"I'll see your options and raise you two derivatives."

I rarely start threads, but after I posted this as a reply in the Stock Market Watch thread over in LBN this morning, some SMWers suggested I post it over here to get more exposure.

Disclaimer: I'm not an economist, have never taken an economics course or finance or anything else. Except for a very small 401k account, I have no investments, never have had. So all this stuff dealing with 'derivatives' and 'CDOs' and so on is just so much Finnish to me. (I took a semester of classical Greek in college, so I can't say it's Greek to me.) Therefore, I posed a question that's been bugging me since about the time a certain energy trading company went suddenly bankrupt something over six years ago . . . . .



Do these 'derivatives' -- which word seems to resonate with 'Enron' -- actually represent something? Are they tangible goods/services, or simply a financial device to create a 'commodity' that has 'value' that can be 'traded/bought/sold' for a profit or loss?

Many many years ago, I worked very briefly for a commodities trader in Chicago, and because I was very young and even more ignorant than I am now, I had no understanding of what was going on at the Chicago Board of Trade or Mercantile Exchange. I got my first clue when one of the firm's clients came screaming into the office and wanted to know how in hell he was going to deal with the freight car full of eggs he had just 'bought.' He thought he was just buying and selling 'futures contracts' on the eggs to make money; he didn't think he was really 'buying eggs.' Well, one of his 'buy' contracts apparently didn't get 'sold' soon enough and he had actually bought the eggs.

Ever since then, I've kind of seen 'the markets,' whether stocks or commodities or 'derivatives,' as a casino on steroids. Most of the people buying and selling aren't 'investing' in the companies whose stock they buy; they're just trying to take money out of someone else's pocket by selling them something purchased previously at a lower price. There's no value added by the seller; if there's any 'value' added at all, it's from someone else's labor -- or someone else's lies.

When someone like this O'Neil person from Merrill Lynch walks away with $160MM or whatever, those dollars had to come from somewhere, didn't they? O'Neil didn't really create any value, did he? Or was the 'value' he created something that is somehow 'valued' by those who see robbing the working person of her/his job/cash as valuable?

How does this kind of system work? We know billions and billions of dollars are steadily flowing into the coffers of these Wall Street types and other CEOs. We know that these billions have to come from somewhere, someone. If it's funny munny handed out in the form of low-interest loans from 'the government' to banks and other financial institutions, doesn't that de-value the real money earned by real working people? Doesn't that drive inflation? (Don't the taxes of the working people fund the government that's making those loans?)

When the Fed throws several billion $$$ into 'the economy' with no tangible goods or functional services behind those $$$, isn't that inflationary? And where are those 'rebate' $$$ handed out to the general population going to go? If they just go to pay off debts or buy short-term necessities -- food, utilities -- that will have to be purchased again in another month or two after the 'rebates' have been spent, how will that really boost the economy? If we don't have an economy that does anything, that produces anything, are we really just shifting money from one account to another, always going steadily from the poor to the rich, and when it all ends up in the hands of ten or twenty or a thousand greedy bastards, what happens? What happens to 'the economy' then?

If we have a defense plant that's making ammunition for The War, federal dollars are coming in to pay for the bullets/bombs, and the workers get paid and the owners/investors get paid. But the government takes the product of their labor, ships it off to Iraq or Afghanistan, and blows it up. So what do the workers have to spend their money on? Cheap crap from China? How does that 'help' our economy?

Am I crazy? Stupid? Both?

If a mortgage broker makes a loan to an underqualified borrower, then 'sells' the loan to a bank and pulls out a profit, what has that broker done to 'help' the economy? Oh, sure, a house is built and people are given jobs and paid to build the house, but then the borrower can't continue to make payments and all he's paid so far goes to the bank and he's left with nothing. The bank has his money, but the bank also now has a house that isn't worth what the bank paid to the construction company/developer/speculator to build it. The bank goes to the government for a bailout, or the insurance company that got paid by the bank to 'guarantee' the loan pays the bank and then has to get a bailout by the government, and ultimately the borrower who is working and paying taxes but not making enough to give huge profits to the developers and mortgage brokers and reinsurers ends up losing everything he's got and STILL paying taxes to bail out the people who screwed him over!

Again -- Am I crazy? Stupid? Both?

Used to be, if you were sick, you went to the doctor. You paid the doctor bill, you paid the prescription bill, you paid the hospital bill. Your money, your health care. Then the insurance companies came along to take the 'risk' out. You paid your money to them rather than to the doctors and pharmacies and hospitals. They pooled the money and 'invested' it so that if you got sick, they paid the bills. If your bills were less than what you paid to the insurance company, well, too bad, but at least you had the peace of mind knowing that if anything really bad happened to you, you wouldn't be stuck with the bills. If your bills were more than what you paid to the insurance company, well, then you won the gamble.

But now it seems that the insurance companies -- and the doctors and the hospitals and everyone else involved -- have become tools for sucking money from the ordinary people and spitting it right back out into the pockets of the rich. The fact that insurance companies can be good 'investments' seems, well, it seems oxymoronic, criminal, un-American. But I guess that's just corporate capitalism at work. :sarcasm:

The prosperity was real -- but it was like a big ass party paid for with credit cards, wasn't it? Oh, we had a good time, all right, but now we have to pay for it. And paying off the bills for the party means, well, no more parties for a while. Belt tightening. Home-brewed iced tea instead of Pepsi; hamburgers instead of steak; home cooking instead of Red Lobster; making those shoes last another six months; driving the car until it's paid for; paying attention to price tags and looking for sales or just wearing those perfectly good last year's fashions; not throwing away that cheap coffee table and buying another cheap one, or maybe learning to buy good stuff that lasts and giving up the disposable 'gotta be trendy like the advertisers exhort' mentality.

I'm sorry for the rant. I went off on a tangent or three. But I sit here feeling like some kind of Cassandra or something -- it all looks so theoretically simple and yet no one seems to get it.

Or maybe the one who doesn't get it is


Tansy Gold

It is all explained here by The Long Johns http://www.youtube.com/watch?v=SJ_qK4g6ntM

and I'm giving it a shameless kick.

Funny thing is, I've been thinking about this whole thing -- options, derivatives, etc. -- just about all day. And I keep coming back to the same idea: it can't be all that difficult to understand. Someone -- the MSM immediately comes to mind -- is keeping it complex, keeping it some kind of 'trade secret' like the source code on touch screen voting machines.

What would happen if it all got put into language ordinary people could understand? Would they bother? Would they care?

Even more important, what if the CANDIDATES started talking about it? Yeah, right, like they're going to expose the very sources of $$$$ that are fueling their campaigns. Well, I can dream! That, at least, is still free.

But maybe, just maybe, if this information were put out there so real people could understand it and see how shamelessly the upper .5% are ripping the rest of us off, maybe there would be a cry for a truly equitable tax system, which seems to me would be a HUGE step toward turning the economy -- including the global economy -- around.

Well, this self-underemployed artist needs to get her shit packed for a big show tomorrow.

Tansy Gold, who actually MAKES THINGS

Don't add anything - but costs / hassle / layers and all the other crap - too About Everything we buy / sale - is that what your saying....then i would agree

on Wall Street.

Again, I want to remind that I am *not* an economist. This is just gut logic, commonsense analysis. So if anyone has better explanations or corrections, PLEASE speak up!

It seems to me that in a diverse and vast economy like ours, there's not going to be any way to avoid "middleman" or what I'd call distributive layers. I'm sure there's some other term for it, but this one works for the purpose of discussion. So when you go looking for a house to buy, you have a real estate agent that handles listings from sellers and brings them together with qualified buyers. The real estate agent keeps the seller from having to deal with strangers just walking up to the house and saying, "Hey, I wanna look at your house." So the real estate agent actually provides a service and is paid for it. They're middlemen, and I'm not sure they add "value" to the house that's being bought and sold, but they do serve a useful function.

An artist can set up on a street corner and try to sell her/his paintings, or put them in a gallery and pay the gallery owner/middleman a commission, freeing the artist to spend her/his time actually painting. The gallery owner, likewise, can provide this service to many artists at the same time, freeing all of them to paint.

My original post was more directed at 'creative commodities,' the sometimes seemingly imaginary stuff that gets traded back and forth but doesn't really exist. What really is a 'derivative'? Is it, as someone said over on SMW, a bet on a bet? Did the smart guys over at Enron create this thing so they could sell a few of them, maybe to each other or to those off-balance-sheet entities, so the Enron stock price would go sky high? Was there really any money involved, or was it all on paper, or in the guts of someone's laptop? Is it the investment equivalent of Dr. Horatio's Snake Oil?

The thing is, as all this talk goes on about 'the economy,' and the only solution being proposed is to lend more money from the government to the banks and give a few pennies to working people -- people who by all rights ought not to need it, since after all THEY HAVE JOBS -- I'm left wondering why no one seems to say right out loud in public,

ALL THE MONEY IS GOING TO THE RICH PEOPLE. THEY'RE MAKING IT IMPOSSIBLE FOR AMERICANS TO WORK AND BE PAID A LIVING WAGE. THEY'RE GETTING FILTHY FUCKING RICH AND THE REST OF US ARE ON THE BRINK OF FIGURATIVE STARVATION. (And for some of us, it's not figurative any more.)

CDOs, hedge funds, SIVs, and so on: It all gives the impression that 'the market' is the stock market, but that's not really the economy. And it doesn't seem to me that the stock markets are even a real reflection of what the economy is doing. But I just don't know enough about it to know for sure, and certainly not enough to be able to explain it to anyone else.

At least not yet.


Tansy Gold

but when you do, it's a keeper.

to the greatest w/ you.
dp

:blush:

well, i'll answer one, anyway. derivatives are real investments that are first and foremost designed to allow very carefully defined risks to be transferred from someone who doesn't want them to someone who does. generally speaking, this is intended, and usually does, benefit both parties -- with enough benefit, in fact, to pay the middlemen.

a farmer might not want to risk prices crashing before harvest time. so he enters into an agreement whereby he gets a guaranteed minimum price for his crop in exchange for a fee. this is really just an insurance policy that protects a farmer from an unfortunate market movement wiping him out. on the other side of the agreement is, perhaps, a food processing company or just a speculator who does this over a wide variety of farms/climates/crops/etc. to diversify the risk. that side of the agreement benefits from the fee most of the time and only loses when prices move adversely, hence the need to diversify. with proper diversification and deep enough pockets, that party is in a better position to manage the risk of the crop prices crashing.

the farmer gets a guaranteed minimum, the other party gets a usually predictable profit, and the risk ends up in the hands of someone who won't get slaughtered should it come to pass.

on the other hand, one could enter into such an agreement simply to gamble.


of course, there are considerably more complex derivatives than what i'm describing, but people on main street don't usually get involved in those. they're really only for companies who can hire people like me to read the contracts and tell them exactly what they're getting themselves into. and when companies can afford to pay top dollar for experts' time to advise them on such matters, they really have little excuse when they then use a derivative to put their company on the line.

we deal structurers are not all saints; i'm sure someone gets duped every now and again, notwithstanding all the lawyers and advisors and rating agencies and so on. but far more often, when you hear whining about derivatives, there's someone who was fully informed but just went ahead and made a bad business decision that bit him in the butt and then couldn't own up to his own recklessness.

anyone who gets rich on derivatives understands them thoroughly, just ask them. it's only when they lose money that they suddenly become oh-so-complicated.

While they aren't investing in companies for the long term, their (collective) capital is what allows businesses to operate without selling bonds every other day.

What percentage of the overall stock market valuation represents the value of primary offerings in which capital was actually delivered into the hands of the companies in question. I suspect it is less than 5%, although I'll admit that's basically a wild guess.

I don't have a comprehensive finance background, but I'm fairly certain the vast majority of corporate financing is debt-based.

But I too wonder about peoples' common sense sometimes. Take the housing thing. There are only two real prices for your house -- the one you buy it for and the one you sell it for. Everything in between is only an accounting entry for the tax man or if you want to use it for collateral on a loan. If your neighbor sells his house and suddenly yours is assessed at $10K more than what you bought it for, you don't have $10K more in your pocket. Sure, your bank would love for you to take out a $10K home equity LOAN based on your neighbor's sale price and your sudden increase in "value", but they would love you to rack up a huge balance on your credit card too. That doesn't mean it's a good idea for you.

Common sense should tell people that the only logical way to increase the long-term value of a home is with actual improvements to the home or neighborhood. And even then, ultimately median house prices must always correlate with median incomes. No matter how much funny business the Fed does with liquidity and interest rates, and the government does with "a rebate check in every pot", people need decent-paying jobs to be able to afford houses.

Viewing the housing and stock markets as barometers of the health of the economy also perturbs me because they are primarily secondary markets -- most of the houses and stocks being traded already exist. Market fluctuations in secondary markets do not create new value; they just shuffle money back and forth, generally into the hands of the already wealthy.

Good rant, though. Most economists seem to have blinders on when it comes to asking these most fundamental of questions.

:banghead:

Ah..that's better.

OK, 1st of all, start by reading this. Then http://www.newyorkfed.org/aboutthefed/fedpoint/fed04.html">this. When you get done with those, read them again. After that, if you've truly gotten a grasp of the concepts, you'll be miles and miles ahead of almost everyone that posts on the SMW thread. Guaranteed. You might even try and share your new understanding, but it will be a pointless exercise. But it is possible someone else might just actually try and understand it and as a result, ....oh, what the hell am I thinking.

Anyway..

Then, read this. That might help you understand part of what you apparently don't understand, but you have to actually be willing to try.

Then your ready to start really learning.

Read this
Then this followed by this.
After that, read this because it has to do with the above and these. There is plenty more information about those, and here is a list of suggested reading. (Sorry, it's kinda long)
Next, this is important, but don't forget to study this, this, http://www.cboe.com/Strategies/EquityOptions/ProtectivePuts/Part1.aspx">this and these.

Of course, we can't forget this and when you're through with that you can start on this


When you are done with all that, if you find yourself still not understanding it, when you get a chance, come on down here,

which is near here

and we'll have a cocktail and I'll explain whatever parts you don't understand.

There is plenty more, but its late.


Sorry to pile so much reading on you, but posting those links was a lot easier than typing for 4 hours.

Enjoy!:hi:

Throughout the ages, their goal has been to escape to a clean, catered, hierarchical leisure paradise for consumers, where their acquisitions buy people, places, and things at as highly favorable an exchange rate as possible.

Investments are all forms of debt. Debt carries risk. Risk begs to be treated as an externality. The predictable result is pyramid schemes, last one holding the reality loses. Complications simply make it easier to hide the cheating.

I'll do the reading later, as I'm up at 4 a.m. to do an art show, which is how I attempt to make a living -- selling things I actually make. That's about all the risk I'm willing to enter into these days, and about all the risk I can afford.


Tansy Gold