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.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
SheepDog-One's picture

While Bloomberg is trying to say investors 'lost' $300 billion because they sold stocks. Sad really, Bloomberg long ago used to be pretty good financial info, now they're just another blowhorn for Wall St.

edb5s's picture

It's not entirely out of the realm of possibility, his work is already published on Wikipedia: http://en.wikipedia.org/wiki/Quantitative_easing#External_links.  Click on the flow chart link.



CaptainAmerica's picture

Always drink upstream from the herd.

Bicycle Repairman's picture

I had to pull out a 20th century version of the OED to find this word "collateral."  What's next from you guys?  Buggy whips?  That "constitution" thing?  Keep up.

DOT's picture

Tut tut, BR, must keep up appearances. Excuse me while I check the chattles and appertunances thereunto.

decon's picture

"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"

In the interest in learning, what would be an example of a derivative created by a sovereign?


Tyler Durden's picture

Any IR, FX, equity or commodity swap or CDS written by a bank backstopped by its host government and/or a central bank, such as virtually all banks in Europe's periphery. But don't worry - those are all "contingent liabilities."

For any other directly underwritten swaps by sovereigns, speak to the BIS directly.

ekm's picture

This further proves my conjecture.

max2205's picture

Unfortunately the Fed could "print" swaps to a quadrillion and we'd never know it for years

ekm's picture

Not necessarily. That money would go to buying stocks like it is and basically end up buying up the whole stock market. That process is finite.


That's why NYSE bankrupted and had to be bought out. Not much stocks left to trade.

cranky-old-geezer's picture



"Full faith and credit of XYZ bullshit bankrupt govt".

THERE'S your so-callled "backing" and "collateral".

Stop drinking the banker koolaid Tylers.  Stop trying to rationalize a fucking fantasy.  Stop trying to make sense out of accounting fraud.  It makes you look stupid as them.

MeelionDollerBogus's picture

Even a well-told, well-rehearsed fiction has a structured narrative. This is indeed well-told & well-rehearsed. We're better for dissecting it repeatedly.

ekm's picture

I've been telling you guys, but nobody is believing me so far.

This all shit is geostrategic and it has got not much to do with finance.


In 2008 when gov wanted to pay pennies on fannie and freddie bonds, both China and Russian which were major holders of those bonds said: No shit.

So Putin attacks the country of Georgia all of a sudden out of no reason as a claim toward bond default. So China starts telling USA to leave South China Sea as again a payment towards bond defaults.

Well, all of a sudden both China and Russia were paid in full.

And that is exactly the reason I have concluded of QE4ever. The counterparties of primary dealers for these derivatives are chinese and russian state owned banks.

If a country owes debt to its population, default is easy. If a country owes debt to a dangerous foreigner like Russia or China, things are quite a lot more complicated.

Bicycle Repairman's picture

So thinking geostrategicly collateral or payment can consist of  pieces from the "grand chessboard."  For example, Taiwan for boatloads of Chinese stuff.  Or a three-way deal:  Iran and $X trillion to the USA, Japan to China and the Caucasus plus a monopoly on gas to Europe for Russia.

Think Risk plus Monopoly.

shovelhead's picture


The new owners of Wall St. will rename it 'Glorious Shining Path.'

Goodbye Nathan's hot dog carts, hello noodle carts.

ekm's picture

Not a joke at all.

The very creation of the United States of America in the current form was a payment from Napoleon to USA with the Louisiana Purchase. Napoleon owed millions of dollars in gold and wanted to finance his wars in Europe. 

He couldn't wage war to Americans in order to cancel the debt, so he sold his US lands in exchange for debt erasure plus some gold.


Hong Kong was a payment to England from China, also, after England waged wars, the so called Opium Wars.


geno-econ's picture

Exactly how US got Alaska when Russian royal treasury ran out of cash.

ekm's picture

Of course I can't prove it, but in my mind I have no doubt that China has asked USA to deliver Taiwan as debt payment.

And of course, all they got was the middle finger, basically Benny creating electrons - .................so far.

game theory's picture

I respectfully disagree...this has everything to do with finance: when you dig down, there is no dividing line between finance and politics.  

We are in a financial war with the Fed playing a major role in the battle. Usually financial wars lead to real war...but that can take more than a decade to happen.  

viahj's picture

the financial war started in '71

ekm's picture

We are basically saying the same thing.

eddiebe's picture

So the IMF figures now can be trusted?       Good one!

DeficitAlchemist's picture

jargon help?


DV01 is?



SafelyGraze's picture


Dollar duration, DV01

The dollar duration or DV01 is defined as the derivative of the value with respect to yield: so that it is the product of the modified duration and the price (value): ($ per 1 percentage point change in yield) or ($ per 1 basis point change in yield)

The DV01 is analogous to the delta in derivative pricing (The Greeks) – it is the ratio of a price change in output (dollars) to unit change in input (a basis point of yield).

Dollar duration or DV01 is the change in price in dollars, not in percentage.

It gives the dollar variation in a bond's value per unit change in the yield.

It is often measured per 1 basis point - DV01 is short for "dollar value of an 01" (or 1 basis point).

The names BPV (basis point value) or PV01 (present value of an 01) are also used, although PV01 more accurately refers to the value of a one dollar or one basis point annuity.

(For a par bond and a flat yield curve the DV01, derivative of price w.r.t. yield, and PV01, value of a one-dollar annuity, will actually have the same value.)

DV01 or dollar duration can be used for instruments with zero up-front value such as interest rate swaps where percentage changes and modified duration are less useful.


GMadScientist's picture

Bond price sensitivity for non-fixed cashflows.


shovelhead's picture

And yet, all we hear in the MSM is about the wrangling over what amounts to less than pocket change by comparison in a 'Fiscal Cliff'.

But...no worries. I'm sure this will all work out well.

As long as nobody defaults on anything...forever.

How hard can that be?

JackT's picture

It's just too horrible to look at, close the box and go back to the party. Point being this is the new Cold War. Everyone knows that this beast cannot pop because it guarantees the destruction of what has taken so long to build and all those involved.

I really think its a game of charades until the bitter end. No warning or build up..just *poof*

Seasmoke's picture

Don't ever let the music stop playing.

Ignorance is bliss's picture

What is the collateral backing the system? Ask yourself what the "system" matrix controls.  All the sheeple, all their labor, and all their wealth. That is the collateral backing the system. 

That's why physical Gold and Silver will never be allowed to rise relative to the arbitrary relative value assigned to paper currencies. As long as the goods and services that we require are denominated in Dollars, then the system will maintain the status quo. 

There is a another game afoot within the derivatives markets, metals markets, etc. The game involves relative power plays by our current group of global masters. Control of fiat flow and distribution is how they control the sheeple. Example: If  you increase taxes then they decrease the amount of fiat that you have to pay for shelter, food, fuel, etc. Taxation creates an artificial demand for dollars.

IMHO if we really see Gold and Silver going parabolic, then we are in for systematic change signaling a change of overlords. Otherwise they would continue to preserve the status quo. They have fiat, and therefore they have a valuable system of control that they can use anytime to manage the population.

The only reason TPTB would ever allow a monetary change is to impoverish another group that was vying for control and power. Perhaps the Chinese and their power brokers are attempting to break the grip of current British and American masters of the Universe. A buy of Gold and Silver is a hedge against the current power brokers. We the people are simply collateral. Let's hope we don't become collateral damage.

alentia's picture

In this casino game, and this is exactly what it is, there will be the end, even if all central banks print $600T to deleverage.

The dealer (read GS or JPM or both) always wins.

The chain reaction will start, which will be impossible to stop. Central banks are doing everything now to avoid the start of "chain reaction" from possible candidates.


Most likely it will come unexpected, from the place no one [at central banks] had thought about.

Sudden Debt's picture

here's 1000$!
tweak it into a million and give me my McMansion Bitch!

kevinearick's picture

So, what you are saying is that leverage goes vertical when velocity goes terminal...in an expected relationship between frequency and time...

evernewecon's picture



Adding to my own (I don't see my own to add to

as a reply to myself, so here it is, as it's not lengthy at all:)


I don't see selling

ever greater risk insurance 

for ever less premium, with

ever less loss coverage for

ever greater bonuses even being

a  legitimate  business absent 

run of the mill Schwab/

Ameritrade-Style net equity at

risk monitoring.


That would NOT be the case where

the banking sector were NOT 

oligopolistic, with which TBTF in name

is synonymous


  So I think a

"nuclear option" may exist

as to bank derivatives 

exposure.   So even where 

the financial and legal risk have

been passed to the taxpayer 

(people will see legal op's for

challenging that) I'd annul them

if/when they were to otherwise 

swamp the taxpayers.



Obviously, if such things as the authority to pass

the financial and legal losses/liabilities to the 

taxpayer can be successfully challenged, then the 

whole idea of the Fed and FDIC was independence-

depositors' protection and confidence (as to the Fed/

unemployment/inflation isn't relevant and where in

a TBTF and revolving door environment it will be 

free reserves and raising reserve requirement later

with employment never rating, the banks themselves

turned back by the Liquidity Trap:


http://www.bloomberg.com/news/2012-07-09/dealers-decline-bernanke-twist-...   )


then I can see extending protection to depositor even beyond 

present FDIC coverage but letting the bank holding cos suck up their

losses in a hurry.

When someone falls off a cliff, after the first 90 ft. it might as well be a mile.

So if a TBTF bank holding co. is allowed to fail with $US100 Trillion in liabilities,

it won't matter.    People should've known to not do business with them.

williambanzai7's picture

I don't understand how one can conclude gross is irrelevant because it is only relevant if there is a financial crisis. But if you are in a financial crisis it is very relevant.

Is this some kind of Zen koan?

Is the risk of an off-piste avalanche only relevent if you are already in one?

This reminds me of a growing pile of nuclear waste...Ignore the danger of a lethal disaster as long as there is no disaster.

Legolas's picture

Looks like the perfect recipe to destroy the wealth of the United States and other countries.  Now all they need is to get the government behind the plan, you know, to make it all enforceable.

Hmmmm ........


alentia's picture

I beg you pardon... You are saying $16T in debt, malfunctioning economy and even more trillions in unfunded liabilities is WEALTH???

Hobie's picture

We're all fucked! Merry Christmas!

EZYJET PILOT's picture

Can someone explain to me please? The banks have only .1% asset base, in creating these derivatives do they actually have to boorow the money or do they just invent them out of thin air? Does this apply to the MBS and the securitized crap they "created" prior to 2008 too? It seems essentially to me that these MBS/Derivatives are nothing more than a US dollar, ie backed by nothing!

resurger's picture

Did you check the Deleverage in the OCC?! see chart?
Kiss good buy to IR derivatives

MeelionDollerBogus's picture

Nothing says stability like 1000:1 leverage.

In fact, that's how I think I balanced my boat out last time.

Not to worry, I made it back intact but you guessed it - somehow I lost all my gold again.

suckerfishzilla's picture

.001% margin requirement or bust bitchez