It’s All About the Derivatives (Wait…What?)
As we celebrate year three of the Great Financial Crisis with the first official bailout of an entire country (Greece), I’m still astounded and the complete and utter lack of coverage the underlying cause of this Crisis has received.
We’ve had tens of thousands, if not hundreds of thousands of articles and research reports have been written about the Crisis, and yet I would wager less than 1% of them actually bother talking about what caused it, let alone how the various efforts to stop it have in fact FAILED to address the key issues.
Remember back in 2007? At that time we were told it was all about Subprime mortgages. Then in 2008, we were told it was the investment banks, specifically Lehman Brothers’ failure and AIG’s credit default swaps. In 2009, we were told it was poor accounting standards and bad bets made by Wall Street. And here we are in 2010, and we’re still being told it was simply bad bets made by Wall Street.
All of these answers are partially right, but none of them are totally 100% accurate. Why? Because they fail to address the one underlying issue that links ALL of these items. I’m talking about the Black Hole of Finance: a bottomless pit that no official or regulator bothers mentioning in public because acknowledging it would mean acknowledging that all of the efforts to stop the Crisis are truly paltry.
What caused the Crisis?
Let’s do some quick math.
If you add up the value of every stock on the planet, the entire market capitalization would be about $36 trillion. If you do the same process for bonds, you’d get a market capitalization of roughly $72 trillion.
The notional value of the derivative market is roughly $1+ QUADRILLION.
I realize that number sounds like something out of Looney tunes, so I’ll try to put it into perspective.
$1+ Quadrillion is roughly:
- 40 TIMES THE WORLD’S STOCK MARKET.
- 10 TIMES the value of EVERY STOCK AND EVERY BOND ON THE PLANET
- 23 TIMES WORLD GDP.
Or $190,000/per person on the planet according to this source.
And no regulator (that I’ve heard of) is talking about taking this black hole on. [Maybe we need magicians or sci-fi theorists to figure out how to fight a black hole].
The Goldman Sachs charge has to do with subprime mortgage credit default swaps. Which sounds like a major push until you remember:
After all, in 2008 the Credit Default Swap (CDS) market (which incidentally is only 1/10th the size of the interest rate-based derivative market) nearly destroyed the entire financial system. One can only imagine what would happen if the interest rate-based derivative market (which is ten times as large) suffered a similar Crisis.
Update I: Good news/bad news (from another pov). Rick Bookstaber in another must read post, doesn’t see derivatives as the biggest threat in the near term, but rather municipal markets. Though the distinction is not crystal clear (at least it isn’t to me) as bond derivatives make up a slice of the overall derivatives market.
Update II: Greginak points to Obama’s announcement today that he will veto a financial regulation bill without derivatives regulation. Which sounds good. I’d like to hear details about how exactly to go about said regulation. But given (yet again) total Republican opposition to dealing with the majority party, we’ll see what deals/compromises he might have to make to get any bill through.