Derivatives Ownership Even More Concentrated Than Ever

As I noted in 2009, 5 banks held 80% of America’s derivatives risk.

Since then, the percent of derivatives held by the top 5 banks has only increased.

As Tyler Durden notes:

The latest quarterly report from the Office Of the Currency Comptroller is out [shows] 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 …. 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.

OCC%201 Amount and Concentration of Derivatives Still Threaten Global Economy

Amazingly, the top 5 banks have virtually 100% of all credit derivatives held by American banks (see the second to last line in the above table).

Dwarfing the World Economy

The amount of derivatives dwarfs the size of the world economy. As Bloomerg reported in May:

Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, said another financial crisis is inevitable because the causes of the previous one haven’t been resolved.

“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said …“Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”

The total value of derivatives in the world exceeds total global gross domestic product by a factor of 10, said Mobius, who oversees more than $50 billion. With that volume of bets in different directions, volatility and equity market crises will occur, he said.

The global financial crisis three years ago was caused in part by the proliferation of derivative products tied to U.S. home loans that ceased performing, triggering hundreds of billions of dollars in writedowns and leading to the collapse of Lehman Brothers Holdings Inc. in September 2008.

Huge Amount of Derivatives Are Dangerous

Credit default swaps were largely responsible for bringing down Bear Stearns, AIG (and see this), WaMu and other mammoth corporations.

And unexpected changes in interest rates could cause a major bloodbath in interest rate derivatives.

And, no, there have not been any reforms or attempts to rein in derivatives, and the Dodd-Frank financial legislation was really just a p.r. stunt which didn’t really change anything.

But the big banks and their minions claim that the huge amounts of derivatives themselves is unimportant because these are only “notional” values, and – after netting – the notional values are deflated to much more modest numbers.

But as Durden – who has a solid background in derivatives – notes:

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?

Netting Amount and Concentration of Derivatives Still Threaten Global Economy

…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.

Prior to Fukushima, nuclear industry engineers said nuclear was safe.

Category: Derivatives

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

15 Responses to “Derivative Concentration Threaten Global Economy”

  1. bman says:

    I’m wondering why I’ve only heard about the wall street protest on facebook… Any thoughts?

  2. baldheadeddork says:

    What I don’t get is, who the hell would still be writing paper on even moderate risk swaps in 2011? I could understand being criminally stupid (hiya AIG) before everything went tango-uniform, and since almost everyone was made whole in 2009 I get that there is still a market for naked swaps on all kinds of dumb shit. But who is playing Russian Roulette with their company and taking the other side of those bets today.

    It isn’t a rhetorical question. Seriously, who’s selling this shit?

  3. philipat says:

    And yet the GOP continues to oppose, promoted via Faux Noise, that there is too much regulation, that derivatives don’t need to be regulated and that Glass Stiegel was wholly unnecessary.

    God help us (Oops, I can’t say that any longer)

  4. Greg0658 says:

    bman I mentioned it in TBP and posted a CNN link (where Erin Burnett went) CNN is doing a 3 or 4am my time financial news show called World Business something (CNBC ish)

    post eastern seaboard really big apocco positioning with one of the 3 in TX to be the next Capital of the USA .. the station is very titan oriented tho (so keep your rose colored flips ready to flickup)

    I did see it there 1st (36 hours ago & its been going on for 8 days) .. it takes a crowd to get noticed (or 1 really horrific act) (not asking for that dis cap fix tho)

  5. number2son says:

    I’m wondering why I’ve only heard about the wall street protest on facebook… Any thoughts?

    Maybe that’s because it only attracted a handful of crazies and oddballs? Unlike the uprising in the Arab world, the vast middle in the U.S. is still too complacent and lazy.

  6. DeDude says:

    Netting 90% on 250 trillions means that it really only is 25 trillion??? Oh now I just feel so much more safe. Who cares, if it just 25 trillion. I sure hope there is something I misunderstood.

    Allowing insurance to be issued without regulation is criminal.

  7. farmera1 says:

    OK I’m going to show my stupidity here, but I have a question. Here’s what I think. What is called “derivatives” in this article means unregulated derivatives, essentially unregulated insurance contracts. These are private commitments between companies/individuals. This makes them completely different than the regulated derivatives say futures and options on grain. The grain derivatives are regulated, have cash reserve requirement and go through clearing houses.

    So the question is when the article says “derivatives” do they really mean “unregulated derivative contracts.” For example company A gives a letter to company B saying that if the FED funds rate goes to x we will pay you y. No regulations, no clearing house no reserve requirements. That is essentially what AIG did as I understand it. They wrote bazillions of these unregulated derivatives (insurance contracts as I see it) with essentially no cash reserves and no way to pay them off. When it came time to pay the derivatives off, AIG couldn’t pay so up steps uncle Sam with the unlimited check book.

    For futures and option contracts on grains, there are clearing houses, capital requirements and all kinds of things that make them regulated. Grain derivatives are regulated and have worked well for many many years.

    Love some help understanding this distinction between the unregulated derivatives that are floating around with no controls and regulated derivatives like those used for futures and options in grain markets.. Thanks

  8. Marc P says:

    I”m with DeDude on the question: does a record high 90.8% netting on $239 trillion mean that there is net exposure of roughly $24,000 billion?

    I think I need a primer on how these derivatives work. It seems that with five banks and $239 trillion in bets, an aggregate loss of just one-tenth of one percent equals $239 billion or enough to bankrupt at least one of those banks.

    The problem it seems is that playing derivatives is like going to a casino and placing bets but not having to purchase chips, and then paying only the net at the end of the evening. That is prohibited in casinos for an obvious reason. Why is it allowed in the markets?

  9. louis says:

    CFMA 2000

  10. farmera1 says:

    baldheadeddork Says:

    “What I don’t get is, who the hell would still be writing paper on even moderate risk swaps in 2011?”

    Here’s my personal take. The management of these companies does all kind of stupid things because that’s how the short term profits are made and hence those big bonuses are made. It”s the old I’ll be gone, you’ll be gone thing. The managers are only interested in making this quarters and maybe the next few quarters bonus money, they could care less whether the company exists in say five years. As John Bogle wrote in his book, the BATTLE FOR THE SOUL OF CAPITALISM we’ve moved on from ownership capitalism to managerial capitalism. Companies are run to profit upper management, not the owners. These guys do all kinds of stupid things from a long term perspective, but baby they get their bonus. That’s how FULD ran Lehman into the ground, and got paid hundreds of millions over six years doing it. AIG, Countrywide on and on behaved similarly. These guys got rich, broke the company, the government then bailed them out. Like a bunch of blood thirsty zombie scavengers they (or more often their replacements) are going to do it again. Just watch it happen.

  11. AHodge says:

    i look a this little different
    the total swap face amount per BIS is $601 TRILLION. but these are mostly rate swwaps, the base for rate flows of fixed vs floating,
    the prob is even if the exposure, or the net owed, is 10% or 3, that exposure is still in the tens of trillions and each of big 4 players is a substantial part??

    th takeaway remains the same

  12. Greg0658 says:

    “takeaway remains the same” .. and that is ? game churn and promises .. just another hand at cards .. till the great ponzi game ends ? no its musicial chairs where 10 chairs remain with the last yank of 6.999B

  13. andrewp111 says:

    Are all these derivatives the reason Geithner and Bernanke are so desperate to bail out the Eurozone banks?

    I am still concerned about AIG. They have only reduced their derivative exposure by 50% or so (from 1 trillion to 500 B) since the government takeover, according to their website. A lot of people (particularly old people and their heirs) have large holdings in AIG annuities, which incidentially are no longer branded as “AIG”. They are branded with the name of a subsidiary, and the websites of the subsidiaries hide all their connections with AIG.

    I’m wondering why I’ve only heard about the wall street protest on facebook… Any thoughts?

    For several reasons. (1) Obama is President, and the press is Democratic. They can’t have serious unrest while Obama is President. If a Republican was in the White House, the MSM would be doing everything it could to encourage major violent unrest. (2) The MSM and their owners are worried that reporting will egg it on and make the protests bigger. Lack of coverage is the best way to damp down protest movements. (3) The Wall Street crowd has been very good to Obama.