Former Fed Official Andrew Huszar on Derivatives Risk

Andrew Huszar does a followup interview with King World News. For those who may have missed it we covered his earlier interview here. Here is the background bio for Mr. Huszar again as well. In this interview, Mr. Huszar discusses a topic we have noted here many times, the unknown risks associated with derivative products. It's one thing when we point it out. It's quite another when someone on the inside like Mr. Huszar points it out. Here is the link to his latest interview on derivatives. Below a few quotes from the interview:

Eric King:  “We have nearly $1.5 quadrillion of derivatives in the system.  We saw a warm-up in 2008.  Can’t that just implode the system entirely?”

Huszar:  “Yes.  I worked on Wall Street and I would argue that from a cultural standpoint there has been almost no change on Wall Street since 2008.  The unprecedented government response, which I think on some level was necessary to stabilize the situation, ultimately it led to a complete sense of denial on the part of Wall Street.  And very little accountability, literally, in terms of no effective criminal convictions, but even in terms of just the day-to-day culture of the place...."

Eric King:  “When you talk about ‘London Whale’ activities, that was supposed to be hedged, right?  And yet everything went sideways and there was $10 billion or whatever it was in losses.  If that $1.5 quadrillion in derivatives starts to have the dominos tumbling, the other party is insolvent, they can’t back up their part of the derivative, and then we are right back to 2008 and worse.  Isn’t that right right?”

Huszar:  “Entirely.  Again, these clearing houses are in place now, but there is a real question as to whether they have sufficient capital.  It’s a model-driven approach still, where they use models to assess how much risk they have.  And those models are driven significantly off of a five-year period where the U.S. government put a floor under the financial markets, and there has arguably been a huge bond bubble.”

Eric King:  “Are derivatives going to destroy the financial system at some point?”

". . .  . I’m not sure if it’s the derivatives or some outgrowth of the derivatives, or maybe a more standard bond market selloff, or some other crisis, but we’ve kicked the can down the road and we have the same structural imbalances that we lived with 5 years ago, sadly.”

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That last underlined statement says all you need to know about why this blog was started and why we will have to stay tuned to this topic well into the future. The man who ran the first QE program for the US Fed says "we've kicked the can down the road and we have the same structural imbalances that we lived with 5 years ago, sadly."

In other words, problems have yet to be solved, they have simply been pushed forward by creating massive liquidity using QE programs to buy time. This is why we believe we will eventually see major monetary system changes. The question for us is over what time frame will they happen and will they happen in a controlled fashion or in a crisis reaction mode. It could go either way so we have to stay alert and flexible to any possible outcome.