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FINANCIAL WEAPONS OF MASS DESTRUCTION

"We view them as time bombs both for the parties that deal in them and the economic system... In our view... derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." -- Warren Buffett

"It could rip your guts out overnight... the biggest, most potentially lucrative, and destructive market in the world." - Into the Fire, by Linda Davies

"Derivatives are nothing more than a set of tools. And just as a saw can build your house, it can cut off your arm if it isn't used properly." - Walter D. Hops, Treasurer, Ciba-Geigy, Business Week, October 31, 1994, p.98

"I once had to explain to my father that a bank didn't really make its money taking deposits and lending out money to poor folk so they could build houses. I explained that the bank actually traded for a living." - Stan Jonas, Derivatives Strategy, April, 1998, p.19

Here's my favourite: "The government announced that it's no longer going to issue 30 year bonds. What better way to inspire confidence in our government than by saying 'We might not be around that long.'" - Jay Leno, The Tonight Show, November 1, 2001

U.S. BANKS HAVE BECOME A PONZI SCHEME

A reader asked me to put in layman's terms what a derivative is and why derivatives are making or have made U.S. banks insolvent:

Derivative -- A financial contract whose value depends on a risk factor, such as:
1. the price of a bond, commodity, currency, share, etc.
2. a yield or rate of interest.
3. an index of prices or yields.

Derivatives are financial instruments that have no intrinsic value, such as a value in silver or gold or anything else that has a value in and of itself. Derivatives get their value from something else, an external value. They hedge (gamble) the risk of owning things that are subject to unexpected price fluctuations, such as foreign currencies, bushels of wheat, stocks, or government bonds.

There are two main types of derivatives:
1. Futures (or contracts for future delivery at a specified price), and
2. Options that give one party the opportunity to buy from or sell to the other side at a prearranged price.

Although futures markets have existed in some form since at least the 17th century, modern futures markets developed in the 1850's with the opening of the Chicago Board of Trade. However, since the early 1970's, financial futures (derivative) markets dealing with currencies, company stock shares, and bonds have become much more important.

In 1971, the Bretton Woods system of fixed exchange rates broke down when the US suspended the exchange of the U.S. dollar to gold. In a world of floating exchange rates among the different world currencies, exporters and importers faced new risks.

By the 1990's, many financial institutions involved with derivatives (risk gambling) were employing mathematicians and physicists to design sophisticated risk financial instruments.

Derivatives (futures and options) are highly "leveraged" transactions. This means that traders or banks are able to assume large future and option positions - accompanied by large risks - with very little up-front capital outlay. In other words, they pay for a derivative contract with pennies on the dollar. When their gamble on the future doesn't pay them back a higher price than their bet (contract price), they have to come up with assets to cover not only their losses, but the full value of their bet.

Sometimes, derivatives are deliberately mispriced in order to conceal actual losses or to make fraudulent "book value" profits. When a U.S. bank has big losses, this is usually what they will do to "cover-up" their great losses. Here are some actual examples:

In 1995, Baring Bank became insolvent. Nick Leeson lost $1.4 billion by gambling that the Nikkei 225 index of leading Japanese company shares would not move from its normal trading range. That assumption was shattered by the Kobe earthquake on January 17, 1995 after which Leeson attempted to conceal his losses with mispriced complex derivatives.

In 1998, the (LTCM) Long Term Credit Management hedge (derivatives) fund was rescued at a cost of $3.5 billion because of worries that its collapse would have severe repercussions for the world financial system.

In 1999, mispriced derivative options were used by NatWest Capital Markets to conceal their losses. The British Securities and Futures Authority concluded its disciplinary action against the firm in May 2000.

In March 2001, a Japanese court fined Credit Suisse First Boston 40 million yen because a subsidiary had used complex (mispriced) derivatives transactions to conceal their losses.

In 2001, Enron - the 7th largest company in the US and the world's largest energy trader - made extensive use of mispriced energy and credit derivatives (and became the biggest firm to go bankrupt in American history) after attempting to conceal huge losses.

In January 2004, four foreign currency dealers at the National Australia Bank have been caught running up $180 million (Australian) mispriced derivative debts in three months of unauthorised trades.

What does all this mean for U.S. banks? Astronomical losses for U.S. banks (as well as most world banks) have been concealed with mispriced derivatives. The problem with this is that these losses don't have to be reported to shareholders, so in all truth and reality, many U.S. banks are already insolvent. What that means is that U.S. banks have become nothing less than a Ponzi Scheme paying account holders with other account holder assets or deposits. The banks have no assets other than newly acquired assets because they have hidden the loss of all previous assets with mispriced derivatives.

Robbing Peter to pay Paul has never worked, and every Ponzi Scheme (illegal pyramid scam) has always ended abruptly with great losses for every person who invested in them. U.S. bank account holders are about to find this out.

 
 
Gnosty