Top Banks + Unregulated Derivatives = Financial WMD

(10 am. – promoted by ek hornbeck)

In the noble tradition of Muck-Rakers, who would investigate the misdeeds of the Wall Street power-brokers — this report examines some modern day gaming of our wild west Financial system.

Warren Buffet gave a prophetic pronouncement back in 2003, about the dangers out a new-fangled class of investment, which he called: “financial weapons of mass destruction“.  

Turns out, Wall Street maybe should have listened to Warren:

Then again with the TARP deal, that the top Wall Street Bankers finagled, from the Treasury and the Fed, and Record-setting DC Bailout which quietly swept all those Toxic Assets, under someone else’s rug — MAYBE the Wall Street Wizards, were right to ignore the ‘Oracle of Omaha’, eh?

Because of course, taking sound investment advice, assumes you are planning to … invest … soundly!

First the Buffet warning:

Buffett warns on investment ‘time bomb’

BBC – 4 March, 2003

The derivatives market has exploded in recent years, with investment banks selling billions of dollars worth of these investments to clients as a way to off-load or manage market risk.

But Mr Buffett argues that such highly complex financial instruments are time bombs and “financial weapons of mass destruction” that could harm not only their buyers and sellers, but the whole economic system.

Contracts devised by ‘madmen’

Derivatives are financial instruments that allow investors to speculate on the future price of, for example, commodities or shares – without buying the underlying investment.

[…]

Some derivatives contracts, Mr Buffett says, appear to have been devised by “madmen”.

He warns that derivatives can push companies onto a “spiral that can lead to a corporate meltdown”,

[…]

Derivatives also pose a dangerous incentive for false accounting, Mr Buffett says.

The profits and losses from derivatives deals are booked straight away, even though no actual money changes hand. In many cases the real costs hit companies only many years later.

http://news.bbc.co.uk/2/hi/bus…

But Buffet is really an “Old School” Investor — heck he didn’t even invest in the Internet Boom, what does he know?

Well maybe there is some sound basis for “Old School” — that requires that there are some Actual Assets behind the speculative fervor, of that “fast buck” Fever.

Derivatives: Buffet calls them financial Weapons of Mass Destruction

By John Riley, Chief Strategist — 01/18/08

What are Derivatives?

Derivatives are private contracts (bets) between financial institutions. They can be on the direction of commodities, the stock markets or currencies, but the banks’ favorites are interest rates. (You can go to the Comptroller of the Currency website to get their quarterly reports and see for yourself what Wall Street hopes you never see.)

[…]

The scariest part of derivatives is their leverage. Like exchange traded options, derivative contracts can control assets for only a fraction of the contract value. The banks take the leverage to an extreme and have very little in assets backing up their derivative portfolios. According to the Comptroller, the top 25 banks have assets that only amount to about 6% of the Notional Value of their derivatives.

[…]

Derivatives have barely any regulation on them. For years, Congress tried and Greenspan stood in the way. Banks barely mention them in the annual reports except for a footnote.

Thanks to the lack of regulation, derivatives have grown dramatically. There has been a 473% increase in the Notional Value of derivatives at the top 25 banks since 1999.

http://www.rapidtrends.com/der…

Amazing, as of the beginning of 2008, the Top 25 banks ONLY HAD 6% Collateral to back up all their over-leveraged Derivative BETS! That includes all those notorious Credit Default Swaps too, tucked in among those Credit Derivatives. The Bankers put only 6% Down, to back up their betting!

In the old days, before Deregulation, betting trading “on margin”, required minimum levels of capital assets on hand to back up, extreme multiples of trading. But with Deregulation, those quaint requirements went out the window.

You got 1 Dollar, and want to bet $40 — No Problem! How about $50?  How about $100?  Step right up, as long as you have the prestige of an Investment Bank, or a Billion Dollar Hedge Fund, to back you up. … “Your Word is your Bond” — in this unwatched and unregulated OTC arena. Or so we were told.

The sheer speculative arrogance of the Top Wall Street Bankers is truly astronomical when you chart it out. The Comptroller of the Currency (pdf), of US Dept of Treasury, has been busy collecting the data, if anyone cares to take the time to chart it out, like I have. (By the way a Trillion, is an awful big number — It’s a Million, Millions!)

The Top 5 Banks — March 2008

The 6th-10th Over-leveraged Banks — March 2008

The 11th-15th sort-of-leveraged Banks — March 2008

The Top 5 Banks vs ALL the Rest of the Banks — March 2008

The Top 5 Banks cornering 96.9% of the Derivatives — March 2008

Those are some mighty “big bets” (in yellow), given the amount of “real assets” the Banks had on the books (in green)! The Biggest Banks, of course were the most extreme speculators. Too bad the Housing Market went south on them, and all those CDS Markers started to become due.

BTW, the OTC Market (Over The Counter) is the one that “No One” officiates; as opposed to the Exchange Traded Market — where “legit” commodity-based Futures Contracts are traded. Commodities like sugar, coffee, rubber, porkbellies, and a barrel of Oil — stablizing seasonable swings in the price of “goods” like these, was the reason why “Future Derivatives” were invented in first place. However “Exchange Traded” Derivatives only make up a small fraction of the Derivative bets these days.

The OTC Market is the Wild West of the Financial Universe. The OTC Market is the place where Contracts like “Dead Peasant Insurance” is dreamt up. If they can count it, they can bet on it. OTC Derivatives Don’t have an “Exchange” (ie a public market) — it is simply the place where unseen “players”, write complex IUO’s to one another. The Percentage of OTC Derivative Trades, as opposed to Commodity Trades in shown, on the Charts, below the Banks names. OTC Derivatives Market is where the Action is — was? … will continue to be?

Good thing Wall Street Legislation is in the works. Hopefully, it isn’t bought and paid for by the same Corporate players, Congress hopes to regulate (cough):

U.S. derivatives bill addresses end user concerns

Fri Oct 9, 2009

By Kevin Drawbaugh and Christopher Doering

WASHINGTON (Reuters)

With the House Financial Services Committee set to vote next week on its bill, Peterson said his panel’s legislation attempts “to reflect the concerns of end users while bringing oversight and transparency to OTC trading.”

The largely unregulated, $450 trillion OTC derivatives market includes credit default swaps, which are used to bet on whether a company will default on its bonds and have been widely blamed for amplifying the severe financial crisis last year that hammered economies worldwide.

[…]

Four large banks control over 90 percent of the U.S. derivatives market: JPMorgan Chase, Goldman Sachs, Bank of America and Citigroup.

http://www.reuters.com/article…

Well, the Comptroller of the Currency (pdf), of US Dept of Treasury, has issued an updated report as of June 2009. And a few things have changed:

The Top 5 Asset-heavy Banks — June 2009

The Assets-to-Liabilities mix has drastically changed, and they DO seem to have a bit more Green “on the Books”, these days. Imagine that! That’s some fine reversal of Fortunes!

What happen?  Well if we do the Math, somehow All those Toxic Assets have magically gone from the Debit side to the Credit side of the Ledger. Easy Money! They must of found an underwriter?

The Top 5 Banks — 15 Month change in Balances, June 2009 – March 2008

Kind of looks like most the “Debts”, were magically made Whole.  How’d that happen?

Besides the TARP Bailout, what could have turned all that Bad Debt into Gold. How about some creative financing? How about basing Valuations on what “you want” something to be worth someday, instead of finding its actual price, on TODAY’s open market?. … Who really needed “Mark-to-Market” Valuations anyways? They’re such a bummer on the down side, like when Housing Market values crash.

Some Creative Accounting for the Derivative holders

Relaxing Mark-to-Market Rules Is a Slippery Slope

By Larry Tabb, wall Street & technology — Nov 04, 2008

So, if I get this straight, the internally marked assets are increasing in value while the externally-priced assets are declining? As Dana Carvey’s Church Lady would say, “Well, isn’t that special?”

This somewhat minor accounting issue is of course not minor at all. Mark-to-market accounting is critical to the valuation of profits, positions, net capital and, for that matter, bank solvency.

http://www.wallstreetandtech.c…

It’s not hard to take those Charge-offs, to write off those bad-bets, to tear up those markers, when you got someone like the Treasury Dept, watching your back, ready to Bail you out. Shoot, you can even revalue those bad debts into, Trillion Dollar assets if you want. The Housing Market will rebound again some day, won’t it? … So why be constrainted to count today’s lousy prices, like normal folks, when you can Value the Asset by what it’s really worth — (what you paid for it).

Not a Problem, if you’re one of those Top Banks, on Geithner’s speed dial.

NO Worries, if you’re one of those Top Banks, who Bernanke is perfectly willing to keep secrets for!

… Just don’t let the little people know, Okay?

Post Script:

How did Goldman Sach and Morgan Stanley, make the Comptroller’s Top 25 Banker list, in 2009, when they were no where to be seen on the 2008 List?

This seems to explain it:

On September 22, 2008, the last two major investment banks in the United States, Morgan Stanley and Goldman Sachs, both confirmed that they would become traditional bank holding companies, bringing an end to the era of investment banking on Wall Street. The Federal Reserve’s approval of their bid to become banks ended the ascendancy of the securities firms, 75 years after Congress separated them from deposit-taking lenders

http://en.wikipedia.org/wiki/G…

Although it does pose a few new questions:

Goldman will now handle Deposits for workers? Who’s watching Goldman?

and

Who’s been “Comptrolling” the 1000’s of Investment Firms and Hedge Funds, from which Goldman and Morgan have manage to “leverage” their way out of?

and

Where did the Valuation on our 401k 201K’s go? … Can WE reset the “Mark-to-Market” Valuations on them, too?

Who is running this Casino anyways? and WHY does only a certain Class of Clientele get all the perks, while the rest of us, just get all the Bills?

How about some write-offs for the American People, about NOW?

But I guess those are some Muck-Raking Concerns, to be researched, another day.

thanks for reading.