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Could the Global Derivatives Market Tip Over?



By: David Chapman


-- Posted Friday, 25 May 2012 | | Disqus

TECHNICAL SCOOP

CHART OF THE WEEK

26 Wellington Street East, Suite 900, Toronto, Ontario, M5E 1S2

Phone (416) 604-0533 or (toll free) 1-866-269-7773 , fax (416) 604-0557

david@davidchapman.com

dchapman@mgisecurities.com

www.davidchapman.com

The picture is rather stark. This is a chart shown in an article at Global Research (www.globalresearch.ca) – Financial Implosion: Global Derivatives at 1,200 Trillion Dollars 20 Times the World Economy. It bears repeating.

 

Specifically the chart shows the assets of five of the USA’s largest banks vs. their respective derivative position. Derivatives dwarf the asset position of the banks. Wachovia and HSBC (USA) are not even amongst the top five derivative players in the US. The top five in order are JP Morgan Chase, Bank of America, Morgan Stanley, Citigroup and Goldman Sachs. There is a huge drop off in derivative positions after the top five players. 

 

The global derivatives market is estimated by some at $1,200 trillion ($1.2 quadrillion). Estimating the size of the market is difficult. The Bank for International Settlements (BIS) shows a size of $647 trillion as of December 2011. However, some market followers who have written books on the subject have estimated the market as being even larger at upwards of $1.2 quadrillion. At that level it is 20 times the size of the global economy estimated at $60 to $70 trillion.

 

The global derivatives market is unregulated and quite possibly under reported. The financial institutions have successfully lobbied for years to block any attempt at regulating the market. Roughly 75% of the market is interest rate contracts (i.e. forward rate agreements, interest rate swaps (the largest component) and options on interest rates). The next largest component is foreign exchange contracts and that only constitutes roughly 10% of the market. The third largest category is credit default swaps (CDS) and that makes up roughly 4% of the market. The rest of the market consists of commodity contracts and equity linked contracts.

 

As noted the BIS estimates the size of the global derivatives market at $647 trillion as of December 2011. But the BIS number only includes the over the counter market (OTC). It does not include exchange traded derivatives. Overall the global OTC derivatives market has a gross credit exposure of $3.9 trillion. What that effectively means is that if all of the derivative contracts defaulted the hit to the financial institutions would be $3.9 trillion. According to www.banksdaily.com the market capitalization of the world’s largest banks who are the most likely to be involved in the global derivatives market is $2.6 trillion. The potential credit exposure of derivatives exceeds the bank’s capital.

 

In the global derivatives market the big five US banks dominate the market. In a total global derivatives market using the BIS number of $647 trillion JP Morgan is the world’s largest with at least $70 trillion of derivatives and possibly as high as $80 trillion. JPM’s derivative position is against an asset base of $1.8 to $2.2 trillion. JPM is estimated to have credit exposure for their derivatives of 256% of capital. For the top five US banks the ratio is 316%. This far exceeds the estimated global credit exposure of derivatives when compared to the market cap of the world’s largest banks.

 

The top five US banks are estimated to hold at least $290 trillion of derivatives making them 44% of the global market using the BIS estimate. The banks have netting agreements which are supposed to cover upwards of 90% of the market. Except the netting agreements are merely a piece of paper to cover the reality that if a major player collapsed it could threaten the entire system. Think of American International Group (AIG-NYSE) in the 2008 financial crash where netting agreements were meaningless in the face of AIG’s collapse. AIG’s share capital was wiped out. The bail out of AIG with taxpayer money was effectively a circle in order to protect the integrity of Goldman Sachs, Morgan Stanley and the other major derivative players.

 

JP Morgan initially reported a $2 billion loss on their derivatives book because of a hedge that had gone offside. JP Morgan later admitted that the loss was now $3 billion. A few days later a Wall Street Journal article raised the estimate to an $8 billion loss. Then several sources raised the loss to $18 billion. Trouble is JP Morgan has been quiet on any of the rumours neither denying nor confirming these numbers. So what is going on?

 

The global derivatives market is huge. Losses in the sector could quickly wipe out the capital of some of the world’s largest banks which could require a bail out on a scale even larger than was seen in 2008. Some have described the global derivatives market as a huge gambling casino.

 

Could an accident in the global derivatives market cause the next financial panic? It happened in 2008 and since then very little has changed. Except the derivatives market has become even larger.

 

I will write more on this subject in the coming weeks.

 

copyright 2012 All Rights Reserved David Chapman


General Disclosures

The information and opinions contained in this report were prepared by MGI Securities. MGI Securities is owned by Jovian Capital Corporation (‘Jovian’) and its employees. Jovian is a TSX Exchange listed company and as such, MGI Securities is an affiliate of Jovian. The opinions, estimates and projections contained in this report are those of MGI Securities as of the date of this report and are subject to change without notice. MGI Securities endeavours to ensure that the contents have been compiled or derived from sources that we believe to be reliable and contain information and opinions that are accurate and complete. However, MGI Securities makes no representations or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to MGI Securities that is not reflected in this report. This report is not to be construed as an offer or solicitation to buy or sell any security. The reader should not rely solely on this report in evaluating whether or not to buy or sell securities of the subject company.

 

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Each MGI Securities technical strategist whose name appears on the front page of this technical market report hereby certifies that (i) the opinions expressed in the technical market report accurately reflect the technical strategist’s personal views about the marketplace and are the subject of this report and all strategies mentioned in this report that are covered by such technical strategist and (ii) no part of the technical strategist’s compensation was, is, or will be directly or indirectly, related to the specific views expressed by such technical strategies in this report.

 

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MGI Securities permits technical strategists to own and trade in the securities and or the derivatives of the sectors discussed herein.

 

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For Canadian Residents: This report has been approved by MGI Securities which accepts responsibility for this report and its dissemination in Canada. Canadian clients wishing to effect transactions should do so through a qualified salesperson of MGI Securities in their particular jurisdiction where their IA is licensed.

 

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-- Posted Friday, 25 May 2012 | Digg This Article | Source: GoldSeek.com

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