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Derivatives – The $600 Trillion Time Bomb Set to Explode

Regulators have let this problem spiral out of control


A governmental default would panic already-anxious investors, causing a run on several major European banks in an effort to recover their deposits. That would, in turn, cause several banks to literally run out of money and declare bankruptcy.

Short-term borrowing costs would skyrocket and liquidity would evaporate. That would cause a ricochet across the Atlantic as the institutions themselves then panic and try to recover their own capital by withdrawing liquidity by any means possible.

And that’s why banks are hoarding cash instead of lending it.

The major banks know there is no way they can collateralize the potential daisy chain failure that Greece represents, so they’re doing everything they can to stockpile cash and keep their trading under wraps and away from public scrutiny.

What really scares me though, is that the banks think this is an acceptable risk because the odds of a default are allegedly smaller than 1 in 10,000.

But haven’t we heard that before?

Although American banks have limited their exposure to Greece, they have loaned hundreds of billions of dollars to European banks and European governments that may not be capable of paying them back.

According to the Bank of International Settlements, U.S. banks have loaned only $60.5 billion to banks in Greece, Ireland, Portugal, Spain and Italy — the countries most at risk of default. But they’ve lent $275.8 billion to French and German banks, and undoubtedly bet trillions on the same debt.

Key Takeaways

There are three key takeaways here:

  • There is not enough capital on hand to cover the possible losses associated with the default of a single counterparty — JPMorgan Chase & Co., BNP Paribas SA (PINK:BNPQY) or the National Bank of Greece (NYSE:NBG) for example — let alone multiple failures.
  • That means banks with large derivatives exposure have to risk even more money to generate the incremental returns needed to cover the bets they’ve already made.
  • The fact that Wall Street believes it has the risks under control practically guarantees that it doesn’t.

It seems to me the world’s central bankers and politicians should be less concerned with stimulating “demand” and more concerned with fixing derivatives before this $600 trillion time bomb goes off.

Article printed from InvestorPlace Media,

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