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InvestmentOptions& Derivatives
» Normxxx - The biggest bubble of all The biggest bubble of all- derivatives Trading Soars to $370 Trillion-it will be the root cause for global depression [¹] Click here for link to complete article: http://www.indiadaily.com/editorial/1427...
An interesting data came out from the Bank for International Settlements. The global market for derivatives soared to a record $370 trillion in the first half of 2006. It is the highest ever and the bubble is bigger than any one can imagine. The kind of euphoria in derivative trading has never been seen before (no one ever actually has to close out a losing position- you can just double your bet and hang in there)! The amount of outstanding credit-default swaps contracts jumped by 60% at the end of last year. This year the rise is even faster. It is a typical pyramiding technique. Limitless credit is creating an illusion of limitless money, which is leaking (actually flooding) into the market for commercial transactions and producing a profound 'liquidity' problem. When the tide ceases to come in, and the balloon bursts, the catastrophe will be unimaginable. The 1929 debacle and resulting depression will be miniscule to what is coming.
Although derivatives were initially designed for hedging monetary assets. They have now entered the arena of trade. An example of what can happen is as follows. Recently Amaranth, the hedge fund, placed 'bets' on the wrong side of the natural gas market, lost billions in days, wiped out the capital of many investors, and went out of business. But something even more sinister happened in London credit swap market. On the news of Amaranth's problems, the value of the credit swaps based on Amaranth funds (many times the value of Amaranth's actual debts) immediately collapsed, creating massive problem for the London credit instuments markets. Even that 'little' hedge fund was able to bring the market to its knees. What will happen when a really large fund collapses, or many smaller hedge funds collapse at the same time? Remember 1987. Before the October crash, everyone was marveling about the fact that the stock market would not give an inch on the down side. Every investor was in the elevator at the Penthouse level. But when the crash finally came, the brokers simply abstained from answering their phones (they just left them off their hooks so no one would be the wiser), and the Dow lost 22% in one day. Something much more serious is building here. That one day wiped out stock markets around the world; but, surprise, hardly anything else was affected. The failure of the derivatives market will sweep all financial markets before it! The current complacency level, the sentiment bordering on euphoria, and above all the deteriorating fundamentals are all ready to put finis to this gargantuan market. Normxxx The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice. -- posted by Normxxx » Normxxx - What Now? Crosscurrents: What Now? [¹]
The Fed's half-point reduction in the Discount Rate on last Friday was foretold in recent days as the effective Fed Funds rate, achieved through various repurchase agreements, fell sharply from the targeted 5.25% rate just weeks ago, to as little as 4.54% last week. Despite concerns that the dollar might trade again to new lows, there was simply no denying that a panic was brewing. Last Friday's early morning 5% dive in Japan spooked the futures markets and a follow through in the U.S. appeared likely. A move down below last Thursday's lows would have had the potential to escalate into a full scale panic. We are in favor of the Fed's move and believe it removes a good deal of the uncertainty investors might harbor about the Bernanke regime's reluctance to act in the face of trouble. But the problem is not rates, it is still about derivatives and it is still about the hubris of academics who have built financial "models" that cannot possibly capture the vagaries of human behavior. Quant hubris will continue to catalyze similar mistakes. Most importantly, we do not believe this particular mistake has concluded. We called this fiasco months ago. Check out the April 2nd issue, page one, third column. Sigh.... Derivative Fiasco In Progress Ben Stein recently commented (http://tinyurl.com/yvo53m) that the "sub-prime mess" is nowhere near as bad as the media has made it out to be and he is right. What is at work is a derivative crisis. Folks are not walking away from their loans in droves. According to the Mortgage Banker's Association, delinquency rates as of June 14th were actually lower than the fourth quarter of 2006 and loans in the foreclosure process were only nine basis points higher. See http://tinyurl.com/ypn9yn for details. Although the numbers encompass all loans rather than just sub-prime, the sub-prime category is decidely small when considering the overall picture. As Stein relates, "....a little over 13 percent [of the total mortgage market]....is subprime.... Of this, nearly 14 percent is delinquent, meaning late in payment or in foreclosure. Of this amount, about 5 percent is actually in foreclosure." Moreover and most importantly, whatever problems have surfaced are clearly regional, and not [[yet: normxxx]] national in scope. The MBA article goes on to reveal that the real damage is confined to as few as seven states, a factor we claimed was the probable outcome over a year ago! MBA's Chief Economist Doug Duncan, said,
Most importantly, regarding sub-primes, the MBA article states,
So, what gives? It's all about derivatives. For too many hedge funds and institutions, bundled packages of mortgage securitizations have proved far too attractive and the lure of a few basis points of spread combined with ample [[insane amounts of?: normxxx]] leverage have proved tragic. The markets that trade such instruments were always relatively illiquid [[and potentially one step away from 'lock-up,' since no one seemed to know anything about the instruments they were trading: normxxx]]. All we ever needed was the smell of fear to catalyze a panic. As a result, the panic spread to other markets as well (see http://tinyurl.com/3x8xgr).
Incredibly, we now see the same ignorant attitudes and beliefs that propelled the markets into near fatal swoons in 1987 and 1998. We point to yet another fatally flawed academic view, that of "models" that consistently fail every few years despite mathematical formulae that predict they cannot fail. See Kaja Whitehouse's NY Times article (http://tinyurl.com/38du4s) for the pompous and amusing revelation of Matthew Rothman, a University of Chicago Ph.D. and quant manager who recently explained, "Events that models only predicted would happen once in 10,000 years happened every day for three days. We heard the same after the Crash of 1987. It was not supposed to happen. We heard the same after the collapse of LTCM took us to the brink of disaster. It was not supposed to happen. Mr. Rothman's admission should be sufficient proof that human behavior cannot be adequately "modeled." The current fiasco was not supposed to happen. The more financial markets rely on mathematical and academic "models" to predict human behavior, derivative events will occur closer together and the outcomes will be worse. THEY WILL HAPPEN.
Margin Of Error-- None Amazing as it may appear, margin debt again swelled in June to yet another new all time record high for the seventh consecutive month. The March 2000 record has now been eclipsed by 36%. Although there has been ample recognition that the prior peak was manic in nature, there is none that categorizes the current environment as manic. As always, only the rear view mirror works for most observers. However, we claimed repeatedly in recent months that then current margin levels clearly indicated a risk-taking mania was in progress. As our charts vividly illustrate, the combination of the historically low mutual fund cash-to-assets ratio and record margin debt can only mean there is even more risk present today than ever before.
Clearly, the last few weeks of stock market action would infer we have been prescient on this matter. Measured on a three-month percentage change basis, the rise of margin debt soared far past the 2000 episode, another indication that risk taking today exceeds that of the mania's peak. Interestingly, there seems to be very little recognition of the surge in leverage and the few comments we have seen downplay the stats as irrelevant versus total stock market capitalization. However, at the end of June, total margin debt was more than 2% of total market cap for only the second time in history, higher than in March 2000 and second only to 1929. That's a lot of relevance in our book. http://www.cross-currents.net/tac0822.gif Normxxx The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice. -- posted by Normxxx
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