Just a note to explain a little more about the current instability.
The collapse of Dubai World is the immediate trigger to today's drop in the market, but the ripple effect well be much greater than suspicion about a the $60 Billion dollar "interest holiday" because the loan itself was a prime candidate for leveraged derivative creation.

(If you're unsure about the impact of derivatives, just consider that the actual amount of underlying value, can be traded up to credit default swaps that would be counted to a leveraged total from 100 times to possibly 1000 times. This means very little by itself, but add to the depth of the problem.)

The point to be made is that it is becoming increasingly difficult to smooth over large losses, because of the black box leverage.

Henry Liu has an ongoing narrative about the problem here:
Henry C.K. Liu on Derivatives
Here is an excerpt from the article that might point up some of the problems with leveraging that doesn't get into the news.

Quote
On September 28, 2009, the Office of the Comptroller of the Currency report on banks derivatives trading activities showed that the estimated value of all derivatives held by US commercial banks was rising, increasing nearly 1% over the last quarter and 12% year to year, to $203.5 trillion (total includes interest rate, FX, credit and other derivatives).

Bank holdings of credit default swap (CDS) contracts remain greatly elevated. Although down from their peak in the fourth quarter of 2008, banks hold more than five times the amount in such derivatives than at the end of 2004, when the US economy was taking off.
Banks exposure to derivatives, while falling slightly, remains alarmingly high. Bank of America’s total derivatives-related credit exposure relative to its capital was 137%; Citibank 209% and Goldman Sachs 921%.

Trading credit derivatives is once again highly profitable. After seeing huge losses on these instruments toward the end of 2008 and into first quarter of 2009, banks generated $1.9 billion in cash and derivative revenue in the second quarter of 2009. That is problematic because regulatory reform is still stuck in Congressional committees and subject to industry pressure not to spoil the party. As banks find it difficult to find credit worthy borrowers, they are using their fund to trade derivatives to drive profits. This asset new bubble built by Fed funny money, unlike the previous ones, does not even bother to create an illusion of prosperity, nor full employment.

Once again derivatives are being used not to hedge risk but to generate unsustainable trading profit. Soon it will be deja vue all over again. But first the world economy needs to recover from the current crisis which may not take hold until 2014. If history is any guide, around 2020 will be the time for the next global market collapse.

November 24, 2009


Hang on to your hat, Dorothy!