Posts Tagged ‘derivatives’

From Black Friday to Derivatives Saturday

November 28, 2015

Back in the crash of ’08, clueless underlings such as myself suddenly were made aware of a mysterious component of our financial system called “derivatives.”

What is a derivative? you may ask. Funny you should ask. I didn’t know either, and I still don’t. Although I have been trying to figure it out for seven years now, every time I think I know what a derivative is, I encounter acronymic terminology such as MBS, CDO, or SEC.

These slimmed-down nomenclatures should simplify things, but they do, in fact simplify nothing. Although everybody knows SEC stands for Southeastern Conference, which is the football conference where the best American football is played, and where my alma mater LSU exercises its right to excel in athletics, except when teams like Alabama or Florida are on the field.


But I digress. I was explaining to you what a derivative is and I mentioned some of the simplifying terminology.

For instance, as alluded to above: MBS.

Well some well-positioned bloggists of the worldwideweb identify an MBS as a Masters of Bullsh*t, which is attained through much blood sweat and tears and dedicated gamesmanship acquired at a venerable institution, such as Barnwell University or Cayman College. The MBS is attained through years and years of shoveling potentially useful data into HFT, which produces a yield from which its index is derived,  and lucrative assets which are then deposited into accounts on behalf of the bullish denizens of WallStreet. These rich deposits build up the notional value of our economy as a hole, thus enriching all of us, not only those who are forever horsing around on Wall Street, but also  you and me and all the folks on Main Street, Easy Street and Ventnor Avenue.

Somebody has to do it. I don’t mind doing my part, working with a shovel. Keeps me in shape.

Anyway, that’s not the MBS of which I spake. I’m talking about Mortgage Backed Securities. I think Uncle Freddie Mac and Aunt Fannie Mae gave these instruments as gifts back during the holidays of 2007, when life was oh simple then, before time had rewritten every line.

My understanding of a Mortgage Backed Security is that they’re something like an Arkansas RazorBack, which is probably why they didn’t work out so well for investors, although Arkansas is ranked third in the SEC west, behind Florida and–excuse my language–Ole Miss.

After that is my LSU Tigers, presently in fourth place of SEC west, but as always and forever will be, bound for greatness.

It’s quite complex to describe just how LSU could be in fourth place, because its position in the rankings is derived from the ratio of victories to losses, divided by the number of footballs passed beneath the legs of a center when he hikes the ball to the quarterback during any given play of the game.

Nevertheless, as I was saying before, a derivative is derived from the outcome, that is to say the, rear-end of a complex financial instrument.

Now I’m sure you’re wondering, as any serious investor is wondering, about the real question here, which is: how much is it worth?

One thing that my research has revealed, and one thing I can tell you with surety is this: The value of any particular derivative is derived from fluctuations in the value of the underlying asset.

Here’s an example: how much is my ticket to this season’s Sugar Bowl worth? Well, at this point it’s an open question, but let’s just say this: I’ll give you my ticket to the Sugar Bowl for your two tickets to the Orange Bowl.

Meanwhile, back at the ranch (Texas Aggies be forewarned), the guys who are shoveling out in the barn are asking what’s the real value of these derivatives. And as I explained before, you remember that the value of any particular derivative is derived from fluctuations in the value of the underlying ass-set. That should come out plain enough.

As for the collective value of all the derivatives, this figure is derived from its notional value, which is calculated based on the notion, as defined by the US Treasury, the Fed, the NYSE, and the AP sportswriters, that whatever goes around comes around, so therefore if the value of the aforesaid derivatives passes through enough piles of assets then when it comes out the other end nobody really knows what its worth, so that it can be revalued at the going rate.

This is unpredictable, of course, as the LTCM affair had indicated  back in the Glass-Steagall days, but it is bound to be worth, somehow somewhere when you least expect it, more than it was in January of 2009. So that’s progress, although the Progressives may not agree with me. I don’t pay much attention to all those freaks on the fringe anyway.

And you understand, of course, that all this has taken place after Cronkite passed from the scene.  Before that, it was pretty much everybody working together in America toward the same values and goals. But that was then and this is now. Derivatives happens.

I’m glad I could clear this up for you. As for the Sugar Bowl and the Orange Bowl,  may the best team win, as it frequently does, but sometimes not.


Glass Chimera


Through the kindling glass: Uncle Ben in ’08

November 22, 2015

History is fascinating when you get into it.

Today I’m remembering the fall of 2008–that perilous time when the financial crash was pummeling down all around us. The reason I’m remembering this is: I’m reading on kindle Ben Bernanke’s book Courage to Act:

So I’m remembering.

My day job during that time was working with students at a local elementary school. The workday began every morning at 8 a.m. I have vivid memories of sitting in my old Subaru wagon in the school parking lot each morning, catching the latest financial news before going inside to punch in. I’d be sitting in the car during the last ten minutes of the 7 o’clock hour while listening to Marketplace Morning on NPR.

Not that I had any real money or assets to work with, mind you, just a little nest-egg house that wife and I had just about paid for, and a little spare change we had after the three young’uns had finished college, etc. just like most folks our age.

But here’s why the memory of those news reports clings to my unfettered mind so tenaciously. Those fateful September days of seven years ago released megalithic destructive financial forces of mayhem and immense complexity that changed forever the economic world as we kno(e)w it.  Perilous WallStreet cluster-fuds suddenly opened a flood of financial and fiscal confusion unprecedented in the history of the world. The only thing that compares to it would be the crash of ’29, but of course that was then and this was now.

In Uncle Ben’s book, Courage to Act, through which he strives to shine a light of transparency into the workings of the Fed and its relationship to the financial powers that be, he explains, in chapter 12, the demise of one particular entity (the AIG insurance conglomerate) that fell during that month’s frantic rearrangement of dominoes. He describes the problem this way:

 “AIG FP’s risk was compounded by the difficulty in valuing its highly complex position, in part because the securities that the company was insuring were so complex and hard to value.”

This universal fragility about value (or sudden loss of value) of toxic assets would be something akin to a global computer-virus, but in the financial world. Nobody knew how, when, or where, the infection of overnight falling  asinine asset prices could obliterate the richness of previously fat portfolios. It was like Ebola on WallStreet.

During that third week of September of 2008, the bankruptcy of investment bank Lehman Bros, and then the unraveling of worldwide cluster-fudded AIG, damn near brought the whole house of WallStreet et al etc cards of down.

I guess US Treasurer Hank Paulson and a few other arm-twisting high-flyers later put the fear of dog into Congress and into whomever else was in charge of this country at the time, so that the gov-softened crash landing of worldwide money tranches wasn’t nearly as bad as when something like that happened in ’29 and the whole dam American economy fell apart.

As I told you before, I was just a detached observer at the time, September 15 2008, a regular guy with no skin in the game trying to figure out what the hell was going as I heard about events on the car radio.

Now reading Uncle Ben’s memoir, I see a little more clearly what was going on behind the scenes. I guess his transparency mission is being realized; at least it is on me.

I see the light. I think I understand. Fear, as Joni Mitchell once sang, is like a wilderland.

Fear is a big part of this whole things fall apart deal that we see in life sometimes.

In the case of the investment banks and Wall Street and all that derivative-induced shenanigans that came unwounded in fall of ’08, it was fear of losing value on a massive scale, fear of diminishing assets on a global scale, and hence fear of metastasizing money-loss on a megadential scale.

But hey, there are worse fears in life. . .fear of dying?

Speaking of death, we could say that old folks are generally closer to it than young ones. But the fear of death can be, I feel, softened somewhat by the sense that one has lived a fulfilling life, or maybe an adventurous life, or perhaps a prosperous life, whatever attribute of the good life floats your boat.

Here’s something Uncle Ben wrote in his memoir about the old-timers on Wall Street during that fateful fall of ’08:

“For Wall Street old-timers, the events of the (Lehman weekend) weekend would evoke some nostalgia. Two iconic Wall Street firms that had survived world wars and depressions, Lehman (Bros.) and Merrill (Lynch), had disappeared in a weekend. I felt no nostalgia at all. I knew that the risks the two firms had taken had endangered not only the companies but the global economy with unknowable consequences.”

Unknowable consequences. That’s what you get when a bunch of old (or young) wise guys play fast and loose with a world-class pile of other people’s money.

But hey, that was then and this is now; it could never happen again.

At least not the same way.


Glass Chimera

Trying to understand complicated stuff

October 6, 2012

Give me a good, old fashioned rest period any day.

That is to say: a dot, at the end of a sentence, so my overworked brain can rest before going on.

Just give me, please, a momentary neuron break so my cognitive brain cells can catch up to what my eyes are gathering.

For I am a tired, weary reader, among the huddled, online masses yearning to be free from confusion.

I have noticed, you see, a certain confusing tendency these days among bloggers, authors, journalists, commenters and other keyboard-tapping idea-flingers. This lamentable tendency is a neglect of periods. People nowadays whack out lengthy run-on phrases and clauses, strung together without the little dots that give us pause.  And yea, I say unto thee, sometimes they do it  even without commas!

This trend confuses me when I am reading and trying to understand messages that people have posted on the ubiquitous little backlit screens that you see everywhere.

It especially baffles me when I’m reading comments that are whacked out by opinionated internet denizens as they respond to the polarizing rhetoric of other internet denizens about the controversial issues of our day like politics religion and how much money should be printed and whether parents should be given choice for their children’s schools and how Congress should spend our tax money and whether Mitt’s comment about the 47% was appropriate and how the President does or does not use a telemprompter and the price of labor in China and the price of tea in Berkeley and the the price of education in Chicago and Milton Friedman’s influence and Paul Krugman’s dogma and and so forth and so on.

Rampant ideas, I say. Ideas are running rampant, without punctuation to separate, sharpen, and clarify them.

Yesterday I was reading a book, an actual, long, chapter by chapter  book, although not a printed one. It was my on my Kindle.

There  I was reading Sheila Bair’s excellent, very informative book, Bull by the Horns,  when, in chapter 9, I came across this sentence:

“But probably the biggest problem related to a fairly technical provision of bankruptcy law that gave all of Lehman’s derivative counterparties the right to cancel their contracts and liquidate any collateral Lehman had posted with them.”

This problem that Ms. Bair is describing is a troublesome one with which our bankers and lawyers were dealing, back in the fall of 2008.

And it is complicated, but I do think it is important that we citizens of this free republic understand the problem.

So I decided to demonstrate, using that sentence as an example, how multi-layered explanations can be made simpler, and thus easier to understand. The first principle is: write shorter sentences.

See if my  version isn’t a little a little easier to comprehend:

But probably the biggest problem related to a fairly technical provision of bankruptcy law. That provision gave to all of Lehman’s derivative counterparties the right to cancel their contracts, and to liquidate any collateral Lehman had posted with them.

Notice the period after the word law. This period helps me, the reader, for two reasons. One reason is that it gives my brain a little neuron break before engaging the next sentence, which is long, multi-layered, and laced with two-dollar words like derivative and counterparties. The second reason that the period helps me is: it clarifies the function of the verb related.

The inquisitive mind wants to know, you see, whether that word related  will prove to be the predicate of the sentence, or if it is being set up as a participle in a subordinate clause to modify the noun problem. However, my re-written version simplifies the reader’s dilemma by inserting a period, thus ending the sentence after the word law. This shortening effect enables the reader to solve his/her syntactical dilemma early on, instead of having the related question suspended all the way through such dense verbiage as derivatives, counter parties, contracts, collateral and so forth.

Another simplification I added to Ms. Bair’s original text was an insertion of the preposition to, in front of the phrase all of Lehman’s derivative counterparties. This identifies all (of Lehman’s derivative counterparties) as an indirect object instead of a direct object in the sentence. The counterparties are receiving something, that something being the right to cancel their contracts. And that right is more easily understand now as the direct object (whatever is being received) in the sentence. Furthermore, a second right that the counterparties receive is the right of liquidationSo my version inserts the preposition to a second times, rendering to liquidate.


I am not criticizing Sheila Bair’s writing style, nor her book, which I highly recommend. We citizens of a free, democratic republic should be informed about the problems that so easily inflict widespread financial cataclysm upon us.  Ms. Bair’s unique perspective as Director of Federal Deposit Insurance Corporation during the tumultuous years 2006-2011 is quite an eye-opener.

To further reinforce this last point, I leave you with this passage from Bull by the Horns, from the first page of Sheila’s chapter 9, which she named Bailing out the Boneheads:

“Lehman’s balance sheet was nontransparent to the market, primarily because of accounting rules that allowed Lehman to hold complex mortgage-related investments at valuations that bore no reality to their true worth.”

And therein lies the real problem of trying to understand complicated stuff.

Glass half-Full