Japan dominates Asian real estate funds' allocations
With the sovereign debt crisis at its peak in Europe and the USA and
the volatility of capital markets persisting, Asian real estate
markets have slightly been forgotten lately. Although the first signs of
uncertainty have started to emerge on the Asian continent as well,
with listed real estate companies trading at discounts, real estate
fundamentals remain largely sound. From the macro-economic perspective,
Asian giants, China and India, continue to enjoy GDP growth rates of
9.1% and 7.7% respectively in Q3 2011 while other significant markets
such as Singapore and Hong Kong also witnessed GDP growth of 6.1% and
4.3% respectively in Q3 2011. Although economic growth has slightly
slowed down in China and India compared to previous years, it remains
clear that Asia’s economies have not been substantially affected by on
the ongoing economic difficulties in Europe and the USA. Furthermore,
the domestic demand in these markets has continuously grown and is
significantly higher than it was during the Asian crisis in the 90’s
contributing to the relative stability of the present growth.
Regardless of its strong economic indicators, China and India were
not the main target markets within the industry in 2011. Asian real
estate private equity funds have a new favorite, Japan. With USD 7.4
billion (€5.6bn) and a market share of 37% for the first 9 months in
2011, Japan tops the “shopping list” of fund managers for the first
time in years. Compared to 2010 (Target equity: USD 2.7bn), the target
equity for Japan has almost tripled with its market share increasing by
13 percentage points y-o-y. The question remains: what are fund
managers seeking in a market that has been recording stagnating growth
and real estate returns for years and in addition; a destination
regularly plagued by natural catastrophes?
Many indicators are currently in favor of the Japanese real estate
market. Firstly, after the USA, Japan is still the second largest
market in the world in terms of commercial real estate and the largest
and most liquid market in Asia. Following the events at Fukushima, the
already significant price correction continued but has bottomed out in
the meantime
Japan dominates Asian real estate funds' allocations
However, initial yields are still far from peak levels of 2007-2008.
Rental levels have also significantly corrected and fell in major
cities such as Tokyo by an average of 44% compared to the peak levels.
Nevertheless, this price correction has proved somewhat beneficial in
relation to vacancy rates, as tenants who could no longer afford CBD
rents are returning to the business districts of Tokyo. Consequently,
the vacancy rate for office space in Tokyo decreased from 7.0% in Q4
2009 to 4.6% in Q3 2011. It is therefore not surprising that 28% of the
equity (USD 2.1bn or €1.5bn) targeted by private equity real estate
funds in 2011, are earmarked for office investments. In addition, the
current financing constraints allow for quality assets that are highly
indebted to be acquired at attractive prices. The lack of competition
on the buyers’ side was also created by the fact that most Japanese
REITs were on the sellers’ side in 2011 as they had to struggle with
financing issues and the equity market due to high discounts of their
shares.
Similar to their European and USA peers, Japanese banks are increasingly
feeling the pressure of liquidity constraints and new financing or
re-financing of real estate transactions are only possible with higher
levels of equity than was required before the financial crisis. This
has created interesting opportunities from the perspective of fund
managers who are increasingly launching debt funds which aim to bridge
these financing gaps. For the first 9 months of 2011, USD 2.7bn of
target equity was being raised for debt investments in Japan. This
reflects a 37% market share and exceeds by far all other sectors. Japan
is a vivid example of how real estate private equity funds immediately
pick up on certain market inefficiencies and provide fund offerings
which aim to capitalize on such opportunities - a model for
anti-cyclical investment.
Myth: Prices will keep rising forever.
Too
many homebuyers, lured by sleek advertising and media-generated hoopla,
buy properties that they can rationally ill-afford, given their
financial background and potential. However, their eyes are usually
centered in to a future where they expect
to sell their newly-acquired properties at huge profits, while allowing
rentals to pay for their EMIs. However, when prices drop, buyers get
financially battered and in worse cases even completely wiped out.
Human
beings have a congenitally designed to not learn from the past. During a
bubble, people don't believe that prices will fall, even though it has
been proven wrong so many times before.
Another indicator of a bubble is the unbridled bidding for worthless land.
At
the peak, an empty three-square-meter parcel (about 32 square feet) in a
corner of the Ginza shopping district in Tokyo sold for $600,000, even
though it was too small to build on.
Prices
were highest here in 1989, with some fetching over $1.5 million per
square meter ($139,000 per square foot), and only slightly less in other
areas of Tokyo. Plots only slightly larger gave birth to bizarre
structures known as pencil buildings: tall, thin structures that often
had just one small room per floor. Such structures later become
reminders of a different era, like the aftermath of a boisterous party.
Another
indicator of a bubble is the acute scarcity of affordable housing. In
Japan too, during the housing bubble, the focus was only on building
commercial property and luxury apartments. In India too, currently,
especially within the city limits of Mumbai, a standard 2-bed room apartments cost no less than Rs 1 crore.
By
2004, a prime “A” property in Tokyo's financial districts were less
than 1/100th of their peak, and Tokyo’'s residential homes were 1/10th
of their peak, and even at this time they were considered to be listed
as the most expensive real estate in the world. At the end of the
Japanese housing bubble, some $20 trillion (1999 dollars) was wiped out
with the combined collapse of the real estate market and the Tokyo stock market.
A housing bubble is in place
when property rates start rising at double-digit rates, and people
start taking loans to invest in property, with the idea that the loan
can be paid back easily and the property sold at a profit.
Once the bubble is burst, the property is worth
a fraction of its purchase price and people get left behind with a
negative asset, where the EMI is higher than what the asset can earn in a
month. In such a situation, the balance outstanding loan cannot be paid
off even if the asset is sold.
Japan is an excellent example of
a housing bubble that went horribly wrong, and it has a glaring
similarity to what is happening in India. Read on and identify the
similarities:
The Japanese real estate market boomed from 1985 to its peak sometime in early 1991.
During this time, Japan’s property prices rose much faster and more steeply as speculators used paper profits from a booming stock market to invest in property, supportability leveraging the prices of both higher and higher.
The
biggest speculators in Japan's frenzy were deep-pocketed corporations,
and they pumped up the commercial property market at the same time that
home prices were inflating.
Japan suffered one of the biggest
property market collapses in modern history. At the market’s peak in
1991, all the land in Japan, a country the size of California, was worth
about $18 trillion, or almost four times the value of all property in
the United States at the time. A commonly-quoted claim was that the land
beneath the Imperial Palace in Tokyo was worth more than the entire
state of California.
Then came the crashes in both stocks and property, after the Japanese central bank moved
too aggressively to raise interest rates. Both markets spiraled
downward as investors sold stocks to cover losses in the land market,
and vice versa, plunging prices into a 14-year trough. In 2005, the land
in Japan was worth less than half its 1991 peak, while property in the
United States has more than tripled in value, to about $17 trillion.
Homeowners
were among the biggest victims of the Japanese real estate bubble. In
Japan’s six largest cities, residential prices dropped 64 percent from
1991 to 2004. By most estimates, millions of homebuyers took substantial
losses on the largest purchase of their lives.
By 2004, a prime
“A” property in Tokyo's financial districts were less than 1/100th of
their peak, and Tokyo’'s residential homes were 1/10th of their peak,
and even at this time they were considered to be listed as the most
expensive real estate in the world. At the end of the Japanese housing
bubble, some $20 trillion (1999 dollars) was wiped out with the combined
collapse of the real estate market and the Tokyo stock market.
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?
Add caption
...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...
Insofar as Morgan Stanley is obviously not too big too fail (the famous "go fuck yourself" line from their CEO to Hank Paulson when as the high and mighty Goldman alum was deciding who to place Morgan Stanley with after he had placed Bear Stearns with JPMorgan. No offense of course!) then i can't see the problem with leverage. Because i don't want to see a repeat of 2008 however i to do have a problem with exposure--not because the failure of Morgan Stanley is going to bring down "the entire global financial system!" as the failure of Lehman brothers allegedly did (which is a total fallacy.) In that sense AIG is truly a case of too big to fail. We know from Hank Paulson's book the President...of the United States that is...literally blurted out "AN INSURANCE COMPANY?!" What you don't get is "the dollar amount required" pre-amble in this bookend to the "War on Terror." Obviously AIG still exists and still writes policies--it does so at the behest of American people and their interests there of. For those who think "blowing up banks" is a "cool and groovy think to do" i say this to you: in the end you may wish for that thing to fail because if it doesn't "they will remember you."
If the guvMINT had done it's job and not deregulated the banking, insurance, finance industries we would not be here today. WHO THE FUCK POLICES THEMSELVES? The constitution was written to prevent this shit but Americans didn't pay attention while they dismantled it. They ain't gonna fix anything--they are breaking it intentionally because they are mere puppets--what rock have you been living under?
I'm with Motley Fool. It is past time to regulate. Time to light the fuse on these shitheads. Find their biggest unhedged exposures and twist the knife, triggering payouts they can't afford so that they all implode. Make the ones with insured deposits firewall those infrastructure and assets to protect the government and the depositors. Make sure the branches are open the next morning. Also ensure the ordinary non-too-big-to-bail banks are given the liquidity to keep main stream afloat as lower Manhattan slides into the Laurentian Abyss.
" only Goldman hedged by buying protection ON AIG." Goldman held a policy from the Bank of Hank. Hank, in turn, covered the bet through the daylight robbery of the American people.
America's industrial might once financed the parasitical Wall Street patty cake "industry".
Do you seriously believe that Wall Street is going to revive America ? Bonuses all around translated is "get out of Dodge"
Deficits and money printing are future claims that require careful investments in future earning assets, not squandering on pump and dump, churn and burn, jobs for the boys schemes.
Lol some agency needs to set exposure limits AND leverage limits. Right
Lol. The Fed is stupid
No, they just need to stop asking taxpayers for a backstop. There is nothing wrong with grownups getting in over their heads - as long as they are the only ones who would pay...
the people who did it definitely wont ever pay. But the whole world is going to feel the result, its only a matter of time. They will asset/value strip for all they are worth, as long as they can...
They'll pay if we make them pay. Like the French did with the guillotine. " When people lose everything and have nothing left to lose--THEY LOSE IT"...Gerald Celente These people mus be identified and hunted down and made examples--like King Luis and his BFF Marie in addition to thousand of "aristocrats" like Buffet, Bernanke, Paulson.
I'm a generous person. I'd settle for all the sonsabitches to be flat broke living in a cardboard box under the nearest overpass. Just so long as we get to pass by velvet rope reception lines and watch them suffer.
Financial Engineering and Financial innovation, madness!
Once re-insurance became a fad, there was only one way to go, Downhill. Because even the thinnest tail could only be sliced in so many ways. And the farther you reached into it, the more unstable the re-re-re-re-re-re insurance pyramid structure became.
And now, with 6 sigma firmly in the Rear view mirror, all of this risk pyramid money making nonssense will finally crash. I see it like a rubber band, snapping back to the new new normal.
Agreed. Everyone is coming over to ZeroHedge. I remember I use to visit a site called daytradingradio[.]com many months ago and used to quote ZH in their membership chat. Basically they were references to TD posts regarding how bad financially the globe was and to be prepared for a downturn. But these guys on there were full tard bullish and basically shrugged me off. The other day I just so happened to stop by to see how they were doing and I shit you not the main guy Dave was quoting ZH... Almost like an addiction he would go to ZH every few minutes to see what TD was pumping out. I just laughed. Just in case those shills are reading this... Glad you guys finally made it here.... - rander.
I have absolutely no doubt that a website with this amount of traffic and nature of the participants is read by politicians and their staff, as well as financial players.
Voting just make one "feel" like they are part of the process. TPTB love that. Once folks get wise and realize they are NOTHING BUT PAWNS, and their supposed "team" of blue or red is primarily responsible to deliver their respective constituencies to whover pays them off with bribes (campaign contributions). Once folks stop voting, the jig will be up. And then TPTB will be very concerned, to say the least.
Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.
...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 who 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.
Super, Duper, B-I-N-G-0!!! It is so relieving to hear someone else espouse what really should be common damn sense, yet happens to be one of the uncommon commodities to be found on the Isle of Manhattan.
Any problems discussed above have already been taken care of under the National Security umbrella. What this means, if institutions like J.P. Morgan are deemed to be integral to U.S. National Security - they could be "legally" excused from reporting their true financial condition.
Intelligence Czar Can Waive SEC Rules,
"President George W. Bush has bestowed on his [then] intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye."
Great Job Reggie. I always figured bi lateral netting was a croc of shit based on the AIG experience. I thank you for the education you and zh have afforded me...
Reggie - it is high time for you to learn a difference between trillion and billion. If you still don't get it - then please return to the Elementary school to take some math classes. This is third time I see this factual error presented by you.
Please kindly read your own presentation, looking for the word 'billion'. See - it does not make sense. The chart that you borrowed has unit of million.
I like your presentations, but you have no shame to repeat the same errors. These are facts - you confuse billions with trillions, and you do repeatedly. I feel sorry for the folks who pay for your advice.
Do you still have problem understanding your errros - please contact me offline, and I can explain it to you.
80,000,000 millions is 80 trillions, not 80 billions.
thanks, good point. the main graph about jpm gross derivatives exposure vs. world gnp is really far more disturbing than reggie's description of it. but like his difficulty with imperfect verbs (have went) it doesn't really undercut his conclusions, though it does make him less acceptable in the mainstream world.
Oh yeah, and while we're at it, this Morgan Stanley thing has been a concern of mine for well over a year now. The interest rate storm is coming, that is unless Europe can maintain historically low rates as several countries default. Then again, they never default, right...
Those who don't subscribe should reference my warnings of the concentration and reliance on FICC revenues (foreign exchange, currencies, and fixed income trading). Morgan Stanley's exposure to this as well as what I have illustrated in full detail via the the Pan-European Sovereign Debt Crisis series, has increased materially. As excerpted from "The Next Step in the Bank Implosion Cycle???":
The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.
Click to expand!
So, How are Banks Entangled in the Mother of All Carry Trades?
Trading revenues for U.S Commercial banks have witnessed robust growth since 4Q08 on back of higher (although of late declining) bid-ask spreads and fewer write-downs on investment portfolios. According to the Office of the Comptroller of the Currency, commercial banks' reported trading revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8 quarters.
High dependency on Forex and interest rate contracts
Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.
As a result of a surge in interest rate and Forex contracts, dependency on revenues from these products has increased substantially and has in turn been a source of considerable volatility to total revenues. As of 2Q-09 combined trading revenues (cash and off balance sheet exposure) from Interest rate and Forex for JP Morgan stood at $2.4 trillion, or 9.5% of the total revenues while the same for GS and BAC (subscribers, see BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb) stood at $(196) million and $433 million, respectively. As can be seen, Goldman's trading teams are not nearly as infallible as urban myth makes them out to be.
Although JP Morgan's exposure to interest rate contracts has declined to $64.5 trillion as of 2Q09 from $75.2 trillion as of 3Q07, trading revenues from Interest rate contracts (cash and off balance sheet position) have witnessed a significant volatility spike and have increased marginally to $1,512 in 2Q09 compared with $1,496 in 3Q07. Although JPM's Forex exposure has decreased from its peak of $8.2 trillion in 3Q08, at $3.2 trillion in 2Q09 the exposure is still is higher than 3Q07 levels. Even for Bank of America and Citi , the revenues from Interest rate and forex products have been volatile despite a moderate reduction in overall exposure. With top 5 banks having about 97% market share of the total banking industry notional amounts as of June 30, 2009, the revenues from trading activities for these banks are practically guaranteed to be highly volatile in the event of significant market disruption - a disruption aptly described by the esteemed Professor Roubini as a rush to the exit in the "Mother of All Carry Trades" as the largest macro experiment in the history of this country starts to unwind, or even if the participants in this carry trade think it is about to start to unwind.
The table below shows the trend in trading revenues from Interest rate and Forex positions for top banks in U.S.
Click to enlarge...
Banks exposure to interest rate and foreign exchange contracts
With volatility in currency markets exploding to astounding levels (with average EUR-USD volatility of 16.5% over the past year (September 2008-09) compared to 8.9% over the previous year), commercial and investment banks trading revenues are expected to remain highly unpredictable. This, coupled with huge Forex and Interest rate derivative exposure for major commercial banks, could trigger a wave of losses in the event of significant market disruptions - or a race to the exit door of this speculative carry trade. Additionally most of these Forex and Interest rate contracts are over-the-contract (OTC) contracts with 96.2% of total derivative contracts being traded as OTC. This means no central clearing, no standardization in contracts, the potential for extreme opacity in pricing, diversity in valuation as well as a dearth of liquidity when it is most needed - at the time when everyone is looking to exit. Goldman Sachs has the largest OTC traded contracts with 98.5% of its derivative contracts traded over the counter. With the 5 largest banks representing 97% of the total banking industry notional amount of derivatives and most of these contracts being traded off exchange, the effectiveness of derivatives as a hedging instrument raises serious questions since most of these banks are counterparty to one another in one very small, very tight circle (see the free article, "As the markets climb on top of one big, incestuous pool of concentrated risk... ").
The table below compares interest rate contracts and foreign exchange contracts for JPM, GS, Citi, BAC and WFC.
JP Morgan has the largest exposure in terms of notional value with $64,604 trillion of notional value of interest rate contracts and $6,977 trillion of notional value of foreign exchange contracts. In terms of actual risk exposure measured by gross derivative exposure before netting of counterparties, JP Morgan with $1,798 bn of gross derivative receivable, or 21.7x of tangible equity, has the largest gross derivative risk exposure followed by Bank of America ($1,760 bn, or 18.1x). Bank of America with $1,393 bn of gross derivatives relating to interest rate has the highest exposure towards interest rate sensitivity while JP Morgan with $154 bn of Foreign exchange contracts has the highest exposure from currency volatility. We have explored this in forensic detail for subscribers, and have offered a free preview for visitors to the blog: (JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb), which is free to download, and JPM Report (Subscription-only) Final - Professional, or JPM Forensic Report (Subscription-only) Final- Retail as well as a free blog article on BAC off balance sheet exposure If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - BAC).
" you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks"
but hadn't tyler already intimated that point? reggie is trolling & needs to keep his reasearch papers "above the line" where we can ignore him and not have him interfere with luddites and people w/ slower download situ's who want to read the blogs w/out having their systems jam due to r.m.'s head being terminally impacted
I thought we were talking about trillions of dollars of derivatives, not billions. There are plenty of multi-billion dollar private equity groups. Reggie's original graph contains a glaring typo, as does the line you quote.
Gee Reggie, nice of you to import the blog into ZH comments. A link would have worked fine, since we all know that you have a blog with a subscriber level. Could you try to tone down the me me meism? It makes reading the data (which is great) like suffering through a car dealership ad.
Why are you telling him how to act? Let his lady friends do that. Unless of course you are his lady friend, then my apologies. Would love to have you and Reggie over some time.
Sometimes lazy people don't click on links and you should only be ecstatic that a guy like Reggie shares his knowledge and research with you. The man clearly loves what he does and gets to the heart of the most important issues. We should know that he has been spot on for quites some time now, so I and me is required in relaying that message.
I like to think of the past 4 years as a quasi default. Issuing debt that is unpayable is the last act of a State, and should be seen as the ultimate default.
reggie i'm starting to think you are a CIA plant. because you are a little TOO good.
and by the way, i love your pronunciation of the word malaise as 'malaysia'.
seirously i'm not making fun of you, i pronounce words differently on purpose all the time because i like too. i think the idiots out there are not the people who dont know the 'correct' pronunciation, but the fools who think they are 'correcting' mine. anyway, malaysia sounds good, but to me, it's contradictory in nature as i have always associate malaysia with a pleasant and good feeling as an island nation with spicy food, and that doesn't jive with 'malaise'. which makes it pretty neat in a way---i like juxtaposition of content/tone/meaning. always makes words more interesting. even if you didnt' mean to do it, still, pretty cool.
I have often wondered, if TBTF is a concept applied to derivatives, - why have all the regulatory agencies, Congress and President Obama ingnored this timebomb. If anything screams of national security if this goes off, one would want to fix this first.
What am I missing here? Can it be as simple as perpetual greed by the five largest banks or is it the inability by politicians to grasp the imperatives of taking action?
signing this petition puts you on the top of the FEMA camp list - no one in their right mind should sign anything having to do with the WH - unless you'd like a visit from the FBI. CIA, etc.
While we are here, I hope everyone visits their coin shop today to buy some silver, gold, or platinum. In the game of musical chairs, you never know when the music is going to stop!
Sprott Money Temporarily Runs Out of Physical Silver:
We also have a new dog in the fight. Gentleman Gerald Celente has joined our war, and is buying silver. Interestingly, he is using the same logic that I did one and a half years ago when I thought that the "governments" would try and confinscate gold but not silver.
At first he kept half of his wealth in gold, and the other half in fiat split between dollars and Euros. Then he sold the Euros for Loonies. Then he sold the Loonies for Swiss Francs. Then he sold his Swiss Francs. He may have traded the capital from the Francs for the silver, which would mean he is 50% gold, 25% dollars, and 25% silver. If he is wary about gold, he may have traded some of that in too. But this does appear to be his first move into silver.
Max Keiser & Stacy Herbert discuss Babyface Bernanke, Eurotarp and 'rogue traders.' In the 2nd half of the show, Max talks to Bill Still, director of The Money Masters & The Secret of Oz, about Fort Knox, state banks and monetary reform.
For all purposes, the 4/25 are a cartel. Individual banker can even in all honesty believe in cut-throat-competition, and perhaps it was all an accident.
For all purposes, the derivateves BIND the 4/25 with CHAINS of prices and trades which is what so many experience as PLANNING.
There are laws against cartels, and they don't even care if there is an intent - "do you agree on what you trade" -> "yes, our DERIVATIVES dictate our behaviour - or we go bust"
I will never tire to write that most derivatives, like CDS, are a form of INSURANCE of the IMMORAL kind - we have found this out in the world of "normal" insurance that it's UNHEALTHY for an insurer to allow people to insure their neighbours' houses, the street and the insurer eventually go up in flames.
Break the cartel, save the sorry bastards from themselves. Separate commercial banking from investment banking. Set employee headcount, balance sheet, services and territorial limitations on all banks.
;-) recently it dawned to me that buying them (their market cap) is in the ballpark of 100x to 1000x less than their exposures.
when the European govs realize this they might buy and nationalize their TBTF banks, which is the same as taking a live granade off the hand of a child by buying it with a lollipop. A bargain.
Not to say that derivitaves haven't gone completely off the fucking rails lately but SOME of them have a purpose.
It's probably pretty nice as a farmer to have a selling price locked in via futures when you put seed into the ground as opposed to depending on the manic-depression we've seen in the markets lately. Or as an airline to know you'll be able to operate at a certain price by locking in fuel via futures. Some predictability and price stability is to be desired (try telling that to the Chairsatan...)
Still, can't argue that the process has gotten insane when we're looking at double digit multiples of GDP tied up in them by the four crime families, err, *cough*, banks.
Not everything on the fucking planet needs to be "financialized".
They enable financing of lower credit rated counterparties.
and not of gambling?
They are most definitely not gambling. They allow you to take a position on any market movement.
just declare all derivatives null and void, bing, problem solved
Except for the fact that credit markets would dry up. Capital seeks to maximise returns while managing risks. If there is no way to manage risk, capital is witheld. The problem with derivitaves lies with systemic risk, which is a function of opacity in OTC markets.
For example: Not legal in most jurisdictions to buy fire insurance on property you do not own (or have a positive interest in).
Because, if you burnt it down to collect the insurance, you would never be charged with arson or insurance fraud?
This is not true of CDS, and it is not a healthy situation.
Once upon a time, the ratings companies told you what they thought the probability of default was for a given issuer (sovereign or corporate). THAT turned out to be unhealthy, because of the conflict of interest. Now with CDS markets, the MARKET tells you what they think is the probability of default.
If you want to get rid of CDS, then I have some Moodys & S&P AAA rated Collateralised Debt Obligations to sell you. Interested?
I agree with your point about what CDS are and how they work, and your point about lack of transparency. But the point of this article and the dissenters have is separate from this.
There is an organic purpose behind CDS. But the lack of transparency (among other things) has led to systematic exposures that create problems of scale that dwarf their benefit and involve people adversely that have no skin in the game. And there is a possibility of cascading failures again.
Yes, in an ideal world with ideal rules, market discipline, and info they would not pose these problems. But the world we have is not ideal, and those in charge of managing it created a vomitorium.
Of course, there is a sensible way out of this. Settle for pennies on the dollar. Then we'll see the true test of how useful these contract really are.
If large numbers of people started dying from some disease, i.e. a pandemic, then it is unlikely that the response would be to start blaming life insurance. It would be considered a public health problem, not a failure of the insurance industry.
Likewise with financial markets. At the core of the problem is a sickness in capital allocation. Capital once flowed to productive industry, however for 20 years before the GFC, capital began flowing to fixed assets (primarily housing). Fixed assets don't produce anything. They don't grow in sales, they inspire no new technologies, they send no food to market.
Yes, it is foolish to believe that one can use complex mathematics to create insurance for what is ultimately complete and utter stupidity, but those derivatives serve other legitimate purposes in capital markets.
It is malinvestment and misallocation of capital that has destroyed derivative markets, not the other way around.
CDS are not the core problem. The core problem is bank balance sheets so impaired that it makes them insolvent. One insolvency leads to a cascading of defaults. CDS are just an instrument that contributes to this problem in a very specific way. They allow credit risk to be concentrated in a few entities that makes them insolvent, leading to the cascade. It is true that central clearing would make alleviate this, because you wouldn't contract with a counterparty with concentrated risk. But that is not where we are.
The reality is that CDS allow a party to assume risk exposures that no regulator would permit if he understood/was uncorrupted. Central bank balance sheet expansion has compressed spreads, altering the price of credit risk. There is an implicit backstop mentality that may nor may not be real, but I'm pretty sure it impacts the price of credit risk. Also, there is a kick-the-can-down-the-road incentive: a CDS dealer gets his commission up front and he doesn't care about what happens to the bank, b/c he is after his FU money. This is exactly how the clowns in government act.
I agree with just about everything you say. I won't even get started with the modelling problems. I'm just saying we need to think about where we are and how to get where we should be in the use of these contracts. Not get rid of them.
this is very good. i will add the same two cents i always do here. "the government is the counter-party now." The United States did this INSTANTANEOUSLY. Europe is only waking up to this fact--and about two years too late it would seem. That's why it's easy for me to say "i give the European Union one week before it implodes." Not saying that's what in actuality going to happen--but when the German President is willing to "use the military" to protect trade routes the question of course is "where are the trade flows to begin with Mein Fuher?" I find it simply unfathomable that the European Community can't see this. Every state in the monetary union is competing separately with China? Answer? Gold, gold, gold, gold, gold. THE ONLY ANSWER.
I agree with everything you say. Here is where you get fuzzy:
The core problem is bank balance sheets so impaired that it makes them insolvent. One insolvency leads to a cascading of defaults.
I'm saying that bank balance sheets are impaired by housing and the underlying theory behind the movement of capital into consumer mortgages over the last 30 years (accelerating in the period from 1994-2004). The entire lending book has changed structure.
The theory behind this is that consumers with mortgages are motivated to create wealth to pay off their mortgage. What is not clear is how consumers can create wealth working for the state or the corporatocracy.
If they want to be entrepreneurial and create some kind of business, they will need access to risk capital, something that is in short supply, because of the desire of those who control capital for risk free returns. Risk aversity has driven capital into unproductive investments, changing the risk to a systemic risk along the way.
Sure. Consumers don't purchase plant and equipment.
Why is it that in the last 30 years, the makeup of bank lending books has gone from 30% mortgages to more than 70%? Not much plant and equipment being purchased there.
If Banksters had to hold reserves (like Insurance Companies are required by law) the current opaque Derivatives market would shrink like a prune, it would no longer be infinitely profitable, and the general public would not be assigned the bill for default at the point of a gun.
By the way, can I put some insurance on your house ? I promise not to burn it down.
Insurance (including derivative insurance) is a form of gambling. With life insurance for example, you are betting you will die, the insurance company is betting you will live.
They enable financing of lower credit rated counterparties.
Isn't that part of the problem, the financing of even "no credit" rated counterparties?
They allow you to take a position on any market movement... Capital seeks to maximize returns while managing risks. If there is no way to manage risk, capital is withheld. The problem with derivatives lies with systemic risk, which is a function of opacity in OTC markets.
Including positions with no stake (like taking out life insurance for a stranger). Insurance reduces the risk of moral hazard for the insured. But derivative insurance reduces the risk of moral hazard for the insurer, and all hell then breaks loose.
The problem is indeed systemic, but it is NOT a function of opacity. Opacity is intrinsic to the distance of counterparties with derivative “insurance“ (gambling).
Isn't that part of the problem, the financing of even "no credit" rated counterparties?
Absolutely! But even more problematic is what those "no credit" rated counterparties use that capital for: housing. A house makes no products (except maybe children), produces no food for market, requires no technological innovation. It just sits there and keeps out the weather. Surely something so unproductive should take as little capital from the total supply as possible.
Insurance (including derivative insurance) is a form of gambling. With life insurance for example, you are betting you will die, the insurance company is betting you will live.
Perhaps, but just because I am betting I will die does not mean I want to die. There is however a RISK that I could die before the life tables say I will (on average). If I did, then the burden of my death would fall on those who lived LONGER than the life tables said they would (on average). We (as a society) or a group have distributed the risk amoungst ourselves.
Including positions with no stake (like taking out life insurance for a stranger)
True, however those who have no stake (speculators) are generally considered to add liquidity to these markets. They also allow losses to be spread over a larger number of participants.
The problem is indeed systemic, but it is NOT a function of opacity. Opacity is intrinsic to the distance of counterparties with derivative “insurance“ (gambling).
The RISK is a systemic risk. Derivatives that a 90% netted will always have a 10% downside unless the entire system collapses (hence the point of the original article). But there is nothing in the original article that points to the fracture point for systemic failure. The only hint is that Morgan Stanley is heavily exposed to FX risk, but there is no further information on the form that exposure takes.
IMO, opacity is the problem, because without transparency toxic exposures can fester to the point of no return (like Barings and Lehman).
I don't know if you are a mollycoddled academic or a laissez-faire, fuck the neighbors, capitalist.
But since housing is "unproductive" why don't you and your family go sleep outside for a year and we shall see how productive you become.
Just because the Fed, through Greenspan and Bernanke fucked up Housing for the American Middle Class, does not make it any less productive.
Except for futures contracts that allow the direct buyer and seller to take a position, all other derivatives serve one primary purpose only- to generate fees for today for the contract originator and push the risk off into the future and onto someone else. That someone is the taxpayer.
I don't know if you are a mollycoddled academic or a laissez-faire, fuck the neighbors, capitalist.
Neither. Have another two ad-hominem attacks gratis in your next post though.
But since housing is "unproductive" why don't you and your family go sleep outside for a year and we shall see how productive you become.
Sure. I live in the tropics, so even a decent tent will suffice. HOWEVER, your statement confuses utility with productivity. A house is usefull, but not productive. It's usefullness stays fairly constant over time, and so it's capital allocation should do likewise. If the house is productive on the other hand, then it's capital allocation can increase without a nett loss in capital. Most houses are unproductive, and more to the point, the materials that were used in their construction are degrading, requiring maintenance and upkeep (further capital). In other words, most housing stock is a liability, a drain on capital. For a liability to go UP in price is an absurdity, and the source of most absurdities is government.
Just because the Fed, through Greenspan and Bernanke fucked up Housing for the American Middle Class, does not make it any less productive.
I would like to hear why you think housing is productive.
Except for futures contracts blah blah blah
The purpose of all derivative contracts is to spread risk over a larger number of participants. To dilute it, if you will. However, some risks are just to big to dilute, like socialist vote programs, or monumental stupidity.
just check how much "real" capital is required to "insure" against loss without "gambling." Gambling means that you are "sure" that a certain percentage of the risk will not go bad. In the cases that are presently insured the percentage is higher than threshold and it was understood to be that way from day 1. Tick....tick.....tick....!!!
So derivatives are basically the equivalent of me telling my friend that I will give him $1,000,000 if he makes a putt or wears a stupid shirt in public. It gets him to do something he doesn't want to do and I really have no intention of paying him.
At hundreds of trillions of dollars outstanding clearly the banks have no intention of ever settling their bets, but I guess it's worth the risk of someone calling your bluff if it gets them to do something they otherwise wouldn't do. And I'm sure there are some nice fees to made shuffling dollars back and forth on the transactions.
So derivatives are basically the equivalent of me telling my friend that I will give him $1,000,000 if he makes a putt or wears a stupid shirt in public. It gets him to do something he doesn't want to do and I really have no intention of paying him.
Nope.
At hundreds of trillions of dollars outstanding clearly the banks have no intention of ever settling their bets,
That's the notional amount. At risk is probably between 500B and 3T. 500B is a scandal and a depression, 3T is a reset. You can probably guess which one they are aiming for.
And I'm sure there are some nice fees to made shuffling dollars back and forth on the transactions.
Derivatives may have started as a nice way to share the risk but this is again an example of banks greed once again making their fucking problems our fucking problems. You may be correct in that the $250T is not the final number at the end of the day when the small circle-jerk of banks finish swapping their 'IOU's' the numbers are still so huge the system will collapse. The question remains how this small cabal of banks once again gets to drag us all down into hell so that they can make even more money?
There is no economic justification for 600 Trillion in notional amount derivatves outstanding - there is not that much risk in the world. Derivatives are being used for some other purpose and it is hard to see what legitimate purpose would support that notional value.
Ah, derivatives, talked about in finance like Lindsey Lohan on a gossip blog. A derivatives is a contract that is valued based upon the value of an underlying asset, index, or security. The are very legal, and logical as long as the risk is covered both ways, and this is important concerning counter party risk. If there is an asset, then it can be owned. It can be owned and traded two ways: bought and sold.
The problem starts with the loophole that you do not need to own the underlying security, although i can be owned, you just need to think you can locate it- and this is what we call trading naked. Although this too seems logical, it is not a responsible way of trading; here's why:
Barclays has an exchange traded fund that is suppossed to hold gold, and one for silver too. These are the infamous GLD and SLVs. They say they have all of this PM. So then others, like JPM, can use these holdings to locate their shorts. You see, the derivatives of the holdings are floating around somewhere. In conclusion, JPM can now, and does, have a massive short position due to being able to locate silver due to Barclays ishares trusts.
Does Barclays have the gold/silver? They may have some, but who says they have not issued more shares than ounces in respect to their holdings?
Mr Lennon Hendrix I think we all know that all commodities, including PM's, FX, and CDS are leveraged to the moon, over and above the underlying assets. The derivatives market serves its main purpose, the generation of fees and the off-loading of risk onto unrelated third parties-the taxpayer.
These banks have the most sophisicated risk management systems in the world.
I doubt it. Having worked on many risk management systems, US banks are about the worst, closely followed by the UK and then Japan.
The problem is, the better your risk management system is, the higher your Tier 1 capital number ends up being. US banks are full of cowboys that don't want capital charges against their desk lowering their bonus (less coke and hookers), so the front office does everything in it's power to make sure that the risk management system is as bad as possible.
Add to this that the SEC and FINRA are clueless, toothless bumblers, and you have a recipe for disaster ... over and over again.
There is a rabid political ideology that wants to let the coked up cowboys run the world without any pesky government interference or evil regulations. They believe too much regulation is the problem. I think a guy named Greenspan once mentioned something about it. Later admitted he was wrong but still couldn't understand how it could be that coked up cowboys didn't do what was best for their shareholders.
There is a rabid political ideology that wants to let the coked up cowboys run the world without any pesky government interference or evil regulations.
Are the followers of this ideology called Randiots?
If these banks run 30x leverage, they should have some $8T in real assets backing the $250T in derivatives.
I bet that backing is also largely an apparition. The whole mess is financial numerology to justify the only real money in the equation: that's the part the management pulls out for themselves in salaries, bonuses, etc.
If humans survive (in some state of sanity) for a few decades, schoolchildren will gasp as they learn about the John Law's of our day and the stupidity of the masses who were taken in by the scam.
If these banks run 30x leverage, they should have some $8T in real assets backing the $250T in derivatives.
Not exactly. Economic capital requirements for loans is based on leverage however, for derivatives economic capital is calculated as a multiple of Value At Risk. It would be interesting to know what VaR these 4 banks are reporting.
Let's see, since the net value of all assets in the U.S. Is probably only around half of that $250T derivative valuation, we should not have more than $125T at risk. How can we risk more than we have?
Oops, forgot. We can mortgage the future!
Hmmm, maybe that's why we have taxpayer bailouts based on future obligations.
Yo Bernanke - man the long bonds.
(On a more serious note, the 30-40x leverage is bad enough. Using VaR just creates more vaporware by making the actual multiplier bigger. What isn't at risk in the fantasyland they call banking?)
"VaR calculates the worst expected loss over a given horizon at a given confidence level under normal market conditions."
Alternate definition by Barry Schacter:
"a number invented by purveyors of panaceas for pecuniary peril intended to mislead senior management and regulators into false confidence that market risk is adequately understood and controlled."
Formerly sane humans should at this point bifurcate into those weeping uncontrollably in their soup and others laughing maniacally while shaking their fists at the gods.
That $250T is built on 30-40x a base and that base is essentially fabricated from nothing. It's all complete madness - just air. And the wizards of finance magically extract billions in salaries and bonuses from that air. Or so it would seem. In truth, they extract it from those who work for a living, and increasingly, from those not yet even born.
"a number invented by purveyors of panaceas for pecuniary peril intended to mislead senior management and regulators into false confidence that market risk is adequately understood and controlled."
Formerly sane humans should at this point bifurcate into those weeping uncontrollably in their soup and others laughing maniacally while shaking their fists at the gods.
That $250T is built on 30-40x a base and that base is essentially fabricated from nothing. It's all complete madness - just air. And the wizards of finance magically extract billions in salaries and bonuses from that air. Or so it would seem. In truth, they extract it from those who work for a living, and increasingly, from those not yet even born.
that's easy Leonardo. "i am a banker and i have much gold. i will sell you some provided you don't mind me lending you money." Of course "you realize your government has already agreed to this deal."
Regulators: "$250 trillion? There's no way anything can go wrong there. Back to sleep, boys, we got government jobs so that we would have high pay and job security, not to actually do something useful."
Jokes aside, is the main reason no one is too eager to start regulating derivatives because the banks wouldn't have anywhere close to the needed collateral and would have to unwind these positions leading to financial armageddon?
when i wtote that comment in 'disapointment with the fed' about people dumping phyiscal at $39. you were one of the few who didnt run me through a woodchipper.
THANK YOU.
what a difference 72 hrs makes,,,
i guess we both know wnat was going on now. i think those people had more than an 'educated guess'. ya' think.
oh well, such is life in the ZH gladiator school for a newbie....
Nonetheless those fees and markups on imaginary money was great while it lasted.
I get that same power kick when I'm the bank in a good Monopoly game.. I play where the market prices on the board mean nothing, IOU's are permitted and encouraged (if I handle the paper) and instead of "go to jail" you just get an additional $2,000,000 (same for passing Go). Unfortunately the games end when the exponets get too great for my calculator...
The evidence is hidden in plain sight. Bonuses are paid today from liquidity- so long as Bernanke keeps the cash flowing to these boys, they will continue to spray perfume over their shit.
I moved the company accounts to Chase...Was supposed to be 100% insured if non-interest bearing. I guess so many people did the same because now there is talk of service charges coming because the banks are paying so much insurance on all the cash parked in these accounts.
You might not understand.. this is the working capital for my company and it is hard to feel safe just putting it anywhere. It had to be spread over several banks before the limit was lifted.
or
You might be a dick
Knowing you are a product of Berkeley, I'll go with the latter.
Negative interest rates have been around a long time- its called banking fees. Smart move, though, to split up your working capital. I don't trust any of these slimy banking sons-of-bitches.
So, how long is it before Tyler gets hired as a consultant by the top-four (or more) big banks. His job will be...to stop researching and especially to stop publicly-reporting on the banks. Great work again ZH!
Warren wants Tyler to replace Becky Quick, but TD is negotiating $5 billion of common, the preferreds are locked up./sarc/ (for you ultra-sensitive types)
Tyler's stock-in-trade is honesty, raw, often brutal. If Tyler sells out, all is lost.
Kind of makes physical look attractive no matter what spot prices they reach. It's hard not to think of the all the folks advice who nailed it in the financial crisis that have not wavered, Burry, Taleb, etc: own physical, hard assets. It kind of makes me rethink my deflation on ideas on the moment patch. inflation/deflation: won't matter.
Banks should be like utilities. Lend some money, earn a reasonable return. High capital requirements, and lots of insurance (FIDC, SIPC) to cover any bank that goes bust.
And to think that in may ways, USA has a better system than many foreign countries. Yes we have deep flaws, but at least we have some form of regulations, SEC filings, and audits. Yes the banks lie and their numbers are gamed, but, it's still better than what you will find almost anywhere else. I believe this is a key reason people still see USA as safe haven: regulations and courts, which are still the envy of many countries. Good luck trying to enforce a contract or recover from a fraud in China if you are up against a Chinese citizen, I've firsthand experience how foreign business gets hometowned like you wouldn't believe in China.
If only our stupid politicians and regulators understood that vigorous enforcement and cleaning out fraud = healthier economy, albeit at the expense of banker bonuses, which is the only thing that seems to matter.
Anyone who says they know for sure is full of shit. The ride from where we are today to whatever is in store for us tomorrow is going to be bumpy. That is about the only thing we can say for sure. The rest boils down to probabilities, staying nimble, staying on step ahead of the crowd, etc.
Hedged both ways seems like a smart place to be right now. That could change tomorrow of course.
These guys look like they keep doubling down on bad bets knowing that eventually one of the bets has to pay off. And in theory, this is true. However, at some point, the doubling and redoubling of the bets gets so large that no one can pay them off (even on a netted basis).
Then add to that TD's analysis that a non-linear event in one counterparty bank wrecks the whole system and you've got a house of cards just waiting for the slightest puff of a breeze. No amount of QE will be able to stop this inverted pyramid from imploding once it starts this time. It's just too big relative to the abilities of counterparties (or their government surrogates) to pay.
PS Thanks for the data and analysis TD. Good work. WS appreciates your efforts.
Once last thought for the night: GoldMoney and Sprottmoney is saying demand is surreal for physical right now which is contrarty to what any conventional wisdom would ever tell you in a quadrillion year lifetime. And, here we have, you know, Bank of America completely on the brink (jsut see ZH post). And here we have this mad dash out of paper and into physical with spot prices falling off a cliff?
Okay, let me guess who the buyers might be: BAC, JPM, GOLDMAN, CITI, et al executive and board members as they dump all paper through businesses while the cocksuckers are loading up. There are no words to describe these cocksuckers.
At this point the economist PhD readers will scream:
Interesting. I had long been under the assumption that one or more of the Tylers were Quants (front office), which are usually Math PhDs rather than economics. Still ...
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
Which, when written, are NETT ZERO.
Morgan Stanley, ... has almost exclusively all of its exposure tied in with the far riskier FX contracts, or 98.3% of the total $1.793 trillion.
Which begs the questions:
1) Which currencies?
2) What moneyness?
3) What maturity profile?
3) Are they actually XCCY IR swaps that they report as FX?
Maybe we are mixing terms. To me an XCCY IR swap each side has a different currency (USD on side 1, GBP on side 2). They rate can be fixed/fixed, fixed/float (pay 3% USD receive GBP 3M LIBOR), float/float(saw this a lot with USD/JPY)
XCCY IR Swaps usually exchanged the principal at initiation and maturity -- there were big red buttons on the IR swap entry screens that said principal exchange (usually at initiation an matuirty).
There were also these 'market value swaps' or some such thing that were more like total return swaps and the currency gain/loss was exchaned periodically (either in cash or the notional balance was increased).
There are two types of cross currency swaps. There are cross currency swaps and cross currency interest rate swaps. In THEORY, because of Interest Rate Parity, there should be no difference in those two swaps, but in practice, there is.
Cross Currency Swaps do exchange a principle, but XCCY IR swaps (I believe) do not (coupon based on notional). I could be wrong though, it's happened before.
It just doesn't seem possible that MS has 1.7T in real FX exposure with so little economic capital, hence my speculation that their FX outstanding is largely notional, tied up in XCCY IR swaps.
If that is not the case, then they truly are fucked.
"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."
Given that the bulk of the derivatives are interest rate swaps, doesn't Operation Twist lower the spreads causing them to get EVEN bigger to make a profit?
Yes. Because of Operation Twist, the banks are gonna up the ante even more.
Now it's 250 trillion, but by June 2012, it'll be way way higher than that. If they did $5.3 trillion in Q1... you betcha they can do, in Q4-Q1-Q2, in 3 quarters.... X5.3 trillion + operation twist factor ... they can add to that at least 20-30 trillion, EASY.
They basically gonna add, in 9 months, half of the world GDP in derivatives to the system.
Little Ben just assured that the collapse would be even bigger when it goes down.
I don't believe 'the system' will still be up and running in 9 months time but that maybe giving it a wider view than it deserves. To your last point, the collapse is going to be well and truly financial armageddon. Jim Rogers is right, buy a farm and learn how to work it.
I had posted a few times that one of the things the Fed needed to do was keep the Big 3 (Euro, $,Yen) rangebound to help with liquidity flows around the world. Never even thought about Fx derivatives...... I shall sign this as The Blind Pig
Questions based on the latest meeting where the Bernanke disappointed and the gold margin increase.
What levels the Fx derivatives are set at and compare against Fed, market rumor action and the Swissy peg?
How much of MS money is being moved to work Fx markets against their clients, or are they being helped by the "idiotic" Fx GS calls? I think the ones at the top realize at this point "you go, I go".
There's a reason why the IRS market is the largest by notional $ derivative outstanding.
As long as basis risk is managed (counterparty risk need not be mentioned..) there is nothing that can happen to those $200tr of exposure.
IRS basically allow a party to enter into synthetic fixed/floating rate financing for firms that need it - and many many do. Yet of course, none of the above posters actually knows squat about swaps and yet the comments come, ridiculing the size of the market. Too funny.
If one wants to ridicule IRS for anything, you can look at their inbred cousins - off market swaps, deferred swaps, circus swaps. Bit more risk involved there, but again, most of the risk is tied into being in the contract with an unworthy counterparty, not to mention not understanding what the fuck kinda of contract one has entered into. OTC IRS clearing will remove the former risk. There is no cure for stupidity however.
I think his point is that IRS are not exclusively a bank issue. They hedge interest rate risk for businesses, alleviates funding pressure and liquidations and readers don't realize this.
Regarding clearing, I can't think of anything more bullet-proof than SwapClear and payers of a 6% 30y can offset that with an <insert number>y30y.
That is the sad part, SwapClear is considered bullet proof. SwapClear is bullet proof because the top ten members can go to the FED, Bank of England, Bank of Canada, Bank of Japan, ECB, RB of Australia (maybe all of them) and borrow at a negative rate with bogus collateral.
And GS and MS were not banks until 2008. They became banks to avail themselves to be able to feed at the pubic trough. And keep SwapClear safe.
none of the above posters actually knows squat about swaps and yet the comments come, ridiculing the size of the market. Too funny.
Amen.
Even counterparty risk is small, given that the principal is notional, and the coupon is the delta of the fixed/floating rate.
Yeah, it might be nasty to lose a coupon (in the case of a default), and there might be some cascading/ripple effect in credit markets, but not really a show stopper.
Given the historically glacial pace of Central Bank changes to overnight cash rates, managing basis risk should be fairly trivial matter. The problem recently is the huge volatility in the yield curve due to Fed meddling and Government muddling, which makes basis risk a little harder to manage, but from memory, the maturity profile of the bulk of IRS is <10Y
Let met get this straight, in 2001, my counterparty agreed to pay me fixed at 6.01% on $100 million for the next thirty years. He decides that he's tired of paying and walks away from the deal. My loss is not worth mentioning?
Granted, if I had collected margin over time, I'd be reasonably okay.
Let met get this straight, in 2001, my counterparty agreed to pay me fixed at 6.01% on $100 million for the next thirty years. He decides that he's tired of paying and walks away from the deal. My loss is not worth mentioning?
First, 6.01% on $100mio with a 3M coupon period is coupon of around 1.5 million. Remember, you only get to default once, so if the counterparty misses a coupon payment, you are 1.5 million in the hole, bonus mangling, but not armageddon.
Second, you are swapping that 6.01 against some agreed floating rate. Current LIBOR 30Y is 4.29%, so the coupon is simply the difference i.e. 2.7%, which means a 3M coupon is roughly 675,000.
Last, if you really don't want to lose that 675k, you could always buy a CDS on the counterparty :)
edit: sorry, my calculations above are wrong, the coupon is actually much smaller than that, but I cbf working it out. Suffice it to say, the risk is small.
Basis risk is ALWAYS "managed" one way or another and yet, the financial wizzardz always manage to fuck it up as complexity grows. $200tr is a ridiculous number regardless of being notional and "risk" free.
yet the comments come, ridiculing the size of the market.
So there is over $300 trillion in interest rate swaps. Not every borrower or lender will want to swap interest rates. There is not enough debt in the world to justify the size of the swap market.
Ironically and sadly it is the poorest of the poor who are grubbing for every dollar trying to stay above water or even alive that are carrying this monster on their back. Wicked is a milk toast word to describe the monsters that are perpetrating this faux banking scheme. The derivatives monster makes the biblical tower of Babel look like an ant heap. In terms of the I Ching: The ridge post sags to the breaking point.
as long as King FRN is here it can go on..seems China Russia and the Oil states can't get a handle on how to bring it down.
Mr Q in libya took a shot at gold back african money and we see what happened there..not one MSM outlet even guestioned that coup..the biggest news never sees print these days.
PM's whipped ties into this nicely..for a while PM's looked to be an out on the FRN...they must kill PM's for the threat they are to the whole game..invest accordingly until there is a real chance the debt risk heats back up thru defaults of EU members.
So to the point: TBTF banks have unlimited FRN's via the FED
why not keep doing what brings the bonus money in??
If Ron Paul got elected well then we might get a new game but by the way the MSM avoids him..he has little chance..and if he did win hope he stays out of Dallas Tx.
Ron Paul would be executed by the banks the moment he talks about Fed audit, gold audit, gold standard, tighter banking controls, issuing silver notes.....anything that threatens their position.
They did it before they will do it again. Paul should invest in full body armor. Forget terrists...the banks are the global mafia extrordinaire.
He confirmed that the firm was in the market buying its own debt to show skittish investors that it had enough cash and liquidity to survive not just the European banking crisis, but the rumors of its own pending demise, which began with a blog posting.
From a 1929 crash article.
Thursday October 25, 1929 the markets crashed, on Friday several of the nation’s largest bankers met to decide what they could do about the situation. Among the attendees were the heads of Morgan Bank, Chase National Bank, and National City Bank. The bankers ultimately decided to purchase a number of U.S. Steel shares above market price. A similar tactic worked to end a previous stock market scare in 1907 when the New York Stock Exchange plummeted, causing many banks and businesses to file bankruptcy. American banker J.P. Morgan and a few other bankers bailed out the banking system using their own money. The bankers who tried to thwart the 1929 stock market crash were unsuccessful. There were positive results, but they were short lived.
When I watch shit like this it makes me so happy I tossed my tv out the window 5 years ago. Watching Gasparino and that piece of ass just makes me sick. Cheerleading ass clowns.
It all boils down to this... This is why the EU has failed. US needs to reverse course or it too will become the EU.
Free Shit
The folks who are getting the free shit, don't like the folks who are paying for the free shit, because the folks who are paying for the free shit, can no longer afford to pay for both the free shit and their own shit,
And, the folks who are paying for the free shit, want the free shit to stop. and the the folks who are getting the free shit, want even more free shit on top of the free shit they are already getting!
Now... The people who are forcing the people who pay for the free shit, have told the people who are RECEIVING the free shit, that the people who are PAYING for the free shit, are being mean, prejudiced, and racist.
So... the people who are GETTING the free shit have been convinced they need to hate the people who are paying for the free shit by the people who are forcing some people to pay for their free shit, and giving them the free shit in the first place.
We have let the free shit giving go on for so long that there are now more people getting free shit than paying for the free shit.
Now understand this. All great democracies have committed financial suicide somewhere between 200 and 250 years after being founded. The reason? The voters figured out they could vote themselves money from the treasury by electing people who promised to give them money from the treasury in exchange for electing them.
The United States officially became a Republic in 1776, 235 years ago. The number of people now getting free shit outnumbers the people paying for the free shit. We have one chance to change that in 2012. Failure to change that spells the end of the United States as we know it.
From Overstock.com DTCC Announcement on Sep. 13, 2011 DTCC Announces Initiative To Revamp Processing of Continuous Net Settlement Obligations New York, September 13, 2011 – The Depository Trust & Clearing Corporation (DTCC) has proposed changing the way its clearing agency subsidiaries, The Depository Trust Company (DTC) and National Securities Clearing Corporation (NSCC), process Continuous Net Settlement (CNS) transactions. The enhanced process would align CNS processing into the risk management control structure used by DTC to reduce risk and boost liquidity efficiencies in the settlement of almost $870 billion in equities that trade in the U.S. markets each day. The proposal is presented in a white paper – CNS Settlement as Delivery Versus Payment in DTC (CNS for Value) – issued to the industry today. In the paper, DTCC asks for feedback on the initiative. NSCC and DTC together clear and settle virtually all broker-to-broker equity, corporate and municipal debt securities transactions in the U.S. In addition, NSCC serves as the equity markets’ central counterparty and guarantees trades by becoming the buyer for every seller and the seller for every buyer for CNS-eligible securities. Under the methodology currently used for CNS obligations, the securities are moved via a book-entry transfer that is free of payment at DTC with the related money settlement occurring at NSCC. With the initiative, called CNS for Value, DTC will process both aspects of the CNS settlement obligation, moving security positions and credits/debits simultaneously through DTC’s settlement system, leveraging DTC’s existing risk management controls (net debit cap and collateral monitor). CNS for Value offers several important benefits to members. It will: • Give them a single, transparent intraday settlement process that allows them to better monitor settlement activity and manage liquidity needs, • Continuously net members’ CNS credits and debits with DTC credits and debits which may reduce a member’s intraday funding requirements, and
• Position DTCC to support more robust intraday settlement finality and liquidity management by supporting a multi-cycle settlement process. "With the implementation of CNS for Value, we will be able to mitigate systemic risk and promote harmonization of the U.S. settlement system with evolving international standards for financial market infrastructures," said Susan Cosgrove, DTCC managing director and general manager, Settlement and Asset Services. "This change will give DTC, NSCC and their members more robust and transparent methodologies for managing intraday settlement liquidity risk." CNS transactions processed as DVP at DTC will be subject to DTC’s collateral monitor and net debit cap risk management controls. The net debit cap control limits the net debit balances of DTC participants so that DTC will have sufficient liquidity to fund end-of-day net settlement with sufficient collateral support based on the collateral monitor. The use of DTC’s collateral monitor and net debit cap controls on CNS transactions will protect DTC from potential spillover risks from NSCC. "The concept of moving DTC from a single end-of-day settlement model to a more robust intraday multi-cycle settlement model is also being explored," said Julie Krill, vice president, Settlement and Asset Services. "This multi-cycle model would further mitigate certain risks by providing members and the market with intraday settlement finality." DTCC anticipates implementation of CNS for Value in early 2014. Details of the CNS Settlement as Delivery Versus Payment in DTC (CNS for Value) initiative and the multi-cycle settlement proposal can be accessed at www.dtcc.com under Thought Leadership, White Papers. http://www.dtcc.com/news/press/releases/2011/press_release_dtcc_announces_initiative.php
But But But.....Plan A for the economy was "Prosperity and Peace Through Financialization!"
That's what all the collective brains promised in the 1980s in response to the plan of De-Industrialization that followed Nixon's China accords. They were supposed to make stuff, we were supposed to buy it on credit. That was supposed to be the deal!! We would all become capitalists to the world: doing the developing world's lending and banking, counting all the beans in CHina and the rest of the developing world!
What a vision! What a world it was suposed to be that was promised to us!
Of course it all rested on accords that only the biggest governments could ever make let alone enforce. China would only make such a deal on the full faith and credit of the US gov for a start. And ironically it was the high priests of small government who pushed the plan, preaching small government while at the same time making the grandest of grand plans to change the enitre US economy over to "The Service Economy", "Financialization" and "The Ownership Society" and also implementing large transfers of wealth using "Trickle Down Theory".
So of course it's only the next logical step to nationalize the TBTF banks that are already running under a hybrid nationalized model now with both implicit and explicit bailout guarantees. Europe will be the guinea pig. When that pig can fly, the US only needs to take the next step and copy. And we might finally be able to go back to our iPads and browse porn and eye candy in peace from anywhere on the planet!
@Pulau: Or....you could go the other way and work for a banker. As a domestic servant, exotic dancer, pyramid construction worker, 'lady' in waiting or whatever! If you can't beat 'em, spoil 'em!
when losing at the track and the day is getting late, the only way to get out is to bet bigger and bigger longshots, that usually doesnt work out to well and go home broke
these "derivatives" are satanic. the people who created them worship satan. the fact that they are legal makes our legal system satanic. the fact that lawyers will defend the creators of said satanic devices is proof that all lawyers are evil. Sanhedrin, our judicial system.
But no. don't discuss that.
lets get lost in the satanic labyryth and intellectual madness of the technicals of denial.
"The few who understand the system, will either be so interested from it's profits or so dependent on it's favors, that there will be no opposition from that class."
Does anyone sleep around here? Getting all riled up early today. These numbers have been known at Zero Hedge for ions now. Just does not matter...till it does. And that day is coming. And also enjoy Reggies posts, but admit a link would be better and a little less of me, me. But he does a great job.
My dealer was so busy late Friday could not get an order in for silver. Hopefully it moves lower on the open. And check out almost every blog advising doomsday for us. It is over, gold moving lower, silver a lost cause for decades. The cockroaches come out in droves once the food spills off the table. Just gives us more opportunity to buy more of what we want.
I am pretty good with numbers but these are so mind boggling I have to think about it again and again. And the brilliant ones want us to sell our gold, silver and miners. Think I will just keep what I got.
NASA’s “errant satellite” plummeting to earth at 27,000 kph
Narayan Lakshman
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...
"“Components which do survive are most likely to fall into the oceans or other bodies of water or onto sparsely populated regions like the Canadian Tundra, the Australian Outback, or Siberia in the Russian Federation,” NASA explained, adding that during the last 50 years an average of one catalogued piece of debris fell back to Earth each day and “no serious injury or significant property damage caused by re-entering debris has been confirmed.”
Yet obviously no place on earth was entirely safe from the dead satellite’s descent – in a small footnote on its website NASA recommended: “If you find something you think may be a piece of UARS, do not touch it. Contact a local law enforcement official for assistance.” This of course assumes it missed the individual in question.
Keywords: UARS, NASA, Upper Atmosphere Research Satellite
When TBTF were bailed out and CDS contracts were honored, this action only reinforced the validity of the derivatives markets which explains why this market has grown since then. At that time, CDS notional was approximately $60T and after all the blowups shrunk to about $28T. Interestingly, global wealth destruction was about $30T. Coincidence? I think not. Now imagine an FX implosion with the failure of the Euro, how much will be sucked out of the markets? What have our puppet leaders learned since then? Only Angela Merkel has banned naked CDS in her country so obviously she has a clue.
As for allowing derivatives to exist to hedge risk, they only create MORE risk. How has credit and capital been extended prior to the creation of derivatives? The old-fashioned way - performing due diligence and and knowing and trusting the borrower. Reputation and character often was the only basis for extending credit as credit history may not have existed, but only a handshake and a promise were required. The derivatives market has made it possible to forgo the basic concept of trusting and knowing your borrower for repayment and instead the notion that all risk can be hedged is a misnomer. The layers and layers of derivatives make for a very unstable system and has only become more unstable as nobody has the first clue how to regulate or unwind them in an orderly fashion. Therein lies the crook of the problem and the only solution is to allow failure to the point where none of these contracts are honored. If the players don't own the actual asset, no payoff, ever. My belief is that the damage would be much smaller as money doesn't change hands and forced-selling would not occur, thus reducing systemic risk. The best way to regulate this market is to make it impotent.
"provided the government can afford it" since the entire idea of securitization was...just like the internet...an invention that without the government could not possibly exist. What say you? Are we "affording it"?
Bilateral netting? Give me a break. Modern PhD economists don't "get it" because they cant the see the forest for the trees. That the macro design of the system is a ponzi scheme that concentrates assets and distributes liabilities. A system built on the paradigm of perpetual growth.
Thanks for the article...I have been writing about the nations top 5 banks exposure to sub-investment grade derivative risk for the last year or so. CNBC, etc. won't ever discuss this issue. These derivatives sit at over $4 trillion now, more than at the height of the 2008 financial crisis.
There will be no real counterparty to these lower grade derivatives except the lender of last resort, the Fed. The Fed's balance sheet is already a mess and it will be a natural conclusion that "faith" in the Fed will be fleeting.
Add to the banking mess the fact they don't mark to market their assets, with the full blessing of the Financial Accounting Standards Board (FASB) and it's plain to see the dire straits they are in. Yet again, CNBC et al never discusses this issue.
Thanks for bringing it up...again... The banking crisis is what will bring this Humpty Dumpty economy to its knees.
I don't know...maybe we are better off investing in a tent and a solar generator. Maybe a pitbull and fishing pole. If you live in an area like I do, hardly any jobs, and its suppose to get worse, maybe its better just to opt out of the system and buy a copy of Walden Pond. I really don't know...
Somebody needs to do something. And people are bitching about some minimum wage dude collecting food stamps? At least the food stamps contribute to the community they are spent in.
What are these derivatives doing for anyone but helping to clean our clocks out? And its growing.
It is depressing, and the players know that liquidity and capital will keep flowing to help defer the inevitable. We ARE the liquidity and the capital, folks. We are coming close to a stalemate, reminds me of the Cold War. Are the players with their WMD going to win or are our governments going to take control and reign in this insanity? Currently the players are ahead in this game as they make up the rules as they go along, and if they don't like something they throw a temper tantrum like a bratty two-year-old and throw a fit. Sadly, there are just too many two-year-olds.
Too big to get my head around. My simplified take, the banks collectively are one big Ponzi scheme. You go in to get money (fiat) and they always have the paper and ink or electrons to provide you with your request and to pay the executive bonuses, with or without the central bank printing.
The fall of the banks will start when someone goes in and asks for cash..... then the bank runs commence.
the question that comes to mind is : How does this derivatives exposure face up to the sovereign debt exposure of French/Italian/ Belgian/Dutch/UK/German banks.
The sums involved are so huge in both cases that we have difficulty evaluating the downside potential risk...for the financial community as a whole.
WOW, the figures of the derivatives' $$$$$$$$ involved here do thwart the issues of the USA's debt and all the debts from other regions/countries... also making the surplus reserves of many countries even the world's highest insignificantly tiny :D One single company of the TOP FOUR is even "worth" more than any medium to big country. OMG...those companies are soooo RICH!!! TBTBF
It's really amazing to learn the "wealth" of those behemoth companies like JP MORGAN, CITI, BANK OF AMERICA, GOLDMAN SACHS, also the newcomer, the fifth: HSBC
OTOH it also makes the entire Planet Earth seems to have much higher values..... JUST IMAGINE ALL THE FIGURES mentioned ON THE PAPER there!!! And the USA is fully loaded of such high value industry...the most lucrative one: FINANCIAL INDUSTRY!!! LOL! Please forgive and save me, The Almighty!
That's the genius of their evil plan...make themselves a weapon of mass destruction. The way to defuse the bomb is simple, unlace all the wiring of the fraudulent paper mills and announce both sides of the fraud are null and void.
The whole concept of Global Governance is to fleece the existing system(s). When the host is dead, many geniuses will appear on camera pitching the new system. These peeps will be speaking to you behind 10" bullet proof glass. The solution will be spun as "removing fraud" and limiting freedoms to restore sovereign state entities. It's all a lie.
Enjoy the next chapter of your central planning comic strip. Don't really care if you disbelieve this warning, you've simply been told.
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
this is probably the quote/warning of the decade. when you've exposed yourself to such gigantic, unfathomable counterparty risk it makes no difference whether you've supposedly netted it out. the exposure to just one couterparty's contracts likely exceeds 100% of the assets of the buyer -- one default will blow everyone up completely. especially when the issuing bank has sold CDS insurance worth many, many multiples of their own net assets -- what can't be paid out, won't.
OK here we go! The IMF conference in Washington DC is being held just a few blocks away from the White House. My friend had dinner reservations tonight at a point in between. GET THIS - the streets were blocked off and he was not allowed in to get to the restaurant. When he insisted on knowing why, he was told that President Obama was going from the White House to the IMF meeting and he would have to wait an unspecified amount of time before he could access the restaurant.
So, what can we learn from this?
1) Obama is meeting with the IMF for some reason
2) this meeting was not planned - otherwise they wouldn't have had to shut down the streets and block all traffic
3) There must be one big time heck of a reason why Obama is rushed to the IMF - couple this with the fact that Obama's NUMBER ONE campaign contributor, Goldman Sachs, is one of the top 5 banks with exposure to Greek debt and thus could suffer most from a Greek default and I bet the phone call went something like this:
Lloyd: "Barry, this is your god, er, I mean Lloyd calling and we need you to help do god's work"
Barry: "Sure boss, what can I do?"
Lloyd: "Get your butt over to that IMF meeting pronto and tell them we ain't taking a haircut, so they're going to have to print their way out of this."
Is this bullish gold and silver? I think most of the world's finance ministers meeting there in Washington DC will agree that, "yes, it is."