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

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Motley Fool's picture

Light the fuse. :P

spiral_eyes's picture

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

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

max2205's picture


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

Lol. The Fed is stupid

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."

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.

nope-1004's picture

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

 Just some Sat. AM humor.  LOL.


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.

Djirk's picture

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

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?

Old Poor Richard's picture

Too big to fail.

Too big to jail.


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.

AmCockerSpaniel's picture

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

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. 

robertocarlos's picture

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

Seize Mars's picture


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...

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...

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.

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.

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.

Stoploss's picture

More like to big to survive..

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.


Uppers and Downers

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.

citrine's picture

They would say "some blogger"

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.

Prometheus418's picture

A good reason to post comments.

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

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.

newworldorder's picture

RE: RSloane

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

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


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

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.

spiral_eyes's picture

Word, Reggie.

Here on Zero Hedge we appreciate what you do. 

nope-1004's picture

Here here!

Thanks Reggie.


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."

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?

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...

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.

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.

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...








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!


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.


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.


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.


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...


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... ").


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).



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.



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

disabledvet's picture

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

gmrpeabody's picture

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

Kayman's picture


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...

slewie the pi-rat's picture


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


Kayman's picture

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

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)?

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.

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.....

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.

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.