Posted by: stillironic | September 17, 2010

Derivatives or the lint in your pants pocket, Part 3 (the last)

Dick Cheney, Bedlam, and Feng Shui

We’ve cleared up what lint is derivatives are. Now it’s time to understand why we the taxpayers need to wrestle control of the gazillion-dollar derivatives market from the big investment banking firms. Of particular concern are Goldman Sachs, JP Morgan Chase, and Morgan Stanley, which in 2008, as we all know, managed to edge out Dick Cheney in the greatest-forces-of-evil category.

Dick Cheney

Was edged out as greatest force of evil

First we have to give a nod to Congress. It recently passed a financial reform bill meant to remove the derivatives market from its current state of bedlam. I happen to think the application of feng shui worth a try. But what do I know.

More important, however, is how in the name of Mary mother of Jesus was this Congress able to do anything coherent, let alone pass major financial legislation? Drugs? Exorcisms? Tantric yoga? Mud wrestling? Or did some Congressperson threaten to read the Iliad, out loud, and in the original Greek?

But hectoring Congress, though entertaining, is fruitless. The battle is what’s important. And it’s over whether the U.S. derivatives market should continue to be the exclusive $300-trillion private clubhouse of Goldman Sachs et al. Or should it be regulated and democratized and lose its restricted access. So it can change from a private club to, say, an upscale restaurant open to the public.

In a private dining club, only a few top members know the cost of the food and beverages. There’s no inventory. Or menu. The diners make up dishes to suit their needs. Foie gras foam on thyme biscuits. Peacock tongues on a bed of watercress. Uni with raw quail egg. Payment is made by slipping wads of cash to the maitre d’. Two people can order the same dish and be charged wildly different prices; checks are printed in invisible ink.

If too many people order the same dish but the kitchen is out of ingredients, chaos ensues. Top members all play golf at restricted golf clubs with top government officials and captains of industry. Who say the club can’t fail. And make us, the taxpayer, bail it out.

In the restaurant, on the other hand, the day’s offerings and their prices are listed for all to see. Anyone who can pay can order. The check is presented, paid, recorded, and made public. Competition among diners keeps a small cadre of them from having exclusive access to the food and drink. The menu reflects what’s in the kitchen. If inventory runs low, the menu is updated.

Just to qualify for membership in the club, diners have to hold a billion or two or more of net capital. The golf-playing restricted club members argue that this restriction brings the club stability. Ha!!! That’s hardly what we learned from the crash. We who try to stay grounded on planet Earth.

On the restricted club’s side is much of corporate America. And for some bizarre reason the Chamber of Commerce. Funny that it bills itself as representing businesses of all sizes, 96% of which have 100 or fewer employees.

The reason all this craziness can happen isn’t just that practically no one understands the issue. Practically no one knows there is an issue.

Even the value of the derivatives market baffles the Earth bound.

The global market value is $600 trillion, give or take whole bunches of billions. That number is called notional value. It doesn’t really represent the worth of all the derivatives out there. That’s because notional means “existing in the mind only.” The minds belonging to the golf-playing restricted club members and their well-heeled lackeys. Ha!!!

What the $600 trillion represents is the value of the underlying assets.

Think of 5 fish in a lake spawning 8,000 eggs each. Each fish is worth $100. So the value of the fishes’ derivatives, the eggs, is $100 x 5 fish x 8,000 eggs = $4 million. But the 40K eggs come from only 5 fish. Those same fish, or underlying assets, are counted over and over again. And added up to create the notional—imaginary—value.

The true market value of the derivatives out there is something like $15 trillion, not $600 trillion. Just like the true market value of the eggs is only 5 fish x $100 = $500. But Goldman Sachs et al. can make billions and pay fines of hundreds of millions without flinching. All because of derivatives based on assets used over and over.

Who’s fighting for the U.S. taxpayer against the restricted club members? The regulators who already failed us.

Is there a chance in hell for reform? In hell, yes. Here on earth? Maybe.

The End

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Responses

  1. BRAVO! This such an excellent post! Everyone should read this. Shall we pass it around?? I think so!

    • Please do, Judie! So happy you like it.

  2. Oh master of the universe and all things financial! It’s a good thing you don’t try explaining religion. The churches would have to close up shop. Everyone would know the truth.

    Uncle Mo hath trained you well.

    • Religion, eh? I think I’d get too emotionally involved. Having been raised Catholic and all. Thanks for the kudos. But know that I have trouble being master of my own house!

  3. Brilliant. Even my math-challenged brain understood it well enough to know we’re screwed.

    • Thanks, Jayne. Was thinking of you when I wrote this!


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