All over the planet, large banks are massively overexposed to derivatives contracts. Interest rate derivatives account for the biggest chunk of these derivatives contracts. According to the Bank for International Settlements, the notional value of all interest rate derivatives contracts outstanding around the globe is a staggering 505 trillion dollars. Considering the fact that the U.S. national debt is only 18 trillion dollars, that is an amount of money that is almost incomprehensible. When this derivatives bubble finally bursts, there won’t be enough money in the entire world to bail everyone out.
The key to making sure that all of these interest rate bets do not start going bad is for interest rates to remain stable. That is why what is going on in Greece right now is so important. The Greek government has announced that it will default on a loan payment that it owes to the IMF on June 5th. If that default does indeed happen, Greek bond yields will soar into the stratosphere as panicked investors flee for the exits. But it won’t just be Greece. If Greece defaults despite years of intervention by the EU and the IMF, that will be a clear signal to the financial world that no nation in Europe is truly safe. Bond yields will start spiking in Italy, Spain, Portugal, Ireland and all over the rest of the continent. By the end of it, we could be faced with the greatest interest rate derivatives crisis that any of us have ever seen. FULL REPORT