- 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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The Eurozone Sovereign Debt Crisis and a Potential OTC Interest Rate Derivatives Crisis
Summary
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Is The 505 Trillion Dollar Interest Rate Derivatives Bubble In Imminent Jeopardy?
Is The 505 Trillion Dollar Interest Rate Derivatives Bubble In Imminent Jeopardy?
All over the planet, large banks are massively overexposed to derivatives contracts. Interest rate derivatives account for the biggest chunk of these derivatives contracts. According to the Bank for International Settlements, the notional value of all interest rate derivatives contracts outstanding around the globe is a staggering 505 trillion dollars. Considering the fact that the U.S. national debt is only 18 trillion dollars, that is an amount of money that is almost incomprehensible. When this derivatives bubblefinally bursts, there won’t be enough money in the entire world to bail everyone out. The key to making sure that all of these interest rate bets do not start going bad is for interest rates to remain stable. That is why what is going on in Greece right now is so important. The Greek government has announced that it will default on a loan payment that it owes to the IMF on June 5th. If that default does indeed happen, Greek bond yields will soar into the stratosphere as panicked investors flee for the exits. But it won’t just be Greece. If Greece defaults despite years of intervention by the EU and the IMF, that will be a clear signal to the financial world that no nation in Europe is truly safe. Bond yields will start spiking in Italy, Spain, Portugal, Ireland and all over the rest of the continent. By the end of it, we could be faced with the greatest interest rate derivatives crisis that any of us have ever seen.
The number one thing that bond investors want is to get their money back. If a nation like Greece is actually allowed to default after so much time and so much effort has been expended to prop them up, that is really going to spook those that invest in bonds.
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