Saying that every human has $190k of derivatives debt is rather like saying that because there are (at a guess) 200 million drivers in the US and EU, and the maximum possible auto insurance claim is about $1M if a driver loses control and drives into a crowd of people, then there must be 200 TRILLION DOLLARS WORTH OF INSURANCE DEBT JUST FOR CARS ALONE! EVERYBODY PANIC!

In reality a much more realistic gauge of the size of the derivatives is the market value, in the same way that the size of the insurance markets is normally measured in premium (which should have some relation to expected claims + costs).

A $1M interest rate swap is just that – a series of payments of the difference between the current rate of interest and a pre-determined fixed rate. If one party stops paying, the maximum loss is the difference of the rates for the rest of the term of the contract. Nobody ever has an obligation to pay the $1M notional (hence the name “notional”).

In addition many contracts are offsetting – if xxx company enters into a contract with a bank, the bank can’t pitch up one day and say “hey, whether you like it or not your contract is now with yyy company who you have never heard of who needed a similar but opposite contract”. Instead it will enter into a second offsetting contract with yyy. This mode of operation leads the notionals to blow up while the total market values remain limited.

As an example, the total notional credit default swaps on Lehman Brothers was $72B and the payout was nearly the maximum possible, but the actual cash exchanged was only $5B in the end because many of the contracts were offsetting.

I’ve also got no idea where the figure for “listed credit derivatives” comes from. If you look at the BIS statistics release (page 108) they mention about $28 B notional in exchange-traded futures and $51 B notional in options (but again, notional is not very meaningful). There are no listed credit derivatives at the moment, as there are technical problems with trading them on an exchange.

In the big book of Folktales for money managers you’ll find this delightful story.  It begins, as folktales do, when stranger who comes to town.  As he checks into the hotel he asking Albert the desk clerk to store ten thousand dollars the money sa…