Where's the Derivatives Exposure?

Here’s another blow to the meme that the derivatives market is efficient at dispersing risk. It comes from a new study by Fitch.

The report indicates that derivatives use by companies is fairly widespread but that the concentration of the risk is overwhelmingly found to rest with just five banks: JPMorgan Chase (JPM), Bank of America (BAC), Goldman Sachs (GS), Morgan Stanley (MS) and Citibank (C). In fact, those five hold 80% of the derivative assets and liabilities held on the books of 100 companies.

There’s no way to look past this sort of concentration of risk — the notional amount of derivatives exposure is $296 trillion. I’m of the position that there is nothing inherently evil about derivatives and that they do improve the functioning of the credit markets, but no matter what the value of a tool and no matter how stable it may have been historically it still has to be controlled.

Comments

[farmer448:]

I am a bit confused. If a derivative is a form of hedge or insurance, then why is 80% of the insurance written by 5 banks? It would seem to me that this is a heavy concentration of risk that go against the basic business principals of risk.

Jul 27 05:15 PM

[Luiz:]

Not all derivatives are used for hedging purposes. Derivatives were created to circumvent taxes, laws, regulations and/or to achieve purposes not visible to the naked mind.
The fact that five banks concentrate most contracts means, among other things, that there is a de facto monopoly on the top of the US financial system, thanks to the existence of those instruments.

Jul 27 06:27 PM

[nmelendez:]

Derivatives are used to increase earnings. Let's take for example a house you buy. You have three components..the interest you pay, the property and the insurance on the property. The bank takes each instrument and sells them individually. Then it insures each component by putting a rating, which, BTW, the bank pays for..as a type of insurance. So there you go. The you have 6 SIV's and the only item that has value is the house. The rest is air.
All these SIV's are bundled, so that gives you a small idea of the mess these banks made. What's in each bundle? Care to guess?

Jul 27 10:36 PM

[TheRealDeal:]

The real truth PART #1. I'd say about 95% of the information going around on derivatives is flat out incorrect. Derivativeness are nothing more than an option. Don't make them confusing, that's why they were invented. There is still a PUT side like an option, a CALL side, and a broker. An Derivative when fully executed is just a SILENT contract between the PUT side investor, the CALL side, and the broker. The SILENT part is the grease to the whole mechanism. You can always break down every math problem, theory, contract, etc and be left with just good old A+B=C. All those big words, scary stories, fear mongering, is only job security. After you break down the derivative to it's most basic form, what's left is the exact legal definition for the business model of Pyramid Fraud. Do all the research and studying you want and you still cannot say otherwise. There's just was never any laws or regulations on that market until June 2009. Now the Pyramid Fraud model is still there, but regulated and monitored for abuse. Lead consultants on regulation and monitoring to the government is Goldman and JP Morgan. Let that sink in and I'll finish tomorrow with (Part #2) which will really blow your mind. I haven't even started explaining why it's only these 5 banks that own 80%. Good night

Jul 28 05:50 AM

[Warm_Paw:]

Fractional reserve banking is a derivative.
One day someone's going to want to know the intrinsic value of something and find out it's all hot air.
Once these banks are wound up, they won't even own their buildings.
The pyramid scheme is good going upwards, it's when it runs out of new victims and everyone's been burnt, that's when the slide begins.
Just wish they'd fess up and give us the real numbers. The hard working solid committed people who rebuild this country, can't get at it working with more hot air.

Jul 28 02:24 PM

[HBWOW:]

Derivatives for the most part are very high risk gambles on non hard
assets and should not be part of any bank's balance sheet, on or off.
Any bank or investment house employee who seeks to deal in this form of high risk gambling using bank capital, bank borrowings, bank customer deposits should be treated as a criminal operating outside of the legitimate forms of their "regular" business. Our banks have placed our whole country and solvency in danger and the same people are still running these organizations. WHAT IS WRONG WITH THIS PICTURE? Where have the regulators, government agencies, auditors, and accountants been and what are they doing about this old and present problem? SEC does what for our public and country?

Jul 28 04:43 PM

[TheRealDeal:]

I applaud your conviction Warm_Paw. I'm with you on that, but no offense intended, if your referring to the Deritive Deposits of Fractional Reserve Banking there is no relation. Deritives that everyone refers to are traded in markets. Deritive Deposits is the term used for all deposits recieved after the primary deposit. These only help calculate the amount of your money supply that you lended out usually at a 10-1. F.R.B. is the everyday banking model used by all banks in order to make profit. No offense intended. If I'm off let me know. Keep up the passion.

Jul 28 07:21 PM

[Vuke:]

If derivatives bestow a greatly leveraged gain on a rising asset base then, conversely, when that asset base declines in price losses are greatly inflated. The five major holders in the derivatives market must be riddled with oozing pustules of them. Too many, in fact, to be allowed to fail.

Why they are permitted to take out such bonuses is now clear. No one can be sacked until they clean up the mess.

Jul 28 07:56 PM

[TheRealDeal:]

Very close Vuke. You pretty much got it right and understand derivitives for the most part. What if I told you or anyone else who is reading this, that these five banks whom hold 80% of all derivative assets and liabilities, have no exposure at all to derivatives, have no risk at all to credit downgrades, and still can make record profits of holding them. Would you think it could be possible or worse, actually occurring as we speak? ....Unfortunately it's true.
If anyone reading this is really interested on how they do it or how they get away with it just ask, I'm more than happy to try and explain it 20 different ways until it clicks. The derivitive concept in use was chosen for only one reason, to confuse.

Jul 29 06:14 AM