Entering into the dangerous zone: World Wealth vs World Derivatives (Above)
The financial reform bill will be coming this week.
The size of the derivative market goes over $6 trillion. Trillions in dollars. The mechanisms of the financial products are deliberately confusing. There are some obvious unethical deals however, such as credit default swap (CDS), betting the money on other's liabilities. It means, when the company nears bankrupt, the debtor's assets soar, making it difficult to assess the balance.
CDS can be depicted as follows: the company have $100 assets and you agree to pay $10 in case of bankruptcy, which could happen at the rate of around 10%. You would sell it at $1 at this point. When the company nears bankruptcy, funny thing happens. When the bankruptcy rate goes up to 20%, then the value will go up to $2.
The lucrative over the counter deals of CDS's, and that of AIG's went without public scrutiny, one of the main causes of the financial crisis, resulting in AIG's $180 billion bailout. Overall, the banks received $700 billion bailouts. The derivatives are expected to be regulated ("Standardized swaps and derivatives would have to be traded on exchanges or clearinghouses."). The tricky part is that some companies that use derivatives to hedge commercial risk would be exempt [*]. Indeed Presdient Obama said he would veto the Wall Street Reform bill if it does not include string restrictions on derivatives. He also said that the minority leader had meetings with the Wall Street executives.
Among the measures in the reform bill that passed the Senate Banking Committee on March 22 contains some measures for the shareholders to have a say on executive pay and nominate directors. Without regulation of any sort, things go wild as the CEO's bonuses. Their pays depends on the money they make in the market -- naturally they dare to risk more, making the market riskier for the companies' and customers' money. Nine banks paid out bonuses of $32.6 billion in 2008 ("Bank Bonus Tab: $33 Billion").
According to the bill that passed the Senate Banking Committee, a $50 billion fund will be created for any liquidation. The finance reform bill that the House passed last year would create up to $150 billion. The both parties are negotiating for this liquidation fund, while the fund is meant to protect tax payers' money for bank bailouts.