Hunting the Squid, Part 2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

Reggie Middleton's picture

Welcome to part two of my series on Hunting the Squid, the
overvaluation and under-appreciation of the risks that is Goldman Sachs.
Since this highly analytical, but poignant diatribe covers a lot of
material, it's imperative that those who have not done so review part 1
of this series, I'm Hunting Big Game Today:The Squid On The Spear Tip, Part 1 & Introduction.
Once one and all have caught up, we can move on to answering the
question posed when we left off in The Squid On The Spear, namely So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?
Condensed, Cliff Notes style hint - Goldman has the most shortable
share price of all the big banks at around $100 and is quite liquid; it
is more susceptible to mo-mo traders than it is to it's own book value,
it is highly levered into the European debt/banking mess, and last but
not least, Goldman is the derivatives risk concentration leader of the
world - bar none!

Click any and all graphics in this post to expand to print quality

Reggie_Middleton_hunting_the_Squid_Known_As_Goldman_Sachs_GS

As
we sit at the precipice of devastating European banking failure, upon
which Goldman is heavily levered into through excessive French exposure
(and you've seen how prescient our French banking analysis has been, bordering the prediction of the fall of Bear Stearns and Lehman),
I feel many of you should take heed when I say this bank's risk is
woefully underappreciated. As in the case of Bear, Lehman, Countrywide,
and a slew of other banks, the 10 minutes or so of your time to read
this heavy, fact filled piece could be worth a small fortune. While
we're at it, I would like to urge all paying BoomBustBlog subscribers  to (admiring the original artwork below, of course) to download and review the latest related documents on this topic:

  1. Goldmans Sachs Derivative Exposure: The Canary in the Coal Mine?
  2. Goldman Sachs Q3 Forensic Review - Retail or Professional levels
  3. Actionable Note on US Bank/ French Bank Run Contagion

You see, in said piece, ZeroHedge dutifully reported that Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure- a very interesting refresh of what I called out two years ago through "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!

bank_ficc_derivative_trading.png

This concept was further illustrated in An Independent Look into JP Morgan...

Click graph to enlarge (there is a typo in the graphic - billion should trillion)

image001.png

ZeroHedge, and the market in general, appear to have a valid concern about one of these banks in particular - Morgan Stanley.

image003_copy

While I'm definitely not one dismiss the risks inherent in the Riskiest Bank on the Street, see The Truth Is Revealed About The Riskiest Bank On The Street - What Does That Say About The Newest Bank To Carry That Title?,
I do believe the equity market is missing the forest due to excessive
tree bark blocking its view. So, it's time to publicly pose the question
that I answered for subscribers months ago, and that is...

Goldmans Sachs Derivative Exposure the Canary in the Coal Mine?

The notional amount of derivatives held by insured U.S. commercial banks have increased at a CAGR of 22% since 2005, which naturally begs the question
“Has the value or the economic quantity of the underlying increased at a
similar pace, and if not does this indicate that everyone on the street
has doubled and tripled up their ‘bets’ on the SAME HORSE?”

Think about what happens if (or more aptly put, "when") that horse loses! Would there be anybody around to pay up?

Sequentially, the derivatives have increased every quarter since Q1-05 except for Q4-07, Q3-08 (Lehman crisis) and Q4-10 while on a YoY basis the growth has been positive throughout recorded history.  In Q2-2011, the notional value of derivative contracts increased 2% sequentially to $249 trillion. The notional value of derivatives was 12% higher than a year ago.
The notional amount of a derivative contract is a reference amount from
which contractual payments will be derived, but it is generally not an
amount at risk. However, the changes in notional volumes can provide
insight into potential revenue, and operational issues and potentially
the contagion risk that banks and financial institutions poses to the
wider economy – particularly in the form of counterparty risk delta. The
top four banks with the most derivatives activity hold 94% of all
derivatives, while the largest 25 banks account for nearly 100% of all
contracts
.  Overall, the US banks derivative exposure is $249 trillion and is more than four folds of World’s GDP at $58 trillion.

In
absolute terms, JPM leads this list with total notional value of
derivative contracts at $78 trillion, or 1.3x times the Wolds GDP.
However, in relative terms, Goldman Sachs leads the list with
total value of notional derivatives at 537 times is total assets
compared with 44x for JPM, 46x for Citi and 23x for US Banks (average).

So,
what does this mean? Well, it should be assumed that Goldman is well
hedged for its exposure, at least on academic basis. The problem is its
academic. AIG has taught as that bilateral netting is tantamount to
bullshit at this level without government bailout intervention. If there
is any entity at risk of counterparty default or who is at the behest
of a government bailout if the proverbial feces hits the fan blades…
Ladies and gentlemen, that entity would be known as Goldman Sachs.

As excerpted from Goldmans Sachs Derivative Exposure: The Squid in the Coal Mine?, pages 2 and 3...

GS__Banks_Derivatives_exposure_temp_work_Page_2

Goldman
is much more highly leveraged into the derivatives trade than ANY and
ALL of its peers as to actually be difficult to chart. That stalk
representing Goldman's risk relative to EVERY OTHER banks is damn near
phallic in stature!

GS__Banks_Derivatives_exposure_temp_work_Page_3

As opined earlier through the links "The Next Step in the Bank Implosion Cycle???"and As the markets climb on top of one big, incestuous pool of concentrated risk... ,
this is not a new phenomenon. Quite to the contrary, it has been a
constant trend through the bubble, and amazingly enough even through the
crash as banks have actually ratcheted up risk and assets in a blind
race to become TBTF (to big to fail), under the auspices of the
regulatory capture (see Lehman Dies While Getting Away With Murder: Introducing Regulatory Capture).
So, what is the logical conclusion? More phallic looking charts of
blatant, unbridled, and from a realistic perspective, unhedged RISK
starring none other than Goldman Sachs...

 image006

And
to think, many thought that JPM exposure vs World GDP chart was
provocative. I query thee, exactly how will GS put a real workable
hedge, a counterparty risk mitigating prophylactic if you will, over
that big green stalk that is representative of Total Credit Exposure to
Risk Based Capital? Short answer, Goldman may very well be to big for a
counterparty condom. If that's truly the case, all of you pretty, brand name Goldman counterparties
out there (and yes, there are a lot of y'all - GS really gets around),
expect to get burned at the culmination of that French banking party
I've been talking about for the last few quarters. Oh yeah, that
perpetually printing clinic also known as the Federal Reserve just might
be running a little low on that cheap liquidity antibiotic... Just
giving y'all a heads up ahead of time...

image009

As you
read exactly how precarios the situation is in France (and Belgium,
through Dexia, et. al.) keep in mind that although this is definitely
not good news for Goldman's numbers, historically since the beginning of
this crisis, GS has actually correlated more with coke laced, red bull
juice powered mo-mo trader patterns than actual book value - reference
The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat
Bonuses That Can't Trade In Volatile Markets? Who's Gonna Tell The
Shareholders and Tax Payer???
from just last reporting period...

...
I'd like to announce to the release of a blockbuster document
describing the true nature of Goldman Sachs, a description that you will
find no where else. It's chocked full of many interesting tidbits, and
for those who found "The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely" to be an iteresting read, you're gonna just love this! Subscribers can access the document here:

As is customary, I am including free samples for those who don't subscribe, so you can get a taste of the forensic flavor. Here are the first 2 pages of the 19

page professional edition, with illustrative option trade setups soon to follow.

 Goldman_Sachs_Q3_Forensic_Review_Page_01Goldman_Sachs_Q3_Forensic_Review_Page_01

Is Goldman Sachs stock really the front running, Mo-Mo traders wet dream?

Goldman_Sachs_Q3_Forensic_Review_Page_02Goldman_Sachs_Q3_Forensic_Review_Page_02 

Given
the high correlation of Goldman’s prop trading desk to equity markets
and taking into consideration the state of equity markets in Q2-Q3, it
would be interesting to see how Goldman Sachs share perform in the
coming quarters. Those who would have followed the traditional
school of thought and bid the price up would have already seen their
capital erode by 20% during the last quarter and by 12% over the last
one month alone.

 

What do you think happens when word of Goldman's true exposures get out? And I'm
not even half way through exposing just SOME of the dirt that
BoomBustBlog subscribers had access to back in July, when those Goldman
puts were nice and cheap!
Interested parties should click here to subscribe,
cause next up we walk through several other American banks to see who's
up for re-enacting 2008-9 put parade - and historically we have usually
if not always been ahead of the curve, particularly when compared to Wall Street and the sells side - see Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

Another BIG Reason Why BNP Paribas (France's LARGEST BANK) Is Still Ripe For Implosion!

As excerpted from our professional series File Icon Bank Run Liquidity Candidate Forensic Opinion:

BNP_Paribus_First_Thoughts_4_Page_01

This
is how that document started off. Even if we were to disregard BNP's
most serious liquidity and ALM mismatch issues, we still need to address
the topic above. Now, if you were to employ the free BNP bank run
models that I made available in the post "The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download"" (click the link to download your own copy of the bank run model, whether your a simple BoomBustBlog follower or a paid subscriber)
you would know that the odds are that BNP's bond portfolio would
probably take a much bigger hit than that conservatively quoted above. 
Here I demonstrated what more realistic numbers would look like in said
model... image008

To
note page 9 of that very same document addresses how this train of
thought can not only be accelerated, but taken much further...

BNP_Paribus_First_Thoughts_4_Page_09

So,
how bad could this faux accounting thing be? You know, there were two
American banks that abused this FAS 157 cum Topic 820 loophole as well.
There names were Bear Stearns and Lehman Brothers. I warned my readers
well ahead of time with them as well - well before anybody else
apparently had a clue (Is this the Breaking of the Bear? and Is Lehman really a lemming in disguise?).
Well, at least in the case of BNP, it's a potential tangible equity
wipeout, or is it? On to page 10 of said subscription document...

BNP_Paribus_First_Thoughts_4_Page_10

Yo, watch those level 2s! Of course there is more
to BNP besides overpriced, over leveraged sovereign debt, liquidity
issues and ALM mismatch, and lying about stretching Topic 820 rules, but
I think that's enough for right now. Is all of this already priced into
the free falling stock? Are these the ingredients for a European bank
run? I'll let you decide, but BoomBustBloggers Saw this coming midsummer
when this stock was at $50. Those who wish to subscribe to my research
and services should click here.
Those who don't subscribe can still benefit from the chronology that
led up to the BIG BNP short (at least those who have come across my
research for the first time)...

Thursday, 28 July 2011  The Mechanics Behind Setting Up A Potential European Bank Run Trastde and European Bank Run Trading Supplement

I
identify specific bank run candidates and offer illustrative trade
setups to capture alpha from such an event. The options quoted were
unfortunately unavailable to American investors, and enjoyed a literal
explosion in gamma and implied volatility. Not to fear, fruits of those
juicy premiums were able to be tasted elsewhere as plain vanilla shorts
and even single stock futures threw off insane profits.

Wednesday, 03 August 2011 France, As Most Susceptble To Contagion, Will See Its Banks Suffer

In
case the hint was strong enough, I explicitly state that although the
sell side and the media are looking at Greece sparking Italy, it is
France and french banks in particular that risk bringing the
Franco-Italia make-believe capitalism session, aka the French leveraged
Italian sector of the Euro ponzi scheme down, on its head.

I then provide a deep dive of the French bank we feel is most at risk. Let it be known that every banked remotely referenced by this research has been halved (at a mininal) in share price! Most are down ~10% of more today, alone!

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