Martin D. Weiss and Mike Larson
to a Financial Meltdown
D. Weiss, Ph.D. *
days of denials that it had liquidity problems, Bear was forced
into a JPMorgan-led, government-backed bailout on March 14. The
arrangement, the first of its kind since the 1930s, resulted in
Bear getting a 28-day loan from JPMorgan with the government's
guarantee that JPMorgan would not suffer any losses on the
deal." - AP Business
near-collapse of Bear Stearns has brought us closer to a financial
meltdown than at any time in our lifetime.
for the first time, the mainstream media is recognizing the real dangers
that Mike Larson and I have been warning you about for so long:
New York Times, for example, headlines the "run on big Wall
Street banks" and "a Wall Street domino theory."
says Fed Chairman Bernanke was forced to "throw out four decades of
monetary history by a financial system choking on miscalculated risks and
a deepening recession."
The Wall Street Journal asks:
the move by Bear suggest the markets are closer to their nightmare
scenario, in which doubts about financial companies that serve as
counterparties in billions of dollars of transactions suddenly freeze
trading, or force investors to unwind existing trades, causing a domino
effect that cripples the markets?"
media — and the authorities — are asking the right questions. But they
dare not provide answers.
think about possible consequences, but talk only about probable causes.
frequently worry about how to protect their own families from future
scenarios, but usually believe their job is to "protect the
public" from knowledge of present realities.
rarely mention the next likely victims ... never tell you what the domino
theory might lead to ... and never guide you to true safety. We do. And
this morning, we will again.
June, when Bear Stearns was the first major firm to announce
multi-billion-dollar losses from the subprime mess, Wall Street and
Washington made a tacit pact — to persuade the world that Bear Stearns
was "alone," and to artificially create a fantasy world in which
"the crisis was contained."
from the facts Mike Larson brought out before and after June of last year
— on subprime
lending, the housing
crisis, the broader
financial crisis and the likelihood of an S&L-type
meltdown — it was obvious that Bear Stearns was not alone;
the crisis, not contained.
as Mike warned, in the days and months that followed, America's largest
banks and brokers revealed subprime losses that greatly exceeded those of
Bear Stearns: First HSBC ... then Merrill Lynch, Citibank, UBS and many
sure enough, the estimates of the industry's total losses continued to
escalate with each new revelation: First, Wall Street analysts said it
would be under $50 billion. Then, Fed Chairman Ben Bernanke said it could
be as much as $100 billion. Next, the OECD estimated it could reach $300
billion. And now, even estimates as high as $1 trillion do not
draw widespread criticism.
despite all the revelations and shocks, no major Wall Street firm
confessed to its gambling habits. None admitted its debt addiction. None
seemed to realize that the first step toward resolving a problem is
recognizing its very existence.
time, the truth was suppressed. And each time, when the reality was
finally revealed, the public was shocked, caught off guard and left
wondering who the next victim might be.
at long last, looking back at the truths — and deceptions — revealed
in recent months, you'd think someone might have learned a lesson from
here we ago again in a typical 1-2-3 pattern ...
June of last year, Bear Stearns is the first to reveal a disaster.
last year, the authorities have been huddling through the weekend,
poring over Bear Stearns' books. And ...
always, they are trying to come up with a story to spin the facts.
this is not June of 2007, when it was still easy to fool most
investors most of the time. Too much has changed too quickly, and the
crisis has already progressed to a more advanced phase. Now ...
of big losses are being replaced by fears of big bankruptcies.
collapse of subprime mortgages has been replaced by the collapse of
nearly all major credit markets.
most worrisome of all, these fears and collapses are threatening to
freeze up the greatest grand casino of all: Derivatives.
Truth and Consequences
Of $172 Trillion in Derivatives
are essentially bets ... and ... debts.
an illustration, if you and I were players, I could bet you that a
particular firm will go bankrupt between now and year-end ... and you
could bet me that it won't.
I could bet you that interest rates on junk bonds will rise more than
interest rates on Treasury bonds ... and you could bet they will rise
less, or not rise at all.
could bet on virtually any market that moves, or even bet that it won't
each wager, we'd likely borrow huge amounts of other people's money. And
in each case, we'd have a contractual obligation (or right) to consummate
the deal: To pay up if we lose (or collect if we win).
the essence of each transaction in the frenzied, hectic world of
what was once a small sideshow in the traditional world of stocks, bonds
and loans has become the towering center ring in the big-top: The
derivatives market has now ballooned into a monster of unimaginable
U.S. commercial banks alone, the total notional value of the derivatives
is $172.2 trillion, according to the latest report by the U.S. Comptroller
of the Currency (OCC). Plus, the OCC reports that:
over 90% of these derivatives, there is no established exchange that
helps protect either party from default.
FIVE major U.S. banks control 97% of all the bank-held derivatives in
the United States, a concentration of power — and risk —
unsurpassed in the history of finance.
five of these major players would likely be severely crippled, or even
bankrupted, by the default of just a few major counterparties like
have more credit exposure to counterparty defaults than they have
have over four times more credit exposure than capital. (More
details in a moment.)
Potential Damage of Bear Stearns' Demise
Today Is Far Bigger Than the Feared Impact of
Long Term Capital Management's Fall in 1998.
the OCC has been reporting similarly large numbers for a long time, and
we've been bringing them to your attention from the very outset.
it wasn't until about 10 years ago that you saw the first widely
recognized threat to the derivatives bubble: The demise of Long Term
Term Capital was simply a hedge fund, far off the radar screen of most
investors. It was also relatively small.
the potential damage it could cause was obvious: It had its tentacles in
enough large Wall Street firms that it was widely agreed its collapse
could trigger a financial meltdown similar to the one feared today. And
that fear was seen as serious enough to warrant an emergency intervention
by the Federal Reserve Bank of New York, much as occurred last Friday.
the differences between 1998 and today are equally obvious:
Stearns is many times larger than Long Term Capital ever was,
or could have dreamed of becoming.
Stearns has bigger, more varied and more complex linkages to other
major Wall Street firms than Long Term Capital ever had, or could have
dreamed of creating.
Stearn's demise is just one aspect of a massive U.S. credit market
collapse that makes the problems of 1998 pale by comparison.
time, the Federal Reserve Bank of New York is doing far more than just
orchestrate an industry rescue. It's directly providing the bailout
funds, using JPMorgan Chase as a pass-through intermediary.
in the days ahead, don't be surprised by new announcements of "big,
bold steps" being taken by Washington and Wall Street. Also don't be
surprised by a bigger-than-expected rate cut by the Fed tomorrow.
throughout it all, don't let them fool you when they again put out the
word that "Bear Stearns is alone" or that "the crisis is
JPMorgan Chase Is
Among the Most Vulnerable
alone dictates that containing the crisis is highly unlikely. Let me walk
you through the facts, and you'll see what I mean ...
major Wall Street firms engage in the same kind of trading strategies
that entrapped Bear Stearns.
use the same kind of high-powered leverage that sunk Bear Stearns.
perhaps most important, all are joined at the hip to each other as
counterparties (trading partners) in derivatives, including
even as you read these words, derivatives are emerging as the new core of
the crisis. And derivatives are definitely not limited to Bear
investment banks that do not report to the Fed, the biggest players are Lehman
Brothers, Goldman Sachs, Morgan Stanley
and Merrill Lynch.
among those who do report to the Fed, the five dominant players in
derivatives that I mentioned a moment ago are Citibank, Bank
of America, Wachovia, HSBC and
the biggest of them all: JPMorgan Chase.
believe all are vulnerable, in varying degrees, to the kind of crisis that
struck Bear Stearns last week.
believe JPMorgan Chase could ultimately be the most vulnerable.
we believe this may help explain why JPMorgan Chase was the Wall Street
firm that emerged as a participant in the Bear Stearns rescue on Friday.
you don't have to take our word for it. Nor do you have to look very far
to validate our view. All you have to do is ...
on this link to pull up the latest derivatives report by the U.S.
Comptroller of the Currency (OCC) ...
down (about 24 pages) to Table 1, "Notional Amount of Derivatives
one look at who's at the top of that chart — JPMorgan Chase — and
see for yourself the unimaginably large quantities of derivatives it
We'll make it easier for you. Here's the guts of the OCC's Table 1,
showing just the top five players and excluding a few of the less
undeniable truth: In the grand casino of derivatives trading, JPMorgan
Chase is overwhelmingly and unabashedly the biggest player of them all. As
you can plainly see in the table above, it controls ...
trillion in derivatives, or over
53% of all derivatives held by U.S. commercial banks,
among which are ...
$7.8 trillion in the oft-inflammable credit
derivatives, or 55.6% of the total.
all with little more than $1.2 trillion in
scroll back up a few pages in the OCC's report to the table under Graph
5A, which I've also reproduced here:
table shows how much each bank has in credit exposure to defaults by
trading partners (like a Bear Stearns). And it measures that credit
exposure in proportion to the bank's capital. For each one
dollar of its capital ...
has 83.3 cents in exposure ...
of America has $1.12 in exposure ...
has nearly $2.53 in exposure, and ...
Chase has more than $4.16 in exposure!
other words, if its counterparties default, JPMorgan Chase's capital could
be wiped out more than four times over.
HSBC's exposure is greater. But that reflects strictly its U.S.
operations. Overseas, recent profits indicate that it's in a relatively
stronger position. That leaves JPMorgan Chase as the most vulnerable, in
many pundits assume that simply because a future scenario is unimaginable,
it must therefore be impossible.
the pattern of human events has never before been bound by the limits of
someone's imagination; and it never will be. Anything can happen. To some
degree, anything will happen.
foresee two scenarios:
The Greatest Federal
Bailouts of All Time
Creates Rampant Inflation
this scenario, Fed Chairman Ben Bernanke continues to do precisely what
yesterday's New York Times says he has already been
doing since last year:
out the rule book of monetary policy,
his prior concerns about the moral hazard of financial bailouts,
new policy on the fly, and ...
history's greatest and most radical money-pumping machines —$100
billion per month in loans to banks in exchange for shaky collateral
... an extra $100 billion in money infusions announced on March 7 ...
an additional $200 billion in loans to brokers in exchange for sinking
mortgage bonds ... and more.
though, in this scenario, despite all of the money pumping already in the
pipeline, the loudest voices will be those who cry out for even more.
will be voices like ...
economists who bemoaned on Friday "the self-feeding downturn now
in place" and who forecast a Fed rate cut tomorrow of a full
percentage point. Or ...
Lynch's chief economist who argued that the Fed's policy so far
"does not address underlying credit problems, does not materially
improve the solvency of the institutions exposed to assets under
stress, and does nothing to put a floor under home prices." The
implication: Bernanke must do much more.
Gretchen Morgenson, also writing in yesterday's New York Times,
leaves little doubt as to the ultimate price to be paid for Bernanke's new
are the consequences of a world in which regulators rescue even the
financial institutions whose recklessness and greed helped create the
titanic credit mess we are in? Will the consequences be an even weaker
currency, rampant inflation, a continuation of the slow bleed that we
have witnessed at banks and brokerage firms for the past year? Or all of
around, because we'll soon find out. And it's not going to be
why this scenario — the greatest federal bailout of all time —
inevitably comes with the most rampant inflation we've seen in our
lifetime. And it has already begun.
is the scenario that nearly everyone on Wall Street is thinking about ...
but virtually no one dares talk about. They can't imagine what it would be
like. Or they fear that the mere discussion of its possibility will bring
it closer to a probability.
nothing could be further from the truth.
unreasonable people conjure up future events with no basis in fact, it's
never taken seriously enough to notably alter the script of history. By
the same token, when there is concrete evidence of a future disaster,
realistically exploring its ultimate consequences can only help the actors
prepare for the future.
talking about the possibility of a wholesale market shutdown.
a much smaller scale, you've already seen bits and pieces of something
akin to this phenomenon. You've seen stocks stop trading in the wake —
or in anticipation — of major news. You've seen futures stop trading
when a particular market rises or falls by the daily allowable limit.
on a broader scale, history has seen the nation's banks declare an
extended holiday, the nation's stock exchanges close down for a week or
more, and a particular industry shut down for extended strikes.
put those together and try to visualize a similar situation on a national
Because the entire country runs on credit. But in a financial meltdown,
the essence of credit — trust — is destroyed. Therefore, the country
cannot run. It must shut down temporarily while the authorities sort out
the mess and come up with a plan that can restore that trust.
this likely? It's too soon to say. But there's one thing we do know:
was precisely to avoid such a scenario that Mr. Bernanke has abandoned the
Fed's rules and loaned money to banks in exchange for bad collateral ...
trashed the rules again to loan even more to brokers ... and
thrown the entire Fed rule book into the Potomac by bailing out Bear
Stearns on Friday.
that's why Mr. Bernanke has vowed to continue doing everything in
his power to prevent more dominoes from tumbling.
ultimate question is: Is his power enough?
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