Too Many Derivatives To Fail


The problem of firms being too big to fail became a prominent theme during the economic crisis. After reading a recent article on about which firms face most of the risk in derivatives, I think it's easy to see why certain firms failing would be so problematic. In particular, there are five banks that control the vast majority of the derivatives market. Thus, almost by definition, they might be considered too big to fail based on their derivatives alone.

The article considers a report Fitch ratings issued earlier this month. Here's what notes about the report's findings:

While derivatives use among U.S. companies is widespread, an "overwhelming majority of the exposure is concentrated among financial institutions," according to the rating agency's review of first-quarter financials.

About 80% of the derivative assets and liabilities carried on the balance sheets of 100 companies reviewed by Fitch were held by five banks: JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley. Those five banks also account for more than 96% of the companies' exposure to credit derivatives.

Those five banks shouldn't shock anyone -- they're the usual suspects. What might seem surprising, however, is the portion of derivatives exposure of those mere five banks. That's probably part of what prompted the Justice Department to begin looking into the derivatives market recently. Even beyond competitiveness concerns, spreading that exposure over a larger number of financial institutions would make a lot of sense from a systemic risk standpoint. The failure of any one of those firms would send our financial system back into crisis.

Also in the report, Fitch confirmed what some concerned with too burdensome derivatives regulation have been saying, via the article:

While "derivatives trading by utilities and energy companies appear to be very limited," for instance, "most of the companies reviewed in both industries report the use of derivatives for hedging commodity risks," the report found.

Companies don't want their hedging practices that use derivatives to become more expensive due to new regulation. But one fascinating case Fitch also noted was Exxon. The largest U.S. energy firm had no derivatives exposure at the end of the first quarter. notes that Exxon says, in its 10-K:

"The corporation's size, strong capital structure, geographic diversity and the complementary nature of the upstream, downstream and chemical businesses reduce the corporation's enterprise-wide risk from changes in interest rates, currency rates and commodity prices. As a result, the corporation makes limited use of derivative instruments to mitigate the impact of such changes. The corporation does not engage in speculative derivative activities or derivative trading activities nor does it use derivatives with leveraged features."
Jump to comments
Presented by

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
Get Today's Top Stories in Your Inbox (preview)

What Crazy Tech Idea Could Become Real?

"There could be great intelligence enhancements, like infinite memory."

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register. blog comments powered by Disqus


A Time-Lapse of Alaska's Northern Lights

The beauty of aurora borealis, as seen from America's last frontier


What Do You Wish You Learned in College?

Ivy League academics reveal their undergrad regrets


Famous Movies, Reimagined

From Apocalypse Now to The Lord of the Rings, this clever video puts a new spin on Hollywood's greatest hits.


What Is a City?

Cities are like nothing else on Earth.


CrossFit Versus Yoga: Choose a Side

How a workout becomes a social identity


In Online Dating, Everyone's a Little Bit Racist

The co-founder of OKCupid shares findings from his analysis of millions of users' data.



More in Business

Just In