THE DEVIL IS IN THE DERIVATIVES
…he lurks in “shadow banking!”
Chapter 7 – Recognizing Deception
By
Dene McGriff
The Devil is in the derivatives – a $500 trillion time bomb that could destroy the world’s financial system, destroy your savings and retirement. This shadow banking system is unregulated and out of control. You have no idea how close we came to a disastrous unraveling last week.
As
much as I try to get away from the subject of the economy, events keep
overtaking us. First, I pondered the take over of the nation’s largest mortgage
lender,
Countrywide, by Bank of America,
as a result of the monstrous HOUSING CRASH! Then I considered the
Bear Stearns fall and
takeover by JPMorgan, Chase & Company, along with guarantees by the Federal
Reserve.
Then there was the quarterly loss by the huge Swiss Bank UBS of $19 Billion on top of the previous loss of $18 Billion and the Deutsche Bank loss of $4.9 Billion. And at the same time, Henry Paulson, the Secretary of Treasury, proposed a plan to make the Fed kind of a financial czar consolidating banking and securities agencies under their control, giving them subpoena and investigative authority. The Federal Reserve isn’t even a true governmental agency, but a private banking cartel! Talk about putting the fox in charge of the hen house!
What is going on here?
Why
was it necessary to bail out Bear Stearns? I began to read about the thousands
of
“counter party” agreements
and the fact that the Federal Reserve saved the banking system from total
collapse.
Ron Insana of CNBC says the
“counter party” risk with thousands of players is incalculable. According to
Michael Hewitt,
“The bailout of Bear was an obnoxious necessity in view of the fact that the firm was too interconnected as a Wall Street counterparty and prime broker to be permitted to fail. Its collapse would have placed many hedge funds and other financial firms at risk.” (John Maudlin's Outside the Box, 3/31/08)
What is going on here? I began to think “DERIVATIVES”!
All of these loans; all of these “investments”; all of this paper has been bundled into packages known as derivatives. It is traded back and forth between hundreds of hedge funds, investment houses and banks. Bear Stearns derivative exposure is $13.4 trillion which is equal to the entire GDP of the United States!!! No wonder this is so huge. If all of these loans (which will never be paid off) begin to unwind, it really will bring down the entire financial system.
A few years ago I wrote an article “Derivatives, Fascism and the Almighty Dollar” and at the time, the derivatives market was estimated to be about $248 trillion and JPMorgan Chase portion was amongst the largest at $43 trillion. We noted that Warren Buffett, the second richest man in the world, said that "Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." That exposure has now risen to over $800 trillion and Morgan’s exposure to $77 trillion. I also wrote an article on how the Federal Reserve works titled “Modern Alchemy: the Money Illusion”. It explains in simple terms how our money system works and how money is created in a fiat currency system. I would highly recommend Edward Griffin’s highly readable book titled “The Creature from Jeckyl Island.” It describes how the banking system uses debt to create more and more money.
So what is the problem?
Why are the banks short of money? Why did the Federal Reserve make $300 billion available to banks to solve their liquidity crisis so they will start to loan money again? The Federal Reserve realizes that if they don’t provide money, the banks won’t be able to meet their obligations and will fail. But it goes even deeper. A “shadow banking” system of derivatives has developed which is unregulated and unknown, but amounts to many times the GDP or money supply of the whole world.
What is a Derivative?
Today, we are faced with a far more sinister reality, and I will try my best to put this in plain terms anyone can understand. The financial institutions have developed a way to get around central banks and traditional currency and create an unlimited amount of money called derivatives. So what is a derivative? I’m going to use the definition from Investopedia:
“In finance, a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.
“Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.”
“Derivatives are generally used to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using American dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into euros.”
In
simple terms, derivatives are bundled debt: options, credit swaps, subprime
mortgages, prime mortgages, credit card debt, automobile debt, junk bonds, etc.
(See:
Hidden Derivatives Crisis)
This is debt that is often packaged and given a AAA rating, and sold and resold
multiple times. They are highly leveraged and may be purchased at a penny or
less on the dollar (See:
US Banks Are Giant Casinos). The only
problem is that, if you buy a million dollars in derivatives for a thousand
dollars and the debt isn’t paid, the purchaser of the derivative has to make
good the difference ($999,000). This is the stuff that makes up many
mutual funds, market fund, retirement fund, hedge fund, brokerage and mortgage
companies, etc. The mortgage on your house was probably bundled with other
mortgages and sold and resold a half dozen times and each time, the purchaser
was more leveraged than the last (meaning he put up less money). This is why
Warren Buffet, the richest man in the world, calls derivatives “financial
weapons of mass destruction.”
The problem is derivatives have provided unlimited amounts of money for financial markets leading to the stock, dot.com, housing and now the commodities bubbles – trillions of dollars of funny money sloshing around the world. Derivatives and money are both forms of debt. The Federal Reserve creates money out of debt.
“The entire function of this machine is to convert debt into money. It’s just that simple. First, the Fed takes all the government bonds which the public does not buy and writes a check to Congress in exchange for them. (It acquires other debt obligations as well, but government bonds comprise most of its inventory.) There is no money to back up this check. These fiat dollars are created on the spot for that purpose. By calling those bonds “reserves,” the Fed then uses them as the base for creating 9 additional dollars for every dollar created for the bonds themselves (Please See: US DOLLAR HEGEMONY: THE SOFT UNDERBELLY OF EMPIRE (AND WHAT CAN BE DONE TO USE IT!). The money created for the bonds is spent by the government, whereas the money created on top of those bonds is the source of all the bank loans made to the nation’s businesses and individuals. The result of this process is the same as creating money on a printing press, but the illusion is based on an accounting trick rather than a printing trick. The bottom line is that Congress and the banking cartel (a.k.a. the Federal Reserve, America’s Central Bank) have entered into a partnership in which the cartel has the privilege of collecting interest on money which it creates out of nothing, a perpetual override on money, a perpetual override on every American dollar that exists in the world. Congress, on the other hand, has access to unlimited funding without having to tell the voters their taxes are being raised through the process of inflation. If you understand this paragraph, you understand the Federal Reserve System.” (Griffin, The Creature from Jekyll Island, p. 193)
Who Owns the Federal Reserve?
Again,
let us explain in no uncertain terms the Wizard of Oz manipulating this
gargantuan monetary system:
“Chart 1 (please see at end of this article) reveals the linear connection between the Rothschilds and the Bank of England, and the London banking houses which ultimately control the Federal Reserve Banks through their stockholdings of bank stock and their subsidiary firms in New York. The two principal Rothschild representatives in New York, J. P. Morgan Co., and Kuhn, Loeb & Co. were the firms which set up the Jekyll Island Conference at which the Federal Reserve Act was drafted, who directed the subsequent successful campaign to have the plan enacted into law by Congress, and who purchased the controlling amounts of stock in the Federal Reserve Bank of New York in 1914. These firms had their principal officers appointed to the Federal Reserve Board of Governors and the Federal Advisory Council in 1914. In 1914 a few families (blood or business related) owning controlling stock in existing banks (such as in New York City) caused those banks to purchase controlling shares in the Federal Reserve regional banks. Examination of the charts and text in the House Banking Committee Staff Report of August, 1976 and the current stockholders list of the 12 regional Federal Reserve Banks show this same family control.” (Chart of Who Owns the Federal Reserve?)
But with derivatives, any financial institution creates money out of debt. The problem is that if the bank loans you $1,000 and uses the promise of being paid back the $1,000, plus interest, and loans again and again, the system breaks down if it can’t be paid back. So if a bank purchases $1 trillion in derivatives (debt to be paid back to third parties) for only one billion dollars, it has to pay it back if the paper is no good and the original debtors (e.g. sub prime mortgage holders) can’t pay.
Why Shadow Banking is Important
Why is this so serious? The entire GDP of the world is about $66 trillion (2007 estimate) and the derivative exposure is $516 trillion. There isn’t enough money in the world to fix this! This is shadow banking. Wall Street and investment houses around the world can now create far more money than all the central banks combined. Almost all debt is based on derivatives. Once it begins to unravel, banks will fail one after another. The graph to the right is several years old but shows the size of the exposure of major banks.
The Federal Reserves recent attempt to help banks is not a bail out. The $300 billion are short term loans that have to be paid back. The Fed is accepting mortgage backed securities as collateral (and we know what that’s worth). The Fed is loaning its own money. The question is does the Fed have enough to loan to bail these banks out? Can the banks pay it back? Or will the banks entangled in the “shadow banking” system begin to fail? Yesterday (April fools), the Dow rose nearly 400 points because the markets felt that with the disclosure of losses from the Swiss Banks that the banking and mortgage crisis were over and the recover had begun.
The Bank of International Settlements recently warned:
“The Bank for International Settlements, the world's most prestigious financial body, has warned that years of loose monetary policy have fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.
Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived, said the bank.
The BIS, the ultimate bank of central bankers, pointed to a confluence a worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.
Behind each set of concerns lurks the common factor of highly accommodating financial conditions. Tail events affecting the global economy might at some point have much higher costs than is commonly supposed, it said.”
Don’t Cry for Me Argentina
Money only has value if it is scarce. Remember, inflation is not rising prices, but rising money supply (printing more and more dollars). If inflation is running at 4 percent and money is loaned at 1 percent, why not borrow as much as possible? Why save? If dollars are losing value, better to spend them today when they buy more than tomorrow. I spent quite a bit of time in Argentina and the stories they tell about double digit inflation in a day are chilling. Savings were wiped out in a matter of months, including retirement and investments. Derivatives are probably the most creative way of fleecing the flock, stripping the middle class of their savings and putting it in the hands of the elites. For a while, you get rich – at least on paper. Your retirement, mutual fund or house rises in value on paper only to have it stripped out, leaving you with nothing.
The Domino Effect
Morgan
Chase, Bank of America and Citi Group are all so intertwined that if one failed,
they all would. The companies that have failed are not exactly small ones.
Countrywide was the largest
mortgage company in America and
Bear Stearns was one of the
largest, oldest and most prestigious investment banks. The
subprime mortgage loan crisis
exposed the weakness in the system and triggered the failures. In spite of all
of the efforts of the Fed and Congress to avert disaster, it remains to be seen
if they can.
According to a March 14 article in Financial Stocks we are about half way through the subprime debacle. But with the falling market, even Prime and Alta mortgages (Note: Upwards of 8,000 home foreclosures are occurring daily in America!) are at risk because borrowers now owe more than their properties are worth. There is still the issue of resetting ARMS or an owner having to sell to move to a new city for a job. There is also the pressure from lost jobs that amounts to millions in banking, real estate, construction, etc. Half the homes for sale in my area (Sacramento) are bank owned bringing more pressure on the market.
Meanwhile all the mortgage paper is sitting out there as little time bombs sitting in those packaged derivatives. People are squeezed because their salaries are not keeping up with the cost of living. Inflation is raging out of control, especially food and fuel – the two things they don’t count. People have nothing to save even if they want to. Credit cards are maxing out. Default rates are rising on credit cards and car loans, as well as home loans and mortgage based lines of credit. Once a spiral of debt default begins, it creates more unemployment, more home loss, more bank and business failures and the derivative dominoes begin to fall in rapid succession.
The government and cheer leader pundits on CNBC and Bloomberg will never admit it, but we have seen them be wrong time after time. They denied the dot.com problems. They denied a housing bubble even existed. They deny there is inflation (but we all know better). They tell us derivatives are good financial instruments that spread the risk. Now they tell us that everything is fine and we have hit bottom. I am sure some suffer sleepless nights as they wonder how giants such as Countrywide and Bear Stearns could have possibly failed.
I
hope you understand now that not only is our banking system flawed, but the
shadow banking system is even more flawed and the risks are beyond calculation.
In fact, one of the pundits,
Ron Insana, said this
afternoon on CNBC as I was writing this, that losses from Bear Stearns were so
big, they were “incalculable.” Hundreds of trillions of debt is coming due and
there isn’t enough money in the whole world to make it better.
God only knows what kind of global crisis this will precipitate or what kind of draconian measures government will take to fix it. Sorry, I don’t even want to think about it.
“AND THAT NO ONE MAY BUY OR SELL EXCEPT ONE WHO HAS THE MARK OR THE NAME OF THE BEAST, OR THE NUMBER OF HIS NAME” (Revelation 13:17).
Dene McGriff,
Sacramento, April 2, 2008
N.M. Rothschild , London - Bank of England
______________________________________
| |
| J. Henry Schroder
| Banking | Corp.
| |
Brown, Shipley - Morgan Grenfell - Lazard - |
& Company & Company Brothers |
| | | |
--------------------| -------| | |
| | | | | |
Alex Brown - Brown Bros. - Lord Mantagu - Morgan et Cie -- Lazard ---|
& Son | Harriman Norman | Paris Bros |
| | / | N.Y. |
| | | | | |
| Governor, Bank | J.P. Morgan Co -- Lazard ---|
| of England / N.Y. Morgan Freres |
| 1924-1938 / Guaranty Co. Paris |
| / Morgan Stanley Co. | /
| / | \Schroder Bank
| / | Hamburg/Berlin
| / Drexel & Company /
| / Philadelphia /
| / /
| / Lord Airlie
| / /
| / M. M. Warburg Chmn J. Henry Schroder
| | Hamburg --------- marr. Virginia F. Ryan
| | | grand-daughter of Otto
| | | Kahn of Kuhn Loeb Co.
| | |
| | |
Lehman Brothers N.Y -------------- Kuhn Loeb Co. N. Y.
| | --------------------------
µ
| | | |
8
| | | |
Lehman Brothers - Mont. Alabama Solomon Loeb Abraham Kuhn
| | __|______________________|_________
Lehman-Stern, New Orleans Jacob Schiff/Theresa Loeb Nina Loeb/Paul Warburg
------------------------- | | |
| | Mortimer Schiff James Paul Warburg
_____________|_______________/ |
| | | | |
Mayer Lehman | Emmanuel Lehman \
| | | \
Herbert Lehman Irving Lehman \
| | | \
Arthur Lehman \ Phillip Lehman John Schiff/Edith Brevoort Baker
/ | Present Chairman Lehman Bros
/ Robert Owen Lehman Kuhn Loeb - Granddaughter of
/ | George F. Baker
| / |
| / |
| / Lehman Bros Kuhn Loeb (1980)
| / |
| / Thomas Fortune Ryan
| | |
| | |
Federal Reserve Bank Of New York |
|||||||| |
______National City Bank N. Y. |
| | |
| National Bank of Commerce N.Y ---|
| | \
| Hanover National Bank N.Y. \
| | \
| Chase National Bank N.Y. \
| |
| |
Shareholders - National City Bank - N.Y. |
----------------------------------------- |
| /
James Stillman /
Elsie m. William Rockefeller /
Isabel m. Percy Rockefeller /
William Rockefeller Shareholders - National Bank of Commerce N. Y.
J. P. Morgan -----------------------------------------------
M.T. Pyne Equitable Life - J.P. Morgan
Percy Pyne Mutual Life - J.P. Morgan
J.W. Sterling H.P. Davison - J. P. Morgan
NY Trust/NY Edison Mary W. Harriman
Shearman & Sterling A.D. Jiullard - North British Merc. Insurance
| Jacob Schiff
| Thomas F. Ryan
| Paul Warburg
| Levi P. Morton - Guaranty Trust - J. P. Morgan
|
|
Shareholders - First National Bank of N.Y.
-------------------------------------------
J.P. Morgan
George F. Baker
George F. Baker Jr.
Edith Brevoort Baker
US Congress - 1946-64
|
|
|
|
|
Shareholders - Hanover National Bank N.Y.
------------------------------------------
James Stillman
William Rockefeller
|
|
|
|
|
Shareholders - Chase National Bank N.Y.
---------------------------------------
George F. Baker
Please see other charts and clarifications at WHO OWNS THE FEDERAL RESERVE?
NOTE: The above and additional charts are sourced from:
Federal Reserve Directors: A Study of Corporate and Banking Influence. Staff Report, Committee on Banking, Currency and Housing, House of Representatives, 94th Congress, 2nd Session, August 1976.