The 2 Billion Dollar Loss By JP Morgan - The Coming Collapse of the Derivative Market?

When news broke of a $2 billion dollar trading loss by JP Morgan, much of the financial world was absolutely stunned. But the truth maybe something far more dangerous. JP Morgan is just a very small preview of what is going to happen when we see the collapse of the worldwide derivatives market.

When most people think of Wall Street, they think of a bunch of stuffy bankers trading stocks and bonds. But over the past couple of decades it has evolved into much more than that. Today, Wall Street and the City of London are the biggest casinos in the entire world, the size of the bets that have been taken by banks are beyond our conception.

As we blogged last month, overall the nine largest U.S. banks have a total of more than 200 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy. It is hard for the average person on the street to begin to comprehend how immense this derivatives bubble is.

The following is how a recent Bloomberg article defined derivatives....
Derivatives are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in the weather or interest rates.

So let's not make too much out of this 2 billion dollar loss by JP Morgan. This is just peanuts. This is just a preview of coming attractions.

Soon enough the real problems with derivatives will begin, and when that happens it will shake the entire global financial system to the core and beyond.

As any gambler will tell you when the banks make good bets, they can make a lot of money. When they make bad bets, they can lose a lot of money, and that is exactly what just happened to JP Morgan.

Their Chief Investment Officer made a series of trades which turned out horribly and it resulted in a loss of over $2 billion dollars over the past 40 days.

But $2 billion dollars is small potatoes compared to the vast size of the global derivatives market. It has been estimated that the notional value of all the derivatives in the world is somewhere between 600 trillion dollars and 1.5 quadrillion dollars.

If you started counting right now at one dollar per second, it would take 32 million years to count to one quadrillion dollars. Nobody really knows the real amount, but when this derivatives bubble finally bursts there is not going to be nearly enough money on the entire planet to fix things.

Sadly, a lot of mainstream news reports are not even using the word "derivatives" when they discuss what just happened at JP Morgan. On a conference call the CEO Jamie Dimon admitted that the strategy was "flawed, complex, poorly reviewed, poorly executed and poorly monitored".

The funny thing is that JP Morgan is considered to be much more "risk averse" than most other major Wall Street financial institutions are. So if this kind of stuff is happening at JP Morgan, then what is going on at some of these other places? That is a really good question but we may not find out until something goes wrong.

In essence, JP Morgan made a series of bets which turned out very, very badly. This loss was so huge that it even caused members of Congress to take note.

The following is from a statement that U.S. Senator Carl Levin issued a few hours after this news first broke...."The enormous loss JPMorgan announced today is just the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making."

We never learned one of the basic lessons that we should have learned from the financial crisis of 2008.

If the bankers make huge bets and they win, then they win big.
If the bankers make huge bets and they lose, then government uses taxpayer money to clean up the mess and we in the public sector get the sharp end of that.

Under those kind of conditions, why not bet the whole lot? So what does the whole lot look like?

The amount of money that we are talking about is absolutely staggering. Graham Summers of Phoenix Capital Research estimates that the notional value of the global derivatives market is $1.4 quadrillion, he tried to put that number into perspective....

If you add up the value of every stock on the planet, the entire market capitalization would be about $36 trillion.

If you do the same process for bonds, you’d get a market capitalization of roughly $72 trillion.

The notional value of the derivative market is roughly $1.4 QUADRILLION.

Put it into perspective. $1.4 Quadrillion is roughly:
-40 TIMES THE WORLD’S STOCK MARKET.
-10 TIMES the value of EVERY STOCK & EVERY BOND ON THE PLANET.
-23 TIMES WORLD GDP.

Most politicians have no idea that we are rapidly approaching a horrific derivatives crisis that is going to make 2008 look like a Sunday picnic if we are left with any bread to make the sandwiches!