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 (NYSE:JPM) and Bank of America (NYSE:BAC) 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.