Are Banks Being Naughty Again with Derivatives? Could Be Good

Here is a recent video from Templeton's perma-bull asset manager Mark Mobius on the rally we've seen in markets. He thinks the rally has legs due to large amounts of liquidity provided by global governments and $600 trillion worth of derivatives still out there. Of the $600 trillion in derivatives market, the amount at risk is currently about $555 billion, a less shocking number, but still a large amount.

So are the Big Four banks, namely Goldman Sachs (GS), JP Morgan (JPM), Citigroup (C) and Bank of America (BAC), on to their naughty ways again? Mark is right about the liquidity generated by derivatives, banks in fact made $5.2 Bil from derivatives in the second quarter of 2009 alone, up 225% from last year. Goldman in fact is about 9x leveraged into derivatives, and JP Morgan about 3x. Hmmm... so 9x ONLY? For a Wall Street institution (well technically they're a "regulated" bank holding company now) whose norm in the past was to leverage way more than that? Maybe not so bad after all. Let's just keep our fingers crossed.

Comments

[Anthony Har...:]

A staggering figure of 107 bank collapses since Lehman’s failure speaks volumes of the problems confronting the US financial system. With close to 90 of these collapses occurring in less than 9 months, are we up for more to come? Are there some big banks lined up as well?
I’m convinced there are. Further, I am confident that some of our large money center banks are technically borderline insolvent, at least on an economic basis.….
Forensic research conducted by our team of research analysts at Reggie Middleton LLC (boombustblog.com) has unearthed some very interesting findings.
Let’s start with the misunderstood, and even more underestimated (in terms of systemic risk) US financial derivative landscape, whose notional value held by US commercial banks is a staggering $202 trillion (14 times the US GDP). Surprisingly, the top 5 commercial banks account for almost 96% of this highly concentrated pool of securities. High concentration risk and excessive leverage built into the system mean that even the slightest impetus as a trigger the markets could set off systematic collapse. Yes, even today, after Bear Stearns, Countrywide, Lehman Brothers, AIG and Washington Mutual. The risk is not only still here, but it is more concentrated (read as “more dangerous”) than ever.
Take JP Morgan as a prime example. This highly respected and highly rated financial giant holds nearly $80 trillion in derivatives (notional value), ahead of Bank of America’s $75 trillion and Goldman Sachs’ $48 trillion. This notional value of JPMs derivatives is nearly 39 times its total assets, 850 times its tangible equity and six times the US GDP.
And here’s more:
- In terms of gross market exposures, JPM’s gross derivatives receivables stood at $1.8 trillion as of 2Q09 (19x times its tangible equity) and its gross derivative payables stood at $1.7 trillion (18 times its tangible equity).
- Of the net derivative receivables exposure of $97 billion, non-investment grade derivatives stood at 22.9%, enough to wipe off 23.6% of the bank’s tangible equity in the event asset prices moved significantly south. This is an exposure a large bank can’t afford to assume under the current and volatile market conditions.
- In addition, the quality of JPM’s derivative exposure is even worse than Bear Stearns’ and Lehman’s derivative portfolio just prior to their fall. We all know what happened to Bear Stearns and Lehman Brothers, don’t we???

There are other large hurdles that JPM faces which, under normal circumstances (without excessive government support), could very well spell doom for a bank. . Here’s the link to the public excerpt of our proprietary research that throws light on JPM’s unconsolidated off balance sheet VIEs, its deteriorating loan exposure, skyrocketing charge-offs, compressing net interest margins, volatile trading revenues, rising VaR and many other insights: boombustblog.com/index...

Sep 29 06:17 AM

[Warm_Paw:]

AIG reports earnings in Oct. If the Fed doesn't continue to prop them up the next bank that leans on them for insurance on a CDS is going to find out the CDS wasn't worth the paper it was written on.
AIG could see a loss of -$3 to -$20 a share.
Intrinsic value is probably in the negatives already.
I can only wonder who is purchasing their shares?
The banks don't have a choice on trying to earn their way out of this.
That's what's occurring. Money's being dumped in to create value to mitigate losses.
That means that once money starts to flow, it will be removed from the markets where it can. That means sideways if not stagnant recovery.
My question is, if each individual on the planet is balance their books and be fiscally responsible, why can't governments do it?
Or is capitalism one big defecit to bankruptcy, only to start again once prices inflate?

Sep 29 10:31 AM

[Jasonaidan:]

The notional value of the derivatives contract seems irrelevant to me considering the fact that some contracts are netted with equal dollar amounts being swapped. It seems to me that the importance of Reggie's analysis is the amount of net credit exposure based on TCE. Yes, there is enough exposure to bankrupt the financials with leverage, provided that they haven't managed risk.

Anthony Harrison wrote: "This highly respected and highly rated financial giant holds nearly $80 trillion in derivatives (notional value), ahead of Bank of America’s $75 trillion and Goldman Sachs’ $48 trillion. This notional value of JPMs derivatives is nearly 39 times its total assets, 850 times its tangible equity and six times the US GDP."

Sep 29 11:20 AM

[Robespierre:]

Yes, there is enough exposure to bankrupt the financials with leverage, provided that they haven't managed risk.

But they are managing risk very well via a future tax payer bail-out if needed. Isn't that kind of peace of mind that you can get when the commander in chief works for you and have nothing to fear?


On Sep 29 11:20 AM Jasonaidan wrote:

> The notional value of the derivatives contract seems irrelevant to
> me considering the fact that some contracts are netted with equal
> dollar amounts being swapped. It seems to me that the importance
> of Reggie's analysis is the amount of net credit exposure based on
> TCE. Yes, there is enough exposure to bankrupt the financials with
> leverage, provided that they haven't managed risk.
>
> Anthony Harrison wrote: "This highly respected and highly rated financial
> giant holds nearly $80 trillion in derivatives (notional value),
> ahead of Bank of America’s $75 trillion and Goldman Sachs’ $48 trillion.
> This notional value of JPMs derivatives is nearly 39 times its total
> assets, 850 times its tangible equity and six times the US GDP."
>
>

Sep 29 11:45 AM

[robert_sare:]

Good job. Your article follows my thoughts exactly.
Thank you,
Bob Sare
Grand Rapids, MI.


On Sep 29 06:17 AM Anthony Harrison wrote:

> A staggering figure of 107 bank collapses since Lehman’s failure
> speaks volumes of the problems confronting the US financial system.
> With close to 90 of these collapses occurring in less than 9 months,
> are we up for more to come? Are there some big banks lined up as
> well?
> I’m convinced there are. Further, I am confident that some of our
> large money center banks are technically borderline insolvent, at
> least on an economic basis.….
> Forensic research conducted by our team of research analysts at Reggie
> Middleton LLC (boombustblog.com) has unearthed some very interesting
> findings.
> Let’s start with the misunderstood, and even more underestimated
> (in terms of systemic risk) US financial derivative landscape, whose
> notional value held by US commercial banks is a staggering $202 trillion
> (14 times the US GDP). Surprisingly, the top 5 commercial banks account
> for almost 96% of this highly concentrated pool of securities. High
> concentration risk and excessive leverage built into the system mean
> that even the slightest impetus as a trigger the markets could set
> off systematic collapse. Yes, even today, after Bear Stearns, Countrywide,
> Lehman Brothers, AIG and Washington Mutual. The risk is not only
> still here, but it is more concentrated (read as “more dangerous”)
> than ever.
> Take JP Morgan as a prime example. This highly respected and highly
> rated financial giant holds nearly $80 trillion in derivatives (notional
> value), ahead of Bank of America’s $75 trillion and Goldman Sachs’
> $48 trillion. This notional value of JPMs derivatives is nearly 39
> times its total assets, 850 times its tangible equity and six times
> the US GDP.
> And here’s more:
> - In terms of gross market exposures, JPM’s gross derivatives receivables
> stood at $1.8 trillion as of 2Q09 (19x times its tangible equity)
> and its gross derivative payables stood at $1.7 trillion (18 times
> its tangible equity).
> - Of the net derivative receivables exposure of $97 billion, non-investment
> grade derivatives stood at 22.9%, enough to wipe off 23.6% of the
> bank’s tangible equity in the event asset prices moved significantly
> south. This is an exposure a large bank can’t afford to assume under
> the current and volatile market conditions.
> - In addition, the quality of JPM’s derivative exposure is even worse
> than Bear Stearns’ and Lehman’s derivative portfolio just prior to
> their fall. We all know what happened to Bear Stearns and Lehman
> Brothers, don’t we???
>
> There are other large hurdles that JPM faces which, under normal
> circumstances (without excessive government support), could very
> well spell doom for a bank. . Here’s the link to the public excerpt
> of our proprietary research that throws light on JPM’s unconsolidated
> off balance sheet VIEs, its deteriorating loan exposure, skyrocketing
> charge-offs, compressing net interest margins, volatile trading revenues,
> rising VaR and many other insights: boombustblog.com/index...;task=doc_download&...

Sep 29 03:01 PM

[Kinabalu:]

"Of the $600 trillion in derivatives market, the amount at risk is currently about $555 billion, a less shocking number, but still a large amount"

The OCC, in its second quarter, 2009 report on bank derivative activities, reported that net current credit exposure, the primary metric the OCC uses to measure credit risk in derivatives activities, DECREASED $140 billion, or 20 percent, to $555 billion.

While the fact that a significant decrease occurred is important it should also be noted that the OCCs metric reflects counterparty netting where the bank has a legally enforceable bilateral netting
agreement, a common provision in the ISDA master agreement that most derivative contracts are based on. In that event contracts with negative values may be used to offset contracts with positive values with the same counterparty. This assumption is explicitly counter to the recent landmark ruling in the Lehman bankruptcy which throws out that provision.

Sep 29 03:28 PM

[Albertarocks:]

$600.000,000,000,000 still out there in derivatives
$80,000,000,000 is the value of all the gold mined on the planet yearly.

Considering that the value of those derivatives is worth thousands of times all the gold that has ever been mined in the history of mankind I think the banks are at some risk. It will only take mankind 7,400 years to mine that amount of gold at today's rate of mining production. Houston... we've got a problem.

Sep 29 05:03 PM

[kmarkt2:]

Anthony,

Are you trying to tell us all, that JP Morgan, BoA and the master of all, Goldman Sachs, has been digitizing $$$$ $$ into the economies of the World through generating derivatives - working on the warp speed of digitized multipliers ? If there is only $$ in the money supply worldwide, then who is lending to the buyers of these derivatives - US Treasury , Chinese ?
Of course, they have every incentive to generate these multipliers when they take fees and commission on a buy and sell trade, with absolutely no risk. SO what, if the holders of these derivatives default - who is at risk ?Lets shake this deck of cards !


On Sep 29 06:17 AM Anthony Harrison wrote:

> A staggering figure of 107 bank collapses since Lehman’s failure
> speaks volumes of the problems confronting the US financial system.
> With close to 90 of these collapses occurring in less than 9 months,
> are we up for more to come? Are there some big banks lined up as
> well?
> I’m convinced there are. Further, I am confident that some of our
> large money center banks are technically borderline insolvent, at
> least on an economic basis.….
> Forensic research conducted by our team of research analysts at Reggie
> Middleton LLC (boombustblog.com) has unearthed some very interesting
> findings.
> Let’s start with the misunderstood, and even more underestimated
> (in terms of systemic risk) US financial derivative landscape, whose
> notional value held by US commercial banks is a staggering $202 trillion
> (14 times the US GDP). Surprisingly, the top 5 commercial banks account
> for almost 96% of this highly concentrated pool of securities. High
> concentration risk and excessive leverage built into the system mean
> that even the slightest impetus as a trigger the markets could set
> off systematic collapse. Yes, even today, after Bear Stearns, Countrywide,
> Lehman Brothers, AIG and Washington Mutual. The risk is not only
> still here, but it is more concentrated (read as “more dangerous”)
> than ever.
> Take JP Morgan as a prime example. This highly respected and highly
> rated financial giant holds nearly $80 trillion in derivatives (notional
> value), ahead of Bank of America’s $75 trillion and Goldman Sachs’
> $48 trillion. This notional value of JPMs derivatives is nearly 39
> times its total assets, 850 times its tangible equity and six times
> the US GDP.
> And here’s more:
> - In terms of gross market exposures, JPM’s gross derivatives receivables
> stood at $1.8 trillion as of 2Q09 (19x times its tangible equity)
> and its gross derivative payables stood at $1.7 trillion (18 times
> its tangible equity).
> - Of the net derivative receivables exposure of $97 billion, non-investment
> grade derivatives stood at 22.9%, enough to wipe off 23.6% of the
> bank’s tangible equity in the event asset prices moved significantly
> south. This is an exposure a large bank can’t afford to assume under
> the current and volatile market conditions.
> - In addition, the quality of JPM’s derivative exposure is even worse
> than Bear Stearns’ and Lehman’s derivative portfolio just prior to
> their fall. We all know what happened to Bear Stearns and Lehman
> Brothers, don’t we???
>
> There are other large hurdles that JPM faces which, under normal
> circumstances (without excessive government support), could very
> well spell doom for a bank. . Here’s the link to the public excerpt
> of our proprietary research that throws light on JPM’s unconsolidated
> off balance sheet VIEs, its deteriorating loan exposure, skyrocketing
> charge-offs, compressing net interest margins, volatile trading revenues,
> rising VaR and many other insights: boombustblog.com/index...;task=doc_download&...

Sep 29 10:45 PM

[fed_alchemy:]

On Sep 29 05:03 PM Albertarocks wrote:

> $600.000,000,000,000 still out there in derivatives
> $80,000,000,000 is the value of all the gold mined on the planet
Sorry.. Houston.......please respond..................

Sep 30 12:32 AM

[Albertarocks:]

On Sep 29 10:45 PM kmarkt2 wrote:

> SO what, if the holders of these derivatives
> default - who is at risk ?Lets shake this deck of cards !

kmarkt2, I'd love to think that could happen and only the banksters would get what they deserve. But the problem with that scenario would be that every bank on the planet would fail. There'd be no funds for "anybody" to borrow. Businesses woud fail, governments would cease to run - cease to exist, utilities would fail... the entire grid would shut down, permanently. That's how outrageously dangerous this situation really is. It's truly an armageddon situation the bastards have created and I can't see the way out. When I figure it out, I'll let ya know. In the meantime, buy some gold brother.

Sep 30 12:55 AM

[Mbuna:]

Let me get to the core issue here. In every argument and dissertation I have read in support of derivatives there are 2 aspects of the arguments that are present in every single case, sometimes explicit and sometimes implicit. The first of these is the absolute fact that the fundamental reason for the creation of derivatives was so that financial institutions could bypass their capital requirements to gain greater leverage. There are other "beneficial" reasons for the creation of derivatives but they are not the fundamental ones. Those who write in support of derivatives will often mention this aspect but always as a secondary matter to the hedging or insurance aspect of derivatives. This brings us to the second matter that I have never failed to find among those who support derivatives. Not only are they in denial of the fundamental reason for the creation of derivatives but they show all the classic signs of addiction, the signs that they should be in a 12 step program or some other kind of rehab. This is why I call derivatives "financial crack" and those who support derivatives "financial crack addicts". These people will happily warp reality to fit their "modus operandi" but the fact of the matter is you have trillions of dollars hanging on financial engineering whose primary purpose was to skirt regulations in order to gain greater leverage. Fools are born at a far greater rate than every minute

Sep 30 02:20 AM

[kmarkt2:]

The world would not come to an end, only the capitalistic fuedal lords of Wall Street, the City of London and the USD.
Mankind has the inert ability to self preserve, even in world wars. As such, it would be in US interest to start decapitating the Wall Street Lords that formulated and peddled these toxic derivatives as a sacrifice for the larger community. There is nothing perverse nor sacrosant about this singular action on these Lords of Finance, in order to save the US from an infinitely extended demise. There are a lot more good people in the US that deserves a better fate.


On Sep 30 12:55 AM Albertarocks wrote:

> On Sep 29 10:45 PM kmarkt2 wrote:

Sep 30 11:44 PM

[Anthony Har...:]

Thank you :)


On Sep 29 03:01 PM robert_sare wrote:

> Good job. Your article follows my thoughts exactly.
> Thank you,
> Bob Sare
> Grand Rapids, MI.

Oct 05 03:36 AM

[Anthony Har...:]

Kmarkt2,
Personally I am of the opinion that the “lending” or in other words, the bail-out program, in itself is like a double-edged sword… To hold the system together, the US Government had no alternative, but to aid these banks. Imagine the turmoil it would cause if the Fed just decided to back off. We’d definitely not be sitting here and discussing this!!! And now I believe, banks are desperately trying to shrug off these derivatives from their books, but unfortunately, there are no takers. The Fed gave over $1.3 trillion to the banks under various schemes – which is virtually a debt in those banks’ balance sheets – to keep their liquidity alive. The world has tried as much to keep its financial stack of cards upright. If this fails and the world enters into a double-dip recession (and I really pray that it doesn’t) do we as a single global economy, even stand a chance for a recovery again??? All multipliers sure go for a toss!!!
boombustblog.com/index...

On Sep 29 10:45 PM kmarkt2 wrote:

> Anthony,
>
> Are you trying to tell us all, that JP Morgan, BoA and the master
> of all, Goldman Sachs, has been digitizing $$$$ $$ into the economies
> of the World through generating derivatives - working on the warp
> speed of digitized multipliers ? If there is only $$ in the money
> supply worldwide, then who is lending to the buyers of these derivatives
> - US Treasury , Chinese ?
> Of course, they have every incentive to generate these multipliers
> when they take fees and commission on a buy and sell trade, with
> absolutely no risk. SO what, if the holders of these derivatives
> default - who is at risk ?Lets shake this deck of cards !

Oct 06 09:25 AM