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Banks Must Bear the Risk of Derivatives Losses, CME Paper Says (Matthew Leising)
Acording to a new white paper from CME Group (NYSE:CME) the world's largest derivatives exchange, banks need to increase the amount of money backing derivative positions. In September, JP Morgan Chase (NYSE:JPM) had said that the CME Group should increase its contribution to the default fund from 5.25% to 10%. There is little agreement about who pays for bank default. This is a big exposure, as recently demonstrated:
The unregulated swaps market contributed to the 2008 financial crisis and worsened its aftermath in large part because the trades were done between private parties where unfunded risk was allowed to build. For example, in 2008 American International Group Inc. had to be rescued by the U.S. government with more than $180 billion after its swaps business blew up.
Ultimately, what will happen in the event of a bankruptcy of a major bank? They will shed assets, according to bank analyst Chris Whalen in the following Bloomberg video. But what is the definition of bankrupt? Isn't it that liabilities exceed assets? So a bank break-up under stress conditions would leave some entities 'holding the bag'. And Whalen implies that the bag could be big and very empty when he says the Fed stress tests are meaningless:
"You don't need an economist to design a stress test."
Econintersect: Who will be left holding the bag? It is better to ask who won't. With new policy being that derivatives are the top ranking claims in a bankruptcy it won't be the counterparties. And yet the CME is arguing that a greater fraction of derivative risks should be backed with cash. Which brings us back to Chris Whalen. Listen to the final sentence uttered at the end of the video, talking about return on equity for major banks:
"On a real risk adjusted basis they are negative."
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Markets pricing in substantial QE operation by the ECB (Walter Kurtz, Sober Look) The decoupling by the Swiss National Bank (SNB) last week have strengthened the market opinion that QE (quantitative easing) by the ECB (European Central Bank) is almost a sure thing. Other factors reinforcing the perception:
What Rajan Wants From Modi to Keep Cutting India’s Rates (Sandrine Rastello, Bloomberg) RBI (Reserve Bank of India) President Raghuram Rajan announced a surprise interest rate cut last week. The question being asked: Will there be more cuts? With inflation (5%) well below current targets of 8% and below 2016 targets of 6% it certainly seems that further cuts could be possible for the benchmark repurchase rate now at 7.75%. To get the cuts, this article says the government will need to:
Price Collapse Hits Scavengers Who Scrape the Bottom of Big Oil's Barrel (Joe Carroll, Bloomberg) The most at risk oil production in the U.S. following the recent collapse in oil prices is that coming from the so-called "stripper wells". Major oil producers typically abandon pumping when output falls into the 10-15 barrels-a-day range. Many of the abandoned wells are then refitted and operated by small independent outfits to harvest the remaining low flows which can continue for decades. Currently these stripper wells are producing 10% of U.S. crude. (As recently as 2008 they produced 18% of total). And, according to energy consultant Wood Mackenzie, many of the strippers lose money when Brent crude drops below $50 a barrel (currently $48.29 at Investing.com, click for latest price). The 2008 price collapse and recovery was so rapid that not many strippers were shut down. But the several-year price depression in the 1990s shut down more than 140,000 stripper wells permanently - they were plugged and capped. That was about 1/3 of the total number of stripper wells out of production. See next two articles. Picture below is a typical stripper well pump.
When could low oil prices halt production? (Wood MacKenzie) This consultant concludes that only a Brent price of $40 a barrel or below would see producers shutting-in production at a level where there is a significant reduction in global oil supply. Only about 1.5 million barrels per day is cash negative at $40 Brent - that is only 1.7% of global oil production. (See next two articles.) The areas that are cash negative include some Canadian oil sands, some U.S. stripper operations and some oil production in Colombia. See preceding article.
World Sets New Oil Production and Consumption Records (Robert Rapier, Energy Trends Insider) Robert Rapier has contributed to GEI. Over the past five years the U.S. has been responsible for more than 83% of the global production increase. Rapier says that if the U.S. fracking boom had not occurred the price of oil today might be $100 to $150 higher than it is. How do you think the global economy would be doing with $200 a barrel oil? Econintersect note: This BP report puts 2013 U.S. oil production at 10 million barrels a day while the U.S. EIA (Energy Information Administration) says it was 7.4 million. The larger number is the total of crude oil plus all other petroleum liquids while the smaller number is crude oil only.
Statistical Review of World Energy 2014 (BP) For those who are cheering the approaching energy independence of the U.S. the data below is sobering. If we depend on oil for that independence we will run out of oil all too quickly and then depend on South and Central America , the Middle East and (for a short time) Africa. Moving away from a high dependence on oil is still a necessity for a sustainable energy supply future.
Upstream spending spree to slow in North America (Wood MacKenzie) With current prices under $50 a barrel for oil, this consultant has the following forecast for capex and operations spending in the oil patch:
Tough times ahead for the Swiss economy (Walter Kurtz, Sober Look) Kurtz says that Switzerland is fated to have a Japanese experience with a long-term bout of deflation. He attributes this to the lack of management of a taper for what amounted to three years of QE (quantitative easing) with three years of central bank balance sheet build-up with euros needed to maintain the currency peg for the franc. Instead of a taper the Swiss took "a plunge". He expects the deflation to be deep and long-lasting.
Other Economics and Business Items of Note and Miscellanea
Honda warns against 'stupid' auto loans driving US sales (Bloomberg) See also GEI Opinion.
U.S. oil production expected to rise as prices stumble (Pittsburgh Post Gazette) Production in 2014 estimated to be 9.1 million barrels per day, 9.3 mb/d for 2015 and 9.5 mb/d for 2016.
The 1% are bad for your health – it’s time to tax them more (The Conversation)
Countdown to calamity (John Myers, Personal Liberty) Written by someone who didn't care what Pres. Obama had to say in the SOTUS.
Here's the letter Michael Jordan got from Coach K when he said no to Duke (SB Nation) It was almost 35 years ago.
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