The Coming Financial Meltdown

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"Any
losses [AIG] may realize … under these derivatives will not be
material."

~ AIG, Feb.
12, 2008

We all remember
how in late 2008, staggering losses on risky derivatives nearly
brought down our entire financial system.

With 43 members
of the House and the Senate hammering out a final version of the
financial-reform bill, one of the biggest contentions remains what
to do about the mind-boggling, vast, and opaque derivatives market
owned by the nation’s too-big-to-fail megabanks.

The problem
is getting worse. Notional amounts of derivatives held by federally
insured banks have risen to more than $200 trillion.


Source: Office
of the Comptroller of Currency as of Dec. 31, 2009

The blue line
you see is the huge profit center of derivatives casinos and squeezing
customers. The yellow one is mostly naked credit default swaps,
the same instruments for gambling on the bankruptcy of other companies
that blew up AIG. Green is what banks use to actually hedge their
risk.

Granted, many
of these positions cancel each other out, but even assuming the
"netting" works, we’re still talking more than $20 trillion.

No matter how
you measure it, this is a ton of risk, and it’s concentrated in
five hands: JPMorgan Chase, Bank of America, Goldman Sachs, Citigroup,
and Wells Fargo.


Source: Office
of the Comptroller of Currency as of Dec. 31, 2009

There are at
least three problems with this picture:

1. This
is crazy.

At 14 times the size of the U.S.’s gross domestic product, if even
a fraction of these opaque and convoluted instruments blow up, as
they did in 1998 and again in 2008, it would be bad news bears for
everyone who doesn’t live on roots and berries.

Read
the rest of the article

June
17, 2010

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