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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Ponzi Unit's picture

Tulsa, go buy a dumb looking Pontiac somewhere.

SilverRhino's picture

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

Marco's picture

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

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.

NidStyles's picture

We are defaulting every day we are in debt.

Oh regional Indian's picture

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


Kayman's picture

Uhhh... the South defaulted....

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. 

jeff montanye's picture

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

JW n FL's picture



Oldie but goodie Reggie.. enjoy!

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!

newworldorder's picture


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?

treasurefish's picture

Please sign the petition to END THE FED!

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.

merizobeach's picture

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

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.

Fips_OnTheSpot's picture

Danke - and now the sheet is linked +1

smlbizman's picture

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

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:

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:

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.

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.

JW n FL's picture



2 of my Favorite People!

Max! and Bill!! all in one spot!

Uploaded by GJT771 on Sep 20, 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.


hondamikesd's picture

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

Sambo's picture

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

Sambo's picture

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.

Fips_OnTheSpot's picture

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

disabledvet's picture


RockyRacoon's picture

I never did get my toaster...

DeadFred's picture

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

nmewn's picture

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

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.

nmewn's picture

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

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

LeBalance's picture

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

Mr Lennon Hendrix's picture

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

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!

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

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.

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 least that could be monitored with little cameras like on the WSOP

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".

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.


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.

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.

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?

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.

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. 

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.