Read the following except from The NYT:
"George Soros, the prominent financier, avoids using the financial contracts known as derivatives 'because we don't really understand how they work.' Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential 'hydrogen bombs.'
And Warren E. Buffett presciently observed five years ago that derivatives were 'financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.'
"One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives - exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. "
For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. 'What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so,' Mr. Greenspan told the Senate Banking Committee in 2003. 'We think it would be a mistake' to more deeply regulate the contracts, he added.
"The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.
"If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, many economists say, the current crisis might have been averted or muted."
With a $531 trillion derivatives value, a mere 10% of them turn bad will be enough to turn all of us back to the stone age, that's why Buffet call derivatives market the " financial weapon of mass destruction's". No body really knows how and by what means those derivatives are slice, dice and being sold ultimately to mutual funds, municipals and investors. Besides turning bad the cost of unwinding those derivatives positions will takes months if not years to determine who own what and the amount of loses that carries with it. The unwinding of all these derivatives position will definitely bring us nearer to Financial Armageddon because there are so huge and intertwined across the globes, no nations will be spared from it's effects.
G7 finance ministers will have to deal with these issues above head on if they are serious in solving the current credit crisis. Any effort to undermine or sweep under the carpet the above problem will prolong the problems itself, it's unenviable position definitely, in one hand you strife to stabilised the financial markets yet in reality these so called financial ingenuity call derivatives are hurting the bankers worldwide. No knows exactly how to have a painless unwinding. Even Soros doesn't knows how this derivatives works!
Any effort to bypass the long unwinding process will make many of the banks look like living zombies because without openly realising those loses cause by this toxic derivatives banks cannot function properly, bank solvency headache will be the issues. Ending up like right now whereby bank don't trust banks in short term lending facilities ( high Libor rates ).
"Clive Maund at clivemaund.com says, "Payback time for Wall St and Washington will be when foreign investors fail to turn up at the bond auctions to finance the bailout plan, whose $800+ billion will have to be created out of thin air. So the bonds will have to be monetized, which will mean an immediate spike in inflation, which will cause the rate of corporate bankruptcies to soar as failing companies take down others in a chain reaction because the losses will be highly leveraged by credit default swaps etc. This is the underlying reason why banks won't lend to each other - they can't calculate the counterparty risk. All of this will set off a massive derivatives meltdown that will bring the whole system crashing down"
No foreign investors turn up at the auctions to finance the bailout plan! In short nobody want to lent money to Uncle Sam anymore, Feds only had one methods left "create it from thin air".
Not surprisingly the G7 media conference offers little tangible efforts in solving above problems today, questions is, are how the G7 finance ministers going to solve the above problems is it by creating more debts? Creating another debts to cover another debts it's a problems by itself we will as good leave it to another day to discuss it. Whatever financial weapons available( reduce interest rates/pump liquidity into banks ) have been used by the world central banker yet the crisis of confidence and fears in the financial markets hardly subsides instead it went up a few notches!
Tim Wood at FinancialSense.com put it more succintly, who uses it to say "manipulation will ultimately not work" and that it will "make matters worse in the end. Yet, the Fed, the Treasury and the politicians continue to think that they can 'fix' the problem by throwing more money at it. They do not understand that they can't 'fix' this economic crisis. They also do not understand that it is their trying to 'fix' things in the past that has created the current situation."
Everybody knows this time the multi trillion financial markets mess is far bigger then any available rescue plans that the central bankers has. As been said earlier no one knows what to do currently, do you damn; don't do you also damn!
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