Now for the real abyss into which our economies stare

[Banquo's Ghost]

Amongst the current panics and draining of trust, there looms an even bigger disaster. The derivatives market.

Derivatives (essentially a gambling scam) are in danger of revealing an enormous loss to the financial system that no one can really quantify (save that it is likely to be trillions) because these instruments are entirely unregulated.

I don't pretend to understand their workings myself, except to be very wary of anything that has no intrinsic value. I offer two articles that certainly frighten me, and I am beginning to revise my earlier assertion that the fundamentals, being strong, will see the West move out of recession reasonably soon. Unfortunately, it seems that fundamentals - being measurable and real - may be swamped by the tsunami of bad debt and financial panic generated by a derivatives failure.

Since markets are still in meltdown even after huge bail-outs, maybe there really is a good reason for panic - that the moneylenders know something we don't?

A £516 trillion derivatives 'time bomb'. The Independent

The complex and opaque derivatives markets in which these hedge funds played has been dubbed the world's biggest black hole because they operate outside of the grasp of governments, tax inspectors and regulators. They operate in a parallel, shadow world to the rest of the banking system. They are private contracts between two companies or institutions which can't be controlled or properly assessed. In themselves derivative contracts are not dangerous, but if one of them should go wrong – the bad 2 per cent as it's been called – then it is the domino effect which could be so enormous and scary.

Without real leadership, we face disaster. Will Hutton, The Guardian

While every bank tries to pass the toxic parcel on to somebody else, the system has to find the money. So will compensation for the near valueless contracts and thus now uninsured debt ultimately be made - and by whom? And because nobody knows - not the regulators, banks or governments - who owns the swaps and whether they are credit-worthy, nobody can answer the question. Maybe holders of insurance policies will get the cash due to them, but will that weaken somebody else? The result - panic.

This is the ultra-dangerous downward vortex in which the system is locked. It is why share prices are plummeting.

One faces Monday with some trepidation.

[gaelic cowboy]

I posted this allready in the Euro bank thread but it still holds true for this thread.

https://www.youtube.com/watch?v=hXBcmqwTV9s

This entire financial debacle is going to hump up everything for a decade at least until someone comes up with a new wheeze to magic away this problem and of course create a new one fo someone else.

[InsaneApache]

I wanted to say cheer up chaps but I fear this is just the beginning. I'm off to the bank in the morning to draw out my pension in full. Let's hope it's still there.

[Gregoshi]

My wife works for The Vanguard Group (2nd largest mutual fund company in the US) and the employees are pulling their hair out because they don't have $10,000 or $100,000 to invest in this down market. It is driving my wife crazy at the moment. Funny how perspective differs.

[Oleander Ardens]

@Gregoshi: True. The market can still go down even 20% or more, but there are great opportunites. Lucky is the one which has liquidated most of his stocks a year ago. Now it becomes time to feel like an oversexed guy in a whorehous, and get rich to quote Buffet.

The derivatives are actual excellent instrument to spread risk. Sadly the huge volume ot them (xxx trillions) and the large scale of "value-at-risk" have created something counterintuitive to classical financial theory. Usually vast liquidity and models able to capture risk up to certain point (95%) should flatten volatility and increase ability to forecast trends and also allow effective hedging. Sadly "the false sense of precisness" which is even featured in the textbook "Value-at-Risk" by Jorion, Philippe, Value at Risk: The New Benchmark for Managing Financial Risk, 3rd ed., McGraw-Hill, 2006, 600 pages. ISBN 0-071-46495-6. has allowed a great deal of investors all over the world, but especially on Wall Street to circumvent the limitations set by risk management and to huge levers to profit from small margins in many markets, but especially in the derivative one. Blind trust in precise number created by this models has blinded the management for risk in general. It is a bit like to navigate just with GPS - what happens if your expensive Garmin breaks down in the wilderness, and you just kept looking on its screen instead of studying the environment?

OA

[Louis VI the Fat]

Amateurs. The lot of you.

All my money's safely stored in art and wine.


So I don't even beging to sweat no matter how much the markets collapse.
Not, unless I shred my reproduction of 'Gypsy Boy with Tear' for cigarette paper and drink those two bottles of wine.

[Hosakawa Tito]

My wife works for The Vanguard Group (2nd largest mutual fund company in the US) and the employees are pulling their hair out because they don't have $10,000 or $100,000 to invest in this down market. It is driving my wife crazy at the moment. Funny how perspective differs.

I have a good portion of my deferred compensation account diversified in various Vanguard Funds. They have done well for me, historically, and I really like the low fees.

Definitely take note of successful investors like Warren Buffett and others who have been hoarding cash to buy into certain other-wise solid securities that have been beaten down in the current panic. Selling now only locks in your losses. Better to stay in if you're looking long term.

Hedge Funds and derivatives are way out of my league. That Voodoo is for high-roller investors with money to burn, I'm not the Herb you're looking for...

[Oleander Ardens]

I personally would invest part of your disposible money in an ETF tracking a large index like the DJ or the DAX, possibly even in a leveraged form. Usually what matters most is the timing of the buy and the timing of the sell. So you have a highly secure tool, easy to liquidate, very transparent and with low fees which will earn you money in the long term.

Buy single stocks with low P/E and a low cashflow per price. I'm more in European stocks so I don't know solid American ones, but get some which don't rely too much on the American consumer - he is suffering greatly.

If possible go also global - but there is a big exchange risk. I would do it only with a large capital.

I have build up quite a big pile of cash and have waited for such a market for over a year.

Be well
OA

[KukriKhan]

Yesterday's 9k point run up on the NYSE, was folks buying bargains, after Friday's fire-sale of pension plans selling off stock to move into Treasuries.

I work with about 100 people; Thursday, we all awaited our quarterly TSP statements, to see what might have happened to the "C" Fund (Common Stock). The statements got released Friday, and we all took a hit; all said we'd moved out of C into the safer G-Fund (Gov't Securities). If that pattern held through the country with Fed employees and the Military, and if other pension plans did similarly, that might explain the Friday dip and Monday spike - or part of it.

Of course, our politicians and bureaucrats say it's because 'the market' trusts 'the plan', which hasn't spent a dime so far, after telling us to hurry up and approve $700Mil, or we'd never retire and lose our house and car.