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by jamess

Derivatives: An Investment on Nothing!

3:58 pm in Uncategorized by jamess

Warren Buffet gave a prophetic pronouncement back in 2003 about the Derivatives market, seeing the exponential dangers of this "paper-thin" type of investment.

Buffet did not mince words. He called them "financial weapons of mass destruction":

Buffett warns on investment ‘time bomb’
BBC – 4 March, 2003

The derivatives market has exploded in recent years, with investment banks selling billions of dollars worth of these investments to clients as a way to off-load or manage market risk.

But Mr Buffett argues that such highly complex financial instruments are time bombs and "financial weapons of mass destruction" that could harm not only their buyers and sellers, but the whole economic system.

Some derivatives contracts, Mr Buffett says, appear to have been devised by "madmen". [...]

BBC Link


Warren Buffet, the billionaire, renown for common-sense Investing, continues with his dire warnings on Derivatives …

Contracts devised by ‘madmen’

Derivatives are financial instruments that allow investors to speculate on the future price of, for example, commodities or shares – without buying the underlying investment.

Some derivatives contracts, Mr Buffett says, appear to have been devised by "madmen".

He warns that derivatives can push companies onto a "spiral that can lead to a corporate meltdown",

Derivatives also pose a dangerous incentive for false accounting, Mr Buffett says.

The profits and losses from derivatives deals are booked straight away, even though no actual money changes hand. In many cases the real costs hit companies only many years later.

BBC Link (same)

SO why are these Derivative Bets, SO Dangerous?

What’s so wrong with a little "back-room trading" of "Profit and Loss Bookkeeping Risk" among Friends Thieves?

Derivatives: Buffet calls them financial Weapons of Mass Destruction
By John Riley, Chief Strategist — 01/18/08

What are Derivatives?

Derivatives are private contracts (bets) between financial institutions. They can be on the direction of commodities, the stock markets or currencies, but the banks’ favorites are interest rates. (You can go to the Comptroller of the Currency website to get their quarterly reports and see for yourself what Wall Street hopes you never see.)

The scariest part of derivatives is their leverage. Like exchange traded options, derivative contracts can control assets for only a fraction of the contract value. The banks take the leverage to an extreme and have very little in assets backing up their derivative portfolios. According to the Comptroller, the top 25 banks have assets that only amount to about 6% of the Notional Value of their derivatives.

Derivatives have barely any regulation on them. For years, Congress tried and Greenspan stood in the way. Banks barely mention them in the annual reports except for a footnote.

Thanks to the lack of regulation, derivatives have grown dramatically. There has been a 473% increase in the Notional Value of derivatives at the top 25 banks since 1999.


Amazing, as of the beginning of 2008, the Top 25 banks ONLY HAD 6% Collateral to back up all their over-leveraged Derivative BETS! That includes all those notorious Credit Default Swaps too, tucked in among those Credit Derivatives. The Bankers put only 6% Down, to back up their betting!

In the old days, before Deregulation, trading betting "on margin", required minimum levels of capital assets (20-30%) on hand to back up, Margin Trading (ie "leveraging shares" you don’t Pay for). But with Deregulation, and the convenience of Derivative Paper contracts, those quaint "Captial Asset" requirements went out the window.

Say, you got $1000 Dollars, BUT you want to bet $40,000No Problem! How about $50,000? How about $100,000? Step right up, as long as you have the prestige of an Investment Bank, or a Billion Dollar Hedge Fund, to back you up … "take a seat at the Table" — ante up with your 1K Chip — We’ll "spot you" the rest!

NOooo Problem!

The sheer speculative arrogance of the Top Wall Street Bankers is truly astronomical when you chart it out. The Comptroller of the Currency (pdf), of US Dept of Treasury, has been busy collecting the data, if anyone cares to take the time to chart it out, like I have. (By the way a Trillion, is an awful big number — It’s a Million, Millions!)

Their lack of Caution about the extreme Risks they were taking, should cause any Regulator, to sound an Alarm … [or cause any Congress-person to want to pass Strong Financial Reform ...]

The Top 5 Banks — March 2008


The 6th-10th Over-leveraged Banks — March 2008


The 11th-15th sort-of-leveraged Banks — March 2008


The Top 5 Banks vs ALL the Rest of the Banks — March 2008


The Top 5 Banks cornering 96.9% of the Derivatives — March 2008


The NEW Top 5 Banks — June 2009


Data source: Comptroller of the Currency (pdf), of US Dept of Treasury, has issued an updated report as of June 2009.

Too bad, most of the Wall Street Regulators, of the LAST Decade, were happy let the Casino continue … they let it all ride.

They bet on the House.

And when the House didn’t have the funds to pay out on all those "Markers" … when the Market Risk finally turned against them?

OOOP’s !!!


Say America, could you "spot us" a few TRILLION Dollars, pretty please ???

Trust us … We’re Good for it!

Really … just let us get back in "the Game" …
Those Derivatives Bets will go our way, this Next time, you’ll see.

We know HOW to Manage Risk! … you simply Trade it away, to someone else!

Problem solved!

Risks-be-gone, has come through again. … There’s NOTHING left to worry about, SEE. On Paper — Everything’s hunky dory …

Warren, really ought to get a clue!

by jamess

With Derivatives, you can Bet on anything — Even the Weather!

9:07 am in Uncategorized by jamess


Introduction To Weather Derivatives
by Felix Carabello, Associate Director, Environmental Products, Chicago Mercantile Exchange

Weather: Risky Business

It is estimated that nearly 20% of the U.S. economy is directly affected by the weather, and that the profitability and revenues of virtually every industry – agriculture, energy, entertainment, construction, travel and others – depend to a great extent on the vagaries of temperature. [...]

In a 1998 testimony to Congress, former commerce secretary William Daley stated, "Weather is not just an environmental issue; it is a major economic factor. At least $1 trillion of our economy is weather-sensitive."

If there were only some way, to "Hedge that Bet" — against the ever present risk of Foul Weather.

No WorriesWhere there’s a Market Risk, there’s always a Wall Street Way!


We still live largely at the mercy of the weather. [...]

However, the inception of the weather derivative – by making weather a tradeable commodityhas changed all this.

Temperature as a Commodity

Until recently, insurance has been the main tool used by companies’ for protection against unexpected weather conditions. But insurance provides protection only against catastrophic damage. Insurance does nothing to protect against the reduced demand that businesses experience as a result of weather that is warmer or colder than expected.

In the late 1990s, people began to realize that if they quantified and indexed weather in terms of monthly or seasonal average temperatures, and attached a dollar amount to each index value, they could in a sense "package" and trade weather. In fact, this sort of trading would be comparable to trading the varying values of stock indices, currencies, interest rates and agricultural commodities. The concept of weather as a tradeable commodity, therefore, began to take shape.

In general, weather derivatives cover low-risk, high-probability events. Weather insurance, on the other hand, typically covers high-risk, low-probability events

Introduction To
Weather Derivatives

by Felix Carabello, Associate Director, Environmental Products, Chicago Mercantile Exchange


Psssst! Dudes, would you like to buy a few Rainy Days? … We got a Truckload of them we need to Unload!

Weather derivatives

Farmers can use weather derivatives to hedge against poor harvests caused by drought or frost; theme parks may want to insure against rainy weekends during peak summer seasons; and gas and power companies may use heating degree days (HDD) or cooling degree days (CDD) contracts to smooth earnings. A sports event managing company may wish to hedge the loss by entering into a weather derivative contract because if it rains the day of the sporting event, fewer tickets will be sold.

Heating degree days are one of the most common types of weather derivative. Typical terms for an HDD contract could be: for the November to March period, for each day where the temperature falls below 18 degrees Celsius keep a cumulative count of the difference between 18 degrees and the average daily temperature. Depending upon whether the option is a put option or a call option, pay out a set amount per heating degree day that the actual count differs from the strike.

There is no standard model for valuing weather derivatives [...] Typically weather derivatives are priced in a number of ways [including]:

Business pricing
Business pricing requires the company utilizing weather derivative instruments to understand how its financial performance is affected by adverse weather conditions across variety of outcomes (i.e. obtain a utility curve with respect to particular weather variables). Then the user can determine how much he is willing to pay in order to protect his/her business from those conditions in case they occurred based on his/her cost-benefit analysis and appetite for risk.

In this way a business can obtain a ‘guaranteed weather’ for the period in question, largely reducing the expenses/revenue variations due to weather.

Alternatively, an investor seeking certain level or return for certain level of risk can determine what price he is willing to pay for bearing particular outcome risk related to a particular weather instrument.

Must be nice to be able to ‘guaranteed weather’ — maybe these Derivative Resellers, can get together with the Climate Change crowd — and simply "trade away" the cost of any "Adverse Weather", we all are creating, in the long-run for Future Generations?

Because fortunately unfortunately you can take a Derivative out on about ANYTHING! … even on those risky Sub-Prime Mortgages (CDOs).

Wherever there’s a Market Risk, Wall Street will find a way to turn it into a Quick Buck!‘Chronic Gamblers’ are funny that way!


The Bet That Blew Up Wall Street   (pg 1 of 4)
Steve Kroft — 60 Minutes

On Credit Default Swaps And Their Central Role In The Unfolding Economic Crisis

Anyone with more than a casual interest in why their 401(k) has tanked over the past year knows that it’s because of the global credit crisis. It was triggered by the collapse of the housing market in the United States and magnified worldwide by the sale of complicated investments that Warren Buffett once labeled financial weapons of mass destruction.

They are called credit derivatives or credit default swaps.

As correspondent Steve Kroft first reported last fall, they are essentially side bets on the performance of the U.S. mortgage markets and some of the biggest financial institutions in the world – a form of legalized gambling that allows you to wager on financial outcomes without ever having to actually buy the stocks and bonds and mortgages.

In other words, three of the nation’s largest financial institutions had made more bad bets than they could afford to pay off. Bear Stearns was sold to J.P. Morgan for pennies on the dollar, Lehman Brothers was allowed to go belly up, and AIG, considered too big to let fail, is on life support thanks to a $180 billion investment by U.S. taxpayers.

"It’s legalized gambling. It was illegal gambling. And we made it legal gambling … with absolutely no regulatory controls. Zero, as far as I can tell," Dinallo says.

"I mean it sounds a little like a bookie operation," Kroft comments.

"Yes, and it used to be illegal. It was very illegal 100 years ago," Dinallo says.

The problems with Gambling are many.

But in an Economic context, when reckless Gamblers, are allowed to simply "swap away" the ultimate Cost, of any real Risk, … with NO light-of-day oversight, to ensure everything’s above board –

Well, you end up with what we got now:   fractured 401k funds, a broken Housing Market, too many Bankers who refuse to lend to Small Business … and a Boatload of Investment Firms Bookies, all claiming "it was the other guy’s fault."

"Buyer Beware!", you know, it’s just OUR "Free Market" — in action!

"Free for Whom?" … should always be the follow up question.

Certainly NOT "Free" to the average Taxpayers (and Homeowners) who end up bearing the brunt of most of that Economic Risk, when those reckless Derivative Bets, inevitably go bad … as speculative Bets, usually do.    (and calling it a "critical" Bail Out, does NOT — make it ALL OK.)

Why do you think they call it "Betting" anyways? (Someone ALWAYS loses!)


Psssst! Sista, would you like to buy a few Alt-A CDO’s? … We got a Truckload of them we need to Unload! … All these undervalued Mortgage-Bond-Instruments, AREN’T going to Re-write themselves, ya know …

Get em, While they’re a steal!

It’s a limited time offer only … step right up … (and be sure to bring your credit cards …)