By Pam Martens and Russ Martens: December 6, 2022 ~
United States Treasury Secretary Janet Yellen has the dual role of chairing the Financial Stability Oversight Council (F-SOC), whose role is to provide “comprehensive oversight of the stability of the financial system of our nation”. The heads of each of the federal agencies that oversee Wall Street and the mega banks attend F-SOC meetings.
You’d think such an august body would get a handle on the “staggering” threats to the US financial system – especially since the F-SOC was created under the Dodd-Frank Financial Reform Act of 2010 to prevent a repetition of off-balance sheet derivatives. which collapsed the US economy in 2008 and forced an unprecedented and secret bailout of US and foreign global banks by the Federal Reserve to the tune of $29 trillion. While Yellen is aware of the latest threat to financial stability, she does not share the details with the public. This information came yesterday through an amazing report written by Claudio Borio, Robert McCauley and Patrick McGuire for the Bank for International Settlements (BIS).
The report focuses on the amount of derivative debt that is not captured in regular statistical reports because it is not recorded on the balance sheet. These derivatives consist of currency swaps, forward contracts and currency swaps. The authors call this exposure “staggering,” but focus primarily on the potential for upheavals in dollar swap lines to settle it at maturity. Of greater concern, in our estimation, is this line from the report: “For banks headquartered outside the United States, the dollar debt of these instruments is estimated at $39 trillion, or more double their dollar debt on the balance sheet and more than 10 times their capital. Their dollar debt on the balance sheet is $15 trillion.
This is reminiscent of Goldman Sachs engaging in derivatives trading with Greece to hide its mountain of debt before it exploded.
Global foreign banks are – for better or worse – an integral part of the US financial system. In times of crisis, such as the Wall Street implosion in 2008 or the pandemic in 2020, the Federal Reserve bails out global foreign banks as well as global domestic banks. Why does it do that? Because the trading units of foreign global banks, as well as domestic global banks, constitute what the Fed calls its “primary traders.” Primary dealers are contractually obligated to purchase US Treasury securities at each US Treasury auction and to negotiate with the New York Fed to carry out Federal Reserve monetary policy.
Since the 2008 financial crisis and the eventual disclosure of unprecedented Fed bailouts, the Fed has put on a great show performing stress tests and boasting about the high level of capital it requires from G-SIBS (Global Systemically Important Banks). Thus, learning yesterday from the Bank for International Settlements that foreign banks have $39 trillion in derivative debt which does not appear on their balance sheets and which represents “10 times their capital” causes the Fed, the F-SOC and its president, Janet Yellen, looks very Alan Greenspan-esque. Greenspan, chairman of the Fed for an unprecedented 19 years from 1987 to 2006, was asleep as Wall Street piled up its toxic off-balance sheet derivatives that would blow up the US economy in 2008. Greenspan had opposed regulation of derivatives.
Of equal concern to Yellen, Congress, and all committed Americans is the fact that it only takes one highly interconnected global bank (foreign or domestic) to unleash a wave of contagion in global financial markets. And, there is no doubt that the counterparties to a significant amount of that $39 trillion in foreign bank off-balance sheet derivative debt are the big five derivative banks in the United States: JPMorgan Chase, Goldman Sachs, Citigroup, Bank of America and Morgan Stanley.
How do we know this? Because the Office of the Comptroller of the Currency publishes a “Quarterly Report on Banking Trading and Derivatives Activities.” In the most recent report for the second quarter of this year, the five bank holding companies listed above accounted for $221.539 trillion in notional derivatives exposures, or 84% of the derivatives exposures of the top 25 holding companies. banking portfolio in the United States (see Table 14 in the appendix of the OCC report linked above.)
Plus, it’s not like the stock prices of these global foreign banks aren’t screaming that there’s a big problem. Credit Suisse (Ticker CS) closed yesterday at $3.34, 35 cents off its all-time low and down 65% year-to-date. Mizuho Financial Group (Ticker MFG) is also trading in the low single digits, closing in New York yesterday at $2.38. Mizuho’s share price has failed to recover significantly since the 2008 financial crisis. Large German lender, Deutsche Bank, is also facing significant headwinds. Shares of Deutsche Bank closed at $10.60 yesterday in New York, less than a fifth of its share price during the 2008 financial crisis.
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