Armageddon, Round Two?

In Financial Armageddon, I wrote about "four impending catastrophes": debt, government guarantees, the retirement system, and derivatives. But well before the first pages of my manuscript saw the light of day, I was particularly concerned about the latter aspect.

In fact, I'll let you in on a little secret: the article I published in November 2005, "The Coming Disaster in the Derivatives Market," was actually derived from material in my original book proposal, tentatively entitled FWMDs: Financial Weapons of Mass Destruction, after Warren Buffett's famous remarks on the subject in Berkshire Hathaway's 2002 annual report.

Eventually, the publisher and I decided that there was a bigger story there, which proved to be far more accurate than anybody (including me) realized at the time, and I set forth my vision of how the derivatives menace would come to interact with the various other threats I saw lurking in the shadows.

Yet even with all that has happened so far, it's hard to ignore the fact that the house of cards that was built on this labyrinthine mass of paper promises remains a serious threat to the financial system and the economy.

To be sure, I'm not the only one who feels this way. Even some of the better known financial experts are worried, as CNBC.com reveals in "Derivatives Could Cause Another Meltdown: Mobius":

Derivatives caused the market Armageddon of recent years and if left unchecked by global leaders, the same market could cause another catastrophe, Mark Mobius, executive chairman of Templeton Asset Management, told CNBC Monday.

When asked by a CNBC viewer what kind of Armageddon could be expected if the derivatives problem is not addressed, Mobius replied: “The same kind of Armageddon that we just had, what we just saw in the last few years has been caused by derivatives.”

The lack of liquidity, transparency, coupled with its sheer size means the derivatives market poses a major risk to financial stability, according to Mobius. The currency derivatives market is especially at risk of causing problems, but interest-rate derivatives also, he said.

Mobius thinks that global leaders meeting for the G20 summit in Pittsburgh next week should focus almost solely on the derivatives trade. Debates over how much bankers are paid in bonuses should be bumped down the agenda, he said.

The derivatives market is ten times the total GDP of the world, or $600 trillion, Mobius pointed out. And the market has been responsible for numerous bankruptcies in recent years as companies don’t know what they have on their books and don’t read the fine print, he said.

“The scary thing for me as an investor is what a company has in their books. One of the first questions we ask a company is: ‘What derivatives do you have?’ Because so many companies have gotten into deep trouble because of that. Why? Because there’s no transparency, there’s no liquidity,” Mobius said.

To read the rest of the article and watch the Mobius interview on CNBC, click here.

Comments

[Josecito Madera]

I wonder what will be the next domino to fall in the QUADRILLION DOLLAR DERIVATIVES world. Will it be another LTCM type entity we don't know about?

Since so many financial institutions have large segments of their broken balance sheets hidden in SPV's and other nebulous structures,

which one could it be and what, if any possible action, could the central bankers worldwide do?

[Alexandra]

Will the tightening of the money supply be next together with the ensuing deflation and associated wave of defaults?
At least the too-big-to-fail have been saved, set to own everyone else.
tNWO is here.

[The Real Deal]

Yes the derivative market is insanely large - "$600 trillion'. But derivative should not be in the G20 or any government agenda.

Because the derivative market, largely unregulated, is the gambling casino of the ultra rich and ultra money manager. They are the one who made it the $600 trillion monster. If it blows, melts, deconstructs, whatever, it's their problem. They got insanely rich from it, then so let it be if they got insanely destroyed by it.

Leave the government and the people out of it. But I have no problem if the government put a nuclear-proof wall around it just before detonation.