A Potentially Nasty Snapshot Of Risk Resulting In Another Trillion Of Taxpayer Funded Bank Bailouts - A Walkthrough

Reggie Middleton's picture

While perusing the news today, I came across this most interesting article in Bloomberg, Swaps ‘Armageddon’ Lingers as New Rules Concentrate Risk'. Before we delve into it, I want to review how vehemently I've sounded the alarm on this topic over the last 6 years. Let's start with So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?, where I've aggregated my warnings into a single article. In a nutshell, 5 banks bear 96% of the global derivatives risk. The argument to defend such ass backwards risk concentration is "but it's mostly hedged, offset and netted out". Right! You know that old trader's saying about liquidity? It's always available, that is until you need it!

Even though I've made this point of netting = nonsense multiple times, I must admit, ZH did a more loquacious job, as follows:

..Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse. 

Hey, there ain't no concentration risk in US banks, and any blogger with two synapses to spark together should know this... From An Independent Look into JP Morgan.

Click graph to enlarge


Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who".

So, the Bloomberg article that got this rant started basically says that the risk is being shifted from the banks to clearing houses, who demand above board, translucent collateral for transactions. This should solve the problem, right? Hardly! You see, the Fed and US banking regulators have made it legal and acceptable for banks to outright lie about the qualit of their collateral and the condition of their finances. It all came to light with my research on Lehman (and Bear Stearns, amonst others). These mistakes are so repetitive of the ones made in the past, I literally do not have to right any new material, let's just re-read what was written several years ago:

Lehman Brothers and Its Regulators Deal the Ultimate Blow to Mark to Market Opponents

Let's get something straight right off the bat. We all know there is a certain level of fraud sleight of hand in the financial industry. I have called many banks insolvent in the past. Some have pooh-poohed these proclamations, while others have looked in wonder, saying "How the hell did he know that?"

The list above is a small, relevant sampling of at least dozens of similar calls. Trust me, dear reader, what some may see as divine premonition is nothing of the sort. It is definitely not a sign of superior ability, insider info, or heavenly intellect. I would love to consider myself a hyper-intellectual, but alas, it just ain't so and I'm not going to lie to you. The truth of the matter is I sniffed these incongruencies out because 2+2 never did equal 46, and it probably never will either. An objective look at each and every one of these situations shows that none of them added up. In each case, there was someone (or a lot of people) trying to get you to believe that 2=2=46.xxx. They justified it with theses that they alleged were too complicated for the average man to understand (and in business, if that is true, then it is probably just too complicated to work in the long run as well). They pronounced bold new eras, stating "This time is different", "There is a new math" (as if there was something wrong with the old math), etc. and so on and associated bullshit.

So, the question remains, why is it that a lowly blogger and small time individual investor with a skeleton staff of analysts can uncover systemic risks, frauds and insolvencies at a level that it appears the SEC hasn't even gleaned as of yet? Two words, "Regulatory Capture". You see, and as I reluctantly admitted, it is not that I am so smart, it is that the regulator's goals are not the same as mine. My efforts are designed to ferret out the truth for enlightenment, profit and gain. Regulators' goals are to serve a myriad constituency that does not necessarily have the individual tax payer at the top of the hierarchical pyramid. Before we go on, let me excerpt from a piece that I wrote on the topic at hand so we are all on the same page: How Regulatory Capture Turns Doo Doo Deadly.

You see, the banking industry lobbied the regulators to allow them to lie about the value and quality of their assets and liabilities and just like that, the banking problem was solved. Literally! At least from a equity market pricing and public disinformation campaign point of view...

A picture is worth a thousand words...


So, how does this play into today's big headlines in the alternative, grass roots media? Well, on the front page of the Huffington Post and ZeroHedge, we have a damning expose of Lehman Brothers (we told you this in the first quarter of 2008, though), detailing their use of REPO 105 financing to basically lie about their
liquidity positions and solvency. The most damning and most interesting tidbit lies within a more obscure ZeroHedge article that details findings from the recently released Lehman papers, though:

On September 11, JPMorgan executives met to discuss significant valuation problems with securities that Lehman had posted as collateral over the summer. JPMorgan concluded that the collateral was not worth nearly what Lehman had claimed it was worth, and decided to request an additional $5 billion in cash collateral from Lehman that day. The request was communicated in an executive?level phone call, and Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday, September 12. Around the same time, JPMorgan learned that a security known as Fenway, which Lehman had posted to JPMorgan at a stated value of $3 billion,was actually asset?backed commercial paper credit?enhanced by Lehman (that is, it was Lehman, rather than a third party, that effectively guaranteed principal and interest payments). JPMorgan concluded that Fenway was worth practically nothing as collateral.

Well, I'm sure many are saying that this couldn't happen in this day and age, post Lehman debacle, right? Well, it happened in 2007 with GGP and I called it -  The Commercial Real Estate Crash Cometh, and I know who is leading the way! As a matter of fact, we all know it happened many times throughout that period. Wait a minute, it's now nearly 2013, and lo and behold.... When A REIT Trading Over $15 A Share Is Shown To Have Nearly All Of Its Properties UNDERWATER!!!

Paid subscribers are welcome to download the corporate level valuation of PEI as well as all of the summary stats of our findings on its various properties. The spreadsheet can be found here - File Icon Results of Properties Analysis, Valuation of PEI with Lenders' Names.In putting a realistic valuation on PEI, we independently valued a sampling of 27 of its properties. We found that many if not most of those properties were actually underwater. Most of those that weren't underwater were mortgaged under a separate credit facility.   

PEI Underwater  Overly Encumbered PropertiesPEI Underwater Overly Encumbered Properties

What are the chances that the properties, whole loans and MBS being pledged by PEI's creditors are being pledged at par? Back to the future, it's the same old thing all over again. Like those banks, PEI is trading higher with its public equity despite the fact that its private equity values are clearly underwater - all part of the perks of not having to truly mark assets to market prices.  

 From Bloomberg: Swaps ‘Armageddon’ Lingers as New Rules Concentrate Risk

Clearinghouses cut risk by collecting collateral at the start of each transaction, monitoring daily price moves and making traders put up more cash as losses occur. Traders have to deal through clearing members, typically the biggest banks and brokerages. Unlike privately traded derivatives, prices for cleared trades are set every day and publicly disclosed.

And what happens when everybody lies about said prices? Is PEI's debt really looking any better than GGP's debt of 2007?

GGP Leverage Summary 2007

Properties with negative equity and leverage >80%   32
Properties with leverage >80%     44
% of properties with negative equity (based on CFAT after debt service) 72.7%

PEI Summary 2012

PEI Underwater  Overly Encumbered PropertiesPEI Underwater Overly Encumbered Properties

Both of these companies have debt that have been pledged by banks as collateral. Would you trust either of them? The banks then use the collateral to do other deals leading to more bubbles. What's next up in bubble land? I warned of it in 2009...

Check this out, from "On Morgan Stanley's Latest Quarterly Earnings - More Than Meets the Eye???" Monday, 24 May 2010:

Those who don't subscribe should reference my warnings of the concentration and reliance on FICC revenues (foreign exchange, currencies, and fixed income trading).  Morgan Stanley's exposure to this as well as what I have illustrated in full detail via the  the Pan-European Sovereign Debt Crisis series, has increased materially. As excerpted from "The Next Step in the Bank Implosion Cycle???":

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!


So, How are Banks Entangled in the Mother of All Carry Trades?

Trading revenues for U.S Commercial banks have witnessed robust growth since 4Q08 on back of higher (although of late declining) bid-ask spreads and fewer write-downs on investment portfolios. According to the Office of the Comptroller of the Currency, commercial banks' reported trading revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8 quarters.


High dependency on Forex and interest rate contracts

Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.

In terms of absolute dollar exposure, JP Morgan has the largest exposure towards both Interest rate and Forex contracts with notional value of interest rate contracts at $64.6 trillion and Forex contracts at $6.2 trillion exposing itself to volatile changes in both interest rates and currency movements (non-subscribers should reference An Independent Look into JP Morgan, while subscribers should referenceFile Icon JPM Report (Subscription-only) Final - Professional, and File Icon JPM Forensic Report (Subscription-only) Final- Retail). However, Goldman Sachs with interest rate contracts to total assets at 318.x and Forex contracts to total assets at 11.2x has the largest relative exposure (see Goldman Sachs Q2 2009 Pre-announcement opinion Goldman Sachs Q2 2009 Pre-announcement opinion 2009-07-13 00:08:57 920.92 Kb,  Goldman Sachs Stress Test ProfessionalGoldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 MbGoldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb,). As subscribers can see from the afore-linked analysis, Goldman is trading at an extreme premium from a risk adjusted book value perspective.


Back to the Bloomberg article:

Disaster Scenario

The need for a Fed rescue isn’t out of the question, said Satyajit Das, a former Citicorp and Merrill Lynch & Co. executive who has written books on derivatives. Das sketched a scenario where a large trader fails to make a margin call. This kindles rumors that a bank handling the trader’s transactions -- a clearing member -- is short on cash.

Remaining clients rush to pull their trading accounts and cash, forcing the lender into bankruptcy. Questions begin to swirl about whether the remaining clearing members can absorb billions in losses, spurring more runs.

“Bank customers panic, and they start to withdraw money,” he said. “The amount of money needed starts to become problematic. None of this is quantifiable in advance.” The collateral put up by traders and default fund sizes are calculated using data that might not hold up, he said.

The collateral varies by product and clearinghouse. At CME, the collateral or “margin” for a 10-year interest-rate swap ranges between 2.89 percent and 4.06 percent of the trade’s notional value, according to Morgan Stanley. At LCH, it’s 3.2 percent to 3.41 percent, the bank said in a November note.

How Much?

The number typically is based on “value-at-risk,” and is calculated to cover the losses a trader might suffer with a 99 percent level of confidence. That means the biggest losses might not be fully covered.

It’s a formula like the one JPMorgan used and botched earlier this year in the so-called London Whale episode, when it miscalculated how much risk its chief investment office was taking and lost at least $6.2 billion on credit-default swaps. Clearinghouses may fall into a similar trap in their margin calculations, the University of Houston’s Pirrong wrote in a research paper in May 2011.

“Levels of margin that appear prudent in normal times may become severely insufficient during periods of market stress,” wrote Pirrong, whose paper was commissioned by an industry trade group.

Oh, but wait a minute? Didn't I clearly outline such a scenario in 2010 for French banks overlevered on Greek and Italian Debt (currently trading at a fractiono of par)? See The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!

The problem then is the same as the European problem now, leveraging up to buy assets that have dropped precipitously in value and then lying about it until you cannot lie anymore. You see, the lies work on everybody but your counterparties - who actually want to see cash!


Using this European bank as a proxy for Bear Stearns in January of 2008, the tall stalk represents the liabilities behind Bear's illiquid level 2 and level 3 assets (including the ill fated mortgage products). Equity is destroyed as the assets leveraged through the use of these liabilities are nearly halved in value, leaving mostly liabilities. The maroon stalk represents the extreme risk displayed in the first chart in this missive, and that is the excessive reliance on very short term liabilities to fund very long term and illiquid assets that have depreciated in price. Wait, there's more!

The green represents the unseen canary in the coal mine, and the reason why Bear Stearns and Lehman ultimately collapsed. As excerpted from "The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style":

The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors.  In cases of the perception of extreme risk, these counterparties are prone to pull funding are request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!


I'm sure many of you may be asking yourselves, "Well, how likely is this counterparty run to happen today? You know, with the full, unbridled printing press power of the ECB, and all..." Well, don't bet the farm on overconfidence. The risk of a capital haircut for European banks with exposure to sovereign debt of fiscally challenged nations is inevitable.

You see, the risk is all about velocity and confidence. If the market moves gradually, the clearing house system is ok. If it moves violently and all participants move for cash at the same time against bogus collateral... BOOMMMM!!!!!!!

Back to the Bloomberg article...

Stress Levels

What’s more, clearinghouses can’t use their entire hoard of collateral to extinguish a crisis because it’s not a general emergency fund. The sum represents cash posted by investors to cover their own trades and can’t be used to cover defaults of other people.

Clearinghouses can turn to default funds to cover the collapse of the two largest banks or securities firms with which they do business. They have the power to assess the remaining solvent members for billions more, enough to cover the demise of their third- and fourth-largest members.

But wait a minute, the other members are only solvent because they have hedges against the insolvency of the insolvent members. If those hedges fail, then the so-called solvent members are insolvent too! Or did nobody else think of that?

After all, this circular reasoning worked out very well for Greece, didn't it? See Greece's Circular Reasoning Challenge Moves From BoomBustBlog to the Mainstream...

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jerry685's picture

There was a much bigger then normal Line at my bank this mourning...wierd..it is a pretty small bank.

The peope in front of me all made withdrawels...while I deposited a few checks to pay 1st of the month bills...

rosethorn's picture

Appreciate this article...was just thinking the other day it would be nice to get an update on this topic.



GottaBKiddn's picture

Rock on, Reggie. A tsunami by any other name is still a tsunami. Preach on!

Kai's picture

Wow, never hear about any of this on the news.  Thanks Reggie Middleton!

Also, might be small typo in the first graphic?  "outstrips the entire world GDP economy by $21 trillion"


Amazing that JP Morgan could be involved in roughly $80 trillion in contracts!  Talk about too big to fail.  Thank goodness someone is spreading the awareness.

JR's picture

The international bankers are robbers. With the economies of China and Europe and the US deteriorating, this paper control is going to stop. The people will demand it.

“The top line story, according to the FDIC's latest Quarterly Banking Review,” writes Shah Gilani, “is that the majority of U.S. banks are in better shape today than they have been in years.  

“The untold story," writes Gilani on Market Oracle, “is that when the Federal Reserve is done transitioning the United States from capitalism to socialism, the few dozen banks that remain in America will all be profitable until they need bailing out again, but will never die and live on in infamy.”

What really matters, he says, “is understanding the Federal Reserve could never exist and do what it does in an open democracy, and that its agenda of socializing risks (making taxpayers eat bankers' losses) and privatizing their profits (letting them keep their bonuses) for the benefit of its club members (the banks) means the Federal Reserve has to transform America to a socialist model in order to maintain its own growth and ultimate power.”

If the politicians think that the banks are going to solve their problems and keep going and going and getting bigger and bigger by taking the income and benefits from the people, especially the elderly and the young, then they don’t know Americans like I do. And the backlash is going to be huge.

Neither political party understands what’s coming.

And it isn’t just Social Security recipients and college students that are targets of the bankers; it’s the unemployed, it's the small businessmen who have to pay taxes while they are strangled with more and more regulation, it's  America’s disenfranchised, inflation-challenged workers. The bankers and the politicians are crushing America’s economic system with regulations and usury, ruining the security and futures of the American people, destroying the opportunities of American free enterprise.

And when you do that, you’re going to have a revolution. The people will fight back against this. When you mix together a Leftist in the oval office, a debt load like this and the continuing political fights over sovereignty, it’s an unsustainable volcanic mixture. And all the while, Bernanke is making statements solely to hold the stock market together; his actions are just for the equity markets and the bankers, not the economy.

Jason Fichtner on MarketWatch wrote today in the Chained CPI: Diet COLA for Social Security that in the fiscal cliff media blitz, the media has yet to focus on the spending side of the negotiations “with one exception — changing the way Social Security Cost-of-Living Adjustments (COLAs) are computed.”

As Bernanke continues to print and print inflation, one proposal to protect this banker-controlled economy is to use “chained CPI” gimmickry to reduce COLAs for seniors by reducing their standard of living.

In this measure of inflation, says John Williams of Shadow Government Statistics, “if steak prices rise sharply, and people shift to buying hamburger as a result, inflation is reduced accordingly by that switch,” i.e., their standard of living.

Here are some startling facts “to keep in mind [regarding] the millions of Americans who rely on Social Security benefits for income protection” presented by Fichtner:

“In fact, 65% of all beneficiaries rely on Social Security to provide 50% or more of their incomes, while 36% rely on benefits for 90% or more of their incomes. For non-married beneficiaries, including widows, the reliance is higher with 74% relying on benefits for 50% or more of their incomes and 46% relying for 90% or more of their incomes.”

If the politicians think the people are going to lie down in the road and let the bankers run over them, they are in for a big awakening.

Element's picture



What really matters, he says, “is understanding the Federal Reserve could never exist and do what it does in an open democracy, and that its agenda of socializing risks (making taxpayers eat bankers' losses) and privatizing their profits (letting them keep their bonuses) for the benefit of its club members (the banks) means the Federal Reserve has to transform America to a socialist model in order to maintain its own growth and ultimate power.”


There's the money-shot.

Not going to be free of this while the same people own the FED, TBTF, Main-Stream-Media and Hollywood, they have to be dealt with as one system-of-systems, or you may as well forget it. This is an organized-crime of the highest order, and the Govt are its facilitators and Mob-protection-ring - literally.

donsluck's picture

Like all the recent changes, the SS modifications will be slow and methodical. It will be death by a thousand cuts. Add the fact that the US population fears their govenment, and I think you are incorrect. They will lay down and die.

JR's picture

The economy of the US has been based on people working, trying to benefit themselves for the future. These international bankers are robbers, taking away that benefit. And the people won’t have it; the American people won’t accept it. This paper control is trying to stop people from working for their dreams and their futures.

It is collapsing now.

There are more and more signs that the economy is deteriorating--this unemployment, Bernanke's rashness, this stealing from the savers and the retirees to pay Wall Street, this government manipulation of statistics, the onrush to buy high end guns for protection from the government.

These bankers are not sitting on a golden stairway;  they are sitting on a volcano that is going to blow.

donsluck's picture

It's simple, Reggie, they already failed and will remain zombies until the system collapses. There is no risk.

Clowns on Acid's picture

Reggie - Great stuff as per usual. But the Central bank scam is so large today....they will play it out to the end. Timing and preparation becomes critical.


Jack Sheet's picture

Yeah, I was wondering how to make a shitload of money using Reggie's advice. I want to, I sincerely do.

Bob's picture

Hey, Reggie, looks like you're not the only genius whose APPL outlook is decidedly negative.  Their own employees feel the same:


yellowsub's picture

Taxpayers are the losers, at the mercy to corrupt pols and public unions and the banking cartels...


donsluck's picture

Trying to stay on topic, I don't believe unions hold significant derivative exposure.

Son of Loki's picture

Great article, Reggie. Thnx.

Jack Sheet's picture

What about Deustche Wank? 59 trillion € derivative book at the last published count. Ask Angie.

johnQpublic's picture

one big snake eating its tail

pine_marten's picture

Monsterous cock sookers the lot of em.  Worse than the nazis in the impact on the world's peoples.  Depraived lunatics.  And the politicians pimp us out to them..........

aleph0's picture

"Or did nobody else think of that?"


Well, yes ... way back in 2001/2.

Seems nothing has changed since .. except it just got bigger !

The JPM Derivatives Monster
Adam Hamilton September 7, 2001 


... JPM is the utterly dominant player with 64% of the interest rate derivatives market, 49% of the foreign exchange market, 68% of the equity derivatives market, and 62% of the gold derivatives market among US commercial banks and trusts....


Imminent Crucible's picture

"except it's all bigger now"

Ain't that the truth. JPM's total notional exposure to derivatives in more than triple what it was in 2001. And there's no use talking about unwinding this risk, because the vast majority of JPM's derivative book is IR swaps, and they're not there because JPM likes to gamble in the rate markets. After all, JPM (with GS) chairs the Treasury Borrowing Advisory Committee, which tells the Treasury what kind of debt they're going to sell to make the primary dealers happy.

No. The reason for the giant IR swap book is that's how they've enabled the gigantic scam of "Treasury Dept. sells $1.5 trillion in new debt to keep the Federal Spending Dirigible in the air, and the Fed monetizes it through the primary dealers". JPM's book of rate swaps must grow, not unwind.

When the United States of Argentina/Botswana/Bananas is selling most of its new bonds to its own central bank, there's only one reason: The market for more Treasury bonds is failing. China can't (won't) buy enough T-bonds to keep USA, Inc. afloat, and Japan is in the last stage of its own debt crisis.

Maybe this time will be different. (Pauses to add black powder to the reloader, while calling Tulving.com)

Jack Sheet's picture


re IR swaps, that figures.- Jim Willie has also been proposing this in detail. Only thing is - nobody explains who buys them if JPM is selling? Or are these banks selling them to each other?

Imminent Crucible's picture

The PDs that manage big Treasury portfolios both buy and sell them. Since the Fed has been hugging the Zero Lower Bound for four years now, my guess is that the swap books are overweighted to the "rates will rise" side.

It's their way of managing the risk of holding trainloads of debt instruments that yield virtually nothing. The moment that inflation seems to be picking up in earnest, the Fed will have to do something like Kyle Bass said, "make a ceremonial 25 bp rate increase". The minute that happens, every bond house in the world is going to be stabbing at the Sell button. If the 5YR yield goes to just 1.5%, those bonds lose HALF their principal value.

So they have these giant IR swap books. But there's a big downside, and that's the fact that hedges aren't free, and everytime the Fed makes another tweak to the Treasury complex (QE X, Operation Twist, whatever) they have to rebalance those swap portfolios to adapt. I look for yet another train wreck.