The Wipeout Ratio

A simple calculation comparing major banks’ derivatives positions to their assets and capital shows how little it would take to wipe out either.  The first ratio is the multiple that derivatives represent of Tier 1 capital.  The second shows the miniscule percentage decline in the value of derivatives portfolio it would take to completely wipe out Tier 1 capital.

Goldman Sachs, for instance, has $47 trillion in derivatives exposure — 2,480 times its Tier 1 capital.  A 0.04% decline in the value of the derivatives portfolio would wipe out Tier 1 capital altogether.

Overall, a 0.18% decline would do the entire bunch in.    Something to think about, especially as the vast majority of derivatives are OTC, are not priced in public markets, and are obscured/netted out in balance sheets.  Remember, “too big to fail” really means “subject to taxpayer bailout.”

A little over a week ago in a Zerohedge article we learned that Italy’s previously hidden derivatives exposure amounted to 11% of the country’s GDP.    A recent $3.4 billion payment to Morgan Stanley to settle a 1994 contract wiped out half the value of the tax hikes recently imposed on an already crumbling economy.

If this doesn’t seem terribly important, consider that the derivatives exposure of the five banks above alone, at $240 trillion, is four times the combined GDP of every country on earth.  JPM, by itself, has notional derivatives exposure that exceeds the combined global GDP.

I fear this is the story of the year, folks.  And, it’s just now starting to get some press.  As we learned with AIG, if one segment of the financial markets suffers unanticipated losses, the entire house of cards can come crashing down.  Banks know how bad the situation is; how else to explain the lack of interbank lending — particularly in the euro zone?

Stay tuned.

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