Go to home page

London Trying To Pull the Fuse Out of Swaps Time Bomb

Oct. 6, 2022 (EIRNS)—This morning the Bank of England provided dramatic testimony to a parliamentary committee on how it had to act to prevent meltdowns of (at least) London credit markets in the last few days of September. Without, apparently, ever actually discussing financial derivatives contracts, the BOE acknowledged that a systemic financial crisis was beginning, triggered by interest rate derivatives, when on Sept. 28 the Bank announced a return to quantitative easing with more than $70 billion equivalent in commitments to buy longer-term British government bonds from big banks. The testimony, summarized by CNBC, described these stages of the crisis:

• British government bonds (gilts) suddenly plunged in value (their interest rates spiked) after the Truss government made completely incompetent energy-bailout and tax-cut announcements;

• Large numbers of pension funds were “hours from collapse” late on Sept. 27;

• Complete panic hit the $1.69 trillion so-called “liability-driven investment” (LDI) pension funds;

• “The Bank was informed by a number of LDI fund managers ... that these funds would have to begin the process of winding up the following morning”;

• A “large quantity of gilts, held as collateral by banks that had lent to these LDI funds, was likely to be sold on the market, driving a potentially self-reinforcing spiral and threatening severe disruption of core funding markets and consequent widespread financial instability”;

• “Bank of England staff worked through the night on Tuesday, Sept. 27 ... to avert this potential crisis, in close communication” with HM Treasury.

The City of London, BOE, and European Central Bank are escalating the demand that the Federal Reserve join the return to QE before it is too late. The financial system blowout threat they are warning of, requires the control of derivatives, now particularly interest rate derivatives, through Glass-Steagall action to force the commercial banks to abandon these derivatives. The 21st Century Glass-Steagall Act in the U.S. Congress several years ago would have done this. The City and the central banks do not want to mention this—it is a disaster they have created. So they “warn” that it’s time to return to QE, just temporarily (again), of course.

Coverage in British publications (The Economist, Financial Times) of the unique warning of a risk to the financial system, by the ECB’s European Systemic Risk Board, was vague, profuse, and generally made into a warning about rising interest rates. Le Monde, by contrast, reported it as a warning about derivatives.

Interest rate derivatives make up 82% (as of end 2020) of all OTC derivatives globally, $495 trillion out of $606 trillion according to the Bank for International Settlements. But to trigger the 2007-08 global financial crash, “just” $65 trillion in credit derivatives (CDS) exposure was sufficient. The central counterparty in 90% of current interest rate derivative exposures, is a bank or non-bank financial institution. Because of the Fed, the margin calls for collateral which wiped out liquidity in the commodity trading-producing sector in March-April (war and sanctions), has now spread to the far, far larger sector of institutions and funds which use interest rate swaps, and their banks.

The BOE returned to QE in order to bail out the more than $2 trillion in pension funds’ assets of “liability-driven investing” in the U.K. alone. LDI consists in making pension fund “assets” out of interest rate derivative houses of cards. (Pensions and Investments, Oct. 5, “U.K.’s LDI-related Turmoil Puts Spotlight on the Use of Derivatives”:

So, the Fed, which led the central banks in creating runaway inflation from September 2019 onward in order to write off unpayable debt, has now acted, in the context of a world war, to write off unpayable debt, to trigger a deep global recession, crush developing economies, and inadvertently light a time bomb in at least a half-quadrillion dollars at risk in interest rate derivatives.

The Bank of England, supposedly “opposed to” Fed strategy momentarily, has acted to bail out the derivative fake values of Brits’ pension funds, while the U.K. government wipes out their living standards and savings by war and financial war on Russia. LDI “asset-building” has also been sweeping big U.S. firms’ pension strategies since the middle of the last decade.

Credit Suisse ironically was just named (Sept. 27) “derivatives house of the year” in the 2022 Asia Risk Awards (humor with Chinese characteristics?). It has taken its third big derivatives bath in two years—Archegos liquidation; Greensill liquidation; now interest rate derivatives losses. Its CDS now cost nearly $400 per $1,000 in credit, but it’s been worse, and Deutsche Bank still is worse. Remember we’re in a case of $500 trillion in derivatives, meaning at least $5-10 trillion is immediately at risk of loss, and there are hundreds of major counterparties in the financial system.

Back to top    Go to home page clear