The instant Asia's economies cracked last year, Howard Greenspan feared the worst for his bank. As a longtime customer and investor in the Canadian Imperial Bank of Commerce, the second largest in Canada, Greenspan knew it was a big player in the Asian derivatives market. The bank would suffer from the Asian fallout, but how much? At the company's annual meeting in January, Greenspan, a Toronto management consultant, asked CIBC chairman Al Flood about the bank's derivatives. But Flood cut him off, and a subsequent attempt was unavailing. So Greenspan took CIBC to court a month later to compel the bank to talk, but he got nowhere. "Derivatives, even if played by the rules, are a deadly game," says Greenspan. "I was very concerned about my bank's exposure." CIBC isn't an isolated case. Among U.S. institutions the dollar amounts are so huge and the risks so high that bankers recoil when the topic is raised. But they may soon have to talk.
Derivatives are a kind of nuclear financial instrument. They are powerful and highly complicated agreements designed to offset certain financial risks. Under steady conditions they work well. But in derivatives, like nuclear mishaps, there are no small accidents. And as the Asian economic crisis worsens--and in Indonesia's case nears catastrophe--the financial Geiger counters are beginning to buzz.
J.P. Morgan, America's fifth largest bank, got bad news this year when several South Korean firms suddenly repudiated their derivative contracts, leaving Morgan out some $500 million. America's biggest lender, Chase Manhattan, saw its "nonperforming" assets in Asia triple in the first three months of 1998, to $243 million, due in part to derivatives. At the end of last year, its total risk from Asian derivatives--should others default--was more than $3 billion. Bankers Trust's derivatives' delinquencies have leaped from zero to $330 million in a year, and the compass points to Indonesian and Thai clients. In total, the bank has some $5 billion of derivative credit exposure in Asia. And Greenspan was quite right to be concerned about CIBC. The bank has nearly $1 billion in gross foreign derivatives with parties that are below "investment grade" (translation: risky).
And now comes the bad news. Some $10 trillion (yes, $10,000,000,000,000) in derivative contracts are set to mature this year for U.S. bankers, and the U.S. bankers are holding their collective breath to see which of their Asian clients will pay up. Many won't. "Those who believe there won't be any further derivative losses from Asia couldn't be more mistaken," says Edward Furash, a bank consultant based in Washington.
There are two types of risk associated with derivatives: market risk and credit risk. The former describes the possibility that you've bet the wrong way. These losses are theoretically limitless, another interesting feature of derivatives. The latter risk is simply that the counterparty doesn't honor the agreement.