$500 Trillion in Derivatives “Remain an Important Asset Class”: Hilariously, the New York Fed, by Wolf Richter

The “good” news  is that the world doesn’t have quite as many financial derivatives as it did in 2013. The bad news is what it has is still seven times global GDP. From Wolf Richter at wolfstreet.com:

Oh, and the unintended consequences of trying to regulate a monster.

Economists at the New York Fed included this gem in their report on a two-day conference on “Derivatives and Regulatory Changes” since the Financial Crisis:

Though the notional amount [of derivatives] outstanding has declined in recent years, at more than $500 trillion outstanding, OTC derivatives remain an important asset class.

An important asset class. A hilarious understatement. Let’s see… the “notional amount” of $500 trillion is 25 times the GDP of the US and about 7 times global GDP. Derivatives are not just an “important asset class,” like bonds; they’re the largest “financial weapons of mass destruction,” as Warren Buffett called them in 2003.

Derivatives are used for hedging economic risks. And they’re used as “speculative directional exposures” – very risky one-sided bets. It’s all tied together in an immense and opaque market interwoven with the banks. The New York Fed:

The 2007-09 financial crisis highlighted weaknesses in the over-the-counter (OTC) derivatives markets and the increased risk of contagion due to the interconnectedness of market participants in these markets.

This chart from the New York Fed shows how derivatives ballooned 150% – or by $360 trillion – in less than four years before the Financial Crisis. They ticked down during the Financial Crisis, then rose again during the Fed’s QE to peak at $700 trillion. After the end of QE, they declined, but recently ticked up again to $500 trillion. I added in red the Warren Buffett moment:

The vast majority of the derivatives are interest rate and credit contracts (dark blue). Banks specialize in that. For example, according to the OCC’s Q4 2016 Report on Derivatives, JPMorgan Chase holds $47.5 trillion of derivatives at notional value and Citibank $43.9 trillion. The top 25 US banks hold $164.7 trillion, or 8.5 times US GDP. So even a minor squiggle could trigger some serious heartburn.

To continue reading: $500 Trillion in Derivatives “Remain an Important Asset Class”: Hilariously, the New York Fed

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