Friday, February 8, 2013

The call to print $30T. Or, maybe $100T.

The use of financial derivatives is out of control. What are these derivatives? Basically, they are paper bets on a lot of things. The problem is how to value them when it comes to requirements of the financial institutions. If your bank places a $10B bet that interest rates will go up, what is the consequence of this? How much margin is your bank to put down? What is the value of the bet? Then your bank buys an insurance against losing (i.e. that interest rates will go up or down - depends whether the bet is a call or a put). now what happens? As these issues got murkier, there was a proposal to codify margin requirements on these bets. Financial entities responded that this may require up to $30T in deposits:

http://dealbook.nytimes.com/2012/10/29/behind-estimated-30-trillion-drain-a-lot-of-hypothetical-assumptions/

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