Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

A Financial Road to Nowhere

Stock-Markets / Credit Crisis 2011 Jan 14, 2011 - 01:43 PM GMT

By: Barry_Elias

Stock-Markets

Last month, I discussed the huge risks undertaken by the financial community and the severe mistrust it has breed.

An unlimited ability to lend, even if you don’t have the money: sounds too good to be true.


Or is it?

Manmohan Singh and James Aitkin authored a recent International Monetary Fund (IMF) working paper, which describes the mechanics that realized this objective.

When a financial institution lends funds, it typically secures collateral to compensate for potential liabilities or losses. Think of it as a catastrophic insurance policy.

Yet, the United Kingdom permits unlimited use of the same collateral for additional lending. This is the equivalent of enabling an infinite amount of credit and debt. In financial parlance this is termed: rehypothecation. The same applies to specific products in the United States, such as futures, derivatives, and repurchase agreements.

Rehypothecation created $4 trillion in lending with only $1 trillion in collateral (a churn or collateral velocity of 4). With the click of a mouse, the financial community gave themselves $3 trillion to lend.

By November 2007, outstanding loans by non-bank entities such as hedge funds were believed to be $6 trillion. This amount has been revised to $10 trillion. Coincidentally, this $4 trillion difference was equal to the amount outstanding at hedge funds.

The New York Times reports that the face (notional) value of all derivatives increased six fold from $100 trillion in 1998 to $600 trillion in 2008. Most of this trading was controlled by several financial institutions including Goldman Sachs, JP Morgan, Morgan Stanley, and Deutsche Bank.

This trading is unusual in that the price spread between buyer and seller is known only to the clearing institution. This means the buyer knows the price it paid, but it does not know the price the seller received. The same applies to the seller. Moreover, much of this trading did not possess the adequate collateral (capital) to offset losses.

This off-exchange derivative transaction was primarily the result of two pieces of legislation signed by President Clinton: Gramm-Leach-Bliley Act of 1999, which permitted banks to perform investment services (partial repeal of Glass-Steagall Act of 1933), and The Commodity Futures Modernization Act of 2000. These acts were sanctioned by the 1999 Presidential Working Group on Financial Markets. The participants included Federal Reserve Board Chairman Alan Greenspan, Securities and Exchange Commission Chairman Arthur Levitt, and Treasury Secretary Lawrence Summers (and against the better judgment Commodities Futures and Trade Commission Chairwoman Brooke Bornsley).

Andrew G Haldane, Executive Director of Financial Stability at the Bank of England, suggests economies of scale and return on investment diminish when deposits at a financial institution reach tens of billions of dollars. During the past several decades a few banks have accumulated hundreds of billions of dollars in assets. At this level, profit margins were eroding, and banks developed creative methods to increase revenue and profit.

Most of the growth in assets and excess risk taking was the result of the deregulation of the derivatives market, not interstate banking. In 1982, the Garn-St. Germain Act allowed any bank holding company to acquire failed banks and thrifts, and in 1997 the Riegle-Neal Act of 1994 took effect, which permitted interstate branching for domestic bank holding companies and foreign banks.

Assets at top three U.S. banks actually declined from 10 percent in 1982 to 7 percent in 1992. By 1997, when interstate banking was permitted, this figure reached 15 percent, and in 1999 it stood at 20 percent. In 1999, Glass-Steagal was partially repealed, allowing banks to enter the securities industry more readily, and in 2000, derivatives were further deregulated. These two pieces of legislation helped propel that figure to 40 percent.by 2008.

Hence, we saw the exponential risk taking implied in off-exchange trading and rehypothecation (reusing the same collateral). These mechanisms also formed the template for opaque, misleading asset securitization (i.e., subprime loans purchased and implicitly guaranteed by Government Sponsored Entities such as Fannie Mae and Freddie Mac).

The result was cataclysmic.

According to Haldane, the financial crisis has far reaching implications.

While U.S. government losses may total hundreds of billions (possibly more in my view), global GDP has underperformed significantly and will continue to do so. The first year following the crisis, global GDP (income) was 6.5 percent lower than the projected path, representing a $4 trillion loss. Over time the projected loss to global income may $60 trillion — $200 trillion (annual world GDP is $60 trillion).

Essentially, the financial community engineered a tremendous transfer of wealth from society to themselves: not a positive return on investment for the U.S., nor the world.

Read more: A Financial Road to Nowhere

By Barry Elias

Website: http://www.moneynews.com/Elias/barry-elias-Financial-Road/2011/01/14/id/382843

eliasbarry@aol.com

Barry Elias provides economic analysis to Dick Morris, a former political adviser to President Clinton.

He was cited and acknowledged in two recent best-sellers co-authored by Mr. Morris: “Catastrophe” and “2010: Take Back America - a Battle Plan.” Mr. Elias graduated Phi Beta Kappa from Binghamton University with a degree in economics.

He has consulted with various high-profile financial institutions in New York City.

© 2011 Copyright Barry Elias - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in