The entire value of all the money on earth is between $50 -$60 trillion dollars.

[kentuck]

So, how is it possible to have $600 trillion in derivatives? That is the estimate that we are told is in these derivatives. What does it mean?

[Orrex]

1. Donald Rumsfeld is giving the President his daily briefing...

[cliffordu]

2. lol

Do you REALLY have me on an ignore list???

what did I do??/

There's been so many. You're prolly just another one night stand....

[BlooInBloo]

3. Because there exist non-monetary assets, in a large variety of forms...

Cars, dvds, factories, contracts, derivatives.

No-one ever guaranteed that it was even theoretically possible to convert ALL assets into cash bills at the same time.

[kentuck]

4. Thanks Bloo..

for putting our cars and DVD into derivatives also. I was looking for a simple explanation. Thanks again.

[BlooInBloo]

6. Useful imagery to have in mind when thinking about large-scale changes is Neurath's proverbial boat:

"We are like sailors who on the open sea must reconstruct their ship but are never able to start afresh from the bottom. Where a beam is taken away a new one must at once be put there, and for this the rest of the ship is used as support. In this way, by using the old beams and driftwood the ship can be shaped entirely anew, but only by gradual reconstruction."


Converting small bits of all available assets into cash is straightforward. Doesn't mean you can do it *all* at the same time. :)

[kentuck]

8. That's a good explanation...

so why did we have to bail out these folks?? Why did they not just build another boat?

[BlooInBloo]

10. Because we were all on the fucking boat with them.

[kentuck]

11. Can we change the captain ..?

or something? Before it happens again? Or maybe get someone to walk the fucking plank?

[BlooInBloo]

12. Would that it were so easy. There's a reason why it's good to be the captain, after all. :)

But the new reform package looks pretty good and should help significantly, despite its not being perfect.

Here's a helpful non-technical article:

http://voices.washingtonpost.com/ezra-klein/2010/04/explaining_financial_regulatio_1.html

[kentuck]

13. This sounds like a con job?

"Experts I spoke to were split on this, with some saying it's a smart move to break apart the risky parts of banks from the commercial deposit divisions but more saying that it's unnecessary and likely to create a lot of disruption in a fragile economy."
=========

So experts disagree. But if I had to choose one, it would be the first, the former. Break apart these parts of the banks that create nothing and suffer the disruption. After all, nothing from nothing eventually leaves nothing. The assets in the commercial banking system would be the same. And they would be protected by the FDIC. I cannot see the wisdom in letting this present system continue.

[BlooInBloo]

14. I'm sure conjobbing is involved to some degree, but there's a lot involved...

I tend to agree with you, though. We've tried it the "don't rock the boat" way; let's try it the other way this time.

[kentuck]

15. Yep. What is the definition of "insanity"?

Doing the same thing over and over and expecting different results? Seems like we might be headed down that same road again, if big changes aren't made?

[BlooInBloo]

16. Meh. Now I suspect you're just running down the road of "nothing's enough!".

Have fun.

[kentuck]

17. Actually...

I'm looking for one person that makes sense on this subject. Or we can put our faith in God...or someone else?

BOHICA ! Bend Over, Here It Comes Again!

[BlooInBloo]

19. Just because one of two alternatives is better doesn't mean the second is *bad*.

But like I said - have a good time.

[kentuck]

20. No need to get all twisted up about it.

Light up a bowl, man. :-)

[anigbrowl]

5. here's a brief explanation...

(copied from thing I wrote on another thread)
...when you hear they amount to more than the GDP of the world, are that a) a great many of these derivatives extend far off into the future; they are contracts about stuff that may happen in the future, but don't represent claims that can be called in in the present; and b) a great many of those contracts either cancel out or will never be payable and are thus void.

If you think of a derivative as being like a bet, imagine you called your bookmaker and said 'I want to bet $100 that UFOs will land on the White House lawn and conduct a bake sale between now and December 31 2012.' your bookmaker laughs and says 'sure buddy, I'll give you a million to one - if it happens, I'll pay you $100m.'

Well now the bookmaker's outstanding exposure is $100,000,000 (plus whatever other bets he has open) but the chances are that he will never have to actually pay this. Of course, if you worked closely with the President or the Joint Chiefs, he might not be so willing to take this bet, in case you knew something he didn't.

There are many derivatives that work the same way. I really don't expect the price of oil to hit $400 within the next decade...but there's a very slim chance it could. So I could insure against that possibility by taking out an option that would pay out of the price of oil actually went up that high, and I can get that option for very little money because the chance of it paying out is considered quite remote.

On the other hand, if I feared the price of oil would increase by 1% and my business was operating on razor-thin margins, then the option would cost me a bit more because a 1% price change is not very unusual.

So when you hear about 'trillions of dollars in outstanding derivatives', don't think of them as bills which have to be paid, but more like lottery tickets - some of which have a very big chance of becoming payable, and some of which have very little chance. the outstanding amount is what would be payable if every single one of those lottery tickets paid off at the same time, but that could never actually occur (because bets that something will not happen and bets that it will cannot both be correct).
...


To expand on this, imagine a bet on a horse race (the horses are an analogy to different companies, or the prices of different commodities - don't over think it :-) ).

There are 5 horses, with different odds:

A: 3-1
B: 2-1
C: 5-1
D: 4-1
E: 8-1

OK, imagine 50 people place bets, and just by chance they all bet $1, with 10 people betting on each horse so the total liability of the bookmaker is $80 (the maximum payout if E wins), and his actual exposure is $30 (because he took in $50 in bets); more likely A or B will win and the bookmaker will payout $30 or $20, and keep the rest as profit. Every race he keeps some of the profit and sets some aside in case of needing to pay out on the long shot (or if he can't cover that, he places a bet with another bookie).

But the total of all the possible payouts written down on the 50 betting slips is $220 ($30 + $20 + $50 + $40 + $80). So that's 4.4 times more than the total amount of money put down, and 2.75 times more than the largest amount the bookmaker might possibly need to pay. As soon as the race is finished, 10 people will go back to collect their winnings and the other 40 people will tear up their betting slips, which are now worthless.

So the $220 would be referred to as the nominal value of all the outstanding betting contracts before the race, but this sum will never actually have to be paid out - not even close.

Here's a more technical explanation, which is fairly up to date and also discusses some of the risk factors: http://www.ennisknupp.com/Portals/0/whitepapers/Introduction%20to%20Fixed%20Income%20Derivatives.pdf

[kentuck]

7. So derivatives are nothing but a gamble...

If I lose, I can get the taxpayers to bail me out??

[anigbrowl]

22. No. I am using that metaphor to make it simpler to understand

It resembles a gamble, but differs in a few fundamental respects. A pure gamble is based on a random outcome - a coin flip, a card deal, a number on a roulette wheel. there is no inherent value to the random outcome, and no cost in testing it. further, the size of the gamble has no effect on the outcome, which remains random (at least, as long as everyone is honest).

Now in derivatives, a good few people are in that market just to make money (duh). But what they are 'betting' on are based on actual prices for specific things, such as barrels of oils or ownership (stock) in a company or title in a piece of real estate. And the derivative contracts aren't just taken out for speculative reasons (although they can be *). Many people have an interest in buying the underlying commodities/stock/whatever - for the needs of their business, their retirement fund (or the one they manage for other people), or because they want to build something on land, etc. etc..

But they don't know in advance exactly how much they will need, or they might not be sure if all aspects of their overall plan will work out before making a big investment. In that case, it would be unwise to tie up all that cash only to find they made the wrong call later on - plus they would have lost the interest they could have earned. Also, the price might look OK now but might change a lot later - again, uncertainty. Plus, you might not even have the cash on hand now - you have to earn it first but again the price could change during that time. So derivatives are a tool that a business or investor can use to keep their options open, or insure against big price changes in the future. In that respect, trading in derivatives can be an important part of a responsible investing strategy.

For example, say you are the CFO of Home Depot (note, I have no idea what their actual strategy is, this is a fictional example). Now, when the economy is good people are usually trading up to larger houses every 10 years or so as they make money money or have more kids. And Home Depot makes $$$ as people buy paint, drywall and all the stuff you use to fix up a house before they sell it or after they buy it.

Cool - but what if the economy changes, which is something Home Depot can't control? Suppose the country goes through a bad patch, and there's a big fall in home sales, then the Home Depot will lose money because they can't sell as much stuff. They could just shut down and sell off stores when that happens, but that's a very wasteful approach, and their competitors might gain a permanent advantage over them.

So if you are looking after Home Depot's assets, it might be wise to invest a small bit of cash in a mortgage derivative (like a CDO swap): if the economy falls and the value of mortgage bonds sink, the CDO swap pays off, and Home Depot gets extra cash to offset their reduced sales income, stores stay open, employees keep their jobs, and price stay affordable because there's still competition in the DIY market. When the economy improves, Home Depot will be able to compete as well (or maybe better) than before the recession.

* speculation (just being in a market for a buck) by itself, is not a bad thing as long as everyone is being honest. Why? because cash in a market is what keeps it liquid. If there's no speculators then there's not much cash in the market and it's hard for people to close deals with each other because not everyone wants to buy at the same time as someone else wants to sell, or vice versa.

[Tierra_y_Libertad]

9. Another explanation.

[keep_it_real]

18. derivatives are paper bets until someone loses the bet.

[theothersnippywshrub]

21. The $50 to $60 trillion is the "notional" value.

A derivative is a financial instrument that derives its value from another asset. The notional value is the price of the underlying asset times the number of units of that asset. There are always two parties to a derivative and most derivatives are a zero sum game so the notional values of a derivative usually zero out.

For example, say you buy an option from your broker to purchase 100 shares of XYZ stock at the current price of $10 per share. Your option derives its value from the price of the stock and therefore is a derivative with a notional value of $1,000. Your broker's obligation to sell you the stock if you exercise your option also is a derivative which has a notional value of $1,000. So the total notional value of these derivatives is $2,000. But there is not $2,000 of risk or money involved. If the stock goes to $11 and you exercise your option you will have a gain of $100 and your broker may or may not have a loss depending on the price he paid to acquire the stock. However, the broker will have a paper loss of $100, which zeroes out your gain.

The most common form of a derivative is a home owners insurance policy. A home owners insurance policy derives its value from the value of the home (usually either the purchase price or the replacement value.)