$700 trillion phony instruments

Discussion in 'Economics' started by Kaneun, Mar 9, 2009.

  1. Kaneun


    Gargantuan derivatives market weighs on all other issues

    There's a $700 trillion elephant in the room and it's time we found out how much it really weighs on the economy.

    Derivative contracts total about three-quarters of a quadrillion dollars in "notional" amounts, according to the Bank for International Settlements. These contracts are tallied in notional values because no one really can say how much they are worth.

    But valuing them correctly is exactly what we should be doing because these comprise the viral disease that has infected the financial markets and the economies of the world.

    Try as we might to salvage the residential real estate market, it's at best worth $23 trillion in the U.S. We're struggling to save the stock market, but that's valued at less than $15 trillion. And we hope to keep the entire U.S. economy from collapsing, yet gross domestic product stands at $14.2 trillion.

    Compare any of these to the derivatives market and you can easily see that we are just closing the windows as a tsunami crashes to shore. The total value of all the stock markets in the world amounts to less than $50 trillion, according to the World Federation of Exchanges.

    To be sure, the derivatives market is international. But much of the trouble we're in began with contracts "derived" from the values associated with U.S. residential real estate market. These contracts were engineered based on the various assumptions tied to those values.

    Few know what derivatives are worth. I spoke with one derivatives trader who manages billions of dollars and she said she couldn't even value her portfolio because "no one knows anymore who is on the other side of the trade."

    Derivatives pricing, simply put, is determined by what someone else is willing to pay for the contract. The value is based on an artificial scenario that "X" will be worth "Y" if "Z" happens. Strip away the fantasy, however, and the reality of the situation is akin to a game of musical chairs -- without any chairs.

    So now the music has finally stopped.

    That's why stabilizing the housing market will do little to take the sting out of the snapback we are going through on Wall Street. Once people's mortgages were sold off to secondary buyers, and then all sorts of crazy types of derivative securities were devised based on those, and those securities were in turn traded on down the line, there is now little if any relevance to the real estate values on which they were pegged.

    We need to identify and determine the real value of derivatives before we give banks and institutions a pass-go with more tax dollars. Otherwise, homeowners will suffer as banks patch up the holes left in their balance sheets by the derivatives gone poof; new credit won't be extended until the raff of the old credit is put behind.

    It isn't the housing market devaluation, or the sub-prime mortgage market defaults that have us in real trouble. Those are nice fakes to sway attention away from the place where greed truly flourished -- trading phony instruments to the tune of $700 trillion.

    Let's figure how to get out from under that. Then maybe the capital will begin to flow again through the markets. Right now, this elephant isn't just in the room, it's sitting on us.

  2. power


    World economy was worth $1400 Trillion.

    By now world economy must have suffered $200 Trillion losses. Not sure of true losses. It maybe $400 Trillion or $600 Trillion or $800 Trillion.
  3. That's a silly overgeneralization. A future is a derivative instrument. Shall we abolish all futures?

    And what about this pearl of wisdom:
    Derivatives pricing, simply put, is determined by what someone else is willing to pay for the contract.
    No, you don't say?! I wonder if there is an instrument whose price is determined by other (possibly, psychic) methods.
  4. plugger


    I think your figure is incorrect, world GDP is $60 trillion. Think, US is 14 trillion, China is 4 trillion, etc. If world GDP is 1400 trillion, we have no problems, all of this is just a drop in the bucket.
  5. power


    $1,400 Trillion world economy includes Stocks, Real estates, commodities, Bonds and I think Derivatives also.

    USA real estates are worth $23 Trillion.
  6. plugger


    Sorry, we're talking two different things here, I thought you meant world GDP.
  7. You can't combine assets and economic activity, or sales. I mean, wow, did you ever pass basic math?
  8. power


    Assets have been assigned a "monetary value". USA real estates are worth $23 Trillion which means $23 Trillion have been invested into USA real estates.
  9. sjfan


    You know... you'd think the basic knowledge of economics on a trading forum ought to be better than your average pub....

    GDP is a flow measure. Assets is a stock measure. You can add flow to stock... but what comes out of it is fairly meaningless on its own.

    To use your example, GDP is what's produced this year. Your $23 trillion investment wasn't all invested this year was it? if it were, then you'd be double counting. If not, then you can't add the two and use it as some proxy for wealth.
  10. power


    But if today, USA sells $23 Trillion real estates, USA economy will get $23 trillion cash or money.

    Asset value = Cash.

    So Asset value will flow into the economy the moment the asset is sold or realised.

    Smaller example, if you have Gold worth $10,000 (asset), you will earn cash $10,000 when you sell it.
    #10     Mar 11, 2009