You might be interested in the following extract from "America's Suicidal Statecraft" which went into print in November 2006 and was actually written some months earlier. At that time, the "bankers" - which includes the formal and less formal banks - were still in the midst of the Ponzi mania. For them, the world was still wonderful and if any of them gave a thought to crashes of any kind, it was hard to catch any sign of it.
The extract reads:
The credit-derivatives concept is new, dating from about 1997 with the launch of a financial product called Bistro (Broad Index Secured Trust Offering). It caught on and spread like wildfire to the $12.4 trillion market today. In a world already gorged on massive credit, Bistro and imitations of it allowed banks to expand their loans, sell the risk of default and so leave their reserves at the ready for more loans whose risk again could be sold on. Just how much expansion of credit the new derivatives have created which would never otherwise have existed, we do not know, but $12 trillion must have allowed a lot.
A worrying feature is that we do not know where the risk of these loans – made almost certainly on the basis of significantly reduced borrower quality – has now settled. Further innovations are already on the drawing board: derivatives of derivatives and “derivatives cubed”. One observer says that “the whole credit derivatives world has exploded at such a dizzy pace that nobody is exactly sure where the loan risk has gone. Have all the investors who have bought credit derivatives contracts checked the fine print to see what losses they could sustain? Does anybody understand the chain reaction that might be triggered by such losses? Could the world’s trading system cope? And what would happen to those hedge funds that have been jumping into the credit derivatives world?” 8
In July 2006, Gabriel Kolko put the credit-derivatives market much higher: “The credit derivative market was almost nonexistent in 2001, grew fairly slowly until 2004 and then went into the stratosphere, reaching $17.3 trillion by the end of 2005.” He then put the question, “What are credit derivatives?” and answered it by saying that “The Financial Times' chief capital markets writer, Gillian Tett, tried to find out, but failed. About ten years ago some J.P. Morgan bankers were in Boca Raton, Florida, drinking, throwing each other into the swimming pool, and the like, and they came up with a notion of a new financial instrument that was too complex to be easily copied (financial ideas cannot be copyrighted) and which was sure to make them money. But Tett was highly critical of its potential for causing a chain reaction of losses that will engulf the hedge funds that have leaped into this market… Nominally insurance against defaults, [credit derivatives] encourage far greater gambles and credit expansion. Enron used them extensively, and it was one secret of their success, and eventual bankruptcy with $100 billion in losses. They are not monitored in any real sense, and two experts called them ‘maddeningly opaque.’ Many of these innovative financial products, according to one finance director, ‘exist in cyberspace’ only and often are simply tax dodges for the ultra-rich. It is for reasons such as these, and yet others such as split capital trusts, collateralized debt obligations, and market credit default swaps that are even more opaque, that the IMF and financial authorities are so worried.”
One of the interesting and, again, highly disturbing features of credit derivatives is that their trading processes tend to be primitive. Deals seem to be recorded with pen and paper – and one imagines on cramped and overwritten shirt-cuffs – while hedge funds and banks scramble to improve their credit-derivatives trading systems by spending hundreds of millions of dollars in aggregate on suitable information technology. As reported by the London Financial Times on 16 August 2006, “Credit derivatives are tools that let investors place bets on whether bonds or loans will default. The industry is estimated to have $17,000bn of total outstanding contracts…and the sector has doubled in size every year since 2002. This growth has taken institutions by surprise and forced them to handle deals with small levels of support staff. A recent survey from the International Swaps and Derivatives Association showed that one in five credit derivatives trades by large dealers in 2005 contained mistakes and many suffered settlement delays.”
All of this sharpens the picture of a financial industry in the dollar size of its deals as big as or bigger than anything in financial history, being conducted by unmonitored institutions and dealers, with staffs that are largely inexperienced and, as the Financial Times puts it, with “sloppy back-office procedures [that] could cause serious damage.” The financial magnitudes they handle are indeed so great that they could, it seems, precipitate a global crash of unprecedented proportions; yet they are being run with some of their procedures apparently comparable with those of a church-fête bingo game.
James Cumes
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