Trillion Dollar Ticking Derivatives Time Bomb to Explode Under Bankrupt Banks

By: Graham_Summers

Dear %$firstname$%,

At Gains, Pains, & Capital I’ve been warning about the Trillion Dollar Ticking Time Bomb of derivatives for months now. As a brief recap, let’s consider the following:

• The current notional value of the derivatives market is
• The current notional value of derivatives on US commercial banks’ balance sheets is $203 trillion.
• 97% of these ($196 trillion) sit on FIVE banks’ balance sheets (more on this shortly)
• If even 1% of this $203 trillion is “at risk” … you’re talking about $2 TRILLION in at risk bets made in the derivatives market
• If 10% of that 1% end badly, you’re talking about $200 billion in losses

Total equity at the five banks is $737 billion. So if you assume that only 1% of derivatives are “at risk” (odds are it’s more) and 10% of that at risk money is lost, you’ve wiped out nearly 1/3 of the banks’ equity.

If 2% of derivatives are “at risk” and 10% of those bets go bad, you’ve wiped out $400 billion or nearly HALF of the banks’ equity.

If 4% of derivatives are “at risk” and 10% of those bets go bad, you’ve wiped out ALL OF THEIR EQUITY and they go to ZERO.

Remember, I’m only accounting for derivatives here… I’m not even including ON BALANCE sheet risks, mortgage backed securities, and all the other junk floating around.

Suffice to say derivatives are HUGE time bomb waiting to go off.

And what could trigger them?

Interest rates.

Of the $200+ trillion in derivatives on US banks’ balance sheets, 85% are based on interest rates.

For this reason, I cannot take ANY of the Fed’s mumblings about raising interest rates seriously AT ALL. Remember %$firstname$%, most if not ALL of the bailout money has gone to US banks in order to help them raise capital. So why would the Fed make a move that could potentially destroy these firms’ equity (essentially undoing all of its previous efforts)?

However, at this point, the Fed may not have a choice….

As I showed in yesterday’s issue, the bond market is DEMANDING higher yields from US debt. Put another way, US debt holders are unwilling to continue funding our profligate spending without getting paid more to do it… I can’t say I blame them, since the prospect of collecting a 3% yield to own a currency that’s lost 15% in the last six months isn’t too appealing.

But if yields rise this could blow up the derivatives market (remember 85% of derivatives are related to interest rates). So the question remains:

WHICH BANKS ARE SITTING IN THE DERIVATIVES MINE FIELD?

I want to be clear here. The above chart MAY not be as bad as it looks. Remember, NOT ALL notional value of derivatives are at risk. For instance, only 1% of the above numbers might actually be REAL money at risk…

The issue however, is that NO ONE knows how much money is at risk here. No one. But considering:

• The derivatives market is TOTALLY unregulated….
• The nightmare that has occurred due to instruments that were allegedly regulated (mortgage backed securities, etc.)…
• EVERY attempt to increase transparency or accounting standards at the banks has been met with threats of financial Armageddon…

It’s very difficult NOT to be freaked out by the above numbers. Personally, I sure hope that less than 0.0001% of that stuff is “at risk.” I hope bankers were more careful with interest-rate based derivatives than they were with mortgage-backed securities.

I hope… But I doubt it.

To that end, I’m already preparing investors for what’s to come with a FREE Special Report detailing THREE investments that will explode when stocks start finally collapse. While most investors are complacently drifting towards the next Crisis lke lambs to the slaughter, my readers are already getting ready with my Financial Crisis “Round Two” Survival Kit.

The investments detailed within this report will not only protect your portfolio from the coming carnage, they’ll also show you enormous profits: they returned 12%, 42%, and 153% last time stocks collapsed.

Swing by www.gainspainscapital.com/roundtwo.html to pick up a FREE copy today!

Good Investing!

Graham Summers

http://gainspainscapital.com

Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets. 

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

© 2009 Copyright Graham Summers - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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