Last week the House passed HR4173 the Wall Street Reform and Consumer Protection Act. Forbes said this about the legislation:
The House bill does address the most important problems of regulating systemic risk and too-big-to-fail institutions directly–make no mistake about it. Guaranteeing the liabilities of major U.S. financial institutions distorts the allocation of capital and competition among financial intermediaries. The guarantee provides these firms with an unfair advantage, because they can raise capital at a lower cost. Since the guarantee is so valuable and pervasive, these giant intermediaries face little market discipline and have a perverse incentive to expand their scope, scale, risk exposure, leverage and financial interconnectedness. The result is a less-competitive and less-efficient financial system.
As Vegas Real Estate pointed out though when he sent us the following video, They failed to include derivatives: [Sorry, the embed wasn't working well.]
So just how big is the derivatives problem? Globally, about $1,144 trillion. This article uses some interesting figures for those of us who have a hard time wrapping our minds around that many zeroes:
1. The entire GDP of the US is about USD 14 trillion.
2. The entire US money supply is also about USD 15 trillion.
3. The GDP of the entire world is USD 50 trillion. USD 1,144 trillion is 22 times the GDP of the whole world.
4. The real estate of the entire world is valued at about USD 75 trillion.
5. The world stock and bond markets are valued at about USD 100 trillion.
6. The big banks alone own about USD 140 trillion in derivatives.
7. Bear Stearns had USD 13+ trillion in derivatives and went bankrupt in March. Freddie Mac, Fannie Mae, Lehman Brothers and AIG have all ‘collapsed’ because of complex securities and derivatives exposures in September.
8. The population of the whole planet is about 6 billion people. So the derivatives market alone represents about USD 190,000 per person on the planet.
Now granted, that’s the global total, not U.S. Geithner however gives the size of the U.S. OTC derivatives market as $605 Trillion. Isn’t that big enough to decide we shouldn’t ignore it?
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I’m just starting up under-construction transcript VI Echo for AEI’s month old event “Will There Be a Consumer Financial Protection Agency?”. Do you remember, from way back, OCC’s Julie Williams in Safety Net VIII (Sept 5, 2006)? She’s one of the speakers, and I’m looking forward to that.
There can be no doubt that the derivatives market will come under intense scrutiny and heavy regulation, neither of which will correct its inherent structural defects.
As Nassim Taleb observed, a credit default swap is like a passenger on the Titanic selling insurance on the Titanic. If the guarantor drowns who pays the policy holder?
If you guessed “the government” you are beginning to see the scope of the problem…