$648 Trillion Derivatives Market Faces New Collateral Concentration Risks

Tyler Durden's picture

In a sad case of deja vu all over again, the over-reliance on 'shaky' collateral and concentration of risk is building once more - this time in the $648 trillion derivatives market. New Clearing House rules (a la Dodd-Frank) mean derivatives counterparties are required to pledge high quality collateral with the clearing houses (or exchanges) in a more formalized manner to cover potential losses. However, the safety bid combined with Central Banks monetization of every sovereign risk asset onto their balance sheet has reduced the amount of quality collateral available; this scarcity of quality collateral creates liquidity problems. The dealers, ever willing to create fee-based business, have created a repo-like program to meet the needs of the desperate derivative counterparties - to enable them to transform lower-quality collateral into high quality collateral - which can then be posted to the clearing house or exchange.

This collateral transformation, while meeting a need, runs the risk of concentrating illiquid low quality assets on bank balance sheets - as Bloomberg cites Darrel Duffie: "The dealers look after their own interests, and they won’t necessarily look after the systemic risks that are associated with this." Regulators are aware of this but as always will be slow to react - until it becomes too big to fix. The CME already accepts corporate bonds as collateral, but the re-collateralization and potential for vicious circle cash calls or forced selling become notably higher as "We just keep piling on lots of operational risk as we convert one form of collateral into another," said Richie Prager, global head of trading at New York-based BlackRock.

Mandating collateralized clearing makes sense from a risk perspective but the daisy-chain of collateral calls and pain that this collateral transformation could create will inevitably be the undoing of the massive derivatives should we see any kind of systemic risk event reoccur - a scenario not with de minimus likelihood in our current game of central bank chicken. The process merely extracts even more quality collateral, while concentrating bad collateral.

In essence the next blow up risk is the eureka moment when all banks are forced to look at the cross-posted collateral. Last time it was the 'fair-value' of housing, now it is the 'fair-value' of 'transformed' collateral that is pledged at par and is really worth nickels on the dollar.

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Colombian Gringo's picture

The world economy burns while the Banksters fiddle.

diogeneslaertius's picture

please do not question the actions of our beloved emperor nero

you have been reported to the department of homeland security for potentially being in league with al-qaeda

GetZeeGold's picture



Nice clothes emperor......you look good!


Dr. Richard Head's picture

The Federal Reserve and other central banks are merely nudists resorts for emperors.  Club Fed Bitchez!

hedgeless_horseman's picture



Demand for collateral? 

Mrs. Watanabe and Mrs. Li could get into the UST repo business.

How does one say, "Will repo US Treasuries for yield," in Japanese or Mandarin?

Truth be told, these ladies' USTs have surely been rehypothecated many times over, so why should they miss out on the fun?

LawsofPhysics's picture

yes, the "repo" business is just booming.  I thought that was how ZHers were making money, by frontrunning the back and forth between equities, PDs, the Fed, and the Treasury.

fuu's picture
Shuryo u irurepo-mai kokusai
MillionDollarBonus_'s picture

The banks have plenty of collateral, such as mortgage backed securities, US tresuries and high yielding European debt. Plus, if any of these are considered "low quality", banks can simply sell these assets to our Federal Reserve and pledge cash instead. The global financial system is not about to "collapse" like doomer libertarians keep saying. Stocks are making new highs, treasury yields are at all time lows and bussiness is booming for smart traders and investment bankers at bulge bracket investment banks.

LawsofPhysics's picture

So the banks have paper promises.  You are so funny MDB, because paper-pushing creates so many things of real value right?  Bahhhhahahhahahhahhah!  

goldfish1's picture

In March 2010, Bill Gross asked the question: What if – to put it simply – you couldn’t get out of a debt crisis by creating more debt? The answer to that question will be supplied by the markets—and soon.


asteroids's picture

Wrong MDB. The point of the article is that banks don't have Trillions and Trillions worth of collateral. Too much debt, too much credit, and an asteroid worth of CDS ready to crash on your pointy head.

LMAOLORI's picture



Too funny MDB on a non sarcastic note the banks have plenty of ways to hide the risk

The Newest Bank Fraud Scheme ("Risk Hiding")

just wait until the interest rates rise on the debt and they start cutting off all the welfare programs then we'll see what a crash really looks like.


Here It Comes (Moody's)



Whiner's picture

Knock yourself out and break a leg, MDB. The strength of America is it's unique primary dealer system the sole transmitter of a visionary economic stimulus program. We will not walk the road of despair.

MeelionDollerBogus's picture

14 up arrows and 5 down including mine.

That's peak nihilism for you - people are too dense and/or too lax to give you the appropriate thumbs down.

Of course this is one of the events meant to be detected, on the macro-scale of readership, by the deployment of the MDB troll-algo.

Lohn Jocke's picture

Long Bail Bonds, Bitchez!

fonzannoon's picture

this will have to get fixed before it goes into effect

mrktwtch2's picture

if i owe you 100 dollars its my problem if i owe you 1 million its yours.why doesnt anyone realize that they can simply default?? russia did in 98 and the world didnt end..just saying..

LawsofPhysics's picture

Having lived in Russia for a period when the ruble collapsed and one dollar bought you several thousand rubles, be careful what you wish for.  Gangs, thugs, and the Mafia rule.  Just saying...

Dr. Richard Head's picture

Gangs, thugs and mafia rule are currently behind the curtain of politicans in Amerika.  The difference would be that the badge will lose it's extra granted rights.

LawsofPhysics's picture

More importantly, with gangs and thugs, at least you know what you are dealing with right up front.

MiltonFriedmansNightmare's picture

Sounds like an improvement over our current situation to me. Just sayin...

Ar-Pharazôn's picture

mmmmmmmmmm russia was the leading world economy in this period? Russia was the superpower in this period? Petrol was based on their fiat shit currencie? etc etc etc

kevinearick's picture

Orchestra please...

LawsofPhysics's picture

Totally stupid, there isn't enough collateral on earth.  Bloody sheep.

crusty curmudgeon's picture

Indeed.  The banks have been expecting this...the time of reckoning is coming.  Let's see...banks are in business to loan money at higher interest yet they park huge excess reserves with the Fed at a paltry interest rate--unprecedented and, at the risk of overusing this word, unsustainable (not exactly a good long-term strategy for a bank).  This is why they did it...and heaven help us when those reserves are drawn down...I'm going to go out on a limb and guess the cost of beer, donuts and bacon are going...let's see now, up or down...up?


"... it does not require a majority to prevail, but rather an irate, tireless minority keen to set brush fires in people's minds ..."  - Samuel Adams

Colonel Klink's picture

"Bloody Sheep"


Don't worry, they'll bleed out soon enough.

falak pema's picture

Collateral authentic jam? who wants it? The squid is going yellow around the gills! 

Dodd Frank must be working for Heinz Ketchup! 

Anything to sell their product and stay in office. 

Quick lets invent the new multilayer hamburger to go with the ketchup!

The all-in-one sure fire collateral guaranteed never to fart in the owner's face!

More juicy than CDS, more spicy than CDO; where are those Quant clowns when we need them! 

Calling Blythe...

BTW : whats this talk about clearing houses? Does that mean a crony meeting over beer and sandwiches and OTC handshaking in dark pools and back room parlours is no longer Kosher?

My, what is the world of private banking coming to! 

Colonel Klink's picture

Dodd Frank works for Vlasic.  They're on the line cleaning Kosher dills!

Lost Wages's picture

In other news, Wal-Mart will now allow customers to trade used toilet paper for new toilet paper.

Dr. Richard Head's picture

Ah ah ah!  Currency laws would not allow for other organizations to compete with the fed.  It's the Bearded one's job to recycle shit filled paper.

Colonel Klink's picture

And it's the work of our government to recycle shit filled diapers.

monopoly's picture

648 Trillion. My God. We are so fucked.

goldfish1's picture

648 Trillion

at least

and rising


remember the old days when the talk was about a $700 billion bailout.

recidivist's picture

The thing that blows me away is that the US money supply is only around $10-12T, depending on how you count those North Korean benjamins, etc.  $648T certainly dwarfs everybody's dollar holdings.  But with ctrl-p, I suppose that can be rectified.

Panafrican Funktron Robot's picture

The funny part is that they keep saying "yeah, but that's nominal/gross exposure, not net exposure!"  Well, even if the net exposure is one tenth of 1%, that's still $648 billion dollars we're talking about.

philosophers bone's picture

The size of the derivatives market is staggering.  Imagine the run on money market funds when the domino falls.  First ones out are redeemed at $10, The rest (most) will be stuck in a frozen fund with little or no value.  POOF!!  We will look back at the 2008 crash with nostalgia.

FubarNation's picture

Jesus - someone thinks this is a good idea and will work out?


I often wonder how higher the bullshit pile can go before it topples over.





StrawberryBlonde's picture

Good to know...thanks for posting, TD!

casey13's picture

I guess they will just have to print up more collateral. Bloody idiots.

forwardho's picture

And the Fat lady softly clears her throat, and begins to...

tocointhephrase's picture


Yardfarmer's picture

after all the articles concerning the fluff in the Eurozone, it's refreshing to see the real 800 pound gorilla back in the room. uga booga!

goldfish1's picture

...mumbling to themselves

Lessee here...we can always legitimize the $648T +. That's the ticket.

Dr. Engali's picture

They are taking an already screwed up system and screwing it up even more. It's like a giant game of Three Card Monte.

Bicycle Repairman's picture

It is a giant game of 3 card monte.  Complete with the BS rap that goes on incessantly between deals.  Make no mistake, the game goes on until the marks are cleaned out.

holdbuysell's picture

What was that catchy 'gross equals net' jingle again?

sudzee's picture

Your vehicle is ready, sir. That will be $500 or 2oz, sir.

petolo's picture

Can i use my line of credit?