You’d think that after derivatives destroyed the global economy three years ago that new regulations would’ve been installed to guard against similar catastrophes in the future.
You’d think, for example, that someone, somewhere would’ve mandated a cap on the total amount of these dicey speculative “instruments” that could be held by banking institutions, given that the government had to step in and bail out the financialk giants that held the lion’s share of dicey derivatives.
Well, guess what?
Banks are holding more derivatives that they did when they went bust, and they’re just as concentrated now as they were at the time of the 2007/8 collapse.
Ben Potress of the New York Times DealBook blog reports, with an assist from Andrew Harrer of Bloomberg News:
The Justice Department is wading into the murky world of derivatives regulations – and it does not like what it’s seeing.
Financial regulators in Washington have been churning out potential new policies to bolster competition in the unwieldy market. But the Justice Department’s antitrust division says the proposals could fall short.
The proposals “may not sufficiently protect and promote competition in the industry,” a high-ranking Justice Department lawyer said Dec. 28 in letters to the Commodities Futures Trading Commission and the Securities and Exchange Commission.
The Justice Department’s concerns center on two proposals released by the commissions in October, which aim to curb Wall Street’s influence over the $600 trillion derivatives market.
Banks now hold $234 trillion of the insurancelike contracts, which derive their value from another asset, like a foreign exchange rate or a package of mortgages. Four of the nation’s largest financial institutions — JPMorgan Chase, Citigroup, Bank of America and Goldman Sachs — account for more than 90 percent of the banking industry’s activity in derivatives, according to a report released this month by the Office of the Comptroller of the Currency.
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Christine Varney, the head of the Justice Department’s antitrust division, likened this situation to “three or five largest airlines controlling all landing rights at every U.S. airport.” In the derivatives world, such concentration translates to higher trading costs, outdated data and less transparency in the market, the letters said.
To avoid this scenario, the Justice Department floated the idea of 40 percent aggregate ownership caps so that two or three select banks could not join forces to monopolize the derivatives market.
Here’s some more numbers from the Office of the Comptroller of the Currency, revealed 17 December:
The OCC reported that net current credit exposure (NCCE), the primary metric the OCC uses to measure credit risk in derivatives activities, increased $43 billion, or 11 percent, to $440 billion this quarter. NCCE peaked at $800 billion at the end of 2008.
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The report shows that the notional amount of derivatives held by insured U.S. commercial banks increased by $11.3 trillion (or 5 percent) in the third quarter to $234.7 trillion. Interest rate contracts increased $7.9 trillion (4 percent) to $196.5 trillion, while FX contracts increased 14 percent to $20.8 trillion.
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Derivatives contracts are concentrated in a small number of institutions. The largest five banks hold 96 percent of the total notional amount of derivatives, while the largest 25 banks hold nearly 100 percent.
Credit default swaps are the dominant product in the credit derivatives market, representing 97 percent of total credit derivatives.
And for some perspective, here’s a stunning graphic from the full OCC report, which is available as a PDF here.
And here’s the OCC’s official definition of the D-word.
Derivative: A financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, commodity, credit, and equity prices. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof.
eats shoots 'n leaves 