Today we have seen the fourth largest investment bank in the world, Lehman Brothers files for bankruptcy. This follows Bear Stearns (who got bought for $2 p/share by JPMorgan) in March this year.
Bank of America pays US$50 billion (A$60 bn) for Merrill Lynch.
Also today, 10 Global banks had "pledged" to throw $US70 billion to help the credit squeeze. Drop in the ocean! I thought they would be more desprite then that...
What is a derivative?
Derivative are essentially bets. They are usually in the form of futures, forwards, options, and swaps. They are used to hedge risk, to speculate future events, and to provide (often significant) leverage to the investor.
There are scores and scores of different derivative products.
Impact of derivative so far:
The sub-prime mess was born through property derivatives. Bundled up mortgages, securitized and sold to foreign investors on the assumption property prices would continue to increase over time.
The US is now witnessing the first of the derivatives bubbles. The Property market bubble. In only 5 years US residential property debt grew from US$4 trillion to US$12 trillion. As discussed previously, Fannie Mae and Freddie Mac have now been bailed out by the US Government to try and hold the mortgage system together.
Derivatives compared to world GDP:
In 2007:
* World GDP is around US$53 trillion.
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)
* Total derivatives market is believed to hit a record in 2008 at over US$750 trillion!
Derivatives have exploded in recent years to be 15 times the size of the world economy. So for every $US dollar being created through goods and services, there are $15 dollars being gambled in the derivatives market!
The Big Three that will ultimately bring the down the world economy?
Remember these 3 banks.
As of March 2008:
* JP Morgan - US$90 Trillion in derivatives
* Bank of America - US$38 Trillion in derivatives
* Citigroup - US$38 Trillion in derivatives
These three banks alone are betting 3 to 4 times world GDP.
The top 25 US banks derivatives exposure is detailed in the table below.
Table 1: source: http://www.occ.treas.gov/ftp/release/2008-74a.pdf (p. 25)
As of 14 September 2008, JP Morgan had a stockmarket capitalisation of US$141 billion, yet according to the US Treasury, the company has potentially $480 billion dollars at stake from derivatives trading alone!
What about Derivatives exposure in the rest of the world?
The rest of the world is knee high in derivatives.
For an overview of the world situation (by currency, instrument etc) see the Bank of International Settlements website.
http://www.bis.org/statistics/derstats.htm
For further study on the Derivatives Bubble ahead I recommend seeing these two video clips as a starting point.
Ponder this last thought:
Two third's of banks in the US filed bankruptcy in the last Great Depression. Lehman Brothers was one of the few that survived this period and went on for 158 years until... today.
Study the past (monetary history) and you will see the future. We live in interesting times.
Cheers,
Scott
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