derivatives article - Barron's

Steve Grube grube at
Sun Sep 27 22:39:53 PDT 1998

The Sep 28th Barron's has an article by Kathryn M.Welling, sitting in for Alan Ableson. It's a great article about the degree to which all the various forms of derivatives handled by all the various institutions is not well known at all. It points out that the biggest financial names in banking and brokerage are much more vulnerable than either: they're willing to admit or than than know! (I think one point was that derivatives when used as insurance are probably under priced for a real debacle in the mkts and consequently those providing them are vulnerable)

Here is part of the middle portion of the article, wherein an estimate is made of global banking equity lost so far.

=========article follows=======

Nonetheless, some reasonable back-of-the-envelope estimates can be made.

With world GDP at about $30 trillion, Andrew reckons -- based on the relationship between GDP and money supply in the G-7 industrialized nations -- that $30 trillion is also a workable estimate of the amount of money sloshing around the globe. From there, using a rough average of 5% Tier One capital, he arrives at a ballpark figure of $1.5 trillion of total equity capital in the global banking system.

Which certainly sounds like a comfortable cushion. Or is it?

Says Andrew, "If current estimates are right and banks have lost $200 billion or so in the combination of recent events in Asia and Russia -- and Fitch has put a $100 billion number on Russia alone -- then the global banking system has probably suffered a contraction of its equity on the order of almost 14%. Which means we must either expect the banks to come to market for more capital -- or see a sharp contraction in their lending activities."

Neither, obviously, is an ideal background for world markets in present circumstances. What's worse, Andrew reckons, is that the $200 billion or so of hits the banking establishment has thus far owned up to could be just the beginning. Especially if "America's financial-asset bubble" pops. The reason: The financial system's immense leverage to derivatives.

Precisely how immense, Andrew ruefully admits, is unknowable. Consistent reporting standards simply don't exist. ========end of article fragment==========

("Andrew" is Andrew Smithers of Smithers & Co.

of London; consultants to the fund industry)

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