Worldwide derivatives market could be over $1.2 quadrillion in notional value

We wrote earlier about the recent move by bankers — and the politicians who serve them — to unreform the derivatives market, to return it to its pre–Dodd-Frank, pre–Crash-of-2007 state. This is a serious move by banks and bank lobbyists, and it could well happen soon. The seven bills in the House package of “tweaks” — as the House Agriculture website dishonestly puts it — have cleared the committee with Democratic support and are headed to the House floor. In the meantime, there are companion bills in the Senate.

What will happen in the Senate? Well, Dick Durbin (always an Obama surrogate) famously said of the Senate that “the banks own the place.” And of course the White House has been notoriously bank-friendly since day 1. As a friend told me last week, “Bank lobbyists are good; they really earn their money.” Indeed.

Our earlier story focused on both aspects of this push — the “bad Dems” side and the derivatives side. Let’s now look at just the derivatives aspect.

What is a “derivative”?

While a general definition of a derivative in this context could be — “A financial product derived from another financial product” (for example, a futures contract tied to a stock index) — in practice, the term applies to a whole world of financial products that are written on a one-off basis between two entities called “counterparties,” as opposed to products that are traded on a broad, well-regulated market.

Standard futures contracts are bought and sold on large exchanges, for example, the Chicago Board of Trade (CBOT). If I buy a futures contract — for example, I go long (contract or agree to buy in the future) a million bushels of wheat, or barrels of oil, in the expectation that the future price will rise within the time limit of the contract — there will be a counterparty on the short, or selling side, but I have no idea who that is. In fact, in a well-regulated market, the contracts are all standardized; there are thousands of identical contracts in pairs (one on the long or buy side, and one on the short or sell side); and as long as there are the same number of identical contracts on each side, it makes no difference who’s on the other side of my personal contract. The exchange just matches up longs with shorts when they liquidate.

The contracts, as you can see, are created by the exchanges themselves (for example, by the CBOT); they keep the operation orderly; and there are rules, both by the exchanges and by the government, that prevent things (mostly) from running out of control. For example, I can indeed buy futures contracts on millions and millions of barrels of oil for delivery next July (say), and I can put up a tenth of the cost of these contracts, but if the market moves against me, I have to increase my margin (add to my escrow if you will) to protect my counterparties from my inability to pay. The exchange requires that, and if I don’t comply, I’m liquidated (at my expense) and kicked out.

Futures contracts are gambling — I can bet on the Dow to go down or up, for example — but trading in futures contracts is regulated gambling, in which winners are protected from losers, and in many cases, losers protected from themselves.

rich guy bank 1%

Rich guy via Shutterstock.

Not so, derivatives, in the usual meaning of the word. Derivatives in that sense are contracts between parties who want to trade risks, but they aren’t market-traded. They aren’t standardized. And counterparties aren’t vetted by any controlling institution.

In derivatives trading, the counterparties know each other, the contracts are one-off between the parties directly, and the only guarantee that either party will get paid is trust … or the naked belief that they just can’t lose on this one.

AIG wrote billions of dollars of CDS “insurance” against the mortgage market without having even a fraction of what it would take to pay off claims … in the naked belief that they could collect fees forever and never have to pay out once. When the whole thing collapsed, they were wiped out. And because their “insurance” was part of the balance sheet of AIG’s many counterparties (Goldman Sachs and everyone like them), Goldman Sachs would have been wiped out too by AIG’s failure (in effect, by their lies and deception).

That’s why the government bailed out AIG — and insisted on giving them 100 cents on the dollar — so that they could pay off Goldman et al. AIG was bailed out to bail out all their counterparties. (Our discussion of CDSs and their role as bets is here.)

How large is the derivatives market? $1.2 quadrillion in notional value; at least $12 trillion in cash at risk

You read that headine right. By at least one estimate, in 2010 there was a total of $12 trillion in cash tied up (at risk) in derivatives as defined above, all of which controlled contracts connected to assets valued at $1.2 quadrillion.

Here’s how we got those numbers — be sure to differentiate the two values, cash value vs. notional value, as explained below (h/t commenter BeccaM for the link; my emphasis):

Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP

One of the biggest risks to the world’s financial health is the $1.2 quadrillion derivatives market. It’s complex, it’s unregulated, and it ought to be of concern to world leaders that its notional value is 20 times the size of the world economy. But traders rule the roost — and as much as risk managers and regulators might want to limit that risk, they lack the power or knowledge to do so.A quadrillion is a big number: 1,000 times a trillion. Yet according to one of the world’s leading derivatives experts, Paul Wilmott, who holds a doctorate in applied mathematics from Oxford University (and whose speaking voice sounds eerily like John Lennon’s), $1.2 quadrillion is the so-called notional value of the worldwide derivatives market. To put that in perspective, the world’s annual gross domestic product is between $50 trillion and $60 trillion.To understand the concept of “notional value,” it’s useful to have an example. Let’s say you borrow $1 million to buy an apartment and the interest rate on that loan gets reset every six months. Meanwhile, you turn around and rent that apartment out at a monthly fixed rate. If all your expenses including interest are less than the rent, you make money. But if the interest and expenses get bigger than the rent, you lose.

You might be able to hedge this risk of a spike in interest rates by swapping that variable rate of interest for a fixed one. To do that you’d need to find a counterparty who has an asset with a fixed rate of return who believed that interest rates were going to fall and was willing to swap his fixed rate for your variable one.

The actual cash amount of the interest rates swaps might be 1% of the $1 million debt, while that $1 million is the “notional” amount. Applying that same 1% to the $1.2 quadrillion derivatives market would leave a cash amount of the derivatives market of $12 trillion — far smaller, but still 20% of the world economy.

To trust that lower number ($12 trillion), a lot depends on what’s being traded. In the example above — an “interest rate swap” — what’s being traded (swapped) is the risk of small interest rate changes on the $1 million you borrowed. It’s never the whole $1 million (the notional value).

But with a CDS — a “credit default swap” as discussed here — what’s traded is a fee paid by one side vs. the whole cost of the default paid by the other side. If I as an “insurer” sold a hedge fund a CDS on $20 million in GM bonds, and those bonds default, I’m on the hook for the whole $20 million, the “notional” value.

As a result, I accept the $1.2 quadrillion notional value number. But I think the $12 trillion cash-at-risk number is way low. And “just” $12 trillion is, as they point out, still 20% of world GDP. Stunning.

And don’t forget, these are 2010 numbers. Banks have grown even fatter since then, even greedier, even riskier. And their push to gut the modest regulations put in place by Dodd-Frank declares their intentions to grow. Whatever the size of this market today, expect it to grow like a weed.

Again, House bill HR 992, one of the seven mentioned at the beginning of this piece, is the one that makes you, the taxpayer, even more on the hook for banker-losses than you were after the Dodd-Frank reform. For the banks, the high-priced lobbyists, and their paid, moderately-priced politicians, this is a Win-Win.

But for you, it’s a second trip to Bailout Village. As for the nation … well, I think there’s rebellion in the air if this happens twice. In this case, the hubris of our enemies is not our friend. Not our friend at all.

I thought you should know this, though. We’re going to be covering the derivatives story to conclusion. Hopefully this post and the previous one will keep you oriented as the game moves forward. Quoting Congressman Grayson again:

“The road to hell is paved with these bills.”



To follow or send links: @Gaius_Publius

Gaius Publius is a professional writer living on the West Coast of the United States.

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19 Responses to “Worldwide derivatives market could be over $1.2 quadrillion in notional value”

  1. A 1% #WallStreetSalesTax would go a long way toward curbing this…

    Even now, Randy Credico ( ) is running for mayor of NYC under a newly created party called the “Tax Wall Street Party” and is advocating a 0.5% #WallStreetSalesTax to pay for free buses and subways, free CUNY education, and free health care.


    If you’re living in NYC, why don’t you get the word out? And if you’re not living in NYC, you can still donate to the campaign.

  2. ComradeRutherford says:

    It’s pretty simple: the bankers write up a piece of paper that says your house is worth three times it’s actual value, or a paper that says derivatives are worth $1.2Q.

    Then they use their politicians to force the taxpayers to pay that made-up amount, under the threat that posting these made-up numbers as ‘losses’ would ruin the global economy.

    And since the GOP has decreed that all regulations are bad, there is nothing to stop the bankers from doing this. Your house, that your town has appraised at $120,000 is on paper at the bank for $340,000, so that is the value you owe the bankers for your house. Forget that in reality it’s only really worth about $90,000, next year the town will reappraise you house at $180,000!

  3. Anonymous says:

    ‘ . . .modest regulations put in place by Dodd-Frank,’ is right. Dodd Frank’s price discovery solution for this paper was to put it on the exchanges. In other words, these securities have been loaded into peoples’ retirement accounts.

    In many ways, including the inflated aggregate face values you talked about here, these securities have become much more dangerous than they were in 2008.

  4. For piles of information about the derivatives holdings of US banks, see the derivative call reports issued by the OCC here:

    Factoid: JPMorgan Chase had a notional value of $69 trillion at 12/31/12

    Factoid: JPMorgan Bank, not the holding company, had a Total Credit Exposure to Risk Based Capital ratio of 228%

    The terms are defined in the report.

  5. Indigo says:

    Thank you.

  6. karmanot says:

    Bankenstein lives! Neo-Marxism is good—-especially based on the pre-Manifesto essays

  7. Indigo says:

    Capitulation to Banksters won’t help because they don’t care about the public. That leaves La Résistance and nothing less. I can’t think of how that works though because the Banksters are worse than Capitalists. Capitalists control the means of production but the Banksters control the finances that empower the Capitalists. Marx is obsolete in this context, we need Neo-Marxism or more interestingly, the Violent Anarchism the Greeks previewed a few years ago. Unfortunately, the Greeks failed to drink the full cup and did not exit the EU. Maybe Cyprus will be wiser. Once somebody (anybody!) exits the EU, that house of cards will start to crumble and with it . . . Banksterism, perhaps.

  8. eahopp says:

    Well, perhaps it is time for the liberals, homosexuals, Jews, Mexicans, and whatever to start stocking up on guns and ammo as well….

  9. Just_AC says:

    Bread and Circuses, bread and Circuses

  10. BeccaM says:

    Thanks for the h/t, Gaius, and for running with the topic. You helped greatly expand my understanding of how this whole derivatives market works.

    I guess the key concept here is leverage. A smaller amount (I can’t say ‘small’ when dealing with trillions) of actual money being used to wield the influence of an almost unimaginably staggering amount of ‘virtual’ money. And I used to think it was an unfathomable crime to let a group of ‘investors’ use a few million dollars to take over a viable company worth billions, against a promise to use that company’s assets to pay for its own takeover. Even if, as you say, the cash value is “only” in the neighborhood of $12 trillion, we’re still talking enough leveraged influence to bring down entire nations. “Nice economy you got here. Be a shame if anything…unfortunate happened to it. Now let’s talk bailout again.”

    The problem as ever — and as is being experienced in the Euro-zone right now — is all this hedging and default swapping and outright gambling depends on things not breaking down. As long as markets remain stable or go up, they keep inventing more notional value out of thin air, building their house of cards ever higher. But when the weight of the overweening greed as must inevitably do becomes overwhelming, down it all comes. And to switch metaphors, I think we’re already seeing the Great Unraveling.

  11. BeccaM says:

    According to every number I’ve seen so far, statistically all of the so-called ‘recovery’ has gone to the top 1%, while everyone else has continued to see declines in real income and inflation in living expenses.

  12. tazintally says:

    For the officers, board members and higher ups in any banks/company that is bailed out there will be no bonuses until all bail out money. This should be retro active.

  13. nicho says:

    I was reading a story over the weekend how the real estate market in The Hamptons is booming. Some summer rentals are going for $800,000 a month. Must be all those “takers” among the 47 percent taking a break from hounding the one percenters.

  14. lynchie says:

    I smell a bailout coming along with increased bonuses.

  15. nicho says:

    Actually, with the propaganda machine working at peak efficiency, the people will first turn on each other. Teabaggers and 2nd Amendment “patriots” will blame liberals, homosexuals, Jews, Mexicans, whatever, giving the banksters time to fire up the private jets and fly to a Blackwater-protected enclave somewhere.

  16. caphillprof says:

    When the guillotine is finally erected down on the Mall, politicians might wonder whether only banksters will lose their heads. And I’m not sure I’d like to be Eric Holder or the Comptroller of the Currency or anybody sitting on the Federal Reserve.

  17. schotzki says:

    END OF DAYS !!!!!

  18. nicho says:

    And we can thank the lack of government regulation — and the crooks and their useful idiots who pushed for unfettered capitalist thievery.

  19. Houndentenor says:

    I don’t know what it will take for the world (not just America) to realize what the banksters have been doing.

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