Gordon T Long

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Sultans of Swap: Smoking Guns!


Sultans of Swap: The Sting!


Sultans of Swap: The Get Away!




SULTANS OF SWAP: Explaining $605 Trillion in Derivatives!


SULTANS OF SWAP: Fearing the Gearing!








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This Time is Different: Eight Centuries of Financial Folly

by Kenneth S. Rogoff, Carmen M. Reinhart

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SuperCycles: The New Economic Force Transforming Global Markets and Investment Strategy

by Arun Motianey (Author)



Freefall: America, Free Markets, and the Sinking of the World Economy

by Joseph E. Stiglitz



Wall Street Revalued: Imperfect Markets and Inept Central Bankers

by Andrew Smithers



The Road to Financial Reformation: Warnings, Consequences, Reforms

by Henry Kaufman



Stephen Roach on the Next Asia: Opportunities and Challenges for a New Globalization

by Stephen Roach


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Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism

by George A. Akerlof


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The Corruption of Capitalism: A strategy to rebalance the global economy and restore sustainable growth

by Richard Duncan





WEEK ENDING 02-05-11

SEC at odds with CFTC on swap trade rules FT

WEEK ENDING 01-29-11

Derivatives still in flux as Dodd-Frank deadline looms FT

Costs expected to limit new US swaps venues

WEEK ENDING 12-18-10

Asian moves to boost transparency in derivatives markets Reuters

CFTC admits will miss deadline on position limits Reuters

Derivatives trading brought into public view  FT

WEEK ENDING 12-11-10

Gensler Says CFTC Needs Funds for Rulemaking, Monitoring Under Dodd-Frank BL

CFTC’S Chilton Urges Position Limits, High-Frequency Trade Curbs BL

US swap trading reforms face obstacle  FT

WEEK ENDING 11-20-10

Positions in global over-the-counter (OTC) derivatives markets at end-June 2010 BIS
In the first half of 2010, growth in amounts outstanding was subdued or negative in all risk categories. Positions of all types of OTC derivatives fell by 4% to $583 trillion...

Today the BIS releases the latest statistics on positions in the global over-the-counter (OTC) derivatives market. These comprise the results of the second part of the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity as well as the regular semiannual OTC derivatives statistics.


  • Positions in the OTC derivatives market went up in the three years since the last Triennial survey (+15%, or 5% annualized) to $583 trillion, but at a slower pace than during the previous period from 2004 to 2007 (+ 131%, or 32% per year). Data from the semiannual survey shows that the modest overall increase is the result of a surge in positions until June 2008, followed by a decline in the wake of the financial crisis. Growth in gross market values, which provide a measure of the counterparty risk of these positions at prevailing market prices, increased far more than notional amounts outstanding, going up by 122% to $25 trillion at the end of June 2010 . This compares to a growth of 74% during the previous (2004-07) reporting period.


  • The modest overall growth in notional amounts outstanding hides significant variations across risk categories. The highest growth was recorded in the interest rate segment of the OTC derivatives (25%), bringing the share of this risk category in the market total to 82%. Positions in foreign exchange derivatives went up by 9%. By contrast, amounts outstanding of the other OTC segments declined substantially, ranging from 30% and 40% (equity and credit) to 60% (commodity contracts). Sharp movements in asset prices, related to a reassessment of risks during the financial crisis, drove up gross market values of foreign exchange (100%), credit (88%) and interest rate derivatives (175%). Gross market values of equity and commodity contracts declined.
  • Data from the semiannual survey shows that, in the first half of 2010, growth in amounts outstanding was subdued or negative in all risk categories. Positions of all types of OTC derivatives fell by 4% to $583 trillion, following the 2% increase in the second half of 2009. The decline occurred against the backdrop of deteriorating market sentiment related to the European sovereign debt crisis. However, much of the contraction reflected a valuation effect due to the depreciation of European currencies against the US dollar, the currency in which the data are reported. In contrast to the decline in the positions, gross market values for existing OTC contracts rose by 15% to $25 trillion at end-June on the back of sharp asset price movements. Gross credit exposures, after netting agreements, which had dropped slightly in the half-year up to end-2009 (-6%) increased by 2% to $3.6 trillion.
  • Notional amounts outstanding of credit default swaps (CDS) declined for the fifth consecutive semiannual period, largely due to terminations of existing contracts. Gross market values for single-name contracts dropped by 16%, while those for multi-name contracts rose by 10%. The latest semiannual survey introduces additional information on the importance of central counterparties (CCPs) in the CDS market. At end-June 2010, about 11% of CDS positions were vis-à-vis a CCP 1 . The CDS counterparty breakdown for contracts with other financial institutions has also been expanded. In particular, special purpose vehicles (SPVs) and hedge funds are singled out for the first time. CDS contracts with hedge funds and SPVs account for about 5% and 4% respectively of total notional amounts outstanding with other financial institutions.

A detailed analysis of elements of the 2010 Triennial Survey and of the end June 2010 semiannual OTC derivatives statistics will be made available in the forthcoming December BIS Quarterly Review. In particular, the publication will include special features on structural changes in the CDS market, on derivatives in the emerging economies, on the drivers of growth in FX markets, and a user's guide to the Triennial survey.

WEEK ENDING 11-13-10

Goldman, Natixis Fight Over Swaps Deal Goes to Trial in London BL

Wall Street Collects $4 Billion From Taxpayers as Swaps Backfire BL

WEEK ENDING 11-06-10

The wizards of ABS ATimes

Investors want more securitisation deals  FT

US midterms muddy waters for derivatives  FT

China ushers in credit default swaps  FT

WEEK ENDING 10-14-10

Wall Street Lobbyists Besiege CFTC to Shape Derivatives Rules  BL

“Every single provision in the bill is dependent on regulators doing well, which is exactly what regulators did very badly in the run-up to the crisis, there really is a question as to whether we can do anything differently this time.”

The fight in Congress over how to increase transparency and reduce risk in the swaps market nearly derailed the Dodd-Frank regulatory bill and it took a contentious all-night session to reach agreement on the outlines. Lawmakers left many specifics to the CFTC and the Securities and Exchange Commission, with the first drafts of some rules to be published by the end of 2010. Since President Barack Obama signed the law July 21, calling its passage a triumph over “the furious lobbying of an array of powerful special interest groups,” those same groups have turned to regulators to try to blunt the impact on profits.

“The volume and intensity of the lobbying is unprecedented in my experience at the agency,” Chilton said. “They all have an ask. The types of loopholes that people are suggesting exist are either non-existent or very farfetched.”

The law gives the CFTC jurisdiction over commodity, interest rate and some credit default swaps, the largest share of the derivatives markets. The financial stakes are high. U.S. commercial banks held derivatives with a notional value of $223.4 trillion in the second quarter, according to the Office of the Comptroller of the Currency. Those banks reported trading revenue of $6.6 billion in the quarter, a gain of 28 percent from the same period a year earlier.

After the Dodd-Frank bill passed, CFTC Chairman Gary Gensler announced that the commission would post the names of anyone who came to discuss the rules. According to the agency’s website, there were more than 230 meetings from July 26 through Oct. 8. Among the firms were Cargill Inc., Vitol Group, JPMorgan Chase & Co., Morgan Stanley, and Bloomberg LP, parent company of Bloomberg News, which has a swaps trading platform, according to testimony and documents the companies have provided to the CFTC.

In September alone, participants included 14 people from Morgan Stanley, 18 from Goldman Sachs and about a dozen from the Air Transport Association, the airline trade group.

The lobbying began before the legislation was passed as firms anticipated new rules. As of early August, the commission had met with 126 different companies this year, according to lobbying records examined by the Washington-based Center for Responsive Politics. That was the highest since the center began tracking the records in 1998, 20 percent higher than in all of 2009 and 68 percent higher than in 2008.

Consumer advocates said they hoped the regulators would fulfill the intent of lawmakers and not weaken oversight. “It would send a message that the rulemaking process isn’t for sale to the highest bidder,” said Barbara Roper, director of investor protection at the Consumer Federation of America, who has met with the CFTC to discuss business conduct standards.

Commissioner Scott O’Malia, 42, a Republican who was appointed last year, said the agency invited the input. “People have an interest in how the market turns out. They are businesses, and we get that,” he said. Still, he said, “If anyone is coming in trying to change the statute through rulemaking, they are fooling themselves.”

Gensler has asked Congress to increase the agency’s budget by 69 percent next year to $286 million and predicts the agency’s budgeted staff of about 650 will need to grow to more than 1,000 to meet its new demands.

Roper of the Consumer Federation, who celebrated the enactment of the law, said she sees danger in the endgame.

“Every single provision in the bill is dependent on regulators doing well, which is exactly what regulators did very badly in the run-up to the crisis,” she said. “There really is a question as to whether we can do anything differently this time.”

WEEK ENDING 10-09-10

CFTC Unveils Derivatives Proposal  WSJ

The proposals by the Commodity Futures Trading Commission would be the first major step by the agency toward regulating the opaque $615 trillion over-the-counter derivatives market.

The measures are part of broad new powers bestowed to the CFTC in the Dodd-Frank Act, named for its authors Sen. Chris Dodd (D., Conn.) and Rep. Barney Frank (D., Mass.). That law aims to reduce risk in the markets by requiring swap dealers and major traders to execute routine swap contracts on trading platforms and use clearinghouses, which guarantee trades. Swaps are contracts often used by firms to hedge risks such as interest-rate changes, but they can also be used by speculators to profit from price movements.

If a majority of commissioners vote on the proposals Friday, they will be issued for public comment. A second vote is then needed before they can be implemented. The rules on governance are likely to be the most contentious because they contain proposals to restrict certain entities, like banks, from controlling a large voting stake in clearing and trading venues.

The plan would prohibit members of trading platforms and exchanges from individually owning more than 20% of the voting equity.

Jim Sinclair’s Commentary JM Mineset
The overwhelming majority of derivatives since 1991 are special performance contracts devoid of any standards. As such there is no market whatsoever for them. As conditions change the only way to keep from bankruptcy is to add more OTC derivatives to your chain to offset the new conditio That means the OTC derivatives are by nature permanent agreements that can only grow. That means we are in greater financial danger than we were in 2008. That means QE to infinity or the end of Democracy.


Swaps trading rules to mirror equities  FT

IBM warns of threat to organic growth  FT
IBM could have to hold off on acquisitions and see its organic growth stunted if it is included on a list of major derivatives users, the technology group’s director of global funding said. Large companies in the US are lobbying hard to escape being designated “major swap participants” by regulators implementing the Dodd-Frank financial reform act. Such a designation will require companies to post margin against derivatives trades. Tammy Evans, director of global funding at IBM, said if the company were designated an MSP “you could potentially have $5bn of capital that’s held up with margin requirements” on its $40bn-$45bn derivatives portfolio.


EU unveils crackdown on derivatives  FT


The rules being proposed by the Commission will need approval both from EU member states and the European parliament. The aim is to have them in force by mid to late 2012.

The proposals follow agreement by G20 leaders last year to standardise derivatives trading and move them on to exchanges or electronic trading platforms where appropriate. The proposals will closely align the EU with the new regime that is coming into force in the US.

The rules will require standard OTC derivatives to be processed through clearing houses – a move aimed at reducing systemic risk arising from a default of one party in an OTC deal. They will also require OTC contracts – the bilateral agreements between buyers and sellers – to be reported to “trade repositories” or data banks, and for this information to be available to regulators.

But Brussels also plans to make it more expensive for firms to deal in non-cleared contracts, by requiring them to hold more capital against these – although that measure will be introduced in separate legislation shortly.

The short-selling proposals suggest that investors must disclose significant net short positions to regulators once these amount to 0.2 per cent of the issued share capital of a company, and to the market at a higher 0.5 per cent threshold.

So-called “naked” short selling – where traders sell a security without owning it or borrowing it in expectation of buying it back at a cheaper level – will only be allowed in limited circumstances.

There will be a specific regime for telling regulators about significant net short positions in credit default swap positions related to EU sovereign debt issuers. The proposals also include powers to allow national regulators to restrict short selling in sovereign CDSs during periods of volatile trading


Swaps rules leave insurers in limbo  FT


Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity BIS



Fighting Flares on Derivatives Rules  WSJ

Banks, companies and trade associations challenged federal regulators Friday over the controversial question of how to regulate derivatives under the new Dodd-Frank financial revamp, the first big day of posturing since the law was enacted last month.

The meetings, particularly a three-hour roundtable hosted jointly by the Commodity Futures Trading Commission and the Securities and Exchange Commission, illustrate how Wall Street's attention has shifted from Congress to the federal agencies that have to interpret the law by writing hundreds of new rules.

Perhaps nowhere is the attention to detail more apparent than the focus on complex financial instruments known as derivatives, in part because the rules will impact scores of companies and can affect how hundreds of billions of dollars in credit moves through the economy.Jason Kastner, vice chairman of the Swaps and Derivatives Markets Association, said if regulators don't allow more companies to participate as part of derivatives clearinghouses, the concentration of big banks dominating these firms would lead to a "real risk that we're going to end up right where we started."

Regulators Begin Process of Labeling the 'Systemically Important'  WSJ

Unlocking the language of structured securities  FT

In brief - there has been $25.85 billion in YTD structured note issuance, and over $60 billion in global interest-linked note volumes. An amusing excerpt from the brief: "Sales of notes linked to wheat jumped this month after Russia’s worst drought in 50 years spurred a surge in the price of futures contracts on the grain. Banks including DZ Bank AG and Royal Bank of Scotland Group Plc, issued 82 wheat-linked warrants this month, compared with a total of 159 in the first seven months of the year, according to data compiled by Scoach, the structured products trading platform run by Deutsche Boerse AG and Switzerland’s SWX Group. The listed notes, called knock-out warrants, offer investors a leveraged way to bet on the price of wheat." For all those who thought Wall Street was dormant in the post-CDO implosion vacuum, this is a rough wake up call - it appears no matter what, idiots and their money are promptly parted, and the world's foremost financial innovators will always find a way (and a product) to guarantee that. And it is very refreshing to see that Germany's DZ Bank has almost learned from the CDO bubble: the questionably solvent German bank dominates the Structured Note market with $7.2 billion in issuance to date, followed closely by such stalwarts of financial stability as Barclays and Deutsche Bank.

Structure Notes  


Derivative dilemmas ---  Reform seeks balance of rules and rewards  FT

Structured Notes Are Wall Street's `Next Bubble,' Whalen Says BL

Using the same “loophole” that allowed OTC sales of CDOs and auction-rate securities, firms are pitching illiquid structured notes whose value is partly derived from bets on interest rates

US regulators tighten control over Wall St risk  FT

Fed staff delve deeper into riskier activities

WEEK ENDING 07-31-10


Swap rates fall below Treasury yields FT

A historic relationship between US government bonds and interest rate swaps has broken down this week, for only the second time, as a flood of corporate debt issuance from banks pushed 10-year swap rates below Treasury yields.   The negative spread between swaps and “risk free” Treasuries occurred for the first time in March and that inversion only abated at the end of April

Goldman threatened with audit  FT
FCIC holds to demand for derivatives data

Financial Crisis Commission Threatens To Audit Goldman Sachs  BI




WEEK ENDING 07-24-10


Derivatives reform hits non-financials  FT


Derivatives reform to punish property industry  FT


WEEK ENDING 07-10-10

Hospitals Claim Wall Street Wounds  WSJ
Hospitals that made wrong-way "swaps" and auction-rate bets are blaming Wall Street. The Street says the hospitals had reaped millions of dollars in savings before the market turned sour.

Some hospitals are paying millions of dollars in penalties to get out of derivatives contracts, after betting incorrectly that interest rates would rise. Other hospitals are paying higher interest rates. At many, these ill-fated financial bets have contributed to layoffs and scuttled projects.

More than 500 nonprofit hospitals—at least one in six—bought interest-rate "swaps" in a bid to lower their borrowing costs, estimates Municipal Market Advisors, a Concord, Mass., consulting firm. The swaps allowed hospitals to act much like homeowners switching from a floating-rate mortgage to fixed-rate one, betting on rising interest rates.

For a fee, the hospitals received a fixed rate to sell bonds, lower than the municipal-bond market at the time. These bets backfired when the Federal Reserve cut interest rates to nearly zero from more than 5% in 2007.

Hospitals also issued auction-rate securities—which reset bond prices weekly or monthly through auctions—that represented about a third of the $330 billion market for these derivatives. Hospitals paid Wall Street firms more than $120 million in fees for the securities between 2005 and 2007, said data firm Thomson Reuters. That market dried in the 2008 financial panic, leaving hospitals with higher interest rates.

Wall Street firms and many hospital executives say interest-rate swaps were a plain-vanilla product that they have sold for years and say no one could have foreseen the crisis that cratered the auction-rate securities market. "For years and years it was a smart strategy," said Richard Clarke, president of Healthcare Financial Management Association, a trade group. "Hospitals made money on these for a long time."

The hospital deals were part of a larger stampede into swaps contracts by cities, schools and other taxing districts seeking to lower their payments on bonds they sold. Some strapped hospitals only now are beginning to break the contracts and pay a financial penalty for it.

Swaps were "the Edsel of the time," said John Hackbarth Jr., chief financial officer of Owensboro Medical Health System of Kentucky, which recently paid about $14 million to end an interest-rate swap with Merrill Lynch, now part of Bank of America Corp.



WEEK ENDING 07-03-10


Companies Push for Clarity on Derivatives Regulation  WSJ
Democrats are trying to quell an outcry over a last-minute change to their financial-regulation overhaul that has sparked confusion over regulation of the giant derivatives market.

Explaining Derivatives, And Goldman's Dominance Thereof, In Four Simple Charts   ZH

Attached are several charts used to explain to confused politicians all they need to know about the biggest ponzi scheme market ever created (synthetic derivatives), how these derivatives are created, how the leverage attributed to just one asset can result in infinite amplification of risk, and how Goldman is in the very middle of a web which encompasses tens if not hundreds of trillions in derivative counterparty exposure with virtually every single other financial company in the world.

Amplification: this explains how you take a small pool of assets (in this case mortgages) and increase the bettable risk almost to infinity courtesy of synthetic products like CDOs which are nothing but side bets with an unlimited cap on the total risk exposure. The original mortgage is cut up into tranches, which are subsequentlly split up into CDOs, whereby risk can be held, sold off, or side-betted via CDS (which is what AIG would be doing by selling CDS on milions of assorted CDO tranches). In the example below the Glacier Funding CDO 2006-4A C has an original value of $15 million which trough CDO-intermediated amplification, or process in which bits and pieces of it are repakcaged in various synthetic afterproducts, ends up being $85 million. In theory there is no limit to what the total amplified value could be, as synthetic products by definition are created out of thin air, and just need a willing buyer and seller.

Deal Creation: For those who have not spent hours poring over the Abacus org chart, this is a summary of how a traditional CDO was structured and subsequently insured (incidentally, this is not the infamous "John Paulson" Abacus deal for which Goldman is currently being sued). Of particular note here is the box in the lower left, the CDS issuers, AIG, TCW and GSC, who were the dumb money, or those infamously collecting pennies before the housing crash steamroller. As the chart shows, they were collecting $3 million a year in CDS payments, and stood on the hook for $1.8 billion in case the CDO collapsed, or specifically if the underlying reference assets stopped generating enough cash through specific attachment levels.


Leverage: here are the key counterparties on the hook for just the above deal, Abacus 2004-1. No surprise, the biggest counterparty, with total downside loss is AIG, at $1.76 billion. The running annual CDS premium payment? $2.1 million. As the exhibit notes, in the end "Goldman negotiated $800 million from AIG." Other losers included TCW and GSC, and Abacus itself via secondary market holders.

Counterparties: The money chart, this shows who Goldman's key derivative counterparties were as of June 2008. While oddly enough AIG is not on this chart (potentially as this is pro forma for the bailout), it shows just what a great web of interconnected synthetic exposure derivatives create. As of this snapshot, Goldman had $20 trillion in notional counterparty exposure. This number has since ballooned. It also shows that the collapse of any individual actor in this maze would very likely result in the collapse of the entire financial system. While we do not know whether the notional depicted is gross or net, we are comfortable that the $2 trillion in Interest Rate Product counterparty exposure between Goldman and JPM and RBS (for example) would be sufficient to blow up either of these parties should the interest rate complex move violently in a direction and amplitude presumed impossible by either firm's VaR models. We are amused to note that Blue Mountain, a hedge fund, has $590 billion in counterparty exposure to Goldman yet no discount window access. Same goes for Citadel in Equity Products, which incidentally we learn is Goldman's largest counterparty in this category. In the very much maligned Commodity Product category, Goldman's key counterparties are Morgan Stanley with $96 billion, Barclays with $69 billion and Tempo Master with $55 billion, etc. So next time you wonder who aside from JPMorgan is writing all those synthetic gold shorts out of thin air, now you will know. Yet the most notable take home from this chart is that courtesy of its extensive network, Goldman knows full well just how every single bank and hedge fund is positioned, and can easily make prop trading decision based simply on counterparty exposure (Goldman tracks every single trade inception, transfer and novation with all its counterparties to know up to the minute who owns what). Welcome to completely legal frontrunning.

via FCIC

Bankers Who Broke Big Dig With Swaps Gone Awry Get Paid for Fix BL

Goldman's Role in Crisis at Stake in Question Over Marks  BL

Berkshire May Be Required To Post Up To $8 Billion In Collateral  ZH

Derivatives Laws Could Cost $1 Trillion: ISDA Reuters

Derivative Monster: Alive and Kicking Despite Reforms Weiss


Commodity position limits included in financial regulation bill  GATA

U.S. Commodity Futures Trading Commission Chairman Gary Gensler appears to be on verge of achieving a big victory in his battle to impose stricter position limits on major energy futures contracts.

Back in January, Gensler unveiled proposals for tough new limits on futures positions in U.S. crude, natural gas, gasoline, and heating oil. Unlike previous limits set by exchanges, these would be set by the commission itself and would aggregate all positions in economically equivalent futures and options for a particular commodity. The proposals were designed to limit exemptions for firms seeking to hedge financial rather than physical exposures and largely restrict financial and physical hedgers from also running speculative positions.


WEEK ENDING 06-26-10

Judge Dismisses Charges in Major 'Swaps' Case  WSJ

US Congress late-night decisions on swaps reforms   Reuters

U.S. lawmakers worked through the night to finalize on Friday new legislation for the $615 trillion over-the-counter derivatives market.

Here are some of the key agreements for swaps rules agreed to by a conference panel of Senate and House of Representatives members:

* Banks can trade foreign exchange and interest rate swaps in house, as well as gold and silver swaps, and derivatives deigned to hedge their own risk.

* Banks need to spin off desks to affiliates to handle agricultural, energy and metals swaps, equity swaps, and uncleared credit default swaps.

* Non-financial companies "using swaps to hedge or mitigate commercial risk" are exempt from clearing the trades, as long as they explain to regulators how they are meeting financial obligations.

* The financing arms of manufacturers like Ford Motor Co (F.N), Deere & Co (DE.N), Caterpillar Inc (CAT.N) and Boeing (BA.N) and other "end users" do not have to clear swaps when they assist in selling the parent company's products.

* Clearinghouses will not be forced to accept credit risk from other clearinghouses -- interpreted as a win for the CME Group (CME.O), the world's biggest operator of futures exchanges.

* Federal Reserve governors and the Treasury secretary would need to agree before a clearinghouse could access the Fed's emergency funds.

* Firms engaged in a "de minimis" amount of swap dealing with or on behalf of customers will be exempt from new rules for swaps dealers.

* Capital and margin requirements for uncleared swaps done by non-bank swap dealers and major players will be set at "appropriate" levels, softening earlier language that said levels would be as strict or stricter than those set for banks.

* Traders can use non-cash collateral to meet margin requirements.

* Regulators "shall" set limits on speculative positions "as appropriate" but have authority to exempt traders or types of swaps from the limits.

* Movie futures will be banned.

* There will be no ownership restrictions set for major swaps players, banks and financial companies involved in clearinghouses, exchanges, or swap execution facilities.

* Regulators will have at least a year after the time of passage to implement the legislation.

Derivatives Compromise Breaks Financial Regulation Impasse  BL
Senator Blanche Lincoln will accept a House compromise on a derivatives measure that would force banks to push swaps trading into subsidiaries, clearing the last major hurdle in the financial overhaul bill.

CFTC set to gain greater prominence   FT

Crunch time for derivatives reform  FT

Democrats face split on derivatives WSJ

Volcker and Derivatives  WSJ

Guest Post- A Bankrupt BP - Worse For The Financial World Than Lehman Brothers  ZH

Submitted by Jim Sinclair for www.oilprice.com

A Bankrupt BP - Worse For The Financial World Than Lehman Brothers?
The BP crisis in the Gulf of Mexico has rightfully been analysed (mostly) from the ecological perspective. People’s lives and livelihoods are in grave danger. But that focus has equally masked something very serious from a financial perspective, in my opinion, that could lead to an acceleration of the crisis brought about by the Lehman implosion.
People are seriously underestimating how much liquidity in the global financial world is dependent on a solvent BP. BP extends credit – through trading and finance. They extend the amounts, quality and duration of credit a bank could only dream of. The Gold community should think about the financial muscle behind a company with 100+ years of proven oil and gas reserves. Think about that in comparison with what a bank, with few tangible assets, (truly, not allegedly) possesses (no wonder they all started trading for a living!). Then think about what happens if BP goes under. This is no bank. With proven reserves and wells in the ground, equity in fields all over the planet, in terms of credit quality and credit provision – nothing can match an oil major. God only knows how many assets around the planet are dependent on credit and finance extended from BP. It is likely to dwarf any banking entity in multiples.
And at the heart of it all are those dreadful OTC derivatives again! Banks try and lean on major oil companies because they have exactly the kind of credit-worthiness that they themselves lack. In fact, major oil companies, conversely, spend large amounts of time both denying Banks credit and trying to get Bank risk off of their books in their trading operations. Oil companies have always mistrusted bank creditworthiness and have largely considered the banking industry a bad financial joke. Banks plead with oil companies to let them trade beyond one year in duration. Banks even used to do losing trades with oil companies simply to get them on their trading register… a foot in the door so that they could subsequently beg for an extension in credit size and duration.
For the banks, all trading was based on what the early derivatives giant, Bankers Trust, named their trading system: RAROC – or, Risk Adjusted Return on Credit. Trading is a function of credit bequeathed, mixed with the risk of the (trading) position. As trading and credit are intertwined, we might do well to remember what might happen to global liquidity and markets if BP suffers what many believe to be its deserved fate of bankruptcy. The Intercontinental Exchange (ICE) has already been and will be further undermined by BP’s distress. They are one of the only "hard asset" entities backing up this so-called exchange.
If BP does go bust (regardless of whether it is deserved), and even if it is just badly wounded and the US entity is allowed to fail, the long-term OTC derivatives in the oil, refined products and natural gas markets that get nullified could be catastrophic. These will kick-back into the banking system. BP is the primary player on the long-end of the energy curve. How exposed are Goldman sub J. Aron, Morgan Stanley and JPM? Probably hugely. Now credit has been cut to BP. Counter-parties will not accept their name beyond one year in duration. This is unheard of. A giant is on the ropes. If he falls, the very earth may shake as he hits the ground.
As we are beginning to see, the Western pension structure, financial trading and global credit are all inter-twined. BP is central to this, as a massive supplier of what many believe(d) to be AAA credit. So while we see banks roll over and die, and sovereign entities begin to falter… we now have a major oil company on the verge of going under. Another leg of the global economic "chair" is being viciously kicked out from under us. Ecological damage is not just an eco-event on its isolated own. It has been added to the list of man-made disasters jeopardizing the world economy. The price tag and resultant knock-on effects of a BP failure could easily be equal to that of a Lehman, if not more. It is surely, at the very least, Enron x10.
All the counter-party risk associated with the current BP situation means the term curve of the global oil trade has likely shut down. Here we have yet another credit-based event causing a lock-up in markets that will now impede trade and commerce. It looks like an exact replication of the 2008 credit market seizure could ensue all over again – and it could probably be a lot worse. The world is in a far more delicate state now.
Although never really discussed, the world is highly reliant on BPs provision of long-term credit to many core industries. Who makes good on all the outstanding paper that so many smaller oil, gas and electricity companies, airlines, shipping companies, local bus, railway and transportation networks that rely on BPs creditworthiness and performance for? It doesn’t take a genius to figure out how this could all unwind. If BP has to be bailed-out, like a bank, the system will have to print even more unimaginable amounts of money.
The market, intellectually lazy and slow to realization, as it often is, probably has not woken up to it yet – but the BP crisis could unleash damage similar to the banking crisis. A BP failure through bankruptcy could make Lehman look small in comparison, and shake the financial house of cards we live in even more severely. If the implicit danger of the possibilities imbedded in such an event doesn’t make an individual now turn towards gold at full speed, it is likely that nothing will.

Source: http://oilprice.com/Energy/Energy-General/A-Bankrupt-BP-Worse-For-The-Financial-World-Than-Lehman-Brothers.html

By Jim Sinclair at JSMineset via Oilprice.com who offer detailed analysis on Oil, alternative Energy, Commodities, Finance and Geopolitics. They also provide free Geopolitical intelligence to help investors gain a greater understanding of world events and the impact they have on certain regions and sectors. Visit: http://www.oilprice.com


WEEK ENDING 06-19-10


US Banks Set to Lose Key Battle Over Lucrative Swaps FT
US banks set to lose swaps fight   CNN


Senator Pitches a Tamer Bank Bill  WSJ

Sen. Lincoln's new proposal would allow banks to trade and deal derivatives through separately capitalized affiliates. Industry officials and others remained cool to Ms. Lincoln's idea.


US banks set to lose swaps fight  FT

Arkansas sharpens debate on bank risks  FT


WEEK ENDING 06-12-10


Hoenig backs controversial derivatives provision in reform bill 

Whole lot OF SWAPPING going on

Illinois pension fund uses OTC derivatives to recoup returns, jeopardizes pensions

Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP  Daly Finance


Derivatives: A tricky pick FT


Counterparty criteria to impact derivatives Structured Credit Investor

The biggest impact from Standard & Poor's proposed changes to its counterparty criteria is on securities with derivative obligations


Q+A:Why are swaps in focus for financial reform bill?  Reuters

The role of banks in the $615-trillion over-the-counter derivatives markets is a central point of contention



Derivatives Market May Be Reshaped by Congress Even Without Swap-Desk Rule  BL


Bank Reform Bait and Switch

Equity derivatives are out of favour


CFTC delays decision on movie futures AP


WEEK ENDING 06-05-10


SocGen derivatives talk pulls down bourses FT


Euro-zone Credit Crunch & Shanghai Shakeout  Gary Dorsch

On May 6th, Greece’s 2-year CDS rate surged to a record 1,195-basis points, and triggered the historic “flash crash” on Wall Street, - an intra-day, 1,000-point  meltdown in the Dow Jones Industrials, climaxed by a shocking 700-point drop, in less than 20-minutes, to below the psychological 10,000-level. Since the mainstream media was unfamiliar with the movements of the Greek CDS market, it peddled a story, that a computer glitch caused the “flash crash.”



5 Equity Derivatives And How They Work  San Francisco Chronicle

3000 Pages of Financial Reform, but Still Not Enough  WSJ

Frank Affirms He Wants Strong Derivatives Rules  NY Times


WEEK ENDING 05-29-10


Frank Affirms He Wants Strong Derivatives Rules  NY Times

Controversial swaps legislation survives as US Senate passes bill  Risk.net


Matt Taibbi's Latest- Wall Street's War, And Some New Perspectives On The Fed's Goblin-In-Chief  ZH


Controversial swaps legislation survives as US Senate passes bill


Swaps Indicators Soar to 10-Month Highs as Investors Cut Exposure to Risk BL

Frank Targets Mandate to Spin Off Operations  WSJ

Rep. Barney Frank signaled that a controversial derivatives provision in the Senate's financial-regulation bill could be stripped out during negotiations when the two chambers hammer out compromise legislation.


WEEK ENDING 05-22-10



Nervous' Wall Street Waits for Congress to Kill Limits on Swaps Trading BL


Why the White House is wrong on derivatives Fortune

Naked Truth on Default Swaps Norris


Italy's Muni Swaps Bigger Threat Than Greece, Prosecutor Says  Business Week

German short sale ban may broadly reduce CDS trading  Reuters

New Jersey Agency Didn't Understand Risk in Swaps, Report Says  Business Week

Feingold, Cantwell Explain Their Votes Against Cloture


Financial markets regulation: The tipping point

Proposal gives regulators discretion in derivatives ban  FT

Dodd amendment in full

The Clearinghouse Rescue Plan  WSJ

Financial regulation bill gets last-minute amendment from Sen. Chris Dodd   Washington Post

Senators grapple with derivatives rules in financial overhaul  LA Times


Ratigan And Sanders "We're An Oligarchy And It's Getting Worse"  Zero Hedge


Dylan Ratigan and Berney Sanders do a great summary of the various parallel amendment attempts to put some teeth into Dodd's joke of a bill. Ironically, as misguided as it is in most regards, at least Merkel's "reform" showed the kind of conviction that Dodd and his mostly incompetent colleagues will never be able to muster, as they scramble all over each other to collect the scraps that Wall Street has promised them so long as Goldman can generate annual revenues of $60 billion and above. And since our politicians would make the Amsterdam Red Light district blush, you can bet the end results of the Senatorial corruption will be unprecedented, resulting in a bill that achieves the opposite of what it is intended to do: i.e., make banks even stronger and gives the Fed even more power. Which is why any debates about the merits of Merkley-Levin or blah-blah are pointless. The only final arbiter in the reg reform issue will be the market itself, which will resolve everything the second it crashes once and for all. And judging by the size of the carry unwind currently occurring, we may not have to wait long. Which is why we think that Angela Merkel may have brought about the unwinding of the market that will be the one real catalyst to any real reform: after all, for people to express any interest in what is going on in Wall Street's Washington branch, people will have to lose everything... again. As Senator Sanders says, the American people have got to stand up. He is right, however the only thing that will wake America out of its slumber will be one more terminal crash, the one that corrupt and busted finreg reform was supposed to prevent.

Democrats open to talks on derivatives


WEEK ENDING 05-15-10


Scrutiny for Bets on Municipal Debt  WSJ

Federal regulators and state officials are examining Wall Street's role in trading derivatives that essentially bet the municipal bonds they sold would go bust.

Bernanke Says Swaps Measure Would Threaten Stability  Business Week


Bernanke Letter to Lawmakers on Swaps Spin Off WSJ

“Depository institutions use derivatives to help mitigate the risks of their normal banking activities”

Should Banks Be Banned From Trading Derivatives?  NPR

Lincoln's derivatives language safe -- at least until Tuesday  Washington Post

Japan passes new financial rules to cut risks  Business Week

Morgan Stanley Denies Justice Department Investigation of Certain CDOs  Housing Wire


WEEK ENDING 05-08-10


Swaps desk ban seen fading from bank reform Reuters

The Senate will likely drop the Lincoln proposal and allow bank holding companies to continue to trade derivatives...

Factbox: Swaps Regulations  Reuters


Rahm Working With Fed To Beat Back Audit HP




POSTS:  Week Ending 05-01-10

Janet Tavakoli: "President Obama - Bring Back Black"

William K. Black, a regulator during the dark days of the Savings & Loan Crisis, gave the most sensible testimony about the financial crisis heard in Washington so far.* Fraud thrives and spreads in a regulatory free, highly paid, criminogenic environment. Cheaters prosper driving honesty out of the market.

"Firms such as Citigroup and Merrill Lynch [and others] were able to create complex securities backed by recklessly underwritten [often fraudulent] mortgages, knowing that they could pass the risk along to someone else who had less information about the underlying loans. [The] $62 trillion credit derivatives market allowed Wall Street to lend without having confidence in the men and women it lent to. Wall Street hedged away the risk of lending and in the process undermined the entire system."

Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff, P. 295, Christine Richard (Wiley, 2010).

It's time to bring back Black and resolute regulators like him. Our proposed "financial reform" bill is a sham, and the health of our society and our economy is at stake. ("William Black Warns That Financial Reform Bill Won't Stop the Wall Street Crime Wave," Dan Froomkin, HuffPo, April 21, 2021)


Q&A: Why are swaps in focus for financial reform bill?  Reuters

Deals of the Day: Buffett Seeks to Influence Derivative Overhaul WSJ

Derivatives industry opposes Lincoln reform bill  Reuters

Derivatives dealers step up political lobbying  InsuranceERM

Lincoln's Derivatives Plan Appears In, Dodd's Out  National Journal

Q+A: Swaps, the Ag Committee and a $400 trillion market




The financial reform blueprint  CNNMoney

US Sen. Lincoln: New Bill Requires Banks To Spin Off Swaps  Market News International




Study: Derivatives rules would cost banks billions (Dealbook)


POSTS:  Week Ending 04-24-10

Are Interest Rate Derivatives a Ticking Time Bomb  Naked Capitalism

Swaps Dealers Prepare Defense as Obama Sees `Big Battle' for Bank Overhaul   Bloomberg

Synthetic Rate Busted Over AIG Swap Gone Awry Raising Snohomish Power Bill   Bloomberg

Banks Punished in Swaps as Industrial Gap Soars: Credit Markets  Bloomberg





POSTS:  Week Ending 04-17-10

Saint-Etienne Swaps Explode as Financial Weapons Ambush Europe  Bloomberg

A warning from France that the financial crisis isn't over  MoneyWeek


POSTS:  Week Ending 04-10-10

Corporate Swap Users Emerge As Major Lobbying Force On Derivatives  WSJ

Cleveland Borrows $130 Million to Cancel Stadium Swap With UBS  Business Week

Matt Taibbi on muni finance scandals  Washington Post

Fannie, Freddie Touch Off Swaps Scrap  WSJ






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Last Update: 02/18/2011 03:25 PM






  04-16-10 A warning from France that the financial crisis isn't over  MoneyWeek  

Saint-Etienne Swaps Explode as Financial Weapons Ambush Europe


1- Saint-Etienne in central France,

2- Pforzheim in western Germany and

3- Apulia, an Italian regional government on the Adriatic


Harvard University in Cambridge, Massachusetts,

agreed last year to pay more than $900 million to terminate swaps that assumed interest rates would rise.


Under the interest-rate swap deals popular with European municipalities, a bank would agree to cover a locality’s fixed debt payment and the government or agency would pay a variable rate gambling its costs would be lower -- and taking on the risk that they could be many times higher.

Use of swaps in Europe soared in the late 1990s and early 2000s because banks pitched them as the easiest way to reduce costs on fixed-rate loans, according to Patrice Chatard, general manager of Finance Active, which helps more than 1,000 localities across Western Europe manage their debt.


City and regional governments in Europe mainly get their financing from banks, while in the U.S. they primarily raise funds by selling bonds to investors. Municipalities and other local authorities in the European Union’s 27 member states had a combined debt of 1.21 trillion euros in 2008, according to Eurostat, the EU’s statistics agency.


Government officials used up-front cash payments from guaranteed rates at the beginning of swap contracts to artificially lower their short-term financing costs and live beyond their means, said Emmanuel Fruchard, who is a city council member in Saint-Germain-en-Laye, near Paris.  “These municipal swaps are the same thing as Greece,” said Fruchard, a former banker at Credit Lyonnais, now a unit of Credit Agricole SA, who designed swaps in the early 1990s. “It’s all trying to dress up your accounts.”

Germany, Italy, Poland and Belgium also used derivatives to manage fiscal deficits, Walter Radermacher, the head of Eurostat told EU lawmakers in Brussels yesterday without being specific.

Municipalities are having to rewrite their budgets. Saint- Etienne raised taxes twice, slashed by three-fourths a plan to renovate a museum commemorating the region’s extinct coal mining industry and sparked the cancellation of a tram line. Pforzheim, on the edge of the Black Forest in Germany, is scrimping on roads, schools and building renovations.

Known as Gold City for its historic jewelry and watch- making industry, Pforzheim was ordered by the Baden-Wuerttemberg regional government office in Karlsruhe to cut its budget by 240 million euros, or about 12 percent annually, over the next four years because of a 55 million-euro loss on derivatives and a projected 50 million-euro annual shortfall from a decline in tax revenue and rising social costs.

The town followed the advice of Deutsche Bank in taking out bets on interest rates in 2004 and 2005, according to Susanne Weishaar, Pforzheim’s budget director until March.


More than 1,000 municipalities in France had 11 billion euros in “risky” contracts at the end of 2009, according to Paris-based Finance Active. In Italy, about 467 public borrowers faced losses of 2.5 billion euros on derivatives as of the end of September, according to the Bank of Italy.

In Germany, Deutsche Bank sold contracts based on the difference between long- and short-term rates to about 50 municipal governments and utilities. Local authorities also bought swaps from regional banks and Commerzbank AG. No national consolidated figures exist, according to Roland Simon of Simon & Partner, a law firm in Duesseldorf.

For cities like Saint-Etienne, the risks from buying swaps were out of proportion to the potential savings.

  04-08-10 Corporate Swap Users Emerge As Major Lobbying Force On Derivatives  WSJ  
  04-06-10 Cleveland Borrows $130 Million to Cancel Stadium Swap With UBS  Business Week  
  04-06-10 Matt Taibbi on muni finance scandals  Washington Post  
  04-05-10 Fannie, Freddie Touch Off Swaps Scrap  WSJ  
  04-01-10 Winning The Cartel's Musical Chairs Game  Deepcaster  
  03-31-10 Looting Main Street  Rollingstone.com  
    More Than Meets The Bottom Line: Are Banks Getting Crushed Due To Negative Swap Spreads And The $154 Trillion IR-Derivative Market?  Zero Hedge

Lots of confused chatter in the bond community as to why the negative swap spread story (anywhere between 7Y and 30Y) is being largely ignored by the media. After all, the associated market, which according to the BIS was roughly $154 TRillion in June 30 makes the Greek bond debacle and various sovereign CDS discussions in the media pale in comparison. As several bond traders pointed out, the likelihood of negative spreads having been modelled out by the TBTFs is very low, if any, meaning that unhedged bank IR-swap exposure is suffering massively, and is likely to surpass all record past prop desk losses. In fact, rumors abound that a few of the desks having placed leveraged bets on spread divergence over the past months and years are currently in critical condition, yet nobody is discussing this for fear of another round of bank run concerns among the TBTF banks. What is odd, is that the Primary Credit borrowings are now at almost financial crisis lows of just under $9 billion, leading many to speculate that banks now satisfy all of their short-term funding needs via the fungibility of excess reserves (and indicating once again that the Fed's discount rate hike was the most irrelevant action in a history of irrelevant actions). And just in case there is still confusion as to what negative swap spreads mean, here is a useful primer.

From Morgan Stanley:

The big news is that 10y swap spreads (Swap Spread = Libor Rate - UST Yield; e.g. 10yr swap spread = 10yr Libor Rate - UST 10yr yield. This spread has always been positive, today it is negative implying that UST 10y yields have risen above 10y Libor rates) have fallen below zero (Exhibit 1). But the bigger questions are how do we define value in spreads and how much more inverted can 10y spreads go? At the height of the crisis in 4Q08, 30y swap spreads got to -41bps and have remained inverted ever since. The inversion of 30y spreads had more to do with technical, exotic and hedge-related factors. But those elements are missing from the inversion of 10y spreads. That's what makes it interesting. Today we view the inversion in 10y swap spreads as a harbinger of the massive supply of UST debt that will ultimately drive yields higher.

What drives swap spreads?

Back in the late 1980's and early 1990's, swaps were a ground-breaking innovation. It was a “magic formula” to turn long-term liabilities into short-term liabilities. ABC Company would issue (that is, pay an interest rate) on, say, 10yr debt in the market, then receive a 10yr fixed interest rate in the Libor market while simultaneously paying a 3-month floating Libor rate (Exhibit 2). And voila, ABC Company 'swapped' a long-term fixed liability for a cheaper and easier to manage short-term liability. Magic! But things were simpler in days of yore. Swaps were a less volatile vehicle used by corporations to manage cash flows on their debt. They used swaps because they could customize the end dates of their fixed cash flows, rather than relying on US Treasuries with their pesky issuance cycles and inherent technicalities. For example, 10y spreads from 1992–1997 trade in a range from 28bps to 41bps, pretty narrow. But this simplicity allowed us to understand what drove swap spreads. These factors were primarily:

  1. The spread between Libor and repo rates
  2. The slope of the yield curve
  3. The US deficit and UST supply

The first point argued that Libor rates should be higher than UST rates because there was a 'repo-specialness' premium between UST’s and Libor. The second point refers to corporate issuance: if the curve steepens, then corporations are more likely to swap their long-term liabilities at higher rate levels into short-term liabilities at lower rate levels. The last point refers to the relative level of UST issuance. If the US economy slows and goes into a deficit, then the US will issue more Treasuries to fund itself, therefore narrowing swap spreads (Exhibit 3). Currently, we have a high 9.9% deficit to GDP ratio and correspondingly, a $2.4Tr gross issuance of UST’s in 2010.

What has changed?

Later in the 1990s and over the last decade, the swaps market took on increased importance not just as a hedging vehicle but also as a speculative vehicle. What drove swaps over the past 10 years has been hedging the interest rate sensitivity in mortgages. But today, a case can be made that mortgages are less interest rate sensitive than in the past (i.e., less negatively convex). The reason is that households may be less able to refinance their mortgages for a given change in interest rates, because refinancing is more related to FICO scores, credit availability, loan-to-value, incomes, etc. We believe swap spreads will narrow and remain inverted as interest rates have stayed low and stable, volatility has fallen, spread products have been narrowing, and there is little hedge-related need to pay fixed in swap. Add to that the old-time reasons, which are becoming more popular drivers of swap spreads today, of reduced specialness premiums, tighter repo-Libor spreads, steeper yield curves and monstrous US Treasury supply. All of which become the contributors to 10y swap spreads moving negative. Oddly, the tight level of swap spreads is a look back into the future. But the inversion of spreads is the new twist.

Morgan Stanley's conclusion is that, independently of our concerns, US Treasury rates are about to spike. To be sure, MS has been pushing for high rates and major curve steepending for a while: recall it is their call that the 10 Year will hit 5.5% this year.

The issuance of UST debt is dwarfing Libor-related issuance. For example, we expect UST net issuance to be $1.7Tr and net issuance of MBS to be zero. Thus, the relative issuance of UST’s vs. Libor-based products mainly accounts for the inversion in swap spreads. This is a first sign of stress leading to higher UST yields and is not to be missed.

And back to our question: is there currently a massive P&L hit to some or all of the Big 5 US banks as a result of this very much unexpected inversion? While surely the full $154 trillion or so amount is not applicable to the 7Y+ inversion, the OCC as of its most recent report does indicate that there is $27 Trillion in Interest Rate swaps outsanding with a maturity greater than 5 years.

And when looking at IR holdings by bank, it would seem that JPM, Goldman, Bofa, and Citi are most impacted. While JPM, GS, BofA, Citi and Wells have about $131 billion in IR swaps among them, more relevantly, JPM, Goldman and BofA have $9, $7 and $5 trillion in >5 year IR swaps. This is very troubling.

Maybe some of those fantastic financial analysts who were telling the general public to buy Lehman a few days before its bankruptcy, and are now saying financial companies will quadruple over the next few years, can do something useful for a change and ask the executive teams of the above mentioned banks 1) how big their exposure to negative swap spreads is and 2) what the negative P&L impact as a result of this unprecedented spread inversion is?


It is not as if no one was able to see this coming. See The Next Step in the Bank Implosion Cycle??? - http://boombustblog.com/200910271188/The-Next-Step-in-the-Bank-Implosion-Cycle.html. I warned about FX and IR swap exposure last year. Goldman is trading at an extreme premium from a risk adjusted book value perspective. 

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As a result of a surge in interest rate and Forex contracts, dependency on revenues from these products has increased substantially and has in turn been a source of considerable volatility to total revenues. As of 2Q-09 combined trading revenues (cash and off balance sheet exposure) from Interest rate and Forex for JP Morgan stood at $2.4 trillion, or 9.5% of the total revenues while the same for GS and BAC (subscribers, see  BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb) stood at $(196) million and $433 million, respectively. As can be seen, Goldman's trading teams are not nearly as infallible as urban myth makes them out to be.

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Then there is always my favorite graph:

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  03-31-10 Are There Signs From The Bond And Swap Spread Markets That Government Debt Risks Will Derail The Expansion?  Zero Hedge

 Cembalest March 30




Another toxic asset -- interest-rate swaps -- is coming home to roost  Fort Worth Star


According to Moody's, Texas accounts for 17 percent of all swaps in state and local government, and the investments are preventing a wave of refinancing at today's rock-bottom interest rates.
Starting in the early 2000s, they became popular with cities, school districts and state agencies, in part because investment firms marketed them so effectively. For several years, they worked great, saving millions in interest for taxpayers. But that changed after the credit markets imploded and Lehman Bros. failed, triggering downgrades on municipal bond insurers, counterparty banks and borrowers.

New York state, for instance, reported losing $23 million in interest and $79 million in terminations last year because of swaps. That was offset by $143 million in savings in previous years, but today's hits are coming when local governments face declining budgets.

The Service Employees International Union, whose members include government workers, says strapped cities nationwide are paying $1.25 billion in charges from the swaps.


SEC Enforcer Probes ‘Egregious Conduct’ as Muni Scrutiny Widens BL


States and localities have also turned to unregulated derivatives to lower borrowing costs and generate cash to close budget deficits. Many of the contracts had to be unwound at a cost of billions of dollars because the floating-rate debt they were hedging was affected when bond insurers lost their top credit ratings.


“You combine difficult financial circumstances with some of these complex issues of valuations or assessing liabilities, and that contributes to our conclusion that this is an area worthy of specialized focus,” Robert Khuzami, the SEC’s director of enforcement, said in a telephone interview.

  03-24-10 Man Bites Dog as Swap Spreads Turn Negative  Barron's Blog  








12:17 PM Eastern - March 9, 2021

Stop the Swaps

Stop the swapsIf you thought taxpayers were done funding payouts for Wall Street, think again.

Sunday's New York Times ran an article blowing the lid off a Wall Street scheme called "interest rate swaps" that are sucking money from cities and states across the country. The swap deals were originally sold to communities as a way to shield against unpredictable interest rates. But, when the banks crashed the economy, the rules of the game changed.

Now, all these swap deals are doing is generating pure profit for the big banks - and it's being paid for with our tax dollars.

Help stop the swaps. Demand a public investigation into these shady deals: http://action.seiu.org/stoptheswaps

These swaps deals amount to the biggest Wall Street bailout you've never heard of - around $28 billion nationwide. The city of Oakland, CA alone is paying $5.2 million annually for a swap deal with Goldman Sachs. That's enough to completely resolve the city's outstanding budget gap - and avoid cuts to critical services. Instead, it's being used to fill Goldman's profit pool, while city services go on the chopping block.

Help expose swap deals in your community; demand an investigation: http://action.seiu.org/stoptheswaps

Taxpayers have already given enough to bailout Wall Street. But that hasn't stopped them from taking more. With communities feeling the squeeze in a tough economy, the last thing we can afford to do is send billions of our local tax dollars to Wall Street.

Click here to contact your attorney general and demand a public investigation into interest rate swaps: http://action.seiu.org/stoptheswaps

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  03-23-10 Swap rate falls below 10-year Treasury yield  Financial Times

The US 10-year swap rate traded below the 10-year Treasury yield for the first time on Tuesday, as hedging activity from corporate bond deals helped break a fundamental relationship between derivatives and bonds

The 10-year swap rate fell more than 2 basis points below the yield on government paper, after closing 3bps above the Treasury note on Monday. In late afternoon trade, the 10-year swap rate was 3.655 per cent, while the 10-year note yielded 3.68 per cent.

Swap rates and Treasury yields have been converging in recent weeks, driven by high government bond supply, and increased demand by investors using swaps for meeting long-dated liabilities rather than committing capital to buying bonds.

Large issuance of corporate debt this week, which is swapped from fixed coupons to floating rates, has also narrowed the difference between swap rates and Treasury yields.

“Issuance is huge and a lot of corporate bond deals are being swapped and no one is fighting the other side of that,” said George Goncalves, head of fixed income strategy at Nomura.

Analysts say a number of structured derivative trades will cease paying a coupon should swap rates fall below those of Treasury yields; this may spark a bout of hedging, which intensifies the negative relationship between swaps and Treasuries.

In the UK, the current 10-year swap at 3.80 per cent sits below the 10-year Gilt yield of 3.91 per cent.

Historically, yields on government bonds have traded at a discount to the derivative as swaps are money market instruments whereas Treasuries reflect triple A sovereign risk. Funding a swap trade over time is more expensive than Treasuries, but constraints on balance sheets make it difficult for traders to implement such trades.


Goldman’s Greek Swap Spurs ECB to Seek New EU Deficit Rules  Business Week / Bloomberg

The two-page document is titled “The Use of Derivative Transactions in Deficit Financing and Government Debt Management, The Greek Case.”

  03-23-10 State-Run Greek Bank Bought Sovereign Swaps, Ex-Official Says  Business Week / Bloomberg  
  03-22-10 Swap Tango: A Derivatives Regulation Dance, Part 1 Satyajit Das

On 30 July 1998, Alan Greenspan, then Chairman of the Federal Reserve argued that: "Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary." In October 2008, the now former Chairman grudgingly acknowledged that he was "partially" wrong to oppose regulation of credit default swaps (CDS). "Credit default swaps, I think, have serious problems associated with them," he admitted to a Congressional hearing. His current views on wider derivative regulation remain unknown though his recent speeches don’t favor greater regulatory oversight generally. Politicians and regulators globally are currently busy drafting laws to regulate derivatives. A common theme underlying the activity is an absence of knowledge of the true operation of the industry and the matters that need to be addressed. As Goethe observed: "There is nothing more frightening than ignorance in action."

Stripped of quantitative hyperbole, derivatives enable traders to take the risk of the asset without the need to own and fund it. For example, the purchase of $10 million of shares requires commitment of cash. Instead, the trader can instead enter a total return swap (TRS) where he receives the return on the share (dividends and increases in price) in return for paying the cost of holding the shares (decreases in price and the funding cost of the dealer). The TRS requires no funding other than any collateral required by the dealer; this is substantially less than the $10 million required to buy the shares. The trader acquires the same exposure as buying the shares but increases its return and risk through leverage.

Derivative volumes are inconsistent with pure risk transfer. In the CDS market, volumes were in excess of four times outstanding underlying bonds and loans. In the currency and interest rates, the multiples are higher.

Investors searching for return drive speculation

Facing increased pressure on earnings, corporations have increasingly "financialized,” resorting to speculative derivative trading to meet profit expectations.

Recent experience suggests that in stressful conditions speculators are users rather than providers of scarce liquidity. Speculative activity amplifies rather than reduces volatility and systemic risks. Perversely, this may impede capital formation and also increase the cost of capital for companies. Current regulatory proposals do not attempt to deal with speculative activity in the derivatives markets.


SENTINEL UPDATE: The Maturity Wall

  03-17-10 Saving Greece in German interest -Deutsche Bank CEO  Reuters

Without the possibility for international investors to hedge their exposure to Greece, refinancing costs for the Greek state and companies would be higher. Furthermore, by putting a price on a Greek default, the risk had become tradable, Ackermann said. But markets would only find acceptance if they were seen to be "reasonable, fair and orderly," he added. Above all the crisis had shown a need for "better, qualified" regulators, Ackermann said.


An Italian derivatives headache for JP, UBS, Deutsche and Depfa   FT Alphaville

An Italian judge ordered on Wednesday four international banks to stand trial on charges four international banks to stand trial on charges stemming from a 2005 derivatives swap for a 1.68 billion euros bond by the city of Milan, legal sources said.





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  03-22-10 Interest-Rate Deals Sting Cities, States  WSJ

Buyer's remorse has hit some cities and states that did deals with Wall Street in different times. Hundreds of U.S. municipalities are losing money on interest-rate bets they made during the bull market in hopes of protecting themselves from higher rates. The deals backfired when rates fell, shriveling the sums paid to municipalities. Now some are criticizing Wall Street and trying to exit the contracts.

The Los Angeles city council approved a measure this month instructing city officials to try to renegotiate an interest-rate deal with Bank of New York Mellon Corp. and Belgian-French bank Dexia SA. The pact, reached in 2006 to help fund the city's wastewater system, currently is costing the city about $20 million a year. The banks declined to say how they would respond to a request to renegotiate.

In Pennsylvania, 107 school districts entered into interest-rate swap agreements from October 2003 to last June. At least three have terminated them. Under one deal, the Bethlehem, Pa., school district had to pay $12.3 million to terminate a swap with J.P Morgan Chase & Co., according to state auditor general Jack Wagner. J.P. Morgan declined to comment.

State lawmakers have proposed restrictions on municipalities' ability to use swaps. "It's gambling with the public's money," Mr. Wagner said. "Elected officials are simply no match for the investment banker that's selling the deal."

The Service Employees International Union said Chicago, Denver, Kansas City, Mo., Philadelphia, Massachusetts, New Jersey, New York and Oregon all are in the hole on swaps agreements they made with financial firms. The required payments range from a few million dollars to more than $100 million a year, the union said.

Such deals are deepening the misery faced by state and local governments throughout the U.S., already facing their worst financial squeeze in decades because of shrinking tax revenue and stubbornly high pensions and other costs.

Government agencies that saw the transactions as a cushion against fiscal surprises now are being squeezed by the arrangements. The supply of municipal derivatives swelled to more than $500 billion before falling in the past two years, estimates Matt Fabian, managing director at research firm Municipal Market Advisors. Moody's Investors Service says the surge was fueled by Wall Street marketing efforts, demand from state and local governments and "relatively permissive" statutes on the use of swaps in Pennsylvania and Tennessee, both of which are taking steps to tighten rules.

Many of the deals generated higher fees for securities firms than traditional fixed-rate debt. Government officials, for their part, entered the deals in hopes of reducing borrowing costs.

The swaps were introduced in many cases along with floating-rate debt that municipalities issued because it was cheaper than traditional fixed-rate debt. Lower interest rates have served them well on this; their borrowing got cheaper

But municipalities also added swaps to the mix, promising to pay a fixed rate to banks, often 3% or more, while receiving payments from banks that vary with interest rates. On the swaps, the municipalities generally have been losers, as the interest that banks have to pay them have often fallen below 0.5%.

Government budgets are stretched thin, prompting officials to look for dollars wherever they can. The clashes over the swaps come amid growing scrutiny of the municipal-bond market, where the U.S. government is investigating whether there was bid rigging in certain cases.

Wall Street firms say no one was complaining when the deals were helping municipalities save. Defenders of swaps say they still can help cities if paired with the right borrowing strategy.

Some securities-industry officials say they are open to renegotiating with municipalities so long as doing do doesn't cause a tidal wave of demands.

"If they can't come to an agreement on how to modify, the contract should stand," said Michael Decker, a managing director at the Securities Industry and Financial Markets Association, a trade group.

Escaping isn't cheap or easy. Under a transaction between Oakland, Calif., and a Goldman Sachs Group-backed venture, Goldman paid the city $15 million in 1997 and $6 million in 2003, according to Oakland financial reports. But now, the city stands to lose about $5 million this year.

That money "is coming out of taxpayers' pockets and could be used for other things," said Rebecca Kaplan, a city council member. She wants the city to renegotiate. But the city faces a $19 million termination payment. Oakland officials didn't respond to requests for comment.

Some deals have led to court. Last August, a unit of bond insurer Ambac Financial Group sued the Bay Area Toll Authority for payments it said it was owed under various swap agreements. The authority paid Ambac $104.6 million to terminate the swaps after the insurer's credit ratings were downgraded and bonds associated with the swaps were retired. Ambac claims it is owed $156.6 million under the agreements.

The toll authority, which is fighting the claim, said it made the payment, and Ambac sued for the other part of what it says it is owed. An Ambac lawyer couldn't be reached for comment.

Next month, Richmond, Calif., is expected to restructure a $65 million agreement with Royal Bank of Canada that could cost the struggling city an estimated $3.5 million a year, based on current interest rates. Under the revised deal, Richmond would make smaller, more regular payments to the bank over time.

In November, RBC and city officials rejiggered a separate transaction that would have cost Richmond about $2.5 million. An RBC spokesman said bank officials are working with the city to "restructure the underlying bonds in a way that best serves the city's interests and those of its residents."

The "goal of the original transaction was to lower borrowing costs for the city," the bank spokesman said, adding that the bonds didn't perform s anticipated because of downgrades at bond insurers that backed them.

Richmond's vice mayor, Jeff Ritterman, said he still is reviewing next month's proposed restructuring. Financial woes have forced Richmond to cut its budget and lay off employees.


Hundreds of U.S. municipalities are losing money on

interest-rate bets they made during the bull market

in hopes of protecting themselves from higher rates.













One District alone had to pay JPM 12.3M to terminate








Kansas City




new Jersey

New York



























































  03-16-10 High debt levels distort swaps and bonds link  Financial Times

The relationship between bonds and derivatives in the UK and the US is being distorted by record government debt issuance, in a clear sign that massive fiscal borrowing is overwhelming the markets.

In normal market conditions, yields on government bonds, such as US Treasuries, UK gilts and German Bunds, trade at a discount to swap rates. This is because swap rates are based on a funding rate that is linked to the interbank lending market. This rate is higher than the repo rate used for financing government bonds. Swaps are money market instruments whereas Treasuries reflect triple A sovereign risk.

However, in the UK 10-year swap rates started trading below equivalent government bond yields in December while recently in the US they traded at a record low of just 2 basis points above government rates.

In the UK, the negative relationship persists, with 10-year government paper at 4.04 per cent and the swap rate at 3.89 per cent. Swap rates have never fallen below bond yields in the US.

"It's a big story and it has a lot to do with the huge amount of supply that must be digested by the market," says Alex Li, strategist at Credit Suisse.

Analysts say the negative spread between swaps and gilts reflects a combination of rising government bond yields, due to worries over supply, and falling swap rates as pension funds, in particular, look to use swaps for meeting long dated liabilities rather than commit capital to buying bonds.

The UK situation also suggests that the default risk for private institutions, such as the pension funds and banks that use swaps, is lower than the UK sovereign risk, despite the state being triple A rated and having the power to raise taxes.

"It is a strong sign of worries about supply as government bond yields are in theory still considered risk free, and therefore should trade below swap rates, which are a reflection of the private markets," says Steven Major, head of global fixed income at HSBC.

"I think this narrowing is due to misplaced concerns about sovereign credit quality in the UK," he adds. However, concerns about sovereign risk look unlikely to go away, with Moody's warning yesterday that the US and UK were moving closer to losing their triple A ratings.

The theory that swap rates should not trade below Treasury yields because they present arbitrage opportunities that can be exploited via the different rates for funding Treasury and money market instruments has been in doubt since the 2008 financial crisis.

Executing such a trade depends on committing capital for an extended period, something that has become very difficult in the current era of balance sheet constraints.

With the demise of Lehman Brothers, US 30-year swap rates fell below those of 30-year government yields and have remained that way. This shows the difficulty of financing long term balance sheet trades in an uncertain financial world. "Some people have been calling for the 10-year spread to get to zero, others are fighting it, but if the 30-year spread can turn negative, the 10-year can follow," says Gerald Lucas, senior investment advisor at Deutsche Bank.

In the UK, the economic outlook has been complicated by worries over the Bank of England's decision to put quantitative easing on hold, says Mr Major. Concerns over a hung parliament (the UK general election is expected on May 6) have also pushed gilt yields higher.

Another factor in the UK is that pension fund demand has pushed swaps into negative spread territory, as rather than commit cash to buying bonds, funds have chosen swaps to lock in long term fixed rates, a synthetic way of buying a bond and receiving a coupon payment.

In the US, there are indications that much of the US swap market has been caught out by the lack of a sharp upward move in rates. Traders say that many structured products based on swaps have been set up in recent months, designed to profit from a sharp rise in market rates, which to date have not materialised.

At the start of March, US swap rates were 8.5 basis points above the 10-year Treasury yield. The 10-year swap was trading yesterday at 3.76 per cent, against a 10-year government yield of 3.72 per cent.

"Positioning matters and we could easily see swap rates converge on Treasury yields based on the fact that people are heavily biased towards rising rates once the Fed ends it mortgage buying at the end of the month," says George Goncalves, head of US rates strategy at Nomura Securities.

"If we don't see a sharp rise in rates, the swap market will move much faster than Treasuries as those positions are reversed," he adds. "I think it's too early to suggest this is a credit issue for the US," says John Brady, senior vice-president at MF Global. "It's highly probable that we see a negative [US] swap spread and it's a clear example of too much cash chasing too little yield."

Also pressuring the US and UK markets is the expectation of further corporate issuance. Much of this debt is seen coming from financials, as they swap the fixed rates of bond payments into floating rate exposure. That type of swapping activity compresses swap spreads and there are indications that some dealers have been getting ahead of a swapping wave.

Mr Lucas says: "It reflects a combination of Treasury supply, the attractiveness of using swaps over cash bonds by some long-term investors and expectations of strong corporate debt issuance in March."


The relationship between bonds and derivatives in the UK and the US

is being distorted by record government debt issuance,

in a clear sign that massive fiscal borrowing is overwhelming the markets.

In normal market conditions, yields on government bonds,

such as US Treasuries, UK gilts and German Bunds,

trade at a discount to swap rates. This is because swap rates

are based on a funding rate that is linked to the interbank lending market.

This rate is higher than the repo rate used for financing government bonds.

Swaps are money market instruments whereas Treasuries reflect triple A sovereign risk.

The UK situation also suggests that the default risk for private institutions,

such as the pension funds and banks that use swaps,

is lower than the UK sovereign risk, despite the state being triple A rated

and having the power to raise taxes.

The theory that swap rates should not trade below Treasury yields

because they present arbitrage opportunities that can be exploited

via the different rates for funding Treasury and money market instruments

has been in doubt since the 2008 financial crisis.

It's highly probable that we see a negative [US] swap spread and it's a clear example of too much cash chasing too little yield."

"It reflects a combination of Treasury supply,

the attractiveness of using swaps over cash bonds by some long-term investors
and expectations of strong corporate debt issuance in March."




angry_bear.gif - (18K)




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