What About Derivatives?

July 20th, 2011
F. Grey Parker

The foggy world of derivatives, the same non-transparent mechanisms that nearly led to a global rollover three years ago, is still fundamentally opaque. They almost drove us into total depression before and that was without the intentional brinkmanship and economic sabotage now being seen from some of our own "conservative" representatives.

As the U.S. flirts with a potential default, most experts seem to think the impact upon the credit default swap market that would follow is minor relative to other nations.

From reporting in late May by the Financial Times (via CNN):

"The size of the US sovereign credit derivatives market is still small relative to the amount of hedging and trading that takes place on eurozone sovereign debt.

For example, the current value of outstanding CDS on Greece is $78bn and CDS on Italy's sovereign debt totals $284bn, DTCC data show. The US derivatives positions are dwarfed by the size of the US Treasury debt market, which adds up to about $9,500bn."

That this news was met with general relief by most American economists seems to indicate a willful disregard for the interconnectedness of "sovereign" systems.  A U.S. default would drag down not only ourselves but also most of the world's other vulnerable economies. First among them would almost certainly be Greece.

A few weeks ago, Louise Story wrote of the potential effect a Greek default alone might have on the CDS market. From her piece:

"It’s the $616 billion question: Does the euro crisis have a hidden AIG?

No one seems to be sure, in large part because the world of derivatives is so murky, but the possibility that some company out there may have insured billions of dollars of European debt has added a new wrinkle to the sovereign default debate.

In years past, when financial crises in Argentina and Russia left those countries unable to make good on their government debts, they simply defaulted. But this time around, swaps and other sorts of contracts have become so common and so intertwined in the financial markets that there are fears among regulators and financial players about how a Greek default would play out among derivatives holders.

The looming question is whether these contracts — which insure against possibilities like a Greek default — are concentrated in the hands of a few companies, and if these companies will be able to pay out billions of dollars to cover losses during a default. If there were a single company standing behind many of these contracts, that company would be akin to the American International Group of the euro crisis."

In fact, just four U.S. banks still control a majority of the global derivatives market.

Where are we now in terms of American oversight? Even after all that has happened, we still have no window into how these are bundled or who is left holding the bag. Every attempt to shine a bit of of light on this dubious fiscal device has been stymied, largely by the GOP who have operated consistently at the behest of their Wall Street allies.

Earlier this week, Chris Kentouris explained just how little has changed since the fall of 2008. Nearly a year to the day since Dodd-Frank was signed into law, with oversight systems not yet in place, there is still no means of accurately estimating holdings or vulnerability. We are no more sure what all of the hazards might be in the event of a full U.S. Treasury default than the Greeks are. However, the former will almost certainly result in the latter.

One more note:

The real madness here just might be this... The odds are that whomever is reading this still doesn't actually even know what the hell derivatives are. Or that all of this was predicted during the Clinton years. The full length video from Frontline that follows is both a primer and, as its title stipulates, a "Warning."