NAMA to Purchase Derivatives

Page 15 of the draft NAMA legislation tells us that the definition of a “credit facility” includes instruments such as “a hedging or derivative facility.”  Section 56, starting on page 46, then defines eligible assets for purchase by NAMA as a range of different types of “credit facilities” as well as “any other class of bank asset the acquisition of which, in the opinion of the Minister, is necessary for the purposes of this Act.”

In theory, this allows NAMA to purchase derivatives from the banks. And indeed, it turns out that they are doing so. Click here to find a tender notice issued yesterday for “a Derivatives Valuation Service Provider to provide valuation services (the “Services”) in respect of derivatives positions which will be transferred to NAMA.”

Part of the work of the service provider will be as follows:

Determine derivatives’ valuations based on market-accepted methodologies and market rates. Valuations will incorporate adjustments which will be based on the creditworthiness of the derivatives’ counterparties and which will be specified in guidelines agreed by NAMA with the service provider.

I’d be interested in knowing how large the purchase of derivatives will be, what types of derivatives they are, what the rationale for their purchase is, and what exactly will be the nature of the “adjustments” incorporated. 

47 replies on “NAMA to Purchase Derivatives”

Sure seeing as they are branching out, Ive some dodgy Meatloaf and Chris De Burg albums … I wonder would they be interested in buying them as well….

As regards valuations, its only a matter of time before these timeless classics come back into fashion again, so I’ll be looking for a long term value price please


@Garry, derivatives would be more on the lines of a ‘Bay City Rollers’ album. Some things will never come back into fashion..

@Karl, firstly, aren’t you supposed to be on holidays? I’m pretty sure (considering the current pace of things) that there will still be plenty of crisis to go around when you get back.

Secondly, would it not be better for NAMA to have the banks close their derivative positions, rather than transfer them to NAMA? If the positions, or the counter-parties, have gone south, then presumably continuing to hold the positions open will only cause further losses.

The most important question is how much of this stuff is there? And what kind of derivatives are we talking about? Are they interest rate and foreign exchange contracts, or are we looking at credit default swaps?

Without knowing the contacts that were engaged in, we have no way whatsoever of knowing the extent of any potential liability. At a high level, we only know the amounts that have been written and type of derivative that was entered into.

Anglo Irish Bank Derivatives Book – Page 76

AIB Derivatives Book – Page 172

Bank of Ireland Derivatives Book – Page 139

The combined sum of derivatives from our banks run into the hundreds of billions. While this is normal for banks in the course of their business (they need to be able to hedge against interest rate movements, currency risk, etc), it is worrying that NAMA has specifically identified derivatives as being a liability.

I hope that this relates to currency and interest hedging. Some banks may have sought protection on assets located outside the eurozone. If it relates to something else, it’s a concern. I feel that the initial draft legislation is too vague. The legal equivalent to a horoscope.

Using the cloak of commercial sensitivity is an attempt to mislead. I’ve previously referenced an offering circular of a CMBS which even contains photos for the buildings relating to reference claims.

It’s not commercial but political sensitivity. At a minimum, we need transparency. What are our government buying and how much?

Maybe the banks wrote some interest rate hedges (interest rate swaps and cross currency swaps) with developers. You could argue these belong in NAMA because they are just a restructuring of developer loans.

Or maybe NAMA is just a dustbin for anything on the banks books with a negative NPV?

e.g. Bank A pays fixed rate on an interest rate swap with Bank B. With todays low interest rates NPV of swap is, say, -10Meuro. Bank A pays NAMA 8Meuro to step into the swap with Bank B.

How can 2Meuro hit to taxpayer be justfied? Well, the “long term economic value” of the swap is -8Meuro of course.

Once you start overpaying for stuff, where does it end?

@ Karl

without a doubt it involves currency hedges to start with (cross currency swaps, forwards, options), as the Indo today helpfully informs us that c €30 billion in Irish bank property loans are in fact relating to property assets abroad.

You’re also going to have complex interest rate structures beyond simple fixed rates – caps, floors, swaptions, and various derivatives of these. You’d be surprised how complex some of the hedging products being sold by the Irish banks were, so lots for NAMA to deal with.

ah yes…. NAMA … a Naff Albums Management Agency… a place to sell on mistakes of a musical nature … Well at least all the talk about haircuts is starting to make sense now.

I know very little about derivatives. But even I know enough to ask what the hell are we doing taking ownership of these weapons of mass destruction?

@ LorcanK

doubt there’s too much CDS involved here – it’s illiquid enough on the big corporates, but there would be near non-existant markets on many of the big property players. Can only see it being an issue if you had let out an entire office block to, say, Citibank and you were worried about them being able to pay the rent, but even then it wouldn’t be a great hedge in terms of cost and efficiency.

It is simply incredible that the the taxpayer is going to assume Toxic derivatives with the toxic property loans. These instruments should have been closed out by now and the fact that the banks are offloading them to NAMA can only mean that they are very toxic. Ask AIG how much they are worth.

Former Swedish Minister for Finance Bo Lundgren, the man hailed as a hero after saving the Swedish banks in the early 1990s has warned that the Irish taxpayer is being forced to take on too much risk under the government’s ‘bad bank’ plan. When he was interviewed on RTÉ radio on 12 April 2009 he said, ‘the problem with bad assets are, if not worthless, they are worth a lot less than the nominal value and to be able to price them in a way where the taxpayer doesn’t lose a lot of money in the end, it is difficult.’

Lungren noted the Swedish did not buy any toxic debts.

In an Irish Times article on 17 April twenty of Ireland’s leading academic economists argued that the Government got it badly wrong in relation to NAMA and it was not the way to clean up the banking mess created by the property bubble. The following signed the article:
When asked to comment on the eminent economists’ view Brian Cowen dismissed it with ’that’s their view’, which is precisely the sort of ignorant discarding of expert advice that got Ireland into the current economic mess.

When Brian Cowen was Minister for Finance in 2004 he sowed the seeds for Ireland’s current economic crisis by fuelling the property bubble instead of reining it in. He made billionaires of the speculators and bankers and in the process bankrupted the nation. Now as Taoiseach Brian Cowen is going to double the already astronomical national debt in an attempt to put even more money into these people’s pockets.

In introducing this bad bank proposal, Finance Minister Brian Lenihan said, ‘Our sole objective is to ensure that house – holders can access credit for home loans and consumer credit, that small and medium-sized business can fund their enterprises, that deposit-holders have confidence that their money is secure and protected, and that international investors are satisfied about the stability of our banking system.’ If the sole objective was to free up credit for house holders and consumer credit, then he should have bailed out the Irish taxpayers and not the property speculators and bankers.

The government created the bank guarantee of €485 billion for this purpose and it failed to work; they recapitalised the banks with €7 billion and it failed to work; and this new measure will also fail beacuse the Irish banks are insolvent and should be allowed to go into bankruptcy.

In Brian Lenihan’s own words ‘Here in Ireland, through the bank guarantee, bank recapitalisation and the protection of public ownership, we have provided very substantial support to the banking sector’. But none of that support has worked, because Irish small businesses are going broke from lack of credit and finance and our unemployment rate keeps soaring.

Over the past five years the bankers created huge amounts of magic and exotic instruments that would make them rich – CDOs, CDUs SIVs, etc. – and there are now massive amounts of these financial instruments floating around, billions and billions worth, which are going to come back and cause massive problems.

If the government keeps trying to bail out the banks it will eventually be forced to face reality when it finally runs out of cash, but of course at that stage it will be too late for us as all the money will have been wasted and the country will be broke and we will begin to default on our international debt.
If that occurs it is ‘game over’.

The government’s view that the banks’ toxic assets are incorrectly priced due to illiquidity is wrong. The low prices of these toxic assets actually reflect the fundamentals, rather than being driven by an illiquid market. The government is mistaking a solvency crisis for a liquidity crisis.

Many of the major Irish banks are now legitimately insolvent. This insolvency can no longer be viewed as a result of bank assets being marked to artificially depressed prices in an illiquid market.
In short, the government cannot save the banks by improving liquidity or changing valuation rules because the problem is not illiquidity or accounting. The problem is that these highly leveraged banks own assets that are worth far less than they thought they would be, and the banks are insolvent as a result. Instead of supporting these zombie banks, the government should allow them to fail and seize the good assets. But that is not on the government agenda.

Under the current government proposals: Banks win. Investors win. Taxpayers lose.

In addition to this we need to reduce the debt overhang for tens of thousands of insolvent householders throughout the country via a 50 per cent reduction of the face value of all owner-occupied residential mortgages.

When I visited Russia back in 1992–3 as part of the EU-TACIS programme (Technical Assistance for the Confederation of Independent States & Russia), our brief was to see how the EU could assist in the privatisation of Russian agriculture. Prior to the fall of communism the Russian agricultural sector was dominated by very large (200,000-hectare), state-owned, collective farms. Like much of the communist system, agricultural production had collapsed and the EU was concerned that this should be rectified as part of support for the country’s fledgling democracy. But at that that time Russia had no money, because the war in Afghanistan and the arms race had bankrupted the country.

We proposed that the collective farms be broken up, giving each worker about 100 hectares, which would allow the farmers to use the land as collateral to buy new machinery, etc.
In a command (or centrally planned) economy the farmers were not used to being independent so we also proposed that the Irish Agricultural Cooperative model could be used as an overall management system to help these new farmers get off the ground and make the transition from collectivisation.

The Russian politicians saw merit in this approach, with the exception of giving the farmers the ability to raise finance through the ownership of their own land. The politicians attitude was a result of previous communist ideology whereby the state owned everything and thereby also controlled everything. We argued that the new system would not work unless the farmers had collateral with which to raise credit for farming materials such as machinery, stock, seed, fertilizer, etc. The Russian politicians wanted themselves to get the finance, which they would then distribute it to the farmers. Prior investigations had shown us that such a course of action would only help restore the power of the previous communist overlords and possibly also tempt corruption. A similar situation now exists in Ireland.

As a result of the 50 per cent collapse in residential house prices, most Irish households have no equity in their properties, all the gains of the past five years have been wiped out and anybody who bought a house since 2006 is in negative equity. So the owners of these properties have no collateral with which to raise finance.
The reduction of the face value of all residential mortgages would immediately create that collateral for every household, allowing people to raise finance, which would boost consumption and in turn give the economy its first lift on the road to recovery, thereby providing some economic activity prior to getting our exports going again.

If instead the money is given to the banks, we will have a situation similar to Russia. The banks will go back to their old ways of leverage and risk which will make themselves millions.
They will say they cannot lend to consumers because they are already burdened with too much debt and are in negative equity.

In light of the present financial crisis, I think it is appropriate to recall what US President Thomas Jefferson wrote to his Treasury Secretary Albert Gallatim in 1802:
“Banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.”

The government should never have attempted to bail out these institutions: propping up bad assets in failed banks will not work. We should put our money into creating good assets that will grow and benefit the economy of the country.

Nobody else will lend these failed banks money, so why should the Irish taxpayer?

The reason nobody will lend them money is because nobody knows what their real assets or debt levels are. They have been showing international investors their balance sheets, but nobody believes them anymore. We hear much talk about Sweden and how they turned around their banking crisis some years ago. One of the very first things they did was to quantify exactly what the banks’ bad debts were. That has not been done in Ireland yet. It should be done, and done properly, i.e., not the banks telling the government what the debts are, but the government going in and determining that for themselves. The major accounting firms should not be hired to do this because they all have connections to the banks and therefore have conflicts of interest.

Another thing the banks have failed to do is to explain how they are spending the funds they have already received, including the funds received since September 2008 from selling commercial paper backed by the taxpayers’ guarantee.

Unbelievably, the government has not put in place a tracking mechanism for these and future funds. The government is handing over billions in taxpayers’ money to the banks without any detailed accounting as to where this money is being spent. At the very least, the government should have a detailed monthly report on where these funds are going.
Because of the banks’ previous behaviour, it would be very foolish on the part of the government to be lax in this area.
As the Irish government has failed to hold any the bankers responsible, international investors assume that such behaviour is condoned and not punished in Ireland, so they go to countries where such behaviour is not tolerated. They feel safer investing their money in such countries.

@ Garry/Podubhlain

Ok, think people need to calm down here. The term ‘derivative’ is a very broad based one, can be something as complex as a CDS contract, or simply be the embedded swap in a fixed term deposit or a fixed rate mortgage. Banks across the world couldn’t adequately hedge their interest and currency exposure without using some form of derivative, and likewise either could their customers. NAMA will without a doubt be using derivatives of some form in their dealings with both the banks and the developers in the course of their work.

@ Eoin: I don’t think anyone doubts that NAMA could and should make use of derivatives.

What has caught a lot of otherwise well-informed people by surprise is the prospect that NAMA will acquire derivatives obligations direct from the participating institutions.

To put it mildly, this is not what it says on the tin. A quick look at the Minister’s statement and the FAQ on the NAMA website confirms again that this enterprise is being promoted to us as a vehicle to acquire secured loans on the banks’ property loan books. Nothing is said about derivatives contracts.

Yet as Karl Whelan has spotted, the draft legislation allows for the acquisition of derivatives, by defining them as a class of loan.

I know I feel misled.

I concede that it may be desirable for NAMA to acquire certain hedging contracts associated with the loans acquired. But the legislation doesn’t specify only those derivatives. Given their past performance, the banks could play all sorts of games on this front.

@Eoin, agreed. Derivative does not = CDS.

I certainly didn’t mean to scare-monger in my post. Like you, I presume most of the derivatives on the books of the banks are interest rate / currency hedging.

But if their forex/interest hedges went south then so what? Surely this means that the got the gain from the asset that they were hedged against?

If NAMA is going to start buying up their hedges that cost them money because the interest rate / forex moved in a favourable direction for the asset they were hedging then NAMA is going to double profit the banks.


The CDS exposure of the Irish banks is allegedly very small (AIB announced in late 2007 that they only had €25m worth), although it would be good to have all the figures available.

There are reasonable derivatives (A bit like the way there are reasonable albums) but then there is also some horrifically toxic stuff.

Basically the problem, again, is one of vagueness in the NAMA bill.

@ Kevin

i understand your worry, i just think it’s ultimately unwarranted. Let me explain, as best i can, how a reasonably simple (in banking terms) financing structure for a developer may look.

As a result of the boom in financial engineering, very very few developers will have financial structures as simple as a variable rate loan of X secured against an asset Y. Typically they’ll have some sort of fixed rate hedging in place, via an interest rate swap, possibly going more exotic by buying an interest rate cap. Indeed, most banks would urge, or even insist, on the developer taking on at some element of this, it’s often even a provision in the loan documentation. Trust me, this is pretty standard and indeed quite prudent if done correctly.

However, without getting into AIG type territory, they could easily also have sold back an interest rate floor to the bank, and bought a swaption with the proceeds, and if some of their property holdings are abroad, a cross currency swap and an FX option could be on their books as well. I work for a bank (non NAMA), and this is done realtively frequently. To make matters even more interesting, these derivatives may not even be with the original lending institution! As such, i can fully understand why NAMA would seek to have all these derivatives housed under the one roof in certain cases, so that a better grasp of the customer’s financial situation in totality can be understood. Indeed, by having all these derivatives under NAMA’s control, this could place the state in a stronger position overall.

@ Lorcan

i can only assume the derivatives will be bought/transferred at current valuations – please note this valuation process is a relatively normal task done every day by every bank in the world. There’s no “long term economic” valuation for almost all interest rate and currency derivatives, its ALL marked-to-market, and these should NOT be mixed up with the CDO/toxic structures that the big US investment banks had on their books and were unable to value. As such, any overpaying at all would be easily identifiable from day one, indeed it’d actually be difficult to hide any under/over-valuations of these derivatives. Most of the fund management firms based in Dublin would have dedicated derivative valuations teams, indeed thats the sole purpose of some of the offices based here. It’s a routine task that even this government would struggle to screw up.

@ Eoin, I hope you are right, but you have to allow me a little cynicism.

Seen as you work for a non-NAMA institution, will you be looking into the option of clicking the big red button on Karl’s original link to the tender notice?


Seeing as you know something about it, care to comment on the fact that Anglo’s derivative book (mostly interest rate swaps and some fx) increased by 70% from 2006 to 2007 (103 bn to 179 bn) and by another 70% from 2007 to 2008 (179 bn to 269 bn)?

Or that is is 90/10 trading/hedging (compared to BoI/AIB 35/65 split)?

Does these alone not imply that Anglo was chasing the market at a time when nobody else was selling IRS? A time when interest rates first looked like they were going to rise substantially and then collapsed?

How about the fact that Anglo stopped reporting the breakdown of their derivative book in 2006?

Or that the Group derivative book is smaller than the Bank derivative book – this implies that the Group was writing derivatives within itself, i.e. from bank to subsidiary. We’ve already seen some of those blow up with the recent FX loss of some 800 mn euro in one of the subsidiaries…


Kevin has outlined my concerns better that I could 🙂

but also I thought with NAMA there would be some ability for the state to use its power to net out stuff and get better value….

It is clear that NAMA now needs a whole new set of skills or else outsource a whole new revenue and risk offloading stream to third parties.

Its all speculation as we haven’t a clue what is proposed to be bought..

It could well be property related as is assumed here.. which at a stretch could legitimately be included…. though never mentioned till now…

Or there could well be a multi billion bill from other non property related derivatives looming.

It highlights the need to have NAMA subject to the law of the land, company law, regulation, publishing audited accounts, paying taxes etc etc etc…

@ yoganmahew

i cant comment on just what type of derivatives Anglo has on its books, or what their net value is, what their purpose is etc etc. However, take account of this: i enter an IRS with bank ABC for 10mio, where i receive the fixed rate and pay the floating rate. The next day i do another interest rate swap for 10mio, this time with bank XYZ, where i recieve floating interest rates and recive fixed. My interest rate risk is zero, but i have nominal IRS on the books of 20mio. So long as neither counterparty goes bust, i will over time be completely flat on p/l, and the effect on my balance sheet will be negligible to zero. The problem arises when one of the counterparties turns out to be Lehman Brothers, and so i turn out to have no hedge on one side of the book! Bear Stearns had notional derivatives on their books of $13 TRILLION when they went to the wall, but obviously a much smaller actual balance sheet.

All im saying is that notional derivative exposures are almost impossible to give an opinion on without knowing the finer details about them. Thats the problem with derivatives, as i said above, that they are such a generic broad based term. It’d be like me saying all my pension is tied up in ‘securities’ – its somewhat difficult to tell safe it is unless i tell you if i own either stock or US Treasuries. The only thing i do know is that the bulk of Anglo’s derivatives would be fairly vanilla in nature, and so any profits and losses would have been announced a long long time ago – as mentioned above, they’re almost impossible to over/under-value.

@ Garry

absolutely. NAMA outsourcing is going to be a very big issue around its operations, there’s no way they can handle it all in-house. Expect some fairly lucrative contracts to eventually be dished out there.

Thanks, yes, I understand that. My concern is that Anglo used to give such a breakdown of their book – bought and sold of each type. Then they stopped and just gave net positions. My worry is that they are doing the deal with XYZ so paying fixed and getting floating, but not doing the deal with ABC to hedge it.

After all, what is the point in trading derivatives (as opposed to using them for hedging) if you don’t set out to make a profit from them?

@ Yoganmahew

true, but all im saying is that outside of the CDO-type sphere of derivatives, 99% of exposure is very very easy to value. As such, and given all different people pouring over the Anglo books in the last couple of years, it seems more or less impossible that they would have any ‘hidden’ losses, or pent up and unnanounced risk positions, that you seem to be alluding to.

But we already have evidence that they have made losses on FX trades. The disclosure was sufficiently opaque that I think it must have been unhedged derivatives?
(Sorry, it’s 715mn euro, not 800 as I stated above).

This bit from the Anglo preliminary report 2009 makes me nervous:
“Fair values are obtained from quoted market prices in active markets and using valuation
techniques including discounted cash flow and option pricing models, as appropriate.” p.37

@ Yoganmahew

the GBP/JPY trade was flagged in their annual report back in February. I’m not 100% on just what it was, but it appears to be something tax based which the accounts claim actually ends up creating a net benefit to the bank of £14mio or so. Basically (i think) they claim a trading loss on the FX, write that off against tax, and book the ‘carry’ (the difference between GBP and JPY interest rates) as the profit. I don’t fully get it (i aint a tax accountant!), but there accountants claim it as a net after tax benefit apparently.

To be honest, this probably didn’t involve any derivatives, it was probably just a basic spot or forward outright GBP/JPY fx position (which technically don’t count as derivatives).

As for the statement in Anglo’s report, well this comes from Rabobanks annual report, so it seems to be fairly generic wording.

“The fair value of the sold and retained interests is based on quoted market prices or calculated as the present value of the future expected cash flows, using pricing models that take into account various assumptions such as credit losses, discount rates, yield curves, payment frequency and other factors.”

I completely understand that derivatives can, when used incorrectly, generate huge losses. However they seem to be the financial market boogieman right now. Derivatives have been part of our financial system for decades, and will be for decades more. Central banks use them, governments use them, banks use them, corporations use them, and the man on the street unknowingly uses them all the time. The fact that they are going to be used by NAMA and taken on alongside the loans should not be surprising, or necessarily worrying unless accompanied by additional information, to anyone.


Fair enough on the Anglo fx thing.

But I take issue with your assertion that most derivatives are marked to market. It appears to me that most are marked to model.

I also take issue with the idea that they have been around for decades. A decade at most. This is the first crisis derivatives have faced and they have been found wanting.

We will not get the additional information about the derivatives, their composition, whether they are hedging or trading to ease any concerns about them. NAMA is shrouded in “commercial sensitivity” so I shall retain my worry.

Derivaitive purchase and derivative valuation experts required by the state. What Next? At least a field was a field if you could not build on it you could value it at an agricultural price. But Derivatives…even AAA? As we all know a derivative can be rated AAA and be worthless!

There is a certain carelessness, haplessness and dare I say it something bordering on criminal negligence or worse about NAMA which all the barristers in the world will not paper over with their legal speak!

And what are the Gardai doing since this crisis unfolded?

There is no crime of Treason anymore. Seems you can slash and burn taxpayers money with impunity until there is none left.

What about Offences Against The State? It seems, bankrupting the state or doing your level best to bankrupt it, is no longer an offence.

What about seizure of criminal assets? Many of the loans given out were given under contracts that were illusions. Shareholders were lied to, accounts filed were false by omission or commission. Valuations were so wide of the mark as to be useless. So why are the CAB not doing their job?

Anglo’s offices were raided and what has happened since? Nothing. Many
of these assets that NAMA is going to overpay for should be seized by the CAB. What are the Gardai doing with the documents seized? Studying them? When are they going to act?

What about the Organised Crime Unit investigating a certain bank that we now own!

Finally, we have the ERU emergency response unit. Emergency response to what? We seem to think there is only one type of crime in this country and it certainly is not white collar crime. In Ireland, the barristers and judges just check your white collar to make sure it is starched and then let you off scott free.

Cearbhall O’ Dalaigh
Welcome! I’m a fan of long winded rants 😉 so I think you are spot on.
The political class are realy hopelss don’t you think?
Consumer demand is the cry of the msm though! It just increases debt and the tax take!

Cearbhall O’ Dalaigh
Like ya site too, mate! Except why reward borrowers with money? They were stupid to borrow when they should have waited. You are subsidizing the stupid. It is an improvement over the subsidy of the stuupid greedy and corrupt but I still do not faovour it. Lets keep the capital for productive small businesses?

Robert Browne
CAB has a job and it is under the control of the Gardai. But it certainly could tackle the proceeds of corruption. But the present Garda Commissioner, (Hiya Fachtna!) who was the first CS in charge of CAB, would lose his job or his life if he ordered the enquiries. Not a joke.

Remember derivatives made a cast iron fortune for that Texas co. that paid off those bad mortgages for their clients! Who says they are entirely bad?

An old trick is to make a trade both ways. And book the losing one to X and the winning one to Y. It only costs cent because there was in fact no sale nor purchase. Just OPM.

@ yoganmahew

almost all interest rate derivatives are marked-to-market using bond/swap prices and quoted volatility indices to value them. The only reason that you don’t value them using quoted prices is because there is no quoted price to reference against, and in our wide wide financial world this doesn’t happen very often. Currency options, however, are actually almost all valued on a model basis. The problem is there’s actually only one recognised model – the Black Scholes model (or minor variations there of). This won a nobel prize in 1997, so its good enough for me. Model-based valuations outside of this are fairly rare and generally relate to far more complex stuff like CDO’s, which the Irish banks have almost no exposure to.

As for your suggestion that derivatives are only a new concept, well the Japanese have been using them for almost 300 years on their rice exchanges, and there’s even writings by Aristotle on some fairly basic financial options. The Chicago Board of Trade (CBOT), the world’s largest futures and options exchange, was established in 1848. As for this being the first crisis they have faced, well the Dutch Tulip crisis in the 17th century involved actual tulip bulb exchanges and futures contracts, and im fairly sure you can find another crisis or twenty that had derivatives involved with them.

Have their use become much more widespread in the last 30 years? Absolutely. Do we over-rely on them? Quite possibly at certain times. But today’s basic derivatives are not all that different from the ones being traded in the early 80’s, and some are even identical to the ones being traded 300 years ago. Claiming that the sky is going to fall because NAMA will be buying derivatives or that Anglo has some on its books is totally unnecessary and pointless.


This statement “The problem is there’s actually only one recognised model- the Black Scholes model ” has convinced me that you really dont have any real understanding of derivatives. I dont think you are even a back office / quant guy let alone a front office / trading desk guys. Go hang out in the technical forum of the Wilmott site (to name but one place) for a while and you will discover that there is a world of non B/S pricing models that are used in real trades. B/S is usually nothing more than a convenient kick of point for more substantive and realistic (i.e profitable) models.

B/S had its heyday back in the 90’s but LTCM put an end to that. B/S is still used because it is convenient and easy to teach (it all sounds so plausible in Hull) but as the last 18 months have shown, those with real trading skills (and knew just how flimsy B/S was ) survived while those with PhD’s and lots of fancy math blew up.

What I found before the big blow up was that back office /quant guys treated derivative and structured instruments in a very offhand way, oblivious to the many (unexpected) downside dangers, while the front office guys treated them with the respect deserved for something that could blow your @#$%ing head off with one misstep.

Everything surround derivatives with regards to Anglo and NAMA stinks to high heaven. I’m not talking about instruments that can be priced with a simple Excel formula here. If something is structured like a scam, its a scam.

@ jmc

first off i never claimed to be a quant guy. Simply thought that this thread was going too far down the road of “derivatives are the devil” without some context being put on it.

secondly, almost everything i claimed about the valuation process was alluding to how Irish banks should be going about it. For all this talk of toxic derivatives and complex products, Irish banks are incredibly vanilla in the nature of their financial exposures.

thirdly, in referencing B/S options model, i was probably somewhat clumsy and myopic in saying its the only model. However, my more general point was that for currency options, most banks use the same relatively small set of models to value their currency options exposure, even more so in the context of the Irish banking system and its fairly vanilla exposure. What i was trying to disclaim was some fear that ‘in house’ or proprietary models were being used to value these exposures, as this seemed to be suggested previously in the thread.

“Everything surround derivatives with regards to Anglo and NAMA stinks to high heaven”. Please, please, enlighten me as just why you think this is so? In particular i’d like to know what sort of instruments you think that either Anglo, NAMA or the other Irish banks have on their books that will be so scary and difficult to value and likely to lead to more carnage in our financial crisis. I state one more time that from my experience i believe the derivatives exposure of the Irish banking sector and their developer clients to be relatively vanilla, transperent, easy to value and difficult to manipulate/overpay for. If someone has examples to the contrary, or at least fact-based suggestions, please let them be known, because everything else is simply guessing and scaremongering. The boogieman MIGHT be under my bed in my house, but i generally sleep fairly well and dont expect him to suddenly jump out.


I would like to back up what you say. OTC interest rate derivatives are treated with respect by anyone who has traded them. Normal banks maintain an army of people to oversee swap & option desks, but blowups still regularly occur. You don’t need exotic products.

Good systems, back-office support, proper risk analysis, honest and competent dealers/managers greatly minimise the risks as Eoin says. But how many of these elements were present at Anglo Irish Bank?

Were some of the irregular practices which characterised Anglo also present in the operation of their 200Bn eur derivatives book? I don’t know, but only a fool would not ask this obvious question. And how come the derivatives book was so actively traded during the period 2008/8 when liquidity had dried up? Who was providing this liquidity? Yoganmahew’s question above deserves to be answered.

The docility of the financial media here with respect to these issues amazes me.


much of what you say about swaps

@ BG

i understand where you’re coming from. Trust in anything involving Anglo, and indeed much of the Irish banking sector, is at an all time low, and it’s fair game to not necessarily believe everything that comes from it without some sort of verification.

But there seems to be two seperate issues going on here, one involving how the Irish banks may have acted around their derivative positions, (despite numerous audited reports) and another involving how derivatives are valued on a more general level. There are many suggestions on this thread that much of the derivatives being taken on by NAMA will be prone to a very subjective valuation process that could easily manipulate their ‘real’ value. Its this second part in particular that seems to have little basis in fact, and is more akin to scare mongering and outright mistruths. As i have said repeatedly, most (ie 95%+) of what NAMA takes on will be realtively vanilla derivative positions, and valued by an independent derivatives valuation supplier (per the tender process above). As such, just what are we so afraid of? I would like someone to explain this to me in categoric fashion rather than the vague “but there COULD be toxic derivatives in their books”. From my experience of the Irish banking sector, complex derivatives were an incredibly rare occurance in the operations of the Irish banks. There are real issues to be worried about in regards to NAMA, but the derivatives are not, in my view, one of them.

@ BG

also, reagrding where Anglo was getting the liquidity: speaking from one of the foreign owned banks based here, we pulled our deposit lines with Anglo as soon as it all blew up, but we maintained the derivative lines. We, like many banks, have whats called a ‘collateral management agreement’ with them, where we would net out with them the daily (or possibly weekly, not 100%) movements on the derivatives positions held by both banks against each other, ie if the derivatives positions went in our favour from one day to the next, Anglo would make a payment to us, and if they didnt make this payment we would be able to either seize collateral or close the contracts out. This means the losses arising from Anglo going bust are much less than without such an agreement (it also protects Anglo in the event of us going bust obviously).

This would explain how they may have faced a cash liquidity shortage, but were still able to trade their derivatives exposures with at least some freedom.

@Eoin, jmc, BG,

I have another question on IRS. When you use them to hedge, say, a commercial loan, you buy fixed and sell floating or vice-versa. What happens if you get no income from the commercial loan? (It becomes overdue).

@ yoganmahew

thats a fair point, and one probably facing the banks at the moment. On the swap obviously all you’re paying id the difference between the fixed and floating legs, but this could be quite big given the way rates have moved over the last couple of years. If the client couldn’t perform on the loan, it seems likely he’d be unable to perform on his out-of-the-money swap (lets assume he’s paying the high fixed rate, seems likely given where rates are right now). As such, the bank would probably look to close out the swap at a loss, and hit the client for this amount. This would obviously increase their potential exposure to the client.

Technically speaking, this could amount to lets say 1.5-2% of the nominal loan (difference between fixed rate on swap when agreed and fixed rate that exists now to close it out, multiplied by the length of the fixed rate swap facility. So 1.75% x 10 years could mean an additional exposure of 17.5% i suppose (ignoring npv). That said, the mix of swaps for the developers would differ depending on the projects (or at least should!): short terms swaps (and so lower cost of closing out) for development loans, medium to long term swaps for fully finished commercial property loans etc.

This, by the way, is precisely why the fixed rate mortgage break costs we keep hearing about are so big, and they are very real costs to the banks despite what your local TD may be saying.

The shadow banking system is essentially broken and there is a fear by certain poster’s here that Angleo is some how involved in all of this.
My gut feeling is that they are probably correct and that the DOF are essentially complicit in a cover up. Think of “Sean Quinn” “CFD’s” “The Green Jersy brigade,etc.
I smell a very BIG rat somewhere. Having said that, it is my gut feeling and do not have any evidence to back this up.
If any one can decipher this please contribute.


“speaking from one of the foreign owned banks based here, we pulled our deposit lines with Anglo as soon as it all blew up, but we maintained the derivative lines.”

i suppose the swaps your bank did with Anglo during 2007 & 2008 were traded via your London desk?

it would be very interesting to know what your dealers thought about anglo’s market activity during this period.

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