Tag Archives: derivatives

Iran goes for “maximum counter-pressure”, by Pepe Escobar

The second order effect of shutting down the Strait of Hormuz would be to collapse huge derivatives market. From Pepe Escobar at strategic-culture.org:

Sooner or later the US “maximum pressure” on Iran would inevitably be met by “maximum counter-pressure”. Sparks are ominously bound to fly.

For the past few days, intelligence circles across Eurasia had been prodding Tehran to consider a quite straightforward scenario. There would be no need to shut down the Strait of Hormuz if Quds Force commander, General Qasem Soleimani, the ultimate Pentagon bête noire, explained in detail, on global media, that Washington simply does not have the military capacity to keep the Strait open.

As I previously reported, shutting down the Strait of Hormuz

would destroy the American economy by detonating the $1.2 quadrillion derivatives market; and that would collapse the world banking system, crushing the world’s $80 trillion GDP and causing an unprecedented depression.

Soleimani should also state bluntly that Iran may in fact shut down the Strait of Hormuz if the nation is prevented from exporting essential two million barrels of oil a day, mostly to Asia. Exports, which before illegal US sanctions and de facto blockade would normally reach 2.5 million barrels a day, now may be down to only 400,000.

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Financial Weapons Of Mass Destruction: The Top 25 U.S. Banks Have 222 Trillion Dollars Of Exposure To Derivatives, by Michael Snyder

It is, as SLL has pointed out, somewhat misleading to list a financial institution’s gross exposure to derivatives without netting out offsetting positions (a long and a short of the same instrument). However, if case of systemic failure, if counterparties are unable to meet their commitments, net exposures can quickly become gross exposures. So read about banks’ gross exposures with a grain of salt, but realize the numbers are not completely irrelevant, especially in a financial crisis. From Michael Snyder at theeconomicollapseblog.com:

The recklessness of the “too big to fail” banks almost doomed them the last time around, but apparently they still haven’t learned from their past mistakes.  Today, the top 25 U.S. banks have 222 trillion dollars of exposure to derivatives.  In other words, the exposure that these banks have to derivatives contracts is approximately equivalent to the gross domestic product of the United States times twelve.  As long as stock prices continue to rise and the U.S. economy stays fairly stable, these extremely risky financial weapons of mass destruction will probably not take down our entire financial system.  But someday another major crisis will inevitably happen, and when that day arrives the devastation that these financial instruments will cause will be absolutely unprecedented.

During the great financial crisis of 2008, derivatives played a starring role, and U.S. taxpayers were forced to step in and bail out companies such as AIG that were on the verge of collapse because the risks that they took were just too great.

But now it is happening again, and nobody is really talking very much about it.  In a desperate search for higher profits, all of the “too big to fail” banks are gambling like crazy, and at some point a lot of these bets are going to go really bad.  The following numbers regarding exposure to derivatives contracts come directly from the OCC’s most recent quarterly report (see Table 2), and as you can see the level of recklessness that we are currently witnessing is more than just a little bit alarming…

Citigroup

Total Assets: $1,792,077,000,000 (slightly less than 1.8 trillion dollars)

Total Exposure To Derivatives: $47,092,584,000,000 (more than 47 trillion dollars)

JPMorgan Chase

Total Assets: $2,490,972,000,000 (just under 2.5 trillion dollars)

Total Exposure To Derivatives: $46,992,293,000,000 (nearly 47 trillion dollars)

Goldman Sachs

Total Assets: $860,185,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $41,227,878,000,000 (more than 41 trillion dollars)

Bank Of America

Total Assets: $2,189,266,000,000 (a little bit more than 2.1 trillion dollars)

Total Exposure To Derivatives: $33,132,582,000,000 (more than 33 trillion dollars)

Morgan Stanley

Total Assets: $814,949,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $28,569,553,000,000 (more than 28 trillion dollars)

Wells Fargo

Total Assets: $1,930,115,000,000 (more than 1.9 trillion dollars)

Total Exposure To Derivatives: $7,098,952,000,000 (more than 7 trillion dollars)

Collectively, the top 25 banks have a total of 222 trillion dollars of exposure to derivatives.

To continue reading: Financial Weapons Of Mass Destruction: The Top 25 U.S. Banks Have 222 Trillion Dollars Of Exposure To Derivatives

$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

Donald Trump Has a Goldman Sachs Problem: Derivatives, by Pam Martens and Russ Martens

Because SLL remembers the last financial crisis, SLL harps on debt and derivatives, which tend to be ignored until they can be no longer. That the world’s toxic combination of debt and derivatives will eventually blow up in a crisis worse than the last crisis is a lead-pipe cinch. From PamMartens and Russ Martens at wallstreetonparade.com:

n the midst of being skewered across media outlets yesterday for his chaotic rollout of an Executive Order that appeared to target Muslims, including those legally living in the U.S. as businessmen, doctors, university faculty and students — who were initially denied reentry after travel abroad — President Donald Trump tried desperately to change the subject. Following a plunge of over 200 points in the Dow Jones Industrial Average yesterday, Trump pivoted to something he thought would please his financial backers on Wall Street. He called the Dodd-Frank financial reform legislation passed in 2010 by the Obama administration a “disaster” and promised to “do a big number” on it soon. The Dow closed down 122 points — now wary of Trump’s fire-ready-aim leadership on complex matters.

The legitimate fear across Wall Street right now is that Trump’s zero-vetting approach to rule-by-Executive-Order could leave Wall Street in the same chaotic state as the airports experienced from his ham-fisted approach to immigration.

But it’s not just Trump that Wall Street needs to fear: it’s Goldman Sachs as well. Trump has stuffed his administration with so many Goldman Sachs progeny that his administration is now regularly referred to as Government Sachs.

Goldman Sachs has a unique vested interest in repealing chunks of Dodd-Frank while making sure that the Glass-Steagall Act is not reinstated. That’s because when it comes to derivatives, Goldman Sachs is keeping a lot of secrets.

The Office of the Comptroller of the Currency (OCC) is the regulator of national banks. Each quarter it publishes a report on the derivative holdings of the biggest Wall Street banks and their holding companies. Its most recent report shows that as of September 30, 2016 Goldman Sachs Bank USA (a taxpayer-backstopped, FDIC insured bank where it holds its derivatives) had “credit exposure to risk-based capital” of 433 percent. That figure was more than double that of JPMorgan Chase (216 percent) and six times that of Bank of America (68 percent).

To continue reading: Donald Trump Has a Goldman Sachs Problem: Derivatives

Now it Begins to Unravel, by Wolf Richter

If you borrow $10 dollars to generate $8 dollars worth of GDP, you’re going backwards and the game will eventually end.  From Wolf Richter at wolfstreet.com:

The Credit Bubble Peak was Marked by “Totally Crazy Lending.”

Debt is good. More debt is better. Funding consumer spending with debt is even better – that’s what economists have been preaching – because the consumed goods and services are gone after having been added to GDP, while the debt, which GDP ignores, remains until it is paid off with future earnings, or until it blows up.

Corporations too have gone on a borrowing binge. Unlike consumers, they have no intention of paying off their debts. They issue new debt and use the proceeds to pay off maturing debts. Funding share-buybacks and dividends with debt is ideal. It’s called “unlocking value.”

Debt must always grow. For that purpose, the Fed has manipulated interest rates to rock bottom. Actually paying off and reducing debt has the dreadful moniker, bandied about during the Financial Crisis, “deleveraging.” It’s synonymous with “The End of the World.”

At the institutional level, “debt” is replaced with more politically correct “leverage.” More leverage is better. Particularly if you can borrow short-term at near zero cost and bet the proceeds on risky illiquid long-term assets, such as real estate, or on securities that become illiquid without notice.

Derivatives are part of this institutional equation. The notional value of derivatives in the US banking system is $190 trillion, according to the Office of the Comptroller of the Currency. Four banks hold over 90% of them: JP Morgan ($53 trillion), Citibank ($52 trillion), Goldman ($44 trillion), and Bank of America ($26 trillion).

Over 75% of those derivative contracts are interest rate products, such as swaps. With them, heavily leveraged institutional investors that borrow short-term to invest in illiquid long-term assets hedge against interest rate movements. But Treasury yields and mortgage rates have moved violently in recent weeks, and someone is out some big money.

These credit bubbles always unravel to the greatest surprise of those institutions and their economists. When they unravel, the above “End-of-the-World” scenario of orderly deleveraging turns into forced deleveraging, which can get messy. Assets that had previously been taken for granted are either repriced or just evaporate. But they’d been pledged as collateral. Suddenly, the collateral no longer exists….

On the way up, lots of money can be made on this debt, in myriad ways, including in interest and fees extracted from consumers directly, and in fees extracted by Wall Street, for example in repackaging risky consumer or corporate debt into highly rated asset-backed securities that are then spread to institutional investors who use proceeds from leverage to acquire them. But no problem; it’s just OPM (other people’s money).

Then there’s the peak. It’s marked by “totally crazy lending.” We’ve seen that peak. One sign: white-hot online peer-to-peer lenders, or rather “platforms” for risky consumer loans. They’re Silicon Valley inventions that were going to revolutionize lending and put banks out of business. They proudly operate with disregard for risks. They borrow from individual and institutional investors and extend unsecured personal loans to consumers. They also repackage consumer loans into bonds and sell them to over-eager institutional investors.

To continue reading: Now it Begins to Unravel

Why A Deutsche Bank Whistleblower Turned Down A $8.25 Million Reward: In His Own Words, by Tyler Durden

At first blush his is a fairly routine story about shoddy bank accounting and the revolving door between the regulators and the regulated in the banking industry, but it is lifted way above the mundane by the principled stand of Eric Ben-Artzi, who refused a multimillion dollar whistleblower reward. From Tyler Durden at zerohedge.com:

At the height of the financial crisis, when risk assets were imploding and counterparties were in danger of overnight collapse, Deutsche Bank avoided failure and nationalization by fabricating the value of its $130 billion derivative portfolio of “leveraged super senior” trades.

Some history: back in 2005, these trades were seen as “the next big thing” in the world of credit derivatives, something which DB at the time was building a massive position in. They were designed to behave like the most senior tranche of a typical collateralised debt obligation, where assets such as mortgages or credit default swaps are pooled to give investors varying degrees of risk exposure. Deutsche became the biggest operator in this market, which involved banks buying insurance against the possibility of default by some of the safest companies, the FT writes.

There was just one problem: when it was building up its portfolio, Deutsche never accounted for the possibility of the financial world nearly collapsing. Which is why as the illiquid portfolio was careening, instead marking it to market – an act that would have resulted in the bank’s insolvency – DB’s risk managers misstated the value of the positions by anywhere from $1.5bn to $3.3bn.

Several years later, in 2012, the SEC found out about this, and in 2015 slapped a $55 million fine on Deutsche Bank for this criminal fabrication (nobody went to jail). “At the height of the financial crisis, Deutsche Bank’s financial statements did not reflect the significant risk in these large, complex illiquid positions,” said Andrew Ceresney, director of the SEC’s enforcement division. “Deutsche Bank failed to make reasonable judgments when valuing its positions and lacked robust internal controls over financial reporting.”

The reason why the SEC learned about DB’s massive mismarked derivative exposure, is because two former employee whistleblowers, Matthew Simpson and Eric Ben-Artzi, told it: the duo alleged that if Deutsche had accounted properly for its positions, its capital would have fallen to dangerous levels during the financial crisis and it might have required a government bailout to survive. The highest estimate for the unaccounted loss was $12bn. Which explains why Deutsche Bank was desperate to manipulated the numbers.

End result: DB got its wristslap with a token fine, the SEC came out looking like it knew what it was doing, and – as we learned today – the two whistleblowers got major awards for helping the SEC collected the $55MM fine, amounting to 15% each.

Only, something unexpected happened: as the FT writes, one of the whistleblowers who helped expose the false accounting at Deutsche Bank turned down a multimillion-dollar award from the Securities and Exchange Commission in protest against the agency’s failure to punish executives at the bank.

Eric Ben-Artzi, the former Deutsche risk officer, told the SEC he is declining his share of a $16.5 million payout — the third largest in the whistleblower program’s history — which represents 30% of the $55 million Deutsche Bank fine.

But why turn down enough money that most people, even ex-Wall Streeters, could comfortably retire on? Ben-Artzi said the fine should be paid by individual executives, not shareholders, and suggested the “revolving door” of senior personnel between the SEC and Germany’s largest bank had played a role in executives going unpunished (understandably he had no comment about the spike in Deutsche Bank suicides in 2013-2014, particularly those emanating from its legal department).

To continue reading: Why A Deutsche Bank Whistleblower Turned Down A $8.25 Million Reward: In His Own Words

U.S. Government Is Now a Major Counterparty to Wall Street Derivatives, by Pam Martens and Russ Martens

Don’t worry about trying to figure out derivatives exposure among banks, housing agencies, and the government. Like Obamacare, the legislation that had to be passed before we found out what was in it, we’ll find out where the bodies are buried in the derivatives market when they blow up. From Pam Martens and Russ Martens at wallstreetonparade.com:

According to a study released by the Federal Reserve Bank of New York in March of last year, U.S. taxpayers have already injected $187.5 billion into Fannie Mae and Freddie Mac, two companies that prior to the 2008 financial crash traded on the New York Stock Exchange, had shareholders and their own Board of Directors while also receiving an implicit taxpayer guarantee on their debt. The U.S. government put the pair into conservatorship on September 6, 2008. The public has been led to believe that the $187.5 billion bailout of the pair was the full extent of the taxpayers’ tab. But in an astonishing acknowledgement on February 25 of this year, the Government Accountability Office, the nonpartisan investigative arm of Congress, issued an audit report of the U.S. government’s finances, revealing that the government’s “remaining contractual commitment to the GSEs, if needed, is $258.1 billion.”

This suggests that somehow, without the American public’s awareness, the U.S. government is on the hook to two failed companies for $445.6 billion dollars. And that may be just the tip of the iceberg of this story.

The official narrative around the bailout of Fannie and Freddie is that they were loaded up with toxic subprime debt piled high by the Wall Street banks that sold them dodgy mortgages. While that is factually true, the other potentially more important part of this story is the counterparty exposure the Wall Street banks had to Fannie and Freddie’s derivatives if the firms had been allowed to fail.

The New York Fed’s staff report of March 2015 concedes the following:

“Fannie Mae and Freddie Mac held large positions in interest rate derivatives for hedging. A disorderly failure of these firms would have caused serious disruptions for their derivative counterparties.”

Exactly how big was this derivatives exposure and which Wall Street banks were being protected by the government takeover of these public-private partnerships that had spiraled out of control into gambling casinos?

To continue reading: U.S. Government Is Now a Major Counterparty to Wall Street Derivatives