Comments (13)

Apr 23, 2012

CPatters, this is a huge deal because it creates an institutional TBTF situation that, when push comes to shove, will cause a major shitstorm. I'm just watching patiently for this to go south fast.

Apr 23, 2012

There's really no one event that would render ALL those derivs worthless simultaneously is there?

Apr 23, 2012

I don't think that there is an event that would render everything worthless at once. I think part of the issue is that we do not know what is outstanding in what markets and for what underlying securities. If there is a ton of money on student loans and the bubble bursts, that's derivatives written against nearly a trillion dollars of underlying debt that will have to get executed with results that no one knows what the results will be. We don't know how much of those contracts are in equities, credit, forex, commodities and rates. We also don't know how many of these are exchange traded versus OTC (which is a private and opaque market). The point is that the pure exposure, if there is a significant adverse cause, would do far more harm than could ever be predicted nor will we know how much of those derivatives will be rendered worthless or fully paid out.

Apr 23, 2012

I'm gonna lose some sleep over this tonight. haha

Apr 23, 2012

Awesome article, it really put things into perspective for me. Thank you.

"death is nothing, but to live defeated is to die everyday" ~Napolean Bonaparte

Apr 23, 2012

This is only the 9 largest banks. I am pretty sure the whole derivatives market is in the quadrillions.

Apr 24, 2012

Well, I don't think the derivative exposure is in excess of a quadrillion. However, the fact that 5 backs account for 95%+ of the outstanding derivative exposure for US banks should say something about the systematic risk it poses for the system. I'd take a look at the OCC report on derivatives for the 4th Quarter and pay attention to page 28. It's pretty heady stuff.

Oh, and Zero Hedge is reporting that it's at 707 Trillion in size.

Apr 24, 2012

During my SA stint over the summer, I read a great research report from CIti that talked about this. You have to remember this is the notional amount not the net amount.

For instance Citi sells 50 Billion dollars of CDS contracts to JPM, JPM sells 45 Billion of CDS contracts to GS, Barclays buys 50 Billion of CDS contracts from Citi.

Hell the notional amount of derivative contracts can hit a Quadrillion or a Sextillion, but because all the banks trade with each other, the net amount will be a fraction of that number.

Apr 24, 2012
jimz:

Hell the notional amount of derivative contracts can hit a Quadrillion or a Sextillion, but because all the banks trade with each other, the net amount will be a fraction of that number.

Ultimately this.

Say you and I start off with $10. We each lend each other $10 a thousand times and a bunch of peripheral transactions, commissions, project financings, etc... are based on that. On paper, it looks like a lot, but if we need to get bailed out, we're only really getting $20 between us. So it is with the derivatives market. That's why the bailout made sense. The alternatives were (1) financial collapse...not an option... or (2) tracking down the money and bailing out every peripheral transaction rooted in that market, point by point, and I'm not sure even the FED can print that much money.

In another sense, the banks are supplying money in the form of credit, not unlike the government but with market constraints. Sort of. This is a Matt Levine topic, that's about as theoretical as I care to get.

Apr 24, 2012
UFOinsider:
jimz:

Hell the notional amount of derivative contracts can hit a Quadrillion or a Sextillion, but because all the banks trade with each other, the net amount will be a fraction of that number.

Ultimately this.

Say you and I start off with $10. We each lend each other $10 a thousand times and a bunch of peripheral transactions, commissions, project financings, etc... are based on that. On paper, it looks like a lot, but if we need to get bailed out, we're only really getting $20 between us. So it is with the derivatives market. That's why the bailout made sense. The alternatives were (1) financial collapse...not an option... or (2) tracking down the money and bailing out every peripheral transaction rooted in that market, point by point, and I'm not sure even the FED can print that much money.

In another sense, the banks are supplying money in the form of credit, not unlike the government but with market constraints. Sort of. This is a Matt Levine topic, that's about as theoretical as I care to get.

2 options (In 2008):

1) Bailouts for all: Unemployment peaks at 10%, stays between 7.7%-9.4% for 15 years, 15 years of no growth, shadow banking system now larger than ever, moral hazard issue now larger than ever, fundamental position weakens, larger crisis kicked down the road until 2014
2) No bailouts (Aka capitalism): Unemployment soars to 20%, market tanks, banks collapse, market clears, bad debts liquidated, prices bottom, growth hits 5% by 2011, unemployment down to 6% by 2011, 5% by 2013, strong V shaped recovery, shadow banking system issues exterminated, no moral hazard issues, fundamental position strengthens

Tough choice.

Apr 24, 2012

People will say this is not a problem because everyone is "hedged" but the reality is, as we saw in 08 specifically with AIG, is that the shadow banking system is a house of cards and can threaten the entire economy in a days time. In good times, one man's liability is another man's asset, but when shit goes south they all become liabilities.

This is why it's hilarious to see the shills on CNBC and even some on this site think that the worst of the crisis is behind us and that we are starting to slowly recover. All we are doing now is creating a another huge bubble, and when the market tanks in another couple of years the US will be forced to bailout the same firms it bailed out in 08 all over again.

Apr 24, 2012

for swaps, do they count the notional, or the market value?
seems like this would make a big difference

Apr 24, 2012
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