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The Eurozone Sovereign Debt Crisis and a Potential OTC Interest Rate Derivatives Crisis

December 19, 2015

THE EUROZONE SOVEREIGN DEBT CRISIS AND A POTENTIAL OTC INTEREST RATE DERIVATIVES CRISIS

Summary
  • After considering the alternative scenarios of Grexit, debt renegotiation, transferring of debt, a deflationary spiral and so on, it is concluded that this will either result (ceteris paribus) in an increase in sovereign debt yields or a decrease in the volume of sovereign debt issued. This is worrying; not only due to the events in Greece and the ripples it has sent throughout the Eurozone but also because elections are approaching in other peripheral countries.
  • The effect that this has on Repo market rates (where “government bond collateral” accounted “for almost 80% of EU-originated repo collateral” in the European repo market) would then have a subsequent, significant impact on EURIBOR rates (EURIBOR being a key rate for unsecured lending which many derivatives – OTC interest rate derivatives especially – are linked to).
  • Given that EURIBOR has remained relatively low in recent years and governments have sought to keep interest rates low in an effort to stimulate a recovery, this would be a sudden shock to a vulnerable, sensitive system.
  • It is further argued (using Keynes’ theoretical analysis) that the sharp increase in liquidity preference and the depression of the marginal of efficiency of capital is, in general, far greater than that which occurred during the Great Depression and that, due to the especially uncertain climate of monetary policy, this means that Central Banking has been the reason why the OTC Interest Rate Derivatives market has been systemically primed for a crisis.
  • I further argue that the potential scale of the OTC Interest Rate Derivatives crisis dwarfs both the Credit Default Swaps and Collateralised Debt Obligations positions that were associated with the Great Recession.
  • It is also argued that the risks are greater than the Great Depression and that, if the money and banking system remains unreformed, the world could be plunged into a crisis that belittles the Great Depression itself.

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Olduvai IV: Courage
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