Nine major financial firms collapsed during the 2007-09 timeframe and, according to retired Fed Chairman Bernanke, 12 out of the 13 largest financial firms were in critical condition. Could a retail mortgage crisis have caused such a ruckus? Heavens no, but the concept of firms attempting to speculate their ways out, of crises they created themselves, is highly possible.
The Dodd-Frank bill was supposed to be the cure-all against a repeat performance. President Obama tried very hard early on to get a serious regulatory bill passed. What finally did pass was the typical watered down version but with a Volcker Rule. This rule is supposed to keep these institutions from being able to speculate for their own accounts. We’ll see. One provision of the bill called for a central repository, of sorts, where private derivatives would have an exchange on which to trade. Five years later, no one has built that exchange. Lobbyists? You bet. So much for transparency.
Just in case you think I’m pulling your legs regarding private derivatives and the dangers they represent, take a look at the front page of the “Money and Investing” section of the Wall Street Journal dated Tuesday, February 11, 2014. You’ll find an informative article on the Detroit bankruptcy and one of the main firms that loaded that city up with interest rate swaps. I was surprised to see that article on any front page. Many times inflammatory articles are relegated to Page 26 of Section D and published only in Saturday morning editions…….especially if the culprit spends major advertising dollars with that publication. Tuesday’s article was a major break. Receiving front page notoriety for a derivatives blow-up is rare indeed. Remember. They were supposed to be a secret.
How many trillions of dollars in private derivatives do these global companies own collectively and what happens if they continually have to come up with big bucks to keep these “contracts” in good standing? The answer to the first part of the question is that I don’t know, but I have read guesstimates ranging from 600 trillion to over a quad. Keep in mind that a portion of these holdings is off-balance sheet and/or off-shore so their quantities are unknown. What we do know is that derivatives holdings among individual major U.S. banking and investment banking firms run from about three and a half trillion to about eighty trillion (Yes…I said “trillion” and Yes….I said “eighty”). The second part of the question deals with what happens when an institution kind of runs out of money to be spent to keep these “contracts” in good standing. The FED helps them find an outlet in which to transfer the risk. Enter the American taxpayer. Stay tuned.