The Oil-Price-Shock Contagion-Transmission Pathway

As we noted previously, counterparty risk concerns (and thus financial system fragility) are starting to rear their ugly heads. In the mid 2000s, it was massive one-way levered bets on "house prices will never go down again." When the cracks started to appear, the mark-to-market losses in derivatives led to forced liquidations and snowballed systemically. In the mid 2010s, it is massively levered one-way asymmetric bets on "commodity prices [oil] will never go down again." Meet WTI-structured-notes... the transmission mechanism for oil-price-shocks blowing up the financial system.


Because nothing says exuberant ignorance like limited upside, unlimited downside OTC (illiquid) derivatives...

Here's BNP Paribas' 1-Yr WTI-linked notes that collapse if oil drops below $70...


And Credit Suisse's ironically-names "TWIn-win" notes that collapse once oil prices close below $65


And finally Barclays, Leveraged Contingent Buffer Enhanced Notes Linked to the Performance of WTI Crude that start to die if oil prices close below $77.28

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All of these "notes" are simply bundles of risk-free bonds subsidized by written derivative premiums on oil-prices - and sold to greater-fool yield-reaching muppet investors around the world who never saw a short-term tren they did not extrapolate - the question is - who is on the other side of all these notes? Especially now that capital is actually being eroded instead of simply less gains...

The snowball is starting (which explains why bank credit spreads have started to bleed higher)


We are still trying to size this market but its complexity and recent issuance suggest it is anything but "contained."


Read more here  via @CalConfidence