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More Than Meets The Bottom Line: Are Banks Getting Crushed Due To Negative Swap Spreads And The $154 Trillion IR-Derivative Market?
Lots of confused chatter in the bond community as to why the negative swap spread story (anywhere between 7Y and 30Y) is being largely ignored by the media. After all, the associated market, which according to the BIS was roughly $154 TRillion in June 30 makes the Greek bond debacle and various sovereign CDS discussions in the media pale in comparison. As several bond traders pointed out, the likelihood of negative spreads having been modelled out by the TBTFs is very low, if any, meaning that unhedged bank IR-swap exposure is suffering massively, and is likely to surpass all record past prop desk losses. In fact, rumors abound that a few of the desks having placed leveraged bets on spread divergence over the past months and years are currently in critical condition, yet nobody is discussing this for fear of another round of bank run concerns among the TBTF banks. What is odd, is that the Primary Credit borrowings are now at almost financial crisis lows of just under $9 billion, leading many to speculate that banks now satisfy all of their short-term funding needs via the fungibility of excess reserves (and indicating once again that the Fed's discount rate hike was the most irrelevant action in a history of irrelevant actions). And just in case there is still confusion as to what negative swap spreads mean, here is a useful primer.
From Morgan Stanley:
The big news is that 10y swap spreads (Swap Spread = Libor Rate - UST Yield; e.g. 10yr swap spread = 10yr Libor Rate - UST 10yr yield. This spread has always been positive, today it is negative implying that UST 10y yields have risen above 10y Libor rates) have fallen below zero (Exhibit 1). But the bigger questions are how do we define value in spreads and how much more inverted can 10y spreads go? At the height of the crisis in 4Q08, 30y swap spreads got to -41bps and have remained inverted ever since. The inversion of 30y spreads had more to do with technical, exotic and hedge-related factors. But those elements are missing from the inversion of 10y spreads. That's what makes it interesting. Today we view the inversion in 10y swap spreads as a harbinger of the massive supply of UST debt that will ultimately drive yields higher.
What drives swap spreads?
Back in the late 1980's and early 1990's, swaps were a ground-breaking innovation. It was a “magic formula” to turn long-term liabilities into short-term liabilities. ABC Company would issue (that is, pay an interest rate) on, say, 10yr debt in the market, then receive a 10yr fixed interest rate in the Libor market while simultaneously paying a 3-month floating Libor rate (Exhibit 2). And voila, ABC Company 'swapped' a long-term fixed liability for a cheaper and easier to manage short-term liability. Magic! But things were simpler in days of yore. Swaps were a less volatile vehicle used by corporations to manage cash flows on their debt. They used swaps because they could customize the end dates of their fixed cash flows, rather than relying on US Treasuries with their pesky issuance cycles and inherent technicalities. For example, 10y spreads from 1992–1997 trade in a range from 28bps to 41bps, pretty narrow. But this simplicity allowed us to understand what drove swap spreads. These factors were primarily:
- The spread between Libor and repo rates
- The slope of the yield curve
- The US deficit and UST supply
The first point argued that Libor rates should be higher than UST rates because there was a 'repo-specialness' premium between UST’s and Libor. The second point refers to corporate issuance: if the curve steepens, then corporations are more likely to swap their long-term liabilities at higher rate levels into short-term liabilities at lower rate levels. The last point refers to the relative level of UST issuance. If the US economy slows and goes into a deficit, then the US will issue more Treasuries to fund itself, therefore narrowing swap spreads (Exhibit 3). Currently, we have a high 9.9% deficit to GDP ratio and correspondingly, a $2.4Tr gross issuance of UST’s in 2010.
What has changed?
Later in the 1990s and over the last decade, the swaps market took on increased importance not just as a hedging vehicle but also as a speculative vehicle. What drove swaps over the past 10 years has been hedging the interest rate sensitivity in mortgages. But today, a case can be made that mortgages are less interest rate sensitive than in the past (i.e., less negatively convex). The reason is that households may be less able to refinance their mortgages for a given change in interest rates, because refinancing is more related to FICO scores, credit availability, loan-to-value, incomes, etc. We believe swap spreads will narrow and remain inverted as interest rates have stayed low and stable, volatility has fallen, spread products have been narrowing, and there is little hedge-related need to pay fixed in swap. Add to that the old-time reasons, which are becoming more popular drivers of swap spreads today, of reduced specialness premiums, tighter repo-Libor spreads, steeper yield curves and monstrous US Treasury supply. All of which become the contributors to 10y swap spreads moving negative. Oddly, the tight level of swap spreads is a look back into the future. But the inversion of spreads is the new twist.
Morgan Stanley's conclusion is that, independently of our concerns, US Treasury rates are about to spike. To be sure, MS has been pushing for high rates and major curve steepending for a while: recall it is their call that the 10 Year will hit 5.5% this year.
The issuance of UST debt is dwarfing Libor-related issuance. For example, we expect UST net issuance to be $1.7Tr and net issuance of MBS to be zero. Thus, the relative issuance of UST’s vs. Libor-based products mainly accounts for the inversion in swap spreads. This is a first sign of stress leading to higher UST yields and is not to be missed.
And back to our question: is there currently a massive P&L hit to some or all of the Big 5 US banks as a result of this very much unexpected inversion? While surely the full $154 trillion or so amount is not applicable to the 7Y+ inversion, the OCC as of its most recent report does indicate that there is $27 Trillion in Interest Rate swaps outsanding with a maturity greater than 5 years.
And when looking at IR holdings by bank, it would seem that JPM, Goldman, Bofa, and Citi are most impacted. While JPM, GS, BofA, Citi and Wells have about $131 billion in IR swaps among them, more relevantly, JPM, Goldman and BofA have $9, $7 and $5 trillion in >5 year IR swaps. This is very troubling.
Maybe some of those fantastic financial analysts who were telling the general public to buy Lehman a few days before its bankruptcy, and are now saying financial companies will quadruple over the next few years, can do something useful for a change and ask the executive teams of the above mentioned banks 1) how big their exposure to negative swap spreads is and 2) what the negative P&L impact as a result of this unprecedented spread inversion is?
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WOW! So, should there be further upside rate pressure, does this mean the Bond Bubble is fully exposed?
It is not as if no one was able to see this coming. See The Next Step in the Bank Implosion Cycle??? - http://boombustblog.com/200910271188/The-Next-Step-in-the-Bank-Implosion-Cycle.html. I warned about FX and IR swap exposure last year. Goldman is trading at an extreme premium from a risk adjusted book value perspective.
As a result of a surge in interest rate and Forex contracts, dependency on revenues from these products has increased substantially and has in turn been a source of considerable volatility to total revenues. As of 2Q-09 combined trading revenues (cash and off balance sheet exposure) from Interest rate and Forex for JP Morgan stood at $2.4 trillion, or 9.5% of the total revenues while the same for GS and BAC (subscribers, see BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb) stood at $(196) million and $433 million, respectively. As can be seen, Goldman's trading teams are not nearly as infallible as urban myth makes them out to be.
Then there is always my favorite graph:
Reggie,
All I wanna hear is that JPM is soon going to explode in a gigantic supernova that will take the Fed, Goldman, AIG, UBS, HSBC, Citi, and BofA with it, leaving behind a white dwarf that we will name "God's work".
Well, I don't have anything against JPM, and I think Dimon is one of the better bank CEOs, but if you clicked on my blog link above you will see that they may have some issues....
What's amazing is that when I first posted this story (last year) it didn't gain the traction that I thought it should. There are actually those who really believe that our big banks are going to shoot through the stratosphere unscathed because their stock prices went up last year. These are fairly bright people, too. Really makes you wonder...
I think everyone knew it would be a problem. It's just a matter of identifying the russian roullete scheme and we sort of all knew it was taking place in the swaps. It's just a matter of watching it all unfold in greece, portugal, spain, us, uk, ireland, dubai. etc etc. Just because they are using a different gun doesn't mean that exactly what happened in russia is not going to happen everywhere.
In your chart you've got JPM at 21 billion notional derivatives above the rest of the planet. It should be 21 trillion.
Also, you have to have units listed on the left side y-axis.
reggie are you familiar with these: Auction Rate Preferred Securities (ARPS)
MS got me into these but told me JPM was the market maker?
they failed on february 13, 2008. i lost 100'sK, poof gone.
class action laws suits abound, but i am interested in how they were concocted and sold. i was told they were muni's and tax free in my state. tried to sell them for months and they just kept saying OHHH this market has just dried up? how can a market like this just dry up? they were in highway improvement I-470 and a hospital.
ARS are the leveraged portion of closed-end bond funds. The fund managers lever to buy munis and pay interest on the borrow. This interest is cash flow to the bank and gets securitized and sold to retail clients as a 'cash alternative' with weekly liquidity. (Hint: anything with weekly liquidity has no market and is not an alternative to cash.) JPM was one of the market makers for these, basically all the banks swore they would provide a market for them, but in Feb 2008 they decided they didn't want them on their books, so stopped providing liquidity.
Didn't the big brokers buy all of these back from their clients at par as part of some settlement? I know Wachovia/Wells did.
AUCTION RATE SECURITIES - CLASS ACTION UPDATE
No they didn't. i transferred my account out of MS into TDAmeriatrade. it was just a mess. giving me the run around. FUCK BANKS. though when i would call in to sell the day before auction and than it failed i received a hell of a interest rate like 15%, so i was trying to feed that animal. one i had was $150,000. so i was making my mortgage for sure with the penalty rate. so how did that happen, well it stopped about 6 months later. 08 was a very dumb down time in my brain. could not imagine i would ever get my principal back. 08 had some pretty tumultuous times indeed.
It's hard to look at the interdependance for underlying swaps and not get the impression that without some type of backstop like the FED, exposure (leverage) would have to be limited.
If one large counter party goes bankrupt, there will be a cascade, an interlinking between firms. Is this not the difinition of systemic risk?
When will the FED grow up and properly address derivatives?
Mark Beck
whoa, SWR you and i really really have one major desire in common. i want JPM to be brought down, so badly. i meditate on their demise daily. i have followed that bastard when it starting devouring up all the banks in the midwest† funny GS doesn't bother me very much.
One of the tinhat theories that makes a lot of sense to me is this one: before the final explosion, all of the bad stuff will be crammed into one giant "bad bank", and when "bad bank" fails, it takes all the buried bodies with it, tying up documentation safely for decades in BK courts, leaving "good banks" standing and the rest of the banking industry smelling like roses. Now I think it's reasonably certain that "bad bank" ain't GS, and it sure as hell ain't gonna be the Fed, in spite of all the tixic waste on its balance sheet. It might be Citi, but I am rooting for JPM.
but curious dimon is touted as the new rock star of WS.
my parents bought LOTS of bank stocks living in the midwest. chase started with bank one. then many more. by the tiime my parents past away in 1999, their portfolio had something like 30Ks worth of JPM chase stocks. frickkin dimon comes out with this gloom and boom statement and the stock plummeted. i think it was his break up with sandy weill or he was establishing himself. bank one was in charge of my father's trust and fucking it over. the estate had to pay on the amount at time of death, and than we went to sell it to pay the death tax, nada worth. i know dimon, been at a party with that stupid scum. how can any one go in front of a congressional committee hearing and say such a stupid ass thing as “my daughter called me up on the phone and asked what is a financial crisis, daddy? i mean with a stupid straight face this schmooze gets away with this. free hall pass. that is when i lost all hope for any reform. what is it, these men think he is distinguished, therefore he is? later
Velobabe, SWRichmond, one of your ZH conversations has been discussed over at FOFOA: Defending a Virtual Currency , way down in the comments of this post.
Discussing holding some cash to protect your PMs.
A strategy I am employing myself.
Sounds like you need to get long physical gold, Velo, and familiarize yourself with FOFOAs' writings. Plenty of tips on suppliers over on the IMF - Sprott ZH thread.
My commiserations regarding your losses. Just as well it was only money eh? Could be worse.
TBTF - enjoy it while it lasts, assholes.
Thanks for the data, Reggie and Tyler.
Strangely, I don't think one actually needs all the detail to see where all this is going. But it doesn't hurt.
That's a tinhat theory? Sounds entirely plausible to me.
+1000
+1000
Thanks TD and Reggie. This is why I turn to Zerohedge. To get the real news as well as the best analysis.
It looks to me like it's time to drive the Stock Market down, and push everyone back to the safety of Treasuries. The way that they've driven up the Dow, they should have some room to spare for now.
Thanks Reggie, it was mentioned on Zero Hedge about a year ago.
http://zerohedge.blogspot.com/2009/03/is-gs-tempting-interest-rate-black-swan.html
Tyler and Reggie,
I was in like diapers back then.
Oh shoot, I just shit again.
I am short the market- right today- and right now,
Poco
Big 5 will be small 5 very soon.
And I'll be laughing all the way to thier head office's with my pants down ready to piss on whoever answers the door.
After that and after I'm arrested, send Geithner to prison y'all.
Practice resisting arrest.
You need to pull you're pants down to piss?
On a banker, Yes!
Maybe some of those fantastic financial analysts who were telling the general public to buy Lehman a few days before its bankruptcy, and are now saying financial companies will quadruple over the next few years, can do something useful for a change and ask the executive teams of the above mentioned banks 1) how big their exposure to negative swap spreads is and 2) what the negative P&L impact as a result of this unprecedented spread inversion is?
I would very much like to have question two answered, as this is way over my head.
Me too. Is it as simple as $100M annual loss per basis point on each $1Tr notional? This would assume no settlement with a zero spread. On $5Tr and with a 10 bp negative spread that's a $5B loss...not a big deal. But the question is are the contracts of the form Libor - UST + 10/25/50 basis points. Anyone know? In this case, and if spreads go further negative, it's easy to see losses in the hundreds of billions. Then what--Fed purchases which would drive rates down further? Also, what is the maturity of the contracts--are they multi-year or less?
Great article TD, thanks.
If there are huge losers on IR swaps, there are also huge winners on the other side. Who and where are those huge winners?
The winners pool is ever narrowing.
Who's holding the debt free end of the strings used to make the strawmen dance?
You're assuming the losers will pay. Remember, this stuff is OTC. Who were the winners in the Ambac and MBIA swap deals?
See the following from 2007:
- Tie-in to the Halloween Story11/21/2007
- Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion in Equity 11/29/2007
- Follow up to the Ambac Analysis 12/4/2007
Now follow up on this news stories yesterday in Bloomberg: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aElPhqrcHVLU and http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aUQr94wN4dqg Ambac clients are receiving 25 cents on the dollar, Ambac is still going bankrupt, and as is usual, it wasn't hard to see this coming THREE years ago. Just as I warned on this, I am warning y'all about these banks! ... and I'm still waiting for these guys to get their comeuppance!A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton -11/13/2007
click on any graph to enlarge it.
And then...
Looks like we are finding out who took the other side with PIMCO...
The market is too fragile for the MSM to be reporting on this stuff... LOL
I don't think there is a Lehman-type apocalypse here (not saying that you implied such), because of SWAPCLEAR settlement and collateral.
The curve steepener trade is a separate issue, right?
Yes there is, jm.
It is 4 to 6 countries before the heat turns to these United States. End game- because of some smart kids that defined and created cdo's cds's and were accepted in a small group called Greed.
Poco
What I'm saying is that a swap steepener trade isn't processed through swapclear because it's not a swap. Unwinding a steepener trade would screw somebody sideways with a jackhammer.
Everyone has their own pet theory was to why this is going on. But I've seen it in gilts myself, and a good sensei told me it happened in Japan. No system blew up. I am surprised it happened to the 10Y.
I think it is because allows more capital efficient yield than treasuries, which lock up capital.
You do realize that Japan was a creditor nation with a growing export economy to the US, right? The Japanese government was still reaping from the benefits of trade with the US, which kept the Japanese tax base from falling off a cliff. Japanese savers then bought JGBs as an act of patriotism during the lost decade. At the current and even projected rate of US Treasury issuance there is simply not enough capital in the world to soak up all the excess. Remember that Japan's massive foreign exchange reserves were only accumulated as a result of surfeit US consumption, when that unwinds look out below for the dollar.
Once again, the SEC isn't interested, because this doesn't involve bodily fluid swaps.
Yeah, very troubling for taxpayers.
This is why I like reading your posts. You cut through the BS and get right to the heart of the matter. :-)
All derivatives are a ZERO sum game but the diversity of players in I-rate swaps say versus the CDs mkt is vast. Corporations and other issuer related entities that imbed the swap with liabilities will not be affected. I suspect some large hedge funds are probably pressing the pants off of the dealers that might be trying to defend, like JPM, who put out a very simplistic report today saying the anomoly will correct after Q end and buy treasuries and TY notes....nothing to see here, move along..
All derivatives are a zero sum game until the loser defaults, at which time it becomes a zero win game.
All derivatives are a zero sum game because we, the taxpayers, pay off on the contracts...
Classic. Assuming 10% hit on that $27 trillion= $2.7 trillion would be enough to wipe out any and all bailout funds not being currently allocated for election bribes.. oops.... foreclosure abatement... I meant most of the federal budget.... err does not compute.... mushroom clouds. Surely all of these beasts were hedged.
If I were a betting man, which I am by the way, Iwould bet that the spread will normalize soon either because LIBOR goes higher or UST goes lower.
Tyler, Tyler, Tyler....don't you remember, IRS are completely and totally benign, no more dangerous than fluffy bunnies and cute puppy dogs, they would never hurt anybody. Who cares about "notional" value? Besides, BIS says they "net" to zero global exposure.
(chuckles fiendishly)
Why don't you illuminate this thread as to the ramifications of swap spreads going negative ? I fail to see how the situation today is any different than what it was yesterday, or the day before that, or the day before that. You clearly think there is a new problem brewing so please share your thoughts, tell the rest of us dummies something we dont already know
there is a lot of jargon aus, but..its like this. Its a big deal because, in theory, Governments are a better credit risk than Goverments, and should pay more not less interest, since a) Governments can tax corporates and b) Governments can tax individuals.
Key difference between swaps and physical Government bonds is that you never have to front the capital on Govt bonds. But with swaps all you have to duns is the interest payments (fixed or floating) and the P/L from interest rates wobbling about, with collateral and/or cash.
What you have is an acknowledgement by the market that "interest only" loan are the preferred form of financing and, for example, you never have to pay pay back the principal on the mortgage. Just the interest.
You will have seen the mumble about Sovereign CDS. The cost of insuring US Governemnt debt if the Credit Default Swap market is higher than many corporates. Follow Tylers and Reggies stuff closely, even if you don't understand it and remember if it was that hard the market couldn't do it. He is right, most of the time, just (as with anyone else) cant get the timing or reflect the fact that miracles of growth and changes in economic theory do happen.
Final point, think on this. US companies are global and are tapped into developments across the globe. The US Government does it by invading and seizing assets, like oil or drugs (yes cocaine from Colombia and heroin from Afghanistan. So do other Governments like China, Russia, UK and France. Can make money on a risky basis or a bully basis. Take your pick.
I understand that, but when UK swap spreads went negative there was no market fall out, likewise in Japan. There have been EM corporates trading tighter than their sovereigns (eg Gazprom v Russia) for years..... I still fail to see how it is particularly relevant. Posters on here tend to think it is the harbinger of some cataclysmic event..... I think not.
Swap spreads are positively correlated with the level of interest rates. As it stands now the US Treasury must issue debt exceeding likely demand, this dynamic is to continue well into the future. A rise in interest rates of course would add even greater pressure to the dollar. Ultimately the value of a currency is based upon its perception. The US dollar is supposed to be the global safe haven and is judged as such by the greater international public, that is what separates it from the rest. When the hot money sitting in US assets decides to look for better returns elsewhere first or is forcibly withdrawn to cover various debts ...get ready for capital flight.
Obviously I could be in total fantasy land, yet, here is what I think is going on.
Ben and Tim kept our crooked bankers to unwind shyte and save there hides and solve the housing mess.......extend and pretend, one thing at a time.
Europe, which is so different culturally than us went in and fired the top 20% of all banking management. So, where did all these guys go. One would have to think a good chunk to hedge funds. Now why would they want them, I'm sure the smart and scrupulous ones know what strings to pull and when to make massive amounts of mullah.
And as you know, there's not a broker on earth who doesn't need the business and would have no clue as to what some smart guys are doing.
Look at the euro on a weekly chart, someone has a stranglehold on it, and has for since mid 08.
It sounds reasonable to me. That is exactly what I would do if I were them.
"That is exactly what I would do if I were them."
Ben and Tim?
If I were Ben, I would shave the beard and get a toupee.
If I were Tim, I would get a penile implant and take a vacation...
I think if anything this is a strong indication of higher Treasury yields to come
The Macro View
http://themacroview.wordpress.com
Could some of this be related to whatever MBS and CDO trash will be left on their books now that the Fed isn't taking any more of it off their hands at par? Perhaps they need to lock in their losses on the remaining toxic trash?
Gee, another messed up black hole financial? By doggies, who coulda imagined such a thing? Don't worry, Geithner or Bernanke or somebody will come ridin' in to the rescue, 'cause you gotta understand, boys, these big shots know just eegzactly what they're a doin' when it comes to all this fancy financial stuff.
In simple english, I think the rate of exchange between short and long was narrow. Somebody has figured out how to widen the exchange rate. Possibly uncontrollably. Blowing up the swap would then blow up the owner. Neat eh?
The perfect summary. Thanks.
The more complicated this crazy globalized world gets, the more we're lucky to have people in charge. Isn't that the real story?
Swaps have gone to zero at about the same time MBS spreads are at there narrowest. So there has be a connection to the two results. So why are MBS narrow to Treasuries? Because Treasury has been issuing tons of Govvies while the Fed was buying 1.25T of MBS. So that is supply and demand.Connect those dots and you have to get back to where the swaps have gone negative.
Logically you would not have expected the swaps with a minus. So you would be willling to write a very big put at around that area. No doubt that has happened. So when it goes negative it is function of someone or a group of someones puking really bad.
I struggle with these things, I guess this low spread maybe just very high demand for these swaps, I guess its speculative and maybe good for the P&L for the banks, The two questions need asking, If the answers are bad market to fraud accounting should sort it, Dont worry.
What is an IR swap for dummies like me, Is below right?
Am I correct, I buy a 10year T bond at 4%, To hedge against higher IRs I swap this bill for Libor + 2% 10 year swap, The bank or counterparty keeps the 4% yield and pays 2.5% at todays level pocketing 1.5% for the bet. I lose 1.5% for the protection, I would gain if Liboor goes higher than 2% I assume the $130tn is other swaps hedging the same bet, I guess it may not matter to the banks how things go win win like a bookie.
This is my dunce view of these things.
Whats that Dick? Lehman is still a buy?
This is why the "Let it burn" solution is so superior.
I think it's a function of a clear global trend: sovereign debt risk aversion. We're down the rabbit hole now and things are getting weird. In a nutshell, The Fed Follies of 2008 and 9 succeeded in 2 things: Flooding the pipes with liquidity and transfering credit risk from private to public balance sheets. Mission accomplished. Now we're paying the piper: there's a vicious cycle setting up whereby sovereign risk is compounded by massive issuance in a background of rising inflation risk. Gargantuan as that problem is the Fed at least had a cocktail napkin plan how to handle it, with Ben grinning at every Congressional hearing to reassure us that he's not crazy and all is going "according to plan". However a little voice just whispered "Houston, we have a problem". Just when Ben thought the sun was about to poke through and he could deploy his magnificent recipe for souffle with an exit strategy on the side there's a line out the door for more bailouts and emergency programs. And housing might be double dipping. And unemployment's up in 23 states. And today's final GDP showed alarmingly that growth is anemic and inflation pressures are emerging and growing. And the projections or Q1 2010 are worse. And the global picture has darkened: China is trying to prick a bubble and is shedding US debt. Euro nations and Japan got many many headaches and won't provide much steam for recovery or big capital flows for issuance. And there's the "sovereign contagion" anxiety. And QE is ending. April Fool's!
The massive liquidity didn't just water the flowers. It transformed the garden into thick muck. And the gardener just seems to think that more water is what the flowers need.
Obama should start getting nervous. Negative Swap Spreads and Lower Yields on Corporate Debt than Treasuries, certaintly do not bode well for our wonderful budget deficit...
The Macro View
http://themacroview.wordpress.com
This is a moronic post. By stating that the big banks have massive mark-to-market losses, you are implying that the big banks are/have been net-net massively paying fixed on their interest rate swaps, which you somehow justify via "rumors" that prop desks made this trade in size. Having a ton of notional outstanding swaps does not mean that they are paying on everything. Does somebody have losses due to negative 7-10 year swap spreads? Yes, some hedge funds and prop desks probably bet that it couldn't happen, and got smoked. But why would negative spreads mean that banks took it on the chin? This is a zero sum game. The quality of your commentary has gotten pretty weak recently.
Couldn't agree more and was scrolling down to write the same thing but you said it better. All this shows is that JPM et al have a lot of exposure, to counterparties through swaps. I think the fact that IRS swaps market has withstood the last few years shows that it's inherently functional.
Counterparty risk is a myth. No such thing as risk for "them".
+1
I think the fact that IRS swaps market has withstood the last few years shows that it's inherently functional.
By that reasoning, everything else is "inherently functional", too. U.S. Congress? Inherently functional. Left-Right political paradigm? Inherently functional. Federal Reserve balance sheet? Inherently functional. Donovan McNabb's passing game? Inherently functional.
All this shows is that JPM et al have a lot of exposure, to counterparties through swaps.
Yes, and no one on the short end of risk is taking a powder, now are they? If the fed dot gov can abrogate contracts, so can the rest of us out here in the hinterlands. There is no way in hell I'm allowing my state or municipality to pay you bloodsuckers.
By that reasoning, everything else is "inherently functional", too. U.S. Congress? Inherently functional. Left-Right political paradigm? Inherently functional. Federal Reserve balance sheet? Inherently functional. Donovan McNabb's passing game? Inherently functional.
Actually, no, by that reasoning it means that the IRS market is functional. Period.
Interest rate vol is significantly lower now than it has been, no ? The fact that the market has stood up, IMO, shows that it can withstand bouts of high volatility and low liquidity.
Yes, and no one on the short end of risk is taking a powder, now are they? If the fed dot gov can abrogate contracts, so can the rest of us out here in the hinterlands. There is no way in hell I'm allowing my state or municipality to pay you bloodsucker
1. I would direct you to the collateral and margining provisions under swaps clear
2. You call me a bloodsucker yet have no idea who I am or what I do
3. You must be seriously deluded if you think you have any influence, whatsoever, on who makes who good on IRS contracts
4. By your reasoning, the abrogation of all contracts means the financial system is soon to be anihilated ..... good luck with that.
5. What does "the short end of risk" actually mean ?
6. It is really boring when people highjack a relevant thread on the functionong of markets with hysterical crap and polemics. I'm sure you can find a better audience elsewhere
The IRS market is functional only to the extent that liquidity is available. Notice how especially during the mid-'07-mid-'09 period while the overall derivatives market had shrunk in notional terms, the IRS market had actually grown. Much of the capital held in other derivatives products and their underlying assets had decreased, while capital in IRS and their underlying assets increased during that infamous bout of "deflation". When municipalities and states start to default, whether they are allowed by the Federal government to abrogate a contract or not will not change the dire situation and the non-fulfillment of obligations.
In my opinion your brain has gotten weak "Bob". You sound like one of the dim-wits that thought parking botttom-tranche and equity exposure in kitchen-sink CDO's OBS was a bitching way to make money. You think the "moronic" IR swap turds at major banks give a shit about risk control versus this years pay-check. Are you a 22 year old MBA student? Why do you piss me off so much? Because blind-faith-in-nothing retards like you got us where we are today. 'Kay?
How exactly does my reasoning relate to CDOs (and what does OBS even stand for)? Dumb banks kept a lot of super-senior tranches of ABS CDOs on balance sheet because the economics didn't make sense to sell them (and in some cases they bought monoline/AIG protection). No one is going to argue that ABS CDOs were not a huge mistake by underwriters, investors, rating agencies, etc. If you are a dealer in interest rate swaps, your main goal is to make the bid-ask spread, not to take a massive position in paying or receiving.
In the light of day my post was rude and I apologize for that. Your righteous tone got me going a bit. OBS means off-balance-sheet to me. My point was/is that risk control at banks/dealers has proven weak to reckless. It is all about volume to the Banksters. To get ABS CDO’s done they kept the crap they couldn’t sell, often OBS in a SIV. CDS is the same story. They will tell you they sell/buy protection is any size and then rush to offload the risk with offsetting buys/sells. Not true. They actually end up with massive exposures, JPM included. So the idea that TBTF banks wouldn’t get massively exposed to IR derivatives because they stupidly eliminated the possibility of negative swap spreads from their idea of risk control is to give them WAY TOO MUCH credit, (think LTCM, Lehman, and AIG etc. etc. etc.). I’m not saying they are in trouble. I’m just saying it is more than possible, contrary to your assumption.
I am not looking to blindly defend banks, and I 100% respect Tyler's attempts to expose questionable behavior in financial markets. My sole point is that you can only cry wolf so many times, so it's important that you get the facts right when making accusations.
Tend to agree with Bob C and aus_punter.
Without knowing the net direction of prop bets by the large notional holders, how can you assume it will result in ginormous losses to the large notional holders (JPM et al)? What did I miss?
Reggie asks the right question, what is the per basis point effect of negative spread widening on P&L, but it seems early to identify this as a dire threat.
Obviously I'm missing something because I know ZH and Reggie don't just mail it in.
Swaps are not my expertise.
It is interesting that XLF had 2x avg volume today and about 70% occured in the last 30 minutes shortly after this blog entry posted.
Minimal Treasury auctions next week but I imagine we'll get another tsunami wave of supply starting April 5th.
If rates keep creeping up next week it could be pure panic time for the bond sellers...which also means pure panic time for equity sellers.
IMHO, if there are bank prop desks or hedgies who might have been looking for a widening of spreads, they are undoubtedly hurtin'....but the trend on this swap spread has been pretty clear for months...so I don't understand tha sudden uproar just because the spread has drifted thru zero...it had been heading that way very clearly....
the rise in govvie yields comes from the obscene issuance from DC and the lack of buying interest from Asian CBs...the fall in swap spreads results also in great part to the fact that there is no rush by anybody contemplating taking out loans to fix their rates by paying in the swap market...no investment=no borrowing=no swap paying=drift lower in swap rates....
furthermore...if you are an investor looking for fixed income exposure, you can obtain it by receiving it in swaps instead of buying Tim & Ben's script...
Uncle Fester:
I thought about this some last night. The steepener "trade" probably isn't an explicit trade... it would be implicit in being net short receiver on the front curve and being net long reciever at longer durations.
This has been going on in 30Y for a while now. So if this exposure profile was a big deal, wouldn't you see the spread narrow as banks reduce exposure?
I think this is due to hedging activity not against treasuries, but against something else. Lots of corporate paper out there.
for SW: it's a Champagne Supernova baby.
look at www.marketoracle.co.uk Today a post titled Sultans of Swaps part III is listed.
Its all about swaps and questionable acts.
Contained in this blog is a complaint link, I promise if its true its the biggest problem I have ever seen, ZH top arrows need to look into it, Its so big the MSM may bang on for decades over this if its true. Its the best scandalous financial event I have come accross if true.
Is it possible this is what Bernanke wanted (negative swaps)?
Put aside for a minute whether or not anybody would anticipate this...
Irving Fisher's debt deflation paper describes the bifurcation between "safe" and "unsafe" credits. It becomes the case of a chain being as strong as its weakest link, the blowout in spreads on the unsafe credit serves to reinforce the debt deflation spiral.
Throwing the US gov balance sheet behind anything and everything serves to counter balance this effect. It also leads to the "unicredit" world described by Bill Gross, which could be Bernanke's goal all along.
Now whether the prop trading desks and hedge funds would have anticipated this (versus just the opposite) is another question. You'd think the banks would be more clued into the end game, right?
Interesting, but I think you give the Feds and Bernanke too much credit. I think it is all about buying time for the Banksters. They know there are no solutions for the developed world: massive financial debts, massive fiscal deficits, trade deficits, outright movement to socialism etc. It is all about buying time so those "in-the-flow" can make/steal more money and prepare for the big blow-up. "They" are not smart enough to anticipate things like negative swap spreads blowing things up prematurely. Trust me. I have met people like Jamie Dimon face-to-face and J.P. Morgan is truly dead. I am making mine, and I am scared...
finally! the apocalypse! as was foretold by the oracle no less!
Jim Cramer wasn't around today to pump up any stocks. They had a repeat show I believe. Do you think it's because of the heat of the SEC investigation.
http://funy1.blogspot.com/2010/03/world-cup-is-near-time-to-kidnap.html
I-N-F-L-A-T-I-O-N! Faber & Rogers, anyone?
Hi sweety,
WILL I DO?
BOINGGGGG
In the age of "what me worry?", three things are certain here:
1. Someone will make (swindle) money despite this situation.
2. It won't be average Americans.
3. No one will ever admit that there is a cause for worry, until the greatly unanticipated, black swan, impossible to predict, gigantic earth quake tsunami, meteor has struck...
Remain absolutely calm...
My gut tells me that this next wave back into Treasuries will be the biggest long squeeze in recorded history, and then the whole boat capsizes beginning the third act of this tragedy we are living through.
Republicans will retake the Congress in Nov. and, with added tax breaks for the rich, bring back the economy to full prosperity.
Nothing like good old tickle-down economics as practiced by Reagan (who tripled the deficit) and Bush (who doubled it), eh. Neither party is here to save you, they are both acting in the interests of Wall Street above all.
The members of the Council on Foriegn Relations and the Trilateral Commission are not worried, so neither am I.
They weren't worried in '07 either were they?
Bid-rigging scandal in the muni bond market:
http://www.google.ca/search?hl=en&tbo=p&tbs=nws%3A1&q=bid+rigging+municipal+bond+market&meta=&aq=f&aqi=&aql=&oq=&gs_rfai=
We need more derivitives this isn't complicated enough.
Yeah, there's at least 3 posters here who still think they know what's going on.
Golf clap for a great shot
ahaha. Why dont we just open an emerging markent based on fairy tales. We can then go around selling fariy dust for awhile. But some people will get nervous that the fairy dust market is risky and we'll have to invent FCSs to help hedge against that. Little did we know that GS and JPM have been choping up their fair dust holdings and selling the off the credit risk labeled as investments. And then..
Aw fuck it, I really dont care anymore.
Buy adult pampers.
-What role does/could LIBOR manipulation play here? You know when you call a dealer desk to price an illiquid bond and you get the big "unchanged!" Is there really any more rigor that goes into the quotes that make up a LIBOR rate? Don't know, just asking.
-Also, how much actual inter-bank lending goes on these days when banks can borrow cheaper in mega quantities from their respective central bank?
-The big underlying story is obviously the credit risk issue(s) surrounding US debt but is it possible something else is at play here?
Thanks Tyler.
Excellent Article. Thanks.
I believe there are no honest men left in Washington or Wall St. I don't believe Ben & Tim are smart enough to control their bladders sufficiently to keep their pants dry, so I certainly don't give them credit for understanding the "craps game" that rate swaps and the other derivative gaming devices produce. I for one would like to turn the treasury department over to the Vegas casino crowd, and put the investment bankers and federal reserve presidents and directors in jail. I know we would get a fairer deal from organized crime than we get from power hungry,fucked up political sycophants who change the rules when they get in trouble.( Try doing that to the mob and see how long your body remains above room temperature!) The finest thing we can hope for in the not to distant future is that the "reset button" gets pushed sooner than later and that the the "masters of the universe, presently in power ends up like the looting bureaucrats in Atlas Shrugged. By the way, John Galt is actually Ron Paul!
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One of the tinhat theories that makes a lot of sense to me is this one: before the final explosion, all of the bad stuff will be crammed into one giant "bad bank", and when "bad bank" fails, it takes all the buried bodies with it, tying up documentation safely for decades in BK courts, leaving "good banks" standing and the rest of the banking industry smelling like roses. Now I think it's reasonably certain that "bad bank" ain't GS, and it sure as hell ain't gonna be the Fed, in spite of all the tixic waste on its balance sheet. It might be Citi, but I am rooting for JPM.
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