A new Layer of Leverage in the Derivatives market

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Oliveoilguy's picture
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A new Layer of Leverage in the Derivatives market

According to Bloomberg the Banks have started a new scheme to get more money invested in derivatives. Since they make a commission every time a derivative is created, they are salivating for ways to allow more money to come into this market. Hence the "collateral transformation" desk at JPM and 6 other banks.

Why "collateral transformation"? Because customers have run out of available treasuries and money to buy more derivatives. 

How does this scheme work?  The Banksters allow people or entities, who want to purchase derivatives, to swap junk paper for treasuries so that the purchaser can then use the treasuries to purchase derivatives. The purchaser is obligated to pay back the treasuries at some point. "Customers swap lower rated securities that don't meet standards for a loan of treasuries or similar holdings that do qualify. A process dubbed "collateral transformation". "

Darren Duffie of Stanford University says " The dealers look after their own interests,  and won't necessarily look after the systemic risks that are associated with this. Regulators are probably going to become aware of it once the practice gets big enough."

I'm not an economist, but this sounds like a whole other layer of leverage on top of a house of cards that is ready to topple.


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