2012-07-01contraryinvestor.com

The second very meaningful issue of the moment is that the mountain of leverage that is the global derivatives markets sits atop what is assumed to be sound collateral.  In most cases government debt/repo vehicles, which is assumed to be risk free, forms the bulk of this collateral, but again there is no disclosure.  Unfortunately in the case of AIG a number of years back, we woke up one day to find that there was a massive shortage of collateral when AIG's derivatives bets went bad.  The regulators never knew.  AIG's derivatives counter parties never knew, and of course AIG shareholders were the last to find out.

Fast forward to the present.  The important issue of the moment is that European collateral is "shrinking" almost by the day.  As interest rates go higher in Spain, Italy, Portugal, etc., the value of their government debt falls in price -- the collateral, if you will, shrinks.  As a very macro comment, the KEY issue in European credit markets is that the large financial players as well sovereigns are running out of collateral.  Will this ultimately mean anything for or have repercussions with US financial institutions intertwined in derivatives contracts with European financial firms?  Again, with a surfeit of disclosure, we only wish we knew.



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