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Quote of the Day
“In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal,”
-Warren Buffett. One of those derivatives owes its creation to an event on this day in 1989. This day in 1989 the Exxon Valdez ran aground, leading to the worst oil spill in American waters at the time. The potential for massive losses due to the Exxon Valdez oil spill led J.P. Morgan bank to create a credit default swap to offload the firms exposure to Exxon risk.
March 24th – This Day in Stock Market History
March 24th, 1792 – The Panic of 1792 reaches its peak. The day prior William Duer was thrown in debtors prison after his speculation in The Bank of The United States Shares, and the uncovering of owing the government more than $250,000 (in 1792 dollars, about $6.1 million today). The resulting loss of confidence leads to bank runs and panic. On this day alone 25 banks would fail. The panic would take down some of America’s wealthiest families at the time.
A New York city judge at the time wrote to a friend: “Duer has failed for three million dollars, and has taken in almost every person in the city…How it will end God only knows; it has put a stop to general business”.
The Panic would be slowed by Alexander Hamilton using the U.S. Treasury to prop of stock and bond prices until markets calmed in April.
March 24th, 1989 – Exxon Valdez tanker runs aground in Alaska, leading to the worst oil spill in American waters (at the time).
The oil spill would cost Exxon around $3 billion (most of which were covered by insurance on the tanker), and $500 million in penalties.
Despite its large cleanup costs, the spill had very little long term impact to Exxon’s stock price. Shares slipped about 10% over the next 2 weeks, but recovered within a couple of months.
The spill also lead to J.P. Morgan creating the first credit default swap. Exxon was facing as much as $5 billion in fines (though that would be reduced to $500 million after nearly 2 decades in court!) and reached out to J.P Morgan for a line of credit to help pay for potential penalties.
J.P. Morgan lent Exxon the money, but would have been on the hook for billions in losses if Exxon were to fail. In response, J.P Morgan created the first credit default swap, sold to the European Bank of Reconstruction and Development, to protect itself in case Exxon would go bankrupt due to the penalties.
Best March 24th in Dow Jones Industrial Average History
1905 – Up 2.39%, 1.36 points.
Worst March 24th in Dow Jones Industrial Average History
2003 – Down 3.61%, 307.29 points.
Read of the Day
20 years after the Exxon Valdez spill, those derivatives used to protect J.P Morgan would nearly bring down the world economy. As mortgage bonds lost value, many firms saw their financial condition worsen. Worse yet, it was unclear how much credit exposure those firms had to those struggling or failing firms through credit default swaps and other derivatives.
Micheal Lewis does a decent job in his Book, The Big Short discussing how these risks made their way through the financial system in 2009, and almost brought down the entire economy. Check the book out here (under $1 used!):
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