The entire US GDP is less than $15 trillion each year. The gross notional amount of derivatives issued in the USA is more than $291 trillion. Does that sound like a lot? Apologists for derivatives dealers don't like it when we talk about derivatives in terms of the notional totals. Large numbers, like these, discussed publicly, frighten too many people. According to the apologists, gross "notional" is misleading, because it does not include "hedges," offsets and the limits on interest rate risk.
In fact, the total amount of derivatives cannot be accurately presented in any other form but gross notional obligations. The risk to society cannot be judged in any other way. That's why the FDIC, US Comptroller of the Currency and the Bank for International Settlement (BIS) all use gross notional.
Final net obligations can only be determined when and if derivatives are triggered. The net can be significantly lower, but neither we, nor the banks themselves actually know exactly what that is. It depends upon the balance sheets of every counter-party, and the extent to which interest rates will change in the future. Not even the banks have full information about either topic...
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In reality, it is impossible to know the true risk of $291 trillion in New York issued derivatives (ignoring the additional $417 trillion issued out of London). A sudden very large increase in interest rates, alone, could trigger trillions of dollars in payments. One could argue that the Federal Reserve could force interest rates down at any time, but that is not entirely true.
If the US dollar came under heavy selling pressure, for an extended period of time, as has happened to the British pound, Chinese yuan, Japanese yen, German mark, Austrian shilling, Argentine peso, and a host of other currencies in the course of history, the Fed would be able to defend the dollar only at the risk of inducing widespread systemic failure.
That is why interest rates cannot rise for many years, regardless of whether that destroys its status as the world's reserve currency, and/or creates extreme levels of inflation or hyperinflation. It is also one more reason for the government to lie about the true inflation rate, to avoid pressure to raise interest rates (see shadowstats.com.)
All the too-big-to-fail (TBTF) banks, with the exception of Morgan Stanley (which uses its SIPC-insured division) are using FDIC-insured depository divisions to house derivatives. That provides them with lower collateral requirements because FDIC depositary units usually have higher credit ratings than investment banks and/or bank holding companies. It also means that, ultimately, the American people will pay for losses.
While no one can determine the exact exposure, it is safe to say is that the risk is astronomical, and imposes a grave risk upon American taxpayers. It is not surprising that FDIC staff is not thrilled with US bank derivative exposures. In fact, Sheila Bair, who until recently ran the FDIC, is as disgusted with the Federal Reserve slush fund and the banking cartel as you and I. A few days ago, she penned a satirical article heavily critical of Fed policy and published it in the Washington Post.
The FDIC staff doesn't like the fact that the Federal Reserve keeps allowing banks to put their derivatives inside insured depositary institutions. This is mostly for the same reason the banks want to put them there. Insolvency laws provides priority to derivatives counter-parties over the FDIC. If and when a bank is liquidated, the FDIC will be on the hook to repay depositors, but the failing bank will be stripped of all assets.
The US government's full faith and credit guaranty means massive amounts of new US Treasuries will need to be sold, massive numbers of new counterfeit dollars will need to be printed under color of law, and significant tax hikes will need to be levied to pay the bill.
FDIC opposition, however, has had little to no effect on keeping derivatives out of insured units. The Federal Reserve, and not the FDIC, has the authority to approve the practice and it keeps doing so. The FDIC staff can complain privately, and issue regulations forcing disclosures, but little more. But, because of the disclosure requirements, more detailed information than ever is now available concerning derivatives.
In fact, FDIC has made far more information about derivatives public, over the last 3 years, than the Fed and OCC ever disclosed over decades. The numbers reveal a frightening concentration of risk. Five large "TBTF" US banks hold 96% of derivatives issued in the United States.
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