The $516 Trillion Dollar Time Bomb

[Mike C]

Bad Ju-Ju here.

http://www.marketwatch.com/news/stor...&dist=printTop

Derivatives the new 'ticking bomb'

Buffett and Gross warn: $516 trillion bubble is a disaster waiting to happen

ARROYO GRANDE, Calif. (MarketWatch) -- "Charlie and I believe Berkshire should be a fortress of financial strength" wrote Warren Buffett. That was five years before the subprime-credit meltdown.

"We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

Derivatives bubble explodes five times bigger in five years

Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends:

1. Sarbanes-Oxley increased corporate disclosures and government oversight
2. Federal Reserve's cheap money policies created the subprime-housing boom
3. War budgets burdened the U.S. Treasury and future entitlements programs
4. Trade deficits with China and others destroyed the value of the U.S. dollar
5. Oil and commodity rich nations demanding equity payments rather than debt

In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession.
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Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier's window at a racetrack or casino, where you'd place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.

To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data:

• U.S. annual gross domestic product is about $15 trillion
• U.S. money supply is also about $15 trillion
• Current proposed U.S. federal budget is $3 trillion
• U.S. government's maximum legal debt is $9 trillion
• U.S. mutual fund companies manage about $12 trillion
• World's GDPs for all nations is approximately $50 trillion
• Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
• Total value of the world's real estate is estimated at about $75 trillion
• Total value of world's stock and bond markets is more than $100 trillion
• BIS valuation of world's derivatives back in 2002 was about $100 trillion
• BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion

Moreover, the folks at BIS tell me their estimate of $516 trillion only includes "transactions in which a major private dealer (bank) is involved on at least one side of the transaction," but doesn't include private deals between two "non-reporting entities." They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average.

Also, keep in mind that while the $516 trillion "notional" value (maximum in case of a meltdown) of the deals is a good measure of the market's size, the 2007 BIS study notes that the $11 trillion "gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets."

[Foolish Old]

Bottom line: Never invest in something you don't fully understand. Derivatives possess a complexity that defies comprehension by even the most sophisticated analysts.

One easy example that our government has failed to adequately police investment offerings is the inability of secondary mortgage holders to substantiate that they hold a particular loan. Many of these portfolios contain a large percentage of loans with no hope for repayment. Yet they received top credit risk ratings and were sold to naive investors as safe havens for their retirement savings.

As horrible as the sub-prime crisis is, it is the tip of the iceberg, the canary in the coal mine.

[Mike C]

It´s a problem intermeshed within the whole world´s economies. If this time bomb blows like Buffett fears it will, there will be a hardcore, worldwide depression dwarfing by far what happened in the 30´s.

Even if the total subprime wreck totals $500 billion in losses worldwide, that is nothing but chump change lost down the sewer grate compared to $516 trillion.

[joviliz]

Mike,
I always wonder who gains? Some people must absorb that trillion $

[Foolish Old]

Mike,
I always wonder who gains? Some people must absorb that trillion $

The rapid increase in the fortunes of the ultra rich may be a clue into discovering the answer to your question regarding the transfer of global wealth.

[gpbullock]

These numbers

just don't make any sense. In the event of a crash these numbers will simply end up being absorbed into numbers that are more realistic. A 200k house will end up being 20k, a gallon of gas will be a quarter. If as the article states that the U.S. GNP is 17 trillion annually and the global GNP is 70 trillion, it will take 7 years of 100% payout to make it 0. The rich will take a hit and it will make a billionaire a millionaire. Just don't see it, these numbers are mind boggling.

[rita.jones56]

Any guy that knows as much about money as Warren Buffet should at least be given some respect and listened to by our federal government and Wall Street. He predicted this and now it's happening. I'm not saying we should listen to everything these wealthy guys say, but at least give it some consideration. This economic dowturn could have been prevented.

[bill j.]

Supervisors Covered Up Risky Loans

Economy
Auditor: Supervisors Covered Up Risky Loans

by Chris Arnold

Listen Now [6 min 35 sec] add to playlist

Morning Edition, May 27, 2008 · Now that millions of people are facing foreclosure because they got into loans that never should have been approved, everybody's looking for someone to blame. Borrowers, or their brokers, lied on loan applications. Others got high interest rates they couldn't afford.

A big unanswered question is whether the Wall Street investment banks that were packaging these mortgages knew they were selling garbage loans to investors. A wave of litigation is starting against these firms. One former worker whose job was to catch bad loans says her supervisors covered them up.

Mortgage Quality Control

Tracy Warren is not surprised by the foreclosure crisis. She saw the roots of it firsthand every day. She worked for a quality-control contractor that reviewed subprime loans for investment banks before they were sold off on Wall Street.

It was her job to dig into the loans and ferret out problems. By 2006, they were easy to find.

"I'd see people who were hotel workers saying that they made, in California, making $15,000 a month so that they could qualify for a $500,000 home," Warren says. "If a hotel worker is making $15,000 a month changing sheets at the Days Inn, everybody would want to do it. It just really made no sense."

Warren has worked in the mortgage business for 25 years, the past five in quality control. Most recently, she was a contract worker for a company called Watterson-Prime, which did loan audits for investment banks. She says their biggest client was Bear Stearns, which recently all but collapsed because of its exposure to bad loans.
more http://www.npr.org/templates/story/s...58&ft=1&f=1001

[jackmcmanus21]

I can't really see this happening

[TheRainman]

I can't really see this happening

Jack

I've seen these types of loans. I write home insurance in s. florida. And it wasn't unusual for these fraud loans.

I wrote one guy who was working as a new car salesman in 2003 and if bought his first investment property for 500,000. Shortly after that he quit his job and by the time 2006 he owned 5 half million dollar or more homes which he refinanced with bogus appraisals and lost all 5 homes to forclosures. He is now broke and selling cars again. But he was spending money like crazy for those three years.

But the good news is. The mortgage companies have cleaned up their act. And the insurance companies stop taking outside appraisal. Now we must do one with the insurer only.

And i'll tell you the government statistics on average home prices are way off. Because their not comparing the average 2006 home to the 2008.

And i'll give you an example. In palm beach co. they reported recently that the average home sold for something like 340,000 and it was 413,000 in 2006. The problem with this is that house that sold for 413,000 is now selling for 250,000 and the homes that are now selling for 340,000 were selling for 550,000 then. And these older homes are not selling. A lot of them are vacant.

The adult community of homes near my office had like 40 2/2 homes for sale and they were not moving at all. In 2006 they were selling well for 200,000 to 235,000. Recently they been dumping them for 80,000 to 125,000. And only one was 125,000 and the banks wouldn't finance it at that price so the investor is carrering the paper on it.