It’s going to be an explosive fall, financially speaking, regardless of what transpires in the Middle East. The culmination of faux regulation, debt ceiling debates, derivatives growth and the ever-expanding Federal Reserve books will provide lots of volatility- for which the White House will be caught unprepared.
In the wake of the Great Crash of 1929, FDR and Congress passed an act to isolate people’s deposits from the speculative pursuits of financiers. The Glass-Steagall or Banking Act of 1933, was even promoted by some of the biggest bankers of the time, as I will explain in greater detail in All the Presidents’ Bankers.
Their reasons were self-serving, yet they also helped the population. They wanted a safer banking structure, they wanted citizens to feel more confident in the financial system that they dominated, and they were willing to forego their trading and securities creation operations to achieve this goal. They were willing to become smaller and substantively less risky in accordance with the Act that FDR signed on June 16, 1933.
We got nothing like that legislation this time around, just a lot of talk about ‘sweeping reform.’ President Obama signed the Dodd-Frank Act in July, 2010 to supposedly protect consumers from Wall Street. But it did not make big banks smaller. It did not separate their speculative / securities creation ability from their FDIC backed deposit and lending business. It did not require banks to dramatically reduce their derivatives positions, the leverage imbedded in complicated assets, or the dangerous chains of inter-dependent exposures to other firms.
Despite billion of dollars of fines, which mean little in the scheme of their bottom lines, the biggest banks are bigger and more complex than ever, and thus, their leaders more sheltered by Washington. Unnecessary global risk remains in the system. We need banking reform ala Glass-Steagall. Anything less is an exercise in political posturing and regulatory futility, no matter how many back-pats accompany the procedure.
Derivatives Take over the World
Last quarter, the total notional value of US banks’ derivatives positions increased by $8.5 trillion to $232 trillion, still mostly concentrated in interest rate products. Credit derivatives, 6% of the total, increased 5.4% to $13.9 trillion. The four largest banks account for 93% of that amount, and 81% of industry credit exposure, 36% of it below investment grade.
The total assets of JPM are $1.95 trillion and total derivatives notional $70.3 trillion, or more than 35 times its asset amount. Citigroup has $1.3 trillion in assets and $58 trillion in derivatives notional. Bank of America has $1.4 trillion in assets and $44 trillion in derivatives, and Goldman has $133 billion in assets and $42 trillion in derivatives. Banks will say they are hedged, notional volume does not equate to the total potential loss, but that just doesn’t matter. In the event that one area of the market or one firm goes belly up, the rest follow. No mega-bank is isolated from the others, though some are more politically connected, have more lobbyists, or are better subsidized than others.
Before the fall of 2008, US banks’ notional derivatives exposure was $180 trillion. Then, five banks held 97% of that notional, and 85% of the industry’s net credit exposure. The concentration of risk and amount of derivatives has increased, since before the government orchestrated bank bailout and subsidization, and Dodd-Frank.
There are $564 trillion worth of notional over-the-counter derivatives that the Bank of International Settlements (BIS) knows about, as of June 2013. America’s global derivatives presence, has now eclipsed its comparative military expenditures; the US is responsible for 39% of the world total of $1.7 trillion of such expenditures, but US banks account for a whopping 41%, and JPM for 12.4%, of the world’s derivatives.
Debt Ceiling Drama
In the backdrop of ongoing discourse conducted by minions of lobbyists over the minutia of Dodd-Frank that can be still be deliberated to keep them employed, comes the major déjà vu non-debate of the season, resurfacing from two years ago – that of the infamous Debt Ceiling. Tune it out. For, Congress will do a lot of partisan grumbling and then vote to raise the debt ceiling anyway.
In the highly unlikely event that it doesn’t, the US is in no danger of defaulting on its debt. At its current credit rating, it’s many notches away from that, plus, it just won’t happen. S&P pre-empted even the potential of a downgrade in June, when it raised its outlook from ‘negative’ to ‘stable’ and left the rating at AA+, citing the Fed’s “timely and conservative actions” to mitigate the effects of the “great recession” of 2008 and 2009 and noted it expects the US economy to match or top other highly rated countries in the next few years.
And, even in a pinch, the Fed is holding about $2 trillion worth of Treasury securities in excess reserves. Technically, these could be returned or sold– which won’t occur because that would mean the end of Zero-Interest-Rate-Policy, an even tighter credit market and plummeting stock and bond market. Congress and Bernanke won’t let that happen.
For the record, I’d retire that $2 trillion in debt, since it’s doing nothing productive anyway, which would alleviate the need to discuss raising the debt ceiling, or put it to some productive job-creating purpose, so we wouldn’t have to hear Bernanke talk about the need for more jobs to be created, while presenting no concrete ideas as to how to do that. Oh gee, I have an extra $2 trillion lying around here, what to do?
But none of that matters. Since Obama came to office, the debt limit has been increased from $10.6 trillion in 2008 to $16.394 trillion now. Under Bush, the debt limit rose from $5.95 trillion to $10.6 trillion. Republican and Democrat controlled bodies of Congress approved the steps along the way. They will again.
Epic Inequality and Excess Capital of the Wealthy
While hundred of trillions of dollars of derivatives and trillions of dollars of debt swirl around the bankosphere, the top 10 percent of earners nabbed more than half of the country’s total income in 2012, the highest level recorded since the government began collecting income data in 1917, according to the latest study by noted Economists, Emmanuel Saez and Thomas Piketty.
These are sad, but unfortunately not shocking results. Income and wealth inequality will continue to grow because of the wealth-accumulation effect of excess capital investment in a political system whose restrictions on damaging financial speculation are so lax. In this construct, it still “takes money to make money.” During the pre-Depression years of the 1920s, investors with more ‘cash to burn’, could – and did - take more investment risks like speculating in the stock market or the various trusts, than those living from paycheck to paycheck. Those with less excess capital to begin with, that did chose to invest it more speculatively, or that were otherwise impacted by losses related to the speculation of others and the general economic crisis (losing jobs because their employers had borrowed or invested recklessly and were cut off from bank loans to run payrolls as banks shut or entered hoarding-survival mode), had no financial cushion for necessary expenses, let alone investments later.
Still during and after the Great Depression, for several decades, inequality shrank because even the wealthier investors chose to behave more prudently, and the financial institutions were forced to by legislation.
Today, more complex investing and speculating avenues abound - from stock market options to credit derivatives to commodities indices - through advanced technology and the sheer scope and opaqueness of the practices of major players.
What is particularly scary about the timing of this study, is that it did not take place during the build-up to this financial crisis, which would have been a more even parallel to the 1920s build-up before the 1929 Crash and 1930s Great Depression. Instead, these results were tabulated after the height of this recent crisis - the plummeting of the stock market in 2009, the escalating foreclosures, and the restriction of credit to individuals and small businesses. The resurgence of the stock market - on the back of the Fed’s Zero-Interest-Rate and QE programs and other forms of cheap capital made available to the banks, and the hedge funds, and other wealthy individual clients to which they cater - has increased capital returns for these participants, but not helped those with less excess capital to begin with that continue struggling for jobs, more livable wages, more affordable health-care and education, and are under mounting other daily expenses.
This time around, there has been a marked divergence in the thing that the White House and Main Stream press calls a “recovery” that renders our overall economy in a more precarious position for more people. The Saez-Piketty study is another indicator that this “recovery” was for the banks and that were disproportionally subsidized by the Fed, Treasury and government policies, and for their wealthy clients and customers that could afford to pick up and churn cheap assets. It was not for the general population.
The Fed and the Fat
Meanwhile, the US bank subsidization exercise isn’t over. It’s in its fifth year. Despite all the will-he-or-won’t-he speech analysis games, the Fed remains an active buyer of securities from banks and holder of treasuries in excess reserve. Since the Fed instituted its plan to buy $85 billion per month (up from an original $40 billion, why be incremental when you can double-down?) – or more than $1 trillion per year – of mortgage securities from banks, its actions have artificially boosted the prices of those securities and related ones. This provides the illusion of a healthier banking system.
The Fed continues to shatter its own records monthly, now holding a total of $3.6 trillion of debt securities on its books, about ten times the figure of 5 years earlier (in July 2008), including $2 trillion of US Treasuries in excess reserve balances maintained by banks at the Fed, receiving .25% interest. The Fed’s mortgage backed securities component is $1.3 trillion, up from zero 5 years ago. None of this helps the general economy, all of it helps interest rates remain low, securities prices high, and money cheap for the big banks.
And, not only are banks coddled by the Fed, they are sitting on record amounts of cash. JPM Chase, for instance, is holding a record $345 billion in cash, just to protect itself, while its earnings statements say things are fine. Hoarding is never a sign of stability.
Then, there’s Larry
As the Fed’s books bulge at the seams, chatter about who the next Fed Chairman will be, persists. Given his proven tendency to populate his inner economic circle with Clintonite-Rubinites, it makes perfect sense for Obama to go with his former economic advisor, and Clinton’s former Treasury Secretary, Larry Summers – if Summers wants the job. Obama has verbally applauded Bernanke many times for saving the country from a Depression (while ignoring the risk, that his policies are infusing into the economy that will manifest after he leaves office). Summers was there through the ‘tough times’ too.
Wall Street will be as happy with Summers in Bernanke’s chair, as they were when Summer’s replaced Robert Rubin as Treasury Secretary under Clinton, days after Congress passed the Financial Modernization Act that repealed the last remnants of the Glass-Steagall Act, and present for Clinton's signing ceremony. Plus, when Hillary Clinton runs for president, she will need all of Rubin’s circle of campaign contributors. What better way to secure them, than to also have an old friend that understands their need to remain ‘globally competitive’ at the Fed? Summers, fresh from a Citigroup-arranged, Kuwait Investment Authority sponsored May talk in Kuwait, would also keep relations with the Middle East sweet for his banker friends.
Obama’s argument for Summers, after he retrieves his foot from his mouth regarding Syria, will be continuity, just as it was for Bernanke’s reappointment, and as it was Bush’s argument for Bernanke after Alan Greenspan. Continuity is a big theme with Congress and with bankers, too. Ergo.