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By: Richard Metcalfe Fri, 02 Oct 2009 11:58:41 +0000 The word ‘nominal’ is used for a reason. It does not — repeat not — represent the amount anybody owes anybody else. What is owed is a small fraction of that amount.

By: williambanzai7 Wed, 30 Sep 2009 00:23:01 +0000 Correlation Mr. Peabody?

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.

By: JackL Tue, 29 Sep 2009 20:53:25 +0000 Notional amounts in derivatives provide very misleading figures. Let’s say two firms trade a call spread with each other. Bank 1 buys a 100-105 spread for $2 and Bank 2 sells. The actual market risk here is small (range of outcomes [-2, 3] for Bank 1; [-3,2] for Bank 2], but notional amounts usually report absolute values of strike prices $205 or $410 (if double counted). So $3 of risk gets reported as $205 or $410 of derivatives.
I agree that counterparty risk is what you really have to worry about on a system level. What if one side can’t pay? The problem is notional derivative exposure isn’t a good way to assess this risk.

By: Charles Swann Mon, 28 Sep 2009 20:06:36 +0000 Traders, Guns and Money. -unknowns-derivatives/dp/0273704745

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.

By: Lilguy Mon, 28 Sep 2009 19:53:11 +0000 …so, jck & quantacide, if one of the larger players goes down (Wells Fargo or BAC will do), it’s all going to work out okay? That is, American taxpayers won’t have to plug in another few hundred billions of dollars a la AIG?

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.

By: michaelc Mon, 28 Sep 2009 19:47:41 +0000 The most useful bit is the relationship between end users and among the dealer commmunity.

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.