The global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar. So what does all this mean exactly? [Let me explain.]
So writes Michael Snyder in edited excerpts from his original article* entitled The 441 TRILLION Dollar Interest Rate Derivatives Time Bomb.
[The following article is presented by Lorimer Wilson, editor of www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Snyder goes on to say in further edited excerpts:
Interest Rates Rising Rapidly
Most people might think that the primary reason why rapidly rising interest rates could take down the entire global financial system would be because:
- the U.S. government would have to pay much more interest on the national debt. Yes, if the average rate of interest on U.S. government debt rose to just 6 percent (and it has actually been much higher in the past), the federal government would be paying out about a trillion dollars a year just in interest on the national debt – but that isn’t it.
- The rapidly rising interest rates would impose massive losses on bond investors. At this point, it is being projected that if U.S. bond yields rise by an average of 3 percentage points, it will cause investors to lose a trillion dollars. Yes, that is a 1 with 12 zeroes after it ($1,000,000,000,000) – but that is not the number one danger…either [but]
- The number one reason…is [actually] because there are more than 441 TRILLION dollars worth of interest rate derivatives sitting out there. This number comes directly from the Bank for International Settlements – the central bank of central banks….Normally these bets do not cause a major problem because rates tend to move very slowly and the system stays balanced but now rates are starting to skyrocket, and the sophisticated financial models used by derivatives traders do not account for this kind of movement.
10-year U.S. Treasury Bonds[As] the chart posted below shows, the yield on 10-year U.S. Treasury bonds rocketed up to 2.66% before settling back to 2.55%…in recent days…
Right now, the yield on 10-year U.S. Treasuries is about 30% above its 50-day moving average. That is the most that it has been above its 50-day moving average in 50 years. We are moving into uncharted territory and this data doesn’t really fit into the models used by derivatives traders.
5-year U.S. Treasury Bonds
The yield on 5 year U.S. Treasuries has been moving even more dramatically:
Last week, the yield on 5-year U.S. Treasuries rose by an astounding 37%. That was the largest increase in 50 years. Once again, this is uncharted territory.
If rates continue to shoot up, there are going to be some financial institutions out there that are going to start losing absolutely massive amounts of money on interest rate derivative contracts.
What Is An Interest Rate Derivative?
The following is how Investopedia defines an interest rate derivative:
“A financial instrument based on an underlying financial security whose value is affected by changes in interest rates. Interest-rate derivatives are hedges used by institutional investors such as banks to combat the changes in market interest rates. Individual investors are more likely to use interest-rate derivatives as a speculative tool – they hope to profit from their guesses about which direction market interest rates will move.”
Interest rate derivatives can be very complicated, but I prefer to think of them in very simple terms. Just imagine walking into a casino and placing a bet that the yield on 10-year U.S. Treasuries will hit 2.75% in July. If it does reach that level, you win. If it doesn’t, you lose. That is a very simplistic example, but I think that it is a helpful one.
At the heart of it, the 441 TRILLION dollar derivatives market is just a bunch of people making bets about which way interest rates will go and, normally, the betting stays very balanced and our financial system is not threatened. The people that run this betting use models that are far more sophisticated than anything that Las Vegas uses but all models are based on human assumptions, and wild swings in interest rates could break their models and potentially start causing financial losses on a scale that our financial system has never seen before. We are potentially talking about a financial collapse far worse than anything that we saw back in 2008.
Remember, the U.S. national debt is just now approaching 17 trillion dollars so when you are talking about 441 trillion dollars you are talking about an amount of money that is almost unimaginable…
The U.S. financial system is a massive Ponzi scheme that is on the verge of imploding. Nobody knows for sure what happens next, but one thing seems certain, the last half of 2013 is shaping up to be very, very interesting.
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
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