World Derivatives Market Estimated As Big As $1.2 Quadrillion Notional, as Banks Fight Efforts to Rein It In

Yves here. Readers have asked us to write about the ginormous scale of the derivatives market. This article is a layperson-friendly discussion of bank efforts to stymie the not-onerous safeguards in Dodd Frank and why you should be up in arms about it. Derivatives, specifically credit default swaps, were the reason what would otherwise been a contained subprime crisis into a global financial meltdown. If you have not done so already, we strongly encourage you to call your Senator and Representative and tell them you are strongly opposed to this stealth effort by banks to keep taxpayers on the hook for the derivatives casino and allow it to continue to operate with minimal supervision.

By Gaius Publius. Cross posted from Americablog

We wrote earlier about the recent move by bankers — and the politicians who serve them — to unreform the derivatives market, to return it to its pre–Dodd-Frank, pre–Crash-of-2007 state. This is a serious move by banks and bank lobbyists, and it could well happen soon. The seven bills in the House package of “tweaks” — as the House Agriculture website dishonestly puts it — have cleared the committee with Democratic support and are headed to the House floor. In the meantime, there are companion bills in the Senate.

What will happen in the Senate? Well, Dick Durbin (always an Obama surrogate) famously said of the Senate that “the banks own the place.” And of course the White House has been notoriously bank-friendly since day 1. As a friend told me last week, “Bank lobbyists are good; they really earn their money.” Indeed.

Our earlier story focused on both aspects of this push — the “bad Dems” side and the derivatives side. Let’s now look at just the derivatives aspect.

What is a “derivative”?

While a general definition of a derivative in this context could be — “A financial product derived from another financial product” (for example, a futures contract tied to a stock index) — in practice, the term applies to a whole world of financial products that are written on a one-off basis between two entities called “counterparties,” as opposed to products that are traded on a broad, well-regulated market.

Standard futures contracts are bought and sold on large exchanges, for example, the Chicago Board of Trade (CBOT). If I buy a futures contract — for example, I go long (contract or agree to buy in the future) a million bushels of wheat, or barrels of oil, in the expectation that the future price will rise within the time limit of the contract — there will be a counterparty on the short, or selling side, but I have no idea who that is. In fact, in a well-regulated market, the contracts are all standardized; there are thousands of identical contracts in pairs (one on the long or buy side, and one on the short or sell side); and as long as there are the same number of identical contracts on each side, it makes no difference who’s on the other side of my personal contract. The exchange just matches up longs with shorts when they liquidate.

The contracts, as you can see, are created by the exchanges themselves (for example, by the CBOT); they keep the operation orderly; and there are rules, both by the exchanges and by the government, that prevent things (mostly) from running out of control. For example, I can indeed buy futures contracts on millions and millions of barrels of oil for delivery next July (say), and I can put up a tenth of the cost of these contracts, but if the market moves against me, I have to increase my margin (add to my escrow if you will) to protect my counterparties from my inability to pay. The exchange requires that, and if I don’t comply, I’m liquidated (at my expense) and kicked out.

Futures contracts are gambling — I can bet on the Dow to go down or up, for example — but trading in futures contracts is regulated gambling, in which winners are protected from losers, and in many cases, losers protected from themselves.

Not so, derivatives, in the usual meaning of the word. Derivatives in that sense are contracts between parties who want to trade risks, but they aren’t market-traded. They aren’t standardized. And counterparties aren’t vetted by any controlling institution.

In derivatives trading, the counterparties know each other, the contracts are one-off between the parties directly, and the only guarantee that either party will get paid is trust … or the naked belief that they just can’t lose on this one.

AIG wrote billions of dollars of CDS “insurance” against the mortgage market without having even a fraction of what it would take to pay off claims … in the naked belief that they could collect fees forever and never have to pay out once. When the whole thing collapsed, they were wiped out. And because their “insurance” was part of the balance sheet of AIG’s many counterparties (Goldman Sachs and everyone like them), Goldman Sachs would have been wiped out too by AIG’s failure (in effect, by their lies and deception).

That’s why the government bailed out AIG — and insisted on giving them 100 cents on the dollar — so that they could pay off Goldman et al. AIG was bailed out to bail out all their counterparties. (Our discussion of CDSs and their role as bets is here.)

How large is the derivatives market? $1.2 quadrillion in notional value; at least $12 trillion in cash at risk

You read that headline right. By at least one estimate, in 2010 there was a total of $12 trillion in cash tied up (at risk) in derivatives as defined above, all of which controlled contracts connected to assets valued at $1.2 quadrillion.

Here’s how we got those numbers — be sure to differentiate the two values, cash value vs. notional value, as explained below (h/t commenter BeccaM for the link; my emphasis):

Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP

One of the biggest risks to the world’s financial health is the $1.2 quadrillion derivatives market. It’s complex, it’s unregulated, and it ought to be of concern to world leaders that its notional value is 20 times the size of the world economy. But traders rule the roost — and as much as risk managers and regulators might want to limit that risk, they lack the power or knowledge to do so. A quadrillion is a big number: 1,000 times a trillion. Yet according to one of the world’s leading derivatives experts, Paul Wilmott, who holds a doctorate in applied mathematics from Oxford University (and whose speaking voice sounds eerily like John Lennon’s), $1.2 quadrillion is the so-called notional value of the worldwide derivatives market. To put that in perspective, the world’s annual gross domestic product is between $50 trillion and $60 trillion. To understand the concept of “notional value,” it’s useful to have an example. Let’s say you borrow $1 million to buy an apartment and the interest rate on that loan gets reset every six months. Meanwhile, you turn around and rent that apartment out at a monthly fixed rate. If all your expenses including interest are less than the rent, you make money. But if the interest and expenses get bigger than the rent, you lose.

You might be able to hedge this risk of a spike in interest rates by swapping that variable rate of interest for a fixed one. To do that you’d need to find a counterparty who has an asset with a fixed rate of return who believed that interest rates were going to fall and was willing to swap his fixed rate for your variable one.

The actual cash amount of the interest rates swaps might be 1% of the $1 million debt, while that $1 million is the “notional” amount. Applying that same 1% to the $1.2 quadrillion derivatives market would leave a cash amount of the derivatives market of $12 trillion — far smaller, but still 20% of the world economy.

To trust that lower number ($12 trillion), a lot depends on what’s being traded. In the example above — an “interest rate swap” — what’s being traded (swapped) is the risk of small interest rate changes on the $1 million you borrowed. It’s never the whole $1 million (the notional value).

But with a CDS — a “credit default swap” as discussed here — what’s traded is a fee paid by one side vs. the whole cost of the default paid by the other side. If I as an “insurer” sold a hedge fund a CDS on $20 million in GM bonds, and those bonds default, I’m on the hook for the whole $20 million, the “notional” value.

As a result, I accept the $1.2 quadrillion notional value number. But I think the $12 trillion cash-at-risk number is way low. And “just” $12 trillion is, as they point out, still 20% of world GDP. Stunning.

And don’t forget, these are 2010 numbers. Banks have grown even fatter since then, even greedier, even riskier. And their push to gut the modest regulations put in place by Dodd-Frank declares their intentions to grow. Whatever the size of this market today, expect it to grow like a weed.

Again, House bill HR 992, one of the seven mentioned at the beginning of this piece, is the one that makes you, the taxpayer, even more on the hook for banker-losses than you were after the Dodd-Frank reform. For the banks, the high-priced lobbyists, and their paid, moderately-priced politicians, this is a Win-Win.

But for you, it’s a second trip to Bailout Village. As for the nation … well, I think there’s rebellion in the air if this happens twice. In this case, the hubris of our enemies is not our friend. Not our friend at all.

I thought you should know this, though. We’re going to be covering the derivatives story to conclusion. Hopefully this post and the previous one will keep you oriented as the game moves forward. Quoting Congressman Grayson again:

“The road to hell is paved with these bills.”


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  1. sd

    For context:

    1,000,000 Million
    1,000,000,000 Billion
    1,000,000,000,000 Trillion
    1,000,000,000,000,000 Quadrillion

    6,000,000,000,000 estimated cost of the Iraq War
    146,020,992 budget of the National Endowment for the Arts in 2012

    How about we give the money to the artists for a change? Considering how creative they can be with nothing, imagine what they can do with something. Sure beats bankers and bombs.

    1. rjs

      $1.2 quadrillion is beyond comprehension; assuming 7 billion people, it’s $171428.57 for every man, woman & child on the planet..

    2. Tinky

      Further perspective:

      If you earn $50,000 per year, it would take you 20 years to earn a million dollars.

      It would take you 20,000 years to earn a billion dollars.

      It would take you 20 million years to earn a trillion dollars.

      1. sgt_doom

        And the human (or psycho-greedhead) perspective:

        AIG wrote billions of dollars of CDS “insurance” …

        Yup, specifically AIG’s Financial Products group, one of their directors being Harvard’s Martin Feldstein, who also is the guy at NBER claiming we’ve been in a recovery all this time, and was a director at Eli Lilly when they were hit with the largest criminal penalty EVER, and a director at HCA when they were hit with the largest out-of-court pentalty settlement for their Medicare/Medicaid fraud. (Notice any pattern here?)

        And AIG wrote $460 billion of unregulated insurance (CDSes) with the potential payout of from $20 trillion to over $40 trillion and that’s why John Paulson, and Goldman Sachs (and Magnetar Capital and many, many other financial fraudsters) created all those crappy-sure-to-fail CDOs, which they purchased each CDS for approximately $1.4 million apiece, with each one having a payout of $100 million apiece and why Paulson made $3.4 billion from those very crooked deals, and why the Fed, and the US Treasury, bailed out AIG, and JPMorgan Chase, and Goldman Sachs, and Citigroup and Bank of America, and …..

  2. M.G. in Progress

    Let’s simply tax it heavily…far more than Tobin Tax or shouldn’t we tax gambling?

  3. Chris Engel

    I would argue that the cash value still overstates things.

    It’s good that you point out that the high-sounding notional values are essentially meaningless in terms of the actual cash flow risk and collateralized assets.

    But even then, a lot of these derivatives are offsetting, there’s a net risk at work that is most relevant for analytical purposes.

    It’s normal for banks to have crazy amounts of interest rate swaps, but they’re all tied to cash flows from other assets and liabilities!

    It reminds me of a case I worked on before with I think it was BankOne or another firm who had huge outstanding swaps in an era before derivatives were sexy, and there were analysts or bureaucrats who didn’t understand that the notionals weren’t relevant. In fact, even the cash value was overstated because the swaps are paired with actual risk-assets and you should therefore be analyzing the derivatives in the context of the assets they’re paired with in a NET risk fashion.

    So the big numbers turn heads, and you’re right to point out that the notionals are misleading.

    But what about the bigger picture, the net risk, since these derivatives by and large are taken out to mollify the risk exposure of existing assets? It’s still misleading to segment the derivatives market and not view the firm risk exposure as a holistic issue.

    That’s why the calls in the comments above this to “tax that money” are misleading. It’s like taxing an outstanding term life policy. Sure, you only pay $20 or so into such a policy semi-anually, but if it has a $500,000 notional value, oooo that sounds a lot juicier doesn’t it? But taxing a notional value of a life insurance policy is totally nonsensical.

    1. Laughing_Fascist

      “these derivatives by and large are taken out to mollify the risk exposure to existing assets”

      You can be sure the bankers and everyone else are arguing “hey we gotta be able to hedge our risks and its legitimate to do so.” All the big players have legitimate needs to hedge. And having the government tell businesses how to hedge would be a regulatory tangle and make these legit hedging operations more difficult. This is a powerful argument that keeps the clothes on the emperor and makes passage of HR 992 a possibility.

      The problem is they aren’t limiting their hedging to their own legitimate business risks. Instead they are betting on bullshit, such as whether Jack will fall down and break his crown. In the case of the banks that are playing the derivatives game and betting on Jack, if HR 992 passes in Congress and Obama signs off on it, and if Jack takes a tumble, the FDIC insured bank deposits can be used to pay Jack’s loan sharks. And even if it doesn’t pass, deposits are at risk anyway because the FDIC is not adequately policing the mandate to keep deposits firewalled.

      1. Laughing_Fascist

        Sorry for ranting on the obvious (above).

        Allowing the Goldman Sachs of the world to raid insured deposits via a call on derivatives is a good strategy for the raiders. The bank will pay GS. FDIC will step up and pay the unsecured depositors whose accounts disappeared.

        In a repeat of the 2007-8 meltdown scenario, FDIC will come up way short. So the argument to Congress from Hank Paulson’s latest successor will be: what! you have to bail out FDIC. Otherwise Mom and Pop and small business America will lose everything.

        And members of Congress will exclaim “we have to bailout FDIC!!” And rubber stamp the whole charade. Meantime GS and its cohorts have already moved on to the next extraction point where fangs can get a good grip.

      2. Marc

        Actually, it’s even worse than that. If many bankers are betting that Jack will lose his crown, there is incentive to help Jack lose his crown. With billions riding on derivative bets, then a few million to pay Jack’s opposition is a good investment. Or a few million to pay Jack’s assassin.

        This is why insurance companies learned long ago not to let anyone but a property owner insure for fire. It is far easier to achieve success if you are seeking destruction rather than construction.

      3. nonclassical

        ..worse yet, banksters can bet against their own known fraudulent assets with CDS….turning bad paper into profitable wreck…and not only bet once-they can place as many bets as they like on same house burning down…(bringing along dogs and marshmallows..)

      4. sgt_doom

        According to a recent study by the CFTC a year or so ago, 90% of futures purchases/trading is strictly speculative in nature — no hedging there!

    2. Simon

      I am willing to admit my lack of understanding, but to say the risk is ‘net’ surely means that someone else is signed up for that risk. Like ‘pass the parcel’ the risk doesnt disappear just because it is netted, it become systemic surely! Also the risk is not netted when the counterparty who offsets the risk tells you they cant pay. Then the whole think blows back in your face. GS had the belief they had netted the risk (or rather led others believe they had).

      1. Chris Engel

        Well that depends on how well the counterparties to the derivatives used to offset risk of an asset are capitalized. That’s a different issue though. The net SYSTEMIC (not net position risk as I was referencing it) risk is something that has to also have adequate reserves to support payouts given certain event probabilities.

        So mispriced CDSes pumped out by dopey firms like AIG would definitely be problematic because AIG had not measured the risk accurately at all and when it came time to pay it wasn’t possible cash-flow-wise.

        For systemic risk then, the appropriate components for soundness would be:

        – Health, capitalization, and risk management practices of derivative counterparties.

        – Aggregated net risk positions/exposure of asset-pairing.

        Again, the analysis has to go deep into figuring out just how offsetting the contracts are. Notionals are quite often not exchanged hands, they’re just reference points for cash flows.

        If the markets are more heavily regulated so that we can have the proper data to actually COMPILE AND MANAGE THESE RISKS then we would know more, but so much of it is mired in private documents and mixed estimates and other incomplete data.

      2. MRW

        Without the insider language, the simpler way of describing it is this:

        You have an IBM bond for $100. Even though you think the bond is good, you’re the cautious type, you still want to buy insurance on it. The CDS desk guy says sure I’ll insure your bond for $2/year. Both happy. If IBM defaults, you get your 100 bucks back.

        Then your friend finds out about your $2 insurance and goes to the CDS desk guy and says, I want to take out $2 insurance on Simon’s IBM bond. The CDS desk guy says, sure. Both happy.

        A dentist finds out your friend bought $2/yr insurance on some Simon guy’s IBM bond, and he goes to the CDS desk guy, who says “No Prob! Insured!” (But now the CDS guy is on the hook for $300 if the bond goes south.)

        Pretty soon 100 people, whom you have no clue about, have taken out have taken out $2/yr insurance on your $100 IBM bond, and the CDS desk guy is on the hook for $10,000 if the bond defaults. But he’s also making $2,000/yr on insurance from these 100 people.

        So the CDS desk guy hedges his exposure by going out and getting insurance on his $10,000 exposure. He gets it for a $200/year. Now he’s making $1,800 gravy. And his ass is covered.

        Until it all goes down like Lehman Brothers. Cascade.

        (1) There is no requirement to reveal the name of the people paying insurance on your bond through a public regulated exchange.

        (2) You have no idea how many other people have a claim against your bond.

        (3) You have no way of knowing if the CDS desk man has hedged his bets so that he CAN ACTUALLY pay you back.

        (4) These derivatives were created to help farmers and manufacturers hedge their bets (up & down) on fuel or resources costs, but they were just one-to-one. Then when Clinton came in and Gore started his ‘business is our client’ government makeover, coupled with Greenspan and Rubin whispering into these elected hayseeds’ heads, derivatives took off as described above. They went into overdrive on Oct 22, 1999 when Glass-Steagall was pried off. Then sealed it on Dec 15, 2000, the last day off congress with a 262-page addendum to an 11,000-page budget that said it was AGAINST THE LAW to regulate derivatives.

        They’d already seen one hedge fund almost go down in the 90s. I’m not a finance person, and I can’t remember the name. It started with “Long.” But Greenspan was saving that catastrophe on a Sunday morning if I remember correctly.

        Now make the entry fee for a CDS $5 million, because that’s what it costs to partay, and do the multiplication. We’re on the hook for the consequences of their risk-taking, and Congress will not give the same deal to the American people who suffered as a result of what they allowed them to do. Now these same moth**uckers want to take away the middle-class safety net? Social Security? And Medicare?

        Hmm. Yves is right. There will be a revolution. And OTP (Obama The Putz) is listening to Clinton’s govt surplus architect, and setting up the same foundation as last time.

        1. MRW

          Correction the math was wrong. He’s making $200/yr on the 100 people. (I original had 1000 people and forgot to change it.)

          So make it that he pays 1% on his $10,000 exposure ($100 fee) and he make $100/yr, the cost of your bond.

          Sorry about that.

    3. ToivoS

      Chris I think you just repeated the main arguments in article. So you really do not support your opening line I would argue that the cash value still overstates things.

      There is $1.2 quadrillion in notional value outstanding in interest rate and credit default swaps. The big question is what is the risk associated with all of those bets. 1% (or 20% of world GDP), 2% or more? Let us say 20% of world GDP disappeared tomorrow in one raging panic. Would that effect the world economy? Would bailing out the banks yet again risk some serious collapse in the standard of living for the rest of us?

      I was thinking of the IRSs against interest rate drops that Jefferson county Alabama sold to GS. Interest dropped and the fact was that the revenues from the sewer system was unable to honor contracts and the county defaulted. Of course the amount of money lost here was considerably less than notional values but how much real pain did this cause to the thousands of those involved. The notional value was a few hundred million dollars.

      Now what happens if a quadrillion dollars are involved — this is now 10 million times larger. I think it is reasonable to worry that the system simply could absorb that loss without some serious pain to every person on this planet.

      The example of Jefferson County involves just IRSs where loses are only small fractions of notional values. There are many CDSs involved here where loses could move towards 100% of notional values. This whole thing is so ridiculously complicated that no one can predict what might cause the whole house of cards to collapse. In fact to stick to that analogy when building a real house of cards can anyone really predict the initial failure point. If one could then it would be possible to reinforce that point in advance. But there is near certainty that it will collapse.

      1. Chris Engel

        Then you misread.

        The cash value calculated still overstates, for the reasons I outlined.

        There are risks offset by the existing assets held, that goes above and beyond what the article is stating about “cash amount”.

        These cash amounts are still partially offset, hedged, etc. And you have to dig much deeper to really understand the true risk exposure.

      2. zygmuntFRAUDbernier

        From NPR’s Planet Money, October 31, 2008,

        “Unregulated Credit Default Swaps Led to Weakness”,

        [excerpt below from the transcript on counterparty risk]:

        “The Greatest Danger

        Jon Zucker, who worked at a credit default swap desk at a major bank for five years until 2007, says if everyone in the chain knew the financial stability of everyone else in the chain, then all this would be fine. The problem, however, is because every deal is private, so they don’t know.

        “You don’t know; it’s far from transparent,” he says. “You know the notion is that I’m working here at NY Money Center Bank and some small bank in Asia goes down and suddenly it just hits a tipping point and several other banks fail and suddenly it’s affecting me.

        “I never had a clue.” “

        1. sgt_doom

          The problem, however, is because every deal is private, so they don’t know.

          No offense intended, but geez, that’s like saying a serial killer murders a bunch of people — it’s damningly obvious, of course!

          Of course, they don’t know, just as the hedge funds are purposely opaque and they can purchase an unlimited number of CDSes and an unlimited number of commodity futures in specific categories, and have an unlimited number of investors (assuming they REALLY are unique investors) per hedge fund.

          And that’s why it’s all done on off-balance-sheet accounts, and offshore, ‘natch!

          Ponzi schemes to the max ARE supposed to be opaque, as is ultra-leveraging! (For every dollar in capital reserve, $1,000 to $100,000 was loand under structured finance and endless layers of securitizations and credit derivatives.

          Hence the Great Deleveraging, and why there are soooo many multi-billionaires (used to call them crooks) and sooo much poverty.

    4. Lune


      The problem with your analysis is your assumption that offsets that are expected to net to zero in theory actually will net to zero in practice. This is precisely what caused the financial crisis. We’ve learned that many assumptions about the behavior of financial instruments become inaccurate during extreme market stress. And all those offsetting hedges don’t actually offset, and indeed, sometimes compound.

      If I was a government regulator, I would avoid dealing with net risk because that will automatically require analyzing and frequently accepting the risk models created by banks which is a quick and easy road to regulatory capture not to mention creating incentives for banks to create faulty models that increase their profits. Rather, regulations should be structured based on the notional and cash values because those are the only independent numbers that the government can rely on: notional is built into the contract, cash value is based on the market price for the instrument. What is the “net offset” value based on aside from a bank’s own theory of the expected behavior of the complex package of derivatives they hold? We’ve seen how well those theories hold up in practice…

  4. Hugh

    The Bush-Obama/Paulson-Geithner/Bernanke plan was always to allow banks carte blanche to steal and gamble their way out of insolvency. As a result, financial reform was never more than a Potemkin exercise to fool the rubes. Dodd-Frank is a perfect example of this. Real reforms like the reinstatement of Glass-Steagall, regulation of shadow banking, admission of mark-to-market losses, banning CDS, and the sharp reduction in the size of the derivatives market were left out of the legislation. Despite its length was really very little there there in Dodd-Frank. Rather than putting anything in the black letter of the law, Dodd-Frank was mostly a series of instructions to agencies to write regulations in very limited areas. The regulatory process would happen after the initial public alarm had died down and largely happen away from the public eye where it could be gamed by financial lobbyists. This was, of course, a feature, not a bug.

    Apparently though the powers that be are growing increasingly restless even bothering putting up the pretense of caring what we in the 99% think and so we see these efforts to rollback what were from the outset mostly kabuki reforms.

    What is important to realize about all this is that the whole world, all the major economic powers and blocs are primed to blow up: China, Japan, the US, and Europe. It is not like some of these are acting as stabilizers for the others. They are all pursuing unsustainable courses and becoming increasingly unstable. The result is likely to be a cascading failure and mega-meltdown. The signs of this have gone from being sporadic to forming a near constant background with the crisis du jour being only relatively more salient. There should be nothing surprising about this. None of the underlying problems have been fixed. They are all still there. They are getting worse and more problems are being added to them with each new crisis. Something will have to give. It is not a question of if but when, like a weak and poorly built dam holding back a 500 year flood, or like being in a munitions factory, gunpowder spilled all over the floor, and matches being flicked about. It will explode. The financial sector controls the economy and government. But it does not control the math, and in the end the math will out.

    1. JEHR

      In the news today regarding those “wonderfully regulated Canadian banks”: we now find out that the Big Six banks in Canada are now Too Big to Fail, according to global regulators! So what happened? Were we lied to (my guess) or did the banks decide that the US example was one that they should emulate?

      So Canada will be in the next big financial blowdown for sure. Our banks were deregulated; they are making insane M & As with smaller American banks; they are in the unregulated derivative business; and the government we have doesn’t seem to know what to do besides introduce austerity and reduce taxes.

      The government also got rid of the tax breaks that credit unions had (since 1972) that allowed them to compete with bank rates. So now credit unions have been forced to lower their interest rates earned on deposits which used to be higher than those in the BIG banks.


      Our goose is cooked (too)!

    2. nonclassical

      …meanwhile bushbama is happy to kick the bushit down the road…just as bushitters did in Iraq..

  5. rich

    “The ‘AIG’ Of The World Is Back”

    Kyle Bass, addressing Chicago Booth’s Initiative on Global Markets last week, clarified his thesis on Japan in great detail, but it was the Q&A that has roused great concern. “The AIG of the world is back – I have 27 year old kids selling me one-year jump risk on Japan for less than 1bp – $5bn at a time… and it is happening in size.”

    so these risks are reflected how?

    1. TomDor

      It is a good graphic.
      Derivatives – detached from real economy? Most.
      Real economy need for derivatives? – Yes, but needs to be attached to real world economy.
      Tax the economic rent seekers at 90+ %

    2. banger

      I’m glad the word “notional” was brought up. I think that these derivatives are part of an emergent notional financial system one that could be called fictional but that could have value depending on who will enforce that value.

      I think the future belongs to a financial system based on the seemingly arbitrary decrees of the world finance oligarchs or people will gradually migrate into precious metals or bitcoin or something like it.

    3. ohmyheck

      Aaaaaaand…of course there is the usual Libertarian take, found in your otherwise-terrific link:
      ” i hope demonocracy and all others out there don’t take the failings of socialized gov and banking and then prescribe more socialism…the market regulates by allowing all these banksters to fail…that is true regulation….mountains of regulations, legislation, bureaucracy have caused this crisis..they can never prevent it”.

      1. sierra7

        Really don’t mean to be “unkind” but,
        Let’s separate the “socialism” for the wealthy and the fiery cauldron for the rest of us!

  6. skippy

    Meh… derivatives is mathematically incoherent… satisfying properties of monotonicity, sub-additivity, homogeneity, and translational invariance…. lalalalala.

    “P” the ***real world*** hahahahahahaha~ the – real world – lasts only nano seconds… shezzzzz… is gawd real[?] and can you model it… Blankinsfiend thinks so.

    Oh and lets not forget **Value at risk** cough… conditional expectations, I’ve got 4 kids… don’t go there…

    Skippy… anywho the time line horizon just keeps getting more compressed and with force majeure becoming de jour… well… risk can go all strange quark in the blink of an eye.

    PS. they should have some CVaR and EVaR apps for the guys and gals in the stans… that sort it all out… full of win!

  7. banger

    When we talk about this market what we are really talking about is, from a traditional financial POV, systemic fraud. But when systemic fraud is normal is it fraud? So far the financial system has been able to survive fairly well despite predictions of doom and so on because the system is actually a form of fiction and can, like fiction, be rewritten.

    I believe the scripts are being re-hashed and re-written in some Hollywood hotel as we speak and tried out on target audiences in Burbank.

    As for the notion that there will be a “rebellion” should we have another major crisis–well it won’t happen in the USA. There is no left-wing movement to speak of here and the right mainly attacks windmills and there rest just follow like cattle because they are as misinformed as the Soviet public was in the heyday of the “Evil Empire”–and the state barely has to do much–Americans prefer to pull the wool over their own eyes.

    1. sierra7

      “We” still have too much of a soial safety net(s) supporting those who are having “hard times”.
      Once legislators feel it is time to wean those who depend on that net off, then all hell may break loose especially as we continue down the path of the corporate state being in charge.
      Rebellion sometimes comes slowly; but when it finds it’s head it is relentless.
      It took more than 100 years for ordinary people in this country to become somewhat “socially conscious” and it historically follows when the repression becomes unbearable, ugly things happen.
      We’re not there yet but I beleive it is inevitable especially as the super-elitists realize that “imminent rebellion” is not on the horizon and they subsequently rule that those safety nets have to go, the purchased legislators will follow……
      By then they also will not realize that they have stirred up the hornet’s nest of violent revolution.

  8. Tom Beckwith

    This is without doubt the best high finance blog on the web from my perspective. My reason for believing this is that a layperson is able to gain entry into a well defended world of hypothecated skullduggery (got real collateral?). This wonderfully accessible lesson is extremely timely because apart from the bankster/kleptocrat battle to reverse skeletal bankster “reforms,” I am convinced that Cyprus is a game changer. Professor Kotlikoff has pulled his money from the casino (stock market) because he is convinced that bank runs (currently in play) will spread from Europe to the United States and that the result will be the collapse of the global banking system in short order.

  9. AbyNormal

    the road to hell may be these bills but the vehicle/bullet train is ICE

    ICE now runs the world’s biggest energy futures market and commodity markets in the US and Canada. The deal (ownership of NYSE) will add NYSE Liffe, the European derivatives exchange to ICE’s portfolio, a business Sprecher has long coveted.

    “Our transaction is responsive to the evolution of market infrastructure today and offers a range of growth opportunities, while enhancing competition in US and European markets and broadening our ability to address new markets and offer innovative products and services on a global platform,” said Sprecher.

  10. Gil Gamesh

    Capitalists will do in the USA. Leftists can’t, of course, and liberals, capitalism’s best friends, have folded their tents.

    The 2d crash, which seems 100% certain: you going long or short?

  11. masaccio

    For piles of information about the derivatives holdings of US banks, see the derivative call reports issued by the OCC here:

    Factoid: JPMorgan Chase had a notional value of $69 trillion at 12/31/12

    Factoid: JPMorgan Bank, not the holding company, had a Total Credit Exposure to Risk Based Capital ratio of 228%

    The terms are defined in the report.

  12. Archer

    As a musician I know little of economics but am sometimes able to understand those who translate for us lay – folk.

    So that’s my entry point and I thank you all – especially writers and commenters her at nc – for that access.

    From that remove I’ve been following the derivative mess for several years now, even as I was surprised to see it slide off the radar of general awareness while various cans were kicked down the road.

    I thought it would rivet our immediate attention much longer than it did.

    As we observe the recent behavior of the “so called elite”, it seems my usual sources are often at a loss to explain their machinations.

    It’s like we’re watching people dancing to music that they can hear but we cannot.

    Others have described this derivative market as a catastrophic financial Black Hole and that made me wonder if these strange, spasmodic, inscrutable actions the so called elite are performing in front of us are the moves one makes when responding to some sort of “Evil Music of the Spheres” emanating from or being sucked into the black void hovering over our heads.

    So my question is – in plainer words- is it fair to theorize that many, if not most or even all decisions being made by the players involved are directly related to any and all possible fallouts from an impending collapse of the derivative market?

    Or would that be overstating the case?

    1. skippy

      The intentional reduction of credit standards in a unsustainable job market gave rise to the prodigious use of unregulated insurance – which facilitated – qualified taking on even more absurd risk.

      The question begging is why… or not…

      Skippy… Jesus thought he had insurance too! Maybe Loyd and Jamie should re-read that – fat tail – of woe….

  13. Bill Hodgson

    The $1.2 quadrillion is a mistake – using both the OTC and Exchange Traded markets combined, and also not using the VALUE of the market. The figure is mis-quoted from a Radio 4 piece, I explain why at the bottom of my response.

    An analysis of your post above, and a response can be seen here:

    The blog post at Demonocracy is also a mistake, confusing SIZE with VALUE. The charts he shows are the SIZE of the business being done but not the VALUE. I contacted the author of that graphic Otto and explained it using a spreadsheet, unfortunately he declined to revise his graphic.


    1. skippy

      Bill the issue – is – quantifying ***Value***.

      The problem with derivatives is that they are – complex assets – that are diffcult to price in the first order of computation. Personally in my book their not an asset at all, more like snorting a line and *feeling* superior about ones self, assisting in making more absurd decisions.

      What ever number you wish to use 1.4Q or 600T it is irreverent if the mathematical underpinnings are rubbish ie human expectations are not rational, let alone force majeure computations.

      Try reading:

      Computational Complexity and Information Asymmetry in
      Financial Products

      What Arora et al. prove is not only are many derivative mathematical models impossible to compute, never mind in real time, because they require more computing power than the world possesses, the missing information to run a mathematical model is a very good place to cheat with.

      Skippy… Financial modeling is a sham… Brownian laws et al do not apply to human expectations cough ambiguous human feelings of price or value.

      1. Bill Hodgson

        Hi Skippy, the value of a Rate Swap is based on straightforward discounted cashflows from a yield curve, based on observed market prices. No brownian motion required, and can be demonstrated in Excel, don’t require excessive computing power, and can be carried out very quickly.

        The Black Scholes option model can also be carried out in Excel and has been proven to be safe and reliable.

        The reason for my post is to illuminate that the Notional size of a Swap isn’t the value of the swap, and to get people seeing the difference.

        CDOs turned out to be a bad thing, but the vast majority of OTC products are much simpler. Also, the 1.2 figure includes futures and exchange traded products which are simpler still – and are the model which the regulators such as the CFTC want to see adopted by the pure OTC market.

        The 1.2q figure is a mis-quote from an interview, and isn’t the value of the worlds stock of Derivatives, whether traded bilaterally, or on an exchange.

        Best wishes, Bill.

        1. skippy

          Bill it is my expressed concern, that the models are an attempt to – qualify – human decision making processes in assessing risk, see Philip Pilkington’s post.

          Rate swap modeling is okiedokie?

          British local authorities
          In June 1988 the Audit Commission was tipped off by someone working on the swaps desk of Goldman Sachs that the London Borough of Hammersmith and Fulham had a massive exposure to interest rate swaps. When the commission contacted the council, the chief executive told them not to worry as “everybody knows that interest rates are going to fall”; the treasurer thought the interest rate swaps were a ‘nice little earner’. The controller of the commission, Howard Davies realised that the council had put all of its positions on interest rates going down; he sent a team in to investigate.

          By January 1989 the commission obtained legal opinions from two Queen’s Counsel. Although they did not agree, the commission preferred the opinion which made it ultra vires for councils to engage in interest rate swaps. Moreover interest rates had gone up from 8% to 15%. The auditor and the commission then went to court and had the contracts declared illegal (appeals all the way up to the House of Lords failed); the five banks involved lost millions of pounds. Many other local authorities had been engaging in interest rate swaps in the 1980s, although Hammersmith was unusual in betting all one way.[4] – wiki

          Skip here… what about the LIBOR effect cough… Banks’ rate swap mis-selling bill to top £1.5bn… eh.

          How about… The valuation of vanilla swaps was often done using the so-called textbook formulas using a unique curve in each currency. Some early literature described some incoherence introduced by that approach and multiple banks were using different techniques to reduce them. It became even more apparent with the 2007–2012 global financial crisis that the approach was not appropriate. The now standard pricing framework is the multi-curves framework. – wiki

          Sadly you can’t model fraud Bill and if “P” = the “real world” with out fraud… your model is rubbish.

          Skippy… are you a tool of the tool?

          1. Bill Hodgson

            Hi Skippy, it sounds like we’re agreeing that the value of a Rate Swap involves something called a yield curve, and isn’t the notional size?


            The 1.2 quadrillion figure is taken from the above Radio interview, where Paul Wilmott adds together both OTC (private) derivatives (the one’s everyone feel bad about), and Exchange Traded derivatives, which the regulators love dearly, and are regarded as safe.

            So my points are: the 1.2 figure is wrong, the scary derivatives are about half that figure.

            And the *value* of the OTC trades isn’t the notional size.

            Best wishes, Bill.

          2. skippy

            Sadly no, it was my attempt to inform you that “P not equals NP” from the very onset and in my opinion no amount of hardening will ever suffice in risk assent due to incoherence (human agency – information arb).

            I must ask as you are a OTC agent, do you understand the mathematical instruments utilized in constructing algos, derivative financial products and tools, the axiomal assumptions they employ at the onset. ***Its theoretical stuff*** And if there was not a massive backing from wall st. etc (no money in it) it would be considered nothing more than and intellectual exercise in virtual gaming theory et al application with in a market based electronic trading platform, hence the deficiency with reality or “P”.

            Also it seems you have not read Yves book or done much in the way of home work to understand the faults which has arrived us to this condition we presently ponder…

            Its more than just models mate, its human agency, see:

            ‘The Formula That Killed Wall Street’?

            The Gaussian Copula and the Material Cultures of Modelling

            Donald MacKenzie and Taylor Spears

            June 2012

            Given how crucial mathematical models are to financial markets, surprisingly little research has been devoted to how such models develop and why they develop in the
            way that they do. The work on models by researchers on finance influenced by science studies (work that forms part of the specialism sometimes called ‘social studies of finance’) has focussed primarily on the ‘performativity’ (Callon 1998 and 2007) of models, in other words on the way in which models are not simply representations of markets, but interventions in them, part of the way in which markets are constituted. Models have effects, for example on patterns of prices. However, vital though that issue is – we return to it at the end of this paper – exclusive attention to the effects of models occludes the prior question of the
            processes shaping how models are constructed and used.


            So in summation I submit that your dissatisfaction with “Notional size of a Swap isn’t the value of the swap argument” is moot in an unregulated laze fair neoliberal self rationalizing homo economus free market environment.

            Skippy… I hate to tell you but… the problem is multifaceted, its a combination of, starting with, a false perspective via ideological agency, compounding as mathematical – physics applications are utilized with human frailty (avarice et al), and as the cherry on top, all conducted with a semi – disconnect between the physical world (living ecology – geo) and a electronic gaming platform.

            PS. both are imploding as we debate… sigh.

  14. Chauncey Gardiner

    This bank lobbying effort to dismantle regulation of their derivatives speculations using our money and placing the FDIC deposit insurance fund at risk is outrageous!

    I want a public utility banking option through the Post Office and reinstatement of the Glass-Steagall Act. Enough already!

  15. Gary

    The taxpayers must be taken off the hook for counterparty losses. They never signed any contracts for these bad-awful deals. It is criminal to have it otherwise.
    Reinstate Glass-Steagall wise old repersentatives!

    1. Ms G

      Or put another way: Governments and Banks have to stop shoving us into contracts we never entered into.

      Taking Larry Conflicts Summers and Foamy Geithner at their word — AIG’s contracts with counterparties were sacrosanct — it follows that it is utterly unacceptable to *foist* innocent by-standers into contracts they never entered into. Sanctity of the decision *not* to contract, no?

      But it seems that with the corruption and destruction of the rule of law there has arrived a total lack of integrity, coherence or equity when it comes to “moral” or “legal” principles.

  16. Teejay

    This is a great illustration of how many derivatives are out there(perhaps dated but still informative). House of Cards doesn’t begin to describe this mess. All unregulated.
    Rubin,Summers,Greenspan tarred and feathered Brooksley Born
    in the late 90’s and got Congress to make it illegal, illegal I tell you to regulate derivatives. That was the end of Brooksley at the CFTC. These derivatives are a time bomb that nobody knows when or how they’ll go off or what the dominoe effects will be. We can be confident there’ll be some saying “who coulda known?” and others saying ” I wish we listened to Brooksley”. It’s sad how many times we listen to the wrong voices and pay the unbelievable price. How many more wrong choices can this society live to tell about.

  17. Mr. G

    Agree with Bill Hodgson. Quoting the notional amount of derivatives is a particularly poor way of expressing the amount of associated risk. It is not necessarily an indication of the fair value let alone the amount required for cash settlement. The notional amount also fails to reflect the offsetting nature of derivatives between counterparties. The headline is therefore more alarmist than informative, undercutting the credibility of the blog post.

  18. Chauncey Gardiner

    Care to quantify the NPV of various risks of loss in the different types of derivatives that are embedded in that $1.2 quadrillion notional amount?

    I believe you cannot with any reasonable degree of probability. Given the sheer magnitude of the amounts involved, I believe that derivatives pose a significant risk to FDIC insured banking institutions. Those who benefit personally from trading these contracts have failed to sustain even a minimal burden of proof concerning cumulative loss exposures IMO, and have actively sought to avoid any significant regulation of their issuance of and speculations in derivatives, often using the same argument you stated here.

    Maybe you missed the recent Senate committee hearings and the losses sustained by JP Morgan on the London Whale’s trades?

  19. Bill Hodgson

    Skippy, I can’t argue with that.

    But in I did wonder if you are any relation to this guy:

    Additionally, the “laze fare” you mentioned is in fact

    And you asked me a question: “do you understand the mathematical instruments utilized in constructing algos, derivative financial products and tools?” My answer would be Yes.

    Notional not = value is where I stand. This doesn’t ignore the fact that CDOs blew up and some parts of the capital markets caused financial destruction.

    Have a good Easter, Bill.

    1. skippy

      Fair enough if you wish to take the position that value is there – somewhere – and would make a good money assumption, if it’s with – your own – good money. Yet we still have not reached the elastic rebound of the electron leverage as applied by those that use others good money… eh… the gravity of CBs will not be adverted.

      If the early carnage had been left along the roadside – for all to view – instead of partitioning it off from public view, we could have at the minimum, encouraged adaptive behavior. That boat has long sailed and are left with imaginary imagery.


      Skippy and the White Slave-Traders

      Ditto on the time off thingy…

  20. Scott Baker

    To get some handle on the size of the derivatives market, take a look at this excellent inforgraphic:
    Also, read my article, citing former Assistant Treasurer Paul Craig Roberts (who may have even cited me earlier), both of us calling for making unpayable derivative bets “null and void” (the phrase we both used). As Michael Hudson says, “debts that can’t be repaid, won’t be.”

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