Russian Roulette: Put one bullet in the cylinder of a revolver, spin the cylinder, point the gun at YOUR head, and pull the trigger. Most revolvers have 6 chambers, so your odds of surviving are 5 in 6, IF you quit after pulling the trigger once.

Press your luck, spin the cylinder, point the gun, and pull the trigger again. It might be okay. Try for a third time?

Now play Russian Roulette – Derivative Style

Note: I have no insider knowledge regarding derivatives, so I am merely speculating. But I think we can assume the following:

Total face value of unregulated derivative contracts is something around 1,000 Trillion dollars – depending on who is counting and who is lying.
Banks (Goldman, JP Morgan, Deutsche Bank, etc.) sell these contracts because they generate huge commissions and probably other long-term profits.
Wall Street banks poured mega-bucks into DC lobbyists to keep the derivative game running with minimal regulation and oversight. Obscene profits, not the public good, are the reason.
Except for commissions upfront, derivatives are supposedly a zero sum game. I win, you lose, and the bank gets a fee. It sounds like a bookie in Las Vegas. You put up $1.1 Billion to win $1.0 Billion. Somebody wins, somebody loses, and the casinos (derivative banks) take the $100 Million as a fee – roughly 5% of every dollar bet on either side.
Let’s be trusting and assume the derivative banks only take 1%, not 5%. If the notional value of derivative contracts is $1,000 Trillion and the fee is only 1%, the cumulative take for the banks writing contracts was $10 Trillion. That is a lot of CEO bonuses.
Even if the commission was one-tenth of a percent, the take was $1 Trillion in fees.
Eventually the system must fail, as commissions and fees suck capital out of the system each time a contract is written. More leverage and more indebtedness will not improve an unsustainable system.
But fees are collected as contracts are written, bonuses are paid, and taxpayers (via bail-outs) or depositors (via bail-ins) might have to cover the losses. Remember TARP and the Cyprus bail-ins!

Another Trigger Pull!

Nothing goes wrong – no crash, no bank failures, no government default. This is unlikely and more so each day.
Banks continue writing derivative contracts because… they can and why would they stop? Let’s guess another $1,000 Trillion each decade in new contracts.
Banks collect a commission that generates perhaps $1 Trillion or more in fees; this is $1 Trillion (or maybe much more) sucked out of the financial system each decade – and it produced nothing. It reminds me of the phrase, “the rich get richer, and the poor get poorer.”

Implications

In ideal circumstances, there is no crash, no bank failures, and all debts get paid.
But derivatives suck a huge amount of capital out of the global economies each year, and that makes ideal circumstances increasingly difficult to maintain. Instead of paying banker bonuses, that capital could be used for constructive projects.
The financial system is unlikely to continue operating under ideal circumstances. When another 2008 crisis arrives, the supposed zero sum game, less commissions of course, becomes a black hole of daisy-chained obligations that might collapse the American, European, and Asian financial systems. It has happened before.
The resulting financial and social chaos will not be pretty!

Got gold? Own silver? They are financial insurance, unless you trust that Wall Street will take care of your needs.

GE Christenson aka Deviant Investor If you would like to be updated on new blog posts, please subscribe to my RSS Feed or e-mail

© 2014 Copyright Deviant Investor - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Only logged in users are allowed to post comments. Register/ Log in

The Market Oracle is a FREE Financial Markets Forecasting & Analysis web-site.
(c) 2005-2024 MarketOracle.co.uk (Market Oracle Ltd) - Market Oracle Ltd asserts copyright on all articles authored by our editorial team and all comments posted. Any and all information provided within the web-site, is for general information purposes only and Market Oracle Ltd do not warrant the accuracy, timeliness or suitability of any information provided on this site. nor is or shall be deemed to constitute, financial or any other advice or recommendation by us. and are also not meant to be investment advice or solicitation or recommendation to establish market positions. We do not give investment advice and our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to enter into a market position either stock, option, futures contract, bonds, commodity or any other financial instrument at any time. We recommend that independent professional advice is obtained before you make any investment or trading decisions. By using this site you agree to this sites Terms of Use. From time to time we promote or endorse certain products / services that we believe are worthy of your time and attention. In return for that endorsement and only in the cases where you purchase directly though us may we be compensated by the producers of those products.