COLUMN-Beware the bull market in derivatives: Matthew Goldstein

September 30, 2009

COLUMN-Beware the bull market in derivatives: Matthew Goldstein
Matthew Goldstein— Matthew Goldstein is a Reuters columnist. The views expressed are his own — 
   By Matthew Goldstein
   NEW YORK, Sept 29 (Reuters) – The Dow is near 10,000 again. The business press is full of stories about the resurgence in mergers, IPOs and even so-called blank check companies.
   There’s one statistic, however, that should give investors pause: the growth in the total dollar value of derivative contracts at the top too-big-to-fail banks in the United States.
   In the second quarter of this year, the notional value of derivatives contracts at JPMorgan Chase <JPM.N>, Goldman Sachs <GS.N>, Bank of America <BAC.N> and Citigroup <C.N> increased by $1.92 trillion, to $191 trillion. Shockingly, Citi is responsible for most of that gain from the end of the first quarter.
   Overall, the total dollar value of outstanding derivatives transactions at the top 25 U.S. commercial banks was $203 trillion, according to the Office of the Comptroller of the Currency, meaning that the nation’s four biggest banks account for 94 percent of the industry’s total exposure to derivatives.
   Now the concentration of derivatives at a handful of banks isn’t new. It’s even to be expected, bank regulators say.
   The OCC, in its quarterly derivatives report, routinely notes that the Big Four “have the resources needed to be able to operate this business in a safe and sound manner.”
   In other words, the biggest banks are best suited to handle all these derivatives contracts because they’ve been doing it for so long.
   But it’s this regulatory logic that has helped enshrine the too-big-to-fail doctrine. A handful of financial institutions are deemed more indispensable than others because they are too interconnected to fail. It’s the large concentration of derivative contracts at a troubled bank like Citigroup that made a big bailout necessary.
   So it’s particularly disturbing to find that the total dollar value of outstanding derivatives at Citi rose by $2.3 trillion, to $31.9 trillion in the second quarter. By contrast, the notional value of derivatives transactions at JPMorgan Chase — the leader in this category — fell by $1.2 trillion, to $79.9 trillion.
   It’s hard to fathom how a bank that has yet to prove it can stand on its own two feet without huge amounts of federal support should be adding to its potential derivatives exposure.
   That’s especially so with Citi losing $238 million in trading revenue because of derivatives in the second quarter. Citi managed that feat even as the nation’s 25 top commercial banks took in $5.1 billion in derivatives trading revenue in the same time period, according to the OCC.
   This is why, of all the proposals for reforming the financial system, the Obama administration’s plan to require that the vast majority of derivatives be traded on well-capitalized exchanges is the most important.
   The president’s team needs to keep the pressure on Congress to enact a measure that will ensure there’s a way for a trading partner to get paid on a derivatives contract, even if the bank on the other side of that transaction fails.
   And if anyone doubts the need for regulating derivatives and making it easier to unwind a troubled too-big-to-fail bank, Citi should provide all the evidence that’s needed.
— For previous columns, Reuters customers can click on [GOLDSTEIN/] (Editing by Martin Langfield) (( Keywords: COLUMN DERIVATIVES/
Tuesday, 29 September 2009 19:58:35RTRS [nN29159369] {C}ENDS

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