helpful or explanatory information is offered by these types to explain exactly what derivatives are, how they work, and what the benefits (and dangers) are to the economy.
Two preliminary things here, before I defer to a more qualified expert than I. First, we can simplify things by defining this important term. The root word of derivative is derive. Derivatives are financial instruments which are derived from some underlying commodity or asset. Most all of you have heard of an option before; this is a financial instrument giving you the option to buy or sell a certain security at a certain price, and by a certain date. Technically, an option itself is a derivative, as it is derived from and dependent on the fate of an underlying asset. So, if you keep this in mind, you’ll have an easier time in general understanding derivatives as just what they are; sophisticated "bets" on the fate of underlying stocks, bonds, interest rate levels, currencies, commodities and such.
The second thing to understand about derivatives is that their use has been critical to the continued life of our fractional reserve banking/credit system, and to the broader economy. All of you have read at least one version of my "signature" essay entitled Understanding the Game. In it, I explain how, over time, it has become necessary for the financial system to create ever more intricate--and inherently risky--devices to "create" wealth. Through the multiplication of these derivative contracts, as you’ll read in a moment, prices for many of the underlying assets have been artificially increased. This new "wealth" has served as the basis for ever more credit creation, merger deals and other means for keeping the rubber band stretching even more.
The trouble is, as even Fed Chairman Alan Greenspan (generally a fan of derivatives) has implied before, the wonderful wealth-creating attributes of derivatives could reverse one day. These very same instruments that have been responsible for the creation of trillions of dollars worth of enhanced values of underlying assets could indeed end up being indiscriminate destroyers of capital, were they to "unwind" in a significant way. This happened with Long Term Capital Management, a hedge fund collapse that nearly brought down the entire system. It happened with Enron; but regulators were on top of things sufficiently ahead of time to limit, for now, the ripple effects. They might not be so lucky next time.
For those of you who want to take the time to study the derivative issue further, I would strongly suggest visiting www.econstrat.com, which is the web site for the Derivatives Study Center. In scouring the Web myself for the most understandable explanations to pass along to you, the commentaries and "primer" by the Center’s Randall Dodd truly stood out.
In his "Derivatives Primer," Dodd--after discussing how these kinds of contracts in a broad sense aren’t exactly new--discusses the risks inherent in derivatives:
"The first danger posed by derivatives comes from the leverage they provide to both hedgers and speculators," he writes. "Derivatives allow investors to take a large price position in the market while committing only a small amount of capital--thus the use of their capital is leveraged. . ."
Back to the Long Term Capital story: some of you remember that this hedge fund had raised approximately $3 billion from investors. Yet, when LTCM blew up, it had "notional" (presumed face) value of derivatives of an astounding $1.4 trillion. This happened because LTCM milked derivative contracts’ ability to create artificial wealth for all they were worth. In the process--and this is one of the inflationary components of what derivatives do--the placing/creating of all these fancy "bets" skewed the values of underlying assets considerably.
Many of you know that if all of a sudden there is unusually large activity, let’s say, in the options for XYZ Company, the share price of that same company will be affected. If a number of options are suddenly being either created or bought betting that XYZ is going up, then the share price of the stock itself will usually go up, as investors think that "somebody knows something good is going to happen." Yet, this might not really be true; and it could be nothing more than the (at its core) unnatural effect of these kinds of derivative activity that give XYZ a falsely inflated value, and give investors similarly wrong expectations.
Using the LTCM example above, you can imagine the magnitude even now of still-inflated values in the financial markets courtesy of derivatives.
In his Primer, Dodd also bemoans the fact that further risks are presented due to the fact that many derivatives traded Over the Counter are mysterious. They are not regulated, nor is there much information available as to their quantity and character. Recently, Sen. Dianne Feinstein (D-CA) attempted to get legislation acted upon which would regulate these, the very same types of deals, it should be remembered, were engaged in by Enron. However, everyone from Fed Chairman Greenspan to Wall Street turned on the lobbying offensive, and her move was defeated. Thus, even after all the hand-wringing over Enron, it appears that the majority of legislators are perfectly willing to allow this ticking time bomb to exist.
Finishing up the commentary section of his primer, Dodd states, "In sum, the enormous derivatives markets are both useful and dangerous. Current methods of regulating these markets are not adequate to assure that the markets are safe and sound and that disruptions from these markets do not spill over into the broad economy."
No doubt this is an understatement; and the fact that Alan Greenspan, for his part, is unwilling to see this huge inflationary mechanism regulated--in spite of the risks--underscores just how unable he is without derivatives to keep the overall credit bubble and the dollar from deflating much further.
by Chris Temple / NationalInvestor.com
Tuesday, October 20, 2009
Listen as Obama speaks of Cap and Trade and explains how it will be necessary for the electric suppliers to pass on the the cost of retrofitting to consumers. The upshot is that there is no way to avoid higher electricity costs to consumers if the bill is passed. In this case, I believe that Obama is telling the truth. Ironically I heard about it first from FOX news. But I just thought it was part of their agenda driven programing so I disregarded it. : ) / GB
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