china declares war on derivatives, page-7

Maybe the following is a reason why gold has suddenly jumped. It could well be that some Wall Street issuers of derivatives are not going to clean up billions and billions of dollars from their victims. China appears to have screamed out, "Stop! Enough is enough."

Jim’s Mailbox
Posted: Sep 02 2009
By: Jim Sinclair
Post Edited: September 2, 2009 at 5:47 pm

Dear CIGAs,

This is a concise and important letter that I respectfully ask you to review. It is error free and a teaching tool that is second to none in my opinion.

You might consider spreading this around the net as it is a perfect argument to the flood of MOPE certain to come on this issue.

The above was written by Jim Sinclair at http://jsmineset.com/

Dear CIGAs,

These recent rumblings about Chinese Government State-Owned Enterprises ("SOEs") reserving the right to terminate certain derivative contracts could be the story of the year. I say "could" because the MOPErs are certain to do everything in their power to keep it from the public.

It’s too early to comment on exactly what is taking place. The news accounts are all over the map. However, I can tell you based on 25 years’ professional experience that you are right on the money in saying there are many fraud-based legal arguments that potentially give parties such as the SOEs the legal right to walk away from these derivative contracts.

The MOPErs have been quick to vilify the Chinese Government even though it is clear they do not know the facts and have not considered the legal issues. On Monday night after comments were first posted here on JSMineset about this story, I searched the web for additional information. I came across a Reuters article titled "Banks uneasy over report China state companies assert right to default of derivatives trades." That article contained the following statements:

(1) "It’s a handful of companies who are being encouraged by regulators to renegotiate," said a second banking source. It’s outrageous, but it’s China, so everyone is treading very carefully."

(2) "For banks that are hoping to sell more derivatives hedges in China, the world’s fastest-expanding major economy and top commodities consumer, the danger goes beyond the immediate risk to existing contracts to the longer-term precedent that suggests Chinese companies can simply renege on deals when they like."

(3) "Beijing-based derivatives lawyers said the so-called "legal letter" has no legal standing – [the State-owned Assets Supervision and Administration Commission] as a shareholder has no business relationship with international banks. "It’s like the father suddenly told the creditors of his debt-ridden son that his son won’t pay any of his debt," said a lawyer from the derivatives risks committee of the Beijing Lawyers Association."

These are incendiary comments that we can be assured are being read by the Chinese government. As you have stated many times in the past, it’s a very bad idea to go around hurling insults at the banker you have come to rely upon most.

Even more to the point, there would be nothing "outrageous" about the Chinese government giving notice to the sellers of these derivative contracts that it believes it has legal grounds to void the contracts.

More recent followers of this site may not know that Jim has been calling out these derivative contracts as being inherently fraudulent for at least a decade. Jim has focused on the fact that the sellers knew that even under the slightest pressure (meaning events not playing out the way the sellers expected them to) the sellers knew they wouldn’t be able to hold up their end of the bargain.

In my view "derivatives" is a fancy word for bets. The financial companies that sell them are basically bookies. These bookies, instead of holding onto the bets and/or laying them off to make sure the winners get paid, book them as profits and pay them out to themselves in executive bonuses. If they start losing the bets the company goes up in smoke. This is the AIG situation.

Another illegal aspect of these contracts is that they were in many cases developed specifically to allow risky investments by customers who by law should not be able to take on risky investments. These customers include treasurers for companies, states and municipalities, money market fund managers and pension fund fiduciaries. This is a subject covered at length by Frank Partnoy in his book, Fiasco, about his experiences selling derivatives on Wall Street between 1993 and 1995.

The financial companies make over-the-top commissions selling these contracts and their management earn bonuses based on short-term profits. Therefore, they have an enormous incentive to mislead customers with respect to the risks the customers are taking on.

As Jim and many other contributors to this site have stated in the past, what the Chinese Government appears to be doing now is exactly what the US Government should have done as soon as the derivatives mess started to blow up. This approach would have had the best chance of preserving the banking system and avoiding hardships to the general public. Instead, the Fed and Treasury adopted an exclusive strategy of funneling public money to the entities that created the mess in the first place.

The Chinese Government’s action therefore has the potential to expose how massively Western governments mishandled the crisis and rewarded the people who should better have been criminally prosecuted. Candidly, I won’t be holding my breath waiting for that to happen. So far, the general public has not been able to connect the dots on any of this.

It will be interesting to see how this plays out.

Respectfully yours,
CIGA Richard B

At http://jsmineset.com/