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Goldman Sachs And The Big Hedge Funds Are Pushing Leverage To Ridiculous Extremes

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Goldman Sachs And The Big Hedge Funds Are Pushing Leverage To Ridiculous Extremes - Photo by bfishadow on FlickrAs stocks have risen in recent years, the big hedge funds and the “too big to fail” banks have used borrowed money to make absolutely enormous profits.  But when you use debt to potentially multiply your profits, you also create the possibility that your losses will be multiplied if the markets turn against you.  When the next stock market crash happens, and the gigantic pyramid of risk, debt and leverage on Wall Street comes tumbling down, will highly leveraged banks such as Goldman Sachs ask the federal government to bail them out?  The use of leverage is one of the greatest threats to our financial system, and yet most Americans do not even really understand what it is.  The following is a basic definition of leverage from Investopedia: “The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.”  Leverage allows firms to make much larger bets in the financial markets than they otherwise would be able to, and at this point Goldman Sachs and the big hedge funds are pushing leverage to ridiculous extremes.  When the financial markets go up and they win on those bets, they can win very big.  For example, revenues at Goldman Sachs increased by about 30 percent in 2012 and Goldman stock has soared by more than 40 percent over the past 12 months.  Those are eye-popping numbers.  But leverage is a double-edged sword.  When the markets turn, Goldman Sachs and many of these large hedge funds could be facing astronomical losses.

Sadly, it appears that Wall Street did not learn any lessons from the financial crisis of 2008.  Hedge funds have ramped up leverage to levels not seen since before the last stock market crash.  The following comes from a recent Bloomberg article entitled “Hedge-Fund Leverage Rises to Most Since 2004 in New Year“…

Hedge funds are borrowing more to buy equities just as loans by New York Stock Exchange brokers reach the highest in four years, signs of increasing confidence after professional investors trailed the market since 2008.

Leverage among managers who speculate on rising and falling shares climbed to the highest level to start any year since at least 2004, according to data compiled by Morgan Stanley. Margin debt at NYSE firms rose in November to the most since February 2008, data from NYSE Euronext show.

So why is this so important?

Well, as a recent Zero Hedge article explained, even a relatively small drop in stock prices could potentially absolutely devastate many hedge funds…

What near record leverage means is that hedge funds have absolutely zero tolerance for even the smallest drop in prices, which are priced to absolute and endless central bank-intervention perfection – sorry, fundamentals in a time when global GDP growth is declining, when Europe and Japan are in a double dip recession, when the US is expected to report its first sub 1% GDP quarter in years, when corporate revenues and EPS are declining just don’t lead to soaring stock prices.

It also means that with virtually all hedge funds in such hedge fund hotel names as AAPL (the stock held by more hedge funds – over 230 – than any other), any major drop in the price would likely lead to a wipe out of the equity tranche at the bulk of AAPL “investors”, sending them scrambling to beg for either more LP generosity, or to have their prime broker repo desk offer them even more debt. And while the former is a non-starter, the latter has so far worked, which means that most hedge funds have been masking losses with more debt, which then suffers even more losses, and so on.

By the way, Apple (AAPL) just fell to an 11-month low.  Apple stock has now declined by 26 percent since it hit a record high back in September.  That is a very bad sign for hedge funds.

But hedge funds are not the only ones flirting with disaster.  In a previous article about the derivatives bubble, I pointed out the ridiculous amount of derivatives exposure that some of these “too big to fail” banks have relative to their total assets…

According to the Comptroller of the Currency, four of the largest U.S. banks are walking a tightrope of risk, leverage and debt when it comes to derivatives.  Just check out how exposed they are…

JPMorgan Chase

Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars)

Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)


Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars)

Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars)

Bank Of America

Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars)

Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars)

Goldman Sachs

Total Assets: $114,693,000,000 (a bit more than 114 billion dollars – yes, you read that correctly)

Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars)

Take another look at those figures for Goldman Sachs.  If you do the math, Goldman Sachs has total exposure to derivatives contracts that is more than 362 times greater than their total assets.

That is utter insanity, but we haven’t had a derivatives crash yet so everyone just keeps pretending that the emperor actually has clothes on.

When the derivatives crisis happens, things in the financial markets are going to fall apart at lightning speed.  A recent article posted on explained what a derivatives crash may look like…

When one big bank faces some kind of trouble and fails, the banks with the largest exposure to derivates (think JP Morgan, Citygroup, Goldman Sachs) will realize that the bank on the other side of the derivatives trade (the counterparty) is no longer good for their obligation. All of a sudden the hedged position becomes a naked position. The net position becomes a gross position. The risk explodes instantaneously. Markets realize that their hedged positions are in reality not hedged anymore, and all market participants start bailing almost simultaneously. The whole banking and financial system freezes up. It might start in Asia or Europe, in which case Americans will wake up in the morning to find out that their markets are  not functioning anymore; stock markets remain closed, money at the banks become inaccessible, etc.

But for now, the party continues.  Goldman Sachs and many of the big hedge funds are making enormous piles of money.

In fact, according to the Wall Street Journal, Goldman Sachs recently gave some of their top executives 65 million dollars worth of restricted stock…

Goldman Sachs Group Inc. GS -0.76% handed insiders including Chief Executive Lloyd Blankfein and his top lieutenants a total of $65 million in restricted stock just hours before this year’s higher tax rates took effect.

The New York securities firm gave 10 of its directors and executives early vesting on 508,104 shares previously awarded as part of prior years’ compensation, according to a series of filings with the Securities and Exchange Commission late Monday.

And the bonuses that employees at Goldman receive are absolutely obscene.  A recent Daily Mail article explained that Goldman employees in the UK are expected to receive record-setting bonuses this year…

Britain’s army of bankers will re-ignite public fury over lavish pay rewards as staff at Goldman Sachs are expected to reward themselves £8.3 billion in bonuses on Wednesday.

The American investment bank, which employs 5,500 staff in the UK, will be the first to unveil its telephone number-sized rewards – an average of £250,000 a person – as part of the latest round of bonus updates.

The increase, up from £230,000 last year, comes as British families are still struggling to make ends meet five years after banks brought the economy to the brink of meltdown.

Wouldn’t you like to get a “bonus” like that?

Life is good at these firms while the markets are going up.

But what happens when the party ends?

What happens if the markets crash in 2013?

When you bet big, you either win big or you lose big.

For now, the gigantic bets that Wall Street firms are making with borrowed money are paying off very nicely.

But a day of reckoning is coming.  The next stock market crash is going to rip through Wall Street like a chainsaw and the carnage is going to be unprecedented.

Are you sure that the people holding your money will be able to make it through what is ahead?  You might want to look into it while you still can.

Goldman Sachs New World Headquarters

  • markthetruth

    The market is fix big time right now they are making money off the shorts because they are inside trading off the fed as when the fed will step in and hold up the market and they know not to worry.

    Every singe news item that’s goes on the first thing out of new is how the market reacts . Everything is the market,market,market nothing about the facts of life or reality.

    This market has no reason to be going up expect that it is the only focus of the media. It will not end well because the fed is going to bail,interest rates have to go up , and layoffs are going to keep coming. and the economy stinks..

    The markets should be a 0 sum game somebody wins someone loses. But the illusion by the analyst that everyone will win in the market as it is manipulated and for their benefit . And the banks have an unfair advantage with the hedging.

    The worst the economic news the more it goes up

    the little guys will lose and this will not end up good when it crashes.

    millions have no homes, 48million on food stamps and everyone could keep buy disposable electronics
    and $100 shoes,everyone twitter,facebooks, sings,raps, reality tv, nobody’s doing any real work but they have money? Kim Kartrasian pregnant and the market goes up.

    la la land.

    the end…

  • K

    Let me ask a question, why wouldn’t they do this. Did anyone really get in trouble last time? Outside of one small timer nobody went to jail. Look they are thieves, morally bankrupt. This government is like a bad cop. Paid to look the other way, while people are robbed.

    • MichaelfromTheEconomicCollapse

      Very good point.


    • Syrin

      Notice what Iceland did. Tossed them in jail. Look what they did here. Donated to the Imbecile in Chief and got plush Cabinet positions.

      • 2Gary2

        yes syrin–you are 100% correct on this!!! I knew we would eventually agree on something 🙂

        • Mark

          Third time is a charm. Very good Gary.

      • Hammerstrike

        Better yet, send them… to Detroit!

    • Mondobeyondo

      Your last two sentences say a lot. The U.S. government is just as corrupt as any third world country. We just hide our corruption better.

      • K

        Mondo you are correct, however corruption no longer covers it. It has reached a point of pure evil. I do not use that term lightly.

  • Syrin

    Guess who Goldman Sachs contributed to at record levels in the past two elections? Guess whose cabinet is filled with former Goldman Sachs board members. Yeah that’s right. Obamugabe. Link will be coming once it passes moderation

    • 2Gary2

      yes yes you are right again!

      • Hambone

        Agreement between you two must be a sign of the coming apocalypse. Time to get my bug-out bag ready.

      • Mark

        My first comment is still awaiting moderation so I wll change this one a tiny bit. You know what has frozen over for a second time. Maybe their is hope yet.

      • Joe Shmo

        You two are starting to scare me…

  • 2Gary2

    Tax the wealthy (rich and corp) to keep us healthy–here’s why:

    and women in distinctly unequal nations like the United States, scientists all
    across the world have been documenting for several decades now,
    live shorter, less healthy lives than men and women in more economically equal

    U.S. health officials recently asked two eminent institutions, the National
    Research Council and the Institute of Medicine, to take their own look at the
    data. The two reported back last week. Americans, they found,
    do “die sooner and experience more illness” than their counterparts in other
    developed nations.

  • 2Gary2

    Yes Obama has been a huge disappointment on regulating wall street. I expect republicans to suck so it is very dismaying to see a dem who should know better keep appointing wall street insiders like jack lew to replace guithner. I guess it may be true that both parties basically suck.

    • K

      Yes, that is the truth. As sad as it is. Well done.

    • DaveP

      2 things to agree with GARY2…OMG…It *is* the apocalypse!

  • 2Gary2

    I am writing to the fed to see if they will let me pay goldman sucks interest rates on my mortgage.

  • 2Gary2

    “Economists on both the right and left, from Kenneth Rogoff of Harvard University to the
    columnist Paul Krugman, are increasingly talking
    about the detrimental consequences of high concentrations of economic and
    political power — concentrations that threaten the innovation that is supposed
    to be what makes unequal outcomes worth the price.”

    Thomas Edsall,
    The Obama Coalition vs. Corporate America, New York Times, January
    9, 2013

    • Ralfine

      What’s new about this? We learned that in school 30 years ago.


    These big banks and Goldman Sachs don’t care, it’s not there money it’s your money. Do you really think they have there money invested where they work.or any other bank, heck no.

  • Mondobeyondo

    Just further confirmation that Wall Street is nothing but a gigantic casino. The individual banks, hedge funds, etc. may win for a while, but as anyone who has been to Vegas knows, the “house” always wins.

    Having said that, I’m heading over to the roulette table with some hedge funds. Think I’ll bet $10 million on 31 red. Wheel spins, ball lands on 14 black. Awwww! We lose again!

  • Ralfine

    They do what laws and regulations permit them to do. And even if they overstep the law – nothing much happens, only a few people ever get caught and prosecuted. The police is busy with shootings, traffic offenses, pot smokers, truancy and handcuffing kindergartners for playing doctor.

    • Hammerstrike

      The law is evidently for the masses.

  • MeMadMax

    It’s all one big pile of poo. The last roll of duct tape that is holding it all together(reserve currency status) may also come to an end soon. Just read that germany repatriated all of its gold from the fed… They don’t trust the fed or the dollar anymore. The dollars will start flying back home soon…..

    • Mondobeyondo

      Did Germany really do that?!? YIKES!!

    • hoax_buster

      Germany is making this move because it has its own internal problems.
      The reason has nothing to do with the safety of the US financial system.

    • Ralfine

      Not all of it. Just a part. About a fifth of their gold that they kept in the US to protect it from the Russians in the Cold War.

  • chilller

    Bankers only have 1 thing in mind…GREED. Imagine if all the money they have been able to steal was put back into the economy, how much better things would be for us all. I for one would gladly live a hobo’s life to see all of them end up on the street with me.

    • hoax_buster

      All money at banks goes into the business. All money earned by bankers is invested in stocks and bonds and real estate.

      It appears you believe bankers hide money in their mattresses.

  • Ever notice that breaking economic news always moves stocks up or down before the retail invester i.e. Joe and Jane IRA can trade on that news? The little guy doesn’t stand a chance with hedge funds and high frequency trading programs reacting in nanoseconds or, what’s worse, trading on inside information.

  • Rancher

    Rather than post support for this article why don’t the posters talk about how smart they have been by building up their lives and abilities is supplies to weather about any crisis? Perhaps because they have little to nothing to post about on those lines?

    • Mark

      Well, what have you done to prepare?

    • K

      Please folks do not share such information. We are playing a hand of poker, with our own Government. It is unwise to show your cards, on a public forum.

      • Hambone

        Amen. Prepared?

        Heck no! If the SHTF, We’ll just go to Wal Mart and buy some Dinty Moore.

        • Mondobeyondo

          Hehehehe… Walmart is closed for an indefinite period of time, if an ongoing crisis breaks out. That’s if the screaming mob with torches and pitchforks doesn’t burn Walmart to the ground first.

  • sharonsj

    About 25 yeas ago there was another derivatives bubble that wiped out a number of school systems and municipalities. So we’ve know for decades that derivatives are nothing but gambling. If you’re an insider, you usually know how to play the game, but it seems that these too big to fail banks and hedge funds now think we’re going to bail them out again. If it happens a second time, I hope the American people will finally do something.

    As for preparing, I’ve know for some time that our economy is in the toilet (and will stay that way) and that climate change is going to help bankrupt us (along with our privatized health care). So my suggestion is to get a piece of country property, pay it off, grow your own food or join an organic co-op, and buy lots of emergency supplies. This country will consist of the really rich 1% and the rest of us serfs, so get used to it or figure out how to replace 99% of Congress.

  • Darin

    This derivatives game should be regulated but that wont happen. These big banks pay out big money to both parties. Any politician coming against this corrupt banking cartel either is pushed out of the debate or marginalized. Barack Obama is in cahoots with these guys but claims to love the middle-class. Sadly many believe him. Thanks for another good article!

  • chumchingee

    When this House of Cards comes down, not if, when, they will let it fall. Meanwhile, back at the ranch, they will have already taken their money and they will have ran for it. Probably someplace without extradition laws. When you own the government, own the monopoly board, it is possible to do just about anything and get away with it. At least that is what it appears to be to me. Someone else will have to pick up the wrecked economy and hopefully repair the damage if it is repairable at all. More than likely it is not. The government will simply start over with a new currency. You and I will have 15 days to present all old currency to the banks and get new currency in return.

  • MichaelfromTheEconomicCollapse

    I wanted to give a shout out for one of my favorite charities. They drill wells to provide clean water for towns in India that desperately need it and they share the good news at the same time…


  • Guane

    When you write that “Goldman sachs and many of the big hedge funds are making enormous piles of money” Who is in the other side of this transaction, who is losing this enormous piles of money, or from where that money comes??

    • Mark

      Many people have lost money and there is plenty of new money each month. You know, the cash that the Fed gives out to their fair haired boys produced out of thin air. 95 billion worth of thin air I did not know that thin air was worth so much. Do you think we could can it or something. This system is rigged and we are going to eat inflation for dinner when enough understand just what the Fed and the congress crooks have done to the middle class. We are the serfs.

  • Hammerstrike

    Democrates, the TRUE party of the rich!

  • Mondobeyondo

    Brrrrrr! Getting a bit chilly in the Eternal Inferno…

  • Mondobeyondo

    Slight edit to a Dr. Seuss classic:

    One fish, Two fish
    Red fish, Dead fish.

    That’s where we’re headed.
    (Apologies to Theodor Seuss Geisel)

  • Nexusfast123

    The last big speculative binge by the banks before the day of reckoning comes. They add no value to anything and are technically bankrupt.

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