“What do you think of the economy and have we seen the worst?” I am always asked, as perhaps you are as well, despite the fact that neither of us work at the Federal Reserve or are economists.
That said, “No!,” I answer loudly. It’s because I think we are looking at a potential financial Armageddon that would make the worldwide depression in the 1930s look like a boom period in global history. And remember what followed that–fascism and all the war and global communism.
It is very possible that we are on the way down the chute globally, if the most secret of financial instruments known as “CDOs” blow up on us all. What is a “CDO”?
It is a Collateralized Debt Obligation; also know as a “derivative,” a seemingly innocuous financial arrangement wherein one or multiple organizations trade risk. If you still don’t get it, they go by another name that explains what they are quite clearly – “Credit Default Swaps.” Feel better now that you understand? You shouldn’t! You should have a bad case of the willies. Credit Default Swaps are like insurance contracts that promise to cover losses on certain securities in the event of a default. The buyer pays premiums to have their potential losses covered. But here’s the thing…
The CDO market is not only non-regulated, it is vast. By mid-2007, according to the International Swaps and Derivatives Association it is more than $45 trillion. Yes, I said trillion. That is twice the size of the US stock market!
“How big, again“, you ask? Well, let’s see. The mortgage market is estimated to be $7.1 trillion and the U.S. Treasuries market is a mere $4.4 trillion. So who are the players? Well, roughly 25 top global banks are the most active in the market, holding more than $13 trillion in Credit Default Swaps. The truth is that nobody even knows how big it truly is because it is totally non-regulated, and inter-institutional in nature. The web of transactional relationships is an untangled web, unknowable like the Internet itself.
A good general rule of thumb is that if you ever meet a financial type who condescendingly says “well, CDO’s and derivatives are quite simple really,” run! You are talking to a suicide bomber!
Want some more bad news? Credit Default Swaps have no standard contracts, no standard capital requirements and no standard way to value the underlying securities. And like really bad credit arrangements, many of these CDS/CDOs are leveraged at 30 to 100 times their value. What’s worse, a CDS/CDO gets traded 20 to 20 times so nobody holding the CDS/CDO knows the whole chain of risk exposure that have purchased. It is a financial combination of a “Secret Santa” game mixed in with “Musical Chairs” played large on a global scale. Actually, it is a simple betting game with hedge funds, speculative investors and others doing the betting and buying these things as CDS/CDOs.
How could it all unravel? A financial institution could have a write-down of $11 billion like American International Group did in the spring of 2008 along with several other institution, due to poor credit policy and it’s off to the races. Look at Wachovia’s drop in value over the last year. And remember, a relatively few players make these global market so the bomb would go off in a relatively small room devasting alot of people all at once. Remember the Bear Stearns crisis in the spring of 2008? It would be like that on steroids.
How bad? I would give you a number but nobody knows what it is. A large bank or set of banks could have bad write-offs to more mortgage write-downs, major credit card debt, as credit cards were given out like candy during this entire decade, or other major credit shortage events related to oil speculation.
What can you do about it all? Nothing. Sit and wait to the shoe to drop. The Gods are Rolling in Heaven.A comet could hit and kill us all before then. If they had any brains, I would recommend that you write your congressperson, asking them to regulate the market but they only react when things melt down.
So start a garden. Homestead your home. Get a shotgun. Get used to coffee and donuts. Learn to hunt rabbits and develop a taste for cabbage and squirrel pie. And pray and hope that I am very wrong about this. Eating humble pie will be better than squirrel.
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