14 March 2008

Bear Stearns: The Smoking Gun(s)

There are at least two ways in which a failure at Bear Stear might have precipitated a decimation of the Wall Street financial community: counterparty risk and the triggering of a chain reaction of failures.

First, as of Nov 30, 2007 Bear Stearns was counterparty to 13 TRILLION in derviatives contracts, as shown in their most recent public 10K Filing with the SEC. (hat tip to jerrbear from PrudentBear for tracking down the reference page. Great catch!).

As of November 30, 2007 and 2006, the Company had notional/contract amounts of approximately $13.40 trillion and $8.74 trillion, respectively, of derivative financial instruments, of which $1.85 trillion and $1.25 trillion, respectively, were listed futures and option contracts...

The Company's derivatives had a notional weighted average maturity of approximately 4.2 years at November 30, 2007 and 4.1 years at November 30, 2006. The maturities of notional/contract amounts outstanding for derivative financial instruments as of November 30, 2007 were as follows:

The second method would be a failure at Bear Stearns that triggers a cascade of failures in the Credit Default Swaps (CDS) market. This is not counterparty risk. The risk here is of CDS wagers on the failure of Bear Stearns itself. This market consists of derivative 'wagers' on the credit failure of specific companies. This market has become a leveraged nightmare, being so large that the failure of any single significant company such as Bear Stearns could precipate a chain reaction of defaults. As you may recall we pointed out some time ago that after subprime the next area to watch closely as a potential tipping point would be the CDS market.

Notice that Bear Stearns is not EVEN LISTED as holding derivatives in any of the tables we looked at in the OCC Report. Is this because of their 'non-bank' status? We wonder how many other US corporations are quietly loaded up with derivatives risks as well, either as a large counterparty, or the target of a pyramid of wagers on failure risk many hundreds of times their actual net worth. What a monster Wall Street has created for the world.

Credit Default Swaps: Is Your Fund at Risk?