On Sun, 27 Jan 2008 11:19:45 -0500, "Ed Huntress"
wrote:
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So, the answer is clear: It's time to learn to dance or shuffle. Practice
those pirouettes, and always deal from the top of the deck, ya'll.
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The black box economy
By Stephen Mihm
January 27, 2008

Behind the recent bad news lurks a much deeper concern: The world
economy is now being driven by a vast, secretive web of
investments that might be out of anyone's control.
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Should we be so confident this time? A handful of financial
theorists and thinkers are now saying we shouldn't. The drumbeat
of bad news over the past year, they say, is only a symptom of
something new and unsettling - a deeper change in the financial
system that may leave regulators, and even Congress, powerless
when they try to wield their usual tools.

That something is the immense shadow economy of novel and poorly
understood financial instruments created by hedge funds and
investment banks over the past decade - a web of extraordinarily
complex securities and wagers that has made the world's financial
system so opaque and entangled that even many experts confess
that they no longer understand how it works.

Unlike the building blocks of the conventional economy -
factories and firms, widgets and workers, stocks and bonds -
these new financial arrangements are difficult to value, much
less analyze. The money caught up in this web is now many times
larger than the world's gross domestic product, and much of it
exists outside the purview of regulators.
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By cleverly exploiting regulatory loopholes, investment banks
created new types of high-risk investments that did not appear on
their balance sheets. Safe from the prying eyes of regulators,
they allowed banks to dodge the requirement that they keep a
certain amount of money in reserve. These reserves are a crucial
safety net, but also began to seem like a drag to financiers,
money that was just sitting on the sidelines.
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"Our modern shadow banking system," Gross writes, "craftily
dodges the reserve requirements of traditional institutions and
promotes a chain letter, pyramid scheme of leverage, based in
many cases on no reserve cushion whatsoever."
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But today, increasingly, a new generation of derivatives doesn't
trade on markets at all. These so-called over-the-counter
derivatives are highly customized agreements struck in private
between two parties. No one else necessarily knows about such
investments because they exist off the books, and don't show up
in the reports or balance sheets of the parties who signed them.

As the derivatives business has grown more complex, it has also
ballooned in scale. Broadly speaking, Das - author of a leading
textbook on derivatives and complex securities - estimates that
investors worldwide hold more than $500 trillion worth of
derivatives. This number now dwarfs the global GDP, which tops
out around $60 trillion.
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These risks are magnified, as they were during the stock bubble
of the 1920s, by the fact that many of these assets are owned by
investors who borrowed money to make the investments in the first
place. When a market shock like the subprime crisis hits, it can
send tremors through the system with incredible speed.
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for complete article click on
http://www.boston.com/bostonglobe/id...k_box_economy/