May 25, 2024

“Investment Time Bomb, Mega Catastrophic Risk”

I have often noted that predictions made early eventually turn out to be the most accurate, but oft most forgotten since it is yesterday’s news.  Perhaps the real nightmare now upon us is the one predicted by Warren Buffet in March 2003, as well as in earlier interviews, in which he prophetically stated that:

“The rapidly growing trade in derivatives poses a “mega-catastrophic risk” for the economy…

Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers … which can trigger serious systemic problems”

Mr Buffet explained the risks of derivatives after buying a reinsurance company with a small portfolio of derivatives. These positions were gradually sold off  for a big loss “in a leisurely way in a benign market”.

In May 2007 Mr Buffet again spoke of the extreme risks to the global financial system saying:

“that excessive borrowing by traders, investors and corporations will eventually lead to significant dislocation in the financial markets.”

Mr Buffet’s dire predictions are not to be taken lightly and,  unfortunately, now appear to be occurring.   A default chain of these insanely devised and leveraged products could cause extremely significant and long lasting damage to the world economy, probably beyond the immediate ability of the world’s central banks to contain.  The collapse of Lehman, a very big player in derivatives, has some wondering if the unwinding of their contracts is the trip point for the “mega catastrophe” and the cause of the current credit crisis.  The Federal Reserve and Treasury Department apparently did not see the risk when they let Lehman go under.

Since these derivatives (specifically the CDS) are essentially a zero sum game for the parties involved (one player’s loss is equal to another player’s gain), and given the potential catastrophe we face, the government should consider a mandated freeze on the contractual obligations involved by all the counter parties in the derivatives market and then allow them to be unwound in a controlled manner.  Hopefully, at the level of power that matters, this situation is being urgently reviewed.

Fortune – The $55 Trillion Time Bomb

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