167 lines
7.9 KiB
Plaintext
167 lines
7.9 KiB
Plaintext
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Conspiracy Nation -- Vol. 1 Num. 26
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======================================
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("Quid coniuratio est?")
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NOT UNDERSTANDING $$ DEALS DOESN'T STOP DEALERS
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By Martin Mann
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From *The Spotlight*, June 27, 1994
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"Derivatives" has been a term often seen -- but never fully
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explained -- in recent financial news. Yet no matter how remote
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and intricate, these financial instruments require a closer look,
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if only because they have been costing American taxpayers
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billions -- over $50 billion in the past 12 months, according to
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one estimate -- and now threaten the entire U.S. economy.
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Total derivative contracts outstanding at the beginning of June
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-- including contracts traded on the futures and options
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exchanges and over-the-counter derivatives -- has been estimated
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by *Fortune* magazine at $16 trillion (the gross domestic product
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of the U.S. is a comparatively piddling $6.4 trillion). But this
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figure is based on the "underlie," i.e., the money involved in
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the contracts. Even *Fortune* admits that the figures are
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somewhat arbitrary, since the dollar value of the contracts is
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only one way to measure the market. The contracts themselves
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control vast chunks of cash, much larger than their so-called
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"notional" value.
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But it is all "off the books," with no way for anyone -- the
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government or the traders themselves -- to confirm any figure.
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Meanwhile, George Soros, known as the "derivatives king," says he
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lost several hundred million in trades last year, while some
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published sources are saying he won $1.1 billion. "There's simply
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no way to know," said a Wall Street source. "There are no
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figures; no paper trail; no way to check anyone's claims good or
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bad."
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Derivatives are financial instruments so convoluted and
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manipulative that even the sharpest speculator, such as George
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Soros, who has used them to gamble -- and win -- billions on
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global currency trades claims he does not understand just how
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derivatives work.
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Yet the basics of derivatives are simple: "Take two businessmen,
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Luke and Lance, and assume that each has borrowed $100,000 to
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invest in a real estate deal," explained veteran Wall Street bond
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trader Hugh Diericks. "The terms of their loans are different,
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though. Luke pays fixed interest on what he owes, while Lance's
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I.O.U. draws interest at what is called a 'variable' rate --
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let's say it follows the fluctuations of the prime rate."
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Both men are concerned about the inherent risk of interest rate
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shifts, but in opposite ways. "Luke hopes that over time,
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interest rates will go up, or at least stay even, because
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otherwise he risks paying too much on his fixed rate obligation,"
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related Diericks. "Lance, on the other hand, is afraid that if
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interest rates are inflated, his variable-rate debt will balloon
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into a losing proposition."
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To "hedge" their investment against such a risk, Luke and Lance
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may enter into a contract stipulating that if interest rates
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drop, "Luke will be compensated for his loss by Lance," noted
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Diericks. "But if interest rates rise and Lance gets clipped, it
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is Luke who pays to make good Lance's loss."
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Because the payout between the two businessmen depends on --
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"derives from" -- the way interest rates fluctuate, it is called
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a "derivative" in the financial markets.
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Major corporations often turn to such derivative contracts to
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hedge the risk to their export revenues raised by sudden swings
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in the international currency markets. Insurance companies have
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used them as "reinsurance" against unpredictable upsets.
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"Derivatives are simply contracts whose value is derived -- the
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key word -- from the value of some underlying asset such as
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currencies or commodities, or from indicators such as interest
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rates," says Carol Loomis, the award-winning business writer and
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longtime editor of *Fortune Magazine*. "In many countries they
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are legally considered mere gambling debts."
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-+- Big Casino -+-
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That was precisely the sort of financial instrument speculators,
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wheeler dealers, corporate raiders and get-rich-quick fund
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managers were looking for in the greed-driven, smash-and-grab
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1980s, Wall Street sources say.
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As Michael Milken and his circle of predatory junk-bond
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manipulators in the Reagan era converted the U.S. into what
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analysts now call a "casino economy," other profiteers began to
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use complex derivatives to play vast international shell games.
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"Most deals involving big stakes leave a paper trail, even if
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moved offshore," says financial reporter Gil Mercer. "But
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derivatives don't. They are the dream of every money manager who
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wants to cover his tracks."
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By the same token, derivatives are also "regulatory nightmares,"
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warns the knowledgable Ms. Loomis, "They are off-balance-sheet
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instruments that obscure what's going on, rather than revealing
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it. Concocted in unstoppable variations... they make total hash
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out of existing accounting rules and even laws."
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With speculation in derivatives becoming the rage on Wall Street,
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major firms hired mathematicians and rocket scientists to devise
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ever more elaborate computerized variations of such contracts.
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The financial markets were swamped with tangled transactions
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worth literally trillions of dollars that not even the money
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managers understood any longer.
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"Let me show you an example," explained Diericks. "At Kidder,
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Peabody & Co., one of Wall Street's largest brokerages, now a
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subsidiary of General Electric, they recently fired a bond
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manager called James Jett. It came as a shock: Jett, head of the
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firm's government bond division, was known as a wizard
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derivatives trader, who received more than $10 million in pay and
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compensation last year for making Kidder some very big paper
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profits."
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But auditors sent in by G.E. found the lucrative deals reported
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by Jett simply didn't exist. "Kidder had to admit that instead of
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booking big profits, it had lost $350 million last year on Jett's
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derivatives contracts, which were never properly supervised or
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audited because no one else at Kidder -- not even the top
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managers -- quite understood them," Diericks revealed.
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A *Spotlight* survey has found that a number of major Wall Street
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investment banks and brokerages, even staid industrial
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corporations such as Procter & Gamble, have been hit by similar
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heavy losses caused by arcane derivatives deals last year.
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"Although he may not find it appetizing... the American taxpayer
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ends up eating a large share of these deficits," warned Diericks.
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"Take the scandal at Kidder: with the total shortfall in
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derivatives trading put at $350 million, the giant brokerage took
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an immediate tax credit of $140 million. That estimated revenue
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must now be squeezed by the government from other taxpayers, most
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likely from you and me."
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Can a speculative craze be reined in by regulators, if no one
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really understands what makes it run? Rep. James Leach (R-Ohio)
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has proposed new legislation, and the establishment of a federal
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Derivatives Control Commission toward that end. His initiative is
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worth serious -- and urgent -- consideration, financial experts
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say.
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-----------------------------------------------------------------
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*The Spotlight*. An alternative newspaper, published weekly. 1
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year's subscription, $36. 1-800-522-6292. Visa/Mastercard.
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Aperi os tuum muto, et causis omnium filiorum qui pertranseunt.
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Aperi os tuum, decerne quod justum est, et judica inopem et
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pauperem. -- Liber Proverbiorum XXXI: 8-9
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