Home for Christmas

I’ll be home for Christmas. Well, not exactly home, although I drove my wife and sleeping son by my old house in Homewood this afternoon. It was brutally cold outside, but it was warm in the car, and we didn’t want to interrupt his nap (thank God gas prices are low again).

It is always good to be in Chicago for the Christmas holidays, because it really seems like Christmas here. It is cold, it is snowy, and it is always festive to be around the family.

Things seem pretty good in my family, although storm clouds are on the horizon. The roads were crowded with Christmas shoppers, even in near-blizzard conditions, but Linens and Things was having a going-out-of-business sale (Everything Must Go!), and there were other signs that things aren’t as good they seem.

The economy is slowing down, but why does it have to slow down? Why does our economy have to suffer? Sure, some folks are overextended, but can’t we all figure out a way to make this a soft landing? Some folks I talk to think that the government should just let the car companies go out of business. I am not among that crowd.

I think we need to keep as many jobs as we can around, keep as many paychecks going out as possible, keep grinding it out so more people can keep living lives of quiet satisfaction. I know a lot of Republicans condemned the president for the bailout, but if I have a criticism of this administration, it is that they have not been really straight with the American people about the problems this country faces.

We are in deep trouble. And the reason is because of something called derivatives.

According to Wikipedia, “derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, equities, stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, or other derivatives). Credit derivatives are based on loans, bonds or other forms of credit.

The value of a derivative is supposed to be closely associated with the value of the underlying asset. But it is not. The derivative market has completely gone out of country over the last five years.

Imagine, for example, if you were playing a poker game. At the beginning of the poker game, everybody put in a hundred bucks, and got back chips that were worth a hundred bucks. Now, imagine that during the game, more chips came into the game, the value of those chips were not tied to actual dollars, but to the perceived value of the chips. Soon, more chips come in, and bets are not made on the cards, but on the value of the chips, which soon explode in value. At the end of the game, the perceived value of a hundred dollars’ worth of chips becomes worth a million dollars. Now, let’s imagine that people have bought things of value with those million-dollar chips (a boat, a house, etc.), but when it comes to pay up, nobody in the game has a million dollars. That is basically what has happened with the derivative market. I am not exaggerating.

For example, the gross domestic product of the United States in about $15 trillion. The U.S. money supply is also about $15 trillion. The current proposed U.S. federal budget is $3 trillion. The U.S. government’s maximum legal debt is $9 trillion. The U.S. mutual fund companies manage about $12 trillion. The world’s GDPs for all nations is approximately $50 trillion. The unfunded Social Security and Medicare benefits are $50 trillion to $65 trillion. The total value of the world’s real estate is estimated at about $75 trillion .

The 2007 valuation of the world’s derivatives is now a whopping $516 trillion.

This is the kind of stuff that makes Ben Bernanke and Hank Paulson lose sleep at night. The reason that banks are holding on to their money is the same reason that the poker players would desperately hold onto their portion of the chips: They don’t know the true value of the portfolios. They know it isn’t worth what they thought it was worth. They know they could be in serious trouble. And they know that the derivatives market, a market that Warren Buffett once called a financial weapon of mass destruction, has really screwed them and their customers.

This is the bubble to end all bubbles. And that is why the government is doing all it can to keep GM alive and to keep the credit markets from completely freezing up.

We are in a brave new world here financially. Let us hope that we can weather this financial storm through an orderly unraveling of bad trades, bad bets and bad decisions.

I don’t know why I think of this as I enjoy a great Christmas holiday with my wife, my son, my dog and my entire extended family. But I worry what the next year will bring, and I wonder if it will be as bad as all the experts seem to fear.

In any event, I will continue to count my blessings, of which there are many, as I prepare for the new year. And I hope you do too.

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