Derivatives 101: Great Financial Tool Or Sinister Financial Time Bomb?

By | October 13, 2015

Derivatives…Derivatives? D-E-R-I-V-A-T-I-V-E-S!

Most if not everyone who reads this article has heard the term derivatives at some point in time. And when they have, it’s likely been in the context of how these financial instruments that are not typically seen and not really understood by the masses are actually fiscal time bombs that, if ever detonated, could bring the global financial system to its knees!

But for you and I who march through our days trying to maximize sales and profits for our businesses and who are possibly managing retirement or investment portfolios, do derivatives really play any role in our lives and are they something that we need to know more about and/or be concerned with?

The answer to that question is that of course we should know more and certainly they potentially could be something that we need to be concerned with. You will see that in the article below from Sprott Money which highlights the MASSIVE exposure that some TBTF (too big to fail) banks have to derivatives bets that hide outside of the light of day (or GAAP).

If you thought that the financial crisis of 2008 posed global systemic risk to the financial system, just imagine if some portion of the $53 TRILLION in bets at an institution like Bank of America begin to go wrong.

The Derivatives Market: Bets, Bookies, and Fraud – Jeff Nielson

No one “understands” derivatives. How many times have readers heard that thought expressed (please round-off to the nearest thousand)? Why does no one understand derivatives? For many; the answer to that question is that they have simply been thinking too hard. For others; the answer is that they don’t “think”, at all.

Derivatives are bets. This is not a metaphor, or analogy, or generalization. Derivatives are bets. Period. That’s all they ever were. That’s all they ever can be. This can be easily illustrated by simply examining and defining some of the more well-known “derivatives”, meaning those derivatives with whom everyone is familiar with their labels.

Let’s start with the two largest and most-important forms of this gambling (and fraud): “interest rate swaps” and “credit default swaps”. What is an interest rate swap? This is a bet between a banker (i.e. the people who control interest rates) and a Chump, on which direction an interest rate will move.

Can anyone see a problem with this form of gambling/fraud? Correct. If you place bets on the direction of interest rates against the criminals who control those interest rates, you’re probably going to lose on those bets, almost all of the time. Is this what we saw in the interest rate swap “market”?

Not at first. At first the Chumps were allowed to win – on their small bets. That’s how you gets lots and lots more Chumps to get suckered into the scam, and how you get the Chumps to place larger and larger bets. But after the initial “success” of the Chumps, it was lose, lose, lose.

Case in point, self-declared “economic genius”: Larry Summers, former Treasury Secretary of the United States, and at that time, President of Harvard. No one thinks that Larry Summers knows more about economics and finance than Larry Summers. So it should be no surprise that this “genius” decided to bet against his friends the bankers in financing Harvard’s debt, via interest rate swaps.

How did he do? Summers managed to lose nearly $1 billion in financing a mere $2 billion of debt. To be more precise, not only did Harvard pay the full rate of interest on their debt, but (thanks to Summers’ gambling) the university paid an additional $900+ million in “penalties” – to avoid losing even more money on Summer’s gambling.

That’s what happens when you bet on interest rates against the people who create those interest rates. It’s obvious fraud, and it has resulted in at least one jurisdiction filing criminal charges against three of the largest fraud-factories in this scam: JPMorgan Chase & Co., Deutsche Bank, and UBS. But that’s all “old news” now.

To really understand “the derivatives market” as a whole requires understanding exactly what it is: history’s largest book-making operation (i.e. bookies). This is all that this rigged casino has ever represented: bookies taking bets. Here readers also need to understand how a bookie’s “market” operates.

Bookies take bets according to “odds”, the prevailing gambling-ratio for that particular bet, or the price it costs to place that bet. But these odds change over time. How do they change? They change based on the amount of money placed on each side of the bet. When more money is placed on one side of the bet, the price to place the bet (on one side) declines, while the price to place the bet on the other side rises.

The gambling itself moves the market. The financial crime syndicate noticed how this gambling operated, and figured out how they could create their own “book-making operation”, where all the bets were rigged, and where these banksters were not only allowed to take bets (i.e. act as bookies), they would also be allowed to place bets, in this same market. All they had to do was to make-up a bunch of euphemisms to hide this systemic crime.

Here we see fraud in its most-elementary form. ‘Legitimate’ bookies never bet in their own “market”. Even in the world of quasi-illicit gambling, it is recognized that allowing this would allow bookies to rig their own gambling. But not in the world of “banking” and “derivatives”. Here the biggest bettors in this fraudulent gambling (by many orders of magnitude) are the bookies themselves.

Goldman Sachs — $47.7 trillion

Bank of America — $53 trillion

Citigroup — $56 trillion

JPMorgan — $78.1 tillion

Read the rest of the article at Sprott Money here.

H/T Zero Hedge

(Note: You may have noticed that many articles here do not specifically relate to either title insurance or real estate. The reason for this is that most of the topics discussed have the potential, in one way or another, to impact real estate and by extension title insurance)

Michael Haltman is President of Hallmark Abstract Service in New York. He can be reached at

One thought on “Derivatives 101: Great Financial Tool Or Sinister Financial Time Bomb?

  1. Pingback: Derivatives 101: Great Financial Tool Or Sinister Financial Time Bomb? – Update | Hallmark Abstract LLC

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