Saturday , 19 August 2017


Will Rising Interest Rates Ignite the Derivatives Time Bomb?

Of the $200+ trillion in derivatives on US banks’ balance sheets, 85% are based on interest rates and for that reason I cannot take any of the Fed’s mumblings about raising interest rates seriously at all. Words: 529

In further edited excerpts from the original article* at www.seekingalpha.com, Graham Summers goes on to say:

Remember, most if not all, of the bailout money has gone to US banks in order to help them raise capital. So why would the Fed make a move that could potentially destroy these firms’ equity and essentially undo all of its previous efforts? That being said, I still see derivatives as a trillion dollar ticking time bomb with a short fuse.

Let me explain the situation in some detail, as follows:

The current notional value of derivatives on US commercial banks’ balance sheets is $203 trillion and 97% of these ($196 trillion) sit on FIVE banks’ balance sheets (more on this shortly).

If even 1% of this $203 trillion is “at risk” … you’re talking about $2 TRILLION in at risk bets made in the derivatives market.

If 10% of that 1% ends badly, you’re talking about $200 billion in losses.

If, with total equity at the five banks at $737, you assume that only 1% of derivatives are “at risk” (odds are it’s more) and 10% of that at risk money is lost, then you’ve wiped out nearly 1/3 of the banks’ equity.

If 2% of derivatives are “at risk” and 10% of those bets go bad, you’ve wiped out $400 billion or nearly half of the banks’ equity.

If 4% of derivatives are “at risk” and 10% of those bets go bad, you’ve wiped out all of their equity and they go to zero.

Remember, I’m only accounting for derivatives here. I’m not even including on balance sheet risks, mortgage backed securities, and all the other junk floating around.

Suffice to say derivatives are a huge time bomb waiting to go off and interest rates could well trigger them.

The bond market is demanding higher yields from US debt, i.e. US debt holders are unwilling to continue funding our profligate spending without getting paid more to do it, but if yields rise this could blow up the derivatives market (remember 85% of derivatives are related to interest rates).

So the question remains: which banks are sitting in the derivatives mine field? Remember, not all notional value of derivatives are at risk and no one knows how much money is at risk here but consider the following:

a) the derivatives market is totally unregulated.
b) the nightmare that has already occurred due to instruments that were allegedly regulated i.e. mortgage backed securities, etc.
c) that every attempt to increase transparency or accounting standards at the banks has been met with threats of financial Armageddon.

It’s very difficult not to be freaked out by the above numbers. Personally, I sure hope that less than 0.0001% of that stuff is “at risk.” I hope bankers were more careful with interest-rate based derivatives than they were with mortgage-backed securities but I doubt it.

*http://seekingalpha.com/article/169859-derivatives-a-banking-time-bomb-waiting-to-go-off

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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