1000x Systemic Leverage: $600 Trillion In Gross Derivatives "Backed" By $600 Billion In Collateral

Tyler Durden's picture

There is much debate whether when it comes to the total notional size of outstanding derivatives, it is the gross notional that matters (roughly $600 trillion), or the amount which takes out biletaral netting and other offsetting positions (much lower). We explained previously how gross is irrelevant... until it is, i.e. until there is a breach in the counterparty chain and suddenly all net becomes gross (as in the case of the Lehman bankruptcy), such as during a financial crisis, i.e., the only time when gross derivative exposure becomes material (er, by definition). But a bigger question is what is the actual collateral backing this gargantuan market which is about 10 times greater than the world's combined GDP, because as the "derivative" name implies all this exposure is backed on some dedicated, real assets, somewhere. Luckily, the IMF recently released a discussion note titled "Shadow Banking: Economics and Policy" where quietly hidden in one of the appendices it answers precisely this critical question. The bottom line: $600 trillion in gross notional derivatives backed by a tiny $600 billion in real assets: a whopping 0.1% margin requirement! Surely nothing can possibly go wrong with this amount of unprecedented 1000x systemic leverage.

From the IMF:

Over-the-counter (OTC) derivatives markets straddle regulated systemically important financial institutions and the shadow banking world. Recent regulatory efforts focus on moving OTC derivatives contracts to central counterparties (CCPs). A CCP will be collecting collateral and netting bilateral positions. While CCPs do not have explicit taxpayer backing, they may be supported in times of stress. For example, the U.S. Dodd-Frank Act allows the Federal Reserve to lend to key financial market infrastructures during times of crises. Incentives to move OTC contracts could come from increasing bank capital charges on OTC positions that are not moved to CCP (BCBS, 2012).


The notional value of OTC contracts is about $600 trillion, but while much cited, that number overstates the still very sizable risks. A better estimate may be based on adding “in-the-money” (or gross positive value) and “out-of-the money” (or gross negative value) derivative positions (to obtain total exposures), further reduced by the “netting” of related positions. Once these are taken into account, the resulting exposures are currently about $3 trillion, down from $5 trillion (see table below; see also BIS, 2012, and Singh, 2010).


Another important metric is the under-collateralization of the OTC market. The Bank for International Settlements estimates that the volume of collateral supporting the OTC market is about $1.8 trillion, thus roughly only half of exposures. Assuming a collateral reuse rate between 2.5-3.0, the dedicated collateral is some $600 - $700 billion. Some counterparties (e.g., sovereigns, quasi-sovereigns, large pension funds and insurers, and AAA corporations) are often not required to post collateral. The remaining exposures will have to be collateralized when moved to CCP to avoid creating puts to the safety net. As such, there is likely to an increased demand for collateral worldwide.

And there it is: a world in which increasingly more sovereigns are insolvent, it is precisely these sovereigns (and other "AAA-rated" institutions) who are assumed to be so safe, they don't have to post any collateral to the virtually unlimited derivatives they are allowed to create out of thin air.

Is it any wonder why, then, in a world in which even the IMF says there is an increased demand for collateral, that banks are making a total mockery out of such preemptive attempts to safeguard the system, such as the Basel III proposal, whose deleveraging policies have been delayed from 2013 to 2014, and which will be delayed again and again, until, hopefully, everyone forgets all about them, and no financial crises ever again occur.

Because if and when they do, the entire world, which has now become one defacto AIG Financial Products subsidiary, and is spewing derivatives left and right, may have to scramble just a bit to procure some of this $599 trillion in actual collateral, once collateral chains start breaking, once "AAA-rated" counterparties (such as AIG had been days before its bailout) start falling, and once the question arises: just what is the true value of hard assets in a world in which the only value created by financial innovation is layering of derivatives upon derivatives, serving merely to prod banker bonuses to all time highs.

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rahbii's picture

So it's not just the metals markets then? 

GetZeeGold's picture



Try doing that with real metal.....and you'll get a hernia.

CPL's picture

One ounce bar hammered to a paper thin sheet the size of a 12x8 dinner table.


Probably need a new shoulder along with the hernia cup.

TwoShortPlanks's picture

I wonder if the Derivative market is even remotely capable of being wound-down. Perhaps it's so Ponzi that it requires constant growth?!

jekyll island's picture

The true value of the assets is what real people will pay for them, not the mark to fantasy world in which we live.   

ball-and-chain's picture

Was this article written by Reggie Middleton?

Middleton is great.

I love his work.


kindape's picture

but the vast majority of those are currency/interest rate swaps etc where the DV01 is puny. 100 mil contract might have 50-100k of risk. so UNLESS a counterparty goes under, these derivatives are not 'claims on natural resources' like the rest of our debt/money supply.  This is big mistake in aggregation of our debt. Financial debt is different than govt/corp/private/household/

Tyler Durden's picture

Lehman's CDS had a puny DV01 when it was trading at a 100 bps 2 months ahead of the Chapter 11. At or around that time, it proceeded to develop a monster DV01.

falak pema's picture

TY TD/ZH for this luminous analysis and based on the IMF itself! SUpreme irony! 

Its a recurrent theme that mind boggles me.

kindape's picture

well thats why I highlighted 'unless' a counterpart goes under, which they will prevent again until it escalates to last man standing. Not saying it is safe or foolproof, just saying that all financial debt could be offset tomorrow aggregating to very small losses (to someone) and everything still functions. Same cannot be said for corp/govt/private debt. Different animals different risks

SafelyGraze's picture

tylers -- please 'splain 

if you and I enter into one of these arrangements, we pretend/posit/suppose that we each borrowed a zillion dollars. me at fixed rate. you at variable rate.

then we pay each other the difference between the rates on the imagined principal.

how does the hypothetical zillion dollars ever materialize? neither of us claimed to owe it to anyone. only the difference in interest rates on the zillion. 


Sudden Debt's picture

neither of you have it, but you resold it 10 times over to lemmings and in that way you can spend it all... unless the lemmings see it on cnbc that there's a problem 6 months later and when they dream of getting their money back.

fuu's picture

I stimulated the shit out of Belgium's economy over the weekend. Thanks for the "End of the World" sale Imageline.

fuu's picture

Any VST for $45 was a pretty good deal.

max2205's picture

I am sure S&P will downgrade the US after reading this......

cranky-old-geezer's picture



Why do Tylers believe the same bullshit fantasies you bitch at bankers for believing?

Derivatives are gambling bets.   Gambling bets don't have collateral. 

There is NO collateral AT ALL.  There's just the appearance of collateral achieved with ACCOUNTING FRAUD that would land any of us in bankruptcy court ...and jail possibly.

It's $600 trillion of GAMBLING BETS.  Its why the financial world is huge damn CASINO, a place where you GAMBLE.

But its a RIGGED casino where there's never a "credit event" so nobody ever has to pay off when they lose, and if they go bankrupt like AIG did, the Fed comes along and pays off their bets.

I heard somewhere the Fed is now backstopping ALL the derivative exposure of the big Wall Street banks.   That's hundreds of trillions right there.

I wish I could go to a casino, bet all I want, keep my winnings, and have the Fed come along and pay off my losses. 

Damn, I picked the wrong career in life.  Should'a been a banker.

CPL's picture

600 trillion back with currency backed with nothing but an IOU redemable in the far future.



cranky-old-geezer's picture



The so-called "US dollar" has NO backing AT ALL.   It's just another damn DERIVATIVE, just another GAMBLING BET.

This is what happens when you go off a commodity standard.  When a currency isn't tied to ANYTHING tangible.

CPL's picture

What the real question is Why do they do it?


Why would they bother running an obviously vapour driven ponzi scheme when the outcome is inevidable every time in history it's been done.  It's not technology gains related either.  

Because all technology gains and education are usually erased in every reset.  Then require archeology majors to re-discover that we've had advanced engineering at the apex of other ancient civilzations that walked down the same path in various stages of technology progression.  Again.  

Anything not written in stone or maintained by the ancient version of a Hard Drive, monk memorization, literally is wiped nearly everytime.

Interesting thing about the monks of all churches/sects/cultures, they learned the secret to photographic memory.  Same mental hacks we use today for photographic memory were all adopted from the various places of worship.  Monks in training, if they were to be listed as a scribe or courrier involved the same techiques used by pilots today for the tachioscope.  Instant recall memory.  Lighting calculation (Think people stopped calculating Pi during the dark ages?  People had wars about it.  To the overly clever, pious and violent, Pi is considered to some as holy as the Trinity because it is unending.) 

That was the function of monks btw, they were walking hard drives of libraries of information, facts, figures and calculations that could be deployed anywhere with the information the organisation burned into their minds, like software.  The Training manuals left by St Mark and Augustine is pretty detailed about how to train your brain to absorb any piece of information and do lighting math.  And that was adopted from Indian Asetics and Hebrew scholars, who learned all those weird mental hacks from the ancient Persians.  Better private schools and parents everywhere pass these tools to their children.

So we know it's not technology or quality of life as a reason because misery with no progress is the outcome everytime in history that fiat and it's masters takes the helm.  

Only reason I've come up with is lunatics are managing this for the sake of doing it.

cranky-old-geezer's picture



Why would they bother running an obviously vapour driven ponzi scheme when the outcome is inevidable every time in history it's been done.

Because their ponzi scheme is a LOOTING SPREE, looting all the wealth from the American people and anyone else they can sucker into their ponzi scheme. 

Like China for example.  China has a couple trillion dollars of our so-called "treasury securites" that are completely fucking worthless ...or soon will be.

CPL's picture

China's in big trouble as well.  They mess around with their media and money as much as the US does.  Chinese leadership have been known for many things, being honest isn't one of them because of cultural concepts of honor, face, ownership and outcomes.  


But the looting sprees always end abruptly.  Usually ends up with most of the villains dead, and everyone gets to catch their breath for a century or longer.  I'm sure a couple sneak out to restart the process.  But why?  It's like locusts.  They consume until they all die off from starvation.  What good is the "loot" if you've got nowhere to spend it or anything of common value to show for it.  I know for certain that the ancient Mesopotamian had a flag.  But nobody cares or knows what it looks like anymore. 

So it's beyond a need to loot, their power vanishes and their lives usually in an upheaval.  They can't be that dumb to at least take a nod from history to determine the possible outcome of complete failure.


So why is the only question that needs an answer.

Winston Churchill's picture

Lehmans exposure was only $8bn.

That worked out well.

itstippy's picture

JP Morgan lost $6B unwinding Bruno "London Whale" Iksil's derivatives position.  Despite all the hoopla, there wasn't much impact on JPM balance sheet or profits.  JPM is again doing stock buybacks and paying dividends. Their stock is way up; they're considered comfortably capitalized.

Obviously a broader derivatives collapse would still be little more than a fly hitting the windshield.   If derivatives posed any real risk to the financial system, guys like Jamie Dimon and Ben Bernanke would recognize it and take appropriate action.

Nothing to see here - move along to the mall. 

itstippy's picture

MF Global hit an economic rough patch when their derivatives positions went pear-shaped, and regretably had to close up shop. Sometimes bad things happen to good financial institutions.

No big deal.  The Honorable Jon Corzine simply liquidated MF Global's collateral holdings and made JP Morgan whole on all outstanding derivatives contracts they were counterparty to.  The system absorbed the shock easily; nobody important got hurt.  A handfull of insignificant Nebraska wheat farmers experienced slight inconvenience, but that's about it.

Obviously, derivatives shocks are contained. 

Nothing to see here - move along to the mall.

Sudden Debt's picture

the 2001 materialized because of a 10 billion sinckhole.
now we piss that kind of money away on a daily basis and still most people think everything is getting better.

CPL's picture

Doesn't matter, it still is represented as capital and therefore credit in an over saturated system already full of USD.


It's derivatives that trigger the hyperinflation scenario.  Wake up one morning and gum is $500 USD per pack because the derivative chain collapses.  Alternatively wake up and silver is 130k per ounce and gold is 3 million.


Of course referring to anything USD is going to be pointless, nobody will use it by that point.

Sudden Debt's picture

now your talking about a paper currency. we've passed that and are already fully into a digital currency where the flow can be much easier controlled.

CPL's picture

The control of currency was never an issue.  Currency is fungible.  It moves where it needs to be because of it's purpose.


The problem we are having is systemic corruption.  People controlling the currencies are at fault.  The blacksmith makes the chain.  The chain itself isn't bad.  The chain is merely a tool.  It can be used to secure something like a tractor to a wagon.  Or brake something, like a biker breaking bones as a whipping flail.  

Intention is the difference when the tool is used.

fuu's picture

Obama should just ban collateral so tragedies like this never happen again.

rehypothecator's picture

Rather than ban it, he could just Corzine it.  

Sudden Debt's picture

YOU don't have that collateral!
Other people do! at least they think so...

max2205's picture

This situation will blow up even your safe money in checking accounts.

POOF and it gone

q99x2's picture

That's quite an imagination.

CPL's picture

Explain.  Be verbose.  Math illustrating your position is good.  This isn't yahoo finance, we like details here.

fiftybagger's picture

one ten thousandth of that money into silver is 2 billion ounces.  Endgame.....


rehypothecator's picture

That will never happen.  First, silver is "too risky".  (Unlike, say, sovereign debt.)  Second, there aren't 2 billion ounces of silver anyway.  

fiftybagger's picture

"Second, there aren't 2 billion ounces of silver anyway."

I believe that was my point

Savvy's picture

AIG... Aaaaand It's Gone.

mrktwtch2's picture

when the shit hits the fan..all the debt will be reorganized..(rememeber the russian default in 98??)..in time buy any 5% pullbacks in the indices..i gave up being bearish in late 2009 once i fugred out that the fed was going to be there for many years..

Winston Churchill's picture

I agree it will be reorganised.Probably at Bretton Woods just as Hitler made Petain sign

at Versailles,with a new reserve currency that will not be the dollar.

SheepDog-One's picture

I find it funny that so many people somehow imagine when this monstrosity implodes, the worst that will happen to them is getting exchanged a new kind of 'money' at face value. Wow...just...wow.

SheepDog-One's picture

There won't be any 'pullbacks' when this present shitpile collapses, suddenly everyone will be staring at -0-'s in their account balances and wondering how the fuck they got Corzined when really they gave plenty of warnings for all to see. This is 'fair play' to them....'hey, ya fucked up! Ya TRUSTED us!'

geno-econ's picture

Not to worry.  Derivatives diversify risk according to Greenspan and he is always right.  Right? If there is inadaquate collateral, then  there is less risk passed on.  Right?   WRONG!    Tick, tick, tick tick, BOOM!

NoDebt's picture

Biggest number in the pile..... INTEREST RATE CONTRACTS!  Everything else is pretty much trivia by comparison.

Sorta flies in the face of the Bearded Potato saying he can unwind all this money printing and ZIRP stuff quickly, doesn't it?  What if rates jumped 100 bps in say, 6 months?  You think that might cause a few problems?

rufusbird's picture

All waves can be made by adding up sine waves. The sine wave has a pattern that repeats.

azusgm's picture

...and where is SAC in the midst of this? What happens if Stevie suddenly needs cash?

q99x2's picture

Wile E Coyote finally made it to the front page of CNBC today. Can WilliamBanzai7 do it next year.