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The Coming Derivatives Panic That Will Destroy Global Financial Markets
When financial markets in the United States crash, so does the U.S. economy. Just remember what happened back in 2008. The financial markets crashed, the credit markets froze up, and suddenly the economy went into cardiac arrest. Well, there are very few things that could cause the financial markets to crash harder or farther than a derivatives panic. Sadly, most Americans don’t even understand what derivatives are. Unlike stocks and bonds, a derivative is not an investment in anything real. Rather, a derivative is a legal bet on the future value or performance of something else. Just like you can go to Las Vegas and bet on who will win the football games this weekend, bankers on Wall Street make trillions of dollars of bets about how interest rates will perform in the future and about what credit instruments are likely to default. Wall Street has been transformed into a gigantic casino where people are betting on just about anything that you can imagine. This works fine as long as there are not any wild swings in the economy and risk is managed with strict discipline, but as we have seen, there have been times when derivatives have caused massive problems in recent years. For example, do you know why the largest insurance company in the world, AIG, crashed back in 2008 and required a government bailout? It was because of derivatives. Bad derivatives trades also caused the failure of MF Global, and the 6 billion dollar loss that JPMorgan Chase recently suffered because of derivatives made headlines all over the globe. But all of those incidents were just warm up acts for the coming derivatives panic that will destroy global financial markets. The largest casino in the history of the world is going to go “bust” and the economic fallout from the financial crash that will happen as a result will be absolutely horrific.
There is a reason why Warren Buffett once referred to derivatives as “financial weapons of mass destruction”. Nobody really knows the total value of all the derivatives that are floating around out there, but estimates place the notional value of the global derivatives market anywhere from 600 trillion dollars all the way up to 1.5 quadrillion dollars.
Keep in mind that global GDP is somewhere around 70 trillion dollars for an entire year. So we are talking about an amount of money that is absolutely mind blowing.
So who is buying and selling all of these derivatives?
Well, would it surprise you to learn that it is mostly the biggest banks?
According to the federal government, four very large U.S. banks “represent 93% of the total banking industry notional amounts and 81% of industry net current credit exposure.”
These four banks have an overwhelming share of the derivatives market in the United States. You might not be very fond of “the too big to fail banks“, but keep in mind that if a derivatives crisis were to cause them to crash and burn it would almost certainly cause the entire U.S. economy to crash and burn. Just remember what we saw back in 2008. What is coming is going to be even worse.
It would have been really nice if we had not allowed these banks to get so large and if we had not allowed them to make trillions of dollars of reckless bets. But we stood aside and let it happen. Now these banks are so important to our economic system that their destruction would also destroy the U.S. economy. It is kind of like when cancer becomes so advanced that killing the cancer would also kill the patient. That is essentially the situation that we are facing with these banks.
It would be hard to overstate the recklessness of these banks. The numbers that you are about to see are absolutely jaw-dropping. According to the Comptroller of the Currency, four of the largest U.S. banks are walking a tightrope of risk, leverage and debt when it comes to derivatives. Just check out how exposed they are…
JPMorgan Chase
Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars)
Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)
Citibank
Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars)
Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars)
Bank Of America
Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars)
Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars)
Goldman Sachs
Total Assets: $114,693,000,000 (a bit more than 114 million dollars – yes, you read that correctly)
Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars)
That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 362 times greater than their total assets.
To get a better idea of the massive amounts of money that we are talking about, just check out this excellent infographic.
How in the world could we let this happen?
And what is our financial system going to look like when this pyramid of risk comes falling down?
Our politicians put in a few new rules for derivatives, but as usual they only made things even worse.
According to Nasdaq.com, beginning next year new regulations will require derivatives traders to put up trillions of dollars to satisfy new margin requirements.
Swaps that will be allowed to remain outside clearinghouses when new rules take effect in 2013 will require traders to post $1.7 trillion to $10.2 trillion in margin, according to a report by an industry group.
The analysis from the International Swaps and Derivatives Association, using data sent in anonymously by banks, says the trillions of dollars in cash or securities will be needed in the form of so-called “initial margin.” Margin is the collateral that traders need to put up to back their positions, and initial margin is money backing trades on day one, as opposed to variation margin posted over the life of a trade as it fluctuates in value.
So where in the world will all of this money come from?
Total U.S. GDP was just a shade over 15 trillion dollars last year.
Could these rules cause a sudden mass exodus that would destabilize the marketplace?
Let’s hope not.
But things are definitely changing. According to Reuters, some of the big banks are actually urging their clients to avoid new U.S. rules by funneling trades through the overseas divisions of their banks…
Wall Street banks are looking to help offshore clients sidestep new U.S. rules designed to safeguard the world’s $640 trillion over-the-counter derivatives market, taking advantage of an exemption that risks undermining U.S. regulators’ efforts.
U.S. banks such as Morgan Stanley (MS.N) and Goldman Sachs (GS.N) have been explaining to their foreign customers that they can for now avoid the new rules, due to take effect next month, by routing trades via the banks’ overseas units, according to industry sources and presentation materials obtained by Reuters.
Unfortunately, no matter how banks respond to the new rules, it isn’t going to prevent the coming derivatives panic. At some point the music is going to stop and some big financial players are going to be completely and totally exposed.
When that happens, it might not be just the big banks that lose money. Just take a look at what happened with MF Global.
MF Global has confessed that it “diverted money” from customer accounts that were supposed to be segregated. A lot of customers may never get back any of the money that they invested with those crooks. The following comes from a Huffington Post article about the MF Global debacle, and it might just be a preview of what other investors will go through in the future when a derivatives crash destroys the firms that they had their money parked with…
Last week when customers asked for excess cash from their accounts, MF Global stalled. According to a commodity fund manager I spoke with, MF Global’s first stall tactic was to claim it lost wire transfer instructions. Then instead of sending an overnight check, it sent the money snail mail, including checks for hundreds of thousands of dollars. The checks bounced. After the checks bounced, the amounts were still debited from customer accounts and no one at MF Global could or would reverse the check entries. The manager has had to intervene to get MF Global to correct this.
How would you respond if your investment account suddenly went to “zero” because the firm you were investing with “diverted” customer funds for company use and now you have no way of recovering your money?
Keep an eye on the large Wall Street banks. In a previous article, I quoted a New York Times article entitled “A Secretive Banking Elite Rules Trading in Derivatives” which described how these banks dominate the trading of derivatives…
On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan.
The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential.
According to the article, the following large banks are represented at these meetings: JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup.
When the casino finally goes “bust”, you will know who to blame.
Without a doubt, a derivatives panic is coming.
It will cause the financial markets to crash.
Several of the “too big to fail” banks will likely crash and burn and require bailouts.
As a result of all this, credit markets will become paralyzed by fear and freeze up.
Once again, we will see the U.S. economy go into cardiac arrest, only this time it will not be so easy to fix.
Do you agree with this analysis, or do you find it overly pessimistic? Please feel free to post a comment with your thoughts below…
View full post on The Economic Collapse
Other • LIBOR, Lies and Derivatives
LIBOR, Lies and Derivatives
MONDAY, JULY 30, 2012
Three weeks, ago, I wrote LIBOR was a criminal conspiracy from the start. An avalanche of articles have been written on LIBOR since, and I think an update is in order, which also gives me a chance to delve a little further into the bold statement in that title.
It’s not that I’m a big fan of using terms like conspiracy, not at all, but then again, neither am I a fan of constantly being lied to.
The average Joe and Jane and Jack and Jill in the street should be able to rely on the fact that those who they vote in office represent them and their interests; it’s the very definition of the essence of our democratic systems. What they get instead, and increasingly so, are lawmakers and regulators who collude with private industries, which due to their size have grabbed an enormously bloated hold on political power. In the US, the UK and EU the actual say a voter gets to exercise from the ballot box has been reduced to something that fast approaches the freezing point.
The story of LIBOR is an excellent example of the inner workings of this process, and of the consequences that follow. Of course, when I label it criminal, I make a moral judgment, knowing full well at the same time that it’s the lawmakers themselves who in the end define what’s legal or not, and what’s criminal or not.
There is no segment of private industry that has grabbed more power than the banking industry. Indeed, it would be hard to find any lawmaker or regulator left at all in the western world willing to stand up to it in more than fleeting soundbites. We will see this exemplified in the upcoming procedures in the LIBOR rigging scandal.
Banks will offer up individual traders as lambs for the sacrificial chopping block, and lawmakers will declare that justice has been done. The traders can protest as much as they will that they were not operating in a vacuum, and that their superiors were very much aware of their machinations, if not outright demanding them, but it will make no difference. Bob Diamond was thrown to the wolves so Mervyn King could stay where he is. King himself made sure of it.
I don’t think that back in 1986, when LIBOR was initiated by the British Bankers Association in light of the advent of new financial instruments such as interest rate swaps, everything that has happened between then and now, 26 years later, was foreseen and consciously instigated. I do believe, however, that the conditions were consciously set to allow for it to happen. It all just got a lot bigger than those who were in charge back then, politicians, bankers and regulators, could ever have dreamed.
Still, the underlying idea for LIBOR was always: "by the bankers, for the bankers". And if anyone involved in setting up LIBOR back in the day now wishes to claim that they had no idea that allowing banks to make up the rates which they borrowed at out of thin air, might have led to manipulation, that would insult everyone’s intelligence including yours and mine. The problem is that in today’s climate, this doesn’t keep them from making precisely such claims. And that is very much part of a trend. It has increasingly become acceptable for bankers and politicians alike to deny anything flat out and see what happens, knowing their friends have their backs.
I don’t know that US Finance Secretary Timothy Geithner said it in exactly so many words, but he did at least strongly imply that he didn’t know about LIBOR manipulation until the spring of 2008. And then proceeded – along with the likes of Hank Paulson and Ben Bernanke – to base the rates for the bailout programs such as TARP, six months or so later, on that same manipulated rate, saving the banks tens of billions of dollars.
Bank of England Governor Mervyn King did him one better: he stated he didn’t know anything about LIBOR manipulation until 2 weeks prior to his Parliamentary hearing on July 17, despite receiving correspondence from Geithner telling him about it, over 4 years ago. Geithner declared he had been very clear, and even went to the unusual step of putting his warnings to King in writing. King claims he never saw any warning sign.
Let’s put it this way: If there is even a whiff of truth to King’s statements, he’s so spectacularly unfit for his job (or at least for what his job should be), it’s not funny. Still, he’s been in the job since 2003.
Some – pretty nauseating – quotes by King from that Parliamentary hearing: "No-one saw it because the game wasn’t fixed", and "There were concerns about the accuracy of LIBOR during the financial crisis but that is not the same as proof that the figures had been manipulated for private gain," [..] "That is my definition of fraud.". King then accused bankers involved in LIBOR rigging of "fraud motivated by personal greed". Mirror, mirror on the wall…
By the way, in November 2008 King described LIBOR to the UK Parliament like this: "It is in many ways the rate at which banks do not lend to each other, … it is not a rate at which anyone is actually borrowing."
Let’s be bluntly honest here, why don’t we: both Geithner and King are simply lying. And even if we can’t prove they are lying, we can certainly state that their words lack all plausibility. That is because LIBOR is arguably the most important number in the financial industry of the past two decades, and people who reach positions such as the ones Geithner and King hold, MUST have known for a long time what was going on with LIBOR.
Along the same lines that you don’t win a Nobel prize in physics if you don’t know that E=MC squared, you don’t get the world’s top jobs in overseeing banking and finance if you don’t know what and who is involved in LIBOR. If only because it would make you a potential threat to those profiting from it.
The reason LIBOR was used as the foundation for TARP and other bailouts despite the fact that in the fall of 2008 everyone in the field knew it was rigged (well, except for Mervyn King) was not because there were no – potentially more reliable – alternatives that could have been used. No, it was the very fact that LIBOR was the rate that could most easily be manipulated. And was. Had been for years. The proof is there for all to see. Emails and letters are there to show this, no matter what denials are issued.
Meanwhile the timeline for who knew, or should have known, what about LIBOR rigging keeps being pushed back.
Whereas Mervyn King, according to his own words, was as innocent as he was ignorant until early July 2012, and Tim Geithner found out in early 2008 (can we hear them both under oath next time, please?!), and other voices mentioned 2005, former Morgan Stanley trader Douglas Keenan wrote in the Financial TImes last week (My thwarted attempt to tell of LIBOR shenanigans) that when he came to the bank in 1991, his colleagues, who had been there longer, found him humorously naive for not knowing that LIBOR was actively being rigged.
That takes us smoothly back a good part of the way to 1986, LIBOR’s year of birth. If and when in 1991 it had been manipulated for long enough to have Keenan’s colleagues snicker at his ignorance, it seems safe to say that it has been rigged pretty much ever since its inception.
And how could it not have been? LIBOR requires no real data, no real rates at which banks lend and borrow. It merely asks banks to state every working day at 11.00 am GMT at what rate they think they can borrow. Ergo: anything goes. This was done on purpose. LIBOR was built to be rigged. And here’s what is was built for:
1986 was the time when the derivatives industry was starting to take off for real. An interest rate was needed to "guide" them. But not one that would be neutral or impartial, not if the bankers had any say in the matter. They had all the say they wanted and needed. Still, as I said, I don’t think it was a conspiracy in the sense that in 1986 anybody knew exactly how big it was all going to get (not that it matters; it’s about intent).
Derivatives "languished" for a while around the 1x global GDP level. Then they came into their own and rose to ten times that or more. The industry began to clue in on the virtually limitless possibilities.
Interestingly, Douglas Keenan writes that in his time at Morgan Stanley, the head of interest rate trading was nobody else than Bob Diamond, who 20-odd years later was forced to leave as CEO of Barclays, because of the LIBOR scandal, by Mervyn King, who claims he did not know, until mere days before that, what for all intents and purposes he should have known for a long long time. The interest rate trade gave birth to some of the earliest new financial instruments that led to the inception of LIBOR. By value, the vast majority of derivatives today consists of interest rate swaps.
The first half of the 1990s brought us Credit Default Swaps. They are habitually – and flatteringly – presented as instruments with which to hedge investments, an innocuous and benign form of insurance. Still, even if they once were invented and intended that way (which I think is highly doubtful), that’s not what CDS are used for these days. They have instead become instruments to hide (gambling) losses and allow the investor/gambler to circumvent reserve requirements.
You invest an $X amount of capital, leverage it Y times, buy a default swap on what you invested in, and do it all over again. Rinse and repeat. You don’t need to keep anything in reserve, since you have bought insurance at every step of the way. Given that the notional value of the derivatives market is somewhere between $500 trillion and $1 quadrillion, we can all get an idea of the leverage involved.
The entire mortgage investment based universe, CDOs, MBS, was/is based on LIBOR as well. Banks could go nuts, and do so all the way to the bank; not only could they insure themselves for a pittance against failure on highly leveraged wagers, through LIBOR they even controlled how much the insurance would cost. AIG stands out as the biggest counterparty; it insured anything under the sun.
From AIGs point of view, it didn’t matter what it insured, or what the rates were: CDS were never supposed to be triggered. They were – and are – merely a way to hide losses in plain sight. The AAA ratings that Moody’s and S&P gave them made it all even better: interest rates could be kept that much lower. All for the sake of the next, and preferably larger, wager. We know how this ended for AIG. It was given our money, so it could keep on hiding losses.
There are reports on plans to change LIBOR into a better, reality-based, standard. But these plans are once again being drawn up by the same people who have for years at best maintained a see no evil hear no evil attitude. If we want a real turnaround, if we want the lies to stop, the last thing we should do is to allow the same old same old crowd of politicians, regulators and bankers, to even come within a mile of negotiations for a new standard. The problem there is of course that there’s no one else left. The rot has spread to all corners of the industry that count. Innocence exists in name only.
The "resolution" of the LIBOR scandal (which will probably never be completed) will show us once again that we have a choice to make between either saving the banks or saving our economies and societies. We can’t do both. But in all honesty, I doubt that the prospect of such a choice is real. It looks to me like the choice has long since been made by a succession of unrepresentative representatives we elected with our empty votes, and who have left us with a runaway crossover between Frankenstein and the Sorcerer’s Apprentice. I wasn’t kidding when I said the other day that if you want your vote to count, you’ll have to get out into the streets to do so.
The LIBOR affair is one in a series of things laid bare by the ongoing financial crisis that will inevitably, at one point or another, force us to confront the moral bankruptcy that has come to control our societies.
http://theautomaticearth.org/Finance/li … tives.html
Statistics: Posted by yoda — Mon Jul 30, 2012 10:52 am
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When The Derivatives Market Crashes (And It Will) U.S. Taxpayers Will Be On The Hook
Warren Buffett once said that derivatives are “financial weapons of mass destruction”, and that statement is more true today than it ever has been before. Recently, JP Morgan made national headlines when it announced that it was going to take a 2 billion dollar loss from derivatives trades gone bad. Well, it turns out that JP Morgan did not tell us the whole truth. As you will see later in this article, most analysts are estimating that the losses will eventually be far larger than 2 billion dollars. But no matter how bad things get for JP Morgan, it will not be allowed to fail. JP Morgan is the largest bank in the United States, so it is essentially the “granddaddy” of the too big to fail banks. If JP Morgan gets to the point where it is about to collapse, the U.S. government and the Federal Reserve will rush in to save it. Because of this “security blanket”, banks such as JP Morgan feel free to take outrageous risks. Today, JP Morgan has more exposure to derivatives than anyone else in the world. If they win, they win big. If they lose, U.S. taxpayers will be on the hook. Not only that, but thanks to Dodd-Frank, U.S. taxpayers are on the hook for bailing out the major derivatives clearinghouses if there is ever a major derivatives crisis. So when the derivatives market crashes (and it will) you and I will be left holding a gigantic bill.
Derivatives almost caused the complete collapse of insurance giant AIG back in 2008. But instead of learning our lessons, the derivatives bubble has gotten even larger since that time.
A Bloomberg article that was published last year contained a great quote from Mark Mobius about derivatives….
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 at the Foreign Correspondents’ Club of Japan in Tokyo today in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”
Never in the history of the world have we ever seen anything like this derivatives bubble.
But instead of getting it under control, we just allowed it to get bigger and bigger and bigger.
Now JP Morgan is in quite a bit of trouble. A recent Daily Finance article summarized how JP Morgan got into this mess….
Bruno Iksil, a trader working in the bank’s London office, placed a massive bet in the derivatives market. Derivatives “derive” their value from the value of an underlying asset, like stocks, bonds, currencies, or a market index. The specific type of derivative used in Iksil’s bet was a credit default swap index, known as “CDX.NA.IG.9.”
CDX.NA.IG.9 tracks a basket of corporate bonds. Iksil’s positions on the index were so big (one report put it at $100 billion) that they were moving the market and interfering with other traders’ positions. These annoyed traders — hedge-fund managers — dubbed Iksil “the London Whale” for his outsize bets.
So if the real number isn’t 2 billion dollars, how much will JP Morgan eventually lose?
Morgan Stanley says that the losses could eventually reach 5 billion dollars.
The Independent is reporting that the losses could eventually reach 7 billion dollars.
One author featured on Zero Hedge suggested that the losses could ultimately reach 20 billion dollars….
Simple: because it knew with 100% certainty that if things turn out very, very badly, that the taxpayer, via the Fed, would come to its rescue. Luckily, things turned out only 80% bad. Although it is not over yet: if credit spreads soar, assuming at $200 million DV01, and a 100 bps move, JPM could suffer a $20 billion loss when all is said and done. But hey: at least “net” is not “gross” and we know, just know, that the SEC will get involved and make sure something like this never happens again.
The truth is that nobody really knows. Everybody agrees that the losses will likely far exceed 2 billion dollars, but the real extent of the crisis will not be known until the trades play out.
According to the Huffington Post, JP Morgan recently sold 25 billion dollars of profitable securities to raise some cash. The profit on the sale of those securities will be somewhere in the neighborhood of a billion dollars.
A billion dollars will help, but it will not be nearly enough.
Many are interpreting this move as a sign of panic by JP Morgan.
Meanwhile, JP Morgan CEO Jamie Dimon continues to do quite well. In fact, his 23 million dollar pay package was recently approved by shareholders at an annual meeting.
Wouldn’t you like to do your job badly and still make 23 million dollars?
Right now, JP Morgan is essentially in a “staring contest” with those on the other side of the derivatives trades that went bad. This “staring contest” was described in a recent CNN article….
It’s clear from public data filed with The Depository Trust & Clearing Corporation that JPMorgan Chase hasn’t sold any of its positions yet. The DTCC tracks trading activity and sizes of positions on the IG9 and other indexes, and there haven’t been any big moves since last week.
“Whatever the size was, it’s clearly not something that you can call one or two dealers and sell,” said Garth Friesen, a co-chief investment officer at AVM, a derivatives hedge fund that’s not involved in these trades.
As soon as it becomes clear that JPMorgan Chase is unwinding its position, it will be obvious to players on every major trading desk. Hedge funds will immediately start piling into that index and buying protection, driving up the bank’s losses.
Until then, it won’t cost the hedge funds much to sit and wait.
JP Morgan is desperately hoping that the markets move in their favor.
If the markets move against JP Morgan in a big way it could potentially be absolutely catastrophic for the biggest bank in America.
An excerpt from an email that Steve Quayle recently received from an anonymous international banking source contained some chilling analysis of the situation….
The derivative market that JPM plays in is the CDX.NA.IG.9, when factions within their London office (London Whale) made overly leveraged swaps, hedge funds smelled blood and so did a few banks. You see any moves that JPM does here on out exposes their weakness further. Which they can not afford any more exposure thus they are not buying back any more shares which is the equivalent of cutting an artery in a pool full of sharks. The strategy they are taking right now is to sit through the storm and ride it out as they can do nothing else for any action will make them even more vulnerable. They can not absorb hits in both JPM SLV and CDX.NA.IG.9. Inactivity is not something they want to do it is something they have to do. There is no other choice for them.
So what will happen if JP Morgan loses too much money?
Well, it will beg the U.S. government and the Federal Reserve for money and the U.S. government and the Federal Reserve will comply.
There is no way that they are going to let the largest bank in America fail.
In addition, as I mentioned earlier, Dodd-Frank has put U.S. taxpayers on the hook for future bailouts of derivatives clearinghouses. This was detailed in a recent Wall Street Journal article….
Little noticed is that on Tuesday Team Obama took its first formal steps toward putting taxpayers behind Wall Street derivatives trading — not behind banks that might make mistakes in derivatives markets, but behind the trading itself. Yes, the same crew that rails against the dangers of derivatives is quietly positioning these financial instruments directly above the taxpayer safety net.
One of the things that Dodd-Frank does is that it gives the Federal Reserve the power to provide “discount and borrowing privileges” to derivatives clearinghouses in the event of a major derivatives crisis.
This is what our politicians love to do.
They love to have the U.S. taxpayer guarantee everything.
Our politicians look at us as one giant insurance policy.
Apparently they believe that if anything in the financial world goes wrong that U.S. taxpayers should be the ones to clean up the mess.
But will we really have enough money to bail everyone out when the derivatives market crashes?
Today, the 9 largest banks in the United States have a total of more than 200 trillion dollars of exposure to derivatives.
That is approximately 3 times the size of the entire global economy.
The U.S. government is already nearly 16 trillion dollars in debt.
How in the world can we afford to keep bailing out the huge messes that Wall Street makes?
Sadly, most Americans have no idea how vulnerable our financial system really is.
It is a poorly constructed house of cards that could come crashing down at any time.
If you still have faith in our financial system you are being quite foolish and you will soon be bitterly, bitterly disappointed.
View full post on The Economic Collapse
Gold and Silver • Re: MELTDOWN UPDATE: The JP Morgan Derivatives Book is Blowi
Some pundits have been saying that the whole derivatives game was planned with the purpose of bringing the current system down.
IOW this is not something that is ‘happening’ to JPM. It was planned to be.
The charade just goes on…
Statistics: Posted by Deo Vindice — Mon May 21, 2012 12:04 am
View full post on opinions.caduceusx.com
Gold and Silver • MELTDOWN UPDATE: The JP Morgan Derivatives Book is BlowingUP
MELTDOWN UPDATE: The JP Morgan Derivatives Book is Blowing Up
http://www.roadtoroota.com/public/899.c … fOosZAZ85B
Statistics: Posted by DIGGER DAN — Sun May 20, 2012 11:41 am
View full post on opinions.caduceusx.com
Other • A Preview Of The Coming Collapse Of The Derivatives Market
The 2 Billion Dollar Loss By JP Morgan Is Just A Preview Of The Coming Collapse Of The Derivatives Market
When news broke of a 2 billion dollar trading loss by JP Morgan, much of the financial world was absolutely stunned. But the truth is that this is just the beginning. This is just a very small preview of what is going to happen when we see the collapse of the worldwide derivatives market. When most Americans think of Wall Street, they think of a bunch of stuffy bankers trading stocks and bonds. But over the past couple of decades it has evolved into much more than that. Today, Wall Street is the biggest casino in the entire world. When the "too big to fail" banks make good bets, they can make a lot of money. When they make bad bets, they can lose a lot of money, and that is exactly what just happened to JP Morgan. Their Chief Investment Office made a series of trades which turned out horribly, and it resulted in a loss of over 2 billion dollars over the past 40 days. But 2 billion dollars is small potatoes compared to the vast size of the global derivatives market. It has been estimated that the the notional value of all the derivatives in the world is somewhere between 600 trillion dollars and 1.5 quadrillion dollars. Nobody really knows the real amount, but when this derivatives bubble finally bursts there is not going to be nearly enough money on the entire planet to fix things.
Sadly, a lot of mainstream news reports are not even using the word "derivatives" when they discuss what just happened at JP Morgan. This morning I listened carefully as one reporter described the 2 billion dollar loss as simply a "bad bet".
And perhaps that is easier for the American people to understand. JP Morgan made a series of really bad bets and during a conference call last night CEO Jamie Dimon admitted that the strategy was "flawed, complex, poorly reviewed, poorly executed and poorly monitored".
The funny thing is that JP Morgan is considered to be much more "risk averse" than most other major Wall Street financial institutions are.
So if this kind of stuff is happening at JP Morgan, then what in the world is going on at some of these other places?
That is a really good question.
For those interested in the technical details of the 2 billion dollar loss, an article posted on CNBC described exactly how this loss happened….
The failed hedge likely involved a bet on the flattening of a credit derivative curve, part of the CDX family of investment grade credit indices, said two sources with knowledge of the industry, but not directly involved in the matter. JPMorgan was then caught by sharp moves at the long end of the bet, they said. The CDX index gives traders exposure to credit risk across a range of assets, and gets its value from a basket of individual credit derivatives.
In essence, JP Morgan made a series of bets which turned out very, very badly. This loss was so huge that it even caused members of Congress to take note. The following is from a statement that U.S. Senator Carl Levin issued a few hours after this news first broke….
"The enormous loss JPMorgan announced today is just the latest evidence that what banks call ‘hedges’ are often risky bets that so-called ‘too big to fail’ banks have no business making."
Unfortunately, the losses from this trade may not be over yet. In fact, if things go very, very badly the losses could end up being much larger as a recent Zero Hedge article detailed….
Simple: because it knew with 100% certainty that if things turn out very, very badly, that the taxpayer, via the Fed, would come to its rescue. Luckily, things turned out only 80% bad. Although it is not over yet: if credit spreads soar, assuming at $200 million DV01, and a 100 bps move, JPM could suffer a $20 billion loss when all is said and done. But hey: at least "net" is not "gross" and we know, just know, that the SEC will get involved and make sure something like this never happens again.
And yes, the SEC has announced an "investigation" into this 2 billion dollar loss. But we all know that the SEC is basically useless. In recent years SEC employees have become known more for watching pornography in their Washington D.C. offices than for regulating Wall Street.
But what has become abundantly clear is that Wall Street is completely incapable of policing itself. This point was underscored in a recent commentary by Henry Blodget of Business Insider….
Wall Street can’t be trusted to manage—or even correctly assess—its own risks.
This is in part because, time and again, Wall Street has demonstrated that it doesn’t even KNOW what risks it is taking.
In short, Wall Street bankers are just a bunch of kids playing with dynamite.
There are two reasons for this, neither of which boil down to "stupidity."
The first reason is that the gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as "weapons of mass destruction." And those weapons have gotten a lot more complex in the past few years.
The second reason is that Wall Street’s incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else—the government or shareholders—covers the downside.
The second reason is particularly insidious. The worst thing that can happen to a trader who blows a huge bet and demolishes his firm—literally the worst thing—is that he will get fired. Then he will immediately go get a job at a hedge fund and make more than he was making before he blew up the firm.
We never learned one of the basic lessons that we should have learned from the financial crisis of 2008.
Wall Street bankers take huge risks because the risk/reward ratio is all messed up.
If the bankers make huge bets and they win, then they win big.
If the bankers make huge bets and they lose, then the federal government uses taxpayer money to clean up the mess.
Under those kind of conditions, why not bet the farm?
Sadly, most Americans do not even know what derivatives are.
Most Americans have no idea that we are rapidly approaching a horrific derivatives crisis that is going to make 2008 look like a Sunday picnic.
According to the Comptroller of the Currency, the "too big to fail" banks have exposure to derivatives that is absolutely mind blowing. Just check out the following numbers from an official U.S. government report….
JPMorgan Chase – $70.1 Trillion
Citibank – $52.1 Trillion
Bank of America – $50.1 Trillion
Goldman Sachs – $44.2 Trillion
So a 2 billion dollar loss for JP Morgan is nothing compared to their total exposure of over 70 trillion dollars.
Overall, the 9 largest U.S. banks have a total of more than 200 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy.
It is hard for the average person on the street to begin to comprehend how immense this derivatives bubble is.
So let’s not make too much out of this 2 billion dollar loss by JP Morgan.
This is just chicken feed.
This is just a preview of coming attractions.
Soon enough the real problems with derivatives will begin, and when that happens it will shake the entire global financial system to the core.
http://theeconomiccollapseblog.com/arch … ves-market
Statistics: Posted by yoda — Fri May 11, 2012 6:36 pm
View full post on opinions.caduceusx.com
The 2 Billion Dollar Loss By JP Morgan Is Just A Preview Of The Coming Collapse Of The Derivatives Market
When news broke of a 2 billion dollar trading loss by JP Morgan, much of the financial world was absolutely stunned. But the truth is that this is just the beginning. This is just a very small preview of what is going to happen when we see the collapse of the worldwide derivatives market. When most Americans think of Wall Street, they think of a bunch of stuffy bankers trading stocks and bonds. But over the past couple of decades it has evolved into much more than that. Today, Wall Street is the biggest casino in the entire world. When the “too big to fail” banks make good bets, they can make a lot of money. When they make bad bets, they can lose a lot of money, and that is exactly what just happened to JP Morgan. Their Chief Investment Office made a series of trades which turned out horribly, and it resulted in a loss of over 2 billion dollars over the past 40 days. But 2 billion dollars is small potatoes compared to the vast size of the global derivatives market. It has been estimated that the the notional value of all the derivatives in the world is somewhere between 600 trillion dollars and 1.5 quadrillion dollars. Nobody really knows the real amount, but when this derivatives bubble finally bursts there is not going to be nearly enough money on the entire planet to fix things.
Sadly, a lot of mainstream news reports are not even using the word “derivatives” when they discuss what just happened at JP Morgan. This morning I listened carefully as one reporter described the 2 billion dollar loss as simply a “bad bet”.
And perhaps that is easier for the American people to understand. JP Morgan made a series of really bad bets and during a conference call last night CEO Jamie Dimon admitted that the strategy was “flawed, complex, poorly reviewed, poorly executed and poorly monitored”.
The funny thing is that JP Morgan is considered to be much more “risk averse” than most other major Wall Street financial institutions are.
So if this kind of stuff is happening at JP Morgan, then what in the world is going on at some of these other places?
That is a really good question.
For those interested in the technical details of the 2 billion dollar loss, an article posted on CNBC described exactly how this loss happened….
The failed hedge likely involved a bet on the flattening of a credit derivative curve, part of the CDX family of investment grade credit indices, said two sources with knowledge of the industry, but not directly involved in the matter. JPMorgan was then caught by sharp moves at the long end of the bet, they said. The CDX index gives traders exposure to credit risk across a range of assets, and gets its value from a basket of individual credit derivatives.
In essence, JP Morgan made a series of bets which turned out very, very badly. This loss was so huge that it even caused members of Congress to take note. The following is from a statement that U.S. Senator Carl Levin issued a few hours after this news first broke….
“The enormous loss JPMorgan announced today is just the latest evidence that what banks call ‘hedges’ are often risky bets that so-called ‘too big to fail’ banks have no business making.”
Unfortunately, the losses from this trade may not be over yet. In fact, if things go very, very badly the losses could end up being much larger as a recent Zero Hedge article detailed….
Simple: because it knew with 100% certainty that if things turn out very, very badly, that the taxpayer, via the Fed, would come to its rescue. Luckily, things turned out only 80% bad. Although it is not over yet: if credit spreads soar, assuming at $200 million DV01, and a 100 bps move, JPM could suffer a $20 billion loss when all is said and done. But hey: at least “net” is not “gross” and we know, just know, that the SEC will get involved and make sure something like this never happens again.
And yes, the SEC has announced an “investigation” into this 2 billion dollar loss. But we all know that the SEC is basically useless. In recent years SEC employees have become known more for watching pornography in their Washington D.C. offices than for regulating Wall Street.
But what has become abundantly clear is that Wall Street is completely incapable of policing itself. This point was underscored in a recent commentary by Henry Blodget of Business Insider….
Wall Street can’t be trusted to manage—or even correctly assess—its own risks.
This is in part because, time and again, Wall Street has demonstrated that it doesn’t even KNOW what risks it is taking.
In short, Wall Street bankers are just a bunch of kids playing with dynamite.
There are two reasons for this, neither of which boil down to “stupidity.”
- The first reason is that the gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as “weapons of mass destruction.” And those weapons have gotten a lot more complex in the past few years.
- The second reason is that Wall Street’s incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else—the government or shareholders—covers the downside.
The second reason is particularly insidious. The worst thing that can happen to a trader who blows a huge bet and demolishes his firm—literally the worst thing—is that he will get fired. Then he will immediately go get a job at a hedge fund and make more than he was making before he blew up the firm.
We never learned one of the basic lessons that we should have learned from the financial crisis of 2008.
Wall Street bankers take huge risks because the risk/reward ratio is all messed up.
If the bankers make huge bets and they win, then they win big.
If the bankers make huge bets and they lose, then the federal government uses taxpayer money to clean up the mess.
Under those kind of conditions, why not bet the farm?
Sadly, most Americans do not even know what derivatives are.
Most Americans have no idea that we are rapidly approaching a horrific derivatives crisis that is going to make 2008 look like a Sunday picnic.
According to the Comptroller of the Currency, the “too big to fail” banks have exposure to derivatives that is absolutely mind blowing. Just check out the following numbers from an official U.S. government report….
JPMorgan Chase – $70.1 Trillion
Citibank – $52.1 Trillion
Bank of America – $50.1 Trillion
Goldman Sachs – $44.2 Trillion
So a 2 billion dollar loss for JP Morgan is nothing compared to their total exposure of over 70 trillion dollars.
Overall, the 9 largest U.S. banks have a total of more than 200 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy.
It is hard for the average person on the street to begin to comprehend how immense this derivatives bubble is.
So let’s not make too much out of this 2 billion dollar loss by JP Morgan.
This is just chicken feed.
This is just a preview of coming attractions.
Soon enough the real problems with derivatives will begin, and when that happens it will shake the entire global financial system to the core.
View full post on The Economic Collapse
Business • Has Derivatives Deleveraging Fueled the Stock Rally?
Has Derivatives Deleveraging Fueled the Stock Rally?
February 7, 2012
A mad scramble to avoid insolvency as Greek default becomes likely may be driving the rally in equities.
Deleveraging typically means selling assets to raise cash to meet margin calls or pay debts coming due. But there may be another twist to deleveraging that has fueled the manic market rally since late December. I am indebted to Peter C. of M3 Financial Sense for explaining this dynamic.
To understand this non-intuitive dynamic, let’s start with a simple example of how options work. If this is new to you, please stay with me, your head will not explode…. at least for awhile.
An option is a financial instrument which grants you the right to buy X number of shares of a company at Y price (the strike price). One option controls 100 shares. An option is either a put (a bet the price will decline in the future) or a call (a bet the price will rise in the future).
An option is "in the money" when the stock price is above the call strike price or below the put strike price. For example, if you own one call option on Netflix (NFLX) at a strike price of $100, then your option is worth $2,900 ($29 per share) as of today because Netflix is trading for $129 per share. (There is also a time value in options, but let’s leave that aside in this example.)
So if you bought 10,000 options on Netflix (NFLX), whomever sold you the options is obligated to deliver 1,000,000 shares of Netflix to you (at the strike price of the option) upon expiration of the option.
If your option is "in the money" as in the above example, the specialist who sold you the options will hedge his position so he can meet the obligation. If your options are just barely in the money, he might buy 250,000 shares of Netflix to cover his future obligation.
As your option becomes ever more valuable, i.e. becomes deeper in the money, the specialist has to increase his hedge up to the full 1,000,000 shares that he is obligated to deliver to you upon expiration.
That purchase of 750,000 shares to cover his bet will drive the price of Netflix up.
Here is an important point about options and derivatives. In theory, the number of options should equal the number of outstanding shares. If there are 1,000,000 shares of a stock outstanding, then there shouldn’t be more than 10,000 options contracts written and sold.
In the parlance of options, these puts and calls are "covered," meaning there are enough shares available to "cover" the options, i.e. when the option expires, there are enough shares to meet the delivery obligations of actual shares.
If a specialist sells options without holding the requisite number of actual shares to cover the options, then he will have to buy those shares as the delivery date looms. If the number of option contracts exceeds the number of available shares, then the rush to acquire those shares for delivery will spark a massive rally.
This is somewhat akin to the infamous "short-covering rallies" triggered when those who sold shares short have to buy shares to close their short positions.
Options and futures contracts are all marked to market at the close of every trading day. The price is thus transparent for all to see.
Derivatives are not marked to market. That sort of requirement is evil, evil, evil and anti-capitalist–or so we are told by the financial cartels who profit from selling derivatives.
Derivatives can be sold in whatever quantity can be fobbed off to credulous buyers. This is how the world ends up with 700 gazillion dollars in notional derivatives.
Consider the debt of a sovereign state–for example, Greece. Just to keep things simple, let’s say there are $100 billion of outstanding Greek bonds. Back in the good old days around 2009, the risk of Geece defaulting on that debt was considered low. Nonetheless, prudent owners of the debt bought insurance against default. The insurance is a derivative called a credit default swap (CDS).
The contract works somewhat like an option, in the sense that if a default occurs, the seller of the CDS must cover their contract by delivering the value promised in the CDS to its owner. If no default ever occurs, the financial institution that originated and sold the CDS gets to keep the hefty premium.
Nice. Since there are no limits on how many CDs I can write on Greek debt, why not sell more CDS? In fact, why not sell more CDS than there are Greek bonds?
As in our options example, in the normal course of things the number of CDS equals the outstanding bonds. In other words, the owners of the $100 billion in bonds would buy $100 billion in notional CDS insurance against default.
If Greece defaulted and the value of the bonds fell in half to $50 billion, the sellers of the CDS would owe the owners of the CDS $50 billion. (This is simplified, but you get the picture.) That was, after all, the bet: in exchange for this hefty premium, if Greece defaults then we will make good your horrendous losses.
But a funny thing happened on the way to the derivatives market: wise guys realized they weren’t limited to selling CDS to the owners of Greek bonds–anyone could buy a CDS on Greek debt. So why not sell $1 trillion in CDS against Greek bonds? That’s ten times the premium.
Some issuers hedged their bet by buying CDS issued by other institutions. These other institutions are the "counterparty", that is, the party who pays off the CDS I bought from them so I can pay off the owner of my CDS. Thus the derivatives market for Greek debt is a daisy-chain of counterparties, all planning to use the proceeds from the CDS they own to pay off the CDS they sold.
It was a license to print money–until Greece defaults. Yikes, now what? Just as in the classic film The Producers, where 100% of the proceeds of the Broadway play were promised to ten different investors, the CDS schemers reckoned the odds of a Greek default were effectively zero–"the E.U. will never let a member state default."
Ahem. Until they do. In The Producers, the schemers devised a play so odious, so bad and so repellent that they felt extremely confident it would close after one night for a tremendous loss–and they would get to keep the 10X oversubscribed investors’ money.
This was the same bet made by sellers of CDS on Greek debt–and on Italian, Portuguese, Spanish, Irish et al. debt as well.
Now that leaves the canny financiers in a pickle, as they owe various parties $1 trillion when $100 billion in Greek debt goes up in smoke.
Now we get to the deleveraging part. As I understand it, some of these CDS are written against various swaps or stock indices, meaning that the asset to be delivered upon default is ultimately a claim against stock indices, currencies, etc.
That means that those holding the CDS obligations have to acquire these assets so they can pay off their obligation when Greece defaults.
There is one more wrinkle. Many sellers of CDS protected themselves against any potential loss by buying a CDS originated by someone else. As noted in When Greece Defaults, the Credit Default Swap Dominoes Fall (February 4, 2012), this "can be likened to a pool of $100 bets leveraged off $5 in cash. If every bet is covered perfectly, then it’s somewhat like $95 in bets being paid by passing $5 around–much like the famous email that depicts all debts in a small town being paid by the same $5."
But some players have issued more CDS than they bought as insurance, meaning that they will be unable to meet all their obligations. Everyone is depending on a host of counterparties to deliver, and now there is a growing fear that some counterparties will be unable to make good on their obligations.
That’s how the dominoes topple. Prudent institutions aren’t waiting around until the dominoes fall–they’re buying the underlying assets so they can meet their CDS obligations. That’s the only way not to topple into insolvency when the default causes CDS to be recognized as due and payable.
In this light, it’s no wonder stocks have been rising. If even a modest percentage of CDS are tied to stock indices, then those deleveraging their derivatives positions must acquire the underlying assets. They can no longer count on all counterparties paying off as promised, and so they are raising cash and buying the underlying assets needed to make good their obligations.
The whole thing is a farce, just like The Producers. The moment the default is recognized, then all the CDS become due and payable, and it will only take handful of failed counterparties to bring the entire system down.
No wonder the Eurocrats and central bankers are twisting everyone’s arms to accept a 70% loss–the alternative is a Greek default and the collapse of the banking cartel’s profitable scheme. It is beyond absurd–what is a 70% loss but default? When banana republics default, their bondholders don’t necessarily absorb a 70% loss. yet now, to "save" the despicably parastic shadow banking system and the "too big to fail" financial institutions, a default cannot be called a default: it is a "voluntary haircut."
Greece, please do the world a favor and openly default–right now, today. Declare a default and pay nothing. Force the shadow banking system to recognize a default and bring down the entire rotten heap of worm-eaten corruption.
At that point, there will be no reason to buy equities.
http://www.oftwominds.com/blog.html?ref=patrick.net
Statistics: Posted by yoda — Tue Feb 07, 2012 10:10 am
View full post on opinions.caduceusx.com