Credit Market Derivatives: The Eve of Destruction

Interest rate turmoil again affected holding company trading revenues heavily in the first and second quarters of 2013. According to the latest report from the U.S. Office of the Compttroller of the Currency (OCC), rate trading derivatives losses were $3.018 Billion in 1Q 2013 and $3.804 Billion in 2Q 2013.

It is noteworthy that the present-day casino in credit derivatives has built up in the era of ZIRP, where interest rate changes have been miniscule. The losses reported in the first two quarters were apparently triggered by the unexpected rate moves of less than 20 basis points. (Two tenths of one percent.)

While the total credit exposure to risk based capital has declined for the top four U.S. commercial banks that do derivatives trading, the notional value of their derivatives increased by $2.2 trillion, to $233.9 trillion. And JPMorgan (the world’s biggest derivatives trader) just by itself holds derivatives contracts with a notional value of around $71 Trillion! (To be precise: $71,289,673,000,000.) To put that in perspective, the total value of the US economy is around $15 trillion.

The counterparty risk in credit derivatives would be gigamongous, if interest rates were to spike several full points, and any large institutions then subsequently failed. If you thought that the bailouts back in 2009-2010 were huge, then just wait and see what the next credit crisis brings. – JWR

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