The markets closed slightly higher today, Wednesday, October 25
Once-transparent global financial systems have become opaque, changing too fast to be visible. New varieties of financial contracts are evolving rapidly, such as credit derivative futures, credit default swaps, binary options, and soon perhaps, derivatives of credit derivatives, or even derivatives cubed (D3, perhaps?).
Risk-seeking traders have displaced traditional investment bankers, elbowing between borrowers and markets. They swap complicated “credit risk” bets designed to be difficult to understand, imitate, or regulate.
Ask questions and listen closely, and you'll hear financial regulators and bankers admit that they don’t understand the chain of exposure, or how to determine who owns what.
The October 2005 Financial Forecast said, “The explosion in credit derivatives is an effort to “manage” the escalating risk. It cannot end happily, however, because no one now trading credit derivatives (except possibly some of the traditional lenders that are selling susceptible credit into the market) envisions the unprecedented default rates to come. When they can’t even figure out who owns what, figuring out who owes what will be nearly impossible.”
Hedge funds may understand their risk better -- they are making it much more difficult for investors to withdraw their money from the cyberspace ping-pong game they’ve invested in.
The October 2006 Financial Forecast stated, “Amaranth’s trouble provides a window of what’s to come. For one thing, there is the stunning speed of its reversal. In the same week that its meltdown started, the fund’s chief operating officer was reporting a net gain of 25% for 2006. Two weeks later, investors “focused on getting what’s left of their money out of the troubled hedge fund as soon as possible. But current redemption rules for the fund basically stipulate that it’s now up to the firm to decide when to return their money.” Amaranth’s founder says "they can’t have it.”
Every day, 10,000 hedge funds trade global derivatives worth half the U.S. Gross Domestic Product. Greenspan expressed “shock,” at the situation. The IMF is repeating dire warnings about global system risk. Credit derivatives, the source of Enron’s “success,” were named "financial weapons of mass destruction," by Warren Buffett.
Creative marketing of debt allows absurdities, like rising bond prices of failing companies (such as Ford). Buying and selling shares, bonds and derivatives now generate higher profits than almost any other form of productive endeavor.
Kevin Phillips, in Wealth and Democracy, described the classic symptoms of the decline of empire, which include, “new financial techniques, institutions and instruments,” “speculative mania,” and, “increasing national reliance on finance and services rather than physical commerce and goods production.”
The financial WMD’s are cleverly “hidden,” but they are powerful, and potentially destructive.
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