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To: GraceZ who wrote (211713)	12/29/2002 2:33:48 AM
From: smolejv@gmx.net	Read Replies (3) \| Respond to of 436258

The cato paper explains in a straightforward way what the swaps, forwards, futures, options (and so on) are. However, its main intent, according to its title ("10 Myths About Financial Derivatives") as well as its content, was to debunk these ten myths. The paper is dated sept 1997. In view of LTCM - that crested march 98 and blew up oct 98 - at least the paragraphs on the first myth "Derivatives Are New, Complex, High-Tech Financial Products Created by Wall Street's Rocket Scientists" need a fresh layer of paint. Also the text on the myth 3 "The Enormous Size of the Financial Derivatives Market Dwarfs Bank Capital, Thereby Making Derivatives Trading an Unsafe and Unsound Banking Practice": "For the 10 largest derivatives players among U.S. bank holding companies, derivative credit exposure averages 15 percent of total assets. The average exposure is 49 percent of assets for those banks' loan portfolios. In other words, if those 10 banks lost 100 percent on their loans, the loss would be more than three times greater than it would be if they had to replace all of their derivative contracts." ...is rather out of date. The latest official number on notional amount is 50+ trillion, up substantially from about 20 in 1997. Dealing in risk seems still to be the one game in town. See occ.treas.gov

To: GraceZ who wrote (211713)	12/29/2002 6:02:16 PM
From: ild	Respond to of 436258

Grace, thanx for the document. Yes, prudent use of the derivatives is a good thing. I think the current problem with derivatives is that Wall Street sells derivatives to companies that don't understand them well. There are some 20-40 Trillion dollars worth of credit swaps. Who are the buyers and who are the sellers? Who is at risk? IMO what happens is that companies are selling the risk in form of credit swaps. WS buys this risk and sells it retail. Very similar was when WS taught companies to sell puts on their stock in off market transactions. Many companies did because it was advertised to them as "free money". WS bought those cheap puts and in turn was able to sell puts on the market without incurring any risk. Now with interest rate swaps WS is doing the same trick. Eventually the companies that are late to the party and/or sold too much risk will pay the nose. In both cases WS was not at risk, but their clients were and still are. Good piece on danger of interest swaps mountain in US from a real guru - Bill Gross: ... Mr. Immelt actually seemed like a pretty nice guy – dressed in that Jimmy Carter sweater and all. But in addition to sticking up for his company and not “dissing” PIMCO, he said the following: “And so while, you know, a move into long-term debt will increase our funding costs slightly,…it has nothing to do with the spread between commercial paper and long-term debt because we swap into matching funds. So you know the incremental cost is de minimus.” De minimus? How could moving $11 billion from 1 3/4% commercial paper to 6 1/2% debt be “de minimus?” At first blush, it appears to be an annual increase in interest expense of about $500 million dollars, which as Everett Dirksen might have said is “real money.” But Immelt could be right if in fact they “swap” that long-term debt back into short-term floating rate paper - but only he and his Treasurer know that. This stuff is complicated folks, so I will go no further down this “swappy” trail other than to say that GE’s actual increase in interest expense might temporarily be limited to say $70 or 80 million not $500 million – if in fact they’re using interest rate swaps. And that is where I came upon what might be another brandie – and this too is where I shall leave the GE saga and move on to the broader context of Corporate America which is what I intended to do in the first place. The fresh idea (although it’s been lying in the grass for years now) was that if lots of corporations were doing the same thing, then the short-term Fed Funds rate is driving the economy. Now that of course is no brilliant observation, it has been thus for eight decades or so with a temporary disconnect in the 1940s for wartime finance. But when a creation of the last 10 years – the interest rate swap – makes it possible for Corporate America to term out their debt and still pay near commercial paper rates, then that’s a revelation – or better yet, a revolution. It means that short-term rates are even more critical to the profitability of Corporate America - to the level of the stock market - to the growth rate of the American economy than ever before. It means that Alan Greenspan dare not raise interest rates too much or risk sinking the stock market and the economy once again; it means that because his ability to raise short rates is limited, that ultimately inflation may be higher than it otherwise would be in a still near deflationary world; it means that bond investors should do certain things and not do others. And that, dear readers, is a bagful of brandies – not in the creek, but lying half-hidden in the tall grass. Explain please. Well, explanations should include proof but when it comes to the interest rate swap/derivatives market, the evidence is nearly impossible to come by. According to recent data by the Bank for International Settlements (BIS), worldwide swaps outstanding (mainly U.S.) total over $43 trillion. That’s a hunk-a-hunk of love folks: love for derivatives that in the corporations’ case may serve to reduce interest rate costs in the short run, but increase exposure/risk in the long run. Try finding these swaps detailed by amount and purpose in a 10K or annual report though. Even Sherlock Holmes couldn’t find something that wasn’t there. pimco.com