Finding a Cure For Financial "Derivatives": The Market Cancer

• Finding a Cure for Financial Derivatives
  
• Part I: What Are Derivatives
  
• Part II: How Derivatives Grew
  
• Part III: Case Studies -- Derivatives and Agricultural Commodity Transfers
  
• Derivatives Create Mass Global Unemployment, by Richard Freeman, also printed in The New Federalist, September 6, 1993.

Finding a Cure for Derivatives: The Market Cancer

This pamphlet presents some materials related to the background of so-called financial derivatives, and to jailed economist Lyndon LaRouche's proposed 0.1% sales tax on each such transaction.

For clarity's sake at the outset, the following ought to be understood, as background to our assessments of current and recent volume of trading in derivatives, and the effect of the proposed tax. This, because in addition to the revenue-raising potentials of the tax, LaRouche also insisted that the imposition of such a tax would contribute to bringing out-of-control, speculation-driven markets under proper executive control. The imposition of the tax would help reveal the problems to be encountered in doing such a cleanup.

Here are some of the problems, and thus some of what has to be brought under control:

1. The bulk of such trading, as is profiled below, the so-called ``over-the-counter'' segment, is blatantly illegal under present U.S. law. Under standing provisions of the Commodity Exchange Act, it is illegal for banks, or anyone else, to deal in futures contracts outside of commodity exchanges. This is never mentioned publicly by any of the partisans of derivatives. ``Over-the-counter'' derivatives are only traded safely at this time because of the work of the former chairman of the Commodity Futures Trading Commission, Wendy Gramm (wife of the loud-mouthed priest of financial orthodoxy Texas Sen. Phil Gramm), who was given the right to ``waive'' existing law.

2. All treatments of derivatives, generated from within the financial and regulatory communities, distinguish between exchange-based and ``over-the-counter'' trading between banks, as if they were completely separate activities. The distinction is fraudulent. ``Over-the-counter'' derivatives--for example, a swap between a floating-rate Swiss franc-denominated instrument and a fixed-rate dollar instrument--are consummated and put into effect through exchange-based trading of currency, bond, and interest rate futures and options. The degree to which the growth of the $1 trillion per day foreign exchange market, or the $300 billion per day market in U.S. government securities, is conditioned by trading generated as a result of illegal inter-bank ``swaps,'' is unknown.

   For these reasons, it is impossible to estimate, to any acceptable degree of accuracy, what the size of the legal market is which would be subject to the tax. And obviously, one would not want to legitimize what is already outside the law, by subjecting such crimes to a tax.

3. Leaving the matter of crime aside, trading volumes, and the rate of turnover of the contracts traded--i.e., the actual, not the notional maturity of the instruments traded--are likewise unknown. This makes EIR's previously relatively high estimates of the effect of the proposed tax, and our presently relatively low estimates, equally suspect. They should be understood as hypothetical extremes. The more so, given the fact that the bulk of such trading is flatly illegal. For example:
   • No reporting of derivative exposure by banks includes instruments with maturities of 14 days or less; yet the purpose of bank swap arrangements, for example, is to transform nominal medium- and long-term maturity instruments into short-term instruments, such that daily trading subserves a contract which is renegotiated every three months.

   • No consolidated accounting exists of activities by bank holding companies and all their subsidiaries, or by so-called non-bank financial companies--e.g., GE Capital Corp. and General Motors Acceptance Corp (GMAC). Volume estimates are based either on particular banks' activities, or on activities of holding companies as such. The reports for both cover different time-frames. They are neither complete, nor are they compatible. Non-deposit-taking lending institutions (non-bank banks in the present parlance) are not covered at all, because they are not regulated. Yet GE Capital and GMAC, and they are only two, are as large as the largest of the bank banks.

Investigate the Federal Reserve

Such an investigation ought to focus on three areas:

1. Narrowly, how has the Federal Reserve has interpreted its regulatory mandate over stock index futures markets, and how and why was the Federal Reserve given such a mandate in the first place?

2. More broadly, what does the Payment and Settlement Committee of the Federal Reserve Bank of New York actually do, and what role does the Federal Reserve play in its work? This committee generally brings together financial institutions, clearing organizations, and securities exchanges ``to facilitate communication on payment and settlement issues,'' and coordinates with senior officials of the Federal Reserve Bank.

3. What is the effect of Federal Reserve involvement in derivative-driven markets on credit generation, the banking system, and the economy as a whole?

4. What is the extent of criminal collusion between the Federal Reserve Bank of New York and the eight commercial banks which account for 90% of the activity in ``over-the-counter'' derivative transactions? The Federal Reserve Bank of New York is owned by the same banks which have systematically been violating the Commodity Exchange Act.

1. So long as present methods of organizing credit flows within the economy and financial system are continued, there will be no prospect of economic recovery, nor a feasible job creation program, nor any capital- and technology-intensive renewal of the economy.

2. Derivative markets--options, futures options, options indexes, swaps, strips--whether on or off exchange, given the rate of growth in their international volume and turnover, especially in currencies and bonds, have become key in setting financially ``acceptable'' rates of return, thus interest rates, and thus overall credit flows.

3. Bush administration policy and Alan Greenspan's Federal Reserve commitments to avoid at all costs the spillover of the savings and loan banking crisis into the nation's commercial banks, by increasing spreads between bank lending and borrowing, made the problem much worse than it would otherwise have been. Returns from commercial and industrial loans cannot match the derivative-enhanced yield on the tax-free 4-5% spread they have been given in recent years.

4. To organize a recovery is to create new wealth. New wealth can only be created by putting Americans back to work in modern infrastructure construction projects, necessary to support expansion in employment and economic activity, and in technologically progressive capital goods industries, to increase productivity. This increases the tax base without increasing tax rates, and thereby reduces the deficit. Every 1 million jobs created at $30-40,000 per year gross will add between $5 and $6 billion to the Treasury's personal taxation revenue stream directly, and will obviously have quite dramatic additional indirect effects.

   Unfortunately, the time-frame for achieving project viability, and the discounted present cash value of the returns on such investments, cannot compete with the derivative money-go-round.

5. Therefore, either derivatives and their users submit to an exercise of national will, or the country submits to the continued rule of those who employ derivatives, in violation of its very laws.

I. What Are Derivatives?

The textbook definition of a financial derivative is a financial instrument, the value of which is based on the value or values of one or more underlying assets or indexes of assets. Derivatives can be based on equities (stocks), debt (bonds, bills, and notes), currencies, and even indexes of these various things, such as the Dow Jones Industrial Average. Derivatives can be sold and traded either on a regulated exchange, such as the Chicago Board of Trade, or off the exchanges, directly between the different counterparties, which is known as ``over-the-counter'' (OTC). The textbook explanation of the purpose of derivatives is that they serve to reduce the risk inherent in fluctuations of foreign exchange rates, interest rates, and market prices. Derivatives traded on exchanges also are said to serve as a ``price discovery'' mechanism.

According to the Bank for International Settlements' October 1992 report, Recent Developments in International Interbank Relations, ``swaps'' are the largest type of derivatives, as measured by the notional prinicpal amount outstanding (Table 1).

A generation or so ago, the matter of what derivatives are might have been adequately summarized by contrasting the difference between investment, on the one hand, and gambling or speculation, on the other.

The instruments which ``underlie'' derivatives--stocks, bonds, commodities, money--represent a claim, usually through ownership, on wealth produced in the economy. Such claims can be purchased. Thus, shares in a company can be bought, as can bonds issued by governments or corporations, or hard commodities produced by agriculture, forest industries, or minerals extractors and refiners.

The instrument so purchased provides a means by which the wealth produced may be turned into money. In the case of stock, this may take the form of the company's dividend payment, the part of after-tax profits distributed to shareholders, or it might take the form of capital gains realized through the appreciation of the stock's value. Formerly, such monetization, or potential for monetization, would have been more or less directly related to the economic performance of the company, in contributing to an increasing overall rate of wealth generation through productivity-enhancing increases in the powers of labor. So too are bonds directly related to economic activity, though where stocks represent equity ownership, bonds represent indebtedness. The interest paid corresponds, more or less, to the dividend yield of a stock. And like stocks, bonds can provide capital appreciation.

A generation ago, such financial instruments were the means for transforming economic surplus into monetized net profit. ``Hard'' commodities are different, because they are part of the materials-flow needed to sustain production and consumption, which ought to be bought and sold so that production might proceed--outputs of production on the one side, are also the inputs for the next level of productive transformation on the other: Wheat becomes flour, flour becomes bread; iron ore becomes steel, steel becomes machinery, buildings, automobiles, and household appliances. Such activities used to contribute to generation of surplus, but their monetization is not part of after-tax profits.

Purchases of stocks and bonds would once have been seen as investment for the long haul. Trade in commodities would have been seen not as investment, but as purchases and sales.

With what are now called derivatives, we move from investment, and purchases and sales of hard commodities, to speculating on the future price or yield performance of what were once investments, and relatively simple, economically necessary transactions.

All derivatives are actually variations on futures trading, and, much as some insist to the contrary, all futures trading is inherently speculation or gambling. Thus until late in 1989, all futures trading, of any sort, was outlawed in Germany, under the country's gambling laws. Such activities were not treated as a legitimate part of business activity. And, who will contend against the observation, that Germany did quite well without them?

There are two types of futures trading; each can be applied to each of the instruments, like stocks and bonds, which, bought directly for cash, monetize what used to be after-tax profits. The first type is, as it were, a second step removed from economic activity as such. This is futures trading per se: contracting to buy or sell at a future date, at a previously negotiated price. Here the presumption used to hold, that commodities, for example, would actually change hands for money, as the agreed-on contracts fell due.

The other kind of futures contract, called an option, moves another step further away from economic activity as such. Now what is bought or sold is the right, but not the obligation, to buy or sell a commodity, stock, bond, or money, at a future price on an agreed-on date.

Where the futures contract speculates on what the price that would have to be paid against delivery will be, the option simply speculates on the price.

At yet another remove from economic activity per se is an index. An index is not the right to buy a commodity or stock in the future which is traded, but the future movement of an index based on a basket of stocks, commodities, bonds, or whatever.

Futures contracts

Since financial deregulation in the 1970s, futures contracts have been developed for things that are not assets or commodities. The first move was the introduction of futures contracts on foreign exchange rates. In May 1972, the International Monetary Market of the Chicago Mercantile Exchange (CME) began trading in the first financial futures: futures contracts on the British pound, Canadian dollar, German mark, Dutch guilder, Japanese yen, Mexican peso, and Swiss franc.

In October 1975, the CBOT introduced trading in the first futures on interest rates, on the Government National Mortgage Association's (GNMA) mortgage-backed certificates. In January 1976, the CME began futures trading in 90-day U.S. Treasury Bills. Trading in futures contracts on 15-year U.S. Treasury Bonds began on the CBOT in August 1977. Trading in such interest rate futures, as they are called, quickly grew to become the most heavily traded futures contracts in the world. On the CBOT, trading in Treasury bond futures and options has risen from 28.3% of total volume in 1981, to 64.4% of total volume in 1991.

In February 1982, futures contracts for indexes of asset values began trading, with the introduction of futures contracts based on the Value Line Average Stock Index, on the Kansas City Board of Trade. Two months later, the CME began trading in the Standard and Poor's 500 Stock Price Index, which is now one of the most heavily traded futures contracts at the CME. Trading in this contract is considered so important, that the CME set up a special room in a different building to allow continued trading in the S&P 500, when the CME was forced out of its building by the flooding waters of the Chicago River in May 1992, closing trading in all other futures contracts. Not coincidentally, the S&P 500 Stock Price Index futures contracts is one of the instruments the U.S. Federal Reserve has reportedly used since October 1987 to reverse collapses on the New York Stock Exchange.

Oher Derivatives

For example, swapping a floating rate Swiss franc-denominated obligation for a fixed-rate dollar instrument between banks, involves the Euromarket, the currency markets, the swap market, and perhaps also the interest rate futures and/or options markets. The intrepid might want to try to calculate how far we now have moved from the first level of cash purchases of stocks and bonds.

An interest rate swap is a transaction in which two counterparties agree to exchange two different types of interest payment streams based on an underlying notional principal amount. For example, assume that a bank with a portfolio full of adjustable rate mortgages (ARMs) wished to receive an income stream of fixed-rate interest payments. The bank would package together, say, $10 million of such mortgages, all paying interest currently at 6.5%, and exchange the ownership of the interest payment stream from that package of ARMs with a corporation that would give the bank in return the ownership of an interest payment stream fixed at, say, 8%. The notional principal amount of the swap would be $10 million, but the actual amount of money that exchanges hands would be limited to the interest payments each counterparty owed to the other over the life of the swap.

Swapping of interest rates is said to have begun in connection with the Eurobond market in the early 1980s, when high interest rates dictated that only the highest quality borrowers could qualify for long-term, fixed-rate financing. Borrowers of lesser quality, who were excluded from such financing, were able to obtain it indirectly through swaps.

However it was not until the U.S. Student Loan Marketing Association (Sallie Mae), began using swaps in 1982, that they began to be widespread. Sallie Mae was seeking a way to avoid having to borrow longer-term, higher-priced funds, to lend out for shorter terms at lower rates. The swaps used by borrowers in the Eurobond markets proved to be the perfect vehicle for Sallie Mae, which, as a quasi-government agency, is perceived by the markets to be an extremely high-grade borrower. The first swap for Sallie Mae was arranged through an investment bank in the summer of 1982, with ITT as a counterparty. ITT reportedly saved 17 basis points (17@nd100 of 1%) in borrowing costs in the deal.

Currency Swaps

In the 1970s, a small number of currency swaps were arranged that were not related to central bank activity. A U.S. dollar/French franc swap, for example, was arranged for the Republic of Venezuela to help meet payment obligations arising from the construction of a commuter rail system in Caracas. The details of these swaps were largely kept from the public view, for fear of disclosing proprietary operating information.

After the debt bomb exploded when Mexico threatened a debt moratorium in 1981, however, the World Bank widely publicized a swap arranged by Salomon Brothers between itself and IBM. The motivations of the World Bank and IBM to conclude the transaction made the swap exceptional at the time. The World Bank was seeking to maximize the rate of interest on its debt, and IBM was seeking to hedge its Swiss franc and German mark debt, while at the same time capturing a paper profit from the appreciation of the dollar against both currencies. As Michael Wood, senior manager of International Financial Markets at Dresdner Bank in Frankfurt, noted in the 1992 textbook Cross Currency Swaps, by Lehigh University professor Carl Beidleman, it was ``the first time that a currency swap was used to arbitrage between capital markets, that is, where a capital market issue was done solely for the purpose of swapping into another currency.''

And then there are caps, floors, and collars, options on the anticipated interest rate movements which make up the swap:

• Caps, in which the buyer will receive from the seller the difference between current interest rates, and some agreed-upon rate, in the event interest rates move above the agreed upon rate. In return for thus limiting its exposure to interest rate increases, the buyer pays to the seller a onetime fee.

• Floors, in which the buyer is protecting himself from decreases in interest rates. That is, if interest rates fall below an agreed-upon level, the seller is obligated to make up the difference to the buyer, in exchange for the up-front fee paid by the buyer.

• Collars, in which the buyer of a cap simultaneously sells a floor at the same time, or vice versa, with the object of maintaining interest rates within some defined band.

• Currency forwards are perhaps the simplest derivative instruments, and perhaps the one with the greatest utility for companies involved in producing and shipping goods in foreign trade, given the insanity of floating exchange rates. Assume that Boeing has sold an airliner to Lufthansa. Rather than go through the trouble of converting the deutschemarks paid by Lufthansa into dollars--and being subjected to the risk of changing exchange rates if Lufthansa is paying Boeing back over a period of time--Boeing pays a fee to an intermediary (a swap dealer) to find a German company that has sold something in the United States that is of comparable value to the Boeing airliner purchased by Lufthansa. Let us assume that Siemens has sold some power-generating equipment to a U.S. utility. Under a currency forward, the utility that had bought equipment from Siemens, will pay dollars to Boeing instead of Siemens, and Lufthansa will pay deutschemarks to Siemens instead of Boeing. In other words, Boeing gets Siemens's U.S. income stream in the United States, in exchange for which Siemens gets Boeing's deutschemark income stream in Germany.

  Thus, the definition of a currency forward is a contract in which two counterparties agree to exchange differently denominated income streams at an agreed upon exchange rate at some point in the future. There is no swapping of principal involved.

II. How Derivatives Grew

According to the October 1992 report of the Bank for International Settlements, Recent Developments in International Interbank Relations, ``since the mid-1980s, the growth of turnover and of volumes outstanding in markets for derivatives instruments, including over-the-counter (OTC) markets that offer more customized products, has outpaced the growth of most other financial activity.'' As seen in Figure 1, by 1988, the ``notional principal amount'' (referring to the value of underlying assets) of derivatives outstanding had exceeded the total market capitalization of the New York Stock Exchange. By 1989, the notional value of derivatives outstanding was almost one-third larger than the total market value of all publicly listed companies in the United States. By the end of 1991, the notional value of derivatives was soaring toward being double the market capitalization of all U.S. publicly listed companies.

In other words, if the phenomenal growth rate derivatives exhibited from 1986 to 1991 has continued in the past two years, the amount of derivative paper outstanding--none of which is carried on corporate balance sheets--is now somewhere around twice the total market value of all publicly listed companies in the United States.

That financial derivatives have grown to such an extent is all the more amazing, considering that these instruments simply did not exist 25 years ago. The largest single type of derivatives, interest rate swaps, did not get off the ground until the summer of 1982. Futures on currencies did not come into use until May 1972. Interest rate futures first came into being in October 1975.

Oddly enough, there are no official figures available for the dollar volume of futures trading in the United States. Not even the Commodities Futures Trading Commission, the federal government agency charged with regulating the futures markets, has figures for the dollar volume of futures trading. Neither do the Chicago Board of Trade or the Chicago Mercantile Exchange, the two largest futures exchanges. The only figures available are for the number of contracts traded (Figure 2).

By multiplying the number of contracts traded of a certain basic type--agricuultural commodities, precious metals, energy products, currencies, and financial products--by an average price for each basic type, EIR has estimated that the U.S. futures markets have an annual turnover of around $25 trillion. This is a major revision from EIR's original estimate of $152 trillion, published in December 1992. Still, it demonstrates that the futures markets dwarf the New York Stock Exchange, which had a market capitalization of $3.713 trillion, and total value of shares traded of $1.520 trillion in 1991.

The futures markets are also some five times larger than the U.S. Gross National Product, which was $5.519 trillion in 1991.

These gigantic markets are highly concentrated, with a mere handful of firms completely dominant. A report by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corp., and Office of the Comptroller of the Currency, Derivative Product Activities of Commercial Banks, issued on Jan. 27, 1993, revealed that the ten largest commercial banks in the U.S. control 95.2% of all derivatives activities by U.S. commercial banks (Figure 3).

The same situation probably exists on the investment bank side. In a listing of the 40 largest institutions in the futures markets, ranked by customer equity (the futures markets define equity as the residual dollar value of a futures account, assuming it were liquidated at prevailing market prices), in the March 1993 issue of Futures magazine, the five largest were investment banks: 1) Merrill Lynch Futures, Inc. ($2,176.9 million); 2) Goldman Sachs and Co. ($1,581.3 million); 3) Shearson Lehman Brothers, Inc. ($1,527.7 million); 4) Dean Witter Reynolds, Inc. ($1,120.1 million); and 5) Prudential Securities, Inc. ($1,106.1 million).

These were followed by 6) Refco, Inc. ($1,071.3 million); 7) Morgan Stanley and Co. ($844.7 million); 8) Cargill Investors Service, Inc. ($804.5 million); 9) Daiwa Securities America, Inc. ($588.5 million); 10) PaineWebber Inc. ($576.2 million); 11) Bear Stearns Securities Corp. ($539.4 million); and 12) Salomon Brothers, Inc. ($488.6 million).

Of these firms, the three with the largest net adjusted capital (the amount of liquid capital established by Commodities Futures Trading Commission capital requirements) were Salomon Brothers ($999.6 million), Goldman Sachs ($963.6 million), and Shearson Lehman ($859.4 million).

EIR's revision of its estimate of the size of the futures markets means that the largest market in the world remains the foreign exchange, or currency, markets. In March, the Bank for International Settlements (BIS) issued a new report, Central Bank Survey of Foreign Exchange Market Activity in April 1992, which states that foreign exchange trading increased 42% from 1989 to 1992, to an estimated $880 billion per business day. This figure includes derivatives trading in currencies (i.e., futures contracts on currencies, swaps, and options), but also excludes offsetting positions. The actual total gross turnover reported by the 26 central banks which conducted the surveys, was $1.354 trillion a day.

According to the BIS report, London now trades more dollars and deutschemarks than the United States or Germany does. London has increased its share of world trading, from 25% or $187 billion in 1989, to over 40% or $300 billion in 1992. Trading in London is also increasingly concentrated, with the 10 most active banks in the City of London accounting for 43% of trading in 1991, compared to 36% in 1986, according to a report issued last year by the Bank of England. That means 10 London banks accounted for 18% of all world currency trading in April 1992 (Figure 4).

The second largest currency market was the United States, reporting a daily volume of $129 billion in 1989, and $192 billion in 1993. Japan was the third largest, with daily volume in April 1989 of $115 billion, and $126 billion in 1993.

The fifth and sixth largest markets were two key members of the British Commonwealth: Singapore and Hong Kong, with $76 billion and $61 billion in daily trading in April 1992, respectively. If the figures for Britain, Singapore, and Hong Kong are added together, it will be seen that the British Empire controlled almost exactly half of the $880 billion in foreign exchange trading that took place every day in April 1992.

In December 1992, for the occasion of the meeting of the finance and bank ministers of the Group of Seven, the BIS issued a new estimate of daily world currency trading, of $1 trillion a day.

III. Two Case Studies
Derivatives and Agricultural Commodity Trading

How much does the trading activity on the futures markets contribute to ``making the economy more efficient?'' Just how many grain futures contracts--covering corn, wheat, oats, soybeans, barley, and sorghum--that are traded on the futures markets, are real, representing the movement of agricultural produce, and how many are purely speculative trades?

Most American farmers will tell you that the agricultural futures markets, whether for grain, livestock products, oilseed products, orange juice, coffee, or sugar, are the farmers' worst opponents, forcing the price of grain products down below production cost. Only 5-15% of farmers even bother to use the futures market to sell their products.

Normally, in theory, the agricultural futures market would work in the following way. A wheat farmer, at planting time in the spring, might see that the price of wheat is but $2.25 per bushel. He might buy a September or December wheat futures contract (a ``put'') that will pay him $2.75 for his wheat at the month at which the contract expires. This way the farmer has guaranteed himself a minimum price for his wheat when it comes time to sell.

However, most farmers know that the theory does not work out that way in practice. The eighth largest futures trading firm in America, for futures trading of all kinds, is Cargill Investor Services, Inc., run by the Cargill grain cartel. The 34th largest futures trading firm is ADM Investor Services, Inc., of Archer Daniels Midland. They directly manipulate prices against the farmer.

Consulting the statistics provided by the Commodity Futures Trading Commission, which regulates the futures and options industry, in 1992, there were 17,552,356 grain futures contracts traded. Of that total, only 64,200 were settled by delivery/cash settlement, meaning that the actual grain produce of the contract was taken for physical delivery. That is but 0.36% of all contracts traded.

However, at the level of the farmer selling his grain to an elevator, for each sale of real grain--called a hedge--there has to be an offsetting speculative trade to make the market. So, on that first level, there are 128,400 legitimate trades. Then, the local elevator usually sells the grain to the sub-terminal or terminal, such as in Omaha, Nebraska or Kansas City, Missouri, and sale by the local elevator operator must be offset by a speculative sale. Plus, the sub-terminal or terminal might have to sell the grain one more time. So, there are three times 128,400 contracts which can be considered legitimate. That is 2.2% of all trades; so 97.8% of all trades are purely speculative, having no connection to the real process involving the farmer and his produce. They involve speculators, often linked to the grain cartels, moving paper back and forth, attempting to capture spreads, or drive down the grain price for farmers.

The Bank of New England blowout

The January 1991, failure of the Bank of New England (BNE), which had until its collapse been one of the 10 largest bank holding companies in the United States, provides a good example of the way federal regulators have propped up the banking system, and of the risks faced by banks which play in the world derivatives markets.

The collapse of the speculative real estate market, which virtually wiped out the Texas banking system in the late 1980s, spread to New England by the end of the decade, bringing to a close the speculative bubble known as the ``Massachusetts miracle.'' Boston-based BNE, which had lent heavily in the regional real estate market, suddenly found itself with overwhelming losses on its real estate portfolio. The bank, which had grown rapidly thanks to the real estate bubble, was dying with the collapse of that bubble.

In October 1989, BNE, which then had $31.4 billion in assets, announced plans to dramatically downsize the bank through massive asset sales and employee cutbacks. The plans included selling some 10% of its branches, closing loan production offices in Chicago, New York, and Philadelphia, and reducing its work force by more than 20%.

In late December 1989, BNE took the extraordinary step of rescinding a previously announced 34@ct quarterly stockholder dividend. The step was forced by federal regulators, who were already making preparations for the inevitable failure of the insolvent bank. Federal regulators also threw out the chairman of the bank, and replaced him with an interim chairman, H. Ridgely Bullock.

In early February 1990, in an attempt to calm public fears and prevent depositor runs, Bullock declared that the bank was ``off the critical list and getting better.... We're in a fix-it mode. We're not going to be as big, but we're going to be better.''

BNE was not ``off the critical list,'' however; the only thing keeping its doors open was a massive covert bailout from the Federal Reserve. By the time Bullock made his statement, the bank had already received nearly $1 billion from the Fed.

Beginning in mid-January, the Fed had begun pumping vast amounts of money into BNE via loans from the Boston Federal Reserve. Federal Reserve statistics show that the Boston Fed lent banks in its region $478 million the week ended Jan. 24, compared to just $3 million the week before. While the Fed does not reveal to which banks the money was lent, it is clear that most, if not virtually all, went to prop up BNE.

The weekly bank lending by the Boston Fed rose dramatically in the following weeks: $440 million the week ended Jan. 31, then $723 million the next week, then $930 million, and $1,280 million the week ended Feb. 21. During each of the next seven weeks, the Fed pumped between $1.5 billion and $1.85 billion into the bank; by April 11, the Boston Fed had lent $15.6 billion to its regional banks, the vast majority going to the Bank of New England.

By March, after some $5 billion of bailout funds had already been injected into the bank, the Office of the Comptroller of the Currency and the Fed issued formal cease-and-desist orders to the bank. The Fed order stipulated that the bank could not pay stock dividends without permission from the Fed--a requirement that had already been in effect for more than three months!

Even more comical was the bank's admission in its second quarter 1990 report to the Securities and Exchange Commission, that it may need government assistance to survive. This, after some $18 billion had already been funnelled into the bankrupt bank!

The end for the Bank of New England came on Jan. 4, 1991, when Chairman Lawrence Fish told federal regulators that the $450 million loss the bank suffered in the fourth quarter of 1990, had wiped out its $225 million in equity, making the bank officially insolvent. At this point, the bank had just $23 billion in assets, and had fallen from 10th place on the list of largest U.S. banks, to 33rd place.

Not surprisingly, the announcement triggered massive depositor runs at the banks, with long lines forming at its corporate offices. Two days later, on Sunday, Jan. 6, 1991, federal regulators officially closed the bank. Federal Deposit Insurance Corp. Chairman William Seidman estimated the ultimate cost to the agency of the failures at $2.3 billion, at the time the second most costly bank failure in U.S. history, after the 1988 failure of First RepublicBank Corp. of Dallas.

Why did federal regulators pump more than $18 billion into the Bank of New England, and then close it? If they were going to close it anyway, why did the regulators keep the bank open for a year after it was insolvent?

The answer is: derivatives.

The Wall Street Journal, in a June 18, 1991, article by Craig Torres, revealed that regulators had propped the bank up for a year in order to unwind its portfolio of ``off-balance sheet'' derivatives transactions.

``Everybody knew we had $30 billion in assets'' on the balance sheet, BNE head of treasury operations Arthur Meehan told the Journal. ``But nobody but a small cadre of regulators and analysts knew we hand $36 billion in off-balance sheet activity.''

During November and December 1989, before BNE publicly revealed the size of its fourth-quarter losses, BNE chief currency and derivatives trader David Pettit was able to trim his off-balance sheet exposure by $6 billion; getting rid of the remaining $30 billion was not so easy.

The bank, under the close supervision of federal bank regulators, began attempting in January to cash out thousands of derivative transactions. However, as word of its financial troubles spread in financial circles, banks all over the world denied BNE credit, and demanded cash up front. Not surprisingly, this is when the Boston Fed began pumping money into BNE.

Having become a pariah on world financial markets, BNE enlisted the help of Shearson Lehman and Prudential Securities to help it unwind its currency swaps on the Chicago Mercantile Exchange's International Monetary Market. By doing so, Meehan acknowledged, ``we moved the risk out of the interbank system into the exchanges;'' but had we not, he said, regulators would have been forced to take over BNE's trading positions.

By the end of 1990, BNE had reduced its derivatives portfolio to $6.7 billion. A week later, the bank was closed.

The collapse of the BNE nearly sent the global banking system into ``gridlock,'' the Journal warned, adding, ``It all sounds far-fetched. But that's just what nearly happened, federal regulators say, in the months before they seized the Bank of New England.''

If BNE, with its $36 billion in derivatives, nearly sent the global banking system into gridlock, imagine what would happen were Citicorp, with its $1.4 trillion in derivatives, to fail.

``For certain banks there is a lot of exposure'' in the derivatives market, a senior examiner at the Office of the Comptroller of the Currency told reporter Torres. ``If we had a real problem with one of the larger banks, a meltdown scenario would be a possibility.''

That meltdown scenario is not just a possibility. It is, in fact, well under way.

The History of the Fight Against Derivatives

Farmers had opposed the highly destructive effect of options, one of the earliest forms of the derivative market, starting in the 1920s, long before they became as large as they are today; even then, farmers still exercised significant influence within the United States. In 1933, an attempt was made to manipulate the wheat futures market using options, which resulted in an opportunity for farmers to force the U.S. government to ban trading in these options. There were attempts to re-introduce trading in agricultural options during the 1970s, but the plan met with only limited success.

It was only in January 1983, when President Ronald Reagan signed the 1982 Futures Trading Act, that the ban was officially lifted. This was a major feature in the disastrous Reagan-era deregulation of the U.S. economy.

America had, for a short time, a small financial transaction tax, and the fight to impose a larger financial transaction tax was very intense in the late 1980s. Throughout the 1950s and early 1960s, the United States had a low-rate transaction tax--called a stamp tax--on the issuance and transfer of stocks and debt. The tax was repealed in 1965.

Rumblings from Congress

Also in the 1989-90 period, during discussion of the 1990 Budget Reconciliation Act, Sen. Lloyd Bentsen, then chairman of the Senate Finance Committee and now secretary of the treasury, raised a proposal for a transaction tax on selected financial instruments on the floor of the Senate.

In February 1990, partly in response to the furor over this issue, the Congressional Budget Office, in its report ``Reducing the Deficit: Spending and Revenue Options,'' had a section on pages 388-89, entitled ``Impose a 0.5% Tax on the Transfer of Securities.'' Its analysis of the tax reported that ``the tax would have to be broad-based, applying to stocks, debt, options and trades by Americans on foreign exchanges.''

In June 1993, Rep. Henry Gonzalez (D-Tex.) proposed an investigation of derivatives high roller George Soros, and the derivatives phenomenon. Derivatives, Gonzalez told the House on June 10, is ``a fancy name for a ... contract in which two parties agree that they will bet on the future value of some market activity--futures--all the way from some commodity, to such things as the currency futures which are volatile ... Is there money out there in these international markets for the procurement of goods, for firing the engines of manufacturing and production? No. It is paper chasing paper.''

What Other Nations Have Done

• In 1986, the government of Sweden doubled its equity transaction tax, which is the tax on trade of stocks on the Swedish stock market. In 1989, Sweden extended the tax to futures and options trades. The effect of this new tax was to substantially reduce the trading of futures on Sweden's Stockholm market. Furthermore, the tax closed the Swedish Option and Future Exchange (SOFE) for two years. But in 1990, apparently under pressure from financiers, Sweden abolished the derivative tax, and trading in the derivatives market exploded, helping to deepen Sweden's financial problems.

• Until as late as 1989, the German government held firm and refused to legalize the trading of some financial derivatives within the country. As a result of pressure from the trading of German government bond futures in the London markets, amendments to Germany's gambling law in 1989 made changes and permitted retail participation in derivative markets, followed by the opening of Germany's first financial exchange, Deutsche Terminbo@aurse in 1990.

• At present, derivative taxes are assessed in Finland, France, Hong Kong, and Japan, although, on the whole, they are not very large. The exception is France, which assesses a significant 2% transaction fee. So far, however, the fee is only used to finance the annual budget for CMT, the French regulatory body for the futures and options markets. Once the CMT's budget requirement is met, the fee is no longer levied.--Richard Freeman

Derivatives Create Mass Global Unemployment

Unemployment, which was already at high levels globally throughout the 1970s and 1980s, has exploded within the past six years, the very time that the derivatives market has risen within the United States from a few trillion to currently $12 trillion outstanding, with a yearly trading volume of greater than $125 trillion. The derivatives market is the leading edge of the global financial bubble, which has caused mass unemployment and underemployment of between one-half and three-quarters of a billion people around the globe. About 55 million are unemployed in the advanced sector, and above 500 million in the developing sector.

In the U.S.A., the official unemployment rate was 4.4 percent in the decade of the 1950s, 4.7 percent in the decade of the 1960s and 7 percent today. In the 12 nations that make up the European Community, the effect is even more dramatic; unemployment has risen from an official rate of 2.0 percent in 1965 to 11.8 percent today. If one adds the officially reported unemployment levels for the European Community of 12 nations to the levels of unemployed in Canada, Japan, and the United States, then the total level of unemployment in the West, with the addition of Japan, is a staggering 29 million people. But even that enormous official number is an understatement: The unofficial, real unemployment level is somewhere between 50 and 55 million. This represents a criminal waste of resources. The European Community reports that just a shade under one-half of the 17 million officially reported unemployed European workers have been out of work for one year or more.

Terrified that they cannot think of how to put their own people back to work, at least two countries, France and the United States, have in the last month initiated discussion of immigration restriction laws.

As the table shows, in every nation but Japan, unemployment has skyrocketed since 1989. To some nations with a large labor force, Canada's officially reported level of unemployment of 1.6 million may not seem much; but consider that against Canada's working population of 13.9 million, this represents 11.4 percent of its work force. Six European Community members have an officially posted rate of greater than 10 percent. They are: Britain, 10.5 percent; Italy, 13.6 percent; France, 10.9 percent; Spain, 21 percent; Ireland 19 percent; and Denmark, 11.5 percent.

The most worrisome part of the explosion in unemployment since 1989 is the layoff of manufacturing workers. In 1989, the United States had 19.39 million manufacturing workers; today it has 17.82 million, a loss of 1.56 million. In 1989, according to the British Information Office, Britain had 5.1 million manufacturing workers. In January 1993, it had only 4.1 million--a loss of one-fifth in four years. Britain is truly the junk-heap of Europe. In the western portion of Germany, between 1989 and the present the number of manufacturing jobs declined from 7.203 million to 6.977 million, a loss of nearly a quarter million. An estimated 1 million manufacturing jobs may have been lost in the former East Germany during this same time frame.

And these are only the official figures. The United States, for example, reports 8.858 million unemployed, representing 6.9 percent of the labor force. But if one adds in 6.580 million workers who work part-time for economic reasons, and 6.378 million workers who are ``not in the labor force,'' but who answer government surveys saying that ``they want a job,'' the total number of unemployed and underemployed is 21.816 million. For a labor force of 128.3 million, that is 17.0 percent, not the official U.S. government figure of 6.9 percent.

If the real unemployed in the other nations under consideration are brought to light, the total unemployed in the West, with Japan, is between 50 and 55 million.

Unemployment in East Bloc and Developing Sector

Take the case of Poland, where IMF conditionalities and the speculative/derivatives market are raging at the same time. Just a few years ago, in this nation of 39 million people, with a labor force of 20 million, unemployment was less than half a million, though some of the jobs were of poor quality. Today, the official unemployment level is 2.3 million, and many believe it is two to three times that rate. 43 percent of all households can food only on the condition that other expenses are cut down to a minimum, or are not even paid, such as rents and electricity bills.

Mexico, where speculator George Soros has been a big player causing the gigantic speculative run-up in the Mexican stock market, is another exemplary case. In Mexico, today, the government reports an official unemployment rate of 2.9 percent. Nobody believes this. In 1980, Mexico had a labor force of 22 million and an official unemployment level of 3.5 million. Since that time, 10 million workers entered the work force, but the economy has stagnated. These 10 million workers are either unemployed or part of the burgeoning ``informal economy,'' i.e., street vendors, criminals, etc. If one adds this 10 million, the unemployment and underemployment level is 13.5 million. There are 2 million additional uncounted workers in the agricultural sector who are unemployed or unemployed. The final result: Mexico has 15.5 million unemployed or underemployed in a labor force of 32 million; nearly 50 percent unemployment. Such levels of unemployment, or only slightly lower, exist in many Ibero-American nations. With an Ibero-American workforce in 1990 of 174 million, assuming an unemployment rate of only 33 percent for Ibero-America, then the level of unemployed and underemployed on that continent is 58 million.

Finally, China and India are two other examples. Both countries are the victims of forced underdevelopment which is the flip side of the speculative derivatives markets. In 1990, together these two huge nations, had 1.987 billion people (37 percent of the world total), and a combined workforce of 1.003 billion (41 percent of the world total). In July 1993, the Chinese Ministry of Labor reported that China has already 170 million surplus agricultural laborers and the number will swell to 400 million by the year 2000. Between 100 to 150 million of these agricultural workers, swarm in mass migrations from city to city desperately looking for work and food. They are the human fodder that is fed into China's slave-labor special economic zones to keep workers' wages at 10 cents an hour: If a worker doesn't want to take a job at that level, an unemployed agricultural worker surely will. Moreover, while some of China's 92 million member industrial workforce is employed in special economic zones, the backbone of old smokestack industry is cracking, and large numbers of Chinese are being laid off there. Total unemployment and underemployment in China exceeds 250 million.

In India, the government admits an unemployment rate of 11 percent, which in a country with a 323 million workforce is 30 million. But in India, 70 percent of the farms are less than 1 acre, a very small area. This means that there is a good part of the year, when there is nothing for the Indian farmer to do on his small plot of land. About 65 percent of India's agricultural population is underutilized if not downright unemployed. Many of them look around desperately for other work. One could conservatively say that the level of unemployed and underemployment in India is 80 million.

In Africa, proportionally, the numbers are as large

In each and every instance, the conditionalities of the IMF and the imposition of Anglo-American speculative markets, led by derivatives are the cause of this misery. The suffering is needless: shut down the derivatives markets and return to the Great Projects perspective of infrastructure building and technology transfer, and the world suddenly has the availability of one-half to three-quarters of a billion of human beings to rebuild it.