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Yes, gross derivative exposure is irrelevant... until there is a breach in the counterparty chain and suddenly all net becomes gross (as in the case of the Lehm

Yes, gross derivative exposure is irrelevant... until there is a breach in the counterparty chain and suddenly all net becomes gross (as in the case of the Lehman bankruptcy), such as during a financial crisis. Perhaps rather than total notational outstanding, a more meaningful number is the amount of real assets this is all backed by. According to the IMF we have $600 trillion in gross notional derivatives backed by a $600 billion in real assets, i.e. 1000x systemic leverage: http://www.imf.org/external/pubs/ft/sdn/2012/sdn1212.pdf http://www.imf.org/external/pubs/ft/sdn/2012/sdn1212.pdf One can imagine this to become just a tiny bit problematic once collateral chains start breaking, such as when "AAA-rated" AIG failed :)

cm2187 11y ago
Your exposure is not the notional, it is the mark-to-market minus any collateral received or posted. This will be a small fraction of the notional.
- randomname2 11y ago
  Well the point still stands... in case of an "event" that blows up collateral chains, Deutsche will be in big trouble. Also, interestingly, from the piece I quoted, a lot of these derivatives get to be created without any collateral being posted at all: "Another important metric is the under-collateralization of the OTC market. The Bank for International Settlements estimates that the volume of collateral supporting the OTC market is about $1.8 trillion, thus roughly only half of exposures. Assuming a collateral reuse rate between 2.5-3.0, the dedicated collateral is some $600 - $700 billion. Some counterparties (e.g., sovereigns, quasi-sovereigns, large pension funds and insurers, and AAA corporations) are often not required to post collateral. The remaining exposures will have to be collateralized when moved to CCP to avoid creating puts to the safety net. As such, there is likely to an increased demand for collateral worldwide."
  - arjunnarayan 11y ago
    > Well the point still stands... in case of an "event" that blows up collateral chains, Deutsche will be in big trouble. Not for bilateral derivatives that can always be netted, even in bankruptcy, which make up the bulk of the notional outstanding. If you read the ISDA Master Agreement[1], derivatives can always be netted as there is a provision that exempts derivatives from the usual bankruptcy automatic stays to stop literally this exact threat you posited [2]. Even beyond the bilateral case, the multilateral cases are increasingly cleared through central clearinghouses[4]. But even when they aren't, multilateral nets can still be pushed through, in one of two ways: 1) even when Lehman failed, there were some multilateral nets that greatly reduced the exposure, under mutual agreement by all creditors, and 2)The Dodd-Frank Act, since 2009, has also greatly helped this, giving the FDIC and Fed enhanced powers under the Orderly Liquidation Authority[3], which allow them to multilaterally net to reduce contagion risks even if there is no such master agreement that a priori would have let them do so[5]. [1] http://en.wikipedia.org/wiki/ISDA_Master_Agreement http://en.wikipedia.org/wiki/ISDA_Master_Agreement [2] A Dialogue on the Costs and Benefits of Automatic Stays for Derivatives and Repurchase Agreements, by Duffie and Skeel, alternatively see [3], or [4] [3]The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences by David Skeel. [4] The Risk Controllers by Peter Norman. [5] Even pre Dodd-Frank, when there wasn't a law that let this happen, usually the creditors come together and fix things, a la LTCM "bailout"[6], which was funded entirely by the creditors and unwound in an orderly fashion through multilateral netting. Bear Stearns and Lehman Brothers were the only creditors that stiffed everyone else, by refusing to participate, and that was partly why they got fucked in 2009 since the other bankers remembered their unwillingness to help out in 1998, and reciprocated. [6] I hate that this is called a Bailout. No taxpayer funds were spent. The creditors (i.e. big banks) bailed out one of their own by pooling together money and fixing their shit. The only governmental involvement was that the Fed president called the CEOs of the big banks and said "yo fix your shit before it spreads", and they did. That's not a bailout in the sense of "taxpayers bailed them out". They bailed themselves out.

cm2187 11y ago

Your exposure is not the notional, it is the mark-to-market minus any collateral received or posted. This will be a small fraction of the notional.

randomname2 11y ago
Well the point still stands... in case of an "event" that blows up collateral chains, Deutsche will be in big trouble. Also, interestingly, from the piece I quoted, a lot of these derivatives get to be created without any collateral being posted at all: "Another important metric is the under-collateralization of the OTC market. The Bank for International Settlements estimates that the volume of collateral supporting the OTC market is about $1.8 trillion, thus roughly only half of exposures. Assuming a collateral reuse rate between 2.5-3.0, the dedicated collateral is some $600 - $700 billion. Some counterparties (e.g., sovereigns, quasi-sovereigns, large pension funds and insurers, and AAA corporations) are often not required to post collateral. The remaining exposures will have to be collateralized when moved to CCP to avoid creating puts to the safety net. As such, there is likely to an increased demand for collateral worldwide."
- arjunnarayan 11y ago
  > Well the point still stands... in case of an "event" that blows up collateral chains, Deutsche will be in big trouble. Not for bilateral derivatives that can always be netted, even in bankruptcy, which make up the bulk of the notional outstanding. If you read the ISDA Master Agreement[1], derivatives can always be netted as there is a provision that exempts derivatives from the usual bankruptcy automatic stays to stop literally this exact threat you posited [2]. Even beyond the bilateral case, the multilateral cases are increasingly cleared through central clearinghouses[4]. But even when they aren't, multilateral nets can still be pushed through, in one of two ways: 1) even when Lehman failed, there were some multilateral nets that greatly reduced the exposure, under mutual agreement by all creditors, and 2)The Dodd-Frank Act, since 2009, has also greatly helped this, giving the FDIC and Fed enhanced powers under the Orderly Liquidation Authority[3], which allow them to multilaterally net to reduce contagion risks even if there is no such master agreement that a priori would have let them do so[5]. [1] http://en.wikipedia.org/wiki/ISDA_Master_Agreement http://en.wikipedia.org/wiki/ISDA_Master_Agreement [2] A Dialogue on the Costs and Benefits of Automatic Stays for Derivatives and Repurchase Agreements, by Duffie and Skeel, alternatively see [3], or [4] [3]The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences by David Skeel. [4] The Risk Controllers by Peter Norman. [5] Even pre Dodd-Frank, when there wasn't a law that let this happen, usually the creditors come together and fix things, a la LTCM "bailout"[6], which was funded entirely by the creditors and unwound in an orderly fashion through multilateral netting. Bear Stearns and Lehman Brothers were the only creditors that stiffed everyone else, by refusing to participate, and that was partly why they got fucked in 2009 since the other bankers remembered their unwillingness to help out in 1998, and reciprocated. [6] I hate that this is called a Bailout. No taxpayer funds were spent. The creditors (i.e. big banks) bailed out one of their own by pooling together money and fixing their shit. The only governmental involvement was that the Fed president called the CEOs of the big banks and said "yo fix your shit before it spreads", and they did. That's not a bailout in the sense of "taxpayers bailed them out". They bailed themselves out.