Letter Re: Drastic Changes in the Global Derivatives Market–Be Ready for the Mother of All Bailouts

Jim,
Scroll down this article to the link to the Quarterly Derivatives Fact Sheet. It shows Citi[Bank] exposed to $3 trillion and J.P. Morgan at $7.8 trillion [in OTC derivatives.]

Continue to the bottom of the piece for “Intelligence Czar Can Waive SEC Rules.” It looks like the Plunge Protection Team is operating in overdrive.

Eisenhower warned of “The military-industrial complex”. What about the corporate-government complex? This looks like something Il Duce would have been proud of.

Best wishes for our free enterprise system, – William

JWR Replies: I’m glad to see that some readers took the time to look through the soon-to-be defunct Economic Indicators page link that I provided earlier this month. The executive summary for the Q3 2007 Quarterly Derivatives Fact Sheet mentions “U.S. commercial banks generated $2.3 billion in revenues trading cash and derivative instruments in the third quarter of 2007, down 62% from the $6.2 billion reported in the second quarter. This decline is attributed largely to the difficult trading environment in credit markets.” That is putting it mildly!

In more recent months, the banking community has been fleeing the derivatives market like a bunch of scalded cats. Since August, the volume of new OTC derivatives has dropped by a whopping 97%. But the scary thought is that there are still trillions of dollars in banking derivative bets in play, with very risky CDS hedges still active in very large numbers. Many of these contracts will not expires for years. In essence, many of the outstanding derivatives were essentially “borrowing short and lending long.” Any time that there is a big swing in interest rates or credit expansion/contraction, such traders are at risk of getting murdered. Every derivative has party and a counterparty. If one party goes belly-up during the life of the contract, there is a huge naked exposure.

Yesterday, rumors been circulating that the Bank of America (BofA) and other bankers (including some from Switzerland) are very quietly courting the US congress, seeking a big bailout. Here it comes, folks! As I mentioned previously, BofA recently bailed out Countrywide, to the tune of $4 billion, partly with taxpayer dollars. (One reason cited was that Countrywide was on the hook to BofA for some huge derivative plays, and that by buying them out, BofA effectively became both party and counterparty which zeroed out that derivative paper.)

Now, it seems, BofA and the other banksters expects Mr. and Mrs. US Taxpayer to bail them all out of their exposure to subprime-backed bad paper! I have warned you, folks: Get ready for the mother of all bailouts. As I’ve said before, there are not nearly enough tax dollars or foreign investor dollars to bankroll these gargantuan bailout. It is very likely that the Federal Reserve will be forced to monetize this debt–effectively creating money out of thin air. This will be outrageously inflationary. Monetization is something that I mention when I wrote the opening chapter of my novel “Patriots: Surviving the Coming Collapse”, back in the winter of 1990. But I never anticipated Federal over-spending on this scale. If the bailouts take place the way that I predict, we are talking about many hundreds of billions of dollars–and possibly even trillions of dollars–by the time all of said and done. Warm up the helicopters, Ben!

Dear readers, I must warn you once again: Get out of any investments other than mining shares that are US dollar-denominated, and into tangibles, pronto! Got Ammo? Got grub?