That's what I was wondering: Just how much of these trillions are in positions that off-set one another. Just as.... a Vegas casino can take in $200M in wagers on the Super Bowl, but... not really have anything at risk...since they offer wagers on both sides. Is that how it works on these "hedge positions"?
#1 There is no "house" that handles and regulates the derivative bets that hedge funds make or that any financial entity (Bear Stearns for example) makes
#2 With derivatives you have two parties making an elaborate bet based on arcane mathematical formulas as applied to financial instruments such as bonds, CMOs etc
#3 .Worst part is these two parties are betting against each other with lots and lots of borrowed money
#4 To borrow such money from Bear Stearns and others they do have to have some collateral. But lately their collateral seems dubious because it is based on sub prime mortgages and other shaky investments
As much as these doomsayers want for the earth to stop spinning, that won't happen with the traditional derivatives market.
Think of your state government. It could decide to go into the muni market and borrow a billion dollars. But they are worried that interest rates may go up between now and the time it takes to get the muni offering ready. So they call up JP Morgan and buy and interest rate cap. Let's say on a billion dollars the cap costs 100,0000 dollars. If rates go above the cap JP Morgan owes your state money.
Now, in this scenario, the notional amount of the cap (or derivative) is a billion dollars. But if JP Morgan goes out of business in the meantime your state is only out a hundred grand plus any extra interest rate expense caused by the loss of the cap.
And JP Morgan will turn around and hedge the cap, creating another billion in derivatives. (Which means they probably won't go out of business.)
And all these billion dollars are included when the worry warts talk about 400 trillion derivatives.