OMG: $707 TRILLION in Derivative Contracts?

[expat_panama]

...Let's start with how a CDS can work in real life. A bank pays an underwriter to guarantee repayment of a $1M mortgage that only has $1 pending....

Lost me already. $1 pending? Meaning what? A million dollar mortgage means...

Whoa, when people are lost they usually decide to stop, look, listen, and think. Try this:

A bank loans a $half million to someone buying a $M property; the bank gets title to the $1M property and borrower gets a $half million debt and can use the place while the mortgage's being paid. Then the borrower pays back $499,999 while the bank pays an underwriter to guarantee repayment of the balance of the $1M mortgage that now has only has $1 to be paid. If the UW turns around and sells the CDS to a broker that bundles it into a package and the note ends up showing up on a million ledgers, then we've got a 'notional value' of a trillion dollars. The instant the last $1 is paid and the mortgage is canceled, it voids each of the CDS's and the entire $T 'notional value' disappears.

Really no point in anyone getting a bee in their pantyhose over this '$707,568,901,000,000 notional value', although I'll concede that some poeple just want to run up and down the street in their pantyhose and the reason's never that important.

 

[Mad Scientist]

...Let's start with how a CDS can work in real life. A bank pays an underwriter to guarantee repayment of a $1M mortgage that only has $1 pending....

Lost me already. $1 pending? Meaning what? A million dollar mortgage means...

Whoa, when people are lost they usually decide to stop, look, listen, and think. Try this:

A bank loans a $half million to someone buying a $M property; the bank gets title to the $1M property and borrower gets a $half million debt and can use the place while the mortgage's being paid. Then the borrower pays back $499,999 while the bank pays an underwriter to guarantee repayment of the balance of the $1M mortgage that now has only has $1 to be paid. If the UW turns around and sells the CDS to a broker that bundles it into a package and the note ends up showing up on a million ledgers, then we've got a 'notional value' of a trillion dollars. The instant the last $1 is paid and the mortgage is canceled, it voids each of the CDS's and the entire $T 'notional value' disappears.

Really no point in anyone getting a bee in their pantyhose over this '$707,568,901,000,000 notional value', although I'll concede that some poeple just want to run up and down the street in their pantyhose and the reason's never that important.

You conveniently leave out the fact that the vast majority of those over leveraged mortgages aren't getting paid off! And maybe never will! What's you answer now Ex-Pat?

The banks want to hang that debt on somebody, anybody! And now we see the bought and paid for politicians all over the world (See Europe) trying to hang all that debt on it's citizens. Any country that tries to hang "austerity measures" on it's citizens (including the US) is proof that it's been taken over by banking interests.

Banks are "too big to fail" but apparently the people aren't "too small to be debt slaves forever" aren't they?

 

[expat_panama]

... the vast majority of those over leveraged mortgages aren't getting paid off...

Ah, that's where we disconnected. You're changing the subject to defaulting over-leveraged mortgages while the rest of us are still doing average loans world wide. Of course you're free to continue off on your little tangent but I'll stick with the group. So much to do, so little time...

 

[Mad Scientist]

... the vast majority of those over leveraged mortgages aren't getting paid off...

Ah, that's where we disconnected. You're changing the subject to defaulting over-leveraged mortgages while the rest of us are still doing average loans world wide. Of course you're free to continue off on your little tangent but I'll stick with the group. So much to do, so little time...

Bullshit! You said all that leveraging "disappears" when the loan is paid off! Quote:

Let's start with how a CDS can work in real life. A bank pays an underwriter to guarantee repayment of a $1M mortgage that only has $1 pending. If the UW turns around and sells the CDS to a broker that bundles it into a package and the note ends up showing up on a million ledgers, then we've got a 'notional value' of a trillion dollars. The instant the last $1 is paid and the mortgage is canceled, it voids each of the CDS's and the entire $T 'notional value' disappears.

And unless the US reverses 30 years of shipping jobs overseas, them mortgages aint getting paid off in 30, 20, 10 or even 5 years from now by people who make minimum wage at Burger King.

 

[expat_panama]

... the vast majority of those over leveraged mortgages aren't getting paid off...

Ah, that's where we disconnected. You're changing the subject to defaulting over-leveraged mortgages while the rest of us are still doing average loans world wide. Of course you're free to continue off on your little tangent but I'll stick with the group. So much to do, so little time...

Bullshit!...

Zowie, you win on that one! No way anyone's ever going to tell you about stuff that you eat, sleep, and live with everyday. Me, I can talk money, loans, mortgages, real estate, and I can live with my limitations. I can only dream of the kind of stink you can make...

Cheers!

 

[uscitizen]

$707,568,901,000,000: How (And Why) Banks Increased Total Outstanding Derivatives By A Record $107 Trillion In 6 Months | ZeroHedge

While everyone was focused on the impending European collapse, the latest soon to be refuted rumors of a quick fix from the Welt am Sonntag notwithstanding, the Bank of International Settlements reported a number that quietly slipped through the cracks of the broader media. Which is paradoxical because it is the biggest ever reported in the financial world: the number in question is $707,568,901,000,000 and represents the latest total amount of all notional Over The Counter (read unregulated) outstanding derivatives reported by the world's financial institutions to the BIS for its semi-annual OTC derivatives report titled "OTC derivatives market activity in the first half of 2011." Indicatively, global GDP is about $63 trillion if one can trust any numbers released by modern governments.

Said otherwise, for the six month period ended June 30, 2011, the total number of outstanding derivatives surged past the previous all time high of $673 trillion from June 2008, and is now firmly in 7-handle territory: the synthetic credit bubble has now been blown to a new all time high. Another way of looking at the data is that one of the key contributors to global growth and prosperity in the past 10 years was an increase in total derivatives from just under $100 trillion to $708 trillion in exactly one decade. And soon we have to pay the mean reversion price.

What is probably just as disturbing is that in the first 6 months of 2011, the total outstanding notional of all derivatives rose from $601 trillion at December 31, 2010 to $708 trillion at June 30, 2011. A $107 trillion increase in notional in half a year. Needless to say this is the biggest increase in history.

So why did the notional increase by such an incomprehensible amount? Simple: based on some widely accepted (and very much wrong) definitions of gross market value (not to be confused with gross notional), the value of outstanding derivatives actually declined in the first half of the year from $21.3 trillion to $19.5 trillion (a number still 33% greater than US GDP).

Which means that in order to satisfy what likely threatened to become a self-feeding margin call as the (previously) $600 trillion derivatives market collapsed on itself, banks had to sell more, more, more derivatives in order to collect recurring and/or upfront premia and to pad their books with GAAP-endorsed delusions of future derivative based cash flows. Because derivatives in addition to a core source of trading desk P&L courtesy of wide bid/ask spreads (there is a reason banks want to keep them OTC and thus off standardization and margin-destroying exchanges) are also terrific annuities for the status quo.

Can someone please explain to me why this is not as insane as it seems to be?

And most think we have hit bottom?

We have learned nothing yet.

 

[Mad Scientist]

Ah, that's where we disconnected. You're changing the subject to defaulting over-leveraged mortgages while the rest of us are still doing average loans world wide. Of course you're free to continue off on your little tangent but I'll stick with the group. So much to do, so little time...

Bullshit!...

Zowie, you win on that one! No way anyone's ever going to tell you about stuff that you eat, sleep, and live with everyday. Me, I can talk money, loans, mortgages, real estate, and I can live with my limitations. I can only dream of the kind of stink you can make...

Cheers!

Please explain how 1,500 Trillion in Global Derivatives gets paid off.

You can't.

They're based on bundled and swapped subprime mortgages that were sold tens and maybe hundreds of times over and will never get paid off. That's why the Bankers are trying to sluff it off onto sovereign countries like Greece and Italy.

The banks made bad bets and lost, let them fail. Let us and our economy get on with our lives.

 

[Toro]

I confess that the games played in the dereivatives markets are beyond my ken, JB...

This happens a lot, people don't understand something so they decide it's bad. My experience is that the lack of understanding is by choice, as I've tried explaining the mysteries on these forums and nobody seems to want to find out that their new found enemy isn't so bad after all.

My take is that this kind of behavior is so common that it's probably part of human nature, and it's the same humanity that's some how been raising an ever advancing civilization. I don't know how that can be possible but while I study it I'll accept the fact that it is. That's the smart thing to do. Derivatives have been around for centuries and they work. Refusing to learn about them and see their benefits is not smart.

As I understand it, for any equity of value X there are at least 8*X in credit default swaps written on it. So how does the company selling all those CDS cover their obligations when a company LARGER than they are goes bankrupt?

Editec is right about AIG and most of what took down AIG was all the CDS written on the derivatives market.

There is not $707 TRILLION worth of capital in all the damned banks combined so this is all just electronic digits in some computer somewhere and the banksters are probably praying right now that they can keep running their ginormous Ponzi long enough to bail out and let the whole damned thing crash and burn after they got theirs.

As to derivative contracts being around forever, maybe, though I doubt it. I do know that as recently as the 1940s most bankers regarded them as fools gold and wrote regs to keep them under control. Cant help but wonder what idiots let that demon out of the bottle.

CDS stands for "credit default swap." CDS is written on debt not equity. Equity cannot default.

 

[JimBowie1958]

This happens a lot, people don't understand something so they decide it's bad. My experience is that the lack of understanding is by choice, as I've tried explaining the mysteries on these forums and nobody seems to want to find out that their new found enemy isn't so bad after all.

My take is that this kind of behavior is so common that it's probably part of human nature, and it's the same humanity that's some how been raising an ever advancing civilization. I don't know how that can be possible but while I study it I'll accept the fact that it is. That's the smart thing to do. Derivatives have been around for centuries and they work. Refusing to learn about them and see their benefits is not smart.

As I understand it, for any equity of value X there are at least 8*X in credit default swaps written on it. So how does the company selling all those CDS cover their obligations when a company LARGER than they are goes bankrupt?

Editec is right about AIG and most of what took down AIG was all the CDS written on the derivatives market.

There is not $707 TRILLION worth of capital in all the damned banks combined so this is all just electronic digits in some computer somewhere and the banksters are probably praying right now that they can keep running their ginormous Ponzi long enough to bail out and let the whole damned thing crash and burn after they got theirs.

As to derivative contracts being around forever, maybe, though I doubt it. I do know that as recently as the 1940s most bankers regarded them as fools gold and wrote regs to keep them under control. Cant help but wonder what idiots let that demon out of the bottle.

CDS stands for "credit default swap." CDS is written on debt not equity. Equity cannot default.

True, I was being overly brief and misstated the thing.

IF Bank 1 loans Billy $1 million to buy $1 million in Ford stock, they might then buy a CDS to cover the loss if Billy fails to repay. This is like insurance, but as Wiki explains it:
Credit default swap - Wikipedia, the free encyclopedia

However, there is a significant difference between a traditional insurance policy and a CDS. Anyone can purchase a CDS, even buyers who do not hold the loan instrument and may have no direct insurable interest in the loan. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults.These are called "naked" CDS, and in fact are a "bet" on default.

But for every $1 where the CDS buyer actually holds the debt on an equity or stock,etc, there are $8 of CDS where the buyer does NOT. This magnifies the damage done by bankruptcies as for every $1 lost in equity value, $8 of CDS is paid off, if the CDS seller is able to make the payments.

Credit default swap - Wikipedia, the free encyclopedia

The risk of counterparties defaulting has been amplified during the 2008 financial crisis, particularly because Lehman Brothers and AIG were counterparties in a very large number of CDS transactions. This is an example of systemic risk, risk which threatens an entire market, and a number of commentators have argued that size and deregulation of the CDS market have increased this risk.

For example, imagine if a hypothetical mutual fund had bought some Washington Mutual corporate bonds in 2005 and decided to hedge their exposure by buying CDS protection from Lehman Brothers. After Lehman's default, this protection was no longer active, and Washington Mutual's sudden default only days later would have led to a massive loss on the bonds, a loss that should have been insured by the CDS. There was also fear that Lehman Brothers and AIG's inability to pay out on CDS contracts would lead to the unraveling of complex interlinked chain of CDS transactions between financial institutions.[89] So far this does not appear to have happened, although some commentators[who?] have noted that because the total CDS exposure of a bank is not public knowledge, the fear that one could face large losses or possibly even default themselves was a contributing factor to the massive decrease in lending liquidity during September/October 2008.[90]

Chains of CDS transactions can arise from a practice known as "netting".[91] Here, company B may buy a CDS from company A with a certain annual premium, say 2%. If the condition of the reference company worsens, the risk premium rises, so company B can sell a CDS to company C with a premium of say, 5%, and pocket the 3% difference. However, if the reference company defaults, company B might not have the assets on hand to make good on the contract. It depends on its contract with company A to provide a large payout, which it then passes along to company C.

The problem lies if one of the companies in the chain fails, creating a "domino effect" of losses. For example, if company A fails, company B will default on its CDS contract to company C, possibly resulting in bankruptcy, and company C will potentially experience a large loss due to the failure to receive compensation for the bad debt it held from the reference company. Even worse, because CDS contracts are private, company C will not know that its fate is tied to company A; it is only doing business with company B.

And so this $707 TRILLION in derivatives is built on shakey sand, to say the least and one major default places more stress on the banking system as a whole.

How much will the system take till the whole thing collapses?

I suspect we are about to find out.

 

[editec]

...Let's start with how a CDS can work in real life. A bank pays an underwriter to guarantee repayment of a $1M mortgage that only has $1 pending....

Lost me already. $1 pending? Meaning what? A million dollar mortgage means...

Whoa, when people are lost they usually decide to stop, look, listen, and think. Try this:

A bank loans a $half million to someone buying a $M property; the bank gets title to the $1M property and borrower gets a $half million debt and can use the place while the mortgage's being paid.

Okay with you so far. Somebody borrows a half mil to buy a place. The buyer has a half mil invested and borrowed another half mil

Then the borrower pays back $499,999 while the bank pays an underwriter to guarantee repayment of the balance of the $1M mortgage that now has only has $1 to be paid.

Whoa! The bank buys an insurance policy to protect $1?!

That makes like ZERO sense

Why would the bank DO THAT?

 

[Toro]

But for every $1 where the CDS buyer actually holds the debt on an equity or stock,etc, there are $8 of CDS where the buyer does NOT. This magnifies the damage done by bankruptcies as for every $1 lost in equity value, $8 of CDS is paid off, if the CDS seller is able to make the payments.

There are far more "uncovered" CDS written than covered CDS, this is true. And what it does is alter the bankruptcy process. It makes it more likely a firm will go bankrupt. But it doesn't necessarily make the bankruptcy process more damaging. CDS has created the perverse affect of incentivizing bankruptcy, but bankruptcy is just the re-ordering of liabilities and assets. Most companies that go bankrupt continue to exist. Bankruptcy re-orders the claims on the assets.

And so this $707 TRILLION in derivatives is built on shakey sand, to say the least and one major default places more stress on the banking system as a whole.

How much will the system take till the whole thing collapses?

I suspect we are about to find out.

I don't want to minimize derivatives. Warren Buffett called derivatives "weapons of financial mass destruction." George Soros said derivatives will end society as we know it. However, most derivatives are plain interest rate and currency swaps. These have been around for decades.

 

[JimBowie1958]

But for every $1 where the CDS buyer actually holds the debt on an equity or stock,etc, there are $8 of CDS where the buyer does NOT. This magnifies the damage done by bankruptcies as for every $1 lost in equity value, $8 of CDS is paid off, if the CDS seller is able to make the payments.

There are far more "uncovered" CDS written than covered CDS, this is true. And what it does is alter the bankruptcy process. It makes it more likely a firm will go bankrupt. But it doesn't necessarily make the bankruptcy process more damaging. CDS has created the perverse affect of incentivizing bankruptcy, but bankruptcy is just the re-ordering of liabilities and assets. Most companies that go bankrupt continue to exist. Bankruptcy re-orders the claims on the assets.

What is damaged is total M3 wealth on the markets. If Company A is worth $100 million, but has $800 million in CDS written on it, then when it goes bankrupt, instead of the market losing $100 million in M3 wealth, it loses the $800 million. The effect on total capital available on the market is amplified by a factor of eight or more.

And so this $707 TRILLION in derivatives is built on shakey sand, to say the least and one major default places more stress on the banking system as a whole.

How much will the system take till the whole thing collapses?

I suspect we are about to find out.

I don't want to minimize derivatives. Warren Buffett called derivatives "weapons of financial mass destruction." George Soros said derivatives will end society as we know it. However, most derivatives are plain interest rate and currency swaps. These have been around for decades.

It is the naked CDS and the inclusion of so much poisonous subprime debt packaged in MBS, and CDOs that are kicking the financial markets in the balls right now. Banks are sitting on trillions of dollars of worthless equities as level three assets on their books when they know it is worthless.

IF they honestly reported the total value they would not have the necesary 3% assets to debt percentage to stay solvent; ie a huge number of banks are actually insolvent and are only solvent by acounting fantasy that the governments are allowing to avoid a huge ripple-tidal wave of crashes.

I have put all my money, such as it is, into bonds and credit unions. I am hoping that when the markets crash I will have time to switch my bonds back into stocks, but who knows when the true bottom will be reached or when bonds will start to tank? As I understand it bonds and stock tend to have an inverse relationship, but with all the High Frequency Trading programs dominating the market, these things can reverse 180 degreee in micro-seconds.

 

[expat_panama]

...this $707 TRILLION in derivatives is built on shakey sand, to say the least and one major default places more stress on the banking system as a whole. How much will the system take till the whole thing collapses? I suspect we are about to find out.

Doom'n'gloom may sell newspapers but what's happening is loans repayments are increasing while charge-off rates are falling back to normal.

 

[JimBowie1958]

...this $707 TRILLION in derivatives is built on shakey sand, to say the least and one major default places more stress on the banking system as a whole. How much will the system take till the whole thing collapses? I suspect we are about to find out.

Doom'n'gloom may sell newspapers but what's happening is loans repayments are increasing while charge-off rates are falling back to normal.

And charge off rates are still higher than historic averages, duh, so nothing is fixed yet. We are simply seeing the ebb of the credit tide for now; much more is coming.

Banks have slowed their foreclosure rates due to the glut of foreclosed homes on the markets and they will sit on 4 month old delinquent loans and go into one kind of arrangement with the borrower to avoid having to charge off the loan.

It costs them less to just let people sit in their homes for free than to take the home and have to maintain it till it eventually gets resold. Some homes are being bulldozed rather than maintained by banks. So much of the drop in charge offs is artificial as banks desperately come up with new ways to avoid more losses.

Also, we have seen the economy recover somewhat since the peak of the recession two years ago. But more bad news is coming as the banks start to collapse in Europe and that ripple effect rolls over here to the US where our banks have huge exposure to European debt with JP Morgan holding $79 TRILLION in CDS and BoA holding $75 TRILLION for example.

What we see happening in Greece, Italy, Spain, Portugal and Ireland is likely to spread to France, then the UK and Germany and then the US as well unless something drastic is done now.

But that wont likely happen as long as pollyana's like you keep telling everyone that everything is fine. You should get "Don't worry, be Happy" tatooed to your forehead.

 

[expat_panama]

...the whole thing collapses? I suspect we are about to find out.

Doom'n'gloom may sell newspapers but...

...charge off rates are still higher than historic averages...

Overnight improvement, we just went from 'collapse' to 'higher than average'. If out of a hundred loans all but 1-1/2 are being paid off then we're a very long way from collapse.

Banks have slowed their foreclosure rates due to the glut of foreclosed homes on the markets and they will sit on 4 month old delinquent loans...

No they won't, that may be what we imagine but bank reports the Fed's gotten tell us--

--over 94% of loans are being paid back are paid on time. Americans are not failures with banks sitting on bad loans, we're good honest hard working and trustworthy people. Most of us that is.

...pollyana's like you...

Super! We're done with economics and now into name calling mode. I can go on to work elsewhere knowing the name calling will be performed by experts that can do it so much better than me.

Have at it guy, and cheers!

 

[Mad Scientist]

...pollyana's like you...

Super! We're done with economics and now into name calling mode. I can go on to work elsewhere knowing the name calling will be performed by experts that can do it so much better than me.

Have at it guy, and cheers!

Don't act all butt hurt. If you can explain to us why 1,500 Trillion in derivatives aren't a problem then just do it.

 

[editec]

I am finally beginning to understand how the "derivative" problem can be multiples of the GROSS WORLD PRODUCT.

The short version of the system

Basically there can be and often ARE are insurance policies on top of insurance policies on top of insurance policies ALL HINGED on the outcome of a single debt instrument.

Basically one investor takes out an insurance contract, but they too are indebted to another lender, so the second lender takes out a contract on the first bank going insolvent based on that debt, and still a third lender to the second bank takes out still another derivative on the second banks and so on and so on.

It has to do with the way the Shadow banking system works to mitigate rish by spreading it out among other fiancial instiutions.

That is in part WHY we can have a cascading debt crises

 

[JimBowie1958]

Doom'n'gloom may sell newspapers but...

...charge off rates are still higher than historic averages...

Overnight improvement, we just went from 'collapse' to 'higher than average'.

No, the collapse is still coming, duh.

You remind me of the guy who fell off the top of the Empire State building and who was heard saying, as he fell past the 30th floor, 'Well, not too bad so far.'

--over 94% of loans are being paid back are paid on time.

And that 6% is disasterous for an industry that makes its money on very small percentages.

Americans are not failures with banks sitting on bad loans, we're good honest hard working and trustworthy people. Most of us that is.

That I agree with you on.

...pollyana's like you...

Super! We're done with economics and now into name calling mode. I can go on to work elsewhere knowing the name calling will be performed by experts that can do it so much better than me.

Have at it guy, and cheers!

Lol, you started the 'name calling' with your broad-brush stroke labeling everyone questioning this stuff as 'doom and gloomers'.

Truth is, though, you are a Polyana.

 

[expat_panama]

This is a bad place for convincing others how smart we are; rarely happens. This is a great place to offer an idea and watch others kick it around; we really need to know how robust our ideas are--

...Doom'n'gloom may sell newspapers but what's happening is loans repayments are increasing...

--and we can usually tell the ideas are solid if others change the subject usually by say, switching from economics to personalities. Most of us here are good people ever improving out communication skills. It's good to ridicule bad ideas and call them either 'delusional', 'pollyanic'. or 'doom'n'gloom', while we understand that good people can sometime offer goofy ideas without they themselves having to be doom'n'gloomers or Pollyannas.

...you started the 'name calling' with your broad-brush stroke labeling everyone questioning this stuff as 'doom and gloomers...

The thing is to attack the idea, not the person. Some posters here are chronic name-callers and it's best to steer clear of that kind of toxic personality. Life is short and we got so many other good threads on this forum as well as so many other good forums (eg. Free Republic and Libery Post ).

 

[diptherio]

Another problem with all this CDS and MBS nonsense...the brokers take their fees up-front and sell the risk down the road, i.e. the guys (or gals) creating all this risk are not the ones who will get burned if it all goes bad. De-coupling risk from gain is a very, very bad thing.

Expat, I just have to say, you can't start out by saying that you're going to show us how CDS's can work in the real world and then present a scenario where a million dollar loan is left with just $1 remaining on it. Come on...