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Good derivatives or Bad derivatives. Interest rates swap are good so we can
all have fixed rate mortgages. CMOs .. part of the equation were bad
because they murdered Orange County.... ever ask yourself who made the money
LTCM and Orange County lost? Misuse of leverage is clearly an issue and in
the end that's what kills the user. Any market where you trade a enormous
amount of leverage and then experience discontinuous pricing will always
result in disaster.
You need a robust derivatives market to manage risk and the process of
transferring risk. When you lose that ability you no longer have fully
functional financial market. You need to bring hedgers, speculators and
liquidity providers together. On occasion the speculators and the liquidity
providers cannot both make money. Sometimes all three make money....
sometimes only one or two of the participants make money.
Before you kill derivatives go try to get a mortgage or buy a foreign car.
Look at the fiasco in California electricity .... some speculators who
didn't figure out they were speculators.... lost tons of money. Some
speculators made tons of money.
You will always have big losers and winners as long as risk occurs.
-----Original Message-----
From: Earl Adamy [mailto:eadamy@xxxxxxxxxx]
Sent: Friday, August 17, 2001 8:58 PM
To: realtraders@xxxxxxxxxxxxxxx
Subject: Re: [RT] Derivatives
There is a strange thing about derivatives ... they work well until they
don't and they usually work quite well until there is major stress put on
the system. Not unlike LTCM, some of the 7 institutions are loaded with
derivatives to a point where there their balance sheets are not remotely
capable of handling an unhinging. We are already seeing stress cracks where
the cream level of some CDO's (Collateralized Debt Obligations) are becoming
near-junk because the underlying levels have deteriorated i.e. that is what
the American Express $600m+ write-off was all about. BA just took a big
write-off of their lease holdings because the residual resale values of the
vehicles underlying the holdings plummeted. There are stress cracks
occurring in the financial system, and while I am not predicting that one of
these institutions will be taken down by derivative risk, the reserving of a
paltry $2 million against $43 trillion of derivative in a less predictable
economy is absurd. If the COC did not have some concerns in this regard, the
report would not have appeared as written.
Earl
----- Original Message -----
From: "Jacobson, Alex" <AJacobson@xxxxxxxxxxxxxx>
To: <realtraders@xxxxxxxxxxxxxxx>
Sent: Friday, August 17, 2001 4:44 PM
Subject: RE: [RT] Derivatives
> Kind of curious that you would assume otherwise. If the lion's share is
> concentrated in the big seven and none of them had problems .. the
> chargeoffs should have been tiny. Most of the stuff is interest rate ..
> over 80% .. with the balance being FX. The mix used to be different ..
> almost the opposite if I remember correctly. They only deal a very small
> portion of the trading with the smaller players therefore the chargeoffs
are
> .. as you would expect tiny. Could they become unhedged. Sure to a
degree,
> but that is why they have balance sheets.
>
> If you didn't have all this activity ... you have very very little
interest
> rate trading and huge vol. swings and risk. Which would you prefer.
>
> -----Original Message-----
> From: Earl Adamy [mailto:eadamy@xxxxxxxxxx]
> Sent: Friday, August 17, 2001 4:14 PM
> To: Realtraders
> Subject: [RT] Derivatives
>
>
> Very interesting report from Office of Controller of Currency Bank
> Derivatives Report. The entire 23 page report complete with tables can be
> found at http://www.occ.treas.gov/ftp/deriv/dq101.pdf. The tables show
> tremendous concentration of derivative leverage, holdings, and risk among
7
> banks. Needless to say, with the entire global financial system under
> stress, there is significant risk that hedged derivative positions will
> become unhedged.
>
> One paragraph stands out: "During the first quarter of 2001 banks charged
> off $2 million due to credit losses from derivatives, or .0004 percent of
> the total credit exposure from derivative contracts. For comparison
> purposes, net loan charge-offs relative to total loans for the quarter
were
> .18 percent." $2 million out of $43.9 trillion!!!
>
> Earl
>
>
>
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