Warren Buffett: Derivatives Are Still Weapons Of Mass Destruction And
‘Are Likely To Cause Big Trouble’ By
Michael Snyder, on June 22nd, 2015
After all these years, the most
famous investor in the world still believes that derivatives are financial
weapons of mass destruction. And you know what? He is exactly
right. The next great global financial collapse that so many are warning about is nearly upon us, and when it arrives derivatives are
going to play a starring role. When many people hear the word
“derivatives”, they tend to tune out because it is a word that sounds very
complicated. And without a doubt, derivatives can be enormously
complex. But what I try to do is to take complex subjects and break them
down into simple terms.
At their core, derivatives represent
nothing more than a legalized form of gambling. A derivative is
essentially a bet that something either will or will not happen in the future.
Ultimately, someone will win money and someone will lose money. There are
hundreds of trillions of dollars
worth of these bets floating around out there, and one of these days this
gigantic time bomb is going to go off and absolutely cripple the entire global
financial system.
Back in 2002, legendary investor
Warren Buffett shared the following thoughts about derivatives with
shareholders of Berkshire Hathaway…
The derivatives genie is now well
out of the bottle, and these instruments will almost certainly multiply in
variety and number until some event makes their toxicity clear. Central banks
and governments have so far found no effective way to control, or even monitor,
the risks posed by these contracts. In
my view, derivatives are financial weapons of mass destruction, carrying
dangers that, while now latent, are potentially lethal.
Those words turned out to be quite
prophetic. Derivatives have definitely multiplied in variety and number
since that time, and it has become abundantly clear how toxic they are.
Derivatives played a substantial role in the financial meltdown of 2008, but we
still haven’t learned our lessons. Today, the derivatives bubble is even
larger than it was just before the last financial crisis, and it could
absolutely devastate the global financial system at any time.
During one recent interview, Buffett
was asked if he is still convinced that derivatives are “weapons of mass
destruction”. He told the interviewer that he believes that they are, and
that “at some point they are likely to cause big trouble”…
Thirteen years after describing
derivatives as “weapons of mass destruction” Warren Buffett has reaffirmed his
view that they pose a threat to the global economy and financial
markets.
In an interview with Chanticleer
this week, Buffett said that “at some
point they are likely to cause big trouble“. “Derivatives, lend themselves to huge amounts of speculation,” he
said.
Most of the time, the big banks that
do most of the trading in these derivatives do very well. They use
extremely sophisticated computer algorithms that help them come out on the
winning end of these bets most of the time.
But when there is some sort of
unforeseen event that suddenly causes a massive shift in the marketplace, that
can cause tremendous problems. This is something that Buffett
discussed during his recent interview…“The problem arises when there is a discontinuity in the
market for some reason or another.
“When the markets closed like it was
for a few days after 9/11 or in World War I the market was closed for four or
five months – anything that disrupts the continuity of the market when you have
trillions of dollars of nominal amounts outstanding and no ability to settle up
and who knows what happens when the market reopens,” he said. So if the markets
behave fairly calmly and predictably, the derivatives bubble probably will not
burst.
But no balancing act of this nature
ever lasts forever. Just remember what happened in 2008. Lehman
Brothers collapsed and then the financial system virtually froze up.
According to Forbes, at that time almost everyone was
afraid to deal with the big banks because nobody was quite sure how much
exposure they had to these risky derivatives…
Fast forward to the financial
meltdown of 2008 and what do we see? America again was celebrating. The economy
was booming. Everyone seemed to be getting wealthier, even though the warning
signs were everywhere: too much borrowing, foolish investments, greedy banks,
regulators asleep at the wheel, politicians eager to promote home-ownership for
those who couldn’t afford it, and distinguished analysts openly predicting this
could only end badly. And then, when Lehman Bros fell, the financial system froze
and world economy almost collapsed. Why?
The root cause wasn’t just the
reckless lending and the excessive risk taking. The problem at the core was a
lack of transparency. After Lehman’s
collapse, no one could understand any particular bank’s risks from derivative
trading and so no bank wanted to lend to or trade with any other bank. Because
all the big banks’ had been involved to an unknown degree in risky derivative
trading, no one could tell whether any particular financial institution might
suddenly implode.
After the crisis, we were promised
that something would be done about the “too big to fail” problem. But instead,
the problem of “too big to fail” is now larger than ever.
Since the last financial crisis, the
four largest banks in the country have gotten approximately 40 percent larger. Today, the five largest banks account for
approximately 42 percent of
all loans in the United States, and the six largest banks account for
approximately 67 percent of
all assets in our financial system. Without those banks, we would not
have much of an economy left at all.
Meanwhile, smaller banks have been
going out of business or have been swallowed up by the big banks at a
staggering rate. Incredibly, there are 1,400 fewer small banks in
operation today than there were when the last financial crisis erupted.
So we cannot afford for these “too
big to fail” banks to actually fail. Even the failure of a single one
would cause a national financial nightmare. The “too big to fail” banks
that I am talking about are JPMorgan Chase, Citibank, Goldman Sachs, Bank of
America, Morgan Stanley and Wells Fargo. When you total up the exposure
to derivatives that all of them currently have, it comes to a grand total of
more than 278 trillion dollars.
But when you total up all of the assets of all six banks combined, it only
comes to a grand total of about 9.8 trillion dollars.
In other words, the “too big to
fail” banks have exposure to derivatives that is more than 28 times the size of their total assets.
I have shared the following numbers
with my readers before, but it is absolutely crucial that we all understand how
exceedingly vulnerable our financial system really is. These numbers come
directly from the OCC’s most
recent quarterly report (see Table 2), and
they reveal a recklessness that is almost beyond words…
JPMorgan
Chase - Total Assets: $2,573,126,000,000
(about 2.6 trillion dollars)
Total Exposure To Derivatives:
$63,600,246,000,000 (more than 63
trillion dollars)
Citibank - Total Assets: $1,842,530,000,000 (more than 1.8 trillion
dollars)
Total Exposure To Derivatives:
$59,951,603,000,000 (more than 59
trillion dollars)
Goldman
Sachs - Total Assets: $856,301,000,000
(less than a trillion dollars)
Total Exposure To Derivatives:
$57,312,558,000,000 (more than 57
trillion dollars)
Bank Of
America - Total Assets: $2,106,796,000,000
(a little bit more than 2.1 trillion dollars)
Total Exposure To Derivatives:
$54,224,084,000,000 (more than 54
trillion dollars)
Morgan
Stanley - Total Assets: $801,382,000,000
(less than a trillion dollars)
Total Exposure To Derivatives:
$38,546,879,000,000 (more than 38
trillion dollars)
Wells
Fargo - Total Assets: $1,687,155,000,000
(about 1.7 trillion dollars)
Total Exposure To Derivatives:
$5,302,422,000,000 (more than 5
trillion dollars)
Since the United States was first
established, the U.S. government has run up a total debt of a bit more than 18
trillion dollars. It is the biggest mountain of debt in the history of
the planet, and it has grown so large that it is literally impossible for us to pay it off at this point.
But the top five banks in the list
above each have exposure to derivatives that
is more than twice the size of the national debt, and several of them
have exposure to derivatives that is
more than three times the size of the national debt.
That is why I keep saying that there
will not be enough money in the entire world to bail everyone out when this
derivatives bubble finally implodes.
Warren Buffett is entirely correct
about derivatives – they truly are weapons of mass destruction that could
destroy the entire global financial system at any time.
So as we move into the second half of this year and beyond, you will want to watch for terms like
“derivatives crisis” or “derivatives crash” in news reports. When
derivatives start making front page news, that will be a really, really bad
sign.
Our financial system has been
transformed into the largest casino in the history of the planet.
For the moment, the roulette wheels
are still spinning and everyone is happy. But sooner or later, a “black
swan event” will happen that nobody expected, and then all hell will break
loose.
Comments
Derivatives should be outlawed. If these banks think taxpayers should
bail them out, they need to know we won’t. There are too many other problems
like government overspending on nonsense, not enough cash in the system and the
world living on credit.
Anti-discrimination laws like the Community Redevelopment Act 1993 and
HUD rules also need to go.
Glass-Steagall needs to be reinstated along with these other changes.
Norb Leahy, Dunwoody GA Tea Party Leader
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