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Thread: Brief history of derivatives

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    Default Brief history of derivatives

    A Brief History of Derivatives
    (The Most Dangerous and Controversial Financial Instruments Ever Created)

    The giant bubble forming in the global derivatives market (led by America’s big banks) bears frightening resemblance to the S&L crisis. In the 1980’s a lack of regulation and oversight, allowed America’s banks to trade dishonestly, hide losses and embezzle client and government funds. The same scenario is unfolding right now amongst the world’s global derivatives traders. America’s big banks, big corporations and mutual funds have turned into giant casinos...using unregulated over-the-counter and massively leveraged derivative bets as a new source of income…and as a way to disguise losses and dupe investors. The difference though to the S&L crisis is that when the derivatives bubble finally blows, the fall-out will be 100 times worse. The S&L crisis cost American taxpayers hundreds of billions of dollars and depressed the real estate market for years. But no pot will be big enough to bail out America this time.

    1973 The Chicago Board Options Exchange opens…and trading in large-scale derivatives begins.

    1983 President Reagan signed the 1982 Futures Trading Act for derivatives. This was a major feature in the disastrous Reagan-era deregulation of the U.S. economy.

    1986 The notational value of derivatives balloons to $618 billion…

    1987 The failure of the stock markets and the derivatives markets to operate in sync, causes the collapse of global stock markets (according to the Presidential Task Force on Market Mechanisms)…and the terrific force of derivatives is felt for the first time.

    1988 The notational value of derivatives hits the $1 trillion mark.

    1994 Global derivatives market exceeds $10 trillion mark…and the first series of major derivatives failures begins. (Metallgesellshaft loses $1.5 billion on oil futures, Procter & Gamble loses $157 million by trading derivatives, Orange County, California, publicly acknowledges a $1.5 billion loss due to its derivatives plays, bankrupting the county).

    1995 Barings Bank goes bust because one rogue trader, Nick Leeson, loses $1.4 billion with derivatives bets on the Nikkei index that were shattered by the Kobe earthquake.

    1995 Wisconsin's $6.7 billion State Investment Board Posts $95 Million Loss From Unauthorized Use of Derivatives.

    1997 Under-regulated, derivative-based credit swap contracts causes the collapse of the Asian markets.

    1998 The derivatives trading of a single hedge fund, Long Term Capital Management, almost causes the collapse of global stock markets. Fed organizes a $3.5 billion bailout.

    2000 Global derivatives positions leaps to more than $95 trillion - even as the stock market crashes and the global economy goes into recession.

    2001 Enron (without the public knowing it) had secretly transformed itself from an energy trader into an unregulated derivatives player, causing its eventual collapse.

    2003 Fannie Mae lost $8.4 billion on its derivatives portfolio causing its stock to plummet.

    2003 Buffett warns investors that the bubble in the derivatives market is a “mega-catastrophe waiting to happen.” His comments send ripples through global markets.

    2006 Global derivatives market exceeds $500 trillion (more than 10 times the size of the entire global economy).

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    Default Re: Brief history of derivatives

    Pick a subject, take a few facts, throw in some filler (actual events that since they are also financial, will look to go hand in hand) and throw in some politics and whalla.........
    Quote Originally Posted by The Snark View Post
    But then I suppose the sort of people who write this kind of crap generally don't allow their opinions to be tainted by things like "facts" and "reality".
    Distortion becomes somehow pure in its wildness
    The note that began all can also destroy

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    Default Re: Brief history of derivatives

    How about the hedge funds scandal hitting WS now....

    http://www.nytimes.com/2008/12/13/bu...damage.html?em

    Hedge Funds Are Victims, Raising Further Questions
    By MICHAEL J. de la MERCED
    Published: December 12, 2008



    Frauds on Wall Street aren’t unheard of. But a $50 billion Ponzi scheme, one that prosecutors say struck at boldface names on several continents, is a bombshell by any standard.

    Skip to next paragraph
    Related
    Times Topics: Bernard L. MadoffThe case against Bernard L. Madoff, the respected longtime trader accused of running one of the biggest frauds in Wall Street history, has been Topic A in the investor community. But close behind is a heated discussion of how the sordid drama will affect the already-battered community of hedge funds and other investment firms — many of which invested with Mr. Madoff.

    Mr. Madoff’s case could hardly have come at a worse time for hedge funds. The whipsawing markets and suddenly unfriendly lenders have already taken their toll on high financiers, and many have already suffered what amounts to runs on the bank by investors clamoring to withdraw their investments.

    “It can’t help but have the effect of further chipping away at the confidence that the investor community has in the hedge fund industry,” said Ralph L. Schlosstein, the chief executive of Highview Investment Group, a money management firm and a former president of BlackRock. “But like many things that come at moments of fragility, its impact is magnified.”

    and on it goes....
    I loved going to strip clubs; I actually made some friends there. Now things are different for the clubs and for me. As a result I am not as happy.

    Customers are not entitled to grope, disrespect, or rob strippers. This is their job, not their hobby, and they all need income. Clubs are not just some erotic show for guys to view while drinking.

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    Default Re: Brief history of derivatives

    I'll start worrying when the amount hits a gazillion. Until then...pffft

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    Default Re: Brief history of derivatives

    They were de-riving most conservative investors crazy too.
    I loved going to strip clubs; I actually made some friends there. Now things are different for the clubs and for me. As a result I am not as happy.

    Customers are not entitled to grope, disrespect, or rob strippers. This is their job, not their hobby, and they all need income. Clubs are not just some erotic show for guys to view while drinking.

    NOTE: anything I post here, outside of a direct quote, is my opinion only, which I am entitled to. Take it for what you estimate it is worth.

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    Default Re: Brief history of derivatives

    Well, this just keeps getting better....

    http://www.nytimes.com/2008/12/17/bu...l?ref=business

    S.E.C. Issues Mea Culpa on Madoff
    By ALEX BERENSON and DIANA B. HENRIQUES

    The Securities and Exchange Commission said Tuesday night that it had missed repeated opportunities to discover what may be the largest financial fraud in history, a Ponzi scheme whose losses could run as high as $50 billion.

    The commission said it received credible allegations about the scheme at least nine years ago and will immediately open an internal investigation to examine why it had failed to pursue them aggressively. <snip>
    I loved going to strip clubs; I actually made some friends there. Now things are different for the clubs and for me. As a result I am not as happy.

    Customers are not entitled to grope, disrespect, or rob strippers. This is their job, not their hobby, and they all need income. Clubs are not just some erotic show for guys to view while drinking.

    NOTE: anything I post here, outside of a direct quote, is my opinion only, which I am entitled to. Take it for what you estimate it is worth.

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    Default Re: Brief history of derivatives

    ^^^ not wanting to veer too far towards the political in Dollar Den, but if the SEC missed $50 billion with Madoff WITHOUT a political motivation to ignore wrongdoing, it really builds confidence that SEC / other gov't oversight of bailed out companies will be properly conducted doesn't it !

    Of course the 'tin foil hat' crowd would also point out that a large number of Madoff's investors were also heavy contributors to Democratic politicians - leading to speculation that there was indeed political motivation to ignore Madoff as long as his fund was paying out high percentages in '''profits''' to those investors.

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    Default Re: Brief history of derivatives

    ^^^ no need to start another unresolvable argument. The economic facts are that quite a few uber-rich personal investors and institutional investors are going to experience substantial losses as a result of Maloff's Ponzi Scheme. There has even been a call for SIPC to step in and make good some of the losses (which ain't gonna happen because the SIPC doesn't have the 50 billion !). Thus the present economic distress has now left the province of 'inner city' mortgages and 'low income' credit cards, and has finally hit some rich and influential people squarely in the wallet.

    I'll also add that, because of 'fraudulent conveyance' laws re bankruptcies, those rich and influential people may face a whole bunch of additional economic pain !!!



    (snip)"BOSTON (Reuters) - Disgraced money manager Bernard Madoff's suspected $50 billion fraud scheme looks set to burn even those who pulled their investments out long before the scandal rippled into the global financial system.

    Such investors may have counted themselves fortunate, withdrawing their money years ago to buy a house or to pay for a daughter's education, and may have even sighed with relief because they ended ties with Madoff long before the scandal erupted late last week.

    But they, too, could face trouble, lawyers say. Because of a legal concept known as "fraudulent conveyance," they could be forced to return their profits and even some of their initial investments to help offset losses incurred by others entangled in the long-running Ponzi scheme.

    A Ponzi scheme is an illegal investment vehicle that pays off old investors with money from new ones, and relies on a constant stream of new investment. Such schemes eventually collapse under their own weight.

    "There were no profits. It was just other people's money," said Brad Alford, who runs investment adviser Alpha Capital Management LLC in Atlanta.

    Alford is well versed in fraudulent conveyance after one of his clients withdrew money from a $450 million scheme by Connecticut hedge-fund company Bayou Group LLC a year before it collapsed in scandal. "We ended up settling with the estate, giving back all the profits and half of our principal."

    Bankruptcy-receivership practices make all investors vulnerable, he added. "Once they can go into bankruptcy they can go back six years. Anything past your principal, I'm guessing, is fair game to be brought back in."

    Philip Bentley, a lawyer at Kramer, Levin, Naftalis & Frankel LLP, who defended investors sued in 2006 by lawyers representing the Bayou estate, said he expected the court-appointed trustee now in control of Madoff's U.S. operations to look hard at who withdrew money from Madoff.

    "The trustee is going to look very closely at redemptions and seriously consider bringing suits just because the trustee's job is to bring in assets any way he can," Bentley said. "Potentially the numbers are enormous."(snip)

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    Default Re: Brief history of derivatives

    Some thoughts on derivatives:

    1) As originally conceived they were used as 'hedges' against movements in commodities. For example, when I was working in metal production and due to deliver and order in 3 to 6 months time, I could hedge my raw materials (typically copper or nickel) against changes in metal prices over that time period.

    In effect this hedge was an insurance policy that cost me about 1.5% of the cost of the raw materials. As raw materials could go up or down by well over that amount in that time period it was a sensible way to operate.

    There was no risk to either party and the only profit came from the 1.5% charge - a sensible way of working that the metals industry (and others) have been using for many years without problems.

    2) The problems came when financial institutions came to see there was money to be made in speculating in instead of manufacturing metals. So they started paper trades on the metal exchanges. These were in effect bets and there were definitely winners and losers. If the speculator got it right, they made of lot of money, and if they got it wrong they lost a lot of money.

    Some traders made a lot of money and (in general) they were gambling with the bank's money. It allowed them to take far more risks than if they were using their own. And the banks were not adverse to the risks - if the traders got it right, the profits were far higher than boring old conventional banking. So the banks lost their way and got lost in the exciting world of speculation.

    (I would also have to say from a manufacturing point of view all speculation does is distort the price of metals in the market - it does nothing to add value to the sector).

    3) My understanding of derivatives is that they are a zero sum game. That is to say, for every winner there is a loser.

    When hedging metals, the winners exactly balanced the losers, and the only profit made was the commission on the hedge, Sensible, low profit business.

    Banks soon worked out that if you didn't balance the trade, there was far more profit, but far more risk. So they dreamed up ever more exotic (and risky) derivatives in the pursuit of profit.

    Where derivatives became more complex, it also became more difficult to value them - so even if the bet went wrong, they could still be held in the banks books at a notional profit (even though the real value could be zero). Not a problem in the good times, but as soon as the derivative had to be sold in the bad times, the real value became apparent.

    4) I wonder how many banker knew that they were wrongly valuing derivatives, but continued to do so in order to maintain their bonuses and the banks illusion of profitability.

    Looking at the banks declared losses in the last year, and their apparent profits over the last decade, I wonder how many banks were genuinely profitable and how many banks were just storing up losses and covering it up by mis-valuing derivative trades that had gone wrong. My moneys on a decade of covering up bad derivative trades.

    5) I would sincerely like to see an independent panel of academics retrospectively value past holdings of derivatives. If the difference was so far from reality as to have been obvious, then the responsible bankers should be tried for fraud.

    Phil.

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    Default Re: Brief history of derivatives

    Phil, good post. Leverage. Zero-sum game. Retrospective study. Good stuff.

    I wonder/if how the tricks that can be played with accrual accounting affected this too.
    I loved going to strip clubs; I actually made some friends there. Now things are different for the clubs and for me. As a result I am not as happy.

    Customers are not entitled to grope, disrespect, or rob strippers. This is their job, not their hobby, and they all need income. Clubs are not just some erotic show for guys to view while drinking.

    NOTE: anything I post here, outside of a direct quote, is my opinion only, which I am entitled to. Take it for what you estimate it is worth.

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    Default Re: Brief history of derivatives

    ^^^ Thanks, but this whole thing p*sses me off.

    I suspect every one in the game; banks, bankers, regulators, government knew we were ultimately heading for the edge of a cliff. They just shut their eyes and made as much short term gain for themselves out of it as possible.

    And now everyone else in 'real life' is going to hurt as well.

    Phil.

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    Default Re: Brief history of derivatives

    Yup, that's just what they did all right, or they were diverted by something else like evangelizing democracy in a part of the world that has little concept of it or regard for it.
    I loved going to strip clubs; I actually made some friends there. Now things are different for the clubs and for me. As a result I am not as happy.

    Customers are not entitled to grope, disrespect, or rob strippers. This is their job, not their hobby, and they all need income. Clubs are not just some erotic show for guys to view while drinking.

    NOTE: anything I post here, outside of a direct quote, is my opinion only, which I am entitled to. Take it for what you estimate it is worth.

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