Posted on 10/22/2011 9:43:11 AM PDT by rabscuttle385
My only business with any major bank is to carry their credit card and I pay my bill in full every month so they hate me. I hate them back, it works for me.
Unfortunately; there is no simplistic or directly quantifiable answer to the liability question because it doesn't exactly work the way your question seems to suggest. I'll try to add some color:
I wasn't aware of the transfer of the $44 trillion in derivative notional value from BOA to Morgan (Morgan Stanley or JPMorgan?). If this is the case; it is not out of the ordinary. Banks and Hedge Funds transfer or 'novate' positions away to other banks all the time after agreeing to a specific settlement based on the present value of the swap being novated.
The counterparties on the other side of those transactions who were facing BOA, but are now facing Morgan will actually be somewhat relieved since their counterparty risk has actually decreased now that they are no longer facing BOA. I would argue that Morgan (either one) is more stable than BOA
Assuming these derivatives are mainly Interest Rate Swaps (80% of the derivatives population), the counterparties can't simply 'demand' the notional value. The swap contracts usually have a tenor of at least 5 years and some go out to 30 years or even more. They are binding contracts. If a counterparty wants to 'early terminate' or 'unwind' an existing swap with another bank (regular occurrence), both sides will have to agree on the Net Present Value on the trade and settle the amount with each other. Naturally; one side will receive and the other will pay depending on what side of the swap they have at the time and the factors that go into the NPV calculation given the present market conditions. The NPV on a swap will likely be nowhere near the notional amount. It could be a simple 5-figure or 6-figure NPV on a swap with a $100millon notional. Obviously there are a lot of other moving parts involved, but this is a pretty accurate representation. The agreed-upon fixed interest rate on one side of the swap will be a main determinant of the NPV. Higher fixed rate (swaps dealt over 2 years ago for example) will likely translate into a higher NPV as will a longer tenor.
On top of that, you have the regular compression cycles and bilateral netting I mentioned in my last post in addition to the fact that hedging with interest rate futures and bonds is constant in the world of derivatives trading as is taking opposite sides of the same swap with two different counterparties with slight pricing variances in an effort to lock in a little bit of a profit while hedging your risk.
Also; just to give you an idea of types of payments being exchanged on the agreed-upon payment dates for a basic Interest Rate Swap with a $100million notional:
You and I agree to a Swap. We will exchange fixed for floating payments on the USD 6M LIBOR rate on a semiannual basis on a notional of $100million for 5 years. I will pay you a fixed amount every 6 months. The current 6M LIBOR rate is about .6%
The fixed side payments will always be 100mio x [180(days)/360Days] x.006 = $300,000
Let's say the 6M LIBOR is.55% on our next settlement date. I will pay you $300K and I will receive 100mio x [180(days)/360Days] x.0055 = $275,000 from you since you agreed to pay the floating rate, or whatever LIBOR is on the day we settle each payment (actually 2 days prior but not relevant right now). We will net these payments and I owe you $25,000. This is a far cry from $100million. This exchange will go on every 6 months for the next 5 years. The change in the 6M LIBOR rate will be what determines how the payment amounts fluctuate. As interest rates rise, it is likely the floating-side payer will have the greater liability. This shouldn't matter though, because even a rookie derivatives trader would have hedged this exposure with futures, bonds, or another swap.
Sorry to be so wordy but I just wanted to try to paint a clear picture. The concerns about derivatives are legitimate to a point, but we need to have a sense of perspective. $55 trillion in notional amount is not actually a true $55 trillion risk even in the worst case scenario. How much of that $55trillion is offsetting? Perhaps the 1% figure you cited is a possible worst case scenario number, but it can't really be quantified that simply.
Thank you again for your writing to me on this subject. In your example of the $100 million notional value resulting in payment of $275,000. Now if that $100 million is $100 Billion the payment is arithmetic....that is to say $275,000,000....Yes,NO? If that $275,000,000 is payment for $100 billion then if the $100,000,000 was actually $10 trillion, then the payout would be raised by a factor of 100 or $27,500,000,000.....yes,NO??? Now if it was raised in this case to $44 trillion that number is approximately 4 times the $10 trillion dollar notional value or approximately $110,000,000,000....Yes/No???? I think I did the relational arithmatic correctly....and if that is how it works then the counterpart, in a worse case scenario would have to come up with about $110 billion dollars.....That would be a lot of money for JPMorgan or Bank of America to produce. That is the point I am trying to make should the system collapse. Am I misrepresenting the outfall of a worsecase situation or am I still off course?
Thank you again for your writing to me on this subject. In your example of the $100 million notional value resulting in payment of $275,000. Now if that $100 million is $100 Billion the payment is arithmetic....that is to say $275,000,000....Yes,NO? If that $275,000,000 is payment for $100 billion then if the $100,000,000 was actually $10 trillion, then the payout would be raised by a factor of 100 or $27,500,000,000.....yes,NO??? Now if it was raised in this case to $44 trillion that number is approximately 4 times the $10 trillion dollar notional value or approximately $110,000,000,000....Yes/No???? I think I did the relational arithmatic correctly....and if that is how it works then the counterpart, in a worse case scenario would have to come up with about $110 billion dollars.....That would be a lot of money for JPMorgan or Bank of America to produce. That is the point I am trying to make should the system collapse. Am I misrepresenting the outfall of a worsecase situation or am I still off course?
Allow me to jump in. Actually, $25,000
Now if it was raised in this case to $44 trillion that number is approximately 4 times the $10 trillion dollar notional value or approximately $110,000,000,000....Yes/No????
You did the math correctly, after your initial error. It would actually be $10 billion. Now you have to understand that the banks involved have positions on both sides of that trade. In some they'd receive the $25,000 from the original example, in some they'd pay the $25,000. The net payments are much, much (much, much, much, much etc)less than $10,000,000,000 per month.
Am I misrepresenting the outfall of a worsecase situation or am I still off course?
Still a bit off course.
Greetings Toddsterpatriot:
Guess I’m just not very smart. So please, explain why this situation is a LOL matter.
Insurance for high risk investments was a cornerstone of the AIG business model. Now these high risk derivative products are insured by FDIC?
You assert the FDIC charged it’s member banks so much in insurance deposit fees, the FDIC can absorb a 20x the US GDP bank failure? If that is the case, kindly provide a source indicating how much in cash reserves the FDIC does have on hand. After the FDIC covering five years of bank failures.
Recently we purchased a $14K used truck which a credit union held title. The credit union, located in a major financial center, would not accept anything but hard cash for the title.
The major bank brand which our money was deposited did not have enough cash on hand at the main downtown headquarters to cover a $14K cash withdrawal. On a Monday afternoon. After the manager failed to convince the credit union manager to accept anything but cash; the manager directed me to various supermarkets and smaller branches where we could pick up cash, $2-4K at a time.
Again, a major bank brand, in a major financial sector city, on a Monday afternoon. A genuine laughing matter?
Cheers,
OLA
I didn't see anything in your link about "high risk".
You assert the FDIC charged it’s member banks so much in insurance deposit fees, the FDIC can absorb a 20x the US GDP bank failure?
20x US GDP is about $280 trillion. What bank failure would cost $280 trillion? Household net worth is much, much less than that. It's a ridiculous claim.
Again, a major bank brand, in a major financial sector city, on a Monday afternoon. A genuine laughing matter?
Yes, the confusion of your source is a laughing matter.
Wish I could say the same. I am headed in that direction though. A major part of the problem is the federal government that allows banks to charge 30% plus interest rates. Talk about a cash cow slave society...
I have always thought that even 17% is usurious but it is a choice to borrow money from a bank.
I was addressing BofA’s acceptance of Consulate initiated I.D.s for illegals to set up accounts. That really P.O.’d me, but I’ll bet other banks are doing it too. You can’t win.
This has been festering in my mind for years...
I know that’s what you meant. It bugs me too. If I had a crystal ball that would tell me the exact date that the SHTF I would max out all my credit cards two weeks in advance and head for tropical retirement. lol
Very interesting reply.
Guess I must be such an idiot, it’s a wonder how I might climb into my shoes each day.
Thinking high risk; given derivatives, by nature and law, lack transparency, are complex, and loaded with risk. Hence the greater risk, the great opportunity for return upon investment. Credit markets routinely under price the risk.
So by my thinking, of course as a total idiot; derivatives mask third party credit risk, and unjustly enrich derivative counterparties selling such trash.
Crony capitalist financial reforms only reinforced special protection for derivative bundlers. Less disclosure. Greater access to sticking taxpayers with the bill when they make a bad risk assessment call. Of course, all from an idiot’s standpoint.
Guess math comes very easy because I’m an idiot. 312 million US residents. $77 Trillion worthless junk dumped on the marketplace if BOA fails. Quarter million dollar loss amortized per US resident. FDIC insures up to $250,000 per account. Overall median income for all 155 million persons over the age of 15 who worked with earnings in 2005 (last available statistics) was $28,567.
With all the honest snake oil salesmen out of work these days, seems they moved to derivative markets.
Wanna buy some derivatives? For $100 million in physical gold today, I’ll trade you $1 billion in financial instruments, payable in 2041.
Many plain vanilla, interest rate swaps (the majority of all derivatives), are low risk and very simple.
So by my thinking, of course as a total idiot; derivatives mask third party credit risk
Being OTC, as opposed to exchange traded, they make it difficult to measure firm risk.
Guess math comes very easy because I’m an idiot. 312 million US residents. $77 Trillion worthless junk
Nothing was worth $77 trillion.
Exactly my point.
Not even close
Akin with a bucket full of steam; zero tangible equals $77 trillion taxpayer liability.
She’s a good derivative, only driven on Sundays. To church, by a old widow...
I had a $2 billion notional bet on the Bears game Sunday.
I won!
Do you think I can retire on my winnings?
Absolutely. Bundle along with Obama's latest mortgage interest swaps. Market as green energy derivative. Trade OTC. What could possibly go wrong?
Absolutely.
The bet was only $10.
Just a bit less than the notional value.
Maybe you're wrong?
Thank you again for making my point. Market intangible returns upon notional investments properly, and who knows, you might become the next US Secretary of State.
no·tion·al [noh-shuh-nl] adjective
1. pertaining to or expressing a notion or idea.
2. of the nature of a notion or idea: a notional response to the question.
3. abstract, theoretical, or speculative, as reflective thought.
4. not real or actual; ideal or imaginary: to create a notional world for oneself.
5. given to or full of foolish or fanciful ideas or moods.
Ever consider cattle futures?
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