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Non-Tech : Derivatives: Darth Vader's Revenge -- Ignore unavailable to you. Want to Upgrade?

To: Freedom Fighter who wrote (846)	3/25/1999 2:00:00 PM
From: Zardoz	Respond to of 2794

Did the stats AG give mention how much of the derivative markets was actually from countries such as Japan, Germany and USA? I lost my book mark to BOJ, but think they accounted for I believe in excess of 20 Trillion in foreign and domestic derivatives. Which might help to explain the Nikkei of late? So if countries are taking on derivative exposure, could they not be creating stable markets? Since monetary policies can affect the markets, and thus derivatives? Should they not be in the derivative markets, as a buyer &/or seller? And then isn't some of the risk not applicable, since they are less then zero sum, but are designed into the system. Can we not look at the FRB's and see their financials?

To: Freedom Fighter who wrote (846)	3/25/1999 2:09:00 PM
From: Freedom Fighter	Read Replies (2) \| Respond to of 2794

Henry, In prior posts you talked about Japanese repatriation. Generally you suggested it would be counter-productive for the Japanese central bank to sell dollars, so any repatriation would come from the private sector. I agree. I wonder however, if the public/market isn't underestimating the potential for our chronic current account deficit, accumulation of foreign holdings of U.S. securities, and compound interest payments to eventually work against the U.S. in the form of a lower dollar and higher interest rates. Perhaps even a realization that on it's current path the U.S. is not a particularly great place to park reserves. Any thoughts? Wayne Crimi

To: Freedom Fighter who wrote (846)	3/25/1999 4:22:00 PM
From: Henry Volquardsen	Respond to of 2794

Hi Wayne, I would have answered sooner but I checked your profile and had to check the value investor's workshop. You and others here might like participating in a new thread that has started Subject 26868 In the example you mention it is still zero sum in the strictest sense. In your example lets say A has the large directional bet and makes $100. He makes this on positions he has on with market makers B and C. B and C run market neutral books so they have laid off their risk with D. D is another directional player but he could also be a hedger. D has lost $100. Now lets say D is bust and can't pay. B and C now lose the $100 as they have to pay A. As you put it we have 3 in trouble. But no more than the $100 owed to A is lost. D can't pay because he doesn't have the money. He winds up losing nothing, he had nothing to begin with otherwise he would have paid. B and C lose because of sloppy credit work. This what Mr G meant, I believe, in saying it is a zero sum game. It is a technical statement. Remember Mr G is a central banker and used to looking at macro accounts and he was speaking very much in that spirit. FWIW I thought it was a marvelous example of Econ-o-speak. There is an old economist joke. A guy goes up in a hot air baloon when a storm hits. He gets lost in the clouds and blown around for hours unable to see the ground. When the storm clears he finds himself floating above a large open plain. He sees no recognizable landmarks and has no idea where he is. He sees a man standing on the ground beneathe him. He shouts down 'Sir can you tell me where I am?' The man responds, 'Of course, you are in a basket hanging beneath a hot air baloon'. The baloonist shakes his head and shouts back 'thank you, I assume you are an economist'. The man responds 'why yes, I am. How did you know?'. The baloonists responds 'Your answer. It was perfectly precise and accurate, of no practical use and totally beside the point. Mr G's comment about zero sum was perfectly precise and besides the point. I'm pretty sure he knows it as well. I don't want to give the impression that I am saying derivatives are riskless. Quite the contrary. There is a lot of risks in derivatives. The recent discussions we have had about derivatives have focused on the pricing impacts and effect on the market and vice versa. In my opinion that iis not where the real risk is. The market makers focus alot on pricing models and economic risk. It is the back door where the real risk lies. Credit and systems is a lot less sexy than trading and sometimes gets short shrift. That is where the risk is. Now by personal experience is that this risk is real but not overwhelming. As far as the size of the exposure I'll try to put it in context a little. A large portion of that number is on futures exchange. To that extent it is margined. The margin will also act as a stop loss on weak players that will help limit the cascade. Another large portion is interbank transactions. This comes from market makers dealing with each other. A lot of this risk will be going in both directions. Lets say banks A and B are both $ swaps market makers. Over the course of time they have done $800 mln in swaps where A is paying fixed rates to B and $750 of swaps in which B is paying fixed rates to A. On the books this appears as $1.55 bln in exposure. However if one of the banks fails there will be a liquidation. All major banks have gone to using netting arrangements in their interbank dealings. This would mean that most of this risk would be netted. The remaining exposure would be $50 mln. And the risk would only be the market risk not the principal risk. I'm a big fan of Mr Buffet. I don't remember his 'meltdown' comment but ha may have said that. What I will say is that every bank is aware of the systemic risks in derivatives trading. We are all concerned about meltdown risk. There has been a lot down over the last ten years to establishing netting facilities and other credit enhancements that will prevent the meltdown risk. It is worth mentioning that last year the derivatives market went through a tremendous test. Some very large players took some hard hits. Yet the system functioned very well. Ten years earlier it would have been much iffier. I strongly think AG was right. The derivatives industry has evolved tremendously and removed a lot of volatility from the system. (I know I'll get called by someone on that statement <grin>) Discouraging derivatives would increase volatility and risk. Henry

To: Freedom Fighter who wrote (846)	3/29/1999 12:30:00 PM
From: Worswick	Read Replies (1) \| Respond to of 2794

Wayne hello and thanks for all your great work and thoughts here and on your site. I keep up with every word you say. You are doing a great, great job. Regardless, of what Henry says about these instruments the modalities here are this: In the derivatives market one is dealing with physics. Here is a self evident, simple exercise. "What happens when only one leg of the three cornered stool collapses and 400 lb. fat man who is sitting on the stool eating chocolate begins to wobble ... where does he go? To Park Place?" For the trader in these derivative instruments baby you are only as whole as your weakest creditor. At that these modalities are always, always subject to the whim of the market, and to the intelligence (or lack of intelligence) of the person(s) or financial institutions who entered into these obligations. Believe me there are people who are hugely leveraged out there. Believe me there are people out there who are hugely irresponsible as well. Remember Long Term Credit at 200 X 1 adn this I am sure is not the only example in the sand box. And it is not 80 trillion of obligations outstanding. Henry, alone, has admitted to holding (a single person) over or nearly 1 trillion dollars of derivative trades at one point. How many Henry are there out there? Only 80 in the whole world? You bet. And we know, all of us, that they are not nearly as smart as our Henry. Now.... the Dow goes to 10 K but do not foreget that.. in times of crisis these instruments are only as good as.... the soon to be troubled and possibly bankrupt counterparty. Best to you, Clark