$582 Trillion. That’s about $100,000 for every person on the planet.
That’s the amount of the leverage hanging over the heads of the world. It is the face (notational) value of the sum of all of the unregulated derivatives. Every radio company owner that I’ve looked at so far (those not privately owned) have used short term variable rate LIBOR credit facilities – with interest rate swaps derivatives to protect them from an increase in LIBOR.
One of the problems with things like Interest Rate swaps are today they are 1 on 1 contracts. There are theories about how you figure out the value of an interest rate swap at a point n time, but there is no liquid market to prove what it is worth. Typicaally you bought them as a condition of getting the credit facility, and you had to buy it from the same folks. Interest rate swaps being 1 on 1 contracts have couterparty risk – if the bank (or insurance company) that sold you the interest rate swap goes under (AIG, for instance), you’re 100% screwed.
Tim Geithner is doing one thing right, but whether it works or will just speed the collapse is not known yet. He wants a publicly traded liquid market in interest rate swaps and other derivative instruments. (by proposing this as his project, he’s stepping all over the toes of the CFTC, and to a lesser degree the SEC). It’s a pretty naked power grab.
If interest rate swaps become a standard commodity (I’ll trade you LIBOR vs 4% for 5 years), then it takes the guesswork out of how much leverage is out there and how much the contract is worth at any point in time. A key part to a commoditized financial product is that you get rid of the counter party risk. Instead of your contract depending on 1 company, all of the people involved in the marketplace pool their assets to guarantee all trades. You can’t play the game if you can’t prove you have the resources to back up your trades. If one of the companies fail, all the other players agree to absorb their loss.
Either Geithner is a brilliant man who is going to save the world, or he is incredibly naive and leading us right off the cliff. I think we’ll know shortly which he is. I don’t see how you get past the fact that one party to the transaction introduces risk via their credit risk, but maybe I just don’t understand it yet.