Monday , 17 June 2024

Derivatives Crisis & Economic Meltdown Could Result From Falling Oil Prices – Here’s Why

I keep on saying it, and I will keep on saying it until it happens.  We are heading for aarmagedecon derivatives crisis unlike anything that we have ever seen.  It is going to make the financial meltdown of 2008 look like a walk in the park. Our politicians promised that they would do something about the “too big to fail” banks and the out of control gambling on Wall Street, but they didn’t. Now a day of reckoning is rapidly approaching, and it is going to horrify the entire planet.

The above introductory comments are edited excerpts from an article* by Michael Snyder ( entitled Plummeting Oil Prices Could Destroy The Banks That Are Holding Trillions In Commodity Derivatives.

Snyder goes on to say in further edited excerpts:

Our entire economy is based on the flow of credit and, at this point, …the 6 largest banks in the country control 67% of all banking assets. If those banks were to disappear tomorrow, we would not have much of an economy left, [and they actually could fail. Here’s why:] the rapidly falling oil prices could trigger a nightmare scenario for the commodity derivatives market…

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If the price of oil stays at this level, or goes down even more, someone out there is going to have to absorb some absolutely massive losses.

  • In some cases the losses will be absorbed by oil producers but many of the big players in the industry have [protected themselves by] locking in high prices for their oil next year through derivatives contracts. (The companies enter into these derivatives contracts…[because 1)] many lenders do not want to give them any money unless they can show that they have locked in a price for their oil that is higher than the cost of production [and 2)] derivatives contracts protect the profits of oil producers from dramatic swings in the marketplace – which rarely happen, but when they do can be absolutely crippling – so the oil companies that have locked in high prices for their oil in 2015 and 2016 are feeling pretty good right about now.)
  • [In many cases, however, the risks lie with those] on the other end of those contracts – the big Wall Street banks – and if the price of oil does not rebound substantially they could be facing absolutely colossal losses.

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When things are nice and stable, the derivatives marketplace works quite well most of the time, but when there is a “black swan event” such as a dramatic swing in the price of oil, it can create really big winners and really big losers and, no matter how complicated these derivatives become, and no matter how many times you transfer risk, you can never make these bets truly safe.  The following is from a recent article by Charles Hugh Smith:

Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but as I have noted many times, risk cannot be disappeared, it can only be masked or transferred to others.

Relying on counterparties to pay out cannot make risk vanish; it only masks the risk of default by transferring the risk to counterparties, who then transfer it to still other counterparties, and so on.
This illusory vanishing act hasn’t made risk disappear: rather, it has set up a line of dominoes waiting for one domino to topple. This one domino will proceed to take down the entire line of financial dominoes.
The 35% drop in the price of oil is the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.

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…Most of the time the big banks are very careful to make sure that they come out on top, but this time their house of cards may come toppling down on top of them. By the middle of next year, we could be facing a situation where many of these oil producers have locked in a price of $90 or $100 dollars a barrel on their oil but the price has fallen to about $50 a barrel. In such a case, the losses for those on the wrong end of the derivatives contracts (the 6 largest “too big to fail” banks who control the $3.9 trillion in commodity derivatives contracts…[of which] a very large chunk of that amount is made up of oil derivatives) would be astronomical…[and] virtually guarantee a full-blown economic meltdown…

[Why? Because. given that]…our economic system is so completely dependent on these banks, there is no way that it can function without them. When these mammoth banks collapse…the entire system is going to utterly fall apart.

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

* (Copyright © 2014 The Economic Collapse)

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