October 10, 2008
The Next Banking Bomb?
CBS News Investigates: Credit Derivatives Comprise $54.6 Trillion Of Risk Among Few Banks Left Standing
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“This bill will, in my judgment, raise the likelihood of future massive taxpayer bailouts. …if you want to gamble, go to Las Vegas. If you want to trade in derivatives, God bless you.”
That was North Dakota Senator Byron Dorgan’s statement on the floor of the Senate - not this week or last, or even during the last six months as Wall Street collapsed - but back in 1999.
Four years later in a letter to shareholders, billionaire investor Warren Buffett followed with his own warning, calling derivatives “weapons of financial mass destruction” controlled by “madmen.”
While financial experts were concerned with the housing bubble and mortgage-backed securities, Dorgan and Buffett were focused on what many now believe may be the next big shoe to drop - the credit derivatives market, better known as credit default swaps.
What worries financial insiders most is the $54.6 trillion of risky credit derivatives concentrated among the few banks left standing.
Credit default swaps (CDS) are the cornerstone of the credit derivatives market accounting for more than 98 percent of all credit derivatives. They are difficult to understand, ignored by regulators and poorly reported on balance sheets. In simplest terms, CDS are insurance policies on things like bonds, loans and corporate debt. But there are two big differences: the seller of a CDS doesn’t need to have the money to cover losses if the security defaults, and the buyer doesn’t need to own the asset it wants to protect.
It’s as if hundreds of people could buy insurance policies on houses they didn’t own yet still collect the full value if it burns down.
The danger comes when the company defaults and the seller - because he’s not required to - doesn’t have the money to pay out on the default.
Investment firms that traded various derivatives, such as CDS, collected an average of $2 billion in fees each quarter over the past two years. And traders who spoke to CBS News said these transactions were the largest cash cows on Wall Street, even more profitable than mortgages. The newfangled transactions were seen as easy money and many traders had the attitude that when it blows up, it’s someone else’s problem.
Today, the same commercial banking heavyweights thought to be the most safe, JPMorgan, Citigroup Inc. and Bank of America, hold 92 percent of all the disclosed credit derivative contracts, according to the Office of the Comptroller of the Currency.
But that number is merely an estimate because the overwhelming majority of these contracts are unregulated - private, mostly undisclosed and difficult to measure.
“There is no question we are at the edge of the cliff and someone is going to fall off,” said Weil, Gotshal & Manges Senior Partner Harvey Miller who is currently overseeing the Lehman Brothers bankruptcy.
Back in 1999 when the legislation was being debated Senator Dorgan opposed the consolidation of commercial and investment banks. In fact, he sponsored two amendments to prohibit these new mega-banks from …investing in derivatives.
Today, Dorgan apparently feels the same way. He was one of 25 senators who voted no on the recent $700 billion bailout.
“No one knows where [the credit derivatives] are, whose balance sheets they may threaten, or how much additional risk they pose to financial firms. Yet, I was told this plan could not require regulation and transparency of these financial markets because there was opposition in Congress and the White House,” Dorgan said in a statement explaining why he didn’t vote for the bailout.
With banks already suffering losses from the subprime fiasco, many now believe they face chain reaction failures from the credit derivatives market.
“If the market keeps going in the direction it’s been going, you’re going to have lots of defaults which are dangerous things,” said Miller.
Some economic analysts predict even more panic over next few months. As more corporations default and banks find out they can’t make good on their contracts, a new round of losses for funds and financial firms could result and make the recent losses in mortgage-backed securities seem miniscule by comparison.
By Kim Lengle
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See all 211 CommentsVote Obama and it will finally arrive.
Scary.
Vote Obama and it will finally arrive.
Scary.
Posted by Yurfulla at
If socialism eliminates the shadow banking industry and the shadow oil markets than I say bring it on. Right now we privatize profits for the rich and socialize their losses.
Maybe researchers at CERN, Europe''s atom-smashing laboratory, can locate these CDSs along with dark matter and the God particle. Physics are the same nomatter where you are in the world.
Worry my friend''s worry.
Now THAT is scary.
Posted by bellschotsch
I agree, they pushed down wages while offering cheap easy credit and encouraging people to go out and spend. Who cold have guessed it would end up like this?
Don''t worry America!
Bush has got his new "Leave No Billionaire Behind" program ready to go.
He''s going to take your tax dollars and give it to the people who caused this mess and eventually it''s going to trickle back down to you.
If, when the trickle finally reaches you, it looks and smells just like urine.........that''s because it is!
Thanks for voting Republican.
What we ALL need to learn from this mess, both Republicans and Democrats alike, is that deregulation - or a lack of adequate regulation - is extremely dangerous for our entire economy.
The entire financial industry needs to be constantly and intensively monitored by our government, if the best interests of the American taxpayers are to be served.
The real moral of this story is that you simply cannot trust business to "police itself". That will never, ever work -- it just encourages massive abuse, and leaves taxpayers financially responsible for cleaning up the mess when the greedy bail out and take their ill-gotten profits with them, leaving the rest of us holding the bag.
Regulation is obviously a good (and absolutely necessary) thing - not a bad thing.
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Posted by SkySoldier75
Yes, America, we need more and bigger government to fix this problem. And our government isn''t big enough, because its a worldwide problem. Hey, I know, let''s just combine all the countries of the world into one big country, and have one big government over them all. Then we''ll have no more wars, no more financial problems...heck...it''ll be heaven on earth!
At least until your new leader let''s you know that he is just like the rest of ''em. Then you''ll realise you created an even bigger problem. Now you realise you gave control of the world to the antichrist! And the only way out is God! But you hate him and his rules more than you hate your new government! Now whatcha gonna do? Burn for eternity in hell? Or give up your selfish greedy sinful lifestyle and face the Truth?
LOL....a fine mess you''ve gotten us into now, stanley...
The biggest problem is a financial hierarchy which is was morally bankrupt to begin with. They manipulate politicians like puppets on strings and fleece our funds as a game. Unfortunately it''s other people who suffer the harm, not the decision makers.
Then there is our government. Talk about a house of bedlam. These clowns in D.C. could care less about real issues. They stuck their heads in the sand like ostriches and hoped the problems would heal themselves or be solved by someone else. All they care about is when the next break occurs so they can rush out to spend their latest payoffs and the pay raise they voted for themselves, but not for the rest of us.
There is plenty of blame to go around, but think about these facts. The Bush administration has performed more blunders than I have time or space to list. - Oil speculators and companies drove the price of oil through the roof to reap fantastic profits. - Shaky mortgages, remember those morally bankrupt financiers, began to default. - Gas prices suddenly increased drastically thus costing most of the population to spend hundreds of dollars more each month on gas and fuel oil. Add that much burden to an already stretched budget and someone isn''t going to get paid on time, thus more mortgage defaults.
We should consider shooting the bankers, hanging the speculators and throwing politicians and lawyers out of upper story windows.
1. Wealth concentration leads to predatory behavior in society. With excess cash, the purpose of the Richs spending inevitably shifts from utility to vanity. Cars, houses, bank accounts do not simply furnish transportation, shelter, and independence; they purchase the envy of neighbors (fast cars, monster houses, grossly-fat bank accounts). That desire, to be able to look down on your neighbors, then infects the society at large, who copy the successful. But the trade in envy has two problems: 1. No amount of money is enough to service the hole envy wants filled. So saving turns to hoarding (Scrooge fever), taking money out of the general circulation which exacerbates the problem, 2. Envy is relative. It can be as easily obtained by breaking down your neighbor as working to elevate yourself. Symptoms of the resulting predation are lying, workplace harassment, racism/ sexism/ ageism, robbery, bullying, workaholics, malicious gossip, monopolistic behavior, gambling, youth exploitation, and withdrawal from society (gated communities, drugs, pornography). As wealth concentrates, there is a shift in the general population from a ''one-for-all'' mindset to a ''winner-take-all'' mindset. Such a society engages in at least as much destructive behavior as constructive, a slave to the ''envy trade''. The various banking bubbles popping around us are 100% driven by the envy trade.
Built every major dam in America (still generating 20% of our electricity today).
Built the interstate system (''freeways'' to stimulate trade and commerce).
Built levees and canals (100% responsible for California''s agricultural miracle).
The rural electrification program (so rural farms could also be factories).
SocSec safety-net (now in need of reform).
Defeated fascism and communism worldwide, and rebuilt war-ravaged Europe.
Fought a major war in SE Asia and, the same decade, flew to the moon.
America needs to roll back wealth concentration to its value in the 1960s, when the wealthiest 10% of Americans'' owned 60% of the nations total wealth. Progressive taxation will do this. It''s the RIGHT thing for our future, and our society.
This a very very serious!
The system is flawed, but but.. ah.... wait.....
american idol is on... and i just got a cool new mp3 player...
Screw it, uh, what was I saying????
That''s GREED for you. People in major cities around this country and the world will cruise by the indigent, sick and homeless on their way to purchase an ice cream sundae at a thousand dollars a pop and then retreat to their estates or penthouses and talk about how we should really do something to get those people off the streets. That conversation probably goes something like this. Maybe we can talk our friends in the police department and city government into passing an ordinance that moves them all over a few blocks so they won''t ruin our appetites next time we go down there.
It''s too late Ubrew!
I loved your post, it was right on, but America has been defeated by ignorance and distraction. Right, left, we all lose. Half the people in this country dont know %$#@ about this story, dont know *** aoout econmomics, dont know *** about political philosophy..
We have been dumbed down to the point of no return, the dream is OVER!! OVER!!
America is dying, dying! and those of us who care will have to be tortured by watching it happen!!
What do we make anymore? What in the world is it BASED on? We must be the only country in the world that can make an economy on interst earnings for credit alone an economic engine, which only works becaus of the massive use of credit to buy everything from consumer goods to paying for the federal government.. That house of cards is falling, and where are all the jobs?? CHINA!
All so people could save a few lousy bucks at traitorous walmart.. Where''s the medium sized businesses? Culture made manufacturing jobs look bad, people are "above" real blue collar work, and now every job there is in a sector that actually MAKES GOODS AND SERVICES is GONE BABY GONE..
Now I expect there to be a glut of MBA''s out there looking for work. Everyone at my school is trying to get an MBA, HA! Ha! Learn all the tricks that got us here..
This is a mathematically impossible situation: there is no way we can handle all this debt, and tax cuts for the rich, and the war, and social security, no country is going to buy our bonds anymore.
Game over!
This will get bad people!
In just 8 short years, Republicans have managed to do what no terrorist ever could.
They''ve bankrupted the country and brought the economy to it''s knees.
Stay the course with McSame?
Thanks but no thanks!
The repubs mantra noted above has destroyed our country, the banks and most of the civilized world!
Its hard to know what to do at this point: wealth has been globalized to such a degree that if one country looks like its going to raise taxes, the wealth goes across border. Countries are now in the position states were in a few years ago: of competing against other states for corporate business with tax credits, preferred status, etc: basically giving away the tax base to get the business. Global businesses are more powerful than countries, and Americas massive debt impedes her ability to do much about corporate greed.
I wouldn''t bet on that. Credit default swaps make subprime mortgage derivatives look like gold. Other articles besides this one have pointed out the unsecured, unregulated atmosphere under which they''ve ballooned.
Government sponsored risky lending: a.k.a Freddie and Fannie Mac + poorly regulated mortgage backed securities and derivatives a congress that couldn''t work together despite repeated attempts over the last 10 years to correct the problem.
Who''s to blame? Congress, both republicans and democrats and ultimately the American people for not electing real leaders.
This might eliminate one level of potential (continued) mismanagement.
The repubs mantra noted above has destroyed our country, the banks and most of the civilized world!
Posted by txlakeside
And it''s funny how many democrats benefited from Freddy Mac and Fanny Mae! Hey, when is congress going to have congressional hearings into that catalyst of economic crises.
THAT''S WHAT THE BAILOUT BILL WAS ABOUT, TO BAILOUT THE WORTHLESS DERIVATIVES TO BLOW OUT THE TAX PAYER ONCE AND FOR ALL!!!!!
THAT WILL ENSURE THE AMERO!!!!
I wouldn''t bet on that."
When journalists have locked down the story, the subeditor does NOT title it with a question. "Did an alien impregnate this Earth woman?" "Is the sky falling?"
It''s likely there''s a risk, but speculative headlines like this, and on the front page, are just sensationalist hysteria-mongering.
The "some people say" formula. I''ve used it myself to my shame. "Some economic analysts predict ...." Yeah, and maybe thousands more don''t.
And then there are the "coulds" and "maybes" - "a new round of losses .. could result" .......
What I''ve seen in the past few days in world markets in Asia and Europe is a drop at the beginning of the day, in response to the hysteria on the other side of the world, and then a holding steady or slight recovery through most of the day. The market is trying to find a base, but you wouldn''t guess it from reading most reports. It''s not good copy.
If, when the trickle finally reaches you, it looks and smells just like urine.........that''''s because it is!
Thanks for voting Republican.
Never we forget that a majority of Democrats voted right along with what he wanted.
it''''s for idiots , stupid
Posted by PythonCharly
It''s funny how when Reagan proposed the "Theory of trickle down" economics it was the Democratic controlled congress who wrote the laws to further increase our national debt since then. The house didn''t change control until Bill Clinton. Sorry PythonCharly both parties have blood on their hands.
Anyone stop to think that since business was so smart to get us into these derivatives that they won''t come up with some creative way to make a profit out of rearranging them and avoiding Doomsday? No one is going to go to the poor house over these things, the freaking world would cease to exist if these things stood up. Fuggetaboutit!
The country where it is now okay for a small business owner to rake more of the profits and invest less in their company because the good ole bank is there to hand out that short term loan to pay your monthly purchases, expenses and payroll. Who needs solvency any more. What business school is teaching this form of economic drivel? All of them. Local companies are locking their doors because the banks insist the credit crunch they caused makes it impossible to continue to loan to companies who trusted them and still have accounts with them. That really helps those ex-employees pay for that mortgage!
The country where Uncle OIL ran up the price of gas in the name of record profits and contributed directly to the present calamity. Take several hundred dollars or more a month out of already tight budgets and of course people have to defer a mortgage payment to pay for gas or fuel oil. I know people in the north who are now strapped for heating costs that are unsustainable.
Rough? Unfortunately you haven''t seen "rough" yet.
When the market crashed in 1929, the worst effects weren''t really peaking until mid 1930 into late 1931.
We''re just watching the waters recede prior to the tidal wave folks.
Posted by exfed4
It''s called blow back. When a country has nothing to lose it will become desperate, and I am not talking about the U.S. I am talking about maybe Russia. Need only look to history and the German Weimer republic of the 20''s and the rise of Nazi Germany when 5 million marks would not buy you a loaf of bread nor a bottle of milk.
And with no credit and shrinking capital, business will lay off more people, who will by less goods, which will fuel the fire for continued layoffs.
Posted by exfed4
Really, when GM lays off 100,000 workers who is going to shore up their home and auto loans, who is going to go shopping to buy goods to keep the "Other" responsible businesses in business. This is the catalyst to economic failure, and it will continue to fuel continued layoffs. It''s not rocket science, it''s common sense.
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