By I. M. Vronsky, May
3, 2016 “Derivatives are weapons of
mass destruction” – Warren Buffett
The What
and Why of Derivatives
"Megabanks trade risk via
derivatives contracts to another firm while keeping the underlying asset on
their books. This way they can bypass capital requirements and take on more
debt. This, in turn, allows them to make more trades, but it also means that if
a sudden downturn surfaces in the markets, the firm which borrowed way beyond
their means may quickly go bankrupt.
Lehman
Brothers experienced this after they’d
borrowed 30 times more money than they had in reserve. In that case, a
relatively small loss of a mere 3% meant that Lehman no longer had reserves
(i.e. capital), and they therefore collapsed…i.e. totally wiped out. The
leverage that derivatives allow is incomprehensible. They are betting 30 TIMES
MORE MONEY THAN THEY HAVE. This is financially insane."
Who was
Lehman Brothers…and what happened to them? Lehman Brothers had humble origins,
tracing its roots back to a small general store that was founded by German
immigrant Henry Lehman in Montgomery, Alabama in 1844. In 1850, Henry Lehman
and his brothers, Emanuel, and Mayer, founded Lehman Brothers.
While the firm prospered over the
following decades as the US economy grew into an international powerhouse,
Lehman had to contend with plenty of challenges over the years. Lehman survived
them all – the railroad bankruptcies of the 1800s, the Great
Depression of the 1930s, two world wars,
a capital shortage when it was spun off by American Express Co. (AXP) in 1994, and the Long
Term Capital Management collapse
and Russian debt default of 1998.
However, despite its ability to
survive past disasters, the collapse of the U.S. housing market ultimately brought
Lehman Brothers to its knees, as its headlong rush into the subprime mortgage market proved to be a disastrous step. On September 15, 2008,
Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt,
Lehman's bankruptcy filing was the largest in history, as its assets far
surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest US investment bank at the
time of its collapse with 25,000 employees worldwide.
The world’s largest financial
institutions trade derivatives. Derivatives are instruments that derive their
value from fluctuations in the price of an underlying asset such as a stock or
a commodity. Financial institutions, asset managers, corporations, and
governments use derivatives to manage volatility in assets that their
respective enterprises are exposed to. At the time of its bankruptcy, Lehman
Brothers had an estimated $35 trillion notional derivatives portfolio.
From 2004-2007 Lehman Brothers and
Deutsche Bank (DB) were indeed riding high on the global financial hog.
They were literally gorging themselves via Derivative
Exposure…ad nauseam. Then the
proverbial poop hit the fan as both Lehman Brothers and Deutsche Bank were
hemorrhaging on insane ingestion of many Trillions of Dollars in DERIVATIVES.
Subsequently, Lehman Brothers went belly up…with its stock price going into
freefall from $25/share in 2007 to a mere 10 cents/share by early 2009. Moreover, Lehman Brothers shares are today
only 12 cents a share.
Likewise, Deutsche Bank’s
catastrophic derivative exposure has hammered down its stock price from $135 in
2007 to only $17/share today…ergo a heart-stopping price loss of -87%. Furthermore,
DB’s stock price appears to be hell bent for leather to follow Lehman Brothers’
lethal path to Wall Street’s graveyard…due primarily to its oppressive
Derivative’s Exposure. See Chart below:
The following US bank numbers reveal a
self-destructing recklessness that is on a level that is near criminal
negligence.
Citigroup: Total
Assets more than 1.8 trillion dollars
Total Derivatives more
than 53 trillion dollars
JPMorgan Chase: Total Assets about 2.4 trillion
dollars)
Total Derivatives more
than 51 trillion dollars)
Goldman Sachs: Total Assets less than a trillion
dollars
Total Derivatives more
than 51 trillion dollars
Bank Of America: Total Assets a little bit more
than 2.1 trillion dollars
Total Derivatives more
than 45 trillion dollars
Morgan Stanley: Total
Assets less than a trillion dollars
Total Derivatives more
than 31 trillion dollars
Wells Fargo: Total
Assets more than 1.7 trillion dollars
Total Derivatives more
than 6 trillion dollars
Today six major US banks are betting 24
TIMES MORE MONEY THAN THEY HAVE (i.e. $237 Trillion in Total Derivatives vs
only $10 Trillion in Total Assets). Even more insanely lethal is the
Derivative exposure of Deutsche Bank, which has $75 Trillion vis-à-vis Total
Assets of a mere $1.6 Trillion. Sadly DB is betting nearly 47 TIMES MORE
MONEY THAN THEY HAVE (astoundingly, it’s the biggest Derivatives Exposure in
the world). Clearly, it’s insanely suicidal. (Source: http://www.zerohedge.com/news/2016-02-03/it-time-panic-about-deutsche-bank)
This is financially crazy for the
following reason. In a hypothetical case where a relatively small Derivatives
Investment Loss of a mere 4% would mean that six major US banks might be
totally wiped out. The leverage that derivatives permit is
incomprehensible…ludicrously suicidal! It’s even worse for Deutsche Bank, where
a Derivative Investment Loss of less than 3% would crash DB into immediate
bankruptcy…a la Lehman Brothers. To be sure, this is Financial Armageddon to
the Nth degree. The
dire warning words of Warren Buffett are gospel: “Derivatives are weapons of mass destruction”
http://www.silver-phoenix500.com/article/derivatives-crisis-banks%E2%80%A6worldwide
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