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that An American in London quoted:


The Truth and Consequences
Of $172 Trillion in Derivatives

Derivatives are essentially bets ... and ... debts.

As an illustration, if you and I were players, I could bet you that a particular firm will go bankrupt between now and year-end ... and you could bet me that it won't.

Or I could bet you that interest rates on junk bonds will rise more than interest rates on Treasury bonds ... and you could bet they will rise less, or not rise at all.

We could bet on virtually any market that moves, or even bet that it won't move.

For each wager, we'd likely borrow huge amounts of other people's money. And in each case, we'd have a contractual obligation (or right) to consummate the deal: To pay up if we lose (or collect if we win).

That's the essence of each transaction in the frenzied, hectic world of derivatives.

But what was once a small sideshow in the traditional world of stocks, bonds and loans has become the towering center ring in the big-top: The derivatives market has now ballooned into a monster of unimaginable dimensions.

At U.S. commercial banks alone, the total notional value of the derivatives is $172.2 trillion, according to the latest report by the U.S. Comptroller of the Currency (OCC). Plus, the OCC reports that:

  • In over 90% of these derivatives, there is no established exchange that helps protect either party from default.

  • Just FIVE major U.S. banks control 97% of all the bank-held derivatives in the United States, a concentration of power -- and risk -- unsurpassed in the history of finance.

  • All five of these major players would likely be severely crippled, or even bankrupted, by the default of just a few major counterparties like Bear Stearns.

  • Four have more credit exposure to counterparty defaults than they have capital.

  • Two have over four times more credit exposure than capital. (More details in a moment.)

Go read the rest at the link.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 24th, 2008 at 03:29:31 PM EST
[ Parent ]
Thanks Jerome for the link.
by An American in London on Mon Mar 24th, 2008 at 04:02:56 PM EST
[ Parent ]
I prefer to define derivatives as insurance policies written by people too dumb and too cheap to pay for an actuary.

Car accidents and home fires are highly decorrelated. Car accidents and home fires can be insured.

Market bets gone wrong are highly correlated. Market crashes cannot be insured.

Simple, no? And yet they keep trying.

by Francois in Paris on Mon Mar 24th, 2008 at 04:26:54 PM EST
[ Parent ]

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