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The Real "Margin" Threat: $600 Trillion In OTC Derivatives, A Multi-Trillion Variation Margin Call, And A Collateral Scramble That Could Send US Treasurys To All Time Records...

Tyler Durden's picture




 

While the dominant topic of conversation when discussing margin hikes (or reductions) usually reverts to silver, ES (stocks) and TEN (bonds), what everyone so far is ignoring is the far more critical topic of real margin risk, in the form of roughly $600 trillion in OTC derivatives. The issue is that while the silver market (for example) is tiny by comparison, it is easy to be pushed around, and thus exchanges can easily represent the illusion that they are in control of counterparty risk (after all, that was the whole point of the recent CME essay on why they hiked silver margins 5 times in a row). Nothing could be further from the truth: where exchanges are truly at risk is when it comes to mitigating the threat of counterparty default for participants in a market that is millions of times bigger than the silver market: the interest rate and credit default swap markets. As part of Dodd-Frank, by the end of 2012, all standardised over-the-counter derivatives will have to be cleared through central counterparties. Yet currently, central clearing covers about half of $400 trillion in
interest rate swaps, 20-30 percent of the $2.5 trillion
in commodities derivatives, and about 10 percent of $30 trillion in
credit default swaps. In other words, over the next year and a half exchanges need to onboard over $200 trillion notional in various products, and in doing so, counterparites, better known as the G14 (or Group of 14 dealers that dominate derivatives trading including
Bank of America-Merrill Lynch,
Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche
Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS,
Societe Generale, UBS and Wells Fargo Bank) will soon need to post billions in initial margin, and as a brand new BIS report indicates, will likely need significant extra cash to be in compliance with regulatory requirements. Not only that, but once trading on an exchange, the G14 "could face a cash shortfall in very volatile markets when daily margins are increased, triggering demands for several billions of dollars to be paid within a day." Per the BIS "These margin calls could represent as much as 13 percent of a G14 dealer's current holdings of cash and cash equivalents in the case of interest rate swaps." Below we summarize the key findings of a just released discussion by the BIS on the "Expansion of central clearing" and also present a parallel report just released by BNY ConvergEx' Nicholas Colas who independetly has been having "bad dreams" about the possibility of what the transfer to an exchange would mean in terms of collateral posting (read bank cash payouts) and overall market stability, and why a multi-trillion margin call could result in the biggest buying spree in US Treasurys... Ever. 

First, for those who are unfamiliar, here is what happens when an exchange (or a Central Counterparties) proceeds to trade OTC derivatives with any given counterparty (from the BIS):

CCPs typically rely on four different controls to manage their counterparty risk: participation constraints, initial margins, variation margins and non-margin collateral.

A first set of measures are participation constraints, which aim to prevent CCPs from dealing with counterparties that have unacceptably high probabilities of default.

The second line of defense is initial margins in the form of cash or highly liquid securities collected from counterparties. These are designed to cover most possible losses in case of default of a counterparty. More specifically, initial margins are meant to cover possible losses between the time of default of a counterparty,8 at which point the CCP would inherit its positions, and the closeout of these positions through selling or hedging. On this basis, our hypothetical CCP sets initial margins to cover 99.5% of expected possible losses that could arise over a five-day period. CCPs usually accept cash or high-quality liquid securities, such as government bonds, as initial margin collateral.

As the market values of counterparties’ portfolios fluctuate, CCPs collect variation margins, the third set of controls. Counterparties whose  portfolios have lost market value must pay variation margins equal to the size of the loss since the previous valuation. The CCP typically passes on the variation margins it collects to the participants whose portfolios gained in value. Thus, the exchange of variation margins compensates participants for realised profits/losses associated with past price movements while initial margins protect the CCP against potential future exposures. Variation margins, typically paid in cash, are usually collected on a daily basis, although more than one intraday payment may be requested if prices are unusually volatile.

Finally, if a counterparty defaults and price movements generate losses in excess of the defaulter’s initial margin before its portfolio can be closed out, then the CCP would have to rely on a number of additional (“non-margin”) resources to absorb the residual loss. The first of these is a default  fund. All members of the CCP post collateral to this fund. The defaulting dealer’s contribution is used first, but after this other members would incur losses. The default fund contribution of the defaulting dealer would be mutualised among the non-defaulting dealers according to a predetermined formula. Some additional buffers may then be available, such as a third-party guarantee or additional calls on the capital of CCP members.

Otherwise, the final buffer against default losses is the equity of the CCP. In order to calculate initial and variation margins, CCPs rely on timely price data that give an accurate indication of liquidation values. Clearing OTC derivatives that could become unpredictably illiquid in a closeout scenario could impose an unacceptable risk on the CCP.

Table 1 summarises the risk management practices of SwapClear, ICE Trust US and ICE Clear Europe, which are currently the main central clearers of IRS and CDS.

The gist of the BIS paper focuses not so much on the inboarding costs and concerns of migrating hundreds of trillions of products to CCP - a topic evaluated much more in depth by Nick Colas - the BIS does instead look at a hypothetical example of what may happen in the case of a "risk flaring" episode, and how much variation margin G14's may need to post:

As shown in the left-hand panels of Graph 2, estimated initial margins can vary significantly with prevailing levels of market volatility, especially for CDS. The upper left-hand panel shows, for example, that Dealer 7 would need to post $2.1 billion of collateral to clear its hypothetical IRS portfolio in an environment of low market volatility, similar to that prevailing before the recent financial crisis. This would grow by around 50%, to $3.2 billion, if volatility increased to the “medium” level seen early in the crisis, just before the rescue of Bear Stearns. And it would grow by around 150%, to $5.3 billion, if volatility increased to the “high” level seen at the peak of the crisis, amidst the negative market reaction to the US Troubled Asset Relief Program (TARP) and before government recapitalisation of banks began in the United Kingdom. In comparison, the bottom left-hand panel shows that initial margin requirements for the hypothetical CDS portfolio of Dealer 7 would increase by around 160% or 325% from $0.6 billion if the prevailing level of market volatility increased from low to medium or high. The total initial margins that the CCP requires clearing members to post are $33 billion (low), $70 billion (medium) and $105 billion (high) for IRS and $6 billion (low), $20 billion (medium) and $35 billion (high) for CDS.

 

Nevertheless, it seems unlikely that G14 dealers would have much difficulty finding sufficient collateral to post as initial margin. The diamonds in the left-hand panels show collateral requirements relative to dealers’ unencumbered assets, with different colours again representing different levels of market volatility. Even the requirements based on high levels of volatility do not exceed 3% of the unencumbered assets of any dealer for which it was possible to estimate this figure. Although many unencumbered assets held by dealers do not presently qualify as acceptable collateral for initial  margins, some of these could be swapped for assets that do qualify.

By contrast, dealers may need to increase the liquidity of their assets as central clearing is extended. The centre panels of Graph 2 show similar patterns in potential variation margin calls as prevailing levels of market volatility change. In the worst case, variation margins could be several  billions of dollars, which would have to be paid in cash within a day. These margin calls could represent as much as 13% of a G14 dealer’s current  holdings of cash and cash equivalents in the case of IRS. A five-day sequence of large variation margin calls that could be expected with a probability of one in 200 would equate to around 28% of current cash and cash equivalents in the worst case.

These results also have direct implications for the liquidity provisions of CCPs, as they would have to pay variation margins in the case of default of  a clearing member. Access to central bank funds in distressed circumstances would help to ensure that CCPs could make substantial variation  margin payments in a timely manner.

...

With a probability of one in 10,000, non-margin resources at risk from the failure of one particular dealer, two particular dealers or any dealer with sufficiently adversely affected portfolios would respectively be 20%, 37% and 42% of total initial margins for IRS, and 36%, 46% and 65% of total initial margins for CDS. If prevailing levels of volatility were high, these figures would equate to $21 billion, $39 billion and $44 billion for IRS, and $13 billion, $16 billion and $23 billion for CDS. By comparison, the G14 dealers contributing to default funds had equity of around $1.5 trillion as of 30 June 2010.

Alas, the problem is that the bulk of this "equity" is, for lack of a better word, worthless, as it is based on such assets as intangibles, and MTM-locked up assets, whose true value is far, far lower than where banks carry these. And of course, the need to sell them would come precisely at a time when everyone else would be selling. Which means that in the event of a market lockup, there would be no one on the other side of the trade, meaning the entire CCP experiment would likely collapse spectacularly, as nowhere near enough cash is available.

Next, we look at one of the "percentile probability" charts to determine just where the system is weakest, because these uber-6 sigma events tend to become the norm when TSHTF. According to the BIS, the absolute worst case scenario from a risk management standpoint is a 0.002% probability event, at which dealers could see $160 billion in total margin shortfalls across the IRS and CDS book. And there are those who wonder why banks are stockpiling cash for a rainy day...

The BIS issues a rather ominous warning at this point:

Even after incorporating expected shortfalls into initial margin requirements, however, a sizeable gap remains between the total margin shortfalls (relative to total initial margins) that could be expected with very low probabilities for CDS and equivalent shortfalls for IRS. CCPs clearing CDS may wish to make an adjustment to default fund contributions to ensure that this is taken into account.

Will dealers do this? Of course not.

While there is much more in the full BIS paper extract (found here), we were less than impressed with the methodology used to construct hypothetical CDS and IRS portfolios. In a nutshell, the BIS assumed a hedged book and matched-maturity positions: something, which every OTC trader knows, absolutely never happens, as the whole purpose of derivatives is to take low margin risk positions that coincide with the herd, and thus, not hedge (otherwise what is the point?). As such, we believe, that the full potential shortfall on the up to $600 trillion in gross notional is the full net exposure in the market at any time. Which we are convinced is well over the $160 billion 0.002% case (according to some estimates, between CDS (this one is easy - just look at weekly DTCC data) and IRS (this one is far more complicated), the net notional at risk at any given moment is anywhere between $2 and 8 trillion. And this is capital that the G-14 supposedly have handy for a rainy day?

And next, moving away from dry academia, we shift to one of our favorite authors, BNY's Nicholas Colas, who coinicdentally, discussed precisely this issue in his Friday edition of his Mornina Markets Briefing:

Bad Nightmares and Good Collateral

Summary: The rulemaking around Dodd-Frank is far from over, but one area of new regulation drawing a lot of attention is what to do about over-the-counter derivates trading. It is a huge market – some $600 trillion at the end of last year – and dominated by interest rate contracts, where the notional value is $465 trillion. Just a little perspective – the entire value of the S&P 500 is $12 trillion. If even a portion of this trading moves to a quasi-exchange structure, it will require significantly more collateral than is currently used to support this market. That is strongly bullish for sovereign debt, should these changes come to pass. This dynamic got us wondering what “good collateral” really means anymore. U.S. dollars and Treasury securities are the bedrock of trading collateral, but those assets might not work as well for this function in the next financial crisis as they have in the past. The reason is that sovereign debt is increasingly losing its “risk-free asset” status as developed countries – not just the U.S., mind you – issue more debt to stimulate their economies and avoid taking the pain for previous mistakes.

My longest lasting repeat nightmare, which this year celebrates its third decade festering in my psyche, is that I have failed a class in business school and therefore don’t actually have my degree. For the first 10 years after graduating I kept my diploma under my bed, so vivid was that particular dream. The actual class that causes this lingering worry was ‘The Pricing of Illiquid Securities,” focusing primarily on exotic mortgage backed bonds. It was part fixed income analysis, part options math, and wholly difficult to understand. I almost failed it. Almost. Thankfully it was pass/fail, and the transcript clearly has a “P.”

But pricing illiquid assets has become a popular form of reality TV, from PBS’ Antiques Roadshow to Pawn Stars to Auction Kings . The formula is largely the same – walk in with something obscure, and an expert will tell you what it’s worth and/or give you cold, hard cash for the item. The analysis is a combination of authentication, historical sleuthing and market analysis of likely buyers and the price they will pay. The head of a rare doll might fetch $10,000. An entire motorcycle, even if owned by a minor celebrity, might only be $5,000. Every item is different and has to be appraised on its own history and merits.

There has been a recent flurry of activity in one capital markets dedicated to oddball illiquid securities – the pricing and trading of over-the-counter derivatives such as interest rate contracts. The reason for the attention is the Dodd-Frank Wall Street Reform and Consumer Protection Act, which gave the Securities & Exchange Commission and the Commodities Futures Trading Commission the power to restructure the ways in which OTC derivatives trade and settle. The new rules aren’t out yet, and likely won’t be available until July, according to various press accounts. That said, there are a few “Hard points” to consider:

  • The global market for OTC derivatives is huge. According to the Bank for International Settlements, the notional amount of total contracts was $601 trillion at the end of 2010.
  • It is primarily an interest rate market. Of the $601 trillion, just over 75% ($465 trillion) is tied up in interest rate contracts, most of which are swaps.
  • This interest rate swaps market is still growing. The poster child of troublesome OTC derivatives, Credit Default Swaps, is down to just $30 trillion in notional value from $42 trillion in December 2008. At the same time, the market for interest rate contracts continues to grow, up to the previously  mentioned $465 trillion from $433 trillion in December 2008.

The reason all is this is significant is simple: a change in how these instruments trade, from strictly OTC to something that more closely resembles an “exchange” could involve market participants posting consistent and predetermined collateral in order to clear trades. That’s not the way it is done now. The major banks that drive this market have freedom to determine what collateral is needed both to initiate a trading relationship and to keep it going. See here for more details: http://www.risk.net/risk-magazine/news/2074073/margin-proposals-lock-usd2-trillion-assets.

All this brings up a whole host of interesting issues, such as how much collateral the major players in OTC derivatives will have to pony up in order to keep trading. It is impossible to come up with a number at this point, given that the rules are still being written and the market structures to support a new trading regime are not yet assembled. July 2011 was the initial target date for proposed rules, but it appears to be slipping. See http://www.businessweek.com/news/2011-06-01/wallstreet-asks-swaps-regulators-to-re-propose-new-rules.html.

Underneath this bubbling surface of regulatory confusion, however, there is an equally interesting existential topic: what is “good” collateral, anyway? In some ways, it is probably easier for a pawn shop to determine the appropriate price for a used electric guitar than it is for an exchange to decide what assets a market participant needs to post in order to transact buy/sell orders. In the spirit of a thumbnail case study, we went to the CME Group website and pulled what kinds of assets they consider “Good Collateral” and the haircuts they give certain types of assets. Before we review that data, however, it makes sense to consider what makes some collateral better than others. A quick list:

  • Good collateral should be something that everyone agrees is valuable. Basically, it is anything that you would rush to pick up off the street before someone else got to it. Gold, developed country currency, and fixed income instruments are all good collateral.
  • It shouldn’t vary too much in price, regardless of market conditions. Ideally it would appreciate slightly in value when financial troubles strike, since that is most likely when counterparties fail and you need the collateral to ensure a trade can clear.
  • It should be very liquid. Again, markets only really worry about the value of collateral when things are going south. That’s not the time to find out that South Florida condo real estate isn’t anyone’s idea of solid collateral.

The attached chart shows some assets that the CME considers “Good Collateral” and the haircuts it gives to those assets. The bigger the haircut, the more of the asset you have to post to support your positions. You can find them here: http://www.cmegroup.com/clearing/financial-and-collateral-management/. A few observations:

  • U.S. Government and agency paper is “King of the Hill.” Only two assets get no haircut: U.S. dollar cash and U.S. Treasury bills. Agency debt is a 3% haircut, and longer dated Treasuries are 3.5-5.0%.
  • Then comes developed country currencies and debt, at 5-9% haircuts.
  • Gold and the Mexican peso aren’t often put in the same risk category, but they are here. Both receive a 15% haircut, which means that in the eyes of the CME they have equivalent appeal as collateral.
  • At the far end of the equation are the Turkish lira (20%) and equities (30%).

Two things pop out to me from this quick analysis:

  • If there ever is an exchange-like trading mechanism set up for OTC derivatives, there is going to be a real run on U.S. government paper. The CME’s list of assets and haircuts tells the story – Treasuries are the most efficient way to fund collateral. The notional amount of interest rate swaps alone – some $465 trillion – is enough to swamp the $14.3 trillion of total government debt outstanding, let alone the $9.7 trillion that is actually available for purchase.
  • The whole notion of good collateral is very much anchored in the thought that U.S. sovereign debt is “risk free.” Whether or not that is true in the absolute sense is irrelevant. Remember that collateral needs to be at least crisis-resistant and preferably negatively correlated to asset prices during financial stress. With the U.S. government currently at loggerheads over how to deal with the Federal Debt Ceiling and the most likely path is to simply issue a lot more government paper, the time could be coming where Treasuries no longer fulfill the purpose of “Good Collateral” during crisis. They are just as likely to be the cause of a financial storm rather than provide shelter from the rain.

Bottom line: instead of wondering how to nudge the silver market (lower) or the ES and TEN contracts (higher), perhaps it is time for the key exchanges, which are obviously captured by the very same G14s on whose tithes their existence depends, to actually proactively engage in some risk-mitigation when it comes to the one biggest threat: not that of the measly several billion dollar silver market, but of the $600 trillion IRS and CDS market, which is and continues to be the biggest ticking timebomb in capital markets.  And on the other hand, if anyone is wondering what will cause the biggest run on US government bonds... ever... then as soon as every dealer is forced to be on a CPP, all one needs to do is a massive "risk-flaring" collapse which sends everyone scrambling to provide collateral. And since there is a 40-to-1 ratio of notional outstanding in OTC derivatives to total US debt, well, readers can do the math.

 

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Sun, 06/05/2011 - 21:46 | 1342245 philgramm
philgramm's picture

600,000,000,000,000? Seriously? It's like a video game. Yay!!!!!!!!

Sun, 06/05/2011 - 22:00 | 1342275 CPL
CPL's picture

Total worldwide derivatives market is around 1.4 Quadrillion dollars.

 

So when the governments of the world mention printing trillions to save themselves, it's true that it's just a drop in the bucket.

Sun, 06/05/2011 - 22:10 | 1342291 cat2
cat2's picture

Unwinding that is truly the end game.  Based on past performance it will be bailed out with QE printing.

Sun, 06/05/2011 - 22:25 | 1342317 Michael
Michael's picture

 G14 (or Group of 14 dealers that dominate derivatives trading including Bank of America-Merrill Lynch, Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS, Societe Generale, UBS and Wells Fargo Bank)

I'm glad they narrowed it down to just about 14 with their m&a activity.

It will make the guillotine processing facility job go that much smother.

Mon, 06/06/2011 - 00:23 | 1342507 cara leaf
cara leaf's picture

Here is the $64 question: 

If Dodd-Frank had been in effect, would it have prevented the '08 Crash.

I say....ummmm...No.

Mon, 06/06/2011 - 02:45 | 1342648 Transformer
Transformer's picture

And here's the $128 question.  What happens to this $1.4 quadrillion mess when Hyperinflationary Depression comes a knockin?

Mon, 06/06/2011 - 08:17 | 1342806 TwoShortPlanks
TwoShortPlanks's picture

The system crashes and a new one is invented.

Mind-you, the real owners of this ICU-Bound dying fiat system left the building. They'll just skim while it's still breathing. But when they bothered to clean-out their Petty-Cash draw (US$1 Billion) you know it's gonna tank.
"On 8 January 2001, an Extraordinary General Meeting of the BIS decided to restrict the right to hold shares in the BIS exclusively to central banks and approved the mandatory repurchase of all 72,648 BIS shares held by private shareholders as of that date against payment of compensation of CHF 16,000 per share. The former private shareholders were informed by means of the Notes to Private Shareholders dated 15 September 2000 and 10 January 2001, which described the transaction in more detail; a further Note was sent on 27/28 November 2002 following the Tribunal's 22 November 2002 decision."

http://www.bis.org/about/shareswd.htm

Mon, 06/06/2011 - 08:35 | 1342846 mayhem_korner
mayhem_korner's picture

It feeds a family of four for two weeks...

Mon, 06/06/2011 - 00:26 | 1342508 High Plains Drifter
High Plains Drifter's picture

is it possible to unwind such a mess?    i heard a lot of talk a few years ago about this stuff and it was called the black hole of finance. it is easy to see why?  it is something that cannot be fixed.  even greenie himself said he did not understand it.

Mon, 06/06/2011 - 01:39 | 1342596 BlackholeDivestment
BlackholeDivestment's picture

Black Hole? Never heard of it. http://www.youtube.com/watch?v=VDQZIWHqUug Ah haa haa haaa!!!

Mon, 06/06/2011 - 02:31 | 1342637 Greyhat
Greyhat's picture

They can not unwind it, thats why they "save Greece". Its all about the CDS contracts. They try to buy time.

http://translate.google.com/translate?u=http%3A%2F%2Fwww.welt.de%2Fwirts...

Mon, 06/06/2011 - 07:08 | 1342730 YHC-FTSE
YHC-FTSE's picture

Exactly. I was wondering when we'll be touching on this topic again, and it's far worse than I remembered. There is no way to fix this, ever. We'll need another planet full of suckers to shift this mess.

Sun, 06/05/2011 - 23:00 | 1342355 Doode
Doode's picture

I spoke with folks in charge of handling all of those positions at a major bank pondering why the numbers were so freakeshly high a few years back - it turns out this number is very deceptive. There is no central clearing house for derivatives so both buy and sell transactions are recorded as separate derivaties. The result that when a bank buys a derivative it records it as a transaction - then to unload that very same derivative they issue a hedge which is yet another separate derivative. Therefore net is 0 (spread), but on books it looks like they have 2 times the exposure - one on a buy side and one on a sell side. Now, the same derivative is recorded at each bank and each time it changes hands so the actual number the same derivative is recorded is equal 2 times the number of transactions this derivative had. Imagine if all that GE stock traded was always recorded as 100 shares bought and 100 shares sold as 200 shares in risk exposure - that is what is happening here. The actual market is much much smaller and does not represent nearly the problem one would derive from the absolute number itself - it is of several orders of magnitude lower than the absolute number.

Sun, 06/05/2011 - 23:23 | 1342396 Amish Hacker
Amish Hacker's picture

Yes, but when there is a triggering event and your counterparty defaults, you'll find that notional value becomes all too real.

Sun, 06/05/2011 - 23:49 | 1342448 traderjoe
traderjoe's picture

+ aig.

We were hours or days from a collapse of the
system if AIG went under. And what have they fixed since then?

Mon, 06/06/2011 - 00:32 | 1342517 High Plains Drifter
High Plains Drifter's picture

AIG is not fixed. it is the gift that keeps on giving. we don't have any idea what was going on with that company, that is for sure.

Mon, 06/06/2011 - 00:16 | 1342491 Cheater5
Cheater5's picture

Totally agree with you.  Except for one thing.  When you sell a share after the trade clears you dont own any remaining exposure.  Since derivatives are contractural liabilities and are not generally novated when a trade occurs that goes through an intermediary it is booked as you have indicated - ie, in the case of CDS, contract written to the intermediary from "protection selling client" and contract written by the intermediary to "protection buying client."  Net/Net if you look at the intermediary banks book, they should be flat (with obviously their commisions, fees, etc. as a possitive).  And that is true up until the "protection selling client" goes belly up without posting enough collateral (which he is unlikely to be able to secure if SHTF systematically - ie not with one single name).  At this point the intermediary bank is still on the hook (and must post collateral) to the "protection buying client." 

 

Mon, 06/06/2011 - 00:23 | 1342510 bingocat
bingocat's picture

Presumably that is why people think it would be a good thing that they all get cleared on an exchange. Banks don't want that because people like JPM make a LOT of money off the fact that trades are 'customized for you, the client, and therefore we require a higher spread.' The fear is that if trades are put through an exchange, the price transparency will kill their profits. This is not necessarily a valid fear - clearing is not the same thing as execution.

But if it all goes on the exchange, then the offsetting risks will all net out, and it will simply be the net open position of each party vis-a-vis the clearing exchange. This will wake a lot of people up, and this is the real reason why companies want special dispensation to not have to post so much collateral.

Mon, 06/06/2011 - 06:58 | 1342702 Highrev
Highrev's picture

.

Sun, 06/05/2011 - 22:50 | 1342348 Concentrated po...
Concentrated power has always been the enemy of liberty.'s picture

Once upon a time a man told a small village, “I will buy monkeys for $10 each.”

Since there were many monkeys in the forest, the villagers caught them and sold them to the man.

As the supply of monkeys diminished, the villagers’ efforts slowed, so the man offered them $20 each.

They renewed their efforts but the supply of monkeys diminished further, so he increased his price to $25.

Soon no one could even find a monkey in the forest.

The man increased his price to $50, but announced, “Since I must go to the city on business, I authorize my assistant to buy monkeys on my behalf.”

As soon as his boss was gone, the assistant told the villagers, “My boss has collected lots of monkeys. I’ll sell them to you for $35 and then, when he returns, you can sell them to him for $50.”

The villagers rounded up all the money they could and bought as many monkeys as possible. Then they had monkeys everywhere…

… but they never saw the man or his assistant again.

And now you understand the workings of the stock market!

 

Moral of the story:  Promises to pay have lots of fine print and monkeys do not equal gold.

Sun, 06/05/2011 - 23:27 | 1342410 HungrySeagull
HungrySeagull's picture

That is SO AWESOME!!!!

Mind if I steal this?

Mon, 06/06/2011 - 02:43 | 1342646 terryfuckwit
terryfuckwit's picture

great analogy

Mon, 06/06/2011 - 08:49 | 1342891 4horse
4horse's picture

monkeybusiness. yes

 

yet here to be seen, timestamped, are the same hourly everyday ZH nitpickers engaged in what is no longer mere communal grooming but, me no butts, the vacuous foreplay of something far more obscene . . . and constantly coming

 

fucked. one-at-a-time. while being caged

 

yes, by all means stall-crawl-and-caterwaul in your incessant goose-goose, grunt-grunt and alltalk

 

 

here is it so easily seen-- yeh. obscene --you all make your living with your mouths

Mon, 06/06/2011 - 09:05 | 1342933 Concentrated po...
Concentrated power has always been the enemy of liberty.'s picture

is that a haiku?

Mon, 06/06/2011 - 00:06 | 1342478 decon
decon's picture

After reading this it should be clear to everyone that the world's central banks will do anything, anything! to try and control interest rates!

Sun, 06/05/2011 - 21:43 | 1342246 Dolemite
Dolemite's picture

 

PMs stocks and oil heading lower?

This would certainly support the Treasuries to the moon thesis ;)

http://deadcatbouncing.blogspot.com

 

Sun, 06/05/2011 - 21:56 | 1342272 Monedas
Monedas's picture

Troll alert ! Trying to talk silver down becuz you're short ? "Clever trick Captain !"....Das Boot. Monedas 2011

Sun, 06/05/2011 - 22:01 | 1342281 Dolemite
Dolemite's picture

Lol I wish I had that kind of power, or ability to see the future.

No, I am just a guy who looks at charts and puts in limit orders with stop losses if I am wrong.

I merely offer my opinion and trade it accordingly. (and for the record I am long physical silver... just short the paper for the time being)

http://deadcatbouncing.blogspot.com

Sun, 06/05/2011 - 22:52 | 1342343 Votewithabullet
Votewithabullet's picture

Danke monedas for the troll alert. I might have missed it otherwise. Even though the avatar has your name alongside, adding it again at the bottom  and with the year...pure genius.

Mon, 06/06/2011 - 06:33 | 1342704 Monedas
Monedas's picture

I am over my head with this crowd....I'm just a peasant hoarder from the hinterland....but I do try to protect the PMs with "Capa y Espada" (with my cape and my sword) ! Monedas 2011 Genius is a little over the top, but thanks !

Sun, 06/05/2011 - 21:45 | 1342253 Manthong
Manthong's picture

If you drink the whole bottle, you deserve to puke your guts out.

Mon, 06/06/2011 - 03:33 | 1342663 iNull
iNull's picture

Bukowski would disagree.

Mon, 06/06/2011 - 06:08 | 1342699 Reptil
Reptil's picture

Belushi (John) too :-)

Mon, 06/06/2011 - 08:43 | 1342882 Manthong
Manthong's picture

New paradigm I guess, and this is what we got now (0:37).

http://www.youtube.com/watch?v=gpDD0eOq-0o

Sun, 06/05/2011 - 21:49 | 1342256 RobotTrader
RobotTrader's picture

Like I said, the commodities are holding up well for now, especially copper which should be getting destroyed with the weak economic data.

The slightest whiff of weakness in copper, gold, oil, etc. could easily send stocks into an epic crash.

If that happens, they you could see the 10-yr. yield completely collapse to world record lows.

By that time, Interactive Brokers will be offering negative margin rates on listed big board stocks to entice more speculators to belly up to the NYSE casino.

Sun, 06/05/2011 - 21:58 | 1342277 Spitzer
Spitzer's picture

And how long do you expect this run to treasuries to last ?3 to 6 months ?

Copper is not getting destroyed, the TSX is up on days when the dow is down over 100 points, gold goes up no matter what, even in the summer.

Things are a changin.

Mon, 06/06/2011 - 01:23 | 1342574 DoctoRx
DoctoRx's picture

A good Fight Club entry, Robo.  Tho you're wrong about gold.  And technically you overstated things re "the slightest whiff of weakness".  It'll take more than a whiff.  But as biflation bites in a deflationary direction, the 10 year has massive downside (yield) potential.

Sun, 06/05/2011 - 21:52 | 1342261 phungus_mungus
phungus_mungus's picture

a trillion....

 

from here on out everything will be known simple, as, a $$$shitload$$$ 

Sun, 06/05/2011 - 21:49 | 1342262 Belrev
Belrev's picture

This $600T is a misleading discussion. If you credit default swap or interest rate swap contracts are each for $1B notional, then what is the total number of these contracts, what do they net out to? The notional catches the eye, but there is not as much wipe out power under it as people are led to beleive.

Sun, 06/05/2011 - 21:55 | 1342267 phungus_mungus
phungus_mungus's picture

Its not real money anyways.... is it.... 

Sun, 06/05/2011 - 22:14 | 1342299 cat2
cat2's picture

The owners of that (influencial rich folks with washington lobbists) will want the value paid to them in $.  Fire up the presses.

Sun, 06/05/2011 - 22:21 | 1342302 Pure Evil
Pure Evil's picture

The money may be fiat, but the anarchy unleashed from pandora's box if everything "collapsed spectacularly" would be no illusion.

It would be Greece, Libya, Yemen, Syria, ad infinitim, on a roid rage.

And, that could be either hemorrhoid or steriod, which ever tickles your fancy.

Sun, 06/05/2011 - 21:55 | 1342268 Tyler Durden
Tyler Durden's picture

Thank you for pointing out gross vs. net notional 101 (which incidentally worked out how in Lehman Ch.11 when gross was net?). Regardless did you read this part: "we believe, that the full potential shortfall on the up to $600
trillion in gross notional is the full net exposure in the market at any
time. Which we are convinced is well over the $160 billion 0.002% case
(according to some estimates, between CDS (this one is easy - just look
at weekly DTCC data) and IRS (this one is far more complicated), the net
notional at risk at any given moment is anywhere between $2 and 8
trillion.
And this is capital that the G-14 supposedly have handy for a
rainy day?"

Probably not since it took about 6 minutes form the moment the article appeared until your comment...

Sun, 06/05/2011 - 21:57 | 1342276 redguard
redguard's picture

YEEOOCH! lol

Sun, 06/05/2011 - 22:05 | 1342286 Dapper Dan
Dapper Dan's picture

It takes me 10 to 15 minutes to reply to a post,  spell check and all.

Tyler replys in less then 10 sec.

Check the time post on TD's reply. You got a delay button?

Sun, 06/05/2011 - 22:16 | 1342303 cat2
cat2's picture

Well 6 minutes or so.

Sun, 06/05/2011 - 22:28 | 1342320 Belrev
Belrev's picture

Tyler, I am not disagreeing with your. But $2 to $8 Trillion of actual wipe out potential is shall we say "manageable" by the Central Bank standards. And they will not be deterred in defending their powerbase and life style.

Sun, 06/05/2011 - 22:34 | 1342324 Tyler Durden
Tyler Durden's picture

It will add up eventually. Dumping $5 trillion in USD in the market overnight will leave a mark.

Sun, 06/05/2011 - 23:06 | 1342362 Pure Evil
Pure Evil's picture

Would tend to agree, even though the US with the largest GDP, approximately 14 trillion. Dumping $5 trillion overnight would more than just make a mark.

Could be the beginning of an event horizon presaging the implosion of the whole turd fest.

"over the next year and a half exchanges need to onboard over $200 trillion notional in various products, and in doing so, counterparites, better known as the G14  will soon need to post billions in initial margin, and as a brand new BIS report indicates, will likely need significant extra cash to be in compliance with regulatory requirements. Not only that, but once trading on an exchange, the G14 "could face a cash shortfall in very volatile markets when daily margins are increased, triggering demands for several billions of dollars to be paid within a day." Per the BIS "These margin calls could represent as much as 13 percent of a G14 dealer's current holdings of cash and cash equivalents in the case of interest rate swaps."

And, from that I have to suspect it's no coincidence that I read a recommendation somewhere suggesting that it was best to be in cash for the next six months. Of course that means that just possibly these turds are using my cash to back up their bets.

Of course, I'm just a paranoid schizophrenic that sees conspiracies around every corner, but if the proletariate were to start pulling cash from accounts, would there be enough to cover the margin calls for these contracts?

I realize drawing a straight line between these two points would take a hyperbolic curve, but nothing gets published without a hidden agenda behind it, except for Tyler, of course.

At the least, the FED has been pumping money into the banks to help, but even the FED would have to balk at entering $35 trillion at the keyboard at a moments notice.

My only question is, why would they only need to post billions in initial margin when they're onboarding some $200 trillion in notionals? The rubber just ain't hittin' the road on that one.

Sun, 06/05/2011 - 23:14 | 1342380 bigwavedave
bigwavedave's picture

Just a skid mark. Embarassing only if you drop off your own laundry. Which these guys dont... 

Sun, 06/05/2011 - 23:34 | 1342417 HungrySeagull
HungrySeagull's picture

It aint the skid. It's the snapped back or the busted driveshaft universal that will pole vault that overvalued pig of a car out of the pothole ... er... abyss.

The wing loading must be a bitch for that piggie to fly. Anywhere except straight down.

Sun, 06/05/2011 - 22:54 | 1342349 Monetative Easing
Monetative Easing's picture

The "G14" nets down IRS exposures on a pretty frequent basis.  I appreciate what this article is trying to say but it seems to overstate the risks in the rates swap market.

And Dodd/Frank is a bloated piece of crap meant to benefit the CME and its benefactors (google "Chris Dodd's wife AKA Jackie Clegg).  Or better yet, I will supply you a link:

http://investor.cmegroup.com/investor-relations/directors.cfm?bioID=16089

Turns out that Ms. Dodd is on the board of the CME (and was at the time that Dodd authored his bill).   The CME stands to finally garner some fees that it has been missing since the OTC market took off. 

Interest rate swaps never were a problem during the financial crisis.  That fell to structured mortgage products, their derivative offshoots and CDS which is far more risky than interest rate swaps.  No, the only problem with the interest rate swap market is that it created formidable competition with the exchanges. 

 

Mon, 06/06/2011 - 00:34 | 1342520 cara leaf
cara leaf's picture

Would Dodd-Frank have prevented the financial meltdown?

 

 

Mon, 06/06/2011 - 00:42 | 1342533 Monetative Easing
Monetative Easing's picture

No.  Dodd-Frank is essentially creating a bunch of brand new TBTF entities in the form of CCPs.  The only thing it does is more clearly disclose where the exposures lie.  However the daisy-chain exposures still exist.  Furthermore, it will completely alter the liquidity in some markets and cause some end-users to run more risk because of its prohibitive treatment of certain types of hedges. 

Dodd-Frank isn't a solution.  Its a bloated, ill conceived piece of legislation written by lobbyists for the CME and other exchanges. 

This is not to say these markets shouldn't be regulated.  But the U.S. congress is populated with people whose only objective is to enrich their campaigns and their benefactors so legislation is not designed to strengthen markets.  Instead its written to strengthen the hands of groups of players within markets.

Mon, 06/06/2011 - 02:47 | 1342650 terryfuckwit
terryfuckwit's picture

could it just mean more complex lies and frauds from the G14... regulation hasn't stopped any of the suicide practices to date..

Mon, 06/06/2011 - 00:43 | 1342535 High Plains Drifter
High Plains Drifter's picture

yes let us also not forget that the slickster dodd,  also got a sweatheart mortgage deal from his friends over at countryslide.

Mon, 06/06/2011 - 04:02 | 1342668 euclidean
euclidean's picture

Jesus H Dodd, ME. What an incestuous bunch of criminals you have running the country! A real 2011 Bonney and Clyde. A Director of CBOT to boot! It's lucky the US has laws to take care of these folks. Really. They are taken care of pretty well.

Might be quicker if you can tell me if you have ANY independent law abiding Senators with integrity ... aarrrgh forget it, who am I kidding.

Sun, 06/05/2011 - 23:47 | 1342445 DoChenRollingBearing
DoChenRollingBearing's picture

The line in the article that got me:

"And there are those who wonder why banks are stockpiling cash for a rainy day..."

I am stockpiling everrything I can for a rainy day.

Great article.  I know very little about the huge derivatives subject.  But, I was able to learn a more here.

+ $1540

Mon, 06/06/2011 - 07:18 | 1342736 chubbar
chubbar's picture

I've read an article that addressed this notational issue (sorry no link) and the conclusion IIRC was the total net on all derivatives (1.2 quad at the time I believe) came in around 16-18 trillion net. That number seems close to what Tyler is putting out for the net on the 600 trillion for the Interest swaps,etc.

Mon, 06/06/2011 - 07:21 | 1342743 bonddude
bonddude's picture

"Brooksley Borne...White Courtesy Telephone for ...Brooksley Borne"

Sun, 06/05/2011 - 22:12 | 1342294 chump666
chump666's picture

Also collateral, CDS are priced on assumption re: collateral values.  They are extraordinary risky plays.  Now Asia is involved in the counterparty CDS risk on their property markets...

Sun, 06/05/2011 - 22:14 | 1342298 euclidean
euclidean's picture

Now, see what you made TD do? What is not misleading is that every 1% movement in the $600T market is what is the real liability to the losing counterparty. So the gist of the story remains valid applicable to $600T, representing the collective pool of liability - albeit leveraged substantially from notional contracts. Margin requirements operate on the $600T, which (contrary to CME) would be linked with market volatility and liquidity.

It leads me to think that (a) before 2012 will come a defeat of the FD requirements and the freeballing of the G14 continues = onwards and upwards to another crash, or (b) all this deliberate fun and games with margins will end on the day collateral is actually posted (haha, and so Santa comes bearing gifts for the Tooth Fairy and Easter Bunny). Since the banking cartel will not seek to impose any restrictions on itself, I put money on the FD bill being laughed out of town.

Until the next big fall, any volatility that creates >1% swing on $600T means there exists a few someone's on the hook for >$6T. We'll find out eventually since it is highly unlikely to go unnoticed.

Sun, 06/05/2011 - 21:59 | 1342273 silvertrain
silvertrain's picture

Even buffet said they were weapons of mass destruction..

Sun, 06/05/2011 - 22:05 | 1342287 Spitzer
Spitzer's picture

Birkshire would have gone bankrupt in 2008 if not for the bailouts. ^That goes to show how much Buffet knows about economics......

 

He knows fuck all. And as for his stupid farm land inflation hedge idea, Gonzalo Lira filled that full of holes the other day. http://gonzalolira.blogspot.com/2011/05/spg-supplement-is-farmland-smart...

 

Warren Buffet lives and die's with fiat.

Sun, 06/05/2011 - 22:48 | 1342342 I am a Man I am...
I am a Man I am Forty's picture

buffett doesn't need credit if he is farming, lira's main points, buffett has lost his edge anyway, him and munger, no minds are as sharp at 80 plus

Sun, 06/05/2011 - 23:35 | 1342423 HungrySeagull
HungrySeagull's picture

Wanna bet? Granny lost her edge somewhere past 86. She lived peacefully till 94.

Mon, 06/06/2011 - 00:40 | 1342537 I am a Man I am...
I am a Man I am Forty's picture

i'm talking judgment on investing decisions, hirings, etc., being able to tell if some ceo u hired is front running you, not just mentally alert and can hold a conversation

good for ur granny just the same, for all i know she rant hft quant hedge fund

Mon, 06/06/2011 - 00:25 | 1342515 Chicken_Little
Chicken_Little's picture

and don't forget that Blythe Masters is being said she's one of the 3 that created these things. She reminds me of the queen egg laying alien in the Aliens movies. And where is she now? Instead of being blown out into space, she's JP Morgan's commodities chief and surely behind most of the manipulations. Jim Sinclair, Jim Willie, and many others called these things well before Warren did. Even Bob Moriarty said recently that there aren't 10 people that understand these things. I'm no expert in these things, but here's what I can gather from a layman's view. These are insurance policies outside of regulation (OTC) that require no collateral. They are only as good as the counterparty has the ability to pay. In the AIG thing, AIG Financial Division should have been split apart and Joe Cassano put in jail. He's only one of many that belong in jail. The big Wall Street and international banks that caused this should have been allowed to fail thus cleaning the system of these crooks and all their derivitaves. Now these big banks are bigger and the Fed and ECB and BOE are helping them steal from us. OTC derivatives will be the un-doing of most of the global finance structure. Until these derivatives are cleared, this is the gorilla in the room that nobody sees. Sorry for my rant and I think most ZH'ers see this gorilla. 

 

Mon, 06/06/2011 - 00:37 | 1342526 cara leaf
cara leaf's picture

Warren Buffet propped up Goldman.  Definitely one of the good guys.

Mon, 06/06/2011 - 00:34 | 1342527 cara leaf
cara leaf's picture

Warren Buffet propped up Goldman.  Definitely one of the good guys.

Mon, 06/06/2011 - 00:44 | 1342540 cara leaf
cara leaf's picture

Do as I say, not as I do.

Sun, 06/05/2011 - 21:56 | 1342274 Arius
Arius's picture

we are tosted...good luck trading!

titanic comes to mind...

Mon, 06/06/2011 - 03:37 | 1342665 iNull
iNull's picture

Eh. Too early. Check out Dan Eric. This is just wave four. Still need the wave five. August my friendos. Then things get biblical.

Sun, 06/05/2011 - 22:04 | 1342279 buzzsaw99
buzzsaw99's picture

And there are those who wonder why banks are stockpiling cash for a rainy day...

They have stockpiled borrowed reserves as they are incentivized[sic] to do. Loss reserves have been given out as bonuses. Counterparty risk will be dealt with AIG style. Buffett and every other derivative gambler is whining about Dodd Frank so don't expect that to remain law or to be enforced in the case of non-repealment[sic].

Sun, 06/05/2011 - 22:05 | 1342282 chump666
chump666's picture

Very good post.

Sun, 06/05/2011 - 22:02 | 1342283 buzzsaw99
buzzsaw99's picture

Fascinating piece nonetheless.

Sun, 06/05/2011 - 22:51 | 1342289 Hansel
Hansel's picture

If the run to treasuries occurs as suggested in this article, delivery fails will also skyrocket.

Sun, 06/05/2011 - 23:47 | 1342449 Amish Hacker
Amish Hacker's picture

http://failstodeliver.com/ is a good site for following this.

In the bond meltup of '08, there was massive naked shorting going on, conveniently overlooked by regulators. Imho, yes, we'll see this again if the margin problems laid out in the article come to pass.

 

Mon, 06/06/2011 - 02:08 | 1342626 BlackholeDivestment
BlackholeDivestment's picture

You have probably seen this guy's movie etc... but if not, it's pretty good.  http://www.deepcapturethemovie.com/ and he posts ''failure to deliver''.

Sun, 06/05/2011 - 22:07 | 1342292 user2011
user2011's picture

Well, I am glad that I am numb to those numbers already.   I know we are fucked, whether we are fucked by a 600 lb gorilla or 5000 lb elephant.   We are just fucked.

 

 

Mon, 06/06/2011 - 01:23 | 1342573 HungrySeagull
HungrySeagull's picture

An irate silverback is good enough.

Sun, 06/05/2011 - 22:10 | 1342293 Pure Evil
Pure Evil's picture

Maybe they should institute late afternoon, early morning, circuit breaker coffee breaks.

http://www.zerohedge.com/article/just-reminder-late-afternoon-circuit-breaker-coffee-breaks

Sun, 06/05/2011 - 23:33 | 1342425 HungrySeagull
HungrySeagull's picture

3600 point days? For what? A week?

Then what?

Sun, 06/05/2011 - 22:09 | 1342297 Slap That Taco
Slap That Taco's picture

Great article-helps to explain the "why" of the Treasury conundrum.

Sun, 06/05/2011 - 22:13 | 1342305 Seasmoke
Seasmoke's picture

no question Derivatives are what will destroy the market once and for all

Sun, 06/05/2011 - 22:18 | 1342310 Dr. No
Dr. No's picture

Not sure who would buy treasuries rather than just hold cash. In a panic push up of prices would treasuries actually exceed their face and coupons? HFTs might be so stupid. Kinda of like wopr and nuke war.

Sun, 06/05/2011 - 22:52 | 1342344 buzzsaw99
buzzsaw99's picture

I inferred the ir down draft theory differently (forced buying) but the exact mechanism which forced the spread compression wasn't exactly clear. I believe zh reported that the fed was selling ir puts, perhaps eventually those on the other side of the trade get blown out of the water and try to cover in a dearthy bond market? It goes like this in my mind - something breaks, somebody gets their tit caught in a wringer, then everyone elses titties get sucked in too, the fed doesn't try to help and so it gets all crack of doom up in the bond markets for certain people.

http://www.youtube.com/watch?v=cbEKFVCrArA

 

[/talking out my ass]

Mon, 06/06/2011 - 02:37 | 1342642 BlackholeDivestment
BlackholeDivestment's picture

Buzz, don't forget to at least post ''Ichiban'' http://wfmuichiban.blogspot.com/ ta go with the side order, it's number one on weekends, don't cha know?

Sun, 06/05/2011 - 22:28 | 1342314 chump666
chump666's picture

Now talking of Asia, someone have a spread for TEPCO CDS's?  ZH?

japan govt bails out that rotten company, what do you think it will do to Asian risk spreads? ...It will blow them out to hell.  Good example of the above UST/CDS/margin call

from wires:

*Further deterioration in Tepco's financial situation could adversely affect their financials and therefore trigger their action to cover losses, which will likely take place in the JGB market as well.

 

Sun, 06/05/2011 - 22:28 | 1342321 Tyler Durden
Tyler Durden's picture

Points upfront

Sun, 06/05/2011 - 22:34 | 1342315 MacGruber
MacGruber's picture

I love the concept of the OTC exchange. It's the equivelent of stressing the importance of documenting genocide. Why not just stop the genocide? How about forcing these gambling houses to just cancel a few hundred trillion in contracts? Oh shit, sorry, logic.

Amazing analysis though, I learn a lot each read.

Sun, 06/05/2011 - 22:31 | 1342326 Pure Evil
Pure Evil's picture

"These aren't the $600 trillion dollar OTC derivatives you're looking for."

Darth Vader

Sun, 06/05/2011 - 23:15 | 1342381 Bárðarbunga
Bárðarbunga's picture

That was Obi-Wan.

 

Next time wave your hand as you're saying it.

Mon, 06/06/2011 - 00:37 | 1342531 Chicken_Little
Chicken_Little's picture

OTC works when the parties have the ability to pay. When they don't as in AIG , the taxpayers pay and are the unwilling counterparties. Sure it's not my money that the fed prints up and gives to them, but go to the grocery store and gas pumps and utility bills you pat outside of "core" inflation. Wake up people, money printing and these OTC derivatives are killing us.

Sun, 06/05/2011 - 22:29 | 1342319 chinaguy
chinaguy's picture

The whole article......

Black Swan = "the net notional at risk at any given moment is anywhere between $2 and 8 trillion."

Borrowed from all CBs - & off loaded to future generations - no problem

 


Sun, 06/05/2011 - 22:35 | 1342325 Steroid
Steroid's picture

Did I miss something? Since when Mexican Peso as good as gold?

Should I ask since when gold is as good as the Mexican Peso?

Sun, 06/05/2011 - 23:57 | 1342468 topcallingtroll
topcallingtroll's picture

They are neither good nor bad. It is purely about volatility.

Gold is considered about as volatile as the mexican peso, if the dollar is your reference point.

Mon, 06/06/2011 - 02:00 | 1342613 Ahmeexnal
Ahmeexnal's picture

When the USD collapses, commerce will have to find alternate currencies: gold, silver, canadian dollars....and mexican pesos. Canada has less than 4 tons of gold. Mexico has around 100 tons of gold. Guess which currency will sink with the USD and which one will survive.

 

http://www.bullionbullscanada.com/index.php?option=com_content&view=arti...

 

Mon, 06/06/2011 - 11:50 | 1343420 Bicycle Repairman
Bicycle Repairman's picture

"They are neither good nor bad. It is purely about volatility."

Volatility is the wrong measure.  Survivability is.  Sure the Mexican peso has more gold backing than the CDN.  But why not cut out the middle man entirely?

Mon, 06/06/2011 - 07:50 | 1342769 LudwigVon
LudwigVon's picture

Since when Mexican Peso as good as gold?

When one is considering collateral. And when HSP is validated and the Mexican Peso isSilver backed, I, for one, agree with the CME that Gold is equivalent to Silver when considering historical monetary metals. Perhaps the CME might enter the new Zim currency as well at that same 15% discount to FRN's. 

Sun, 06/05/2011 - 22:32 | 1342327 monopoly
monopoly's picture

That is way too much too print. Even for Bernank. I have seen this number before and will admit have a hard time understanding it all, but I know what I have to do and am ready.

Sun, 06/05/2011 - 23:38 | 1342427 HungrySeagull
HungrySeagull's picture

It's all Binary. Ones and Zeros.

It will hold off the run on the bank of all banks until the cotton harvest catches up in sufficient to match the imaginary printing press.

Sun, 06/05/2011 - 22:42 | 1342333 Downtoolong
Downtoolong's picture

Gold and the Mexican peso aren’t often put in the same risk category, but they are here.

 

Hilarious.

Sun, 06/05/2011 - 22:44 | 1342336 whisperin
whisperin's picture

Tyler,

I would think those banks etc. who drive down their duration on some of these may escape some of the fallout. If they can wipe out any long term duration in their derivatives they should survive long enough to see how the regulatory apparatus is really going to work. I sure as hell wouldn't want to be putting up any monies until the amount of margin (initially) were set in stone so I could look at the other counterparties as well. I think the safest bet is none at all.

Sun, 06/05/2011 - 23:47 | 1342451 Dr Zaius
Dr Zaius's picture

"...the only winning move is not to play. How about a nice game of chess."  - WOPR

Mon, 06/06/2011 - 02:05 | 1342625 HungrySeagull
HungrySeagull's picture

That movie packed all theaters in our mall standing room only with lines 6 across snaking across both levels and a 9 hour wait.

Even today I still watch it with some sense of wonder.

However, I think the SAC is out of the Nuclear business as it used to be. Those were the days we all were living 32 minutes from either hell or peace delivered within 30 minutes.

 

"Greed is Good" is the other line from that time I remember as well.

Mon, 06/06/2011 - 01:04 | 1342556 Chicken_Little
Chicken_Little's picture

I can't quote the source from 3 years ago, but they said if all the OTC derivatives were called and made whole by the parties able to pay, only 60 trillion would be left unfunded. Huh? WTF? Weapons of financial destruction is an easy comment. What should have happened in 2008 was Bush declaring a financial emergency and declaring all derivatives null and void. Then the big Wall Street banks would have failed and the regional banks supported by the FDIC and the system cleaned. No more bullion banks, no more Blythe Masters and GS doing "Gods work". I'm so tired of Dick Cheney's and Hank Paulson's and the rest of them. Sorry about this rant, a little Off Topic.

:)

 

Sun, 06/05/2011 - 22:47 | 1342338 cherry picker
cherry picker's picture

A whole new set of acronyms and words have been developed so derivatives will take on a whole new meaning, but the scam is the same and as old as the hills.

The old saying, "if it walks like a duck, looks like a duck it is probably a duck" applies to financial instruments whose descriptions are too large for the mind to grasp..

The suckers who get into the derivatives, even though they may have made billions, will end up losing that and much more.

Easy come, easy go holds as much truth now then when the phrase was coined.

 

 

Sun, 06/05/2011 - 23:00 | 1342351 Caviar Emptor
Caviar Emptor's picture

Yu can bet the line, take the odds or make "proposition bets". The latter describes derivatives in their simplest form. 

Sun, 06/05/2011 - 22:56 | 1342340 Caviar Emptor
Caviar Emptor's picture

I don't profess to be an expert in the derivatives markets. Not even close. 

But to me there's a key piece of the puzzle missing in the discussion.

If ever there is an exchange-like trading mechanism set up for OTC derivatives, there is going to be a real run on U.S. government paper. 

 

The "run" on treasuries will have to be paid for with something, unless the Treasury is just going to give paper away. Where are the funds for these hundreds of trillions going to come from? So the next problem will be raising the cash. That would effectively render the group of 14 insolvent. Enter the Fed. They would have to set up a program such that hundreds of trillions of new crispy dollar bills would be available to purchase treasuries with. Sound familiar? This is in essence QE-Quantum-Xtra-HiTest. The Fed would purchase Treasury paper from PDs at concessionary rates sufficient to allow the PDs to retain enough to post collateral with. A mega program! The Fed's balance sheet would be gargantuan. They would have to buy Treasuries at par, making interest rates effectively zero and real rates in the negative double digits. It's truly QE to infinity. And that friends would stoke up biflation to the moon and collapse the real economy in the manner it is heading toward collapse now, just faster. And once again gold would be the clear winner. 

Sun, 06/05/2011 - 22:58 | 1342352 holdbuysell
holdbuysell's picture

You answered my basic question on the 'run on treasuries' terminology in that it means a 'run to buy' rather than a 'run to sell'.

You ask a good question: where do they get the initial money to buy the treasuries that would be the collateral?

Mon, 06/06/2011 - 00:22 | 1342506 trav7777
trav7777's picture

dump everything else or borrow it.

Mon, 06/06/2011 - 11:57 | 1343434 Bicycle Repairman
Bicycle Repairman's picture

Borrow it.

Sun, 06/05/2011 - 23:24 | 1342399 steveo
steveo's picture

It wouldnt be that big, just the margin has to be covered with known collateral.

Sun, 06/05/2011 - 22:51 | 1342341 Nate H
Nate H's picture

600 Trillion, in real exposure is probably about 20 trillion.  Most of that is forex swaps and stuff of large notional, little risk between big banks.  Alot, but not what it seems by a longshot.  (total money supply as debt is around 250-300 trillion in OECD -financial stuff largely offsetting)

Mon, 06/06/2011 - 01:23 | 1342578 Chicken_Little
Chicken_Little's picture

So I was off by 40 trillion. So there's only 20 trillion in derivatives that can't be settled with current funds. Okay right. With alot of the financial problems in the world going on where these bomb contracts are getting close to having to pay off, where's the money coming from? Greece never had the requirements to enter the Euro but GS helped them hide their balance sheet. JP Morgan is also to blame in other countries. These big banks need to fail. Sorry for rant #2.

 

Sun, 06/05/2011 - 22:53 | 1342345 ugly_avatar_Muir
ugly_avatar_Muir's picture

This seems like an excellent read.

But I must get some sleep.

I'll read first thing....

As always thx ZH.

__

p.s. enjoy new avatar all

Sun, 06/05/2011 - 22:49 | 1342346 holdbuysell
holdbuysell's picture

Sorry...a bit confused on the whole 'run on treasuries' point.

If collateral is desired to be in treasuries, then the run on them results in the massive buying of them as collateral or the massive selling of them to make good when TSHTF? What is the starting point?

The article seems to indicate that the run on them would be a massive buying spree to ensure enough collateral?

Sun, 06/05/2011 - 23:16 | 1342379 Pure Evil
Pure Evil's picture

Basically it's just a way for the FED to cover up the fact that they entered $35 trillion at the keyboard and loaned it to the G-14 at negative interest rates.

No need to tell the proles about anything.

Magically the black hole is moved onto the backs of the American taxpayers via the Treasury, um..., I mean the American taxpayers grandchildren and great grandchildren.

Sun, 06/05/2011 - 23:53 | 1342458 topcallingtroll
topcallingtroll's picture

Yeah he is using the term "run on________" incorrectly.

His english is almost impeccable, but occasionally this bulgarian makes a small slip.

Sun, 06/05/2011 - 23:10 | 1342365 Destinapp
Destinapp's picture

Didn't Geithner exempt a large part of this market?

Sun, 06/05/2011 - 23:14 | 1342371 pitz
pitz's picture

Just buy gold you motherfuckers.  They'll start a QE3, QE4, QEx to try and knock treasuries down if any of this ever happened...

Sun, 06/05/2011 - 23:49 | 1342456 DoChenRollingBearing
DoChenRollingBearing's picture

Yes, just buy gold.  Especially if you do not own any in your physical possesion.

+ $1540

Mon, 06/06/2011 - 00:27 | 1342512 trav7777
trav7777's picture

forcing people to scramble to buy treasuries to post as collateral on illusory bets would be incredibly deflationary in monetarist terms.

All that competition for paper; the USG could fund for nothing

Sun, 06/05/2011 - 23:15 | 1342372 phyregold
phyregold's picture

Okay so for idiots like me,

 

Massive run on bonds good or bad?

Sun, 06/05/2011 - 23:17 | 1342377 pitz
pitz's picture

Just more fuel for a collapse.  The higher the highs...the lower the lows... 

Sun, 06/05/2011 - 23:16 | 1342374 Rick64
Rick64's picture

  G14 dealers have more tricks then a clowns pocket. The collateral is the problem, remember REPO 105 that Lehman used which turned out to be fraudulent. If the G14 is forced to buy treasuries then a big problem will be solved for the FED and Treasury.

Sun, 06/05/2011 - 23:22 | 1342394 steveo
steveo's picture

Good, maybe my 401k wont be forced to buy treasuries

Sun, 06/05/2011 - 23:36 | 1342432 HungrySeagull
HungrySeagull's picture

If you are a Federal Employee, this summer's looting by dear old Uncle Sam might just leave you with a voucher IOU instead of a 401k you can spend.

Sun, 06/05/2011 - 23:55 | 1342460 Dr Zaius
Dr Zaius's picture

Yeah, but look on the bright side.  GS will very likely set up a market for the IOUs.  You'll be fine.

Sun, 06/05/2011 - 23:55 | 1342462 DoChenRollingBearing
DoChenRollingBearing's picture

I cashed in my IRA in late 2008.  I paid the txes and penalties, but have slept well ever since.

I do not know if you can cash in a 401k.  If so, I would recommend doing it...

Mon, 06/06/2011 - 00:28 | 1342516 HungrySeagull
HungrySeagull's picture

We cashed out ours earlier this year. The numbers were pitfully small and minus a good sized contribution... It became my first Silver Pile.

Sun, 06/05/2011 - 23:14 | 1342378 Caviar Emptor
Caviar Emptor's picture

We could extend the "good-bank, bad-bank" model to "good-century, bad-century" where toxic derivative risk gets a time spread. That way we kick the can to the 22nd century as a gift. 

Sun, 06/05/2011 - 23:20 | 1342387 Pure Evil
Pure Evil's picture

I'll buy that for a dollar!

Robocop.

Sun, 06/05/2011 - 23:23 | 1342395 malek
malek's picture

As part of Dodd-Frank, by the end of 2012, all standardised over-the-counter derivatives will have to be cleared through central counterparties.

I thought I had read that doesn't apply to existing contracts.
If higher margins are required starting 2013, doesn't that only mean that after their regular termination, less of those derivatives will be renewed by the sellers?

Sun, 06/05/2011 - 23:29 | 1342405 ebworthen
ebworthen's picture

As long as the military is strong and in control any risk will be shifted to the U.S. middle class and their assets.

Those homeland security units had better start buying the Hummer mounted microwave guns and sonic control devices:

http://www.salon.com/news/opinion/glenn_greenwald/2008/09/24/army

http://en.wikipedia.org/wiki/Active_Denial_System

http://news.softpedia.com/newsImage/G20-Protesters-Subjected-to-Sonic-Weapon-Attack-2.jpg/

Sun, 06/05/2011 - 23:45 | 1342420 blindman
blindman's picture


@ "The attached chart shows some assets that the CME considers “Good Collateral” and the haircuts it gives to those assets. The bigger the haircut, the more of the asset you have to post to support your positions. You can find them here: http://www.cmegroup.com/clearing/financial-and-collateral-management/. A few observations:
•U.S. Government and agency paper is “King of the Hill.” Only two assets get no haircut: U.S. dollar cash and U.S. Treasury bills. Agency debt is a 3% haircut, and longer dated Treasuries are 3.5-5.0%.
•Then comes developed country currencies and debt, at 5-9% haircuts.
•Gold and the Mexican peso aren’t often put in the same risk category, but they are here. Both receive a 15% haircut, which means that in the eyes of the CME they have equivalent appeal as collateral.
•At the far end of the equation are the Turkish lira (20%) and equities (30%).

Two things pop out to me from this quick analysis:
•If there ever is an exchange-like trading mechanism set up for OTC derivatives, there is going to be a real run on U.S. government paper. The CME’s list of assets and haircuts tells the story – Treasuries are the most efficient way to fund collateral. The notional amount of interest rate swaps alone – some $465 trillion – is enough to swamp the $14.3 trillion of total government debt outstanding, let alone the $9.7 trillion that is actually available for purchase.
•The whole notion of good collateral is very much anchored in the thought that U.S. sovereign debt is “risk free.” Whether or not that is true in the absolute sense is irrelevant. Remember that collateral needs to be at least crisis-resistant and preferably negatively correlated to asset prices during financial stress. With the U.S. government currently at loggerheads over how to deal with the Federal Debt Ceiling and the most likely path is to simply issue a lot more government paper, the time could be coming where Treasuries no longer fulfill the purpose of “Good Collateral” during crisis. They are just as likely to be the cause of a financial storm rather than provide shelter from the rain."
.
comment: cme maybe should reevaluate hierarchy of collateral. and if they
do ... wow on au. etc..
John Exter’s Inverted Pyramid of Assets
http://lonerangersilver.wordpress.com/2011/04/17/john-exter%E2%80%99s-in...

Sun, 06/05/2011 - 23:48 | 1342447 topcallingtroll
topcallingtroll's picture

This is one of the reasons I predict ten year treasurys trading at a yield of 2.1 percent in about two years.

Of course most bull markets move in a way to keep most people away from them and they never benefit.

Who is willing to ride this bull?

Mon, 06/06/2011 - 00:59 | 1342503 blindman
blindman's picture


@"Who is willing to ride this bull?"
.
king world news
http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2011/6/4_Ji...
.
explains the fail of economic repression as monetary
policy at this stage. fugly ongoing

Mon, 06/06/2011 - 01:25 | 1342575 HungrySeagull
HungrySeagull's picture

Only those who are able to wear size 26 jeans and a foot wide one inch thick belt buckle. They still have the beef necessary to hang on.

The rest of us old obese fucks will be tossed out of the building with the rest of the garbage.

Mon, 06/06/2011 - 01:46 | 1342611 blindman
blindman's picture


wait a minute, we have em' out numbered.

Mon, 06/06/2011 - 00:30 | 1342519 blindman
blindman's picture


if this scheme results in a global run on treasuries,
meaning purchase as collateral for global casino
speculating, does that mean the us will have to find
more creative ways to waste money and resources? this
just sounds too good to be true; and no one will ever have
to pay any taxes, right? i think i'm learning to hallucinate
while i eat fast food and drive .

Sun, 06/05/2011 - 23:39 | 1342431 Peak Everything
Peak Everything's picture

Every time I think I understand the depth of our shithole ZH grabs a shovel. Thanks, I think.

Sun, 06/05/2011 - 23:38 | 1342439 HungrySeagull
HungrySeagull's picture

A movie suggestion is:

 

"The Hudsucker Proxy"

 

Aint no building tall enough to accomodate a entire board's desire to off load suicidal thoughts.

Sun, 06/05/2011 - 23:52 | 1342465 Peak Everything
Peak Everything's picture

Thanks for movie tip. Downloading now.

Sun, 06/05/2011 - 23:53 | 1342461 Problem Is
Problem Is's picture

" Bank of America-Merrill Lynch, Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS, Societe Generale, UBS and Wells Fargo Bank...

 

could face a cash shortfall in very volatile markets when daily margins are increased, triggering demands for several billions of dollars to be paid within a day."

Light Bulb Over The Bernank's Head: "Ahhhh, QE4..."

Mon, 06/06/2011 - 00:08 | 1342483 chump666
chump666's picture

I don't think QE3 will do crap, margins have been shrinking since 2008 meltdown.  The bullish stock spec trade may not have capitalised the above investment banks/banks.  They all still utilize collateral to pile into bubble debt/CDS markets.  So yeah, volatility coming right now, could knock one of them out.

The mind boggles on the Euro Zone, Germany fronts the collateral for bailouts and and a perfect example of chaos theory has just happened E.Coli outbreak from Germany.

The is a Lehman event creeping up, then QE3

Mon, 06/06/2011 - 00:10 | 1342479 jmc8888
jmc8888's picture

Ahh probabilty.  In ivory tower land it has some weird number which is supposed to mean something it doesn't.  In reality it is either 0 or 1.

My gut , mind, and all common sense should tell everybody it's 1, the only question is when.

But TSHTF is a good starting point, before TSReallyHTF

Was my statistics teacher the ONLY one that said this?...it's either 0 or 1, it's NEVER anything else.  But ivory tower wizards love charging hundreds of thousands to teach and get people to believe you can be 'a little pregnant'.

Glass-Steagall because such finanical weapons of mass destruction are not supposed to exist.

Mon, 06/06/2011 - 00:05 | 1342480 Caveman93
Caveman93's picture

I need a Google "Flash Mob" Map and cumulative story. Any takers?

Mon, 06/06/2011 - 00:26 | 1342509 downwiththebanks
downwiththebanks's picture

Great work, TD.  Fantastic stuff.

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