…the dark heart of the global financial system [is] the $55 trillion market in credit derivatives and, in particular, credit default swaps, the mechanisms routinely used to insure banks against losses on risky investments. This is a market more than twice the size of the combined GDP of the US, Japan and the EU. Until it is cleaned up and the toxic threat it poses is removed, the pandemic will continue. Even nationalised banks, and the countries standing behind them, could be overwhelmed by the scale of the losses now emerging.
Chris Floyd adds:
The only slim hope we have for any genuine reform — even an imperfect, conflicted, compromised reform, which is the only kind we will ever have in this world, until the lion lies down with the lamb — is that the sheer scale of the real problem — the $55 trillion beast, the very real potential for the complete destruction of the global economy, and the state power that depends upon it — might force some politicians to turn apostate, renounce the market cult, and bite the hands that have fed them for so long.
Absent this near-miraculous possibility, we will be left with yet another rickety house of cards, slapped together on the fly — largely at the malefactors’ direction and for their benefit — while the beast gapes wide his ponderous jaws, and prepares to swallow us whole.
That was written in October of 2008. The derivatives market is still unregulated, and the hole in our economy has yet to be filled, well, not with much more than pea gravel anyway. We still have no idea where or what the so-called “toxic assets” are, much less the “value” of those assets. And no one went to jail except a banker for rich people because he was a banker for rich people. A reminder.
› LIBOR Scandal Jumps Pond: US Banks, Regulators Face Grilling over Manipulation of Baseline Interest Rate
Though the Libor interest rate scandal that has rocked the financial world in the UK — forcing the resignation of the Chairman, CEO, and COO of banking giant Barclays last week — the furor over the scheme has yet to garner similar media coverage or public outrage in the United States.
That may change as Americans learn more about how manipulation of Libor has impacted their own finances and as US lawmakers begin to make inquiries about the level of complicity by US banks and the shortcomings of financial regulators. The controversy showed some evidence of catching fire in Washington on Tuesday as members of the powerful US Senate Banking committee indicated that US Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke will be expected to testify about what and when US regulators knew about the Libor manipulation and bank malpractice.
“I am concerned by the growing allegations of potential widespread manipulation of LIBOR and similar interbank rates by some financial firms,” Senate committee chairman Tim Johnson said in a statement. “At my direction, the Committee staff has begun to schedule bipartisan briefings with relevant parties to learn more about these allegations and related enforcement actions.”
“It is important that we understand how any manipulation may impact American consumers and the U.S. financial system,” he said.
News reports at the end of last week indicated that US banks JP Morgan Chase, Citigroup — and possibly Bank of America — were the primary focus of inquiries by government investigators.
The Libor rate is used as a baseline interest rate for a range of financial products across the world, from US credit cards and student loans to European mortgages and more complex instruments. In total, Libor is estimated to set the price of lending for over $550 trillion in loans, securities and derivatives.
According to Reuters, “By manipulating Libor, banks could have made profits or avoided losses by wagering on the direction of interest rates. During the enormous liquidity problems in the financial crisis they could, by reporting lower than actual borrowing costs, have signaled that they were in better financial health than they really were.”
› Yes, Virginia, the Real Action in the LIBOR Scandal Was in the Derivatives | Yves Smith
As the Libor scandal has given an outlet for long-simmering anger against wanker bankers in the UK, there have been some efforts in the media to puzzle out who might have won or lost from the manipulations, as well as arguments that they were as “victimless” or helped people (as in reporting an artificially low Libor during the crisis led to lower interest rate resets on adjustable rate loans pegged to Libor; what’s not to like about that?)
What we have so far is a lot of drunk under the streetlight behavior: people trying to relate the scandal to the part that is most visible and easy to understand, meaning the loan market that keys off Libor. As much as that’s a really big number ($10 trillion), it is trivial compared to the relevant derivatives. Fromthe FSA letter to Barclays:
The Eurodollar futures contract traded on the CME in Chicago (which is the largest interest rate futures contract by volume in the world) has US dollar LIBOR as its reference rate. The value of volume of that contract traded in 2011 was over 564 trillion US dollars.
This is only one blooming exchange contract, albeit a monster of a contract. There are loads of OTC contracts in addition to that:
Interest rate derivative contracts typically contain payment terms that refer to benchmark rates. LIBOR and EURIBOR are by far the most prevalent benchmark rates used in euro, US dollar and sterling OTC interest rate derivatives contracts and exchange traded interest rate contracts.
For the past fifteen years, the records of Western capitalism have been debased, leaving governments without the facts to spot what needs to be fixed and for businesses to know what their risks are. To regain its vitality, Western capitalism must bring under the rule of law and public memory hundreds of trillions of dollars now swirling mindlessly out of control in the obscure world of financial innovation. That task requires major political leadership.
Hernando de Soto (via azspot)
Too-big-to-fail banks like JP Morgan, with trillions in assets and trillions more in high-risk investments and trading, require regulation and transparency. This is yet another example of the need for the more than $700 trillion derivatives market to be brought into the light of financial regulation. That is the only thing that will reduce the risk these banks pose to the taxpayers, the financial system and the economy. Jamie Dimon and JP Morgan Chase just proved what anyone not getting a paycheck from a Wall Street bank already knows: gigantic too-big-to-fail banks are too-big-to-manage. They must not be allowed to continue to threaten our financial system and our economy.
Dennis Kelleher, JPMorgan Loss Proves Need for Financial Reform, Strong Volcker Rule | Better Markets
JP Morgan is missing $2 billion by the way.
› Regulators to Ease a Rule on Derivatives Dealers | NYT
The SEC and the CFTC let the titans of the financial and energy sectors write the new rules for the derivatives market, or as the New York Times puts it:
As federal regulators put the finishing touches on an overhaul of the $700 trillion derivatives market, a major provision has been tempered in the face of industry pressure.
On Wednesday, the Securities and Exchange Commission and the Commodity Futures Trading Commission are expected to approve a rule that would exempt broad swaths of energy companies, hedge funds and banks from oversight. Firms would not face scrutiny if they annually arrange less than $8 billion worth of swaps, the derivative contracts tied to interest rates and commodities like oil and gas.
The threshold is a not-insignificant sum. By one limited set of regulatory data, 85 percent of companies would not be subject to oversight. After five years, the threshold would reset to $3 billion; it is the same amount suggested by a group of energy companies in a February 2011 letter, according to regulatory records.
When regulators first proposed the rules in late 2010, they set the exemption at $100 million. At that level, only 30 percent of the players would have been excused from the oversight, which was mandated by the Dodd-Frank financial overhaul law.
It is unclear whether that data tells the full story. Other numbers produced by the S.E.C. suggest that the initial $100 million plan would have ensnared some companies that the law did not intend to affect.
The agencies that wrote the rule covering so-called swap dealers note that their policy would oversee the largest derivatives players that pose a systemic risk to the broader economy. And despite exempting many companies from oversight, the rule still would capture the vast majority of swaps contracts because it applies to several big banks like Goldman Sachs that arrange most of the deals. Under the rule, the agencies also must study whether the $8 billion figure is appropriate. The agencies could change the figure if it proved too high or low. Some watchdog groups, however, fear that regulators are carving out a significant loophole that will open the door to problems. The exemption, the culmination of wrangling among the regulators and a yearlong lobbying blitz, would excuse firms from having to post additional capital and file reports.
In the new rule set to be completed on Wednesday, the controversy lies in the so-called de minimis exemption, a sort of regulatory hall pass for firms that have insignificant derivatives holdings. At $8 billion, Mr. Kelleher said it amounts to a de maximum exemption.
The initial $100 million limit met harsh criticism from most derivatives players, who argued that a single swaps trade can carry a notional value of billions of dollars. The notional amount reflects the value of the underlying assets rather than the amount of money that changes hands. So, on the face of it, even the $8 billion level would be a blip for a market that is valued at $700 trillion.
But the regulatory fine print could allow many firms to whittle down the size of their activity to under $8 billion.
Enjoy the rest →