Thread: America 's Financial Apocalypse Heralds Decade Long Depressi

America 's Financial Apocalypse Heralds Decade Long Depression

Economics / US Economy Sep 14, 2008 - 04:28 AM
By: Mike_Stathis

Despite attempts made by Greenspan and Bernanke, there is no way to avert the payback period that has been building for over two decades. Over this stretch, America has consumed much more than it has produced. As a result, both consumer and federal debt have ballooned to record levels. And now, the payback period is upon us. The bailout buffet won't end with Fannie and Freddie. There's a lot more where that came from because the “Fed's food courtâ€

Wall Street crisis: Is this the death knell for derivatives?

On page 62 of last year's accounts, under the heading "off balance sheet arrangements" Lehman had derivative contracts with a face value of $738bn

All comments (77)
Nils Pratley
guardian.co.uk,
Monday September 15 2008 09:18 BST

If this is the death of Wall Street as we know it, the tombstone will read: killed by complexity.

Derivatives in their baffling modern forms – collateralised debt obligations, credit default swaps and so on – lie at the heart of the failure of Lehman, Bear Stearns, Fannie and Freddie, and even our own Northern Rock.

The philosophy that underpins the growth of derivatives is the idea that risk can be transferred to institutions more able to take the strain. In theory, it's a terrific scheme – the weak can get rid of risks they can't handle, and the financial system should be stronger as a result.

The practice is very different, as Warren Buffett worked out years ago. His 2002 letter to his Berkshire Hathaway shareholders made headlines by condemning derivatives as "financial weapons of mass destruction". The passage comprised only a couple of pages of the lengthy letter but read it again today - it is the best guide to understanding how Wa ll Street has arrived at today's mess.

Here is Buffett on General Re Securities, a derivatives dealer that Berkshire inherited with its purchase of insurer General Re. "At year-end (after ten months of winding down its operation) it had 14,384 contracts outstanding, involving 672 counterparties around the world. Each contract has a plus or minus value derived from one or more reference items, including some of mind-boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have widely varying opinions."

Now consider Lehman Brothers balance sheet. On page 62 of last year's accounts, under the heading "off balance sheet arrangements" you will find a staggering figure. Lehman had derivative contracts with a face value of $738bn.

The notes, fairly, make the point that the fair value is smaller than the notional amount – Lehman believed the figure was $36.8bn. Even so, "mind-boggling complexity" perfectly describes Lehman's business

How can you hope to sell such a business over a weekend? You can't, unless the state is willing to underwrite the risk. This time, the US Treasury, said "no". Quite right, too: the US taxpayers are on the hook for too much already.

Complexity breeds other faults, as Buffett described. Derivatives, because they are so hard to value, make it easier=2 0for traders and chief executives to inflate earnings. They exacerbate problems if a company, for unrelated reasons, suffers a credit downgrade that requires it to post collateral with counterparties – "a spiral that can lead to a corporate meltdown," he wrote. They create a "daisy chain" of risk as the troubles of one company infect another.

Buffett made a gloomy prediction half a decade ago. "The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear," he said. "Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts."

That event has duly arrived. Lehman Brothers has declared bankruptcy. Merrill Lynch has rushed into the arms of Bank of America. AIG, once the US's largest insurer, is pleading with the Fed for funds.

Unwinding a big derivatives book is no easy task - like Hell, derivatives are easy to enter and impossible to exit, said Buffett. That's why the failure of a firm the size of Lehman presents such a risk to the financial system – we don't know how many other firms will be brought down as the body is extracted from the financial web.

In the long run, though, financial regulators must now know what must happen: it's time for=2 0them to bring down the curtain on the era of opaque financial derivatives.

http://www.guardian.co.uk/business/2008 ... wallstreet

Are these threesome ready for a paycut?

I didn't know the facts, but I have suspected for a long time that the economy is a whole lot worse than we are being lead to believe