Best of the Week
Most Popular
1.Canada Real Estate Bubble - Harry_Dent
2.UK House Prices ‘On Brink’ Of Massive 40% Collapse - GoldCore
3.Best Cash ISA for Soaring Inflation, Kent Reliance Illustrates the Great ISA Rip Off - Nadeem_Walayat
4.Understanding true money, Pound Sterling must make another historic low, Euro and Gold outlook! - Marc_Horn
5.5 Maps That Explain The Modern Middle East - GEORGE FRIEDMAN
6.Gold Back With A Vengeance As Bitcoin Bubble Bursts - OilPrice_Com
7.Gold Summer Doldrums - Zeal_LLC
8.Crude Oil Trade & Nasdaq QQQ Update - Plunger
9.Gold And Silver – Why No Rally? Lies, Lies, And More Lies - Michael_Noonan
10.UK Election 2017 Disaster, Fake BrExit Chaos, Forecasting Lessons for Next Time - Nadeem_Walayat
Last 7 days
The Fed May Show Trump No Love - 20th Jul 17
The 3 Best Asset Classes To Brace Your Portfolio For The Next Financial Crisis - 20th Jul 17
Gold Stocks and Bonds - Preparing for THE Bottom - 20th Jul 17
Millennials Can Punt On Bitcoin, Own Safe Haven Gold For Long Term - 20th Jul 17
Trump Has Found A Loophole To Rewrite Trade Agreements Without Anyone’s Permission - 20th Jul 17
Basic Materials and Commodities Analysis and Trend Forecasts - 20th Jul 17
Bitcoin PullBack Is Over (For Now): Cryptocurrencies Gain Nearly A 50% In Last 48 Hours - 19th Jul 17
AAPL's 6% June slide - When Prices Are Falling, TWO Numbers Matter Most - 19th Jul 17
Discover Why A Major American Revolution Is Brewing - 19th Jul 17
iGaming – Stock Prices - 19th Jul 17
The Socionomic Theory of Finance By Robert Prechter - Book Review - 18th Jul 17
Ethereum Versus Bitcoin – Which Cryptocurrency Will Win The War? - 18th Jul 17
Accepting a Society of Government Tyranny - 18th Jul 17
Gold Cheaper Than Buying Greek Villas in 2012 - 18th Jul 17
Why & How to Hedge the Growing Risks of Holding Stocks - 18th Jul 17
Relocation: Everything You Need to do for a Smooth Transition Abroad - 17th Jul 17
A Former Lehman Brothers Trader: It’s Time To Buy Brick And Mortar Retailers - 17th Jul 17
Bank Of England Warns “Bigger Systemic Risk” Now Than 2008 - 17th Jul 17
Bitcoin Price “Deja Vu” Corrective Sequence - 17th Jul 17
Charting New Low in Speculation in Gold and Silver Markets - 17th Jul 17
Bitcoin Crash - Is This The End of Cryptocurrencies? - 17th Jul 17
The Fed's Inflation Nightmare Scenario - 17th Jul 17
Billionaire Investors Backing A Marijuana Boom In 2017 - 17th Jul 17
Perfect Storm - This Fourth Turning has Over a Decade of Continuous Storms to Come - 17th Jul 17
Gold and Silver Biggest Opportunity Since Late 2015, Last Chance at These Prices - 17th Jul 17
Stock Market More to Go - 17th Jul 17
Emerging Markets & Basic Materials Stocks Breaking Out Together - 16th Jul 17
Stock Market SPX Uptrending Again After Microscopic Correction - 15th Jul 17
Global Currency Reserve At Risk - 14th Jul 17
Picking Great Gold Stocks - 14th Jul 17
BBC Tree Expert's Verdict on Sheffield Amey / Labour City Council Tree Felling's - 14th Jul 17
SPX Cycles, Fed Funds and Gold - 14th Jul 17
Should Platinum Be More Expensive Than Gold? - 14th Jul 17
What's Next for US Dollar, Stocks, Bonds and Gold? - 13th Jul 17
India Gold Imports Surge To 5 Year High – 220 Tons In May Alone - 13th Jul 17
Gold and Silver: Your Stomach Is Probably Wrenching Right Now - 13th Jul 17
Gold Industry Is In A Deep State Of Dysfunction, Delusion And Denial - 13th Jul 17
Cryptocurrency Bloodbath! Sell Everything We Were Totally Wrong! - 12th Jul 17
Gold to Silver Ratio - Preparing for THE Bottom - 12th Jul 17
Iran and North Korea: Brothers in Nuclear Arms - 12th Jul 17
Down Dollar Down: Time for "UP"? - 12th Jul 17
Most Tech People Are Too Young To Remember That Silicon Valley Hasn’t Had A Real Crisis In 17 Years - 11th Jul 17
Stock Market Rally May be Over - 11th Jul 17
Silver Price Plunge Is Nearing Completion - 11th Jul 17
Soaring Global Demand for Lithium Presents Triple-Digit Profit Scenario - 11th Jul 17
Gold Price Outlook Increasingly Bullish - 11th Jul 17
Sheffield Street Tree Protestors / Campaigners vs Amey Labour City Council 2017 - 11th Jul 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

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

© 2005-2017 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