By Pam Martens and Russ Martens: January 3, 2017
Just 17 days from today, Donald Trump will be sworn in as the nation’s 45th President and deliver his inaugural address. Trump is expected to announce priorities in the areas of education, infrastructure, border security, the economy and curtailing the outsourcing of jobs. But Trump’s agenda will be derailed on all fronts if the big Wall Street banks blow up again as they did in 2008, dragging the U.S. economy into the ditch and requiring another massive taxpayer bailout from a nation already deeply in debt from the last banking crisis. According to a report quietly released by the U.S. Treasury’s Office of Financial Research less than two weeks before Christmas, another financial implosion on Wall Street can’t be ruled out.
The Office of Financial Research (OFR), a unit of the U.S. Treasury, was created under the Dodd-Frank financial reform legislation of 2010. It says its role is to: “shine a light in the dark corners of the financial system to see where risks are going, assess how much of a threat they might pose, and provide policymakers with financial analysis, information, and evaluation of policy tools to mitigate them.” Its 2016 Financial Stability Report, released on December 13, indicates that Wall Street banks have been allowed by their “regulators” to take on unfathomable risks and that dark corners remain in the U.S. financial system that are impenetrable to even this Federal agency that has been tasked with peering into them.
At a time when international business headlines are filled with reports of a massive banking bailout in Italy and the potential for systemic risks from Germany’s struggling giant, Deutsche Bank, the OFR report delivers this chilling statement:
“U.S. global systemically important banks (G-SIBs) have more than $2 trillion in total exposures to Europe. Roughly half of those exposures are off-balance-sheet…U.S. G-SIBs have sold more than $800 billion notional in credit derivatives referencing entities domiciled in the EU.”
When a Wall Street bank buys a credit derivative, it is buying protection against a default on its debts by the referenced entity like a European bank or European corporation. But when a Wall Street bank sells credit derivative protection, it is on the hook for the losses if the referenced entity defaults. Regulators will not release to the public the specifics on which Wall Street banks are selling protection on which European banks but just the idea that regulators would allow this buildup of systemic risk in banks holding trillions of dollars in insured deposits after the cataclysmic results of similar hubris in 2008 shows just how little has been accomplished in terms of meaningful U.S. financial reform.
Adding to the potential for another epic crash on Wall Street taking down the entire U.S. economy is data within the OFR report showing how interconnected the big Wall Street banks have become to the largest U.S. insurers through derivatives. This has been allowed to happen despite the fact that the giant insurer, AIG, required a government backstop of $182 billion following the 2008 crash because it had sold credit default protection via derivatives to the big Wall Street banks.
The OFR report includes the following data on life insurers:
“At the end of 2015, U.S. life insurers’ derivatives exposure, as reported in statutory filings, totaled $2 trillion in notional value. This $2 trillion does not include derivative contracts held in affiliated reinsurers, non-insurance affiliates, and parent companies that do not have to file statutory statements. Details on these entities’ derivatives positions are not publicly available.”
Just who is backstopping this $2 trillion in risk? The answer is mind-numbing. The counterparties to the life insurers are the same behemoth Wall Street banks who have their own potential nightmare scenario if there are major European bank defaults. The OFR report indicates the following:
“According to statutory data on insurance company legal entities, nine large U.S. and European banks are counterparties to about 60 percent of U.S. life insurers’ $2 trillion in notional derivatives. These data show that despite central clearing, derivatives interconnectedness between the U.S. life insurance industry and banks remains substantial.”
An accompanying chart shows (in order of magnitude) the following Wall Street banks with the greatest interconnectedness via derivatives to U.S. life insurers: Goldman Sachs, Deutsche Bank, Bank of America, Citigroup, Credit Suisse, Morgan Stanley, Barclays, JPMorgan Chase, and Wells Fargo.
It is impossible to overstate the dangers of this daisy chain of interconnectedness. The Wall Street banks that created the greatest financial collapse since the Great Depression in 2008 have now metastasized their failed derivatives model throughout the life insurance industry of the U.S. – raising the very real specter that in the next crash both massive banks and massive life insurers would require a taxpayer bailout.
Five of the largest U.S. banks that show up on the derivatives counterparty list to the U.S. life insurers, also show up on another list. The OFR report notes:
“The Basel Committee methodology measures banks’ complexity in part by looking at data on notional derivatives positions. These data reflect the nominal value of underlying derivatives contracts. They have been volatile since 2012 but remain highly concentrated among the five largest banks. As with OFR findings on insurance (see Section 2.5), OFR analysis suggests higher derivatives exposures for banks are associated with greater systemic risk.”
The five banks referenced above are: JPMorgan Chase, Citigroup, Goldman Sachs, Bank of America and Morgan Stanley.
The OFR report also indicates that regulators still do not have access to adequate data from the biggest banks and insurers to assess the dangers in real time. The report notes:
“Deficiencies in data and data management remain a critical vulnerability. Data needs remain unfilled, particularly in shadow banking markets. Many of the new data are not ready or available for analysis. Despite progress, the probability remains high that data deficiencies will again prevent risk managers and regulators from assessing risks before it is too late.”
President-elect Donald Trump and his closest advisers should make it their top priority to read this OFR report carefully, reflect on the current and future ramifications of the reckless and irresponsible U.S. banking model on its citizens and economy at large, and immediately begin to press Congress for the restoration of the Glass-Steagall Act upon his swearing in on January 20.
By Pam Martens and Russ Martens: December 28, 2016
Each quarter the Office of the Comptroller of the Currency (OCC) releases a detailed report showing the exposure to derivatives at U.S. banks. The most recent report for the quarter ending June 30, 2016 indicates that U.S. bank holding companies have a total notional amount (face amount) of derivatives of $252.6 trillion. Of that total, just five Wall Street banks hold $230 trillion or 91 percent, underscoring how massively concentrated this high risk game has become. Those five banks are: Citigroup, JPMorgan Chase, Goldman Sachs Group, Bank of America and Morgan Stanley.
There are numerous U.S. units of foreign banks on the derivatives list of bank holding companies but one name is conspicuously missing: the German giant, Deutsche Bank. Without knowing how much potential exposure U.S. banks have to Deutsche Bank in the derivatives arena, the U.S. public is left completely in the dark on just how dangerously exposed our banks are, once again, to the potential failure of a systemically interconnected counterparty. Here’s what we do know – no thanks to the OCC’s copious reports.
From late summer and into the fall of this year, Deutsche Bank was struggling in quick sand with Wall Street banks trading like they were tethered tightly to its sinking hulk. Here’s how Wall Street On Parade reported the situation on September 27:
“Yesterday, Germany’s largest financial institution, Deutsche Bank, lost 7.06 percent by the close of trading on the New York Stock Exchange. That plunge in one of the most globally-interconnected banks dragged down the shares of every major Wall Street bank yesterday: Bank of America lost 2.77 percent; Morgan Stanley declined by 2.76 percent; Citigroup lost 2.67 percent; Goldman Sachs shed 2.21 percent; and JPMorgan Chase closed down 2.19 percent. Deutsche Bank, whose shares traded at more than $120 pre-crisis in 2007, closed at $11.85 yesterday in New York and was down another 3 percent in overnight trading in Europe.”
Since October, Deutsche Bank has recovered some lost ground, closing yesterday on the New York Stock Exchange at $18.37. That trading price, unfortunately, still puts it at a share price loss of 86 percent over the past decade.
A major global bank bleeding gobs of equity value is cause enough for concern but Deutsche Bank raises other serious red flags to the U.S. banking system. According to a report released in June of this year by the International Monetary Fund (IMF), Deutsche Bank is “the most important net contributor to systemic risks.” The researchers wrote:
“Notwithstanding moderate cross-border exposures on aggregate, the banking sector is a potential source of outward spillovers. Network analysis suggests a higher degree of outward spillovers from the German banking sector than inward spillovers. In particular, Germany, France, the U.K. and the U.S. have the highest degree of outward spillovers as measured by the average percentage of capital loss of other banking systems due to banking sector shock in the source country…
“Among the G-SIBs [Global Systemically Important Banks], Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse…The relative importance of Deutsche Bank underscores the importance of risk management, intense supervision of G-SIBs and the close monitoring of their cross-border exposures, as well as rapidly completing capacity to implement the new resolution regime.”
The report includes the graph below, indicating that a blowup at Deutsche Bank would spill out to every major Wall Street bank — banks which are holding almost half of the insured savings deposits in the U.S. – effectively mandating more massive taxpayer bailouts such as those that occurred in 2008.
In February 2005, the U.S. Treasury’s Office of Financial Research also quietly warned that U.S. banks were using foreign counterparties for their derivative trades, writing as follows:
“Surprisingly, OTC derivatives contributed only about half as much to intrafinancial system liabilities ($632 billion) as to intrafinancial system assets ($1.2 trillion). Across all OTC market participants, derivatives assets must equal derivatives liabilities, so this imbalance indicates that the U.S. banks held large positive OTC derivatives positions with financial institutions outside this group.”
If all of this wasn’t concerning enough, the very type of derivatives that blew up the giant insurer AIG in 2008 (credit derivatives) are making a big comeback at Citigroup, the recipient of the largest taxpayer bailout of a bank in U.S. history during the 2008 crash. The OCC’s June 30 report shows Citigroup’s holding company with $2.2 trillion in credit derivatives and $53.6 trillion in total notional amount of derivatives — at a bank holding company with only $1.8 trillion in assets.
According to a January 2016 report in Risk Magazine, Citigroup bought $250 billion of credit derivatives from Deutsche Bank in 2013. The same article indicates that Citigroup is now considered one of the top three market makers in single name Credit Default Swaps in both North America and Europe. In her book, Bull by the Horns, Sheila Bair, the Chair of the Federal Deposit Insurance Corporation (FDIC) at the time of Citigroup’s implosion in 2008, singles out credit derivatives as one of the factors leading to Citigroup’s epic crash to a penny stock. Bair writes: “It was taking losses on credit default swaps entered into with weak counterparties….”
The OCC is the dominant regulator of national banks. According to its 2015 Annual Report, it has 3,959 employees and a budget of $1.09 billion. It has bank examiners stationed at the major Wall Street banks. According to its Annual Report, its regulatory model “makes it possible for examiners, bank managers, and the board of directors to identify changes in the bank’s risk profile at an early stage, which in turn provides additional time, if necessary, to develop and implement strategies for mitigating that risk.”
That statement would clearly be more reassuring to Americans had not the largest bank in the U.S. in 2008, Citigroup, blown itself up while lying to the public and its shareholders about its exposure to subprime debt and holding more than $1 trillion in assets off its balance sheet.
The OCC’s reassurance would also be more believable had JPMorgan Chase not lost more than $6.2 billion of its depositors’ money gambling in high risk derivatives in London in 2012 – just four years after the biggest financial crash since the Great Depression and just two years after the Dodd-Frank financial reform legislation was supposed to have restored sanity to the U.S. banking system.
The OCC urgently needs to defog its lenses and defang the derivative entanglements at the biggest Wall Street banks.