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Financial Weapons Of Mass Destruction: The Top 25 U.S. Banks Have 222 Trillion Dollars Of Exposure To Derivatives May 15, 2017

The recklessness of the “too big to fail” banks almost doomed them the last time around, but apparently they still haven’t learned from their past mistakes.  Today, the top 25 U.S. banks have 222 trillion dollars of exposure to derivatives.  In other words, the exposure that these banks have to derivatives contracts is approximately equivalent to the gross domestic product of the United States times twelve.  As long as stock prices continue to rise and the U.S. economy stays fairly stable, these extremely risky financial weapons of mass destruction will probably not take down our entire financial system.  But someday another major crisis will inevitably happen, and when that day arrives the devastation that these financial instruments will cause will be absolutely unprecedented.

During the great financial crisis of 2008, derivatives played a starring role, and U.S. taxpayers were forced to step in and bail out companies such as AIG that were on the verge of collapse because the risks that they took were just too great.

But now it is happening again, and nobody is really talking very much about it.  In a desperate search for higher profits, all of the “too big to fail” banks are gambling like crazy, and at some point a lot of these bets are going to go really bad.  The following numbers regarding exposure to derivatives contracts come directly from the OCC’s most recent quarterly report (see Table 2), and as you can see the level of recklessness that we are currently witnessing is more than just a little bit alarming…

Citigroup

Total Assets: $1,792,077,000,000 (slightly less than 1.8 trillion dollars)

Total Exposure To Derivatives: $47,092,584,000,000 (more than 47 trillion dollars)

JPMorgan Chase

Total Assets: $2,490,972,000,000 (just under 2.5 trillion dollars)

Total Exposure To Derivatives: $46,992,293,000,000 (nearly 47 trillion dollars)

Goldman Sachs

Total Assets: $860,185,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $41,227,878,000,000 (more than 41 trillion dollars)

Bank Of America

Total Assets: $2,189,266,000,000 (a little bit more than 2.1 trillion dollars)

Total Exposure To Derivatives: $33,132,582,000,000 (more than 33 trillion dollars)

Morgan Stanley

Total Assets: $814,949,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $28,569,553,000,000 (more than 28 trillion dollars)

Wells Fargo

Total Assets: $1,930,115,000,000 (more than 1.9 trillion dollars)

Total Exposure To Derivatives: $7,098,952,000,000 (more than 7 trillion dollars)

Collectively, the top 25 banks have a total of 222 trillion dollars of exposure to derivatives.

If you are new to all of this, you might be wondering what a “derivative” actually is.

When you buy a stock you are purchasing an ownership interest in a company, and when you buy a bond you are purchasing the debt of a company.  But when you buy a derivative, you are not actually getting anything tangible.  Instead, you are simply making a side bet about whether something will or will not happen in the future.  These side bets can be extraordinarily complex, but at their core they are basically just wagers.  The following is a pretty 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.

Those that trade derivatives are essentially engaged in a form of legalized gambling, and some of the brightest names in the financial world have been warning about the potentially destructive nature of these financial instruments for a very long time.

In a letter that he wrote to shareholders of Berkshire Hathaway in 2003, Warren Buffett actually 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.

Warren Buffett was right on the money when he made that statement, and of course the derivatives bubble is far larger today than it was back then.

In fact, the total notional value of derivatives contracts globally is in excess of 500 trillion dollars.

This is a disaster that is just waiting to happen, and investors such as Buffett are quietly positioning themselves to take advantage of the giant crash that is inevitably coming.

According to financial expert Jim Rickards, Buffett’s Berkshire Hathaway Inc. is hoarding 86 billion dollars in cash because he is likely anticipating a major stock market downturn…

Far from a bullish sign, Buffett’s cash hoard could mean he’s preparing for a market crash. When the crash comes, Buffett can walk through the wreckage with his checkbook open and buy great companies for a fraction of their current value.

That’s the real Buffett style, but you won’t hear that from your broker or wealth manager. If Buffett has a huge cash allocation, shouldn’t you?

He knows what’s coming. Now you do too.

Warren Buffett didn’t become one of the wealthiest men in the entire world by being stupid.  He knows that stocks are ridiculously overvalued at this point, and he is poised to make his move after the pendulum swings in the other direction.

And he might not have too long to wait.  In recent weeks I have been writing about many of the signs that the U.S. economy is slowing down substantially, and today we received even more bad news

Despite high levels of economic confidence expressed by business owners and consumers, one key indicator shows that it has not translated into much action yet.

Loan issuance declined in the first quarter from the previous three-month period, the first time that has happened in four years, according to an SNL Financial analysis of bank earnings reports filed for the period. The total of recorded loans and leases fell to $9.297 trillion from $9.305 trillion in the fourth quarter of 2016.

This is precisely what we would expect to see if a new economic downturn was beginning.  Our economy is very highly dependent on the flow of credit, and when that flow begins to diminish that is a very bad sign.

For the moment, financial markets continue to remain completely disconnected from the hard economic data, but as we saw in 2008 the markets can plunge very rapidly once they start catching up with the real economy.

Warren Buffett is clearly getting prepared for the crisis that is ahead.

Are you?

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Global Financial Markets Plunged Into Chaos As Italy Overwhelmingly Votes ‘No’ December 4, 2016

italy-flag-map-public-domainItalian voters have embraced the global trend of rejecting the established world order, but the “no” vote on Sunday has plunged global financial markets into a state of utter chaos.  The euro has already fallen to a 20 month low, Italian government bonds are poised for a tremendous crash, and futures markets are indicating that both U.S. and European stock markets will be way down when they open on Monday.  It is being projected that Italian Prime Minister Matteo Renzi’s referendum on constitutional reforms will be defeated by about 20 percentage points when all the votes have been counted, and Renzi has already announced that he plans to resign as a result.  When new elections are held it looks like comedian Beppe Grillo’s Five-Star movement will come to power, and the European establishment is extremely alarmed at that prospect because Grillo wants to take Italy out of the eurozone.  In the long run Italy would be much better off without the euro, but in the short-term the only thing propping up Italy’s failing banking system is support from Europe.  Without that support, the 8th largest economy on the entire planet would already be in the midst of an unprecedented financial crisis.

I know that I said a lot in that first paragraph, but it is imperative that people understand how serious this crisis could quickly become.

This “no” vote virtually guarantees a major banking crisis for Italy, and many analysts fear that it could trigger a broader financial crisis all across the rest of the continent as well.

Just look at what has already happened.  All of the votes haven’t even been counted yet, and the euro is absolutely plummeting

The euro dropped 1.3 percent to $1.0505, falling below its 1 1/2-year low of $1.0518 touched late last month, and testing its key support levels where the currency has managed to rebound in the past couple of years.

A break below its 2015 March low of $1.0457 would send the currency to its lowest level since early 2003, opening a way for a test of $1, or parity against the dollar, a scenario which many market players now see as a real possibility.

In early 2014, there were times when one euro was trading for almost $1.40.  For a very long time I have been warning that the euro was eventually heading for parity with the U.S. dollar, and now we are almost there.

Meanwhile, Italian government bonds are going to continue to crash following this election result.  This is going to make it even more difficult for the Italian government to borrow money, and that will only aggravate their ongoing financial troubles.

But the big problem in Italy is the banks.  At this moment there are eight banks in imminent danger of collapsing, and virtually all of the rest of them are in some stage of trouble.  The following comes from a Bloomberg article about the crisis that Italian banks are facing right at this moment…

They’re burdened with a mountain of bad loans. Their stocks have cratered. And they have to operate in an economy prone to recession and political upheaval.

Signs have been mounting for months that Italy’s weakest lenders, and in particular Banca Monte dei Paschi di Siena SpA, were sliding toward the precipice, threatening to reignite a broader crisis.

And we may get some news regarding the fate of Banca Monte dei Paschi di Siena as early as Monday morning if what the Sydney Morning Herald is reporting is correct…

A last-gasp rescue for Monte dei Paschi di Siena, the world’s oldest surviving bank, has been thrown into doubt after reformist prime minister Matteo Renzi decisively lost a referendum on constitutional reform on Sunday.

MPS and advisers JPMorgan and Mediobanca will meet as early as Monday morning to decide whether to pull a plan to go ahead with a €5bn recapitalisation, the FT reports, citing people informed of the plan.

Senior bankers will decide whether to pursue their underwriting commitments or exercise their right to drop the transaction due to adverse market conditions, these people said. In the event the banks drop the capital plan, the Italian state is expected to nationalise the bank, say senior bankers.

If Banca Monte dei Paschi di Siena fails, major banks all over Italy (and all over the rest of Europe) could start going down like dominoes.

So what were Italians voting on anyway?

Well, the truth is that the constitutional reforms that were proposed actually sound quite boring

“The changes involve sharply reducing the size of one of the chambers of Parliament — the Senate — shifting its powers to the executive, and eliminating the Senate’s power to bring down government coalitions.

“The amendments also shift some powers now held by the regions to the central government, thereby reducing frequent and lengthy court battles between Rome and the regional governments.”

The reason why this vote was ultimately so important is because it became a referendum on Renzi’s administration.  The fact that he announced in advance that he would resign if it did not get approved gave a tremendous amount of fuel to the opposition.

So now Beppe Grillo’s Five-Star Movement stands poised to come to power, and that could be very bad news for those that are hoping to hold the common currency together.

The following is how NPR recently summarized the main goals of the Five-Star Movement…

“It calls for a government-guaranteed, universal income, abolishing Italy’s fiscal commitments to the European Union and a referendum on Italy’s membership in the Euro — a prospect that could unravel the entire single currency Eurozone.”

If Italy chooses to leave the euro, it will probably mean the end of the common currency, and the continued existence of the entire European Union would be called into question.

So this vote on Sunday was huge.  The Brexit had already done a tremendous amount of damage to the long-term prospects for the European Union, and now the crisis in Italy is sending political and financial shockwaves throughout the entire continent.

Over the next few weeks, keep a close eye on the euro and on Italian government bonds.

If they both continue to crash, that will be a sign that a major European financial crisis is now upon us.

And what happens in Europe definitely does not stay in Europe.

If Europe goes down, we are going to go down too.

At this point we still have almost a month left in 2016, but 2017 is already shaping up to be a very troubling year.  As always, let us hope for the best, but let us also keep preparing for the worst.

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