Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure

Zero Hedge ^ | 09/24/2011 | Tyler Durden

[SeekAndFind]

The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact 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 (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). 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.

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?

...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. 

...

Lastly, and tangentially on a topic that recently has gotten much prominent attention in the media, we present the exposure by product for the biggest commercial banks. Of particular note is that while virtually every single bank has a preponderance of its derivative exposure in the form of plain vanilla IR swaps (on average accounting for more than 80% of total), Morgan Stanley, and specifically its Utah-based commercial bank Morgan Stanley Bank NA, has almost exclusively all of its exposure tied in with the far riskier FX contracts, or 98.3% of the total $1.793 trillion. For a bank with no deposit buffer, and which has massive exposure to European banks regardless of how hard management and various other banks scramble to defend Morgan Stanley, the fact that it has such an abnormal amount of exposure (but, but, it is "bilaterally netted" we can just hear Dick Bove screaming on Monday) to the ridiculously volatile FX space should perhaps raise some further eyebrows...

[Toddsterpatriot]

For example: 2 parties may engage in a Swap transaction on a $100million notional amount. They are not exchanging the entire $100million. They are only exchanging interest payments on that $100 million on a monthly, quarterly, semi-annual or annual basis (whatever they agree to), so the true exposure is nowhere near the $100 million notional amount of the swap.

Don't post facts. The only proper response is panic!!!

[Lorianne]

Multi-trillion plan to save the eurozone being prepared
http://www.telegraph.co.uk/finance/financialcrisis/8786665/Multi-trillion-plan-to-save-the-eurozone-being-prepared.html

[chuckles]

This stuff is a little above my pay grade, but what I've been wondering is, it looks as if we have moved from a tech bubble in 2000, to a housing bubble in 2008, and now we have a Bond bubble. We have made bonds the "safe haven" and driven interest rates so low so we can float the $14 trillion( soon to be $19 trillion) debt and still pay for it. If it costs $250- $500 billion in annual interest when interest rates are under 1%, then imagine what we will do when the bubble bursts.

Can the Fed keep the bubble inflated? For how long? Now the very same banks just had their profit potential slashed by Bernanke with the "twist". Will the banks keep floating with lower profits? Will we prop them up indefinitely? Are we even able to do that? What will the bond rates be when China, Saudi, or Japan decide they need their money back? There are just so many variables here, it reminds me of the old circus trick where the guy has about 14 plates spinning on sticks and he is trying to get one more going while 3 of them are wobbling at 1 RPM. At some point one will fall and then what?

I'm 60 yrs old, and I'm skert. You know the old saying about it being "different this time" just might be true now.

[SAJ]

Exactly so. And don’t forget the initial phase of this rubbish, namely, the effective repeal of Glass-Steagall by Gramm-Leach-Bliley Act of 1999, which, when combined with CFMA2K, allowed the banksters to **fund** their derivatives trading and initiation with the monies of their depositors on the commercial banking side.

Capone and Luciano would be in awe.

[Pelham]

“And don’t forget the initial phase of this rubbish, namely, the effective repeal of Glass-Steagall by Gramm-Leach-Bliley Act of 1999, which, when combined with CFMA2K, allowed the banksters to **fund** their derivatives trading and initiation with the monies of their depositors on the commercial banking side.”

That’s the truth.

Politicians and the Wall Streeters who lobbied them counted on the fact that only a tiny fraction of the public had any idea of what the Glass Steagall Act was about or why dismantling it was a bad idea.

They promoted G-L-B and the CFMA as beneficial deregulation. It was a bipartisan effort.

[Toddsterpatriot]

Except for AIG, who have no depositors, did any major firm have much of an issue with derivatives?

If they were exchange traded and margined, would that solve all the problems you currently have with them?

[SAJ]

Toddy, don’t have an answer to that one. If investment banks’ derivatives were, as you say, exchange-traded and (fully) margined, this would be theoretically good and certainly soothing. However, in such a world, it would be VERY difficult to get a lot of quite legitimate things done that are now handled by OTC derivatives.

Note please that a return to Glass-Steagall would not impair financing, per se, at all — it would simply force the banksters to use something other than commercial deposits (read: your and my money) to fund these overgeared schemes.

[Toddsterpatriot]

Note please that a return to Glass-Steagall would not impair financing, per se, at all — it would simply force the banksters to use something other than commercial deposits (read: your and my money) to fund these overgeared schemes.

Can you think of a firm that cost the taxpayers money because they used our money to "fund these overgeared schemes"?

[SAJ]

Toddy, m'FRiend...how about "all of the above"? AIG was the absolute poster child for overgearing; while not technically an outright IB, they traded as if they were, with implicit guarantys of bailout nicely in place.

Murder Pinch and Goldbug Slacks? You're joking, right? Their **reported** gearing, via derivatives, was in 2008-9 well in excess of 700% (and probably much higher, if we, or someone, would use honest numbers to quantify their leverage).

No domestic IB is entirely clean in this matter. JPM have, as virtually every futures trader knows very well, been up to their eyeballs in manipulating trading the PMs for more than a decade, and they've finally been caught out. AND, would probably be formally bankrupt but for dodgy bookkeeping and sundry provisions of CFMA2K, along with quite a bit of greasing the parasites who infest Crapitol Hill.

Now, you may attempt to protest that the taxpayers have not "lost" money on assorted bailouts of these IBs, to which I will respond: "And just exactly WHEN do you suppose that the bailout funds -- of whichever type, makes no difference -- will be repaid, hmm?

Not being rude, m'FRiend, just highly realistic (plus, I know that most folks at assorted IBs, including a lot of classmates from college, could not and would not look you in the eye and give a firm answer to the question above. Bottom line: the vast majority of them, right now today, will stay in the IB biz for exactly as long as they receive their annual bonuses (and, of course, aren't put on the streets by way of outright cutbacks and dismissals).

Sound cynical to you? Well, you're surely entitled to your view, but I should suggest you substitute "spot on" for "cynical".

Good trading and best wishes, mate!

[Toddsterpatriot]

Yeah, lots of a-holes work for those IBs, but were they trading derivatives with commercial bank deposits?

And just exactly WHEN do you suppose that the bailout funds -- of whichever type, makes no difference -- will be repaid, hmm?

Which bailout funds?

[mo]

“uh..we are right back in 2008..”

Uh...it MAY be even worse than 2008...it appears to have been “only” 180 trillion then...

http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq108.pdf

[SAJ]

C'mon, Toddy. Don't waste my time. TARP I and TARP II. Half a dozen Fed initiatives (if so they may be called). Didn't stop there, either. The Fed have indirectly pumped well over $1 trillion (I don't have the precise number; I suspect that nobody outside the Fed does) into **foreign** IBs...Societe General, Royal Bank of Scotland, all 4 Greek majors, name your hog, pick your poison.

Trying to sum the total of the assorted bailouts of the past 3 years would give anyone seeking an honest answer a migraine, because the Fed (regarding the US) and the other CBs, each with its own patch, have produced arguably the LEAST transparent money trail in all history.

This isn't a twice-told tale, Toddy. This is an NTH-time told tale. If you still, after all this time, need a roster of all the bailouts, and from-whom and to-whom, and when-and-how-often (which, btw, is the new game, and Greece is so far the only 'bailoutee' in this game, but there will be more and in short order), well, then get a programme. Or, watch a programme; take any number cited by the so-called financial press and treble it. Then, double it again. The 'multiplier effect' **MAY** apply in terms of production/income generation in an industrial economy; it ALWAYS applies in a completely debt-dominated economy (uh, that is to say that debt, once a certain point is passed, which we have done, is self-multiplying. The only variable is the multiplier, i.e. the speed of the multiplication).

The notional sum, just btw, is well over $40 trillion in direct bailouts (and 'special facilities' and EFSF and that lot), and I'm probably low by half in the actual accounting.

[Toddsterpatriot]

TARP I was paid back, the bank portion that is.

What's TARP II?

Not trying to waste your time, but still haven't heard which IBs funded their derivatives losses with commercial bank deposits.

[SAJ]

Todd, G-d love ya. If you believe that TARP I was paid back in reality, as opposed to "paid back" by accounting mopery and dopery, then I hope that that works out for you.

Not a penny, m'FRiend. Not one penny, except just barely possibly a pro forma dollar or two, here and there, for PR and/or propaganda purposes.

By way of example of the (unfortunately entirely typical) chicanery that occurs on an everyday basis in the rarefied circles of international lending (cough), please consider this. It is entirely true, easily (well, not so easily these days...) demonstrable, and a nearly perfect paradigm of the LACK of repayment of debt from one goobermint or goobermintal institution to another.

Are you aware that, in this wonderful game of international lending/subsidy, that the ONLY (as of 2007) debt (principal, not interest) that was EVER paid back to the US, aside from Finnish war debt from pre-1950, was exactly $190 million -- million with an 'm' -- from Peru in the mid-1980s? If there has been ANY subsequent repayment of principal by ANY nation/nations/int'l banks to the US, I am unfortunately unaware of it. And the same from the US to any of its creditors, most specifically the ChiComs. As ti Peru's evidently unique repayment of capital, I suspect that their finance minister, after said repayment, must have ended up roommate to Jimmy Hoffa in the Meadowlands.

Lend and extend, Toddy. It is and has been the only real national/international banking game for a couple of decades, more's the pity. It goes at least as far back as Walter Wriston's famous (and utterly incorrect) comment that "nations don't go broke", said by him as a justification excuse for continuing Citibank's disastrous sovereign loan programme of the 1970s.

Further, this applies generally to any domestic subsidisation of banks/companies/whomever in, afaik, every 'developed' nation, too. Most recently and infamously, of course, we have the stellar (cough...) example of GM, which will NEVER (write it down in big, black letters, and you PERSONALLY crime me if I'm wrong here...but I'm not) repay any of the taxpayer-funded bailout.

Where this chain-letter world of finance ends up is of course perfectly clear. The only thing that keeps this bizarre little game afloat is that the big players in the status quo WANT, and will expend essentially unlimited effort and capital, TO keep the game afloat. Therefore, the date of Armageddon either will remain effectively unknown or will not be observable generally when -- not if -- it occurs.

Rather like Heisenberg's Uncertainty Principle, come to think of it.

If you want a motto for the int'l game today, it is: you're only really broke when you cannot borrow the interest now due.

Sorry for the gloomy view, but there it is.

[Toddsterpatriot]

Not a penny, m'FRiend. Not one penny, except just barely possibly a pro forma dollar or two, here and there, for PR and/or propaganda purposes.

B of A didn't pay back $50 billion on $45 billion in loans?

Citi didn't pay back $57 billion on $45 billion in loans?

Goldman didn't pay back $11 billion for their $10 billion loan?