Saturday, October 18, 2008

Comment: A week of economic indicators

US economic reports released this week showed the economy taking the dips expected after a year and a half of financial sliding, not just the most recent crash cycle.

The financial downturn was sparked largely by the mortgage crisis and thus it is not surprising that new housing construction for the year will be lower than anytime since World War II.

U.S. industrial production plunged 2.8 percent in September, the steepest decline since 1974.

With more mortgage resets due in the coming years, there will be continued downward pressure on real estate values further damaging exposed financial institutions.

On Friday we also heard that US consumer confidence has fallen more in September than in any month since records began in 1978.

What's a derivative?

You've probably heard about derivatives in all the news related to the current credit meltdown.

They are the most important type of debt or "leverage" existing out there although not often included in general debt assessments. The totally unregulated derivative market is estimated at around $500 trillion to $600 trillion -- no one really knows. Of course, this is not real "money." No one quite knows for sure what a derivative really represents.

Derivatives are a type of insurance to help divert risk.

Warren Buffet called them "financial weapons of mass destruction" that carried the potential of harming both buyer and seller.

The most important type of derivative is the credit default swap (CDS), a type of insurance purchased to protect a company or investor from its own debt bubble. Thus, if a bankruptcy occurs there is a type of CDS that will actually pay people to make up the loss. There are about $60 trillion worth of CDS in the world today.

It doesn't take a genius to note that if a major financial crisis occurs, there could be a wave of bankruptcies with the resultant CDS payoffs.

The problem of course is there is not enough money to cover these credit default swaps. Who around is going to pony up possibly tens of trillions of dollars?

Consumer sentiment plunges at fastest rate ever
MarketWatch - Oct 17, 2008
It's unlikely that consumer confidence will reach levels consistent with rising spending until next year, Shepherdson added. While inflation has eased ...
Worst Drop in Consumer Confidence in History PoliGazette
Here's a surprise, consumer confidence plummets in October AXcess News

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