Last week, I was talking to my friend, Landon Rowland. Landon is the kind of guy who knows what is going on in the business world. He's highly respected as a national leader in the industrial space, having run a major railroad. But he's also Chairman Emeritus of Janus Capital, he understands finance like the back of his hand, and he is a major civic leader with a deep knowledge of politics and the regulatory world. Last week, he says to me, "Dylan, no matter who I talk to, no one can give me the total American bank exposure to the Eurozone." Landon knew how much his own bank stood to lose directly if the Eurozone banks couldn't pay their debts, but as to the total risk to our system, no way. He couldn't find out. And it's not because people were keeping secrets, it's probably because no one knows. So the danger is that some random strikes in Greece, a country whose economy is the size of Dallas, could set off a chain reaction destroying the American banking system.
The world's financial system is so tightly linked, so tightly coupled, that semi-random events halfway around the world with zero real economy impact on anything American can still crash our economy. And the links are opaque, so we don't really know who is vulnerable or how to firewall off the real economy from financial speculation.
The root cause is something I've written about in my book, Greedy Bastards: leverage. Leverage means borrowing money and using the proceeds to invest or speculate -- it's a way to multiply gains and losses. Leverage isn't good or bad -- like dynamite, it can be used on construction projects, or as a dangerous weapon. When you buy a house with a mortgage, you're using leverage. When you borrow from your father to go gambling in Las Vegas, that too is a form of leverage. And let's not even get to complex betting instruments used by big banks known as derivatives, because then leverage starts to get dangerous.
Leverage matters on a systemic level because it is the mechanism that links your financial condition to that of your debtors and creditors. You might look solvent, or even wealthy, but if one of your debtors goes under can't pay you back, suddenly you are broke too. And then your own creditors might also be broke, and on up the chain. If enough entities are borrowing and lending enough money to each other, the net effect is that their balance sheets effectively combine into one mega-balance sheet. Since you look wealthy, neither you nor regulators would even know how close to going bankrupt you might actually be. This is why Federal Reserve Chairman Bernanke called the subprime crisis "contained" in 2007. He thought, like many officials, that there would be a mild economic disruption due to falling housing prices, but he had no idea that the entire financial system was on the verge of a meltdown. He simply didn't know how interlinked subprime mortgages had become with global bank balance sheets.
When you prudently borrow money to buy a house or build a factory, you are investing in the future using leverage. But when a bank uses fancy complex derivatives through opaque secret deals, a bank is linking its balance sheet to risks it may not understand and to systemic threats regulators can't track. Banks are essentially making money by throwing dynamite into random mine shafts and hoping they dig a gold mine. Goldman Sachs and JP Morgan have written credit protection on $5 trillion of global debt, but can't say how much is Eurozone debt. This is why our markets have gone crazy -- last week, the Dow jumped by 400 points in one day, after swooning in November and nearly crashing in August. Asset prices these days reflect guesses about which stick of dynamite will go off, as opposed to doing what markets are supposed to do, which is reflect prudent profit making potential of securities and credit instruments.
When balance sheets are linked across the world, that creates the possibility of a systemic collapse. One day, you're wealthy, the next day, you're insolvent, and so is everyone you know. Secrecy magnifies the problem, because it means that we cannot prepare for shocks. None of this is inherent. If derivatives were put on exchanges with multiple bidders and sellers, at least we could more easily see price movements that indicate risks. As Gretchen Morgensen reported, the financial reform bill passed in 2010, known as Dodd-Frank, actually accomplishes this. Last week, however, Democratic Congresswoman Carolyn Maloney and Republican Congressman Scott Garrett passed a bill in the House Financial Services Committee to gut the main provision forcing a mandatory display of pricing. This kind of bipartisan collusion is increasing risks to our system. Policy-makers like Maloney and Garrett, bought as they are by bankers, are making it worse. They are the reason that neither my friend Landon Rowland nor anyone else can figure out our banks' Eurozone exposure.
The scale of the problem is enormous, but so is the scale of the opportunity. As I write in my upcoming book, there are three paths out of this trap. One, we can hope that the problem goes away, as we've done before when previous shocks (like the East Asian crisis) have hit the financial system. Two, we can prepare for the social unrest coming due to policies that retain this tightly coupled poverty-inducing policy framework. Possible consequences to prepare for include increasing nationalism, a trade war, or even real wars. Or three, we can engage in a Marshall Plan style debt restructuring now, to write down debts to a manageable level. This is the global solution, and hopefully, we'll do it before a cataclysmic event.
I did podcasts with Morgensen on this problem, as well as blogger Yves Smith of Naked Capitalism and financial analyst Chris Whalen. I would give them a listen, because it's clear we're in serious trouble, but also that we have an enormous opportunity in front of us. The volatility we're seeing in our credit and equity markets is an indication that we're heading off the rails. And it's not just a few people carping about the problem -- legendary investor George Soros says the system is on the brink of collapse.
So it's time to grab a hold of this scary problem, and build the society we want.
Follow Dylan Ratigan on Twitter: www.twitter.com/DylanRatigan
I'm almost ready to say, "the system has gotten away from us - let these dogs have their day - let the system CRASH - let the bodies hit the floor...
for that's the ONLY way Americans will listen and rise up for a "Call to Action" and stand up to the corruption.
As you clearly point out - even the band aids that are affixed to the problems - are stripped away by corrupted public servants.
...and we allow it.
That is nothing new. What is new is this absurd notion that the taxpayers need to
cover any private bets. This "too big to fail" scam is the biggest rip-off in modern history.
That goes for grandma's savings account or BofA's balance sheet.
You can buy insurance to cover losses. It is not a government responsibility,
especially when the banks can be as reckless as they want, and the insurance
is still free. Usually reckless behavior has consequences, but not for banks anymore!
www.offthegridmpls.blogspot.com
If they were called insurance, they would have to be regulated as insurance. In fact they are closer to bets. Apparently, you don't even have to have any interest in what is being insured. That is as if I could get insurance on your house even though I haven't a penny invested in it. However, I now have an interest in your house burning down.
Will you be wanting a CDS on that mortgage sir? It now matters not one iota to the lender whether or not the borrower can pay, in fact it is better if he doesn't. If defaulted, the CDS pays out and the lender forecloses.
Greece for instance has X amount of bonds outstanding. Yet the amount of insurance against those bonds defaulting is far larger than the amount at risk. How could that possibly be? If I insure my car, I can only insure it at most, for the actual value. A credit default swap can be purchased to insure a given bond, whatever, even if I don't own it. Ludicrous.
So if you want to start winding down the leveraging, start by making one simple rule. You can't buy a hedge, a credit default swap, insurance on something you don't own, period. If you don't own a Greek bond, then you can't buy insurance to protect you against a default. You have no potential loss to insure. You've got not skin in the game.
So, start there. If you don't own the underlying asset, you can't own any insurance or hedge against its failure. This alone would drop a huge amount of the overall derivatives value right off the balance sheets.
Are the managers at these banks that dumb, or are they corrupt? They have had plenty of opportunity to unload these positions, why don't they?
I'm for the Marshall Plan idea. The power elite will just have to take a multiple trillion dollar hit...
-End the secrecy of the banks and the Federal Reserve.
-End the corruption in Congress.
-Let the banks engaged in bad risky investments meltdown just crash. They knew investments in Greece were risky. It won't be a win-win situation all the time for them.
One World is enough for all of us.
One world is enough for all of us.
We all sink or we all float,
Because we're all in the same debt boat.
A. Grundrisse author of the blog "NOT the Wall Street Journal" available at notthewallstreetjournal.blogspot.com
Capital suppliers like Lenders need to achieve a certain rate of return on capital. The rate of return on capital is calculated by multiplying the spread between the interest rate charged and the cost of its money by the leverage factor and adding that result to the interest rate charged. In a simple illustration imagine the desired rate of return is 8 %. At 100 to one leverage the necessary spread is about 80 basis points. At four to one leverage the spread must be about 200 basis points. At zero leverage the spread must be the full 8 percent. So reducing leverage will inevitably and directly result in increased interest rates. These increased interest rates would have widespread, devastating effects on the economy overall; to give just a couple obvious examples, reduced leverage ( and the accompanying increase in interest rates ) will result in a dramatic further decline in real estate prices and increases in interest rates on government debt, which will of course exacerbate the already existing government debt crisis. This is not to say that leverage is unambiguously positive, just that it has become deeplyembedded in the current financial system -- indeed it can fairly be said the financial system is addicted to leverage --and any attempt to wean us of it may in fact kill the patient.
A. Grundrisse NOTTheWallStreetJournal.blogspot.com
We've exposed the failures of this system adnauseum for over a decade now. It's up to those with the power to do something - to DO IT.
The social and security fabric of our country is collapsing. Even if it's something unprecedented and radical, the system needs to be turned on its head.
Who or what is going to decouple the global leverage system?
I guess we could bring back Herman Cain.
Hey I know let's reelect Obama he has done such a great job already!
What about the ghost of Paul Revere's horse?
What Dylan is the "something" we could do that would fix these huge problems before it is too late? I think by now millions upon millions of US citizens are aware. So what to do? Occupy what? Do what?
I am serious, we have to inquire about solutions and leadership. I do not hear any. I do not see any. I do not sense a discussion going on. These comments are not getting us anywhere either. So Dylan what is there in your opinion?
A chain of events will happen from here ---