First, dash over to Salon and read this Tom Tomorrow cartoon. It establishes some context for the bail out proposal. Now let’s look at derivatives — investments (or “bets”) that are meant to spread and reduce portfolio risk. Thanks to RB for forwarding this, it originated here.
Analogies are never perfect, but here’s one using horse racing. Don’t expect a perfect correspondence to the banking situation, but I think it is close enough for government work.
Joe goes to the track and bets $2 on a horse.
Two guys standing nearby get into a discussion and Fred says to Sam, “I’ll bet you $5 that Joe wins his bet.”
Next to them are Bill and Bob. Bill says: “I’ll bet you $10 that Fred welshes on his bet if he loses.”
Next to them is Sally. Sally says: “For $3 I’ll guarantee to Bill that if Bob fails to pay off, I’ll make good on the bet.”
Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn’t expect to every have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.
A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.
Question how much has been “invested” in the horse race?
$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.
The author goes on to say: “…when you hear everybody saying this is a crisis caused by the housing collapse, be skeptical. We are in the midst of a classic pyramid or Ponzi scheme and there is no way out except for people to lose a lot of money. All that is different this time is that it is the taxpayers who are being asked for the cash.”
Somebody seems to have gotten the message, because instead of the quick banking industry bail out that would have merely been a first installment on the American tax payers paying down (for the “greed is good” crowd) the trillions of dollars worth of casino-like losses on derivatives that are emerging due to the mortgage crisis, today the bailout was rejected by the House of Representatives. Congress has finally told GW Bush, “Fool me once, shame on me, fool me again and again, well f**k you.” It remains to be seen what government will do, but in any case they won’t get it done before the end of the quarter tomorrow, so we can expect some rocky third quarter reports from the corporate world.
Some indication of [the derivative market's] anatomy has been revealed in a report released this month by the Bank of International Settlements (BIS) in Basel, Switzerland. These guys should know, because BIS is the mother of all central banks. It lends money to central banks of other countries, clears international give and take and generally keeps track of financial markets.
According to its quarterly report, the total amount outstanding in the derivatives market was $677 trillion at the end of 2023.
Half the world’s derivative trading takes place in the US. How much of the trillions of dollars worth of vapor produced by the gamblers in the derivatives market is toxic? How much links directly to institutions and institutional clients that are sinking or have been sunk by the mortgage mess? I’ve seen estimates of five to eight trillion dollars, but have no clue what those were based on. Suffice it to say that the “bail out” would probably have been a 10% down payment on covering the markers that the free marketeers have outstanding.
If this kind of thing happened on the street, somebody would have broken kneecaps by now. As it is, the corporate elite feel entitled to a “bail out.” This brings us back to the Tom Tomorrow cartoon. If we don’t bail them out, they threaten to take all of us down with them. A collapse of insurance funds, pension funds, devalued equities held by the widows and orphans that Wall Street has always been so proud to serve — these things could pauperize a sizable chunk of the middle class. What will Congress do to cushion the impact?