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The REAL $200 TRILLION Problem Bernanke’s Worried About
I’ve stated before that Bernanke isn’t interested in interest rates for employment of economic purposes. We now have definitive proof this is the case.
As you can see, interest rates have actually RISEN after the announcement of QE lite, QE 2 AND Operations Twist #2.
The evidence is clear, QE has not lowered interest rates. Indeed, the only time rates FELL in the last two years was when the Fed WASN’T engaged in QE (May 2010-August 2010 and June 2011-September 2011).
So what gives? Does the Federal Reserve not have a stockcharts account? Don’t tell me that with the TRILLIONS spent bailing out banks the Fed can’t afford to print a couple hundred bucks to see Treasury yields. Heck, there are plenty of FREE sources for Treasury charts.
Jokes aside, it’s clear the Fed is engaged in QE for another reason or reasons. I believe they are:
1) To absorb the insane debt issuance to permit the US’s massive deficit.
2) To keep the interest rate based derivative market in check.
Regarding #1, it’s no surprise that the US has been running a deficit that would make Greece proud. Indeed, the primary strategy of the powers that be since the Great Crisis began in 2008 was to attempt to make up for the sharp downturn in the private sector by spending obscene amounts of money.
The Fed played a big part in this. Indeed, since QE 1 was announced the Fed has bought over $1.2 TRILLION in Treasuries. The Fed claims it isn’t funding the deficit directly. That’s only partially correct. The Fed is supposedly buying old Treasuries from the banks. However, the definition of “old” can mean one or two weeks.
Tell me with a straight face that isn’t somehow buying new Treasuries.
As for the derivatives situation or #2 in my list above, 82% of the $244 TRILLION in derivatives sitting on US commercial bank balance sheets are based on interest rates. Put another way…
US Commercial banks have $200 TRILLION in interest rate based derivatives sitting on their balance sheets. And guess which banks have the greatest exposure?
Looks a lot like the list of the VERY banks the Fed has been giving the most money/ preferential treatment to. Coincidence? Nope. This is the $200 TRILLION problem Bernanke’s so worried about. It’s THE reason he keeps funneling money to the TBTFs.
And he WILL lose control of it, just as he did in 2008.
Consider that Financial leverage levels today are higher than during the Tech Bubble. Only this time, the problem will be far FAR worse.
Why?
Because 2008 was caused by the Credit Default Swap (CDS) market which was $50-60 trillion at the time. As I stated before, the interest-rate based derivative problem is $200 TRILLION in size.
Even if only 4% of this is “at risk” and 10% of that “at risk” money blows up, you’ve STILL pretty much wiped out the equity at the TBTFs.
You think Bernanke might be worried?
On that note, if you have yet to prepare yourself for what’s coming, now is the time to do so. Whether it’s by moving to cash and bullion, opening some shorts, or simply getting out of the markets altogether, now is the time to be preparing for what’s coming (remember, stocks took six months to bottom after Lehman… and that was when the Fed still had some bullets left to combat the collapse).
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This figure is so big its difficult to discuss its consequences. If the derivatives netting generates even 10% write offs of bank balance sheets, that's 20 T. That's more than GDP and more than federal debt. Can't discuss the consequences of such a new hole in the national economic balance sheet...Makes USA worse than Greece today. Game over for first nation on earth.
Buying week old treasuries is just another way to funnel commissions to his Primary Dealer buddies. Classic trick of skimming billions off the Trillions withouth being noticed
...Classic trick of skimming billions off the Trillions without being noticed...
"We can lie to most people some of the time..."
You know the sequel...
Thanks Mr Summers for clarifying the real reason Ben 'Dorm Boy' Bernanke was bending over backwards and bailing out his fellow elite educated bum chums on WS and in DC
it wasn't because these high-flying University insolvents were all out of money... it was so Benny could bend the space/time continium of interest rate derivative exposures (hi-finance betting for elite-educated losers and village idiots on Park Avenue and across in Rochester and New Hamptons)
...thanks for explaining why they got bailouts ...they're crap at betting and like Las Vegas bums didn't know when to stop (Why should they? Benny was designed - conceived in a dorm- 100 years ago to back-stop them!)
This practice of bailing out bad investments didn't begin in 2008, it started with the Internet Bubble exploding in March of 2000. The reflation of the personal balance sheets of investors who lost huge in the collapse of the Web Vans of the world was focused, guess where? On housing when rates were driven to below inflation, causing the Great and Final Bubble for this cycle in the housing market.
it started with the latin american debt crisis.
it started with 'democratic Govt' (a monopoly) who then extended the power of monopolists to money (and central banking) ....if anyone has found anything good about any monopolist organisation, public or private, in the past oh, 500 years, please write in to:
Soros EC-ECB Campaign for a Central Euro-Money Monopoly, Dept. for Systemic Rigging, Insolvent Crooks Plaza, Brussels, Tokyo & Washington. Postcode: USSR-EUSSR-USASSR-JAPANSSR-ZOMBIES-R-US-RIP
i think this is why they said long ago that usuary is a sin.
goldman is planning on not being any bank longer.....so problem solved with them
Wait until we short selling hedge funds finish up with Goldman, driving their stock down to the flat line. They'll wish they never gave up their Bank Holding status. :)
So, I'm wondering, since the States and local governments have been playing the interest swap game, what kind of collateral have they been putting up? If they have been putting up land and other public assets, what are the unwitting taxpayers going to do when the private pipers come calling? And what collateral has the Fed been putting up?
Of course, the FED is just a private bank, a legal fraud (by the way, they aren't subject to any law).
That chart tells you BAC and CITI will never (be allowed to) fail.
This sort of stuff keeps springing up from time to time - much the same as some congresscritter rises and being upset at all the unpaid taxes on corporates' balance sheets (deferred taxes, which are an accounting entry only). So, once more:
1. There is no principal exchange on Interest rate swaps. Only coupons are exchanged - often net. The 200 trillion notional is quite overstated as an exposure. the difference in coupon rates' value is usually counted in basis points (hundreds of a percent - ie. 8 bps of $200 trillion would be $160 billion - not small but not armagedon either). The 8 bps is arbitray - but also remember that while some swaps are in the money for one counterparty they are out of the money for the other party. The reverse is true on the hedge swap (see point 2 and 3).
2. The swaps are usually used to take on or remove interest rate exposure (floating rate), and sometimes as a basis swap they are used to exchange one floating rate for another. In other words, if I borrow fixed, and I think that rates will fall, I will swap it to floating when I issue the debt.
3. If I did a fixed to float swap to get exposure on debt to floating rates, then the counterparty likely hedged away that exposure themselves. The net remains the same - but the notional counted has increased - me and the counterparty's; and the counterparty's and their hedge counterparty.
4. Everyone except the brain-dead has collateral agreements in place based on the perceived credit risk of counterparties - based on the aggreagate VALUE of the swap, not notional. The actual exposure is a lot less. If one of my counterparties fails, then I am no longer receiving their swap coupon - but I no longer have to pay my own. If I have collateral (and the swap was in my favour), then replacing the swap (because it was hedging exposure) is not likely to have much of a cost (= increased cost of funding). If I have no collateral, then replacing the swap depends on the interest rate exposure that I would like and how the book has shifted. If the swap is in the favour of the counterparty that defaults, it is an asset that will likely be liquidated - and I will be happy to since it will lower my cost of funding to get rid of it. (clear as mud?)
5. The real thing to worry about is if there is some ultimate naked exposure - such as for AIG previously when the were the insurer of last resort (and woefully mispricing the instruments) in the CDS market.''
Let's say that I did a $1 billion swap fixed to float - note that all swaps have a zero value at initialization for the credit profile of the participants - to hedge away a fixed rate loan. I would be receiving fixed and paying floating rate. The value of the swap would shift from zero, only if the yield curve shifts. If rates rise, I'm in the hole by the difference. If they fall, I'm ahead - because the swap rates are priced so that there is no arbitrage between the fixed rate on one leg, and the implied forward rates for the floating coupon based on the curve being used (usually OIS or LIBOR / SWAP). If over time, the swap gains in value, to my favour, then I will ask for collateral to be posted by the counterparty (T-bills and T-notes), so that I am protected. My net exposure will be whatever exposure some credit department has decided is appropriate for the risk profile of my counterparty.
Using the poster's example:
So, if 4% of that $200 trillion notional is at risk, and only 10% fails, we are talking about 40 basis points OF THE MARKET VALUE - NOT the notional. Let's take the $160 billion in NET value of those swaps that I estimated, and lose those 40 bps of this. this results in losses to capital of $640 million - AND THAT'S ASSUMING NO COLLATERAL. Hardly something that will keep anyone up at night in the current environment.
When pundits talk about this issue, they always fail to disclose the extent of collateral from the notes - because the collateral covers all dealings with a particular counterparty, not just swaps. It is difficult to allocate.
The biggest risk, IMHO, is the flattening yield curve which will severly hinder all the financial system from recapitalizing from profits.
"Hardly something that will keep anyone up at night in the current environment."
Good to hear, sleep well...
but it's the current environment that's keeping everyone awake.
Perhaps after your long slumber, you'll awake refreshed and go more macro in your thinking.
Exactly. There is much more going on now than worrying about a notional amount of derivatives that may or not be real. That is where the focus should be. there is still a trillion plus in toxic MBS, CDO and other alphabets that are out in SPVs, and on the FED's balance sheet. that is where the worry should be. They are real.
gmak
Everyone understands that you are swapping the coupons, not the principal represented by the notional.
The point is, firstly, that there is not 600 Trillion in debt principal or anything close to that to support the notional value of the derivatives.
Secondly, the coupons on 400 Trillion in notional principal for interest rate swaps are still going to represent far more than the capitalization of the worlds banks.
Thirdly, if the banks are so exquisitely balanced that their net exposure is only a few billions then the swaps and other derivatives are probably sham transactions entered into for the purpose of evading taxes or regulatory controls.
Six hundred trillion (total derivative market, including interest rate swaps), even just as notional principal and even if everything gets double counted, is simply too big to be legitimate.
the lion's share of interest rate swaps are nominal payments on 30 year fixed interest rate mortgages.
the lion's share of bank profits are the spread earned on these derivative transactions.
if the 10 year jumped 5% so that anyone who has a fixed mortgage was in the money, not a single one of these banks would be solvent.
summary: the spread main street is paying between the fixed rate & the variable borrwing rate is a fraudulent insurance product. this also poses the greatest wealth transfer from main street to wall street, entirely off the credit of the US Treasury. I agree that this is the primary motivation for twist, with the government borrowing requirements being 2nd.
I'm not sure you are correctIn fact, it sure sounds like you are making something up to hear the sound of your own voice, so to speak.
If I have a lot of fixed rate mortgages on my B/S, I'm not going to swap them to floating. Swaps are usually used to create a particular risk profile on the funding side, not the asset side.
For those hedging MBS exposure, the 10 year T-note is the preferred vehicle.
fixed interest rate mortgages are interest rate swaps, you idiot.
No they're not. They are loans secured by real estate. The funding behind them on the bank's side may be a swap, but not the mortgage. Glad to see you're such a pleasant person to discuss things with.
An interest rate swap involves a two way exchange of coupons. With a mortgage, the coupon is one way - the amortizing payment from the debtor to the bank.
an interest rate swap is simply one person selling interest rate risk and another person buying that risk.
if i am purchasing real estate, let's say i choose a fixed rate loan over a a variable rate loan. if i elect a fixed rate loan for a 30 year duration and the counterparty cannot meet that interest rate risk year 11 into the deal (because interest rates have gone up and it is undercapitalized), i have compensated that counterparty for 11 years for fake insurance. it's not a difficult concept to understand.
now, if the banks were rightfully treating these 11 years of interest rate risk payments as liabilities rather than income- for which they pay bonuses & raise money- the whole profitability of the banking sector would look a lot different.
I have no idea what you are saying. You buy real estate. The loan is secured by the real estate. there is no swap. the bank has title to the property by virtue of the mortgage on it.
What do you mean by "counterparty cannot meet that interest rate risk?" Are you saying that they default? What insurance have you compensated the counterparty for? You live in the house and you owe the mortgage. If they go bankrupt, you still owe that mortgage, but now to whomever takes over the bank. How are you exposed to counterparty risk?
If I understand your last paragraph, you are saying that an asset that generates a revenue stream is a liability?
However you want to look at all this, feel free. The end of it is that mortgages are not counted as interest rate swaps. Period. You can spin a verbal fantasy all you want - like most of the central bankers - but in the end, it is reality that rules.
dupe deleted
I understand what you are saying, and in theory you are right. The flattening of the yield curve is a big problem too. There is no shortage of big problems at this point.
For every OTC derivative there is a counterparty. Sure there are collateral agreements. As I'm sure you know those collateral agreements can be gamed, expecially since there is no regulation in an OTC market. The real risk in this new and untested OTC derivative market ishow it will hold up with multiple cross-defaults when the triggers go off. The swap holder may have pyramided many swaps and derivatives, in an attempt to shed risk. On paper, they may have completely shed the risk and everything nets out. But in reality risk still exists, and all it takes is one failed counterparty to gum up the whole perfect perpetual motion machine.
That said, I hear Greece also "gamed" their derivative exposure. That's why they won't them default. It all goes nuclear when they do.
Collateral agreements gamed? Explain please.
One acronym, maybe: ISDA?
Huh?
Tell that to the people of Harrisberg!
What has that got to do with interest rate swaps? They overspent on a trash incinerator that failed to deliver the necessary cash flow to service that debt.
http://online.wsj.com/article/SB1000142405297020400230457662675299792208...
ZIRP4EVA!
The financial system won't be hindered, but destroyed and replaced by gov programs. (Just like Fannie & Freddie destroyed the financial system behind the housing market)
QE has not lowered interest rates
Tell that to my CD's which have come due recently.
Well, a poor comparison to CDS based crash (no to say that another crash is impossible or unlikely) but the interest rate derivatives covered in the article are mostly interest rate SWAPs. Unlike the CDSs and CDOs, most interest rate SWAPS counterparties are in the "real economy sector". Banks find participants and underwrite a portion of the counterparty risk, as per ISDA, but it's the two counterparties who exchange cash flows. And this is also another point, there is actual cash which moves every cycle (typically, qrterly or annually)...
There is not enough debt in the world to justify hundreds of trillions in interest rate hedges. These instruments are being used for some other purpose and create systemic risks in the process. Governments should have forced the interest rate swap market to unwind years ago.
Absalon,
Sooner or later, (yes, even here), folks are going to have to acknowledge that this is all by design.
Been preaching it since way before I came here nearly 2yrs ago.
It's the only way to COLLAPSE the old systems globally, and MAKE the world use a new system.
You're not the only one who sees the trees AND the forest. I wholeheartedly agree it's all by design. They aren't that stupid, they are that smart.
That said they are too clever by half and will have their ultimate failure right at their presumed moment of success. Almost 7 Billion people will be against them at that point and all the media in the world won't save them then and neither will their thugs when the thugs families are thrown to the wolves with everyone else. Nope, their all in move is gonna cost them.
They always think they are in control, they never have been the Universe is at the helm and it never sleeps.
How does the FED pay for all this? They must have a huge stash of gold or other tangible assets?
... or, maybe, they have a really good product that is selling like hot-cakes and making them lots of monies?
Well?
On it's balance sheet, the Fed sports the rubbish assets, but..being a private club of bankers, OFF balance sheet there probably Is a shitload of gold. That pile is only increasing--after all, he who has the gold makes the rules.
hookers
. . . or maybe they are funding themselves via the printer/tax-payer backed debt, just as they are all the other TBTFs.
DING DING DING WE HAVE A WINNER.
It is great to see ZH write about the REAL reason the Fed is shitting tungsten bricks. On another discussion board a few years back a bankster kept telling the sheeple how the derivative market did not matter much. Needless to say i was the only voice calling him out on his lies. Of course he was anti-gold/silver too, as expected.
Hey No Doubt, are you still lying to the sheeple while your daughter wears bullet-proof accessories at school?
Take a good look at the long term charts of the blue chips and PM's. They are all bottoming out. Same with TBT, the anti-bond x2. What does that tell you? TIMES UP!!! It says rising inflation and rising interest rates. Blue chips are being put in the same catagory as gold and silver, and some of them look even stronger than the precious metals. So Bennie, what's it going to be, death by a thousand cuts, or blow your head off. In either event, we'll look back upon Ben with some fondness if we then get Martin Feldstein, because Marty will not hesitate to skull fuck America on Main Street on a bright Sunday afternoon if that's what our ruling Kleptocracy orders him to do. At least Ben waits until its dark out.
Do you think anyone will want Ben's job when he 'exits'?
"Jokes aside, it’s clear the Fed is engaged in QE for another Treason or Treasons. I believe they are:
Fixed it!
he is not worried, he has it made.
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