Hello threadsters... a bit of work we have been doing in terms of disclosure for a very long time on this subject. (since 1998 on Silicon Investor on this thread)
Best to you,
Clark
NB I wonder if this will all load up?
Note: Beware gold supporters and their presently flawed "metric" … according to a principal at the largest bank in the US when I had this conversation…
”derivative pledges again each ounce of physical gold were 250 times thereabouts each ounce in 2002.”
What is it now? 2,000 times -4,000 times?
***
Largest banks in the US: look it up yourself.
*****
Alasdair McLeod interview King World News
Alasdair Macleod 10.14.2022
October 14 ( King World News) – Alasdair Macleod: You can see the whole of the derivatives complex, we’re talking about $600 trillion of OTC derivatives, is beginning to unwind. And as that begins to unwind there are going to be accidents along the way. The idea that somehow the problem that the British pension funds have got themselves into is unique — forget it!
This is a problem all over Europe where the REPO market is far, far larger. It’s a problem elsewhere (in the US and Asia) as well. This is one reason why…to continue listening to Alasdair Macleod discuss the catastrophic unwind of the $600 trillion derivatives market
https://kingworldnews.com/kwn-metals-wrap-with-alasdair-macleod-10-14-2022/
Much gold puffery hen …10 minutes in the European US crisis
Michael Oliver
J. Michael Oliver: Founder of MSA – Michael Oliver entered the financial services industry in 1975 on the Futures side, joining E.F. Hutton’s International Commodity Division, headquartered in New York City’s Battery Park. He studied under David Johnston, head of Hutton’s Commodity Division and Chairman of the COMEX.
https://kingworldnews.com/michael-oliver-10-15-2022/
Decade After Crisis, a $600 Trillion Market Remains Murky to Regulators
See: https://www.nytimes.com/2018/07/22/business/derivatives-banks-regulation-dodd-frank.html
Top of Form
Bottom of Form
By Emily Flitter NY TIMES July 22, 2018
In the maze of subsidiaries that make up Goldman Sachs Group, two in London have nearly identical names: Goldman Sachs International and Goldman Sachs International Bank.
Both trade financial instruments known as derivatives with hedge funds, insurers, governments and other clients.
United States regulators, however, get detailed information only about the derivatives traded by Goldman Sachs International. Thanks to a loophole in laws enacted in response to the financial crisis, trades by Goldman Sachs International Bank don’t have to be reported.
A decade after a financial crisis fueled in part by a tangled web of derivatives, regulators still have an incomplete picture of who holds what in this $600 trillion market.
“It’s a global market, so you really have to have a global set of data,” said Werner Bijkerk, the former head of research at the International Organization of Securities Commissions, an umbrella group for regulators around the world overseeing derivatives markets. “You can start running ‘stress tests’ and see where the weaknesses are. With this kind of patchwork, you will never be able to see that.”
Derivatives are instruments whose values are derived from the prices of other things, like a stock or a barrel of oil or a bundle of mortgages. Originally designed to protect their holders against future risks, they evolved into vehicles that traders used for financial speculation. Unlike stocks, they often aren’t traded over public exchanges, which means the market — and who is exposed to what — is opaque.
The 2010 Dodd-Frank law was supposed to improve regulators’ ability to monitor derivatives. American banks had to start reporting specifics about their trades, including whom they traded with, to the Commodity Futures Trading Commission.
Daily business updates The latest coverage of business, markets and the economy, sent by email each weekday. Get it sent to your inbox.
The goal was to prevent a recurrence of the financial crisis, when fatal problems at Lehman Brothers caused a tidal wave of troubles at other banks that were connected through derivatives. In part because nobody could map out those connections, nobody knew where problems lurked, and fearful banks stopped lending to one another.
But the Dodd-Frank Act contained a big gap: Banks don’t have to disclose to American regulators their holdings of derivatives housed in certain offshore entities. The critical variable is whether the American parent company is legally on the hook to bail out its foreign subsidiary if it gets into trouble. As long as the answer is no, the foreign entity isn’t subject to the Dodd-Frank requirements.
The size and severity of this blind spot are hard to measure. One consequence is that United States regulators are unable to grasp the full exposure of American banks to their foreign rivals. Germany’s troubled Deutsche Bank, for example, is one of the largest players in the derivatives market, and much of its derivatives trading occurs in foreign markets that are outside the purview of American regulators. That means they have limited visibility into United States banks’ connections to Deutsche Bank.
Other countries’ regulators can seek information about those holdings, but they generally do not collect the same data that is reported to American regulators.
The Dodd-Frank law “didn’t really give a mandate to coordinate on the things that naturally would benefit most from coordination, one of which is the flow of information,” said Guy Dempsey, a derivatives lawyer.
Goldman, for example, reports its total exposure to the derivatives market as a single number: The bank had $45 billion in over-the-counter derivatives alone on its balance sheet at the end of 2017. Because of the trading in its Goldman Sachs International Bank unit and other foreign subsidiaries, a certain amount of those trades are invisible to American regulators.
A Goldman spokesman said less than 1 percent of the bank’s global derivatives activity wasn’t visible to the Commodity Futures Trading Commission, but he declined to comment further.
For JPMorgan Chase, trades not reported to the commission account for less than 10 percent of all the bank’s derivatives, a spokesman said. (The firm reported $56.5 billion in outstanding derivatives for 2017.)
A Citigroup spokeswoman said the bank’s European derivatives trades were made “predominantly” through subsidiaries that reported their trades to the Commodity Futures Trading Commission.
The portion of Bank of America’s derivatives portfolio that isn’t reported to regulators is not discernible in its public filings. A bank spokesman would say only that the percentage is small. A Morgan Stanley spokesman said “virtually all” of its trades were reported to American regulators.
The banks say that they aren’t trying to hide anything and that in some cases they are responding to demands from overseas clients who don’t want the United States government looking at their transactions. Even foreign bank regulators argue there’s no reason American law should apply to financial instruments held outside the United States.
“This problem, I think, is really driven more by regulators each wanting their own silo,” said Sheila Bair, a former chairwoman of the Federal Deposit Insurance Corporation. “I think the industry would be fine with some type of consolidated reporting.”
Mr. Dempsey, the lawyer, said, “What you have is a picture that has more clarity to it than what the regulators had in 2008, but you still don’t have maximum clarity.”
Regulators can still monitor risk for individual institutions. The Federal Reserve, for example, can ask for specific information about derivatives trades as it sees fit. But because the trades aren’t automatically reported, the regulator would have to decide which trades to ask about beforehand. Theoretically, the Fed could ask for banks to report every single trade, but the central bank hasn’t done that.
In October 2016, the Commodity Futures Trading Commission proposed a rule that would have closed the reporting loophole by requiring all American bank subsidiaries to report their derivatives exposure. It also would have subjected the subsidiaries to financial regulations that would have made derivatives trading less profitable.
The banking industry opposed the rule. After President Trump took office, it was never authorized.
Officials at the Commodity Futures Trading Commission acknowledge that there is a problem. The agency noted in an April paper that the current reporting “cannot provide regulators with a complete and accurate picture” of risks in the market.
Even so, Amir Zaidi, the director of the commission’s market oversight division, said more data was available to regulators now than before the financial crisis, enough to enable “effective oversight.”
In a recent paper, a University of Maryland law professor, Michael Greenberger, argued that banks were exploiting the disclosure loophole and creating a major vulnerability for the financial system.
The largest banks “have engineered a way to evade Dodd-Frank’s regulations at will,” Mr. Greenberger wrote. He warned that in a period of financial stress, derivatives cause cascading losses. Because the ownership and connections of those derivatives remain murky, he wrote, “the economic chaos and harm of the 2008 financial meltdown may very well be repeated.”
Mr. Greenberger’s warnings — published last month by the Institute for New Economic Thinking, a progressive think tank — have been endorsed by the former Federal Reserve chairman Paul Volcker and Thomas M. Hoenig, who stepped down as vice chairman of the Federal Deposit Insurance Corporation in April.
Mr. Hoenig noted that the universe of derivatives was already very complicated, “and so when you make it even more opaque in a foreign subsidiary, I think the ability to control outcomes is very different.”
He recalled earlier efforts to bring transparency to the derivatives markets. Such proposals were derailed by senior officials in the Clinton administration, and Mr. Hoenig warned against repeating that mistake.
***
Macleod: The Great Global Unwind Begins
BY TYLER DURDENFRIDAY, OCT 14, 2022 –
See: https://www.zerohedge.com/markets/macleod-great-global-unwind-begins
Authored by Alasdair Macleod via GoldMoney.com,
There is a growing feeling in markets that a financial crisis of some sort is now on the cards.
Credit Suisse’s very public struggles to refinance itself is proving to be a wake-up call for markets, alerting investors to the parlous state of global banking.
This article identifies the principal elements leading us into a global financial crisis.
Behind it all is the threat from a new trend of rising interest rates, and the natural desire of commercial banks everywhere to reduce their exposure to falling financial asset values both on their balance sheets and held as loan collateral.
And there are specific problems areas, which we can identify:
It should be noted that the phenomenal growth of OTC derivatives and regulated futures has been against a background of generally declining interest rates since the mid-eighties. That trend is now reversing, so we must expect the $600 trillion of global OTC derivatives and a further $100 trillion of futures to contract as banks reduce their derivative exposure. In the last two weeks, we have seen the consequences for the gilt market in London, warning us of other problem areas to come. Commercial banks are over-leveraged, with notable weak spots in the Eurozone, Japan, and the UK. It will be something of a miracle if banks in these jurisdictions manage to survive contracting bank credit and derivative blow-ups. If they are not prevented, even the better capitalised American banks might not be safe. Central banks are mandated to rescue the financial system in troubled times. However, we find that the ECB and its entire euro system of national central banks, the Bank of Japan, and the US Fed are all deeply in negative equity and in no condition to underwrite the financial system in this rising interest rate environment. The Credit Suisse wake-up call Definition of
“SIB” .. A Systemically Important Bank
In the last fortnight, it has become obvious that Credit Suisse, one of Switzerland’s two major banking institutions, faces a radical restructuring. That’s probably a polite way of saying the bank needs rescuing.
In the hierarchy of Swiss banking, Credit Suisse used to be regarded as very conservative. The tables have now turned. Banks make bad decisions, and these can afflict any bank. Credit Suisse has perhaps been a little unfortunate, with the blow-up of Archegos, and Greensill Capital being very public errors. But surely the most egregious sin from a reputational point of view was a spying scandal, where the bank spied on its own employees. All the regulatory fines, universally regarded as a cost of business by bank executives, were weathered. But it was the spying scandal which forced the bank’s highly regarded CEO, Tidjane Thiam, to resign.
We must wish Credit Suisse’s hapless employees well in a period of high uncertainty for them. But this bank, one of thirty global systemically important banks (G-SIBs) is not alone in its difficulties. The only G-SIBs whose share capitalisation is greater than their balance sheet equity are North American: the two major Canadian banks, Morgan Stanley, and JPMorgan. The full list is shown in Table 1 below, ranked by price to book in the second to last column. [The French Bank, Groupe BPCE’s shares are unlisted so omitted from the table]
The Credit Suisse wake-up call Definition of
“G-SIB” .. A Systemically Important Bank
Before a sharp rally in the share price last week, Credit Suisse’s price to book stood at 24%, and Deutsche Bank’s stood at an equally lowly 23.5%. And as can be seen from the table, seventeen out of twenty-nine G-SIBs have price-to-book ratios of under 50%.
Despite the mess that Japan’s Keynesian policies has created, it is difficult to see the BOJ changing course willingly. But the crisis for it will surely come if one or more of its three G-SIBs needs supporting. And it should be noted (See Table 1) that all three of them have balance sheet gearing measured by assets to shareholders equity of over twenty times, with Mizuho as much as 26 times, and they all have price to book ratios less than 50%.
The Fed’s position
The position of America’s Federal Reserve Board is starkly different from those of the other major central banks. True, it has substantial losses on its bond portfolio. In its Combined Quarterly Financial Report for June 30, 2022, the Fed disclosed the change in unrealised cumulative gains and losses on its Treasury securities and mortgage-backed securities of $847,797 million loss (versus June 30 2021, $185,640m loss). [iii] The Fed reports these assets in its balance sheet at amortised cost, so the losses are not immediately apparent.
But on 30 June, the five-year note was yielding 2.7% and the ten-year 2.97%. Currently, they yield 4.16% and 3.95% respectively. Even without recalculating today’s market values, it is clear that the current deficit is now considerably more than a trillion dollars. And the Fed’s capital and reserves stand at only $46.274 billion, with portfolio losses exceding 25 times that figure.
Other than losses from rising bond yields, instead of pushing liquidity into markets it is withdrawing it through reverse repos. In this case, the Fed is swapping some of the bonds on its balance sheet for cash on pre-agreed, temporary terms. Officially, this is part of the Fed’s management of overnight interest rates. But with the reverse repo facility standing at over $2 trillion, this is far from a marginal rate setting activity. It probably has more to do with Basel 3 regulations which penalise large bank deposits relative to smaller deposits, and a lack of balance sheet capacity at the large US banks.
Repos, as opposed to reverse repos, still take place between individual banks and their institutional customers, but it is not obvious that they pose a systemic risk, though some large pension funds may have been using them for LDI transactions, similarly to the UK pension industry.
While highly geared compared with in the past, US G-SIBs are not nearly as much exposed to a general credit downturn as the Europeans, Japanese, and the British. Contracting bank credit will hurt them, but other G-SIBs are bound to fail first, transmitting systemic risk through counterparty relationships. Nevertheless, markets do recognise some risk, with price-to-book ratios of less than 0.9 for Goldman Sachs, Bank of America, Wells Fargo, State Street, and BONY-Mellon. JPMorgan Chase, which is the Fed’s principal policy conduit into the commercial banking system, is barely rated above book value.
Bank of England — bad policies but some smart operators
In the headlights of an oncoming gilt market crash, the Bank of England acted promptly to avert a crisis centred on pension fund liability driven investment involving interest rate swaps. The workings of interest rate swaps have already been described, but repos also played a role. It might be helpful to explain briefly how repos are used in the LDI context.
A pension fund goes to a shadow bank specialising in LDI schemes, with access to the repo market. In return for a deposit of say, 20% cash, the LDI scheme provider buys the full amount of medium and long-dated gilts to be held in the LDI scheme, using them as collateral backing for a repo to secure the funding for the other 80%. The repo can be for any duration from overnight to a year.
One year ago, when the Bank of England suppressed its bank rate at zero percent, one-month sterling LIBOR was close to 0.4% percent to borrow, while the yield on the 20-year gilt was 1.07%. Ignoring costs, a five-times leverage gave an interest rate turn of 0.63% X 5 = 3.15%, nearly three times the rate obtained by simply buying a 20-year gilt.
Today, the yield differential has improved, leading to even higher net returns. But the problem is that the rise in yield for the 20-year gilt to 4.9% means that the price has fallen from a notional 100 par to 49.95. Since this is the collateral for the cash obtained through the repo, the pension fund faces margin calls amounting to roughly 2.5 times the original investment in the LDI scheme. And all the pension funds using LDI schemes faced calls at the same time, which crashed the gilt market. This is why the BOE had to act quickly to stabilise prices.
Very sensibly, it has given pension funds and the LDI providers until this Friday to sort themselves out. Until then, the BOE stands prepared to buy any long-dated gilts until tomorrow (Friday, 14 October). It should remove the selling pressure from LDI-related liquidation entirely and orderly market conditions can then resume.
This experience serves as an example of how rising bond yields can wreak havoc in repo markets, and with interest rate swaps as well. That being the case, problems are bound to arise in other currency derivative markets as bond yields continue to rise.
Like the other major central banks, the BOE has seen a substantial deficit arise on its portfolio of gilts. But at the outset of QE, it got the Treasury to agree that as well as receiving the dividends and profits from gilts so acquired, it would also take any losses. All gilts bought under the QE programmes are held in a special purpose vehicle on the Bank’s balance sheet, guaranteed by the Treasury and therefore valued at cost.
Conclusions
In this article I have put to one side all the economic concerns of a downturn in the quantities of bank credit in circulation and focused on the financial consequences of a new long-term trend of rising interest rates. It should be coming clear that they threaten to undermine the entire fiat currency financial system.
Credit Suisse’s public problems should be considered in this context. That they have not arisen before was due to the successful suppression of interest rates and bond yields, while the quantities of currency and bank credit have expanded substantially without apparent ill effects. Those ill effects are now impacting financial markets by undermining the purchasing power of all fiat currencies at an accelerating rate.
From being completely in control of interest rates and fixed interest markets, central banks are now struggling in a losing battle to retain that control from the consequences of their earlier credit expansion. That enemy of every state, the market, has central banks on the run, uncertain as to whether their currencies should be protected (this is the Fed’s current decision and probably a dithering BOE) or a precarious financial system must be the priority (this is the ECB and BOJ’s current position).
But one thing is clear: with CPI measures rising at a 10% clip, interest rates and bond yields will continue to rise until something breaks. So far, commercial banks are dumping financial assets to deleverage their balance sheets. The effects on listed securities are in plain sight. What is less appreciated, at least before LDI schemes threatened to collapse the UK’s gilt market, is that the $600 trillion OTC derivative market which grew on the back of a long-term trend of declining interest rates is now set to shrink as contracts go sour and banks refuse to novate them. That means that up to $600 trillion of notional credit is set to vanish, in what we might call the Great Unwind.
This downturn in the cycle of bank credit boom and bust will prove difficult enough for the central banks to manage. But they themselves have balance sheet issues, which can only be resolved, one way or another, by the rapid expansion of base money. And that risks undermining all public credibility in fiat currencies.
******
Cue Dollar Squeeze Panic: Fed Sends A Record $6.3 Billion To Switzerland Via Swap Line
BY TYLER DURDEN FRIDAY, OCT 14, 2022 (ZERO HEDGE)
BofA Chief Investment Strategist Michael Hartnett (whose latest weekly note we will dissect shortly) has a favorite saying for when critical phase (to avoid the most hated word in the world "paradigm") shifts take place in the market, one which may be the only word a trader in this day and age needs (or rather hopes for): "Markets stop panicking when central banks start panicking."
So in what may be the best news to shellshocked bulls after the worst September and worst Q3 in generations, in a harrowing year for markets, and on a Friday which is set to reverse much of yesterday's historic intraday reversal, the 5th biggest on record, central banks are starting to panic more with every passing day. First it was the BOJ, then the BOE and now, for the second week in a row, it's Switzerland's turn.
Recall that three weeks ago after the (first) panicked pivot by the BOE, when global markets were in freefall, we said that markets desperately needed some words of encouragement from the Fed, or failing that - and with the dollar soaring to new all time highs every day - the Fed had to make some pre-emptive announcement on USD Fx swap lines, if only to reassure global markets that amid this historic, US dollar short squeeze, at least someone can and will print as many as are needed to avoid systemic collapse.
So fast forward two weeks to October 5, when there still hasn't been any formal announcement from the Fed, but ever so quietly the Fed shuttled $3.1 billion to the Swiss National Bank to cover an emergency dollar shortfall, as we first reported a few days ago.
Remarkably, this was the first time the Fed sent dollars to the SNB this year, and the first time the Fed used the swap line in size (besides a token amount to the ECB every now and then)!
But it certainly won't be the last time - as we have warned, expect far wider use of Fed swap line usage as the world chokes on the global dollar shortage - and sure enough overnight the Fed announced that as of Thursday it doubled the size of its USD swap with the world's most pristine economy and its central bank, the Swiss National Bank, sending some $6.27 billion to avoid an emergency funding crunch.
Remarkably, this was only the second time the Fed sent dollars to the SNB this year, and was also the largest single USD swap transfer in history!
The next logical question obviously is: why does Switzerland have a financial institution needing a record $6.3 billion in cheap (3.33%) overnight funding for the second week in a row. We don't know the answer, but have a pretty good idea of who the culprit may be courtesy of Goldman which earlier this week issued the following note:
And speaking of the coming crisis, recall what we said at the start of September: the coming Fed pivot will have nothing to do with whether the Fed hits or doesn't hit its inflation target, and everything to do with the devastation unleashed by the soaring dollar (a record margin call to the tune of some $20 trillion) on the rest of the world.
And speaking of the coming crisis, recall what we said at the start of September: the coming Fed pivot will have nothing to do with whether the Fed hits or doesn't hit its inflation target, and everything to do with the devastation unleashed by the soaring dollar (a record margin call to the tune of some $20 trillion) on the rest of the world.
Today, none other than Bob Michele, the outspoken chief investment officer of J.P. Morgan Asset Management, told everyone that we were right: as paraphrased by Bloomberg, Bob said "the relentless dollar could forge a path to the next market upheaval."
Michele has been in de-risking mode, sitting on a pile of cash which is near the highest level he has held in 10 years. And he is long the dollar. While a market crisis sparked by the greenback is not his base case, it’s a tail risk that he is monitoring closely.
Here’s how it could happen: Foreigners have snapped up dollar-denominated assets for higher yields, safety, and a brighter earnings outlook than most markets. A big chunk of those purchases are hedged back into local currencies such as the euro and the yen through the derivatives market, and it involves shorting the dollar. When the contracts roll, investors have to pay up if the dollar moves higher. That means they may have to sell assets elsewhere to cover the loss.
“I get concerned that a much stronger dollar will create a lot of pressure, particularly in hedging US dollar assets back to local currencies,” Michele said in an interview. “When the central bank steps on the brakes, something goes through the windshield. The cost of financing has gone up and it will create tension in the system."
The market probably saw some of that pressure already: as we noted at the time, investment-grade credit spreads spiked close to 20 basis points toward the end of September. That’s coincidental with a lot of currency hedges rolling over at the end of the third quarter, he said -- and it may be just “the tip of an iceberg.”
So far so good: and where we agree especially with Michele is what he thinks happens next: as Bloomberg writes, "the central bank will be so committed to combating inflation that it will keep raising rates and won’t pause or reverse course unless something really bad happens to markets or the economy, or both. If policy makers pause in response to market functionality, there has to be such a shock to the system that it creates potential insolvencies. And a rising dollar might do just that."
And the fact that the Fed is already quietly shuttling billions of dollars to various central banks to plug dollar overnight funding holes, confirms that the rising dollar has already done just that. One look at the meltup in FRA-OIS is enough confirmation.
As for what happens next, we suggest that you i) quietly panic if you are still short USD, which so many since at last check (which was March 2020) JPMorgan calculated that the global dollar short was $12 trillion, some 60% of US GDP, a number which has conservatively grown to about $20 trillion as of today...
(... and I'd keep a very close eye on these particular money hotels) |
