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Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure; Is Morgan Stanley Sitting On An FX Derivative Time Bomb?

Tyler Durden's picture




 

The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively. And that's your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return.

At this point the economist PhD readers will scream: "this is total BS - after all you have bilateral netting which eliminates net bank exposure almost entirely." True: that is precisely what the OCC will say too. As the chart below shows, according to the chief regulator of the derivative space in Q2 netting benefits amounted to an almost record 90.8% of gross exposure, so while seemingly massive, those XXX trillion numbers are really quite, quite small... Right?

...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else whole on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse. 

...

Lastly, and tangentially on a topic that recently has gotten much prominent attention in the media, we present the exposure by product for the biggest commercial banks. Of particular note is that while virtually every single bank has a preponderance of its derivative exposure in the form of plain vanilla IR swaps (on average accounting for more than 80% of total), Morgan Stanley, and specifically its Utah-based commercial bank Morgan Stanley Bank NA, has almost exclusively all of its exposure tied in with the far riskier FX contracts, or 98.3% of the total $1.793 trillion. For a bank with no deposit buffer, and which has massive exposure to European banks regardless of how hard management and various other banks scramble to defend Morgan Stanley, the fact that it has such an abnormal amount of exposure (but, but, it is "bilaterally netted" we can just hear Dick Bove screaming on Monday) to the ridiculously volatile FX space should perhaps raise some further eyebrows...

 

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Sat, 09/24/2011 - 06:28 | 1704682 Motley Fool
Motley Fool's picture

Light the fuse. :P

Sat, 09/24/2011 - 07:02 | 1704711 spiral_eyes
spiral_eyes's picture

denials to begin in 3..2.....1

"who is this zero hedge and why should we care??" 

Sat, 09/24/2011 - 08:12 | 1704792 max2205
max2205's picture

MS=AIG? Wow

Lol some agency needs to set exposure limits AND leverage limits. Right

Lol. The Fed is stupid

Sat, 09/24/2011 - 09:46 | 1704943 disabledvet
disabledvet's picture

Insofar as Morgan Stanley is obviously not too big too fail (the famous "go fuck yourself" line from their CEO to Hank Paulson when as the high and mighty Goldman alum was deciding who to place Morgan Stanley with after he had placed Bear Stearns with JPMorgan. No offense of course!) then i can't see the problem with leverage. Because i don't want to see a repeat of 2008 however i to do have a problem with exposure--not because the failure of Morgan Stanley is going to bring down "the entire global financial system!" as the failure of Lehman brothers allegedly did (which is a total fallacy.) In that sense AIG is truly a case of too big to fail. We know from Hank Paulson's book the President...of the United States that is...literally blurted out "AN INSURANCE COMPANY?!" What you don't get is "the dollar amount required" pre-amble in this bookend to the "War on Terror." Obviously AIG still exists and still writes policies--it does so at the behest of American people and their interests there of. For those who think "blowing up banks" is a "cool and groovy think to do" i say this to you: in the end you may wish for that thing to fail because if it doesn't "they will remember you."

Sat, 09/24/2011 - 11:26 | 1705097 Tunga
Tunga's picture

"Obviously AIG still exists and still writes policies--it does so at the behest of American people and their interests there of." - disabledvet

Errt! AIG is beholden to US citizens; aka corporate entities that bare only a faint semblance to Americans.


Sat, 09/24/2011 - 11:44 | 1705114 nope-1004
nope-1004's picture

When I was a kid, a trillion dollars seemed like a lot of money.

 Just some Sat. AM humor.  LOL.

 

Sat, 09/24/2011 - 12:05 | 1705221 Pinto Currency
Pinto Currency's picture

 

The top six banks are sitting on the biggest A-bomb of all - the interest rate derivative bomb.

That's how they blew the debt and financial sector bubble.  They forced interest rates down.

Sat, 09/24/2011 - 15:33 | 1705798 Djirk
Djirk's picture

I am not a big fan of guvMINT regulation, but time to step in boyz/girlz and fix this mess

Sat, 09/24/2011 - 19:00 | 1706146 Ag Star
Ag Star's picture

If the guvMINT had done it's job and not deregulated the banking, insurance, finance industries we would not be here today.  WHO THE FUCK POLICES THEMSELVES?  The constitution was written to prevent this shit but Americans didn't pay attention while they dismantled it.  They ain't gonna fix anything--they are breaking it intentionally because they are mere puppets--what rock have you been living under?

Sat, 09/24/2011 - 19:38 | 1706241 Old Poor Richard
Old Poor Richard's picture

Too big to fail.

Too big to jail.

TOO BIG TO BAIL.

I'm with Motley Fool.  It is past time to regulate.  Time to light the fuse on these shitheads.  Find their biggest unhedged exposures and twist the knife, triggering payouts they can't afford so that they all implode.  Make the ones with insured deposits firewall those infrastructure and assets to protect the government and the depositors.  Make sure the branches are open the next morning.  Also ensure the ordinary non-too-big-to-bail banks are given the liquidity to keep main stream afloat as lower Manhattan slides into the Laurentian Abyss.

Sun, 09/25/2011 - 04:40 | 1706941 AmCockerSpaniel
AmCockerSpaniel's picture

I don't want the banks to fail. I do want the CEO's & COO's to do 20 ~ life .

Sat, 09/24/2011 - 12:20 | 1705268 Kayman
Kayman's picture

only Goldman hedged by buying protection ON AIG."  Goldman held a policy from the Bank of Hank. Hank, in turn, covered the bet through the daylight robbery of the American people.

America's industrial might once financed the parasitical Wall Street patty cake "industry".

Do you seriously believe that Wall Street is going to revive America ? Bonuses all around translated is "get out of Dodge"

Deficits and money printing are future claims that require careful investments in future earning assets, not squandering on pump and dump, churn and burn, jobs for the boys schemes. 

Sat, 09/24/2011 - 16:00 | 1705858 robertocarlos
robertocarlos's picture

Hank is number one in the hood. He'll be the first to pay.

Sat, 09/24/2011 - 11:16 | 1705082 Seize Mars
Seize Mars's picture

MS=AIG? Wow

Lol some agency needs to set exposure limits AND leverage limits. Right

Lol. The Fed is stupid

 

No, they just need to stop asking taxpayers for a backstop. There is nothing wrong  with grownups getting in over their heads - as long as they are the only ones who would pay...

Sat, 09/24/2011 - 13:07 | 1705395 eisley79
eisley79's picture

the people who did it definitely wont ever pay.  But the whole world is going to feel the result, its only a matter of time.  They will asset/value strip for all they are worth, as long as they can...

Sat, 09/24/2011 - 19:09 | 1706157 Ag Star
Ag Star's picture

They'll pay if we make them pay.  Like the French did with the guillotine. " When people lose everything and have nothing left to lose--THEY LOSE IT"...Gerald Celente   These people mus be identified and hunted down and made examples--like  King Luis and his BFF Marie in addition to thousand of "aristocrats" like  Buffet, Bernanke, Paulson.

Sun, 09/25/2011 - 00:39 | 1706725 RockyRacoon
RockyRacoon's picture

I'm a generous person.  I'd settle for all the sonsabitches to be flat broke living in a cardboard box under the nearest overpass.  Just so long as we get to pass by velvet rope reception lines and watch them suffer.

Mon, 04/02/2012 - 14:59 | 2310335 EightSouthMan
EightSouthMan's picture

Flat broke, hounded by the IRS, in poor health with no help available, sorta more like the average American these days.  Daily raids by the thugs with badges who have done Nison's dirty work of the war on drugs to bring this country to the tyrannical POS it has become.

Sat, 09/24/2011 - 17:03 | 1705960 Stoploss
Stoploss's picture

More like to big to survive..

Sat, 09/24/2011 - 08:14 | 1704798 Oh regional Indian
Oh regional Indian's picture

Financial Engineering and Financial innovation, madness! 

Once re-insurance became a fad, there was only one way to go, Downhill. Because even the thinnest tail could only be sliced in so many ways. And the farther you reached into it, the more unstable the re-re-re-re-re-re insurance pyramid structure became.

And now, with 6 sigma firmly in the Rear view mirror, all of this risk pyramid money making nonssense will finally crash. I see it like a rubber band, snapping back to the new new normal.

Mourge on Stanley, mourge on.

ORI

Uppers and Downers

Sat, 09/24/2011 - 08:48 | 1704848 trampstamp
trampstamp's picture

Agreed. Everyone is coming over to ZeroHedge. I remember I use to visit a site called daytradingradio[.]com many months ago and used to quote ZH in their membership chat. Basically they were references to TD posts regarding how bad financially the globe was and to be prepared for a downturn. But these guys on there were full tard bullish and basically shrugged me off. The other day I just so happened to stop by to see how they were doing and I shit you not the main guy Dave was quoting ZH... Almost like an addiction he would go to ZH every few minutes to see what TD was pumping out. I just laughed. Just in case those shills are reading this... Glad you guys finally made it here.... -  rander.

Sat, 09/24/2011 - 09:59 | 1704963 citrine
citrine's picture

They would say "some blogger"

Sat, 09/24/2011 - 11:44 | 1705158 RSloane
RSloane's picture

I have absolutely no doubt that a website with this amount of traffic and nature of the participants is read by politicians and their staff, as well as financial players.

Sat, 09/24/2011 - 12:14 | 1705245 Prometheus418
Prometheus418's picture

A good reason to post comments.

What, did you think "voting" was going to do anyone any good?

Sat, 09/24/2011 - 17:38 | 1706029 Dingleberry
Dingleberry's picture

Voting just make one "feel" like they are part of the process. TPTB love that. Once folks get wise and realize they are NOTHING BUT PAWNS, and their supposed "team" of blue or red is primarily responsible to deliver their respective constituencies to whover pays them off with bribes (campaign contributions). Once folks stop voting, the jig will be up. And then TPTB will be very concerned, to say the least.

Sat, 09/24/2011 - 13:47 | 1705520 newworldorder
newworldorder's picture

RE: RSloane

Not read by Obamer or the Congressional leadership. Too far below their pay grade to bother.

Sat, 09/24/2011 - 09:13 | 1704890 Reggie Middleton
Reggie Middleton's picture

Hey, there ain't no concentration risk in US banks, and any blogger with two synapses to spark together should know this...

An Independent Look into JP Morgan.

 

Click graph to enlarge

 image001.pngimage001.pngimage001.png

Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.

This public preview is the culmination of several investigative posts that I have made that have led me to look more closely into the big money center banks. It all started with a hunch that JPM wasn't marking their WaMu portfolio acquisition accurately to market prices (see Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful! ), which would very well have rendered them insolvent - particularly if that was the practice for the balance of their portfolio as well (see Re: JP Morgan, when I say insolvent, I really mean insolvent). I then posted the following series, which eventually led to me finally breaking down and performing a full forensic analysis of JP Morgan, instead of piece-mealing it with anecdotal analysis.

  1. The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
  2. Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
  3. As the markets climb on top of one big, incestuous pool of concentrated risk...
  4. Any objective review shows that the big banks are simply too big for the safety of this country
  5. Why hasn't anybody questioned those rosy stress test results now that the facts have played out?

You can download the public preview here. If you find it to be of interest or insightful, feel free to distribute it (intact) as you wish.

JPM Public Excerpt of Forensic Analysis Subscription JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb

Sat, 09/24/2011 - 09:42 | 1704912 Reggie Middleton
Reggie Middleton's picture

...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse.

Super, Duper, B-I-N-G-0!!! It is so relieving to hear someone else espouse what really should be common damn sense, yet happens to be one of the uncommon commodities to be found on the Isle of Manhattan.

Sat, 09/24/2011 - 10:20 | 1704996 spiral_eyes
spiral_eyes's picture

Word, Reggie.

Here on Zero Hedge we appreciate what you do. 

Sat, 09/24/2011 - 11:37 | 1705126 nope-1004
nope-1004's picture

Here here!

Thanks Reggie.

 

Sat, 09/24/2011 - 14:15 | 1705340 P Rankmug
P Rankmug's picture

Any problems discussed above have already been taken care of under the National Security umbrella.  What this means, if institutions like J.P. Morgan are deemed to be integral to U.S. National Security - they could be "legally" excused from reporting their true financial condition.

 

 

Intelligence Czar Can Waive SEC Rules,

"President George W. Bush has bestowed on his [then] intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye."

http://www.businessweek.com/bwdaily/dnflash/may2006/nf20060523_2210.htm?...


Sun, 09/25/2011 - 05:58 | 1706994 jeff montanye
jeff montanye's picture

thank you.  nice to see five year old news that is still unknown, at least to me.  they just never quit do they?

Sat, 09/24/2011 - 13:38 | 1705493 Hulk
Hulk's picture

Great Job Reggie. I always figured bi lateral netting was a croc of shit based on the AIG experience.  I thank you for the education you and zh have afforded me...

Sat, 09/24/2011 - 16:04 | 1705854 FinalCollapse
FinalCollapse's picture

Reggie - it is high time for you to learn a difference between trillion and billion. If you still don't get it - then please return to the Elementary school to take some math classes. This is third time I see this factual error presented by you. 

Please kindly read your own presentation, looking for the word 'billion'. See - it does not make sense. The chart that you borrowed has unit of million.

I like your presentations, but you have no shame to repeat the same errors. These are facts - you confuse billions with trillions, and you do repeatedly. I feel sorry for the folks who pay for your advice.

Do you still have problem understanding your errros - please contact me offline, and I can explain it to you.

80,000,000 millions is 80 trillions, not 80 billions.

Sun, 09/25/2011 - 06:06 | 1707003 jeff montanye
jeff montanye's picture

thanks, good point.  the main graph about jpm gross derivatives exposure vs. world gnp is really far more disturbing than reggie's description of it.  but like his difficulty with imperfect verbs (have went) it doesn't really undercut his conclusions, though it does make him less acceptable in the mainstream world.

Sat, 09/24/2011 - 09:32 | 1704916 Reggie Middleton
Reggie Middleton's picture

Oh yeah, and while we're at it, this Morgan Stanley thing has been a concern of mine for well over a year now. The interest rate storm is coming, that is unless Europe can maintain historically low rates as several countries default. Then again, they never default, right...

Don't belive me, let's look at history...

image022

 

image021_copy

 

image034

 

 

So, as I was saying...

Check this out, from "On Morgan Stanley's Latest Quarterly Earnings - More Than Meets the Eye???" Monday, 24 May 2010:

Those who don't subscribe should reference my warnings of the concentration and reliance on FICC revenues (foreign exchange, currencies, and fixed income trading).  Morgan Stanley's exposure to this as well as what I have illustrated in full detail via the  the Pan-European Sovereign Debt Crisis series, has increased materially. As excerpted from "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

So, How are Banks Entangled in the Mother of All Carry Trades?

Trading revenues for U.S Commercial banks have witnessed robust growth since 4Q08 on back of higher (although of late declining) bid-ask spreads and fewer write-downs on investment portfolios. According to the Office of the Comptroller of the Currency, commercial banks' reported trading revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8 quarters.

bank_trading_revenue.png

High dependency on Forex and interest rate contracts

Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.

In terms of absolute dollar exposure, JP Morgan has the largest exposure towards both Interest rate and Forex contracts with notional value of interest rate contracts at $64.6 trillion and Forex contracts at $6.2 trillion exposing itself to volatile changes in both interest rates and currency movements (non-subscribers should reference An Independent Look into JP Morgan, while subscribers should referenceFile Icon JPM Report (Subscription-only) Final - Professional, and File Icon JPM Forensic Report (Subscription-only) Final- Retail). However, Goldman Sachs with interest rate contracts to total assets at 318.x and Forex contracts to total assets at 11.2x has the largest relative exposure (see Goldman Sachs Q2 2009 Pre-announcement opinion Goldman Sachs Q2 2009 Pre-announcement opinion 2009-07-13 00:08:57 920.92 KbGoldman Sachs Stress Test Professional Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb, Goldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb,). As subscribers can see from the afore-linked analysis, Goldman is trading at an extreme premium from a risk adjusted book value perspective.

bank_forex_exposure.png

As a result of a surge in interest rate and Forex contracts, dependency on revenues from these products has increased substantially and has in turn been a source of considerable volatility to total revenues. As of 2Q-09 combined trading revenues (cash and off balance sheet exposure) from Interest rate and Forex for JP Morgan stood at $2.4 trillion, or 9.5% of the total revenues while the same for GS and BAC (subscribers, see BAC Swap exposure_011009 BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb) stood at $(196) million and $433 million, respectively. As can be seen, Goldman's trading teams are not nearly as infallible as urban myth makes them out to be.

bank_ficc_trading_revenue.png

Although JP Morgan's exposure to interest rate contracts has declined to $64.5 trillion as of 2Q09 from $75.2 trillion as of 3Q07, trading revenues from Interest rate contracts (cash and off balance sheet position) have witnessed a significant volatility spike and have increased marginally to $1,512 in 2Q09 compared with $1,496 in 3Q07. Although JPM's Forex exposure has decreased from its peak of $8.2 trillion in 3Q08, at $3.2 trillion in 2Q09 the exposure is still is higher than 3Q07 levels. Even for Bank of America and Citi , the revenues from Interest rate and forex products have been volatile despite a moderate reduction in overall exposure. With top 5 banks having about 97% market share of the total banking industry notional amounts as of June 30, 2009, the revenues from trading activities for these banks are practically guaranteed to be highly volatile in the event of significant market disruption - a disruption aptly described by the esteemed Professor Roubini as a rush to the exit in the "Mother of All Carry Trades" as the largest macro experiment in the history of this country starts to unwind, or even if the participants in this carry trade think it is about to start to unwind.

The table below shows the trend in trading revenues from Interest rate and Forex positions for top banks in U.S.

Click to enlarge...

bank_ficc_exposure.png

Banks exposure to interest rate and foreign exchange contracts

With volatility in currency markets exploding to astounding levels (with average EUR-USD volatility of 16.5% over the past year (September 2008-09) compared to 8.9%  over the previous year), commercial and investment banks trading revenues are expected to remain highly unpredictable. This, coupled with huge Forex and Interest rate derivative exposure for major commercial banks, could trigger a wave of losses in the event of significant market disruptions - or a race to the exit door of this speculative carry trade. Additionally most of these Forex and Interest rate contracts are over-the-contract (OTC) contracts with 96.2% of total derivative contracts being traded as OTC. This means no central clearing, no standardization in contracts, the potential for extreme opacity in pricing, diversity in valuation as well as a dearth of liquidity when it is most needed - at the time when everyone is looking to exit. Goldman Sachs has the largest OTC traded contracts with 98.5% of its derivative contracts traded over the counter. With the 5 largest banks representing 97% of the total banking industry notional amount of derivatives and most of these contracts being traded off exchange, the effectiveness of derivatives as a hedging instrument raises serious questions since most of these banks are counterparty to one another in one very small, very tight circle (see the free article, "As the markets climb on top of one big, incestuous pool of concentrated risk... ").

bank_ficc_otc_exposure_and_currency_volatility.png

The table below compares interest rate contracts and foreign exchange contracts for JPM, GS, Citi, BAC and WFC.

JP Morgan has the largest exposure in terms of notional value with $64,604 trillion of notional value of interest rate contracts and $6,977 trillion of notional value of foreign exchange contracts. In terms of actual risk exposure measured by gross derivative exposure before netting of counterparties, JP Morgan with $1,798 bn of gross derivative receivable, or 21.7x of tangible equity, has the largest gross derivative risk exposure followed by Bank of America ($1,760 bn, or 18.1x). Bank of America with $1,393 bn of gross derivatives relating to interest rate has the highest exposure towards interest rate sensitivity while JP Morgan with $154 bn of Foreign exchange contracts has the highest exposure from currency volatility. We have explored this in forensic detail for subscribers, and have offered a free preview for visitors to the blog: (JPM Public Excerpt of Forensic Analysis SubscriptionJPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb), which is free to download, and File Icon JPM Report (Subscription-only) Final - Professional, orFile Icon JPM Forensic Report (Subscription-only) Final- Retail as well as a free blog article on BAC off balance sheet exposure If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - BAC).

bank_ficc_otc_exposure_jpm.png

bank_ficc_otc_exposure_bac_and_gs.png

Subscribers, see WFC Research Note Sep 2009 WFC Research Note Sep 2009 2009-09-30 13:01:30 281.29 Kb, ~ WFC Off Balance Sheet Exposure WFC Off Balance Sheet Exposure 2009-10-19 04:25:53 258.77 Kb ~ WFC Investment Note 22 May 09 - Retail WFC Investment Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb ~ WFC Investment Note 22 May 09 - Pro WFC Investment Note 22 May 09 - Pro 2009-05-27 01:56:54 853.53 Kb ~ Wells Fargo ABS Inventory Wells Fargo ABS Inventory 2008-08-30 06:40:27 798.22 Kb to expound on our opinions of Wells Fargo, below.

bank_ficc_otc_exposure_wfc_and_c.png

bank_ficc_otc_exposure_ms.png

Subscribers, see MS Simulated Government Stress Test MS Simulated Government Stress Test 2009-05-05 11:36:25 2.49 Mb and MS Stess Test Model Assumptions and Stress Test Valuation MS Stess Test Model Assumptions and Stress Test Valuation 2009-04-22 07:55:17 339.99 Kb

Sat, 09/24/2011 - 09:55 | 1704956 disabledvet
disabledvet's picture

"Even at a penny Lehman still trades." Move along.

Sat, 09/24/2011 - 11:54 | 1705188 gmrpeabody
gmrpeabody's picture

Yes.., but what does it all mean, Reggie?

Sat, 09/24/2011 - 13:06 | 1705391 Kayman
Kayman's picture

gmrpeabody

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"

Summary for you...

Sat, 09/24/2011 - 13:34 | 1705474 slewie the pi-rat
slewie the pi-rat's picture

duh

but hadn't tyler already intimated that point?  reggie is trolling & needs to keep his reasearch papers "above the line" where we can ignore him and not have him interfere with luddites and people w/ slower download situ's  who want to read the blogs w/out having their systems jam due to r.m.'s head being terminally impacted

 

Sat, 09/24/2011 - 20:23 | 1706344 Kayman
Kayman's picture

Hi Slewie the pie-rat, of the 230 IQ, self-measured of course. 

Sun, 09/25/2011 - 06:11 | 1707006 jeff montanye
jeff montanye's picture

and, as per above, isn't the risk multi trillion (a trillion here, a trillion there and soon we are talking real money)?

Sun, 09/25/2011 - 06:44 | 1707028 merizobeach
merizobeach's picture

I thought we were talking about trillions of dollars of derivatives, not billions.  There are plenty of multi-billion dollar private equity groups.  Reggie's original graph contains a glaring typo, as does the line you quote.

Sat, 09/24/2011 - 10:14 | 1704986 wannabe traitor
wannabe traitor's picture

much appreciated!

Sat, 09/24/2011 - 10:14 | 1704987 TulsaTime
TulsaTime's picture

Gee Reggie, nice of you to import the blog into ZH comments. A link would have worked fine, since we all know that you have a blog with a subscriber level. Could you try to tone down the me me meism? It makes reading the data (which is great) like suffering through a car dealership ad.

Just sayin.....

Sat, 09/24/2011 - 11:07 | 1705066 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Why are you telling him how to act?  Let his lady friends do that.  Unless of course you are his lady friend, then my apologies.  Would love to have you and Reggie over some time.

Sat, 09/24/2011 - 11:55 | 1705192 gmrpeabody
gmrpeabody's picture

Well played.

ROTFLMAO!

Sat, 09/24/2011 - 12:00 | 1705206 JLee2027
JLee2027's picture

LOL

Sat, 09/24/2011 - 11:28 | 1705099 spankthebernank
spankthebernank's picture

Sometimes lazy people don't click on links and you should only be ecstatic that a guy like Reggie shares his knowledge and research with you.  The man clearly loves what he does and gets to the heart of the most important issues.  We should know that he has been spot on for quites some time now, so I and me is required in relaying that message.

Sat, 09/24/2011 - 11:41 | 1705140 nope-1004
nope-1004's picture

+1

 

Sun, 09/25/2011 - 01:22 | 1706764 Ponzi Unit
Ponzi Unit's picture

Tulsa, go buy a dumb looking Pontiac somewhere.

Sat, 09/24/2011 - 10:30 | 1705011 SilverRhino
SilverRhino's picture

The US has never defaulted? How about 1933 and 1971?

Sat, 09/24/2011 - 10:56 | 1705048 Marco
Marco's picture

The whole world followed in both cases though ... and the whole world will follow the next time too.

Sat, 09/24/2011 - 11:10 | 1705070 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

I like to think of the past 4 years as a quasi default.  Issuing debt that is unpayable is the last act of a State, and should be seen as the ultimate default.

Sat, 09/24/2011 - 11:29 | 1705103 NidStyles
NidStyles's picture

We are defaulting every day we are in debt.

Sat, 09/24/2011 - 11:52 | 1705181 donsluck
donsluck's picture

Huh?

Sat, 09/24/2011 - 11:56 | 1705195 Oh regional Indian
Oh regional Indian's picture

I think it's exponential growth in debt and negative velocity of money he is referring to.

ORI

Sat, 09/24/2011 - 13:09 | 1705400 Kayman
Kayman's picture

Uhhh... the South defaulted....

Sat, 09/24/2011 - 13:11 | 1705405 bankruptcylawyer
bankruptcylawyer's picture

reggie i'm starting to think you are a CIA plant. because you are a little TOO good. 

 

and by the way, i love your pronunciation of the word malaise as 'malaysia'. 

seirously i'm not making fun of you, i pronounce words differently on purpose all the time because i like too. i think the idiots out there are not the people who dont know the 'correct' pronunciation, but the fools who think they are 'correcting' mine. anyway, malaysia sounds good, but to me, it's contradictory in nature as i have always associate malaysia with a pleasant and good feeling as an island nation with spicy food, and that doesn't jive with 'malaise'. which makes it pretty neat in a way---i like juxtaposition of content/tone/meaning. always makes words more interesting. even if you didnt' mean to do it, still, pretty cool. 

Sun, 09/25/2011 - 06:16 | 1707013 jeff montanye
jeff montanye's picture

and because "jibe" doesn't capture the bouncy beat of the music that goes with the spicy food.

Sat, 09/24/2011 - 13:36 | 1705481 JW n FL
JW n FL's picture

 

 

Oldie but goodie Reggie.. enjoy!

http://www.youtube.com/watch?v=g_U_lV2WyDs&feature=

Music.. if you dont like my taste in music.. dont listen or bitch like a woman about it..

if it's too loud you are too old!

Sat, 09/24/2011 - 13:58 | 1705547 newworldorder
newworldorder's picture

Reggie,

I have often wondered, if TBTF is a concept applied to derivatives, - why have all the regulatory agencies, Congress and President Obama ingnored this timebomb. If anything screams of national security if this goes off, one would want to fix this first.

What am I missing here? Can it be as simple as perpetual greed by the five largest banks or is it the inability by politicians to grasp the imperatives of taking action?

Sat, 09/24/2011 - 10:56 | 1705049 treasurefish
treasurefish's picture

Please sign the petition to END THE FED!  

 

http://wh.gov/gMx

Sat, 09/24/2011 - 19:55 | 1706280 KingdomKum
KingdomKum's picture

signing this petition puts you on the top of the FEMA camp list  -  no one in their right mind should sign anything having to do with the WH -  unless you'd like a visit from the FBI. CIA, etc.

Sun, 09/25/2011 - 06:49 | 1707030 merizobeach
merizobeach's picture

No FEMA camps on this side of the world.  Just sayin', y'ain't gotta live there.

Sat, 09/24/2011 - 06:38 | 1704690 Fips_OnTheSpot
Fips_OnTheSpot's picture

Last sheet is almost unreadable, could you add a zoomed version? (EDIT: just "view image", it just not linked)

 

Anyway, frightening for paper sheeples.

Sat, 09/24/2011 - 06:52 | 1704703 Fips_OnTheSpot
Fips_OnTheSpot's picture

Danke - and now the sheet is linked +1

Sat, 09/24/2011 - 08:49 | 1704851 smlbizman
smlbizman's picture

ot, but what is going on with the lbma...are they going under or being bought or other trouble?

Sat, 09/24/2011 - 11:13 | 1705075 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

While we are here, I hope everyone visits their coin shop today to buy some silver, gold, or platinum.  In the game of musical chairs, you never know when the music is going to stop!

Sprott Money Temporarily Runs Out of Physical Silver:

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2011/9/23_Sp...

Sat, 09/24/2011 - 11:21 | 1705084 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

We also have a new dog in the fight.  Gentleman Gerald Celente has joined our war, and is buying silver.  Interestingly, he is using the same logic that I did one and a half years ago when I thought that the "governments" would try and confinscate gold but not silver.

Gerald Celente Announces He’s Buying Silver:

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2011/9/23_KW...

Sat, 09/24/2011 - 11:32 | 1705111 NidStyles
NidStyles's picture

I thought he had been a while back but sold to go all in on Gold. I remember him saying something like that in the past.

Sat, 09/24/2011 - 11:57 | 1705196 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

At first he kept half of his wealth in gold, and the other half in fiat split between dollars and Euros.  Then he sold the Euros for Loonies.  Then he sold the Loonies for Swiss Francs.  Then he sold his Swiss Francs.  He may have traded the capital from the Francs for the silver, which would mean he is 50% gold, 25% dollars, and 25% silver.  If he is wary about gold, he may have traded some of that in too.  But this does appear to be his first move into silver.

Sat, 09/24/2011 - 13:37 | 1705492 JW n FL
JW n FL's picture

 

 

2 of my Favorite People!

Max! and Bill!! all in one spot!

http://www.youtube.com/watch?v=wWRb38fE3S8

Uploaded by GJT771 on Sep 20, 2011

20/09/2011

Max Keiser & Stacy Herbert discuss Babyface Bernanke, Eurotarp and 'rogue traders.' In the 2nd half of the show, Max talks to Bill Still, director of The Money Masters & The Secret of Oz, about Fort Knox, state banks and monetary reform.

 

Sat, 09/24/2011 - 06:38 | 1704693 hondamikesd
hondamikesd's picture

Glad to see the cockroaches at Morgan the lesser finally getting some light shined on them. 

Sat, 09/24/2011 - 06:41 | 1704695 Sambo
Sambo's picture

How long is the fuse on that Time bomb? 24 hrs? and has it been lit?

Sat, 09/24/2011 - 09:58 | 1704961 disabledvet
Sat, 09/24/2011 - 11:39 | 1705136 Sambo
Sambo's picture

ssssssssssssssssssssssss.....sss..ss.....boooooooooooooooooooooooooooooooooooooooooom

Sat, 09/24/2011 - 06:46 | 1704698 Ghordius
Ghordius's picture

For all purposes, the 4/25 are a cartel. Individual banker can even in all honesty believe in cut-throat-competition, and perhaps it was all an accident.

For all purposes, the derivateves BIND the 4/25 with CHAINS of prices and trades which is what so many experience as PLANNING.

There are laws against cartels, and they don't even care if there is an intent - "do you agree on what you trade" -> "yes, our DERIVATIVES dictate our behaviour - or we go bust"

I will never tire to write that most derivatives, like CDS, are a form of INSURANCE of the IMMORAL kind - we have found this out in the world of "normal" insurance that it's UNHEALTHY for an insurer to allow people to insure their neighbours' houses, the street and the insurer eventually go up in flames.

Break the cartel, save the sorry bastards from themselves. Separate commercial banking from investment banking. Set employee headcount, balance sheet, services and territorial limitations on all banks.

Sat, 09/24/2011 - 06:48 | 1704700 Fips_OnTheSpot
Fips_OnTheSpot's picture

Word! But I think it wont happen - at least not before this whole thing goes up in one big BOOOOM.

Sat, 09/24/2011 - 10:00 | 1704968 disabledvet
disabledvet's picture

HOW ABOUT FREE CHECKING THOUGH?

Sun, 09/25/2011 - 01:08 | 1706751 RockyRacoon
RockyRacoon's picture

I never did get my toaster...

Sat, 09/24/2011 - 10:52 | 1705040 DeadFred
DeadFred's picture

But they can't do that or they might lose some money.

Sat, 09/24/2011 - 06:46 | 1704699 nmewn
nmewn's picture

Good thing AIG was re-capitalized, oh wait...what was that number again? ;-)

Sat, 09/24/2011 - 06:55 | 1704706 Ghordius
Ghordius's picture

;-) recently it dawned to me that buying them (their market cap) is in the ballpark of 100x to 1000x less than their exposures.

when the European govs realize this they might buy and nationalize their TBTF banks, which is the same as taking a live granade off the hand of a child by buying it with a lollipop. A bargain.

Sat, 09/24/2011 - 07:01 | 1704710 nmewn
nmewn's picture

No doubt a bargain for the "dear innocent child".

Not so much for the future value of EU lollipops ;-)

Sat, 09/24/2011 - 09:12 | 1704891 LeBalance
LeBalance's picture

Who are the EU govs beholden to and what was their strategy from the get-go?  They Own the Game!

Sat, 09/24/2011 - 11:18 | 1705087 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

They are beholden to Mordor and their strategy is to feed the population poison laced lolies.

Sat, 09/24/2011 - 06:51 | 1704701 Racer
Racer's picture

They just didn't learn any lessons did they! Allowing them to get even bigger and allowing them to build an even bigger bomb!

Sat, 09/24/2011 - 08:31 | 1704821 oogs66
oogs66's picture

truly insane....force unwinds/assignments to collapse the gross notionals and force as much onto clearing/exchanges as possible

this should have been fixed after Lehman  (actually after Bear)

total failure of government and regulators....Fed should be spending more time on this and less time on QE

Sat, 09/24/2011 - 06:58 | 1704704 MichaelG
MichaelG's picture

$23trn chump change now? (9.2% of $250trn.) Even with a (near oxymoronic) "orderly collapse," I'm not sure even Ben has sufficient printer ink.

Sat, 09/24/2011 - 06:53 | 1704705 johnQpublic
johnQpublic's picture

not to big to fail, more like ripe to fail

any reason derivatives are legal?

in what way are they a function of banking?

and not of gambling?

just declare all derivatives null and void, bing, problem solved

 

switch over to insuring poker hands instead...at least that could be monitored with little cameras like on the WSOP

Sat, 09/24/2011 - 07:14 | 1704723 hondamikesd
hondamikesd's picture

Not to say that derivitaves haven't gone completely off the fucking rails lately but SOME of them have a purpose.

It's probably pretty nice as a farmer to have a selling price locked in via futures when you put seed into the ground as opposed to depending on the manic-depression we've seen in the markets lately. Or as an airline to know you'll be able to operate at a certain price by locking in fuel via futures. Some predictability and price stability is to be desired (try telling that to the Chairsatan...)

Still, can't argue that the process has gotten insane when we're looking at double digit multiples of GDP tied up in them by the four crime families, err, *cough*, banks. 

Not everything on the fucking planet needs to be "financialized".

Sat, 09/24/2011 - 08:50 | 1704856 snowball777
snowball777's picture

Two huge differences...those derivatives are a function of something to which the buyer has exposure and would not fret about having on an exchange.

 

Sat, 09/24/2011 - 07:17 | 1704728 o2sd
o2sd's picture

any reason derivatives are legal?

Same reason insurance is legal.

in what way are they a function of banking?

They enable financing of lower credit rated counterparties.

and not of gambling?

They are most definitely not gambling. They allow you to take a position on any market movement.

just declare all derivatives null and void, bing, problem solved

Except for the fact that credit markets would dry up. Capital seeks to maximise returns while managing risks. If there is no way to manage risk, capital is witheld. The problem with derivitaves lies with systemic risk, which is a function of opacity in OTC markets.


Sat, 09/24/2011 - 07:57 | 1704769 Watson
Watson's picture

Insurance is generally legal, but not totally.
For example: Not legal in most jurisdictions to buy fire insurance on property you do not own (or have a positive interest in).

This is not true of CDS, and it is not a healthy situation.

Sat, 09/24/2011 - 08:06 | 1704783 o2sd
o2sd's picture

For example: Not legal in most jurisdictions to buy fire insurance on property you do not own (or have a positive interest in).

Because, if you burnt it down to collect the insurance, you would never be charged with arson or insurance fraud?

This is not true of CDS, and it is not a healthy situation.

Once upon a time, the ratings companies told you what they thought the probability of default was for a given issuer (sovereign or corporate). THAT turned out to be unhealthy, because of the conflict of interest. Now with CDS markets, the MARKET tells you what they think is the probability of default.

If you want to get rid of CDS, then I have some Moodys & S&P AAA rated Collateralised Debt Obligations to sell you. Interested?


Sat, 09/24/2011 - 09:03 | 1704862 jm
jm's picture

I agree with your point about what CDS are and how they work, and your point about lack of transparency.  But the point of this article and the dissenters have is separate from this.

There is an organic purpose behind CDS. But the lack of transparency (among other things) has led to systematic exposures that create problems of scale that dwarf their benefit and involve people adversely that have no skin in the game.  And there is a possibility of cascading failures again. 

Yes, in an ideal world with ideal rules, market discipline, and info they would not pose these problems.  But the world we have is not ideal, and those in charge of managing it created a vomitorium.

Of course, there is a sensible way out of this.  Settle for pennies on the dollar.  Then we'll see the true test of how useful these contract really are.

Sat, 09/24/2011 - 09:56 | 1704957 o2sd
o2sd's picture

If large numbers of people started dying from some disease, i.e. a pandemic, then it is unlikely that the response would be to start blaming life insurance. It would be considered a public health problem, not a failure of the insurance industry.

Likewise with financial markets. At the core of the problem is a sickness in capital allocation. Capital once flowed to productive industry, however for 20 years before the GFC, capital began flowing to fixed assets (primarily housing). Fixed assets don't produce anything. They don't grow in sales, they inspire no new technologies, they send no food to market.

Yes, it is foolish to believe that one can use complex mathematics to create insurance for what is ultimately complete and utter stupidity, but those derivatives serve other legitimate purposes in capital markets.

It is malinvestment and misallocation of capital that has destroyed derivative markets, not the other way around. 

Sat, 09/24/2011 - 10:37 | 1705021 jm
jm's picture

CDS are not the core problem.  The core problem is bank balance sheets so impaired that it makes them insolvent.  One insolvency leads to a cascading of defaults.  CDS are just an instrument that contributes to this problem in a very specific way.  They allow credit risk to be concentrated in a few entities that makes them insolvent, leading to the cascade.  It is true that central clearing would make alleviate this, because you wouldn't contract with a counterparty with concentrated risk.  But that is not where we are. 

The reality is that CDS allow a party to assume risk exposures that no regulator would permit if he understood/was uncorrupted.  Central bank balance sheet expansion has compressed spreads, altering the price of credit risk.  There is an implicit backstop mentality that may nor may not be real, but I'm pretty sure it impacts the price of credit risk.  Also, there is a kick-the-can-down-the-road incentive: a CDS dealer gets his commission up front and he doesn't care about what happens to the bank, b/c he is after his FU money.  This is exactly how the clowns in government act.

I agree with just about everything you say.  I won't even get started with the modelling problems.  I'm just saying we need to think about where we are and how to get where we should be in the use of these contracts.  Not get rid of them. 

Sat, 09/24/2011 - 11:20 | 1705088 disabledvet
disabledvet's picture

this is very good. i will add the same two cents i always do here. "the government is the counter-party now." The United States did this INSTANTANEOUSLY. Europe is only waking up to this fact--and about two years too late it would seem. That's why it's easy for me to say "i give the European Union one week before it implodes." Not saying that's what in actuality going to happen--but when the German President is willing to "use the military" to protect trade routes the question of course is "where are the trade flows to begin with Mein Fuher?" I find it simply unfathomable that the European Community can't see this. Every state in the monetary union is competing separately with China? Answer? Gold, gold, gold, gold, gold. THE ONLY ANSWER.

Sat, 09/24/2011 - 18:42 | 1706123 o2sd
o2sd's picture

I agree with everything you say. Here is where you get fuzzy:

The core problem is bank balance sheets so impaired that it makes them insolvent.  One insolvency leads to a cascading of defaults.  

I'm saying that bank balance sheets are impaired by housing and the underlying theory behind the movement of capital into consumer mortgages over the last 30 years (accelerating in the period from 1994-2004). The entire lending book has changed structure.

The theory behind this is that consumers with mortgages are motivated to create wealth to pay off their mortgage. What is not clear is how consumers can create wealth working for the state or the corporatocracy.

If they want to be entrepreneurial and create some kind of business, they will need access to risk capital, something that is in short supply, because of the desire of those who control capital for risk free returns. Risk aversity has driven capital into unproductive investments, changing the risk to a systemic risk along the way.

 

Sat, 09/24/2011 - 13:37 | 1705489 Kayman
Kayman's picture

 

o2sd

"Fixed assets don't produce anything. They don't grow in sales, they inspire no new technologies, they send no food to market."

Now hold on there Sparky, I guess I will stop investing in plant and equipment, and put all my money into the TrickFuck PattyCake paper game.

Would you care to review that sloppy comment ?  You can't sucker punch at Fight Club.

 

 

Sat, 09/24/2011 - 18:14 | 1706078 o2sd
o2sd's picture

Would you care to review that sloppy comment ?

Sure. Consumers don't purchase plant and equipment.

Why is it that in the last 30 years, the makeup of bank lending books has gone from 30% mortgages to more than 70%? Not much plant and equipment being purchased there.

Sat, 09/24/2011 - 18:12 | 1706074 snowball777
snowball777's picture

And if all their policies paid out to the same person who was caught with a bottle of arsenic?

 

Sat, 09/24/2011 - 18:44 | 1706124 o2sd
o2sd's picture

And the person with the bottle of arsenic turned out to be The President of the United States????

Sat, 09/24/2011 - 13:29 | 1705463 Kayman
Kayman's picture

If Banksters had to hold reserves (like Insurance Companies are required by law) the current opaque Derivatives market would shrink like a prune, it would no longer be infinitely profitable, and the general public would not be assigned the bill for default at the point of a gun.

By the way, can I put some insurance on your house ?  I promise not to burn it down.

Sat, 09/24/2011 - 08:32 | 1704825 oogs66
oogs66's picture

then options should go away too

Sat, 09/24/2011 - 09:02 | 1704877 rwe2late
rwe2late's picture

o2sd

Same reason insurance is legal.

Insurance (including derivative insurance) is a form of gambling. With life insurance for example, you are betting you will die, the insurance company is betting you will live.

They enable financing of lower credit rated counterparties.

Isn't that part of the problem, the financing of even "no credit" rated counterparties?

They allow you to take a position on any market movement... Capital seeks to maximize returns while managing risks. If there is no way to manage risk, capital is withheld. The problem with derivatives lies with systemic risk, which is a function of opacity in OTC markets.

 

Including positions with no stake (like taking out life insurance for a stranger). Insurance reduces the risk of moral hazard for the insured. But derivative insurance reduces the risk of moral hazard for the insurer, and all hell then breaks loose.

The problem is indeed systemic, but it is NOT a function of opacity. Opacity is intrinsic to the distance of counterparties with derivative “insurance“ (gambling).

Sat, 09/24/2011 - 10:00 | 1704945 o2sd
o2sd's picture

Isn't that part of the problem, the financing of even "no credit" rated counterparties?

 

Absolutely! But even more problematic is what those "no credit" rated counterparties use that capital for: housing. A house makes no products (except maybe children), produces no food for market, requires no technological innovation. It just sits there and keeps out the weather. Surely something so unproductive should take as little capital from the total supply as possible.

Insurance (including derivative insurance) is a form of gambling. With life insurance for example, you are betting you will die, the insurance company is betting you will live.

Perhaps, but just because I am betting I will die does not mean I want to die. There is however a RISK that I could die before the life tables say I will (on average). If I did, then the burden of my death would fall on those who lived LONGER than the life tables said they would (on average). We (as a society) or a group have distributed the risk amoungst ourselves.

Including positions with no stake (like taking out life insurance for a stranger)

True, however those who have no stake (speculators) are generally considered to add liquidity to these markets. They also allow losses to be spread over a larger number of participants. 

The problem is indeed systemic, but it is NOT a function of opacity. Opacity is intrinsic to the distance of counterparties with derivative “insurance“ (gambling).

The RISK is a systemic risk. Derivatives that a 90% netted will always have a 10% downside unless the entire system collapses (hence the point of the original article). But there is nothing in the original article that points to the fracture point for systemic failure. The only hint is that Morgan Stanley is heavily exposed to FX risk, but there is no further information on the form that exposure takes.

IMO, opacity is the problem, because without transparency toxic exposures can fester to the point of no return (like Barings and Lehman).

Sat, 09/24/2011 - 13:51 | 1705526 Kayman
Kayman's picture

o2sd

I don't know if you are a mollycoddled academic or a laissez-faire, fuck the neighbors, capitalist.

But since housing is "unproductive" why don't you and your family go sleep outside for a year and we shall see how productive you become.

Just because the Fed, through Greenspan and Bernanke fucked up Housing for the American Middle Class, does not make it any less productive.

Except for futures contracts that allow the direct buyer and seller to take a position, all other derivatives serve one primary purpose only- to generate fees for today for the contract originator and push the risk off into the future and onto someone else.  That someone is the taxpayer.

Sat, 09/24/2011 - 18:27 | 1706103 o2sd
o2sd's picture

I don't know if you are a mollycoddled academic or a laissez-faire, fuck the neighbors, capitalist.

Neither. Have another two ad-hominem attacks gratis in your next post though.

But since housing is "unproductive" why don't you and your family go sleep outside for a year and we shall see how productive you become.

Sure. I live in the tropics, so even a decent tent will suffice. HOWEVER, your statement confuses utility with productivity. A house is usefull, but not productive. It's usefullness stays fairly constant over time, and so it's capital allocation should do likewise. If the house is productive on the other hand, then it's capital allocation can increase without a nett loss in capital. Most houses are unproductive, and more to the point, the materials that were used in their construction are degrading, requiring maintenance and upkeep (further capital). In other words, most housing stock is a liability, a drain on capital. For a liability to go UP in price is an absurdity, and the source of most absurdities is government.

 Just because the Fed, through Greenspan and Bernanke fucked up Housing for the American Middle Class, does not make it any less productive.

I would like to hear why you think housing is productive.

Except for futures contracts blah blah blah

The purpose of all derivative contracts is to spread risk over a larger number of participants. To dilute it, if you will. However, some risks are just to big to dilute, like socialist vote programs, or monumental stupidity. 

Sat, 09/24/2011 - 20:30 | 1706358 Kayman
Kayman's picture

Productivity, is output over input.  Without adequate housing, productivity, directly or indirectly, will decline.

If you wish to argue over how many angels can dance on the head of a pin, call the Pope to mediate.

Sun, 09/25/2011 - 19:36 | 1708862 ZeroPower
ZeroPower's picture

Youve clearly missed his point concerning asset productivity.

As an investor that must choose one or the other, would you rather invest in a high growth company, or a firm like HPQ or DELL which are slowly but surely coming to the end of their life cycles as a firm, or a high growth firm assuming you know it will deliver on its promises.

Similarly, would you invest in a piece of land in the arctic which is cheap and *might* appreciate in price in a few hundred years... or hit more close to home and buy some land in suburbia where development is coming under way.

Not to try and bring game theory into this (too late!), but basically investing in a home besides for reasons of family security (in the context of Maslows hierarchy that is) and having a roof under your head, there is no reason to. It just sits there while you speculate on a boom or bust in housing.

Sat, 09/24/2011 - 09:16 | 1704897 LeBalance
LeBalance's picture

just check how much "real" capital is required to "insure" against loss without "gambling." Gambling means that you are "sure" that a certain percentage of the risk will not go bad.  In the cases that are presently insured the percentage is higher than threshold and it was understood to be that way from day 1.  Tick....tick.....tick....!!!

Sat, 09/24/2011 - 09:26 | 1704908 NumberNone
NumberNone's picture

So derivatives are basically the equivalent of me telling my friend that I will give him $1,000,000 if he makes a putt or wears a stupid shirt in public.  It gets him to do something he doesn't want to do and I really have no intention of paying him. 

At hundreds of trillions of dollars outstanding clearly the banks have no intention of ever settling their bets, but I guess it's worth the risk of someone calling your bluff if it gets them to do something they otherwise wouldn't do.  And I'm sure there are some nice fees to made shuffling dollars back and forth on the transactions. 

Sat, 09/24/2011 - 10:06 | 1704973 o2sd
o2sd's picture

So derivatives are basically the equivalent of me telling my friend that I will give him $1,000,000 if he makes a putt or wears a stupid shirt in public.  It gets him to do something he doesn't want to do and I really have no intention of paying him. 

Nope.

At hundreds of trillions of dollars outstanding clearly the banks have no intention of ever settling their bets,

That's the notional amount. At risk is probably between 500B and 3T. 500B is a scandal and a depression, 3T is a reset. You can probably guess which one they are aiming for.

 And I'm sure there are some nice fees to made shuffling dollars back and forth on the transactions. 

Liquidity has its price.



Sat, 09/24/2011 - 12:05 | 1705223 NumberNone
NumberNone's picture

Derivatives may have started as a nice way to share the risk but this is again an example of banks greed once again making their fucking problems our fucking problems.  You may be correct in that the $250T is not the final number at the end of the day when the small circle-jerk of banks finish swapping their 'IOU's' the numbers are still so huge the system will collapse.  The question remains how this small cabal of banks once again gets to drag us all down into hell so that they can make even more money? 

 http://www.bloomberg.com/news/2010-04-19/bank-equity-derivatives-fees-rising-as-push-for-new-rules-threatens-profit.html

http://www.nytimes.com/2010/12/12/business/12advantage.html?pagewanted=all 

Sat, 09/24/2011 - 13:56 | 1705540 Kayman
Kayman's picture

o2sd

Liquidity has its price.

Yeah, the price started at $700 billion, grew to $10-50 trillion.

And the average citizen is paying the price daily.

Sat, 09/24/2011 - 14:51 | 1705710 Absalon
Absalon's picture

There is no economic justification for 600 Trillion in notional amount derivatves outstanding - there is not that much risk in the world.  Derivatives are being used for some other purpose and it is hard to see what legitimate purpose would support that notional value.

Sat, 09/24/2011 - 10:12 | 1704982 disabledvet
disabledvet's picture

let'see what happens to (the entire Continent) of Europe first. I agree "this is big." Should be quite the data dump!

Sat, 09/24/2011 - 11:39 | 1705107 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

any reason derivatives are legal?

Ah, derivatives, talked about in finance like Lindsey Lohan on a gossip blog.  A derivatives is a contract that is valued based upon the value of an underlying asset, index, or security.  The are very legal, and logical as long as the risk is covered both ways, and this is important concerning counter party risk.  If there is an asset, then it can be owned.  It can be owned and traded two ways:  bought and sold.

The problem starts with the loophole that you do not need to own the underlying security, although i can be owned, you just need to think you can locate it- and this is what we call trading naked.  Although this too seems logical, it is not a responsible way of trading; here's why:

Barclays has an exchange traded fund that is suppossed to hold gold, and one for silver too.  These are the infamous GLD and SLVs.  They say they have all of this PM.  So then others, like JPM, can use these holdings to locate their shorts.  You see, the derivatives of the holdings are floating around somewhere.  In conclusion, JPM can now, and does, have a massive short position due to being able to locate silver due to Barclays ishares trusts.

Does Barclays have the gold/silver?  They may have some, but who says they have not issued more shares than ounces in respect to their holdings?

Sat, 09/24/2011 - 14:02 | 1705568 Kayman
Kayman's picture
Mr Lennon Hendrix I think we all know that all commodities, including PM's, FX, and CDS are leveraged to the moon, over and above the underlying assets.  The derivatives market serves its main purpose, the generation of fees and the off-loading of risk onto unrelated third parties-the taxpayer.
Sat, 09/24/2011 - 14:14 | 1705603 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

right?  So....

Sat, 09/24/2011 - 07:11 | 1704719 phungus_mungus
phungus_mungus's picture

The fuse was lit on this bad bitch long time ago... BOOOOOOM!!!!!

Its about fucking time someone put this in print!

 

Sat, 09/24/2011 - 07:12 | 1704720 Sutton
Sutton's picture

These banks have the most sophisicated risk management systems in the world.  What can go wrong?

Sat, 09/24/2011 - 07:27 | 1704733 o2sd
o2sd's picture

These banks have the most sophisicated risk management systems in the world. 

I doubt it. Having worked on many risk management systems, US banks are about the worst, closely followed by the UK and then Japan.

The problem is, the better your risk management system is, the higher your Tier 1 capital number ends up being. US banks are full of cowboys that don't want capital charges against their desk lowering their bonus (less coke and hookers), so the front office does everything in it's power to make sure that the risk management system is as bad as possible.

Add to this that the SEC and FINRA are clueless, toothless bumblers, and you have a recipe for disaster ... over and over again.


Sat, 09/24/2011 - 09:21 | 1704879 LetThemEatRand
LetThemEatRand's picture

There is a rabid political ideology that wants to let the coked up cowboys run the world without any pesky government interference or evil regulations.  They believe  too much regulation is the problem.   I think a guy named Greenspan once mentioned something about it.   Later admitted he was wrong but still couldn't understand how it could be that coked up cowboys didn't do what was best for their shareholders.

Sat, 09/24/2011 - 10:08 | 1704977 o2sd
o2sd's picture

There is a rabid political ideology that wants to let the coked up cowboys run the world without any pesky government interference or evil regulations.

Are the followers of this ideology called Randiots?


Sat, 09/24/2011 - 11:02 | 1705060 LetThemEatRand
LetThemEatRand's picture

Lucky guess!

Sat, 09/24/2011 - 12:13 | 1705239 fxrxexexdxoxmx
fxrxexexdxoxmx's picture

Soro's bitch Obama wants to be the leader!

Sat, 09/24/2011 - 07:12 | 1704721 kito
kito's picture

Thanks tyler, as if this week wasnt enough to turn me alcoholic, this post mightve just put me over the edge.......
where...is...that....red....pill....antidote...?.......

Sat, 09/24/2011 - 10:20 | 1704997 RSloane
RSloane's picture

I'm thinking Bloody Marys with eggs for breakfast. Or I can just skip the eggs.

/hic

Sat, 09/24/2011 - 14:09 | 1705590 Kayman
Kayman's picture

kito

Come on Kito, take another suck on that Hopium Hookah.

No need see where the rubber hits the road.

Now where are those red shoes, Tinman....

Sat, 09/24/2011 - 07:13 | 1704722 joe.schmuck
joe.schmuck's picture

Kudos Tyler,  reporting on the OCC report  can only be found at ZH.

Have to admit "bilaterally netted" brought other thoughts to mind, but it is Sat night here...

Sat, 09/24/2011 - 09:07 | 1704883 PontifexMaximus
PontifexMaximus's picture

Contraryinvestor.com used to discuss it too, but those bay area guys unfortunately closed....

Sat, 09/24/2011 - 07:16 | 1704725 zhandax
zhandax's picture

Oh wretch, thou debaseth the currency....

http://www.ronpaulforums.com/showthread.php?206841-Penalty-for-Debasing-...

 

 

Sat, 09/24/2011 - 07:43 | 1704726 williambanzai7
williambanzai7's picture

Gee wiz, the US has manageable exposure to European Banks.

FWMD

Sat, 09/24/2011 - 08:33 | 1704829 Tao 4 the Show
Tao 4 the Show's picture

Banzai, this is hilarious. Just need to show the megatons of destructive power.

Sat, 09/24/2011 - 09:22 | 1704905 AssFire
AssFire's picture

Seems Bernanke's has multiple warheads..highly destructive.

 

Sat, 09/24/2011 - 09:52 | 1704952 fishface
fishface's picture

Who is that little suicide bomber on the left ?

Sat, 09/24/2011 - 10:18 | 1704991 RSloane
RSloane's picture

I believe that is Little Timmy Geithner.

Sat, 09/24/2011 - 11:49 | 1705169 Sambo
Sambo's picture

LOL!

Who is he going to blow up? All those 65+ yr old retirees? (Buffet hasn't retired yet)

Sat, 09/24/2011 - 07:17 | 1704729 Tao 4 the Show
Tao 4 the Show's picture

If these banks run 30x leverage, they should have some $8T in real assets backing the $250T in derivatives.

I bet that backing is also largely an apparition. The whole mess is financial numerology to justify the only real money in the equation: that's the part the management pulls out for themselves in salaries, bonuses, etc.

If humans survive (in some state of sanity) for a few decades, schoolchildren will gasp as they learn about the John Law's of our day and the stupidity of the masses who were taken in by the scam.

Sat, 09/24/2011 - 07:33 | 1704737 Crash N. Burn
Sat, 09/24/2011 - 10:19 | 1704993 RSloane
RSloane's picture

I did. Thanks for posting that.

Sat, 09/24/2011 - 12:21 | 1705272 Crash N. Burn
Crash N. Burn's picture

You are very welcome

Sat, 09/24/2011 - 08:00 | 1704774 o2sd
o2sd's picture

If these banks run 30x leverage, they should have some $8T in real assets backing the $250T in derivatives.

Not exactly. Economic capital requirements for loans is based on leverage however, for derivatives economic capital is calculated as a multiple of Value At Risk. It would be interesting to know what VaR these 4 banks are reporting.


Sat, 09/24/2011 - 08:49 | 1704853 Tao 4 the Show
Tao 4 the Show's picture

Thanks for pointing that out.

Let's see, since the net value of all assets in the U.S. Is probably only around half of that $250T derivative valuation, we should not have more than $125T at risk. How can we risk more than we have?

Oops, forgot. We can mortgage the future!

Hmmm, maybe that's why we have taxpayer bailouts based on future obligations.

Yo Bernanke - man the long bonds.

(On a more serious note, the 30-40x leverage is bad enough. Using VaR just creates more vaporware by making the actual multiplier bigger. What isn't at risk in the fantasyland they call banking?)

Sat, 09/24/2011 - 09:29 | 1704914 Tao 4 the Show
Tao 4 the Show's picture

For those interested:

"VaR calculates the worst expected loss over a given horizon at a given confidence level under normal market conditions."

Alternate definition by Barry Schacter:

"a number invented by purveyors of panaceas for pecuniary peril intended to mislead senior management and regulators into false confidence that market risk is adequately understood and controlled."

Formerly sane humans should at this point bifurcate into those weeping uncontrollably in their soup and others laughing maniacally while shaking their fists at the gods.

That $250T is built on 30-40x a base and that base is essentially fabricated from nothing. It's all complete madness - just air. And the wizards of finance magically extract billions in salaries and bonuses from that air. Or so it would seem. In truth, they extract it from those who work for a living, and increasingly, from those not yet even born.

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