Thank you for writing. You give more clarity than my post. I would ask you this. Recently, just last week, it was reported that Bank of America transferred 44 trillion in notional derivitives off of its books....I think to Morgan...but I am not sure of that.....but they did transfer 44 trillion. If the counterparties make demand on those 44 trillion of notional value, what would that translate in terms of actual liability to the counterparties. If it is only 1%, that is an astronomical number. Can you illucidate?
Unfortunately; there is no simplistic or directly quantifiable answer to the liability question because it doesn't exactly work the way your question seems to suggest. I'll try to add some color:
I wasn't aware of the transfer of the $44 trillion in derivative notional value from BOA to Morgan (Morgan Stanley or JPMorgan?). If this is the case; it is not out of the ordinary. Banks and Hedge Funds transfer or 'novate' positions away to other banks all the time after agreeing to a specific settlement based on the present value of the swap being novated.
The counterparties on the other side of those transactions who were facing BOA, but are now facing Morgan will actually be somewhat relieved since their counterparty risk has actually decreased now that they are no longer facing BOA. I would argue that Morgan (either one) is more stable than BOA
Assuming these derivatives are mainly Interest Rate Swaps (80% of the derivatives population), the counterparties can't simply 'demand' the notional value. The swap contracts usually have a tenor of at least 5 years and some go out to 30 years or even more. They are binding contracts. If a counterparty wants to 'early terminate' or 'unwind' an existing swap with another bank (regular occurrence), both sides will have to agree on the Net Present Value on the trade and settle the amount with each other. Naturally; one side will receive and the other will pay depending on what side of the swap they have at the time and the factors that go into the NPV calculation given the present market conditions. The NPV on a swap will likely be nowhere near the notional amount. It could be a simple 5-figure or 6-figure NPV on a swap with a $100millon notional. Obviously there are a lot of other moving parts involved, but this is a pretty accurate representation. The agreed-upon fixed interest rate on one side of the swap will be a main determinant of the NPV. Higher fixed rate (swaps dealt over 2 years ago for example) will likely translate into a higher NPV as will a longer tenor.
On top of that, you have the regular compression cycles and bilateral netting I mentioned in my last post in addition to the fact that hedging with interest rate futures and bonds is constant in the world of derivatives trading as is taking opposite sides of the same swap with two different counterparties with slight pricing variances in an effort to lock in a little bit of a profit while hedging your risk.
Also; just to give you an idea of types of payments being exchanged on the agreed-upon payment dates for a basic Interest Rate Swap with a $100million notional:
You and I agree to a Swap. We will exchange fixed for floating payments on the USD 6M LIBOR rate on a semiannual basis on a notional of $100million for 5 years. I will pay you a fixed amount every 6 months. The current 6M LIBOR rate is about .6%
The fixed side payments will always be 100mio x [180(days)/360Days] x.006 = $300,000
Let's say the 6M LIBOR is.55% on our next settlement date. I will pay you $300K and I will receive 100mio x [180(days)/360Days] x.0055 = $275,000 from you since you agreed to pay the floating rate, or whatever LIBOR is on the day we settle each payment (actually 2 days prior but not relevant right now). We will net these payments and I owe you $25,000. This is a far cry from $100million. This exchange will go on every 6 months for the next 5 years. The change in the 6M LIBOR rate will be what determines how the payment amounts fluctuate. As interest rates rise, it is likely the floating-side payer will have the greater liability. This shouldn't matter though, because even a rookie derivatives trader would have hedged this exposure with futures, bonds, or another swap.
Sorry to be so wordy but I just wanted to try to paint a clear picture. The concerns about derivatives are legitimate to a point, but we need to have a sense of perspective. $55 trillion in notional amount is not actually a true $55 trillion risk even in the worst case scenario. How much of that $55trillion is offsetting? Perhaps the 1% figure you cited is a possible worst case scenario number, but it can't really be quantified that simply.