Did you know that there are 5 “too big to fail” banks in the United States that each have exposure to derivatives contracts that is in excess of 30 trillion dollars? Overall, the biggest U.S. banks collectively have more than 247 trillion dollars of exposure to derivatives contracts. That is an amount of money that is more than 13 times the size of the U.S. national debt, and it is a ticking time bomb that could set off financial Armageddon at any moment. Globally, the notional value of all outstanding derivatives contracts is a staggering 552.9 trillion dollars according to the Bank for International Settlements. The bankers assure us that these financial instruments are far less risky than they sound, and that they have spread the risk around enough so that there is no way they could bring the entire system down. But that is the thing about risk – you can try to spread it around as many ways as you can, but you can never eliminate it. And when this derivatives bubble finally implodes, there won’t be enough money on the entire planet to fix it.
A lot of readers may be tempted to quit reading right now, because “derivatives” is a term that sounds quite complicated. And yes, the details of these arrangements can be immensely complicated, but the concept is quite simple. Here is a good definition of “derivatives” that comes from Investopedia…
A derivative is a security with a price that is dependent upon or derived from one or more underlying assets. The derivative itself is a contract between two or more parties based upon the asset or assets. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes.
I like to refer to the derivatives marketplace as a form of “legalized gambling”. Those that are engaged in derivatives trading are simply betting that something either will or will not happen in the future. Derivatives played a critical role in the financial crisis of 2008, and I am fully convinced that they will take on a starring role in this new financial crisis.
And I am certainly not the only one that is concerned about the potentially destructive nature of these financial instruments. In a letter that he once wrote to shareholders of Berkshire Hathaway, Warren Buffett referred to derivatives as “financial weapons of mass destruction”…
The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.
Since the last financial crisis, the big banks in this country have become even more reckless. And that is a huge problem, because our economy is even more dependent on them than we were the last time around. At this point, the four largest banks in the U.S. are approximately 40 percent larger than they were back in 2008. The five largest banks account for approximately 42 percent of all loans in this country, and the six largest banks account for approximately 67 percent of all assets in our financial system.
So the problem of “too big to fail” is now bigger than ever.
If those banks go under, we are all in for a world of hurt.
Yesterday, I wrote about how the Federal Reserve has implemented new rules that would limit the ability of the Fed to loan money to these big banks during the next crisis. So if the survival of these big banks is threatened by a derivatives crisis, the money to bail them out would probably have to come from somewhere else.
In such a scenario, could we see European-style “bail-ins” in this country?
Ellen Brown, one of the most fierce critics of our current financial system and the author of Web of Debt, seems to think so…
Dodd-Frank states in its preamble that it will “protect the American taxpayer by ending bailouts.” But it does this under Title II by imposing the losses of insolvent financial companies on their common and preferred stockholders, debtholders, and other unsecured creditors. That includes depositors, the largest class of unsecured creditor of any bank.
Title II is aimed at “ensuring that payout to claimants is at least as much as the claimants would have received under bankruptcy liquidation.” But here’s the catch: under both the Dodd Frank Act and the 2005 Bankruptcy Act, derivative claims have super-priority over all other claims, secured and unsecured, insured and uninsured.
The over-the-counter (OTC) derivative market (the largest market for derivatives) is made up of banks and other highly sophisticated players such as hedge funds. OTC derivatives are the bets of these financial players against each other. Derivative claims are considered “secured” because collateral is posted by the parties.
For some inexplicable reason, the hard-earned money you deposit in the bank is not considered “security” or “collateral.” It is just a loan to the bank, and you must stand in line along with the other creditors in hopes of getting it back.
As I mentioned yesterday, the FDIC guarantees the safety of deposits in member banks up to a certain amount. But as Brown has pointed out, the FDIC only has somewhere around 70 billion dollars sitting around to cover bank failures.
If hundreds of billions or even trillions of dollars are ultimately needed to bail out the banking system, where is that money going to come from?
It would be difficult to overstate the threat that derivatives pose to our “too big to fail” banks. The following numbers come directly from the OCC’s most recent quarterly report (see Table 2), and they reveal a recklessness that is on a level that is difficult to put into words…
Total Assets: $1,808,356,000,000 (more than 1.8 trillion dollars)
Total Exposure To Derivatives: $53,042,993,000,000 (more than 53 trillion dollars)
Total Assets: $2,417,121,000,000 (about 2.4 trillion dollars)
Total Exposure To Derivatives: $51,352,846,000,000 (more than 51 trillion dollars)
Total Assets: $880,607,000,000 (less than a trillion dollars)
Total Exposure To Derivatives: $51,148,095,000,000 (more than 51 trillion dollars)
Bank Of America
Total Assets: $2,154,342,000,000 (a little bit more than 2.1 trillion dollars)
Total Exposure To Derivatives: $45,243,755,000,000 (more than 45 trillion dollars)
Total Assets: $834,113,000,000 (less than a trillion dollars)
Total Exposure To Derivatives: $31,054,323,000,000 (more than 31 trillion dollars)
Total Assets: $1,751,265,000,000 (more than 1.7 trillion dollars)
Total Exposure To Derivatives: $6,074,262,000,000 (more than 6 trillion dollars)
As the “real economy” crumbles, major hedge funds continue to drop like flies, and we head into a new recession, there seems to very little alarm among the general population about what is happening.
The mainstream media is assuring us that everything is under control, and they are running front page headlines such as this one during the holiday season: “Kylie Jenner shows off her red-hot, new tattoo“.
But underneath the surface, trouble is brewing.
A new financial crisis has already begun, and it is going to intensify as we head into 2016.
And as this new crisis unfolds, one word that you are going to want to listen for is “derivatives”, because they are going to play a major role in the “financial Armageddon” that is rapidly approaching.
If you have a bank account anywhere in Europe, you need to read this article. On January 1st, 2016, a new bail-in system will go into effect for all European banks. This new system is based on the Cyprus bank bail-ins that we witnessed a few years ago. If you will remember, money was grabbed from anyone that had more than 100,000 euros in their bank accounts in order to bail out the banks. Now the exact same principles that were used in Cyprus are going to apply to all of Europe. And with the entire global financial system teetering on the brink of chaos, that is not good news for those that have large amounts of money stashed in shaky European banks.
Below, I have shared part of an announcement about this new bail-in system that comes directly from the official website of the European Parliament. I want you to notice that they explicitly say that “unsecured depositors would be affected last”. What they really mean is that any time a bank in Europe fails, they are going to come after private bank accounts once the shareholders and bond holders have been wiped out. So if you have more than 100,000 euros in a European bank right now, you are potentially on the hook when that bank goes under…
The directive establishes a bail-in system which will ensure that taxpayers will be last in the line to the pay the bills of a struggling bank. In a bail-in, creditors, according to a pre-defined hierarchy, forfeit some or all of their holdings to keep the bank alive. The bail-in system will apply from 1 January 2016.
The bail-in tool set out in the directive would require shareholders and bond holders to take the first big hits. Unsecured depositors (over €100,000) would be affected last, in many cases even after the bank-financed resolution fund and the national deposit guarantee fund in the country where it is located have stepped in to help stabilise the bank. Smaller depositors would in any case be explicitly excluded from any bail-in.
And as we have seen in the past, these rules can change overnight in the midst of a major crisis.
So they may be promising that those with under 100,000 euros will be safe right now, but that doesn’t necessarily mean that it will be true.
It is also important to note that there has been a really big hurry to get all of this in place by January 1. In fact, at the end of October the European Commission actually sued six nations that had not yet passed legislation adopting the new bail-in rules…
The European Commission is taking legal action against member states including the Netherlands and Luxembourg, after they failed to implement rules protecting European taxpayers from funding billions in bank rescues.
Six countries will be referred to the European Court of Justice (ECJ) for their continued failure to transpose the EU’s “bail-in” laws into national legislation, the European Commission said on Thursday.
So why was the European Commission in such a rush?
Is there some particular reason why January 1 is so important?
This is something that I will be watching.
Meanwhile, there have been major changes in the U.S. as well. The Federal Reserve recently adopted a new rule that limits what it can do to bail out the “too big to fail” banks. The following comes from CNN…
The Federal Reserve is cutting its lifeline to big banks in financial trouble.
The Fed officially adopted a new rule Monday that limits its ability to lend emergency money to banks.
In theory, the new rule should quash the notion that Wall Street banks are “too big to fail.”
If this new rule had been in effect during the last financial crisis, the Federal Reserve would not have been able to bail out AIG or Bear Stearns. As a result, the final outcome of the last crisis may have been far different. Here is more from CNN…
Under the new rule, banks that are going bankrupt — or appear to be going bankrupt — can no longer receive emergency funds from the Fed under any circumstances.
If the rule had been in place during the financial crisis, it would have prevented the Fed from lending to insurance giant AIG (AIG) and Bear Stearns, Fed chair Janet Yellen points out.
So if the Federal Reserve does not bail out these big financial institutions during the next crisis, what is going to happen?
Will we see European-style “bail-ins” when large banks start failing?
And exactly what would such a “bail-in” look like?
Earlier this year, I discussed the concept of a “bail-in”…
Essentially, what happens is that wealth is transferred from the “stakeholders” in the bank to the bank itself in order to keep it solvent. That means that creditors and shareholders could potentially lose everything if a major bank in Europe fails. And if their “contributions” are not enough to save the bank, those holding private bank accounts will have to take “haircuts” just like we saw in Cyprus. In fact, the travesty that we witnessed in Cyprus is being used as a “template” for much of the new legislation that is being enacted all over Europe.
Many Americans assume that when they put money in the bank that they have a right to go back and get “their money” whenever they want. But if we all went to the bank at the same time, there wouldn’t be nearly enough money for all of us. The reason for this is that the banks only keep a small fraction of our money on hand to satisfy the demands of those that conduct withdrawals on a day to day basis. The banks take the rest of the money that we have deposited and use it however they think is best.
If you have money at a bank that goes under, that bank will still be obligated to pay you back, but it may not be able to do so. This is where the FDIC comes in. The FDIC supposedly guarantees the safety of deposits in member banks, but at any given time it only has a very, very small amount of money on hand.
If some major crisis comes along that causes banks all over the United States to start falling like dominoes, the FDIC will be in panic mode. During such a scenario, the FDIC would be forced to ask Congress for a massive amount of money, and since we already run a giant deficit every year the government would have to borrow whatever funds would be required.
Personally, I find it very interesting that we have seen major rule changes in Europe and at the Federal Reserve just as we are entering a new global financial crisis.
Do they know something that the rest of us do not?
Be very careful with your money, because I am convinced that “bank bail-ins” will soon be making front page headlines all over the world.
As we approach the end of 2015, researchers at both JP Morgan and Citigroup agree that the probability that the U.S. economy will soon plunge into recession is rising. Just last week, a member of the U.S. House of Representatives asked Janet Yellen about Citigroup’s assessment that there is a 65 percent chance that the United States will experience an economic recession in 2016. You can read her answer below. And just a few days ago, JP Morgan economists Michael Feroli, Daniel Silver, Jesse Edgerton, and Robert Mellman released a report in which they declared that “the probability of recession within three years” has risen to “an eye-catching 76%”…
“Our longer-run indicators, however, continue to suggest an elevated risk that the expansion is nearing its end, and our preferred model now puts the probability of recession within three years at an eye-catching 76%.”
The good news is that the economists at JP Morgan believe that a recession will probably not hit us within the next six months. But due to steadily weakening economic conditions, they are convinced that one is almost certain to strike within the next few years…
“When we first wrote, only manufacturing sentiment was signaling an above-average probability of imminent recession,” they said. “But recent weakening in the Richmond Fed services survey and the ISM nonmanufacturing index have now pushed the nonmanufacturing sentiment probability up somewhat as well.”
In the short term, the note says that the 6-month likelihood is only 5%, but within a year it stands at 23%, in two years 48%, and in three years the “eye-popping” 76%.
To be honest, I believe that this assessment is far too optimistic, and it appears that researchers at Citigroup agree with me. According to them, there is a 65 percent chance that the U.S. economy will plunge into recession by the end of next year. Last week, Janet Yellen was asked about this during testimony before Congress…
In testimony before Congress’ Joint Economic Committee, Yellen was asked by Rep. Pat Tiberi about a piece of research released by Citigroup’s rates strategy team Monday.
Specifically, Tiberi, an Ohio Republican, wanted to know what Yellen made of Citi’s conclusion that there is a 65 percent chance of a U.S. recession in 2016.
“The economists said that they would assign about a 65 percent likelihood of a recession in the United States in 2016. Now, 65 percent sounds high to me, but I’m not an economist and I’m not the Fed chair. But zero risk might be too low as well. So what would you assign a risk level of a recession next year?” Tiberi asked.
So how did Yellen respond?
Her answer was about what you would expect…
“I absolutely wouldn’t see it as anything approaching 65 percent,” the central banker said.
This reminds me so much of what former Federal Reserve Chairman Ben Bernanke said when he was asked a similar question back in 2008…
“The Federal Reserve is not currently forecasting a recession.”
Later on, when the official numbers finally came out and all the revisions were done, we learned that the U.S. economy was already in a recession when he made that statement.
And when it is all said and done this time around, I believe that history will show that a new global recession had already started when Janet Yellen made her statement.
But don’t just take my word for it. British banking giant HSBC is the largest bank in the western world, and they recently announced that the global economy has already entered a “dollar recession“. According to HSBC, total global trade has fallen 8.4 percent so far this year, and global GDP expressed in U.S. dollars is down 3.4 percent.
If their figures are correct, a new global recession has definitely begun.
And without a doubt, we have already seen a tremendous amount of global financial turmoil. This is something that I highlighted in my recent article entitled “27 Major Global Stocks Markets That Have Already Crashed By Double Digit Percentages In 2015“. When Zero Hedge republished my article, several excellent charts were added that really illustrate how bad things have gotten, and I wanted to share a couple of them with you. Of the 93 largest stock market indexes in the world, an astounding 47 of them (more than half) are down at least 10 percent year to date. This first chart shows which ones fall into that category…
Another chart that was added to the article by Zero Hedge shows how decoupled U.S. stocks have become from global stocks overall. As you can see, U.S. stocks are not too far from recent highs at the moment, but global stocks overall are solidly in bear market territory…
Since mid-2015, trillions of dollars of stock market wealth has been wiped out globally.
Let that sink in for a moment.
The debate is over. The “major financial collapse” that so many warned was imminent has actually happened.
It is just that U.S. stocks have not gotten the memo yet. Up to this point they have defied gravity, but at some point U.S. stocks and world stocks will converge once again.
And if you want to see many of the reasons why U.S. stocks will soon take a big tumble, just check out this article. There is no way that U.S. stocks will be able to defy the underlying economic fundamentals that are pummeling other global markets for much longer. Just like in 2008, a global stock market slide that starts elsewhere will eventually hit the United States. It is just a matter of time.
But once again, even though U.S. stocks are doing okay for the moment, that doesn’t negate the fact that more than half of all major global stock indexes are down by double digit percentages year to date.
We have not seen numbers like this since the great stock market crash of 2008, and it seems abundantly clear to me that the great financial shaking that so many warned was coming in 2015 is already happening.
And if JP Morgan and Citigroup are correct, what we have seen so far is just a preview of some very troubling times ahead.
Warren Buffett once referred to derivatives as “financial weapons of mass destruction“, and it was inevitable that they would begin to wreak havoc on our financial system at some point. While things may seem somewhat calm on Wall Street at the moment, the truth is that a great deal of trouble is bubbling just under the surface. As you will see below, something happened in mid-September that required an unprecedented 405 billion dollar surge of Treasury collateral into the repo market. I know – that sounds very complicated, so I will try to break it down more simply for you. It appears that some very large institutions have started to get into a significant amount of trouble because of all the reckless betting that they have been doing. This is something that I have warned would happen over and over again. In fact, I have written about it so much that my regular readers are probably sick of hearing about it. But this is what is going to cause the meltdown of our financial system.
Many out there get upset when I compare derivatives trading to gambling, and perhaps it would be more accurate to describe most derivatives as a form of insurance. The big financial institutions assure us that they have passed off most of the risk on these contracts to others and so there is no reason to worry according to them.
Well, personally I don’t buy their explanations, and a lot of others don’t either. On a very basic, primitive level, derivatives trading is gambling. This is a point that Jeff Nielson made very eloquently in a piece that he recently published…
No one “understands” derivatives. How many times have readers heard that thought expressed (please round-off to the nearest thousand)? Why does no one understand derivatives? For many; the answer to that question is that they have simply been thinking too hard. For others; the answer is that they don’t “think” at all.
Derivatives are bets. This is not a metaphor, or analogy, or generalization. Derivatives are bets. Period. That’s all they ever were. That’s all they ever can be.
One very large financial institution that appears to be in serious trouble with these financial weapons of mass destruction is Glencore. At one time Glencore was considered to be the 10th largest company on the entire planet, but now it appears to be coming apart at the seams, and a great deal of their trouble seems to be tied to derivatives. The following comes from Zero Hedge…
Of particular concern, they said, was Glencore’s use of financial instruments such as derivatives to hedge its trading of physical goods against price swings. The company had $9.8 billion in gross derivatives in June 2015, down from $19 billion in such positions at the end of 2014, causing investors to query the company about the swing.
Glencore told investors the number went down so drastically because of changes in market volatility this year, according to people briefed by Glencore. When prices vary significantly, it can increase the value of hedging positions.
Last year, there were extreme price moves, particularly in the crude-oil market, which slid from about $114 a barrel in June to less than $60 a barrel by the end of December.
That response wasn’t satisfying, said Michael Leithead, a bond fund portfolio manager at EFG Asset Management, which managed $12 billion as of the end of March and has invested in Glencore’s debt.
According to Bank of America, the global financial system has about 100 billion dollars of exposure overall to Glencore. So if Glencore goes bankrupt that is going to be a major event. At this point, Glencore is probably the most likely candidate to be “the next Lehman Brothers”.
And it isn’t just Glencore that is in trouble. Other financial giants such as Trafigura are in deep distress as well. Collectively, the global financial system has approximately half a trillion dollars of exposure to these firms…
Worse, since it is not just Glencore that the banks are exposed to but very likely the rest of the commodity trading space, their gross exposure blows up to a simply stunning number:
For the banks, of course, Glencore may not be their only exposure in the commodity trading space. We consider that other vehicles such as Trafigura, Vitol and Gunvor may feature on bank balance sheets as well ($100 bn x 4?)
Call it half a trillion dollars in very highly levered exposure to commodities: an asset class that has been crushed in the past year.
The mainstream media is not talking much about any of this yet, and that is probably a good thing. But behind the scenes, unprecedented moves are already taking place.
When I came across the information that I am about to share with you, I was absolutely stunned. It comes from Investment Research Dynamics, and it shows very clearly that everything is not “okay” in the financial world…
Something occurred in the banking system in September that required a massive reverse repo operation in order to force the largest ever Treasury collateral injection into the repo market. Ordinarily the Fed might engage in routine reverse repos as a means of managing the Fed funds rate. However, as you can see from the graph below, there have been sudden spikes up in the amount of reverse repos that tend to correspond the some kind of crisis – the obvious one being the de facto collapse of the financial system in 2008:
What in the world could possibly cause a spike of that magnitude?
Well, that same article that I just quoted links the troubles at Glencore with this unprecedented intervention…
What’s even more interesting is that the spike-up in reverse repos occurred at the same time – September 16 – that the stock market embarked on an 8-day cliff dive, with the S&P 500 falling 6% in that time period. You’ll note that this is around the same time that a crash in Glencore stock and bonds began. It has been suggested by analysts that a default on Glencore credit derivatives either by Glencore or by financial entities using derivatives to bet against that event would be analogous to the “Lehman moment” that triggered the 2008 collapse.
The blame on the general stock market plunge was cast on the Fed’s inability to raise interest rates. However that seems to be nothing more than a clever cover story for something much more catastrophic which began to develop out sight in the general liquidity functions of the global banking system.
Back in 2008, Lehman Brothers was not “perfectly fine” one day and then suddenly collapsed the next. There were problems brewing under the surface well in advance.
Well, the same thing is happening now at banking giants such as Deutsche Bank, and at commodity trading firms such as Glencore, Trafigura and The Noble Group.
And of course a lot of smaller fish are starting to implode as well. I found this example posted on Business Insider earlier today…
On September 11, Spruce Alpha, a small hedge fund which is part of a bigger investment group, sent a short report to investors.
The letter said that the $80 million fund had lost 48% in a month, according the performance report seen by Business Insider.
There was no commentary included in the note. No explanation. Just cold hard numbers.
Wow – how do you possibly lose 48 percent in a single month?
It would be hard to do that even if you were actually trying to lose money on purpose.
Sadly, this kind of scenario is going to be repeated over and over as we get even deeper into this crisis.
Meanwhile, our “leaders” continue to tell us that there is nothing to worry about. For example, just consider what former Fed Chairman Ben Bernanke is saying…
Former Federal Reserve chairman Ben Bernanke doesn’t see any bubbles forming in global markets right right now.
But he doesn’t think you should take his word for it.
And even if you did, that isn’t the right question to ask anyway.
Speaking at a Wall Street Journal event on Wednesday morning, Bernanke said, “I don’t see any obvious major mispricings. Nothing that looks like the housing bubble before the crisis, for example. But you shouldn’t trust me.”
I certainly agree with that last sentence. Bernanke was the one telling us that there was not going to be a recession back in 2008 even after one had already started. He was clueless back then and he is clueless today.
Most of our “leaders” either don’t understand what is happening or they are not willing to tell us.
So that means that we have to try to figure things out for ourselves the best that we can. And right now there are signs all around us that another 2008-style crisis has begun.
Personally, I am hoping that there will be a lot more days like today when the markets were relatively quiet and not much major news happened around the world.
Unfortunately for all of us, these days of relative peace and tranquility are about to come to a very abrupt end.
Keep an eye on the shadow banking system – it is about to be shaken to the core. According to the Financial Stability Board, the size of the global shadow banking system has reached an astounding 75 trillion dollars. It has approximately tripled in size since 2002. In the U.S. alone, the size of the shadow banking system is approximately 24 trillion dollars. At this point, shadow banking assets in the United States are even greater than those of conventional banks. These shadow banks are largely unregulated, but governments around the world have been extremely hesitant to crack down on them because these nonbank lenders have helped fuel economic growth. But in the end, we will all likely pay a very great price for allowing these exceedingly reckless financial institutions to run wild.
If you are not familiar with the “shadow banking system”, the following is a pretty good definition from investing answers.com…
The shadow banking system (or shadow financial system) is a network of financial institutions comprised of non-depository banks — e.g., investment banks, structured investment vehicles (SIVs), conduits, hedge funds, non-bank financial institutions and money market funds.
How it works/Example:
Shadow banking institutions generally serve as intermediaries between investors and borrowers, providing credit and capital for investors, institutional investors, and corporations, and profiting from fees and/or from the arbitrage in interest rates.
Because shadow banking institutions don’t receive traditional deposits like a depository bank, they have escaped most regulatory limits and laws imposed on the traditional banking system. Members are able to operate without being subject to regulatory oversight for unregulated activities. An example of an unregulated activity is a credit default swap (CDS).
These institutions are extremely dangerous because they are highly leveraged and they are behaving very recklessly. They played a major role during the financial crisis of 2008, and even the New York Fed admits that shadow banking has “increased the fragility of the entire financial system”…
The current financial crisis has highlighted the growing importance of the “shadow banking system,” which grew out of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States, but it has had a profound influence on the global financial system. In a market-based financial system, banking and capital market developments are inseparable: Funding conditions are closely tied to fluctuations in the leverage of market-based financial intermediaries. Growth in the balance sheets of these intermediaries provides a sense of the availability of credit, while contractions of their balance sheets have tended to precede the onset of financial crises. Securitization was intended as a way to transfer credit risk to those better able to absorb losses, but instead it increased the fragility of the entire financial system by allowing banks and other intermediaries to “leverage up” by buying one another’s securities.
Over the past decade, shadow banking has become a truly worldwide phenomenon, and thus it is a major threat to the entire global financial system. In China, shadow banking has been growing by leaps and bounds, but this has the authorities deeply concerned. In fact, according to Bloomberg one top Chinese regulator has referred to shadow banking as a “Ponzi scheme”…
Their growth had caused the man who is now China’s top securities regulator to label the off-balance-sheet products a “Ponzi scheme,” because banks have to sell more each month to pay off those that are maturing.
And what happens to all Ponzi schemes eventually?
In the end, they always collapse.
And when this 75 trillion dollar Ponzi scheme collapses, the global devastation that it will cause will be absolutely unprecedented.
Bond expert Bill Gross, who is intimately familiar with the shadow banking system, has just come out with a major warning about the lack of liquidity in the shadow banking system…
Mutual funds, hedge funds, and ETFs, are part of the “shadow banking system” where these modern “banks” are not required to maintain reserves or even emergency levels of cash. Since they in effect now are the market, a rush for liquidity on the part of the investing public, whether they be individuals in 401Ks or institutional pension funds and insurance companies, would find the “market” selling to itself with the Federal Reserve severely limited in its ability to provide assistance.
As far as shadow banking is concerned, everything is just fine as long as markets just keep going up and up and up.
But once they start falling, the whole system can start falling apart very rapidly. Here is more from Bill Gross on what might cause a “run on the shadow banks” in the near future…
Long used to the inevitability of capital gains, investors and markets have not been tested during a stretch of time when prices go down and policymakers’ hands are tied to perform their historical function of buyer of last resort. It’s then that liquidity will be tested.
And what might precipitate such a “run on the shadow banks”?
1) A central bank mistake leading to lower bond prices and a stronger dollar.
2) Greece, and if so, the inevitable aftermath of default/restructuring leading to additional concerns for Eurozone peripherals.
3) China – “a riddle wrapped in a mystery, inside an enigma”. It is the “mystery meat” of economic sandwiches – you never know what’s in there. Credit has expanded more rapidly in recent years than any major economy in history, a sure warning sign.
4) Emerging market crisis – dollar denominated debt/overinvestment/commodity orientation – take your pick of potential culprits.
5) Geopolitical risks – too numerous to mention and too sensitive to print.
6) A butterfly’s wing – chaos theory suggests that a small change in “non-linear systems” could result in large changes elsewhere. Call this kooky, but in a levered financial system, small changes can upset the status quo. Keep that butterfly net handy.
Should that moment occur, a cold rather than a hot shower may be an investor’s reward and the view will be something less than “gorgeous”. So what to do? Hold an appropriate amount of cash so that panic selling for you is off the table.
In order to avoid a shadow banking crisis, what we need is for global financial markets to stabilize and to resume their upward trends.
If stocks and bonds start crashing, which is precisely what I have projected will happen during the last half of 2015, the shadow banking system is going to come under an extreme amount of stress. If the coming global financial crisis is even half as bad as I believe it is going to be, there is no way that the shadow banking system is going to hold up.
So let’s hope that the financial devastation that we have seen so far this week is not a preview of things to come. The global financial system has been transformed into a delicately balanced pyramid of glass that is not designed to handle turbulent times. We should have never allowed the shadow banks to run wild like this, but we did, and now in just a short while we are going to get to witness a financial implosion unlike anything the world has ever seen before.
After all these years, the most famous investor in the world still believes that derivatives are financial weapons of mass destruction. And you know what? He is exactly right. The next great global financial collapse that so many are warning about is nearly upon us, and when it arrives derivatives are going to play a starring role. When many people hear the word “derivatives”, they tend to tune out because it is a word that sounds very complicated. And without a doubt, derivatives can be enormously complex. But what I try to do is to take complex subjects and break them down into simple terms. At their core, derivatives represent nothing more than a legalized form of gambling. A derivative is essentially a bet that something either will or will not happen in the future. Ultimately, someone will win money and someone will lose money. There are hundreds of trillions of dollars worth of these bets floating around out there, and one of these days this gigantic time bomb is going to go off and absolutely cripple the entire global financial system.
Back in 2002, legendary investor Warren Buffett shared the following thoughts about derivatives with shareholders of Berkshire Hathaway…
The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so
far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.
Those words turned out to be quite prophetic. Derivatives have definitely multiplied in variety and number since that time, and it has become abundantly clear how toxic they are. Derivatives played a substantial role in the financial meltdown of 2008, but we still haven’t learned our lessons. Today, the derivatives bubble is even larger than it was just before the last financial crisis, and it could absolutely devastate the global financial system at any time.
During one recent interview, Buffett was asked if he is still convinced that derivatives are “weapons of mass destruction”. He told the interviewer that he believes that they are, and that “at some point they are likely to cause big trouble”…
Thirteen years after describing derivatives as “weapons of mass destruction” Warren Buffett has reaffirmed his view that they pose a threat to the global economy and financial markets.
In an interview with Chanticleer this week, Buffett said that “at some point they are likely to cause big trouble“.
“Derivatives, lend themselves to huge amounts of speculation,” he said.
Most of the time, the big banks that do most of the trading in these derivatives do very well. They use extremely sophisticated computer algorithms that help them come out on the winning end of these bets most of the time.
But when there is some sort of unforeseen event that suddenly causes a massive shift in the marketplace, that can cause tremendous problems. This is something that Buffett discussed during his recent interview…
“The problem arises when there is a discontinuity in the market for some reason or another.
“When the markets closed like it was for a few days after 9/11 or in World War I the market was closed for four or five months – anything that disrupts the continuity of the market when you have trillions of dollars of nominal amounts outstanding and no ability to settle up and who knows what happens when the market reopens,” he said.
So if the markets behave fairly calmly and predictably, the derivatives bubble probably will not burst.
But no balancing act of this nature ever lasts forever. Just remember what happened in 2008. Lehman Brothers collapsed and then the financial system virtually froze up. According to Forbes, at that time almost everyone was afraid to deal with the big banks because nobody was quite sure how much exposure they had to these risky derivatives…
Fast forward to the financial meltdown of 2008 and what do we see? America again was celebrating. The economy was booming. Everyone seemed to be getting wealthier, even though the warning signs were everywhere: too much borrowing, foolish investments, greedy banks, regulators asleep at the wheel, politicians eager to promote home-ownership for those who couldn’t afford it, and distinguished analysts openly predicting this could only end badly. And then, when Lehman Bros fell, the financial system froze and world economy almost collapsed. Why?
The root cause wasn’t just the reckless lending and the excessive risk taking. The problem at the core was a lack of transparency. After Lehman’s collapse, no one could understand any particular bank’s risks from derivative trading and so no bank wanted to lend to or trade with any other bank. Because all the big banks’ had been involved to an unknown degree in risky derivative trading, no one could tell whether any particular financial institution might suddenly implode.
After the crisis, we were promised that something would be done about the “too big to fail” problem.
But instead, the problem of “too big to fail” is now larger than ever.
Since the last financial crisis, the four largest banks in the country have gotten approximately 40 percent larger. Today, the five largest banks account for approximately 42 percent of all loans in the United States, and the six largest banks account for approximately 67 percent of all assets in our financial system. Without those banks, we would not have much of an economy left at all.
Meanwhile, smaller banks have been going out of business or have been swallowed up by the big banks at a staggering rate. Incredibly, there are 1,400 fewer small banks in operation today than there were when the last financial crisis erupted.
So we cannot afford for these “too big to fail” banks to actually fail. Even the failure of a single one would cause a national financial nightmare. The “too big to fail” banks that I am talking about are JPMorgan Chase, Citibank, Goldman Sachs, Bank of America, Morgan Stanley and Wells Fargo. When you total up the exposure to derivatives that all of them currently have, it comes to a grand total of more than 278 trillion dollars. But when you total up all of the assets of all six banks combined, it only comes to a grand total of about 9.8 trillion dollars. In other words, the “too big to fail” banks have exposure to derivatives that is more than 28 times the size of their total assets.
I have shared the following numbers with my readers before, but it is absolutely crucial that we all understand how exceedingly vulnerable our financial system really is. These numbers come directly from the OCC’s most recent quarterly report (see Table 2), and they reveal a recklessness that is almost beyond words…
Total Assets: $2,573,126,000,000 (about 2.6 trillion dollars)
Total Exposure To Derivatives: $63,600,246,000,000 (more than 63 trillion dollars)
Total Assets: $1,842,530,000,000 (more than 1.8 trillion dollars)
Total Exposure To Derivatives: $59,951,603,000,000 (more than 59 trillion dollars)
Total Assets: $856,301,000,000 (less than a trillion dollars)
Total Exposure To Derivatives: $57,312,558,000,000 (more than 57 trillion dollars)
Bank Of America
Total Assets: $2,106,796,000,000 (a little bit more than 2.1 trillion dollars)
Total Exposure To Derivatives: $54,224,084,000,000 (more than 54 trillion dollars)
Total Assets: $801,382,000,000 (less than a trillion dollars)
Total Exposure To Derivatives: $38,546,879,000,000 (more than 38 trillion dollars)
Total Assets: $1,687,155,000,000 (about 1.7 trillion dollars)
Total Exposure To Derivatives: $5,302,422,000,000 (more than 5 trillion dollars)
Since the United States was first established, the U.S. government has run up a total debt of a bit more than 18 trillion dollars. It is the biggest mountain of debt in the history of the planet, and it has grown so large that it is literally impossible for us to pay it off at this point.
But the top five banks in the list above each have exposure to derivatives that is more than twice the size of the national debt, and several of them have exposure to derivatives that is more than three times the size of the national debt.
That is why I keep saying that there will not be enough money in the entire world to bail everyone out when this derivatives bubble finally implodes.
Warren Buffett is entirely correct about derivatives – they truly are weapons of mass destruction that could destroy the entire global financial system at any time.
So as we move into the second half of this year and beyond, you will want to watch for terms like “derivatives crisis” or “derivatives crash” in news reports. When derivatives start making front page news, that will be a really, really bad sign.
Our financial system has been transformed into the largest casino in the history of the planet. For the moment, the roulette wheels are still spinning and everyone is happy. But sooner or later, a “black swan event” will happen that nobody expected, and then all hell will break loose.
Central banking has truly taken over the entire planet. At this point, the only major nation on the globe that does not have a central bank is North Korea. Yes, there are some small island countries such as the Federated States of Micronesia that do not have a central bank, but even if you count them, more than 99.9% of the population of the world still lives in a country that has a central bank. So how has this happened? How have we gotten the entire planet to agree that central banking is the best system? Did the people of the world willingly choose this? Of course not. To my knowledge, there has never been a single vote where the people of a nation have willingly chosen to establish a central bank. Instead, what has happened is that central banks have been imposed on all of us. All over the world, people have been told that monetary issues are “too important” to be subject to politics, and that the only solution is to have a group of unelected, unaccountable bankers control those things for us.
So precisely what does a central bank do?
You would be surprised at how few people can actually answer that question accurately. The following is how Wikipedia describes what a central bank does…
A central bank, reserve bank, or monetary authority is an institution that manages a state’s currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency, which usually serves as the state’s legal tender. Examples include the European Central Bank (ECB), the Bank of England, the Federal Reserve of the United States and the People’s Bank of China.
In the United States, we are told that we have a free market system. But in a true free market system, market forces would determine what interest rates are. We wouldn’t need anyone to “set interest rates” for us.
And why have we given a private banking cartel (the Federal Reserve) the authority to create and manage our money supply? The U.S. Constitution specifically delegates that authority to Congress.
It is not as if we actually need the Federal Reserve. In fact, the greatest period of economic growth in U.S. history happened during the decades before the Federal Reserve was created.
Unfortunately, a little over 100 years ago our leaders decided that it would be best to turn over our financial future to a newly created private banking cartel that was designed by very powerful Wall Street interests. Since that time, the value of our currency has diminished by more than 96 percent and our national debt has gotten more than 5000 times larger.
But despite all of the problems, the vast majority of Democrats and the vast majority of Republicans are not even willing to consider slightly curtailing the immense power of the Federal Reserve. And the idea of getting rid of the Fed altogether is tantamount to blasphemy to most of our politicians.
Of course the same thing is true all over the planet. Central banks are truly “the untouchables” of the modern world. Even though everybody can see what they are doing, there has not been a single successful political movement anywhere on the globe (that I know about) to shut a central bank down.
Instead, in recent years we have just seen the reach of central banking just continue to expand.
For example, just look at what has happened to some of the countries that were not considered to be “integrated” into the “global community”…
-In 2001, the United States invaded Afghanistan. In 2003, Da Afghanistan Bank (who picked that name?) was established by presidential decree. You can find the official website of the bank right here. Now Afghanistan has a modern central bank just like the rest of us.
-In 2003, the United States invaded Iraq. In early 2004, the Central Bank of Iraq was established to manage the Iraqi currency and integrate Iraq into the global financial system. The following comes from the official website of the Central Bank of Iraq…
Following the deposition of Saddam Hussein in the 2003 invasion of Iraq, the Iraqi Governing Council and the Office for Reconstruction and Humanitarian Assistance began printing more Saddam dinar notes as a stopgap measure to maintain the money supply until new currency could be introduced.
The Banking Law was issued September 19, 2003. The law brings Iraq’s legal framework for banking in line with international standards, and seeks to promote confidence in the banking system by establishing a safe, sound, competitive and accessible banking system.
Between October 15, 2003 and January 15, 2004, the Coalition Provisional Authority issued new Iraqi dinar coins and notes, with the notes printed using modern anti-forgery techniques, to “create a single unified currency that is used throughout all of Iraq and will also make money more convenient to use in people’s everyday lives. Old banknotes were exchanged for new at a one-to-one rate, except for the Swiss dinars, which were exchanged at a rate of 150 new dinars for one Swiss dinar.
The Central Bank of Iraq (Arabic: البنك المركزي العراقي) was established as Iraq’s independent central bank by the Central Bank of Iraq Law of March 6, 2004
-In 2011, the United States bombed the living daylights out of Libya. Before Muammar Gaddafi was even overthrown, the U.S. helped the rebels establish a new Central Bank of Libya and form a new national oil company.
Central banks are specifically designed to trap nations in debt spirals from which they can never possibly escape. Today, the debt to GDP ratio for the entire planet is up to an all-time high record of 286 percent. Humanity is being enslaved by a perpetual debt machine, but most people are not even aware that it is happening.
It is time for an awakening. We need to educate as many people as possible about why we need to get rid of the central banks. For those living in the United States, my previous article entitled “On The 100th Anniversary Of The Federal Reserve Here Are 100 Reasons To Shut It Down Forever” is a good place to start. In other countries, we need people to write similar articles about their own central banks in their own languages.
The global elite dominate us because we allow them to dominate us. Their debt-based system greatly enriches them while it enslaves the remainder of the planet. We need to expose their evil system and the dark agenda behind it while we still have time.
Every great con game eventually comes to an end. For years, global central banks have been manipulating the financial marketplace with their monetary voodoo. Somehow, they have convinced investors around the world to invest tens of trillions of dollars into bonds that provide a return that is way under the real rate of inflation. For quite a long time I have been insisting that this is highly irrational. Why would any rational investor want to put money into investments that will make them poorer on a purchasing power basis in the long run? And when any central bank initiates a policy of “quantitative easing”, any rational investor should immediately start demanding a higher rate of return on the bonds of that nation. Creating money out of thin air and pumping into the financial system devalues all existing money and creates inflation. Therefore, rational investors should respond by driving interest rates up. Instead, central banks told everyone that interest rates would be forced down, and that is precisely what happened. But now things have shifted. Investors are starting to behave more rationally and the central banks are starting to lose control of the financial markets, and that is a very bad sign for the rest of 2015.
And of course it isn’t just bond yields that are out of control. No matter how hard they try, financial authorities in Europe can’t seem to fix the problems in Greece, and the problems in Italy, Spain, Portugal and France just continue to escalate as well. This week, Greece became the very first nation to miss a payment to the IMF since the 1980s. We’ll discuss that some more in a moment.
Over in Asia, stocks are fluctuating very wildly. The Shanghai Composite Index plunged by 5.4 percent on Thursday before regaining all of those losses and actually closing with a gain of 0.8 percent. When we see this kind of extreme volatility, it is a very bad sign. It is during times of extreme volatility that markets crash.
Remember, stocks generally tend to go up during calm markets, and they generally tend to go down during choppy markets. So most investors do not want to see lots of volatility. Unfortunately, that is precisely what we are witnessing all over the world right now. The following comes from the Wall Street Journal…
“Volatility over the last days has been breathtaking, especially in bond markets,” said Wouter Sturkenboom, senior investment strategist at Russell Investments. He said that it rippled through equity and currency markets, which overreacted.
The yield on the benchmark German 10-year bond touched 0.99%, its highest level since September, before erasing the day’s rise and falling back to 0.84%. The 10-year U.S. Treasury yield, which hit a fresh 2015 high of 2.42% earlier Thursday, recently fell back to 2.33%. Yields rise as prices fall.
Sometimes when bond yields go up, it is because investors are taking money out of bonds and putting it into stocks because they are feeling really good about where the stock market is heading. This is not one of those times. As Peter Tchir has noted, the huge moves in the bond market that we are now seeing are the result of “sheer panic in the market”…
In a morning note before the open, Brean Capital’s Peter Tchir wrote: “It is time to reduce US equity holdings for the near term and look for a 3% to 5% move lower. The Treasury weakness is NOT a ‘risk on’ trade it is a ‘risk off’ trade, where low yields are viewed as a risk asset and not a safe haven.” And Tom di Galoma, head of fixed-income rates and credit at ED&F Man Capital Markets, told Bloomberg, “This is sheer panic in the market from the standpoint of what’s been happening in Europe … Most of Wall Street is guarded here as far as taking on new positions.”
But this wasn’t supposed to happen.
After watching the Federal Reserve be able to successfully use quantitative easing to drive down interest rates, the European Central Bank decided to try the same thing. Unfortunately for them, investors are starting to behave more rationally. The central banks are starting to lose control of the financial markets, and bond yields are soaring. I think that Peter Boockvar summarized where we are currently at very well when he stated the following…
I’ve said this before but I’m sorry, I need to say it again. What we are witnessing in global markets is the inherent contradiction writ large that is modern day monetary policy where dangerously ZIRP, NIRP and QE are considered conventional policies. The contradiction is simply this: the desire for higher inflation if fulfilled will result in higher interest rates that central banks are trying so hard and desperately to suppress.
Outside of the short end of the curve, markets will always win for better or worse and that is clearly evident now. The ECB is getting their first taste of the market talking back and in quite the violent way. In the US, the bond market is watching the Fed drag its feet (its never-ending) with wanting to raise interest rates and finally said enough is enough. The US Treasury market is tightening for them. Since mid April, the 5 yr note yield is higher by 40 bps, the 10 yr is up by 55 bps and the 30 yr yield is up by 65 bps.
And if global investors continue to move in a rational direction, this is just the beginning. Bond yields all over the planet should be much, much higher than they are right now. What that means is that bond prices potentially have a tremendous amount of room to go down.
One thing that could accelerate the global bond crash is the crisis in Greece. Negotiations between the Greeks and their creditors have been dragging on for four months, and no agreement has been reached. Now, Greece has missed the loan payment that was due to the IMF on June 5th, and it is asking the IMF to bundle all of the payments that are due this month into one giant payment at the end of June…
Greece has asked to bundle its four debt payments to the International Monetary Fund that fall due in June so that it can pay them in one batch at the end of the month, Greek newspaper Kathimerini reported on Thursday.
The request is expected to be approved by the IMF, the newspaper said. That would mean Greece does not have to pay the first tranche of 300 million euros that falls due on Friday.
Greece faces a total bill of 1.5 billion euros owed to the IMF over four installments this month.
Of course that payment will not be made either if a deal does not happen by then. And with each passing day, a deal seems less and less likely. At this point, the package of “economic reforms” that the creditors are demanding from Greece is completely unacceptable to Syriza. The following comes from an article in the Guardian…
Fresh from talks in Brussels, Tsipras faced outrage on Thursday from highly skeptical members of his own Syriza party. A five-page ultimatum from creditors, presented by the European commission president, Jean-Claude Juncker, was variously described as shocking, provocative, disgraceful and dishonourable.
“It will never pass,” said Greece’s deputy social security minister, Dimitris Stratoulis. “If they don’t back down, the country won’t be lost … there are alternatives that would cost less than our signing a disgraceful and dishonourable agreement.”
Ultimately, I don’t believe that we are going to see an agreement.
Well, I tend to agree with this bit of analysis from Andrew Lilico…
The Eurozone does not want to make any compromise with the current Greek government because (a) they don’t believe they need to because Greek threats to leave the euro are empty both because internal polling suggests Greeks don’t want to leave and because if they did leave that doesn’t really constitute any threat to the euro; (b) because they (particularly perhaps Angela Merkel) believe that under enough pressure the Greek government might collapse and be replaced by a more cooperative government, as has happened repeatedly before in the Eurozone crisis including in Italy and Greece itself; and (c) because any deal with Greece that is seen to involve or be presentable as any victory for the Greek government would threaten the political positions of governments in several Eurozone states including Spain, Portugal, Italy, Finland and perhaps even the Netherlands and Germany.
Furthermore, it’s not clear to me that the Eurozone creditors at this stage would have much interest in any deal based upon promises, regardless of how much the Greek had verbally surrendered. Things have gone too far now for mere words to work. They would need to see the Greeks deliver actions — tangible economic reforms and tangible, credible primary surplus targets and a sustainable change in the long-term political mood within Greece that meant other Eurozone states might eventually get their money back. That is almost certainly not doable at all with the current Greek government. The only deal possible would be with some replacement Greek government that had come in precisely on the basis that it did want to do a deal and did want to pay the creditors back.
On the Syriza side, I see no more appetite for a deal. They believe that austerity has been ruinous for the lives of Greeks and that decades more austerity would mean decades more Greek economic misery. From their point of view, default or even exit from the euro, even if economically painful in the short term, would be better than continuing with austerity now.
You can read the rest of his excellent article right here.
Without a deal, the value of the euro is going to absolutely plummet and bond yields over in Europe will go through the roof. I am fully convinced that this is the beginning of the end for the eurozone as it is currently constituted, and that we stand on the verge of a great European financial crisis.
And of course the financial crisis that is coming won’t just be in Europe. The global financial system is more interconnected than ever, and there are tens of trillions of dollars in derivatives that are tied to foreign exchange rates and 505 trillion dollars in derivatives that are tied to interest rates. When this giant house of cards collapses, the central banks won’t be able to stop it.
In the end, could we eventually see the entire central banking system itself totally collapse?
That is what Phoenix Capital Research believes is about to happen…
Last year (2014) will likely go down in history as the “beginning of the end” for the current global Central Banking system.
What will follow will be a gradual unfolding of the next crisis and very likely the collapse of the Central Banking system as we know it.
However, this process will not be fast by any means.
Central Banks and the political elite will fight tooth and nail to maintain the status quo, even if this means breaking the law (freezing bank accounts or funds to stop withdrawals) or closing down the markets (the Dow was closed for four and a half months during World War 1).
There will be Crashes and sharp drops in asset prices (20%-30%) here and there. However, history has shown us that when a financial system goes down, the overall process takes take several years, if not longer.
We stand at the precipice of the greatest economic transition that any of us have ever seen.
Even though things may seem very “normal” to most people right now, the truth is that the global financial system is fundamentally flawed, and cracks in the system are starting to appear all over the place.
When this system does collapse, it will take most people entirely by surprise.
But it shouldn’t.
All con games eventually fall apart in the end, and we are about to learn that lesson the hard way.