Monday, May 28, 2012

Derivatives: Wolf on Your Doorstep

Well, here we are. Just when you thought our banks were safe and your had good fuzzy feelings about your low mortgage interest rates going forward, a new danger lurks at your door.

No, not the fabled wolf from Little Red Riding Hood, although more on that analogy later, but the danger I warned about last year.

Derivatives on your house.

The world financial system is built on derivatives so large, that the numbers don't make sense anymore. The figure has been put at $1.5 Quadrillion, that is 1,500 Trillion dollars. Can you imagine that amount of money? I can't. But that's OK, because it doesn't exist. It exists on balance sheets all over the world as liabilities and assets, assets that have a book value now that are essentially meaningless. Therefore, if you begin to unwind these derivatives they will eventually unravel all the way back to something you can touch or feel. A commodity, or a business producing things.

Only those assets aren't worth $1500 quadrillion.

So now our lovely bankers in New Zealand, now that they have exhausted most other means of extracting money from us, are going to use your house as collateral for money they want to borrow. Borrow for what I hear you say? Perhaps to cover the losses coming from some of these derivatives they hold about to explode in Europe? Who knows.

Covered Bonds are what these dervatives are called and they are the financial systems latest attempt at thuggery. Here's what the banks do. They take your mortgage, which you rightly thought was held and owned by your bank, and bundle it up with other mortgages and use that wee bundle as collateral (backing) for loans they sell to anyone who will take them. Simply put, they sell your house to someone else.

I bet you didn't know that when you signed up for that lovely view of the sea.

And here's the rub. If the bank here defaults on these loans, your house goes to this new onwer who then likely has the ability to do anything he/she likes with it. Including raising that mortagge interest rate your thought was so good yesterday.

So the bank has created a derivative from the asset they hold. Your house. This derivative then gets thrust out into the wild woods with a wolf you probably can't trust. The worst that can happen? Your bank doesn't pay up, and the wolf has it's ugly way with your assets.


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Previous all-time high: $59.19
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