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Frank Schnittger:
It should have been obvious to everyone - bankers, regulators etc. that there is no way that Derivatives valued at 2 to 3 times Global GNP can be outstanding at any one time.  

Not at all.

Let's take a nice little example in the Brent Crude Oil "15 Day" market in Forward Contracts for cargoes of  500,000 barrels.

A has rights to production and in January he sells a July cargo to B at $100/ bbl; in due course trader B sells a cargo at $105 to C; then a month or two later C at $95 to D, who sells to E and so on until K sells at $102 to A and A sells to X at $104.

Eventually the time comes when the July forward contract reaches the point when it goes into its delivery cycle, and what happens then is that "chains" of "nominations" form, and that "nomination" process is always great fun, as people who have sold "short" try not to be left still holding a nomination at 5 o'clock which they cannot pass on in time.

In which case a "distressed" seller who has been "clocked" needs a cargo to fulfil his contract and is fair game for being stuffed by a seller who has one.

So maybe 250 outstanding "open" forward July contracts are settled as nominations pass one way down chains, and the money flows the other way up them, with traders collecting profits, or suffering losses, along the way.

It wasn't unknown for chains to be over 100 links long and for "book-outs" to take place wherever nominations  went full circle, as in the example, from A back to A again.

Only the net (say) ten cargoes actually pumped out that month go to delivery and become "wet" so that tankers are chartered to arrive at the nominated "delivery window" at Sullom Voe. All the rest of the forward sales/ derivatives are cashed out.

Great fun.

Note that like the credit derivatives markets, the Brent 15 day market is a bilateral "Over the Counter" market with no central clearer standing in the middle to guarantee and settle trades.

The point is that although there may well be $172 trillion of derivatives out there, they will in fact - if they are all performed - for the most part net down to zero (unlike derivatives in real things like oil where physical delivery takes place in "money's worth" rather than money).

The problem is that no one has the foggiest idea as to which of these derivatives are going to be performed, and which are not, let alone who is actually holding the shit, who can stand the losses and who cannot.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 24th, 2008 at 09:27:16 PM EST
[ Parent ]
ChrisCook:

The point is that although there may well be $172 trillion of derivatives out there, they will in fact - if they are all performed - for the most part net down to zero (unlike derivatives in real things like oil where physical delivery takes place in "money's worth" rather than money).

The problem is that no one has the foggiest idea as to which of these derivatives are going to be performed, and which are not, let alone who is actually holding the shit, who can stand the losses and who cannot.

So we have a large collection of assets which individually look like they have value (and sit on the assets column of balance sheets) but in the aggregate have no value at all? That's even worse than with stock shares. Or maybe not, maybe a share is an "option on liquidity" and has nothing to do with a proportional share of discounted future dividends, or with a proportional share of a company's net equity.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 04:25:36 AM EST
[ Parent ]
I once asked the guy sitting next to me how many June Brent cargos there were (about 1995 ish).  He said roughly 50.  "and I own 80 of them".  He had a fun month with that squeeze play.  15 day Brent was such a stupid contract.

Not a market for widows and orphans.  But it's not like people just get to walk up and start punting.  The credit groups were paid very well to try to keep a handle on who  we had too much risk exposure with and to demand margin from the poorer credit risks.

by HiD on Wed Mar 26th, 2008 at 07:32:26 AM EST
[ Parent ]
HiD:
The credit groups were paid very well to try to keep a handle on who  we had too much risk exposure with and to demand margin from the poorer credit risks.

Well I came into regulation in 1986, (and the IPE in 1990) people were still coming to terms with Brent credit risk after a few embarrassments which came about from trading with "tiddlers".

Btw this

Metallgesellschaft Case study

 is interesting in the oil market context....  

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Mar 26th, 2008 at 09:00:55 AM EST
[ Parent ]
that's the real problem.  People in the credit world assume Exxon or MG are too big to actually fail and give them open credit.  And then they really really F/up.

I got lightly singed a time or two by small players but no worse than a bad demurrage snafu.  part of doing business.  

Trading is not for the faint of heart or the risk adverse.

by HiD on Tue Apr 1st, 2008 at 01:45:59 AM EST
[ Parent ]

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