What are Credit Derivatives and Credit Default Swaps?

Originally written in December 2010:

Dear Friend:

I hope you take heed and do something now to prepare yourself by getting more self sufficient. I know this has nothing to do with alternative energy, but it does have everything to do with survival and sustainable living. I am really not trying to scare you or anything like that. I'm just trying to inform you, so you can be well prepared. So...

What if...

  • You lost all your investment assets overnight?
  • You lost your job, social security, or other income source overnight?
  • The economy totally collapsed overnight like it did in 1929?
  • A virus, worse than H1N1, appears overnight?
  • A natural disaster like what happened in Haiti happened in an instant?

Would you be prepared?
Would you be able to feed your family?
Would you have water to drink?
Don't think this can happen to you?

Think again!... The World's economy is being propped up like the little Dutch boy with his finger in the dike. In June 2009, I warned you about the coming credit bubble which really has not played out fully yet. But what I want to tell you about now is an even worse scenario.

Do you know what a derivatives contract is?
How about a credit default swap?

No? Well... basically, a derivatives contract, or more specifically an interest rate derivative, is a wager. The buyer is betting that the bond interest rates will go up and the seller is betting that the bond interest rates will go down. Now... I'm being overly simplistic here as there are tons of different kinds of derivatives. A credit default swap is basically a wager between two parties. The seller is betting that the underlying loan or bond (credit) stays good. The buyer gets paid if a negative event like a default occurs. These credit default swaps were at the core of the AIG bailout and the housing crisis.

But the scenario to come has to do with Over The Counter (OTC) interest rate derivatives. Basically, there are six big banks that hold about 196 trillion in these derivatives. If interest rates were to rise due to inflation, they would have to cover their positions on these derivatives. So... any economic recovery may cause interest rates to go up to keep run away inflation down to a minimum. With the amount of money the government is printing, inflation is sure to rear it's ugly head sooner or later.

Do you see the problem here?

Interest rates are sure to go up causing these big banks to have to fork out 196 trillion in lost interest rate derivative bets. This may be why interest rates have been so low for so long and the economy seems to be having trouble recovering - it's the only scenario where the banks survive for another day. But it can't last forever. And... 196 trillion is way too much for any Country or entity to bail out. The housing market credit default swap fiasco was "only" 62 trillion by comparison.

Don't think you are exposed?

Think again... as most financial assets in the world are exposed to this unwinding problem. We're talking about the biggest banks in the World... JP Morgan Chase, Bank of America, Citibank, Goldman Sachs, Wells Fargo, and HSBC Bank USA. A lot of people and institutions lost a ton of money just when Lehman Brothers went bankrupt in September of 2008. It was one of the worst weeks in history for the stock market. If those six banks go under, the Lehman Brothers bankruptcy will seem like the good old days!

The truth is... it will affect everybody worldwide. All but the most self sufficient people will be affected. Like I always say... take care of the necessary stuff first... you can not survive without water. Collect rain water if you have to.

After that, secure your food source. Here's a great web site I found that sells dehydrated (not freeze dried) food packages for emergency purposes... www.efoodsdirect.com. I may buy their "Freedom Unit" myself real soon! It's a one year supply of what looks to be some tasty food for 1 adult.

You can do without things like generating your own electricity if you have to but you can't live long without food and water for very long.

Just a quick update on generating hydrogen...

I ran across a guy's web site who has increased electrolysis efficiency by effectively increasing the surface area of the plates by using nano particles on the plates. Pretty cool idea, isn't it? His web page is www.doppstein.com. And while researching hydrogen production, I also ran across this cool web site... www.hydrogencarsnow.com which is like the Taj Mahal of hydrogen car information. I mean they really did their homework on this site!


Bill Anderson