Free Republic
Browse · Search
Bloggers & Personal
Topics · Post Article

Skip to comments.

1000x Systemic Leverage: $600 Trillion In Gross Derivatives "Backed" By $600 Billion In Collateral
Zero Hedge ^ | 12/24/2012 | Tyler Durden

Posted on 12/25/2012 7:55:15 PM PST by SeekAndFind

There is much debate whether when it comes to the total notional size of outstanding derivatives, it is the gross notional that matters (roughly $600 trillion), or the amount which takes out biletaral netting and other offsetting positions (much lower). We explained previously how gross is irrelevant... until it is, i.e. until there is a breach in the counterparty chain and suddenly all net becomes gross (as in the case of the Lehman bankruptcy), such as during a financial crisis, i.e., the only time when gross derivative exposure becomes material (er, by definition). But a bigger question is what is the actual collateral backing this gargantuan market which is about 10 times greater than the world's combined GDP, because as the "derivative" name implies all this exposure is backed on some dedicated, real assets, somewhere. Luckily, the IMF recently released a discussion note titled "Shadow Banking: Economics and Policy" where quietly hidden in one of the appendices it answers precisely this critical question. The bottom line: $600 trillion in gross notional derivatives backed by a tiny $600 billion in real assets: a whopping 0.1% margin requirement! Surely nothing can possibly go wrong with this amount of unprecedented 1000x systemic leverage.

From the IMF:

Over-the-counter (OTC) derivatives markets straddle regulated systemically important financial institutions and the shadow banking world. Recent regulatory efforts focus on moving OTC derivatives contracts to central counterparties (CCPs). A CCP will be collecting collateral and netting bilateral positions. While CCPs do not have explicit taxpayer backing, they may be supported in times of stress. For example, the U.S. Dodd-Frank Act allows the Federal Reserve to lend to key financial market infrastructures during times of crises. Incentives to move OTC contracts could come from increasing bank capital charges on OTC positions that are not moved to CCP (BCBS, 2012).


The notional value of OTC contracts is about $600 trillion, but while much cited, that number overstates the still very sizable risks. A better estimate may be based on adding “in-the-money” (or gross positive value) and “out-of-the money” (or gross negative value) derivative positions (to obtain total exposures), further reduced by the “netting” of related positions. Once these are taken into account, the resulting exposures are currently about $3 trillion, down from $5 trillion (see table below; see also BIS, 2012, and Singh, 2010).


Another important metric is the under-collateralization of the OTC market. The Bank for International Settlements estimates that the volume of collateral supporting the OTC market is about $1.8 trillion, thus roughly only half of exposures. Assuming a collateral reuse rate between 2.5-3.0, the dedicated collateral is some $600 - $700 billion. Some counterparties (e.g., sovereigns, quasi-sovereigns, large pension funds and insurers, and AAA corporations) are often not required to post collateral. The remaining exposures will have to be collateralized when moved to CCP to avoid creating puts to the safety net. As such, there is likely to an increased demand for collateral worldwide.

And there it is: a world in which increasingly more sovereigns are insolvent, it is precisely these sovereigns (and other "AAA-rated" institutions) who are assumed to be so safe, they don't have to post any collateral to the virtually unlimited derivatives they are allowed to create out of thin air.

Is it any wonder why, then, in a world in which even the IMF says there is an increased demand for collateral, that banks are making a total mockery out of such preemptive attempts to safeguard the system, such as the Basel III proposal, whose deleveraging policies have been delayed from 2013 to 2014, and which will be delayed again and again, until, hopefully, everyone forgets all about them, and no financial crises ever again occur.

Because if and when they do, the entire world, which has now become one defacto AIG Financial Products subsidiary, and is spewing derivatives left and right, may have to scramble just a bit to procure some of this $599 trillion in actual collateral, once collateral chains start breaking, once "AAA-rated" counterparties (such as AIG had been days before its bailout) start falling, and once the question arises: just what is the true value of hard assets in a world in which the only value created by financial innovation is layering of derivatives upon derivatives, serving merely to prod banker bonuses to all time highs.

TOPICS: Business/Economy; Society
KEYWORDS: collateral; derivatives; leverage; zerohedge
Navigation: use the links below to view more comments.
first previous 1-2021-27 last
To: Mogger

I’m pretty sure options are included in any course on markets and investing in college.
Back to your example there’s no systemic risk to a purchase of a call. The defined risk is simply the amount paid for the call. Now someone selling a naked call, one they are not long the underlying security has a great deal of risk. Selling puts would entail risk from the strike down to zero. All the risk should of course be mitigated by hedging.
The risk in the article is more along the lines of bond insurance as well as capital requirement rules.

21 posted on 12/26/2012 4:58:46 AM PST by wiggen (The teacher card. When the racism card just won't work.)
[ Post Reply | Private Reply | To 8 | View Replies]

To: ctdonath2

“This in contrast to paper currency, where the paper is imputed with actual value verified by simple possession.”

Exactly. The ultimate totalitarian This socialist-induced debt fiasco is the vehicle used to take us there.

From the link above...

“How much of your wealth is allocated as zeroes ad ones on computer servers? How much is physical, in your possession and defensible?”

“If you can’t stand in front of it with an assault rifle and defend’s not really yours.”

“It can be confiscated instantaneously.”

DIGITAL enslavement is the ultimate totalitarian tool. You won’t have an “assault rifle” or a bullet. The transaction will not be allowed. Your time of life/labor is the treasure of the totalitarian slavemaster.

“Socialism Is Legal Plunder” - Bastiat


DEFUND/DISMANTLE domestic socialist collectives.

DEPOPULATE socialists from the body politic.

live - free - republic

22 posted on 12/26/2012 5:51:36 AM PST by PGalt
[ Post Reply | Private Reply | To 11 | View Replies]

To: Mogger

Nice explanation. So, there is a grand house of cards with cards added every day. And, any major economic event will send this house of cards crashing taking the world economic system with it.

23 posted on 12/26/2012 5:54:42 AM PST by VRW Conspirator (We were the tea party before there was a tea party. - Jim Robinson)
[ Post Reply | Private Reply | To 8 | View Replies]

To: SeekAndFind

Derivatives have become “the world’s casino”, a scheme by which sovereigns can ruthlessly speculate using virtually no margin. If this .1% margin was examined, I imagine that this $600b collateral is made of sawdust that, weight for weight, is valued a million times more than gold.

Nature abhors unsupported margins even worse than vacuums.

24 posted on 12/26/2012 8:18:27 AM PST by yefragetuwrabrumuy (Pennies and Nickels will NO LONGER be Minted as of 1/1/13 - Tim Geithner, US Treasury Sect)
[ Post Reply | Private Reply | To 1 | View Replies]

To: VRW Conspirator

If you haven’t already seen Ann Barnhardt’s latest YouTube 8 part series, you need to. It takes 2 hours and 30 min. But worth it.

25 posted on 12/26/2012 9:15:23 AM PST by wastoute (Government cannot redistribute wealth. Government can only redistribute poverty.)
[ Post Reply | Private Reply | To 23 | View Replies]

To: ctdonath2
You wrote: "Digital currency is debt. That’s the only way ownership of the bits can be validated. This in contrast to paper currency, where the paper is imputed with actual value verified by simple possession."

Paper currency was imputed with actual value back when it said things like "Pay to the bearer on demand". Or, even more so when you could trade a dollar bill for 10 dimes that were each about 1/10th of an oz of silver at any bank.

But those days are long gone. All dollars whether printed Federal Reserve Notes or ones and zeros in your bank account represent debt. Dollars are created by banks as debt, that's the only mechanism of creation of money in America now, and the fact that the Treasury prints up a small fraction of the money in circulation as currency doesn't change that fact.

Or, at least that is my understanding. You seem to be making a different point, could you better explain what you mean?

26 posted on 12/26/2012 10:23:20 AM PST by Jack Black ( Whatever is left of American patriotism is now identical with counter-revolution.)
[ Post Reply | Private Reply | To 11 | View Replies]

To: wastoute
Ann Barnhardt’s latest YouTube 8 part series,

Seen all 8. Had to change my underwear. I am spreading the word. The question is when?

27 posted on 12/27/2012 5:17:46 AM PST by VRW Conspirator (We were the tea party before there was a tea party. - Jim Robinson)
[ Post Reply | Private Reply | To 25 | View Replies]

Navigation: use the links below to view more comments.
first previous 1-2021-27 last

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.

Free Republic
Browse · Search
Bloggers & Personal
Topics · Post Article

FreeRepublic, LLC, PO BOX 9771, FRESNO, CA 93794 is powered by software copyright 2000-2008 John Robinson