As stocks continue to climb and the U.S. economy sustains its third longest period of expansion in history, market forecasters are seeking clues for when our next crisis may strike. So far, three uncommon signals have them worried.
Here’s an explanation of the three uncommon signs causing alarm, and what they mean for your savings…
Sign #1: Resurgence of Synthetic CDOs
The riskiest plays on Wall Street are made using financial instruments known as derivatives.
Derivatives are named for how they “derive” their value from the underlying assets on which they’re based. They give investors the ability to leverage assets — that is, control large quantities of an asset without actually buying or selling it.
Depending on how the underlying asset performs, derivatives can generate either massive gains or crushing losses.
But it’s when big banks and financial institutions start gambling in derivatives that things become especially dangerous. And that’s exactly what happened in the case of our last crisis: A slew of “too big to fail” organizations took on excessive risk through derivatives (mortgage-backed securities and others), and they couldn’t shoulder their losses when the bets went bad.
Now one of the most potentially destructive derivatives is regaining popularity after being shunned by Wall Street for years because of its role in the 2008 collapse.
The derivative is called a synthetic collateralized debt obligation (CDO), and Citigroup is spearheading its resurgence.
Granted, post-2008 regulations do make the market for these kinds of derivatives less liable to spark another collapse, and Citigroup executives claim to be pursuing this endeavor responsibly (we can trust them, right?). But Bloomberg reports the positive trend toward CDOs is still a negative sign (emphasis ours):
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