After Tuesday's "DealBreaker Talks Insider Trading" another longform post.
One more and DB has a serial.
What Are You Paying Ratings Agencies Zero Dollars For, Anyway?
Fitch released a report today saying “ohmygod banks Europe” and the market went down and maybe there’s a causal link, whatever.
The report mostly takes notice of US banks’ European exposures in general, and the mystery of net versus gross derivatives exposure in particular, in which one asks “if Bank A sells CDS on $100bn of Italian debt to Bank B, and buys CDS on $100bn of Italian debt from Bank C, then when things go pear-shaped is it on the hook for zero (because it has no ‘net exposure’) or $100bn (because Bank C goes belly-up) or somewhere in between (because of collateral, sub-1 correlations, etc.)?”
It’s an important question: net exposures are manageable, gross exposures are terrifying, and there are legitimate questions about whether in a stress case the netting could break down. Various people who are smarter than me have tried to triangulate around parts of the answer using public data.
I don’t know the answer and doubt I’ll find out, though my gut is that netting should kind of sort of mostly work (I find Graph 5B of this, and the definition of “bilateral netting,” oddly comforting). What troubles me today, though, is that Fitch has no clearer answer than I do. From their report:
Exposures to Major Markets: Gross exposures to large European countries and major banks are greater than exposures to the stressed markets. For instance, cross-border outstandings to France totaled $188bn for the top five U.S. banks (based on 2Q11 FFIEC and 10Q data). Of this total, $114bn was to French banks (25% of T1C). Aggregate outstandings to the UK were $225bn, of which $51bn (11% of T1C) was to UK banks.
Exposures Overstate Direct Risks?: A large portion of this exposure is likely secured (such as repo-related exposures), subject to margin/collateral agreements and/or hedged. Nevertheless, the exposure data show the susceptibility of banks to contagion risk and the interconnectivity of large global banks.
Disclosure is generally limited to aggregate claims outstanding to a country greater than or equal to 0.75% of a bank’s assets. Consequently, it is not possible to gather complete exposures for all countries. Total country exposures include deposits, central bank balances, securities, loans, participations, acceptances, fair value of derivatives, and reverse repos, among other items, but details of many categories are not disclosed. The long lag time before FFIEC quarterly country exposure data become available also hampers analysis.In theory, one way we could all find out for sure is something like the following:
1. Call Jamie Dimon,
2. Have him send over JPMorgan’s derivatives book at a reasonable level of granularity, showing what kinds of derivatives it’s bought and sold from what counterparties,
3. Read it,
4. Put those exposures into some sort of plausible model, plug in some plausible loss assumptions, and go all Margin Call on it, and
5. Figure out that everything’s cool or rush into The Mentalist’s office and to freak out and sell everything.
That’s the approach that the market took with Jefferies, and it worked! ,,,MORE