Does the public have any clue how big of an event that GM going under would be?
From Weiss:
In the event of a GM bankruptcy, we have a pretty good idea about what would happen to individuals or institutions that hold their stocks and bonds.
We also can guess what might happen to the banks that have granted them loans.
But there’s one other major category of investments that are in an entirely different category.
I’m talking about derivatives — high-leveraged bets that are a giant blind spot in the rear-view mirror of Wall Street.
First, here’s what we know about these derivatives:
1. We know that the amounts involved are huge: $82 trillion held by US banks alone, according to the Office of the Comptroller of the Currency (OCC). That’s the “notional” or face amount, which overstates the problem. But it’s still far too big — 33 times more than the entire budget of the U.S. government.
2. We know that 85% of these bets are tied to bond prices and interest rates — the category most likely to be impacted in the event of a GM bankruptcy. That’s nearly $70 trillion, or over 28 times the entire budget.
3. We know that a very common practice is to bet on the “spread,” or price difference, between high-quality bonds (like U.S. Treasury bonds) and low-quality bonds (like GM’s). If the spread stays narrow, they win. If the spread gets larger, they lose.
4. We know that many large banks and other players have been betting that this spread will remain very small, as it has been for many months. They assumed that big companies like General Motors would stay solid ... that their bonds would retain a high value ... and that investors would be able to find ready buyers — all assumptions that are turning out to be incorrect.
5. We know that, back in 1998, when Russia defaulted on its debt, major players placing similar bets were severely wounded or even wiped out.
6. We know that the failure of just one of these players — a relatively obscure hedge fund by the name of Long Term Capital Management — nearly brought the world’s financial system to its knees.
7. We know that GM’s total debts today are close to $450 billion, many times larger than Delta’s or Delphi’s, and THREE times greater than Russia’s debt in 1998.
By that measure, if the Russian default was tantamount to, say, a Category 3 hurricane, GM’s default could be close to a Category 5.
8. We know that derivatives are highly concentrated in the hands of a small handful of large banks: According to the OCC, 99% of all derivatives are held by only 25 U.S. commercial banks. Worse, 96% of all derivatives are held by just FIVE commercial banks.
9. We also know which banks are taking the biggest risks associated with derivatives.
JP Morgan Chase has $6.25 in risk per dollar of capital, according to the OCC. HSBC has $4.07; Citibank, $3.10; Bank of America, $1.68. Even in the absence of a major corporate failure, that’s excessive by any measure.
