According to a study reported in the WSJ, the incomes of the wealthy have become far more variable than incomes for the rest of Americans.

They find that both growth and declines for the top 1% from 1982 to 2006 were more than twice as volatile as the comparable numbers for all taxpayers. The wealthiest of the wealthy had even more volatile incomes, with the top one-10th of 1% experiencing volatility of more than four times the average.

Derivatives help firms avoid taxes & regulation (leverage and synthetic exposure to a forbidden asset class.) They also add a layer of opacity that ensures the clients have no idea of how they are getting raked.

That in a nutshell is why derivatives will continue to explode in volumes.

These derivatives are truly a Ponzi scheme that allows the dealers–personally & institutionally–to get rich on the runup, and the public to pay the tab when (surprise) the CDS’ are found to be worth nothing.

I’m with Dan on this one.

If anyone wonders why the pace and enthusiasm for reform is so tepid, they merely need to look at your chart. Derivatives are too massive to ignore, and too terrifying to politicians to reregulate quickly. Regulating core banking is easy, but most of the banks activites now are hedge fund(ish) and much more difficult to regulate properly. Since the banks profitablity is so inextricably linked to derivatives markets no one dares try to cut that Gordian knot at this time, lest we have another AIG counterparty calamity.
(My simple solution would be to declare all the trading units at banks as hedge funds, strip banks of the right to run hedge funds, spin them off, and let them compete in the hedge fund arena without government guarantees)

A good chunk of the derivative notionals are associated with the underlying cash instruments (i.e hedges)

The naked spec positons via derivatives is also a huge chunk of the notionals. (think commodities books – Phibro for example).

The banks claims that they’re flat is probably not too far off the mark. The major risk then is counterparty exposure, and since the major players are TBTF, at the moment the banks have little incentive to reduce that risk.

Politicians and regulators are praying that higher capital charges will be an effectively blunt instrument to use while the scalpel needed to amputate trading/ core banking functions (Glass/Steegal II/,derivatives exchanges, size limitations) are developed

One quibble about the OCC data. Bear in mind this only reflects the top US dealers. It doesn’t include DB, CS, non US HSBC, Barclays, Soc Gen, for example.

Banks make money selling the contracts – and don’t need to bother with considerations of the risk involved. Specifically, in calendar Q209, banks made $5.2B selling this useless paper amongst themselves.

http://www.google.com/hostednews/ap/arti cle/ALeqM5ju66OABjQrBVZVWFtIUfgxL4s2ygD9 AUF68O0

Fleece the taxpayer, book a profit!

My apologies that I sounded “ad hominem” to you. Irritation at inaccurate data references tends to bring out my snarky side — a definite danger of participating in comment threads.

Well we are seeing some of the effects of our unwillingness to send folks at places like AIG to prison for fraud for writing what were essentially insurance contracts without reserves and without there being an insurable interest. There is no ability of counterparties to pay when disaster really strikes, and speculators can massively distort the market. We have been unwilling to regulate these products as the insurance products that they plainly are, which says to me that the 2008 blowup was simply too small to stir folks to action.

Thankfully credit default swaps values are slowly receding, but interest rate swaps are at unfathomable levels and growing fast. This at a time when interest rate uncertainty is very high due to the uncertain effects of massive Q.E. and deficits. We have no idea how these would behave if interest rates jump by a few hundred BP or even 1000 BP in the case of an inflationary flare-up.

Does anyone think Wall Street is properly reserved for any *major* interest rate event, even as extraordinary fiscal activities by governments and central banks make such an event likely? Guys like John Paulson are expecting an inflationary flare-up.

I’m (and I believe jck) not arguring that these banks are perfectly flat, but that the numbers are not as incendiary as the commenters purport. 400MM is still a large number, but it is not the 187,600MM SCREAMER.

The myopia that Unsympathetic espouses w/ his/her AIG comment leads me to believe most people read Felix’s post, and erroneously think because notional derivative amounts have increased at a faster rate for banks than for non-trading parties, there is a huge conspiracy here that is stealing government cheese from starving children.

Given that:
1. Bear Stearns, Lehman Brothers, and to some extent ML are no longer Credit Derivs dealers.
2. Capital requirements are now onerous for counterparties (anyone starting up has very prohibitive costs of financing on Credit Derivative trades).

I’m not too shocked to see end users down and dealers up.

How do you explain the fact that bilaterally netted current credit exposure of the top five banks has also increased three fold over this period (Table 4) — during which time there has been no increase in derivative use by end users? Or Table 12 which shows that the top 5 banks have bought $400 billion more in CDS than they sold? This implies that contracts are offsetting each other less than “running a balanced book” would imply. (It’s pretty obvious that aggregate numbers can’t be used to demonstrate the existence of a balanced book.)