Fed's rescue halted a derivatives Chernobyl

Telegraph (UK) ^ | 11:33pm GMT 23/03/2008 | Ambrose Evans-Pritchard

[dennisw]

Do you honestly believe that these hedge funds are just playing paddycake with monopoly money, for their amusement, that when counterparties can't pay, the contracts just disappear and everybody has a laugh and goes to lunch?

Actually they do treat it like funny money, monopoly money
I'm sure they have all kinds of insider jokes about how hard it is to respect electronic notations as real money. It's like a woman going on an inane shopping spree with credit cards. The credit card is her funny money. Hard to treat as real money

Also these Wall Street rats are making tens of millions each year on these rackets which is so intoxicating. This makes them loose track of what's real as far as money

[groanup]

When NC does the swap it doesn't magically get another stream of interest payments. It receives floating and pays fixed. They offset. So your implication that they could take the stream and borrow against it is preposterous.

Now if you think real hard you can probably come up with another idiotic scenario. How about NC takes the bond proceeds and uses it to margin a billion dollars worth of oil futures?

[DeaconBenjamin]

You say:

It's not a loan.

But you start out your example by stating:

Say you loaned out $1,000,000 at an adjustable rate, say 3 month Libor plus 2 points.

Is this a loan?

You proceed to state:

You go to another bank that is willing to pay you 5% fixed for the next 3 years in exchange for your adjustable payment.

Is this a loan? If not, how is this swap structured? Can you walk into a bank and tell them "I'll trade you my income stream lasting 3 years based on 3 month LIBOR plus two percent for a flat 5 percent per month, and the loser pays the difference"?

[groanup]

Just how much of these trillions are in positions that off-set one another.

As much as these doomsayers want for the earth to stop spinning, that won't happen with the traditional derivatives market.

Think of your state government. It could decide to go into the muni market and borrow a billion dollars. But they are worried that interest rates may go up between now and the time it takes to get the muni offering ready. So they call up JP Morgan and buy and interest rate cap. Let's say on a billion dollars the cap costs 100,0000 dollars. If rates go above the cap JP Morgan owes your state money.

Now, in this scenario, the notional amount of the cap (or derivative) is a billion dollars. But if JP Morgan goes out of business in the meantime your state is only out a hundred grand plus any extra interest rate expense caused by the loss of the cap.

And JP Morgan will turn around and hedge the cap, creating another billion in derivatives. (Which means they probably won't go out of business.)

And all these billion dollars are included when the worry warts talk about 400 trillion derivatives.

[Toddsterpatriot]

Is this a loan?

No.

If not, how is this swap structured?

If one party made a fixed rate loan and the other made an adjustable rate loan, they can swap the payment streams. Or, they can swap a payment stream without actually having loans outstanding.

Can you walk into a bank and tell them

No, you can't. If you worked on a trading desk for JP Morgan you could call Goldman Sachs and set up a swap. If you worked for a hedge fund, you could call an investment bank and set up a swap.

You can build a derivative based on almost anything. A derivative derives its value from something else. An option traded on the CBOE derives its value from the performance of the underlying stock or index.

An interest rate swap derives its value from the performance of some interest rate index. Could be based on the 1 year US T-Bill or Libor or Fed Funds. Some derivatives are pretty commoditized. Some might be one-of-a-kind.

Is that any clearer?

[groanup]

#2 With derivatives you have two parties making an elaborate bet based on arcane mathematical formulas as applied to financial instruments such as bonds, CMOs etc

Maybe you could give us an example of this?

[iThinkBig]

Sigh... How sad and true and current financial system indicative of the greatest fleecing of the middle class since the French Revolution.

[iThinkBig]

Because Tim, I am a student of human nature and history. Yes, I am worried for the short-term but I had several months since June studying this, so the fear and anger are gone and now replaced with resolve to come up with solutions and push them to be executed. And if collapse and a global conflict occurs, we will rebuild. History has shown this over and over and those whom are prepared survive. Survival of the fittest applies to every species on earth.

[AndyJackson]

When NC does the swap it doesn't magically get another stream of interest payments. It receives floating and pays fixed. They offset.

Are you such an idiot that only I can understand the implications of what you just wrote? They only offset if one of them has not defaulted, and you act as though the streams of revenue from a swap do not matter. If they did not then why would anyone do them?

Of course, one trades swaps because the revenue stream DOES matter, and the default on a swap surely matters if someone has a portfolio of offsetting swaps without a lot of actual capital in the game. A default on one side exposes you to the entire downside of the offsetting swap, and your bankruptcy and default could sink the guy on the other end who was trying to hedge the risk that you were supposedly offsetting.

One of these days when you talk down to all the rest of us you will actually show us that you understand the technobabble that you spew forth. So far you haven't.

[AndyJackson]

And all these billion dollars are included when the worry warts talk about 400 trillion derivatives.

What you don't point out when you talk down to everyone is that it is not that $400T at risk. It is that small mistakes or market inefficiencies or unanticipated defaults could put 1% of that at risk and 1% is $4T which would go a long way towards tanking our economy and did, on a smaller scale, tank LTCM, requiring another "free to the public" Federal Reserve sponsored emergency rescue effort.

[grey_whiskers]

And, of course... I understand Mongolian Fluster Clucks...

Careful, now. I own the patent, copyright, trademark, and future drilling rights on that phrase. ;-)

When life hands you a lemon, sell lemonade.

When life hands you a Mongolian Cluster, sell condoms.

Cheers!

[groanup]

Are you such an idiot that only I can understand the implications of what you just wrote?

No. You're such an imbecile that you don't understand what I wrote.

[Travis McGee]

Bear and every other WS denizen is flying on collateralized borrowed money. There's nothing wrong with that until the counter parties freeze up. Why do they freeze up? Because of irrational fear.

You are such a hoot. Everything is just fine in the world if finance, it's just all that "irrational fear" that's causing the crunchiness. Why, if we'd all just think happy thoughts, it would all go away!

And I say Bernanke and Paulson are sweating bullets, because I've been watching them speaking in public, and they are twitching, stuttering, shaking their heads involuntarily and giving every other known indication that they are indeed sweating bullets.

[dennisw]

#2 With derivatives you have two parties making an elaborate bet based on arcane mathematical formulas as applied to financial instruments such as bonds, CMOs etc

Maybe you could give us an example of this?

You seem to be in the business
Why don't you explain it
 

 

[groanup]

Not what I said. If you are in a business that uses a lot of leverage and suddenly the counterparties get scared you're scr^^ed. But you and your ilk seem to really enjoy this. I'm sad for you.

Don't you wish you were able to live in ancient Rome and watch the gladiators die?

[groanup]

And I say Bernanke and Paulson are sweating bullets, because I've been watching them speaking in public, and they are twitching, stuttering, shaking their heads involuntarily

Now you're a body language expert. Maybe you should go on O'Reilly.

[groanup]

You seem to be in the business Why don't you explain it

I'm not in the business. I used to be and it has changed a hell of a lot since then.

I'm not in the habit of explaining posts to those who post them.

I'll assume that your answer means that you don't have any idea what a derivative is but that you are trying to explain it to someone else anyway.

[dennisw]

LOL
I knew you would not elaborate or explain it better.

[groanup]

In post #120 on this thread you wrote:

#2 With derivatives you have two parties making an elaborate bet based on arcane mathematical formulas as applied to financial instruments such as bonds, CMOs etc

I asked you to give us all an example.

Ever since I asked you that question you have done nothing but plead with ME to explain YOUR post.

Now you are amused that I have refused to explain YOUR post.

Since your post WAS an explanation and since I asked you to give us all an example of what you mean, I can only infer that you have no clue what you are posting yet you post it as something educational.

BTW, I have explained derivatives at least once on this thread in post #124 in language that perhaps even you can grasp. If not may I suggest reading skills rehabilitation?

[dennisw]

Blah blah blah but the important part is 124 and I will read it. And thanks. (I mean it)