oldgoldbug

How Banks Hedge Counterparty Risk

Right on copperbaron. Now the gigantic leverage employed makes sense. I guess in my simple mind it is like buying a stock, selling a call and buying a put. Theoretically you are all hedged up against loss and if you can put this position on with even a small positive return you just keep doing it, because leverage isn't seen as a danger. Especially if you are a GS, LEH(MQ) etc and can do everything really cheap. However if the stock plunges (lets just use MOS because it seemed so unlikely based on the fundamentals) and the seller of the put goes under and can't buy from you at a much higher price, your hedge just went bye, bye. Now you have to mark to the market, meet the margin call, end up long and hope for the best or sell the stock and owe your brokerage firm lots of money. Ouch.
Gets a lot worse if you can't sell the stock or more calls, kind of like the "seized up" credit markets. Then you are stuck and hope Uncle Henry can bail you out. I think I am starting to have an inkling of what is going on.
Ah, I love the smell of deregulation in the morning.