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Banks, Collateral And Leverage

Article at Bloomberg today, about banks transforming collateral for clients. Collateral for derivative trades is required to be high grade, and many of the hedge funds involved don't have the proper collateral. Big banks to the rescue, they will transform it, as a service to clients. It's a kind of securities lending.

Discussion of clearing houses, notional amounts, collateral ratios as low as .5%. That would be 200 to 1 leverage, backed by borrowed collateral.

Meanwhile the amount of collateral required is material with respect to the amount of triple A in circulation. So there is additional demand for treasuries, to back derivative speculation.

It is peculiar, the high leverage permitted to place speculative bets, many of which are designed to profit from systemic collapse or weakness. Meanwhile, the cost of capital for honest businesses, such as life insurance, is such that P/E's under 10 are the norm.

It appears regulators, by focusing on the big banks, have forced them to operate in a relatively stable and secure way. The risk has been pushed out into uncharted areas of the financial system, mainly hedge funds and private equity. LTCM was big enough to endanger the system, with 20 to 1 leverage on a bond business. 200 to 1 on derivatives doesn't look good.

At age 65, and with my portfolio close to meeting objective, I am starting to go defensive. That includes some hedging, as well as moving cash toward 20%.