Swaps: Definition, Types, and Dangers to the U.S. Economy

Table of Contents

Swaps

What is a Swap?

A swap refers to an agreement between two parties to exchange the cash flows or liabilities from two different financial instruments. The financial instruments swapped can be anything but often involve two ‘legs’: a fixed cash flow (e.g., a loan or bond) and a variable cash flow based on an index price, commodity price, benchmark interest rate, exchange rate, etc. The most common kinds of swap are interest rate swaps and currency swaps. 

Swaps, unlike futures contracts, do not trade on exchanges. Rather they happen over-the-counter (OTC). This means buyers and sellers directly negotiate deals among themselves, tailoring each trade to meet their respective needs. While OTCs have their benefits, the lack of standardization and protections can make them vulnerable to defaults. 

In this article, the Zero Theft Movement will take a deeper look at swaps and how they work. Keep reading if you want to see how you and the U.S. economy might have been affected by one kind of infamous swap.

Long-Term Capital Management alleged trading strategies eventually failed catastrophically and led to a $3.65 billion bailout in 1998. Should the government have intervened as the lender of last resort? See what the ZT community has uncovered…

 

Understanding Swaps

Financial players use swaps to acquire a different scheme of payments that better fits with their business/investment needs or goals. Retail clients, investors, or even corporations can have swaps in their portfolios. 

 

All swaps must have the following conditions established:

  • The start and maturity dates for the deal
  • A nominal price to calculate payments for both sides
  • The interest rate, or margin, for each party
  • Index of reference for the variable leg
  • Frequency of payments

DID YOU KNOW?

The market for swaps represents 80% of the global derivatives market and amounted to $320 trillion at the end of 2015.

Why Swap Financials? 

Financial players would want to use swaps for two main reasons: commercial needs and comparative advantage.

Commercial needs

The standard business operations of certain companies can incur interest rates or currency exposures. Swaps allow these businesses to circumvent these extra costs. For instance, a bank might be paying a floating rate of interest on deposits and earning a fixed rate of interest on loans. To match its liabilities to its assets, the bank can use a fixed-pay swap to exchange its fixed-rate assets into floating-rate interests. The variability of its liabilities and assets, therefore, align. 

Comparative Advantage

Some companies might want to gain a comparative advantage by swapping for their desired type of financing. Take, for instance, a U.S.-based company that wants to establish itself in Europe. The business has a strong presence nationally, but no foothold overseas. That means it will have a much more  difficult time finding favorable financial terms outside of the U.S. To gain a comparative advantage, the company should execute a currency swap in the U.S., providing them the necessary euros to finance its expansion. 

Different Types of Swaps

While we have already mentioned different types of swaps, let’s take a closer look at how these trades occur.

Interest Rate Swaps

The most common type of swap, the interest rate swap enables parties to exchange cash flows based on a notional principal amount. Both sides can execute these swaps to either hedge against interest rate risk or to speculate. 


To explain how interest rate swaps work, consider them in their simplest, ‘plain vanilla’ form. On one side, party X agrees to pay party Y a fixed rate of interest (dictated by a notional principal) on specified dates (known as settlement dates). Party Y agrees to pay party X a floating interest rate (this too dictated by the same notional principal) on the specified dates. As swaps are OTC contracts, interest payments can happen annually, quarterly, monthly, or on any other schedule that both parties agree to follow.

The LIBOR scandal uncovered alleged manipulation of a global interest rate. Millions of contracts, including swaps, could have been affected by major banks potentially involved in the case.

Commodity Swaps

Commodity swaps involve the trade of a floating commodity price for a set price over a period. Businesses would want to execute a commodity swap in order to hedge against price fluctuations and budget. They get to lock in the current spot price of the underlying commodity. 

The underlying commodity must involve a physical product, such as oil, livestock, or coffee beans. Crude oil is the commodity that gets traded most globally.

Currency Swaps

In a currency swap, parties exchange interest and principal debt payments in different currencies. These swaps do not have a notional amount as the principle, but it still gets exchanged. 

Countries and businesses can engage in currency swaps. Due to the recent pandemic, the U.S. opened up 14 ‘swap lines’ to help other countries weather the major economic downturn. According to an NPR report, “Dollars are the lynchpin of global trade. International loans, debts, and bank transactions are largely done with dollars. Foreign central banks need dollars to stabilize their financial systems. The dollar isn’t just America’s money. It’s the world’s money. It’s why when the COVID-19 crisis hit, there was a record-breaking rush to get dollars around the globe. And the Fed is the only institution with the power to print them.”

Debt/Equity Swaps

Debt/equity swaps involve trading debt for equity. A publicly traded company would exchange bonds (i.e., debt) for stocks (i.e., equity). These swaps allow businesses to refinance their debt or maintain a target debt/equity ratio. 

Total Return Swaps

Total return swaps refer to when the total return from an asset gets exchanged for a fixed interest rate. The financial player who pays the fixed-rate receives exposure to the underlying asset. For instance, an investor can pay a fixed rate to another investor in exchange for the capital appreciation and dividend payments of a pool of stocks.

Credit Default Swap (CDS)

Credit default swaps (CDS) involve an agreement by one party to pay the lost principal and interest of a loan to the purchaser of the CDS in the event a borrower defaults on a loan. 

Overzealous investment in CDSs has been cited as a major contributor to the 2008 financial crisis. In essence, the expansion of credit default swaps in the 2000s resulted in the boom of credit default obligations (CDOs). Essentially insurance for the debt in case it defaulted. Hedge funds, banks, and…AIG, a corporation with little relation to the industry, handed out the insurance liberally. But AIG was the odd one out for more than one reason.

Reuters reported that “AIG was on one side of these trades only: They sold CDS. They never bought. Once bonds started defaulting, they had to pay out and nobody was paying them.”

The Center for American Progress, an independent nonpartisan policy institute, claimed “At the time, borrowers’ protections largely consisted of traditional limited disclosure rules, which were insufficient checks on predatory broker practices and borrower illiteracy on complex mortgage products, while traditional banking regulatory agencies…were primarily focused on structural bank safety and soundness rather than on consumer protection…In many of these cases, brokers offered loans with terms not suitable or appropriate for borrowers. Brokers maximized their transaction fees through the aggressive marketing of predatory loans that they often knew would fail.”

Better Markets estimates the 2008 subprime mortgage crisis caused upwards of $20 trillion in lost GDP. See what your fellow citizens have discovered about the potential economic foul play that might have caused the biggest financial collapse in history.

Have you Lost Money due to Manipulation in Futures Contracts?

Swaps play a major part in the global financial economy today. They allow parties to strike deals and achieve their business/investment goals. Their significance makes proper regulation and oversight all the more important. 

As illustrated by the role of CDSs in the 2008 financial crisis, irresponsible and sometimes even corrupt financial players can build too much leverage through swaps. Couple that with the lack of standardization with these financial instruments and you have a recipe for disaster. Retirements, investments, savings, job opportunities all took a hit due to the crisis. Some bankers profited from the disaster they’d allegedly caused.

The Zero Theft Movement is dedicated to finding and eliminating the rigged parts of the U.S. economy so that American businesses and citizens can flourish. Our community works to calculate the most accurate estimate for the monetary costs of corruption in the United States. 

We achieve this collectively through our independent voting platform. The public investigates potential problem areas, and everyone votes on whether (1) theft is or isn’t occurring in a specific area of the economy, and (2) how much is being stolen or possibly saved. Through direct democracy, we can collectively decide where the problem areas are and start working on addressing them systematically. 

Only through hard evidence can we prove where the rigged parts of the economy exist and force Congress to hold all the bad actors accountable.

Standard Disclaimer

The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.   

Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. Zero Theft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.  

The public has spoken! See how much the rigged economy is ripping off from you…

Explore the Problem Hierarchy

We have primers on potential problem areas of the economy. Before you start voting, it’s important you get a basic understanding of the issues at hand, so you can be as helpful as possible to other community members. Take a few minutes and come prepared.

Serve your fellow citizens as a citizen investigator

The success of our movement rests in your hands, the leaders willing to dedicate time to conduct investigations into potentially rigged areas of the economy. Lead the movement and help create an ethical economy.

Heroism made easy

Twenty minutes! That’s all the time you need to contribute to our effort. Just review a proposal and vote. Our reports will only gain legitimacy and power with your contributions.

Commitment to nonpartisanship

The rigged layer causes all of us to suffer, regardless of our political allegiances. If we wish to eliminate rigged economy theft, we have to set aside our differences and band together against crony capitalists and corrupt officials. 

Beyond the Plunge Protection Team…

An educated public is an empowered public.

We regularly publish educational articles on ZeroTheft.net, just like this one on the Plunge Protection Team. They teach you all about the rigged layer of the economy in short, digestible pieces.

The Volcker Rule: Loosening the Ban on Proprietary Trading

Table of Contents

Plunge Protection Team

What is the Plunge Protection Team?

A nickname coined by The Washington Post, the Plunge Protection Team refers to the Working Group on Financial Markets. The group, formed in the aftermath of the 1987 ‘Black Monday’ stock market crash, provides financial and economic advice to the U.S. President during market crises.

In recent years, some have had suspicions concerning the methods of the Working Group, as it does not release records of its meetings and recommendations. Plummeting indices have rebounded in a day, leading to speculation that the Plunge Protection Team manipulates markets. 

The Zero Theft Movement and our growing community are dedicated to eradicating the rigged parts of the U.S. economy in order for the ethical parts to flourish. While government intervention in stock markets may, on the surface, appear like a positive action, it may not be the case when you think about it a bit more. In this article, we will cover how potential market manipulation (even to save it) can lead to undue losses for all investors.

Membership and Functions of the Plunge Protection Team

President Ronald Reagan’s Executive Order 12361 names the members of the Working Group and details its responsibilities.

Membership

The following officials serve as members of the Plunge Protection Team:

 

Purposes/Functions

The Executive Order identifies three purposes/functions of the Plunge Protection Team. Below, we have quoted the exact text from the order verbatim.

  1. Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation’s financial markets and maintaining investor confidence, the Working Group shall identify and consider:

a. The major issues raised by the numerous studies on the events in the financial markets surrounding Black Monday, and any of those recommendations that have the potential to achieve the goals noted above

b. The actions, including governmental actions under existing laws and regulations (such as policy coordination and contingency planning), that are appropriate to carry out these recommendations.

2. The Working Group shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.

3. The Working Group shall report to the President initially within 60 days (and periodically thereafter) on its progress and, if appropriate, its views on any recommended legislative changes.”

The Few Meetings of the Working Group

To expand on the introduction, let’s take a quick look at the events that led to the formation of the Plunge Protection Team. 

While economists have debated the true causes of Black Monday, one common explanation attributes the stock market crash to two factors. Mark Carlson, a member of the Board of Governors of the Fed, points out (1) the U.S. House Committee on Ways and Means proposed new tax legislation to decrease the benefits linked to funding mergers and leveraged buyouts; and (2) the U.S. Department of Commerce’s announcement of unexpectedly high trade deficit numbers hurt the value of the U.S. dollar, increasing interest rates and decreasing stock prices.

On October 19, 1987, the Dow Jones Industrial Average (DJIA) dropped by an unprecedented 508 points (22.6%) in a single day. The S&P 500 Index plummeted 20.4%, falling from 282.7 to 225.06. While the NASDAQ Composite decreased by just 11.3%, it exposed the failures of the NASDAQ market system.

In March 1988, President Reagan wanted to create an expert, though informal, financial advisory team to help him and regulators make economic decisions during the recovery effort. The initial intention was for the Working Group to report specifically on the crisis and recommend next steps; however the Plunge Protection Team has met throughout the years whenever the president has deemed it necessary.

In 1999, the team released a report advising Congress to request reforms to regulations of the derivatives market. It reconvened nearly a decade later to examine the 2008 subprime mortgage crisis. Most recently (as of June 2021), the Plunge Protection Team met on Christmas Eve, 2018, to discuss a bad run in financial markets. 

The Mysteries of the Plunge Protection Team

While the Plunge Protection Team obviously exists, the inner workings often remain private. The minutes of its meetings, its recommendations, all of that remains privy to only the few people involved. These ‘mysteries,’ let’s say, have led observers to question whether top financial officials have the license to control the country’s (relatively) free markets.

 

George Stephanopoulos, former advisor to President Clinton, actually spoke on the Plunge Protection Team and its strategies in an appearance on Good Morning America on Sept 17, 2000. 

 

“Perhaps the most important the Fed in 1989 created what is called the Plunge Protection Team, which is the Federal Reserve, big major banks, representatives of the New York Stock Exchange and the other exchanges and they have been meeting informally so far, and they have a kind of an informal agreement among major banks to come in and start to buy stock if there appears to be a problem. They have in the past acted more formally… I don’t know if you remember but in 1998, there was a crisis called the Long term Capital Crisis. It was a major currency trader and there was a global currency crisis. And they, with the guidance of the Fed, all of the banks got together when it started to collapse and propped up the currency markets. And, they have plans in place to consider that if the markets start to fall.”

Mid-to-Late 1992

On July 28, Shearson Lehman aggressively purchased stock index futures contracts when equity prices started dropping due to a loss of consumer confidence. The company’s purchases managed to mitigate the losses. 

 

According to Buffalo News, “That day the Dow ended 51.87 points higher. Newspapers the next day said the bad news about the economy had made Wall Street believe that interest rates would decline again — a bullish move for stocks…Similar suspicious trading has occurred for months, traders say. Just last Monday, for instance, when stock prices were sliding because of the weak dollar, traders say that nearly identical orders for several hundred Standard & Poor’s 500 futures contracts were handled at the Chicago Mercantile Exchange by Shearson and Goldman Sachs.”

July 24, 2002

After the investment fervor that created the Dotcom Bubble, the collapse of NASDAQ was swift. Some companies allegedly attempted to hide their losses, leading to the Enron scandal and Worldcom scandal. 

 

Michael Edward, from the alternative news site Rense, claims: “An event that should have sent markets spiraling downward was the Enron, et al, unprecedented corporate accounting scandals. Yet despite this, an unprecedented across-the-board markets rally began on July 24, 2002. Once again, the European Press called it a ‘PPT rally.’”

February 5, 2018

Observers cite, for example, the time DJIA dropped by 1,175 points on February 5, 2018. The loss was doubly worse than the biggest decline in the index’s history. For the two following days, stocks opened lower, but aggressive stock purchases continued to prop up markets. Some have attributed the buying to the Plunge Protection Team (New York Post and GoldSilver). 

 

Another potential case emerged during the aforementioned meeting on Christmas Eve. Throughout the month, the DJIA had been dropping, and the S&P 500 appeared to be on the cusp of a major downturn. Nevertheless, the day after Christmas, the DJIA shot up by over 1,000 points.

December 26, 2018

That whole month, the S&P 500 had been heading towards a record decline—the motive for the team’s meeting—and the DJIA dropped 650 on the 24th alone. The Plunge Protection Team’s aforementioned teleconference on Dec. 24, 2018.  But when trading resumed after Christmas, the DJIA rallied over 1,000 points. Some believe the recovery came as a result of market manipulation by the Plunge Protection Team. 

Why Secret Market Intervention Could be a Problem

If the Plunge Protection Team (or any other person or entity) manipulates the market, it creates serious problems for investors. 

 

At first blush, especially in the case of the Working Group, their potential market manipulation might seem like a positive. What investor wants to lose money on the stock market? If the allegations are true, then the team would be mitigating losses for many. 

 

But it’s not so simple. 

 

For one, there’s the matter of deceit. Investors operate under the assumption that the U.S. stock market is free. Any manipulation, if found, results in a criminal investigation by the Securities and Exchange Commission. Boom and bust periods happen, and all investors should be subject to the same free market forces.

 

Furthermore, chartered financial analyst David Amerman writes: “…[The Plunge Protection Team] is a committee that is dedicated not to investors but to the financial system. If in the interest of serving the financial system, government manipulations create excessively high prices – then by definition, investors are being cheated out of future yields. This is because for any future stream of cash flows-whether it be interest payments, dividend payments, or the future sales price-the higher the price we pay today for what the cash flow will be in the future, then the lower our future profits or returns.”

 

In other words, investors are not getting the proper opportunity to get in low and cash out high if the Working Group is trying to artificially maintain markets at a high price.

What can YOU do about the Plunge Protection Team?

Now, we should once again note that, due to the team’s private proceedings, most of us do not have definitive proof that the Working Group manipulates markets. Nevertheless, perhaps it might be in the public’s best interests to know just what recommendations the Plunge Protection Team makes.

 

What justifies keeping these discussions secret? 

 

If the team does, in fact, manipulate markets, it would be a good case to investigate with the Zero Theft Movement. Our community works to calculate the best estimate for the monetary costs of corruption and unethical practices in the U.S. Corporate, political, and everything in between.

Stock market manipulation is one area that requires extensive investigation. If it is rigged, it can significantly reduce your savings. Citizens who want to retire may have to postpone it due to minimal returns. Not due to free market forces, but others rigging the market. 

 

We have built a safe and independent voting platform where you and your fellow citizens collaborate to thoroughly investigate potential problem areas across the economy. Everyone votes on whether (1) theft is or isn’t occurring in a specific area of the economy, and (2) how much is being stolen or possibly saved. Through direct democracy, we can collectively decide where the problem areas are and start working on addressing them systematically. 

Only through hard evidence can we prove where the rigged parts of the economy exist and force Congress to hold the bad actors accountable. We can achieve economic justice, a financial system that allows the many good businesses (big, medium, and small) and good individuals (regardless of their socioeconomic status) to thrive.

Standard Disclaimer

The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.   

Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. Zero Theft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.  

The public has spoken! See how much the rigged economy is ripping off from you…

Explore the Problem Hierarchy

We have primers on potential problem areas of the economy. Before you start voting, it’s important you get a basic understanding of the issues at hand, so you can be as helpful as possible to other community members. Take a few minutes and come prepared.

Serve your fellow citizens as a citizen investigator

The success of our movement rests in your hands, the leaders willing to dedicate time to conduct investigations into potentially rigged areas of the economy. Lead the movement and help create an ethical economy.

Heroism made easy

Twenty minutes! That’s all the time you need to contribute to our effort. Just review a proposal and vote. Our reports will only gain legitimacy and power with your contributions.

Commitment to nonpartisanship

The rigged layer causes all of us to suffer, regardless of our political allegiances. If we wish to eliminate rigged economy theft, we have to set aside our differences and band together against crony capitalists and corrupt officials. 

Beyond the Plunge Protection Team…

An educated public is an empowered public.

We regularly publish educational articles on ZeroTheft.net, just like this one on the Plunge Protection Team. They teach you all about the rigged layer of the economy in short, digestible pieces.