Best of the Week
Most Popular
1.Crude Oil Price Trend Forecast 2016 Implications for Stock Market - Nadeem_Walayat
2.Odds of Winning Walkers Crisps Spell & Go olidays K, C and D Letters - Sami_Walayat
3.Massive Silver Price Rally During The Coming US Dollar Collapse - Hubert_Moolman
4.Pope Francis Calls For Worldwide Communist Government - Jeff_Berwick
5.EU Referendum Opinion Polls Neck and Neck Despite Operation Fear, Support BrExit Campaign - Nadeem_Walayat
6.David Morgan: There Will Soon Be a Run to Gold Like You've Never Seen Before - Mike Gleason
7.British Pound Soars on BrExit Hopes Despite Remain Establishment Fear Mongering - Nadeem_Walayat
8.Gold Price Possible $200 Rally - Bob_Loukas
9.The Federal Reserve is Not Going To Raise Interest Rates and Destroy Gold - Michael_Swanson
10.Silver Miners’ Q1’ 2016 Fundamentals - Zeal_LLC
Free Silver
Last 7 days
Will the Fed be Blind Sided by Stagflation? - 31st May 16
Gold Price Not Ready for a Final Intermediate Cycle Low - 31st May 16
EU Referendum - British People vs Establishment Elite, Vote LEAVE an Act of Defiance! - 31st May 16
Gold - Mr. Cool Cucumber is starting to Sweat - 31st May 16
AMAT Chirps, b2b Ramps, Yellen Hawks and Gold’s Fundamentals Erode - 31st May 16
Stock Market Re-Testing Overhead Resistance - 30th May 16
David Cameron Questioned on Out of Control Immigration at TEN TIMES Conservative Election Pledges - 30th May 16
Bitcoin Price Skyrockets And Is Now Up More Than 100% This Jubilee Year - 30th May 16
This Is Not The America My Parents Immigrated To In 1957 - 30th May 16
“Debt, Not The Economy, Reaches Escape Velocity” With Graham Mehl - 29th May 16
EU Referendum, Black Vote LEAVE or REMAIN? Which is Worse for Racism for Britain's Ethnic Minorities? - 29th May 16
Billionaire Gross: Jubilee Debt Relief as Prelude to New Global Economic Order - 29th May 16
Wargaming North Korea - Assessing the Threat - 29th May 16
EU REMAIN Population Forecasts - England 4.1 million Explosion, London Migration Crisis - 28th May 16
A Guide to the Trump-Sanders Debate - 28th May 16
Gold And Silver – At Significant Support. New “Story” Developing - 28th May 16
The Next Systemic Lehman Event - New Scheiss Dollar & Gold Trade Standard - 27th May 16
Energy and Debt Crisis Point to Much Higher Silver, Metals Prices - 27th May 16
Gold Junior Stocks Q1 2016 Fundamentals - 27th May 16
These Crisis Markets Are Primed to Deliver Big Gains, Platinum Never Cheaper! - 27th May 16
Operation Black Vote BrExit Warning for the Wrong EU Referendum - 27th May 16
UK Immigration Crisis Hits New Extreme, Catastrophic ONS Migration Stats Ahead of EU Referendum - 27th May 16
Many of the World’s Best Investors Made Their Fortunes This Way…And You Can Too - 27th May 16
The Ugly Truth About Stock Market Manipulation and Gold Prices - 27th May 16
Gold Price Looking Vulnerable While Gold Stocks Correct - 27th May 16
The 5 Fatal Flaws of Trading - 27th May 16
The Next Big Crash Of The U.S. Economy Is Coming, Here’s Why - 27th May 16
A New Golden Bull or Has the Market Gone Too Far Too Fast? - 27th May 16
It Feels Like Inflation - 26th May 16
Negative Interest Rates Set to Propel the Dow Jones to the Stratosphere? - 26th May 16
S&P Significant Low has Occurred – Not Likely! - 26th May 16
Statistics for Funeral Planning in UK Grave - 26th May 16
Think Beyond Oil And Gold: Interview With Mike 'Mish' Shedlock - 26th May 16
Hard Times and False Mainstream Media Narratives - 26th May 16
Will The Swiss Guarantee 75,000 CHF For Every Family? - 26th May 16
Is There A Stocks Bear Market in Progress? - 26th May 16
Billionaires Are Wrong on Gold - 26th May 16
How NOT to Invest in the Gold Market - 26th May 16
The Black Swan Spotter...Which Saw the Oil-Crash coming; now says the “Invisible Hand” will push Brent to $85 by Christmas - 26th May 16
U.S. Household Debt Still Below 2008 Peak - 25th May 16
Brexit: Wrong Discussion, Wrong People, Wrong Arguments - 25th May 16
SPX is at Strong Resistance - 25th May 16
US Dollar, Back From the Grave? - 25th May 16
Gold : Just the Facts Ma’am - 25th May 16
The Worst Urban Crisis in History Could be Upon Us - 24th May 16
Death Crosses Across The Board Are IRREFUTABLE Stock Market Sell Signals - 24th May 16
Bitcoin Trading Alert: Bitcoin Price Stays below $450 - 24th May 16
Stock Market Crash Death Cross Doom Prevails - 23rd May 16
Did AMAT Chirp? Implications for the Economy and Gold - 23rd May 16
Stocks Extended Their Rebound On Friday - Will They Continue Higher? - 23rd May 16
UK Treasury Propaganda Warns of 3.6% Brexit Recession, the £64 Billion Question? - 23rd May 16
Stock Market Support Breached, But Not Broken! - 23rd May 16
George Osborne Warns of 18% Cheaper House Prices - BrExit for First Time Buyers - 22nd May 16
Gold Bull-Phase I Continues to Confound (The Trek to “Known Values”) - 22nd May 16 r
Avoiding a War in Space - 22nd May 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Why 95% of Traders Fail

Banks Are Already Setting Us Up for the Next Financial Crisis

Companies / Credit Crisis Bailouts Sep 17, 2012 - 05:50 AM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: Just five years after they played a primary role in engineering the worst financial crisis since the Great Depression, America's big banks are quietly setting the world up to do it all over again.

Only this go-round the costs will be far higher and the damage much worse. This time the fall could be $2.6 trillion or more.


Let me explain.

It started back in the mid-2000s. Wall Street was busy packaging low-rated subprime loans into securitized offerings that were somehow worth more than the sum of their parts.

In reality, what they were doing was little more than laundering toxic debt while raking in obscene profits along the way.

You know the rest of the story as well as I do. Not long after, the stuff hit the proverbial fan and it was not evenly distributed.

Well here we go again...

Both JPMorgan and Bank of America are quietly marketing a new scheme designed to "transform" sub-par assets into quality holdings that will serve as treasury-quality collateral needed to meet the new capital requirements that come into effect in 2013 as part of the Dodd-Frank Act.

Wall Street Is Up to Its Old Tricks
This may sound complicated but it's not. It works like this.

When you trade on margin like these mega-institutions do, you are required to post collateral to offset counterparty risk. That way, if the trade busts and you are unable to deliver on your side of the trade, there is recourse.

If you have a mortgage or a car loan, you know what I'm talking about. Your lender can seize both if you default or otherwise fail to meet your payment obligations.

Trading collateral works the same way. In years past, trading collateral has most commonly taken the form of U.S. treasuries (or other securities) that meet stringent requirements with regard to ratings, liquidity, value and pricing.

However, since the financial crisis began, treasuries are in increasingly short supply. Investors and traders who have preferred safety over return are hoarding them.

Consequently, traders like JPMorgan's London-based "whale," Bruno Iksil, who want to write increasingly bigger, more sophisticated trades are in bind. They find themselves unable to trade because many times the clients they represent can't post the collateral needed to "gun" the trades.

As you might imagine, Wall Street doesn't like that because it means billions in profits and bonuses get lost as trading volumes drop.

So they've gone to the unregulated woodshed again and come up with yet more financial hocus pocus designed to circumvent rules in the name of profits.

At the same time, they're once again hiding the true extent of the risks they are taking - and that's the outrageous part.

These same banks that have already driven the world to the brink of financial oblivion and been bailed out once may need another $2.6 trillion dollars or more to backstop the unregulated $648 trillion derivatives playground they've created for themselves.

And don't think for a minute that your money isn't at risk either...

If you have a retirement fund, a money market fund or are invested in any sort of pension plan whatsoever, you are already involved in this game whether you signed up to play or not.

We're talking about trillions of dollars' worth of sovereign and agency debt. Think the United States, Japan, Italy, Spain, and Germany here, along with the bets on that debt -- all of which has been "backed" by central bankers, effectively removing the risk of failure from the financial markets and specifically from the firms engaged in these kinds of trades.

Of course, Wall Street has just pulled the wool over everybody's eyes by marketing most of these derivatives as "insurance" against default. In reality, they are king-sized bets levered up to levels so high that they now place entire nations at risk of default, not just individual traders or institutions.

That's because derivatives allow traders to effectively bet on directional changes in everything from interest rates to markets and currencies. They also allow firms to effectively arbitrage the relative risks between various financial instruments or lock in specific prices on everything from bonds to commodities.

The Biggest Margin Call of All Time
Here's where we get to the meat of the matter.

As part of new rules driven by the 2010 Dodd-Frank Act, traders will have to drive the majority of privately-traded derivatives contracts through clearing houses like the Chicago based CME or the London based LCH.Clearnet, which was formerly known as the London Clearing House.

Previously they didn't because upwards of 90% of the derivatives were privately negotiated and therefore exempt from centralized exchange requirements, including margin.

In the process, they'll have to post additional collateral that can be "perfected," meaning seized and converted to cash, in the event of a counterparty failure or default.

As reported by Bloomberg, estimates from Morgan Stanley suggest the new requirements could mean the banks trading in derivatives have to come up with $481 billion in top-rated collateral on the low side to $2.6 trillion on the high side, which is what the Massachusetts-based Tabb Group projects.

My own estimate is somewhere in the $4-5 trillion range, because I believe the total value of the derivatives markets is still being understated by banks and trading houses not keen to let skeletons out of the proverbial closet.

And therein lies the problem. Neither the trading firms nor their clients have the additional collateral.

What's more, they likely won't be able to get it because the vast bulk of the $33 trillion in worldwide top-tier AAA- or AA-rated debt is already pledged as collateral or otherwise accounted for in separate transactions.

Were these banks and their clients living like the rest of us, they'd simply conclude they were "tapped out" and their resources exhausted because there would be nothing left.

But noooooo...... Under the terms of both the JPMorgan and Bank of America programs, clients not meeting the new collateralized quality standards can pledge other less-than-treasury-quality assets to the bank against a "loan" of Treasuries from the trading firm that's then posted by the trading firm as collateral acceptable to the clearing houses.

In other words, the trading firms are going to loan treasuries to clients who are incapable of meeting liquidity requirements while accepting lower grade assets in exchange. Details are hard to come by at the moment with regard to the fees they'll rake in, but you can bet "transforming" lemons into lemonade won't be cheap.

This is similar to what happens in the commercial "repo-market" where banks and trading firms temporarily pledge their assets in exchange for cash loans. Nor is it much different than pledging your paycheck at an instant loan store. In both cases, you are pledging assets against transactions that you wouldn't otherwise be able to conduct.

The fundamental question boils down to this: If we know that billions in improperly assessed risks led to the first blowup in 2007, how on earth could this be any different-- especially with trillions now on the line?

You can't wave your hand over a pile of less-than-treasury-quality assets and have them suddenly, miraculously become treasury quality because they are grouped together.

Yet, this is exactly what Wall Street is doing here.

And just like before, Wall Street's latest scheme is expressly intended to disguise risk and circumvent the specific rules about to be put in place to prevent excess leverage from potentially destroying the world's financial system.

Is there a fix?

I can think of one, but it's from a source you'd never believe in a million years would come out of my mouth: Fed Chairman Ben Bernanke.

Congress can't balance its checkbook. Our politicians can't make tough decisions. Our regulators are out-lobbied and outmaneuvered at every turn. No president can ask his nation to take its medicine regardless of party affiliation.

But Bernanke can. Supposedly - emphasis on supposedly - he's apolitical.

Acting under the Fed's dual mandates of maintaining "monetary and credit aggregates commensurate with the economy's long-run potential," Chairman Bernanke could bypass the entire political, regulatory and lobbyist morass in one fell swoop by declaring that the United States government will not back any derivatives trades -- or any firm that engages in them -- worldwide in the event of default.

Not only would this re-introduce the concept of failure into capital markets but it would do what neither Congress nor our regulators have been able to do -- put an immediate end to the kind of "profit at all cost regardless of risk behavior" that exemplifies everything wrong with Wall Street.

I can only imagine the disclaimer on one of those Uncle Sam posters more commonly associated with wartime military recruiting. It might read: "Counterparty Beware."

Until then, it's investors who should be "aware."

Source :http://moneymorning.com/2012/09/17/banks-are-setting-us-up-again-this-time-the-fall-could-be-2-6-trillion-or-more/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife