OTC Derivatives

Friday Flush Sticksave Provided By Fed, As Basel Capital Charge Requirement "May" Be Lowered From 3% To 2-2.5%

Nothing like the Criminal Reserve announcing at 2pm on Friday, just as the market was about to flush all stops to the bottom that the already laughable 3% capital charge buffer (initially expected to be 9%) required by Basel may be reduced even more (according to NY Fed mouthpiece Steve Liesman, a hypothetical which will likely be refuted before long), probably down to 2-2.5%. This number is woefully inadequate to protect financial companies from the the material capital infusion that will be needed post the onboarding of $200+ trillion in OTC derivatives to exchanges as we reported previosuly, but who the hell cares: must kick the can down the road one more day.

XLF's knee jerk reaction.

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...

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. 

Mark Mobius Echoes Carl Icahn: "There Is Definitely Going To Be Another Financial Crisis"

In an almost verbatim repeat of Carl Icahn's words of caution which we noted yesterday, Templeton's legendary chairman Mark Mobius said that "another financial crisis is inevitable because the causes of the
previous one haven’t been resolved" during a luncheon (menu included herb crusted chicken breast with cheese and tomato sauce, mashed potato and green vegetables, seasonal salad) at the Foreign Correspondents’ Club of Japan in Tokyo. Bloomberg reports: "There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan in Tokyo today in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes." Unlike Icahn, Mobius stopped short of calling for a return to Glass-Stegall and a repeal of the abominable Gramm-Leach-Bliley which unleashed the era of zero margin derivatives and financial system neutron bombs. On the other hand, it is nice of Messrs Icahn and Mobius to speak up now, two years after the ongoing systemic instability transferred $3.5 trillion in capital from current and future taxpayer generations to the present financial elite. We do, however, forgive them because in their better late than never contrition, they join the likes of Zero Hedge who since January of 2009 have warned, over and over, that nothing in the structure of capital markets has changed, and that the market could any day open not only bidless, but broken beyond even Brian Sack-ian band aid repair.

Frontrunning: April 19

  • Bernanke May Sustain Stimulus to Avoid ‘Cold Turkey’ End to Aid (Bloomberg) -  a plan that will be woefully insufficient as discussed extensively before
  • Asia voices confidence in U.S. debt after S&P jolt (Reuters)
  • Americans Shun Cheapest Homes in 40 Years as Owning Loses Appeal (Bloomberg)
  • Funds accuse banks of Libor manipulation (FT)
  • Deutsche Bank’s $4 Billion Las Vegas Bet (NYT)
  • Obama Embarks on Tour to Sell Debt Plan, Not Dwell on S&P (Bloomberg)
  • Greek bond fears intensify debt debate (FT)
  • With much at stake, Asia voices confidence in US debt after S&P jolt (Reuters)
  • Deutsche Bank Algo Cribs HFT Strategies (Traders Magazine)

Bill Dudley Speaks Again: Will iPad 2 Serving Suggestions Follow?

The last time Bill Dudley hosted a Q&A on inflation, he made the now legendary phase, noted here, that people should just eat iPads and let their betters worry about such trivial problems as "transitory" inflation. Today Jan Hatzius' predecessor and Goldman's plant at the New York Fed continues his Titans of Taste (substitution) world tour, speaking in Tokyo, Japan, where he is experiencing one after another aftershock while discussing "Regulatory Reform of the Global Financial System." Select highlights from the speech: US economy in better shape than last summer; QE2 is partially responsible for recent rebound although the US economy has lost momentum in past few months due to oil prices; oil prices are negative to economic outlook; big focus for Fed is inflation expectations; expectations have not become anchored; CPI rise in US may be more modest than other countries as US starting at lower base; "it is important to not to overreact to rise in headline inflation as its likely to be temporary", there is more slack in the US economy than in Europe; "there should not be too much enthusiasm about tightening monetary policy too early", and many other such dovish rambling which once again confirm that Hatzius and Dudley are laying the groundwork for additional QEasing.

Guest Post: Bullion Bank Trading – A Closely Guarded Secret

Adrian Douglas submits: The latest LBMA clearing statistics (Feb 2011) reveal that the LBMA bullion bank members traded a total average net daily gold volume of 18.1 million ounces with a value of $24.8 billion. Some analysts have in the past estimated that the gross volume is likely to be 3-4 times the net volume giving potentially over 70 million ounces of gross gold trading worth 100 billion dollars. This would be equivalent to trading all the gold that is mined in world each year each and every day! Clearly the majority of this trading is unbacked by physical gold. The bullion banks only make a ledger entry for gold sold or bought and as long as the client never asks for delivery the bank never has to have the gold. I have through my studies indicated that probably 45 ounces of gold have been sold for each one that exists. The bullion banking business is very opaque but it struck me that if the members of the LBMA are collectively trading a net value of $6.2 trillion annually this should be laid out and explained in the bullion banks annual reports. In analyzing the Annual reports of the major bullion banks I made some astonishing discoveries. For most of these banks their bullion banking business is entirely hidden from the accounting. In the text there is almost no mention of gold, silver, bullion, or precious metals. In fact it is impossible to know that these banks are even in the bullion banking business let alone know anything about their trades, assets and liabilities. The only exception is Scotia Mocatta (see below). The bullion banking business is completely obscured from view in the annual reports. We know from our discussion that there should be revenues of $1.2 trillion annually be reported which would make the activity the largest activity in any of the banks, yet instead it is entirely missing! How could such trading and references to it be almost entirely absent from these reports?

Guest Post: Federal Reserve Carbon Footprint And The End Of Cheap Coal

When analyzing the Federal Reserve monetary expansions, pundits only assess economic issues like inflation, balance sheets, bubbles or public debt. Significant as they are, it will be very useful that all this smart people were added to the camp of those who want to “save the planet”. Let me to try pin down it.

Paul Mylchreest's Latest Must Read Report: Gresham’s Law Squared – Gearing Up For Game Over

So here we are, waiting for the “event” which triggers a loss of confidence across the system. Will it be a sovereign, a US state, a bank, QE3 or QE5, the oil price, Chinese fixed investment, a false flag event (a convenient distraction/excuse) or a revolution? When it happens, the speed at which capital will move in today’s over-liquefied world will take people’s breath away. Where will it go? This is the global end of normal (baby) so that, first and foremost, it will go into the strategic assets - gold/silver, energy, food/agriculture, rare earths, etc, (as well as the equities of the financially strongest economies). Bernanke’s QE2 is nothing short of economic warfare, in the form of a wave of inflation, directed at the rest of the world and even his own population (at least anybody without a large stock market, commodities or precious metals portfolio). This inflation is not temporary, as per the false reassurances, it’s baked in. In response, creditor nations have no other choice than to cut purchases of US Treasuries (China is selling), leaving the Fed increasingly standing alone. Rampant or hyperinflation results from the complete loss of confidence in a currency and we are being steered in this direction by the gentlemen above. Sure, they are smartly dressed, well educated (kind of) and pretend to know what they’re talking about with their carefully worded “policies”. It’s all NONSENSE. All they’re doing is leading us down a well-trodden path which has happened time and again throughout history.

The Charts From The FCIC Report

We will get to the text shortly (and at last check the word count for "Goldman" was well over 200 and rising). For now, enjoy the charts in the 662-page (with appendices) report. Also, cutting to the puppet chase, the FCIC said during the hearing that it has made criminal referrals (more than 0, less than 1000). Won't go into details. Wristslapping to follow.

Chris Whalen On The Zombie IPO: Is American International Group the "Blood Doll" of Wall Street?

In this issue of The Institutional Risk Analyst, we return to the zombie dance party to check in on the queen of the prom, American International Group ("AIG"). First a question: Vampires are all the rage now in popular culture, so allow us to offer a macabre metaphor for AIG. Do you know what a "blood doll" is? A girl who craves to be the regular victim of or willing donor to a vampire. But hold that thought.

rcwhalen's picture

The fact that the unveiling of Facebook was done with so much noise and fanfare by GS, a firm that never does anything rash you understand, suggests that there was a need to divert attention from the issue of valuation.

Presenting The Baltic Fat Finger Index

The chart below, while obviously a misprint, is certainly quite amusing, and provides a serendipitous look at what may happen once HFTs have bled stocks, options, exchange traded bonds, OTC derivatives, and lastly FX, dry of all adverse selection participation. Perhaps in 5 years all we will have to look forward to are massive self-reinforcing feedback looping, momentum swings, in pretty much anything and everything (alternatively, this "print" is as good an approximation of the true state of the world economy as any, should one eliminate the monetary and fiscal crutches that have propped up the global economy for the past 2+ years). In the meantime, we await to see what the first real BDIY print of the year will be. That said, the one carryover theme from 2010 is that good is good and bad is gooder, so should the BDIY really faceplant by 27% overnight we expect a new all time high in the S&P shortly thereafter.

ilene's picture

You can blame inflation or POMO or tax cuts or commodity speculation for throwing off our forecast but that doesn't matter - we have to be ready to go with the flow, even if we don't agree with the direction of the flow at the moment.

Goldman Works Its Capture Magic, Hires 15 Year New York Fed Derivatives Reform Veteran

If you can't beat them, might as well get paid by them. Such were the prevailing thoughts in the head of New York Fed veteran Theo Lubke, who after 15 years at Liberty 33, most recently as head of reform efforts in the private derivative market, famous due to its size of roughly €583 trillion which may or may not take the financial system down with it during the next market meltdown. And so, after realizing the derivatives reform is impossible, and further realizing that getting paid a grossly exaggerated government salary for what is basically a lobby job, Lubke has instead decided to get paid an even more exorbitant amount by everyone favorite monopolistic bloodsucking parasite. What is most ironic is that during an ISDA conference in Beijing in April 2009, Ludke said: “It is simply unacceptable in today’s environment that the design and structure of the OTC derivatives market can be controlled by a handful of large dealers.” Oh well - an average government salary is $119,982, an average Goldman Sachs salary is about 4 times greater, an infinite amount of hypocrisy - priceless. For everything else there is the taxpayer bailout debit card.