Dec 192014
 

Last 30 days commentaries list.

In fact it’s so boring it takes two words. Derivative market.

A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, index or security. Common underlying instruments include: bonds, commodities, currencies, interest rates, market indexes and stocks.

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Who’s ready for really boring economic information about derivatives? Yeah, I know. And I’m writing this at 4:30 in the morning. The term I’m seeing in the reporting of this situation is “putting out a 5 alarm fire with a garden hose”. Which means anything that the economic authorities do will not work because the entire derivative market is overloaded with bad stuff.

Related article: This is what a currency collapse looks like

Look, this stuff is pretty boring however when you consider what the consequences are, it get pretty exciting. For instance can you imagine hundreds of corporations, their employees, their investors, their brokers all losing their jobs at the same time from a derivatives collapse?

We know the government is easing restrictions on Wall Street – a stupid move in itself – which means that any economic safety buffer that happens to be built into the system right now will cease to exist. The fact is these people love to take chances. For the most part they already have more money than God. So they lose a few million each – who cares? Well, us schleps at in the former middle class care. How about your 401k. Can you afford to lose even more?

If these two corporations have exposure to the derivatives then you know damn well there are others. The questions to ponder are:

1. How many companies are exposed to derivatives?

2. When will the bubble burst and how many other bubbles will it take with it?

Honeywell exposed

Honeywell International is exposed to a number of market risks, such as changes in interest rates, foreign exchange rates and commodity prices, because of its global reach, the company’s assistant treasurer told a Senate committee Wednesday.

Jim Colby made his comments to members of the Senate Agriculture, Nutrition and Forestry Committee at the first of what’s expected to be a series of hearings on reauthorizing the Commodity Futures Trading Commission, an independent agency that regulates the futures and options markets.

Colby noted that more than half of Honeywell International’s sales are outside the U.S. in discussing his company’s use of the derivatives market.

“When appropriate, we hedge exposures through the use of derivative contracts,” he said. “The purpose of our hedging activities is to eliminate risks that we cannot control, allowing us to focus on our core strengths, namely delivering high-quality products, on time, to our customers.”

Colby, who also was speaking on behalf of the Coalition for Derivatives End Users, urged senators to pass legislation that would provide companies like his with an exception from margin requirements.

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RadioShack exposed

A good general principle in thinking about derivatives is that real effects tend to ripple out from economic interests. This is not always true, and not always intuitive: If you and I bet on a football game, that probably won’t affect the outcome of the game. But most of the time, in financial markets, it is a mistake to think of derivatives as purely zero-sum, two-party bets with no implications for the underlying thing. Those bets don’t want to stay in their boxes; they want to leak out and try to make themselves come true.

It is in some financial distress, having lost money in each of the last 11 quarters and having recently hired a restructuring consultant as its interim chief financial officer.
It is a small company, these days, and it has only $841 million of debt as of November ($325 million of bonds and the rest in three bank loans). Being in distress, those bonds trade at, oh wow, under 20 cents on the dollar.
For idiosyncratic reasons, having to do with indexes, there are a lot of credit default swaps outstanding on RadioShack’s debt, now about $26 billion gross and $550 million net notional.

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LCH credit / derivatives swap

LCH.Clearnet Group Ltd. said it obtained regulatory permission to clear credit default swaps for U.S. members via its clearinghouse in Europe, a day after American and European Union authorities agreed to cut overlap.

The U.S. Commodity Futures Trading Commission gave the approval to Paris-based LCH.Clearnet SA, even as it considers LCH’s application to register as a derivatives clearing organization, or DCO. U.S. members can now clear proprietary CDS index trades through the unit, LCH said.

The CFTC and the European Commission yesterday said they broke a deadlock over whether the U.S. could impose its rules on trades booked in Europe. Banks and other swaps traders said the deal reduces the chance they will be forced to comply with conflicting regulatory regimes.

The decision “enables us to offer clearing services across the broadest range of OTC derivative asset classes and geographies in the market,” Ian Axe, LCH.Clearnet Group’s chief executive officer, said in a statement.

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