Tuesday, January 27, 2015


Russia is going to get hurt more and a part of the shock wave would touch the world markets too. But I find that more risky assets are going to go for a wild burst affecting the global markets. The depth of the burst is over $9 TRILLION worth of potential explosions waiting in the wings. If crude prices don’t come up then global currency as well as the equity markets and risky bonds are just going to explode like time bombs.  Remember we did not account the plunging home prices of US and at that point of time we were all rejoicing the equity markets growth forgetting the economic calculations.

Russia has borrowed heavily in terms of dollar due to Debt repayments from companies and banks got ripe. Around $50 billion have been raised during Oct-Dec and the number is simply growing up. Slide in the crude prices has also lead to significant growth in dollar borrowings as companies are unable to meet their debt obligations. But the hammering of the global currency would come when the dollar rallies and these borrowings become more expensive to finance in relative basis. Most of the “recovery” of the last five years has been fueled by cheap borrowed Dollars. Now that the US Dollar has broken out of a multi-year range, you’re going to see more and more “risk assets”.  The biggest risky asset is the oil junk bonds and also the derivative contracts across all segments. The big banks are holding trillions in commodity derivatives that could blow up if the price of oil does not rebound.  Overall, there are five U.S. banks that each has more than 40 trillion dollars of exposure to derivatives of all types, and the total global derivatives bubble is at least 700 trillion dollars at this point. Now the threat is this that if crude which is a ancillary commodity product of many commodities. Now if crude prices increases all derivative contracts get justified valuations otherwise the loss is not possible to be calculated.

Through derivative contracts high valuations of crude have been hold and hence there is high risk that they might boil down. Now thinking politically a war in any part of crude exporting country would be sufficed to drive the price up and support this plunge. But don’t get into wild speculations. So the oil companies that have locked in high prices for their oil in 2015 and 2016 are feeling pretty good right about now.  But who is on the other end of those contracts?  In many cases, it is the big Wall Street banks, and if the price of oil does not rebound substantially they could be facing absolutely colossal losses.

It has been estimated that the six largest “too big to fail” banks control $3.9 trillion in commodity derivatives contracts.  And a very large chunk of that amount is made up of oil derivatives. By the middle of this year we could be facing a situation where many of these oil producers have locked in a price of 90 or 100 dollars a barrel on their oil but the price is around the level 50 dollars a barrel. In simple terms an oil derivative typically involves an oil producer who wants to lock in the price at a future date, and a counterparty – typically a bank – willing to pay that price in exchange for the opportunity to earn additional profits if the price goes above the contract rate. The downside is that the bank has to make up the loss if the price drop Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015.Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production. Hence those who are making merry Christmas celebration for the low crude prices would land up in huge precarious conditions.

The depth is more deep from here. Falling crude prices has lead bankruptcy filing to be on a increasing scale. For example, Continental Resources cashed out approximately 4 billion dollars in hedges about a month ago in a gamble that oil prices would go back up.  Instead, they just kept falling, so now this company is likely headed for some rough financial times. The global economy and the interconnected bank transactions are the hidden time bombs which will burst and bring stupendous T-sunami across the financial markets through these derivative products.

I find the US citizens are again going to take up the hit of the bankruptcy and the tax payers funds are going to get into bailouts. Yes the world might think that the new amendment law of US to protect the tax payer’s money is sufficient but unfortunately the policy makers created a loophole into the system.Find below the list of Banks position in derivatives: Well the list is Q1 2014 and hence updated numbers would be on the higher side.

Under the Lincoln Amendment, FDIC-insured banks were not allowed to put depositor funds at risk for their bets on derivatives, with certain broad exceptions.

Starting in 2013, federally insured banks would be prohibited from directly engaging in derivative transactions not specifically hedging (1) lending risks, (2) interest rate volatility, and (3) cushion against credit defaults. The “push-out rule” sought to force banks to move their speculative trading into non-federally insured subsidiaries.

The Federal Reserve and Office of the Comptroller of the Currency in 2013 allowed a two-year delay on the condition that banks take steps to move swaps to subsidiaries that don’t benefit from federal deposit insurance or borrowing directly from the Fed. 

The rule would have impacted the $280 trillion in derivatives primarily held by the “too-big-to-fail (TBTF) banks that include JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo. Although 95% of TBTF derivative holdings are exempt as legitimate lending hedges, leveraging cheap money from the U.S. Federal Reserve into $10 trillion of derivative speculation is one of the TBTF banks’ most profitable business activities. Hence stop praying for low crude prices.If crude prices don't increase all derivatives would go for a wild burst.


Ajay Gupta

if this bubble is going to burst ,how as an individual who has no exposure to derivatives and is putting all savings in FD's with govt banks is going to be adveresally affected. i think houses will become more affordable .real estate will be cheaper. etc.etc.

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