by Wayne Spencer - February 24, 2009

Revelation - 1. The act of revealing or disclosing. 2. Something revealed, especially a dramatic disclosure of something not previously known or realized.

Revelation. The financial crisis as it applies to the financial crisis on Wall Street has nothing whatever to do with the housing market nor the amount of bad mortgages. I am not saying that the mortgage crisis is not important. It is tragic and should be fixed, but I submit that it is not the cause of the Wall Street meltdown as we have been led to believe.

I can hear it now, "Yeah Spence, the whole world has the financial crisis all wrong. Are you crazy."

My analysis is that we have been watching a very good magic act. We have been misdirected into thinking that we see something when in effect it is an illusion.

Nearly every evening before bed I watch the Charlie Rose program on PBS. He usually has very good guests and Charlie is a very good interviewer. Last night Charlie was interviewing John Mack who is the CEO of Morgan Stanley. Morgan Stanley had been a brokerage house. Since the crisis it was one of those companies that declared itself a bank so that it could take advantage of funds from the U.S. Treasury and the FED.

The topic turned to executive compensation. Mr. Mack told us that it wasn't really the top executives that needed the large bonuses but rather the risk managers. He then asked how he could cap the compensation of a sharp commodity trader who was earning $70 million for the corporation?

I thought that it was a rather strange question. How did a risk manager suddenly become a commodity trader? Isn't a commodity trader actually a risk taker?

As I thought about it, my mind went back to the 1990's when I was involved with the futures trading markets as a computer programmer. I then had to ask myself how was it that a commodity trader was working for a brokerage house and how could he make tens of millions of dollars in a zero sum game.

I was under the impression that a brokerage house was buying and selling on behalf of its clients accounts with the risk taken by the clients. It appears from Mr. Mack's statement that Morgan Stanley is both broker and client. If that is what has been going on on Wall Street then it is no wonder they are in trouble. Commodity trading is a zero sum game in that for every winner there is a loser on the other side of the futures contract. One side is betting that the commodity will go up and the other side is betting that it will go down. Why should we the U.S. Taxpayer bail out a gambling casino calling itself a brokerage house and now a bank that has employees who are gamblers or commodity traders who are called risk managers. This sounds like a whole lot of deception to me.

Mortgages as far as I know are not traded like commodities by commodity traders.

The next question I had to ask myself was: what commodity had a big run upward and then a sudden drop during 2008? The answer is oil! During the summer of 2008 the price of a barrel of crude oil was $147. By October it was around $55 per barrel and by January it was down to $30 per barrel. Wow! Why didn't I see that before? Misdirection. No one was even hinting that the brokerage houses could be losing a great deal of money speculating on oil. Remember when Enron went broke when the California electric futures went down?

If we take the total value of all of the oil being traded at the time of the oil bust it makes the total housing foreclosure crisis in the United States look like pocket change.

My theory is that the big brokerage houses were buying contracts in crude oil with the expectation that the price would continue to climb.

To see if my theory could be right I needed to look at the futures prices through 2008 and compute the value by the number of open interest contracts times the price. This is a matter of record on the NYMEX (The New York Mercantile Exchange). I also needed to verify the value of all mortgages in trouble in the United States in September 2008 and compare the values rather than just guessing.

Here is the chart for Light Crude Oil on the NYMEX

Note that the average open interest is around 2.5 million contracts. A contract is 1,000 barrels. At the peak of the "oil bubble" the price was $147 per barrel or $367,500,000,000 ($147 x 1000 x 2,500,000). This is for just a single contract date for crude oil futures on the NYMEX exchange. It does not include contracts beyond the October contract. It does not include other exchanges with similar amounts nor does it include the more highly leveraged options markets. But it is something that can be used as a base for the full extent of the exposure. The total exposure could be more than a trillion dollars.

Now compare that with the amount of exposure due to foreclosed homes from the beginning of 2008 projected through the end of 2009 of $80 billion. Source: U.S. Congress Joint Economic Committee Calculations of Mortgage Banker Association data; projections by the Center for Responsible Lending. For just 2008 alone it is more like half of that amount.

Why was it necessary to bail out lending institutions and Wall Street brokerage houses to the tune of $700 billion with the FEDS kicking in another $2 trillion with a promise of $2.5 trillion more just to cover projected foreclosures of $80 billion.

From what I can gather by the available data the housing crisis pales when compared with the possible losses in the oil futures and derivatives markets.

Note also that the precipitous drop in oil prices coincides nicely with Treasury Secretary Paulson's trip to capitol hill to ask for $700 billion.

I believe that my theory makes more sense in light of the fact that nothing has been done to date to solve the housing crisis while huge sums have either been spent or are planned to be spent in the financial markets. If the problem is indeed in the housing market then wouldn't it follow that more of the funds would be used in that area?

In closing, I am not accusing the Wall Street brokerage houses of speculating in oil futures last year, but I think that at the very least the American people need to know that their government has looked into the real cause of the meltdown before taxpayer money is freely given out. We need to have the whole story complete with actual figures that make some kind of sense.

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Copyright © 2009 by Wayne Spencer - This article may be freely distributed in its entirety with this copyright notice attached.