The D-bomb is the Derivatives Market. In theory, derivatives are balancedrisk investments that allow Hedge Funds, banks, insurance companies andothers to profit from the spread created by the bet. The three designproblems with D-bombs are that the risk is usually an either or option thatdoesn’t factor in a third alternative. Many bundled derivatives havecomponents that don’t represent outside financial instruments that mighthave value after a D-bomb explosion. The Derivatives Market represents aboutforty times the total value of all world currencies combined. If the D-bombgoes off, all world currencies would be worthless about forty times over.There simply isn’t enough money to cover a D-bomb meltdown.

In simple terms, a derivative is merely a bet. And it can be a bet onanything: interest rates, exchange rates, stocks, commodities, etc.Find acounter-party willing to wager against you, and you havecreated aderivative. And to make the bet you usually only have to put downa smallfraction of the bet amount. However, if their bet explodes, the Hedge Fundmust cover the leveraged amount of their bets. It’s this coveragerequirement for dangerous bets that puts the global financial market atrisk. The D-bomb risk/reward ratio doesn’t make sense to anyone whounderstands it.

Consider Long Term Capital Management. In 1998, it was the largestHedge Fund in the world. It’s derivatives shenanigans almost triggered thecollapse of the entire global financial system. It careened to the brink offailure and would have gone under if the U.S. Government had not organizedan emergency bailout. That bailout took the taxpayers of twenty countries tocut the timer to D-bomb denotation. And, Long Term Capital Management wasn’teven an American Hedge Fund.

The global derivatives market is around $272 trillion, according to therecent figures from the Bank of International Settlements. And three bigAmerican banks’ JP Morgan Chase, Bank of America and Citicorp – account for$77.6 trillion of the money being bet.

European banks are at risk for over $100 trillion and are the global centerfor D-bomb development. However, America is racing to close the D-bomb gap.Because they aren’t regulated like banks, U.S. Hedge Funds are on thecutting edge of D-bomb development. American Hedge Funds manage over onetrillion dollars, up from thirty nine billion in 1990. In the first quarterof 2005, wealthy investors added twenty seven billion dollars to the capitalof Hedge Funds. These Funds are borrowing billions of dollars from majorbrokerage firms and others. With the help of Hedge Funds, America is closingthe D- bomb development gap. A small bad bet can easily bring down thelargest financial institution. Hedge Fund trading may account for up to 50%of the trading volume on the NYSE. A few bad bets would collapse the DowIndustrial Average. Because there are no reporting requirements, nobodyknows how well or badly Hedge Funds are doing. However, I’ve never met aHedge Fund manager who wasn’t seeking new blood for their operations. Ifthey were doing so well, they wouldn’t need a constant influx of newcapital.

GM is in financial trouble. The company is planning to layoff 25,000 U.S.employees. The troubles were evident to the investment community for over ayear. Hedge Fund managers made a simple bet on GM. Funds bought GM’scorporate bonds and hedged the risk of default by shorting GM stock. Theplan was to hold the bonds and the Hedge Funds would lock in the interestrate spread between the coupon on the debt and the dividend on the commonstock. This was a simple either or bet. If GM defaulted on the bonds, theshorted GM stock would cover the bond loss and allow for a profit. If theCompany strengthened its financial position, the interest on the bonds wouldcover any losses sustained by the short position. As with many D-bombs, itappeared the Hedge Funds couldn’t lose.

The D bomb exploded when GM debt was downgraded (causing its bonds to godown) and Kirk Kerkorian made a tender offer for 3% of GM’s stock, causingGM shares to rise. Hedge funds got shredded in this little D-bomb explosion.A similar thing happened with Ford stock and debt. And, it happens oftenwith no one the wiser.

The fact is those betting on Derivatives are betting on the future ofCivilization. At some turning point in the economic situation, whether it bea recession or double-digit inflation, the Hedge Funds will lose sufficientbets to create a cascading explosion that will destroy Civilization. The sadfact is most people don’t see that the D-bomb is in play and will eventuallyexplode.