Monday, July 25, 2016

The Brisk And Bracing Quatloos Trade

Unintended Consequences Of Interdependent Systems

Creating "Exotic" financial instruments, such as derivatives, in The Great Casino was one reason The Crash was more than just a garden-variety Recession. They amplified its effects. Lest we forget:
In derivatives trading, the counterparties know each other, the contracts are one-off between the parties directly, and the only guarantee that either party will get paid is trust … or the naked belief that they just can’t lose on this one.

AIG wrote billions of dollars of CDS “insurance” against the mortgage market without having even a fraction of what it would take to pay off claims … in the naked belief that they could collect fees forever and never have to pay out once. When the whole thing collapsed, they were wiped out. And because their “insurance” was part of the balance sheet of AIG’s many counterparties (Goldman Sachs and everyone like them), Goldman Sachs would have been wiped out too by AIG’s ... lies and deception.

That’s why the government bailed out AIG — and insisted on giving them 100 cents on the dollar — so that they could pay off Goldman, et al. AIG was bailed out to bail out all their counterparties.
Per Reuters, in its biannual update on U.S. stability, the government Office of Financial Research reported that overall risks to the U.S. economy "remain in the medium range" -- where they have been for a reported 18 months -- "but have been pushed higher by the United Kingdom vote to exit the European Union.

Richard Bermer, Director of OFR, said at a press conference on Monday that the Brexit vote's effects could take some time to develop in the United States, since the decoupling between UK and EU will is expected to take several years.

"Because the U.K. economy, and especially the U.K. financial system, are highly connected with the rest of Europe and United States," Bermer said, "severe adverse outcomes in the U.K. and spillovers to Europe could pose a risk to U.S. financial stability."

Buried a bit further on in the article was this paragraph:
The office found financial claims from U.S. banks, insurance companies, asset managers, hedge funds and others on U.K. entities total $2.1 trillion, or 11.3 percent of the U.S. economy. Claims on European Union entities, minus the United Kingdom, total $2.9 trillion, or 15.9 percent of U.S. GDP. Those numbers do not include derivatives or guarantees.(Emphasis added)
What this tells us, class, is the U.S. economy has a $6.0 Trillion Dollar exposure in both the UK and the EU -- or, over one quarter (27.2%) of our GDP.  That doesn't mean we could lose all $6T, but some portion of it is "at risk".

It also tells us that this does not include derivatives, guarantees, or other "exotic" forms of options on the Market (essentially, betting your entire paycheck on "Destroyer Of Worlds" to Win at 23:1 in the third Greyhound race at Pampano Park. You saw the video).

And what's the estimated total of the worldwide derivatives market? $1.2 Quadrillion Dollars US. That, boys and girls, is roughly ten times the GDP of all nations on Planet Earth. One hell of a lot of Quatloos.

MEHR, MIT RANDOM BARKING:  Hey; you know, I wonder when we'll see our first Trillionaire?  I can't wait; can you?  So exciting.