TIME for an April Fool joke? If only….

It’s Easter Monday. Europe is closed. The US wishes it were.  Along comes this scary headline…which is even scarier because it’s from a column in TIME written by a contributor: Why Derivatives May Be the Biggest Risk for the Global Economy.

We furiously click through the link to get to the entire article. We read through it, drawing nary a breath. We see claims (with absolutely no attribution or substantiation) that the OTC derivatives market is bigger than the BIS says it is. Which means the risks are even greater than many had supposed.

We are puzzled.

And then we come to the piece de resistance, the giveaway:

“…in theory, at least, the total losses could add up to more money than there is in the entire world.”

A moment of clarity descends upon us. We “get” it.

It’s April 1. The column is an April Fool’s Day prank.

It has to be…because the story simply makes no sense. The venerable TIME would never run a column that confuses its facts so badly. It mixes up notional amounts outstanding with the level of OTC derivatives risk outstanding (which is properly measured by market value). If you do a $100 million interest rate swap, you agree to exchange payments based on the $100 million notional amount. You don’t actually exchange the $100 million.

We know people sometimes find OTC derivatives confusing, but we had imagined that by now just about everyone gets this point (or at least everyone with the yank to write a column in TIME). Notional does not measure risk. In fact, the amount at risk in OTC derivatives typically averages about 4% of the notional outstanding. And it’s less after you factor in collateralization and netting (about 0.2% of notional).

Unfortunately, the misguided notions on notional are not all that’s wrong with the column. It also fails to recognize the significant growth in central clearing, the progress made in increasing regulatory transparency, the continuing efforts in collateral management – all of which help to reduce risk.

We’re glad April Fool’s Day only comes once a year.

One thought on “TIME for an April Fool joke? If only….

  1. Pingback: The week that was (issue of 2nd April 2013) | The OTC Space

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