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Tuesday, March 31, 2009


how you know interest rates are going to stay low, or how goldman sachs could blow sky high

zero hedge poses some interesting questions about goldman sachs and the $160tn (notional outstanding) interest rate swap market.

Has Goldman, in its pursuit to catch up with the imaginary PIMROCK decided to chew off a little more than its assets would allow? 1,056% more in fact? Or, alternatively, has the company bet a little too much in its bet that it can easily anticipate interest rate moves? As pointed out, over $160 trillion in Interest Rate contracts exist currently. What the credit crunch taught us is that the risk management of credit derivatives was woefully inadequate in a time when credit was flowing freely and the system was nice and liquid. After the bubble burst, certain entities (wink wink AIG) ended up having to commit capital to a sizable amount, more than half at times, of the total notional of derivatives the company had underwritten - a scenario previously never thought possible. And the massive reduction in global CDS notional outstanding over the past year and a half (from over $60 trillion to under $30 trillion today) has been a direct result of financial companies realizing they did not provision well enough for the "black swan" day, and thus rushing to unwind as much of these ticking time bombs as they could.

In the meantime, the interest rate black swan is growing. Do not misunderstand us: Zero Hedge has no idea what, if any, a black swan in Interest Rates may be. It is - by definition - an unexpected, unpredictable, outlier, aka fat-tail, event. Its prediction would immediately render it a grey swan at best, if not beige. However, instead of focusing so much on CDS as the financial system bogeyman, is it not time to look at some of these other derivative instruments that may soon plague the Basel I/II and whatever other risk consortia appear in the future. At $200 trillion in total derivatives, and $160+ trillion plus concentrated in Interest Rates, a fat tail event here, whether due to a paradigm shift in US monetary policy (that whole thing about Greenspan focusing on inflation instead of deflation now might raise a few eyebrows), or something totally different, even partial needs to satisfy these contracts will result in staggering and unmanageable repercussions to the global economy (tangentially, is it even physically possible to print $200 trillion in one year?)

Of course, as everything is smooth sailing in IR Swaps for now, I doubt anyone will even think about potential issues in this space... until it is too late.

the easy conclusion from this is that goldman sachs -- being the wall street house of the democratic party, with alumnus robert rubin aiding protoges larry summers and tim geithner in pulling levers of power in washington -- knows what the federal reserve is going to be doing over the next year in such totality that they don't mind wagering not only the firm but a large chunk of western civilization on the outcome, so certain are they of monster profits.

the harder conclusion is that -- just perhaps -- the united states government doesn't really control its interest rates under every conceivable scenario.

and who's on the other side of the trade, you ask, making fixed payments and receiving floating? here's some.

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