The Great Asset Bubble
Managing to not learn a single thing from the ancient history of last year’s economic meltdown (and just in time for the first anniversary, how quaint), reports are still surfacing that the banking industry as a whole continues to engage in, and profit from, the ultra-risky bet taking in the world of derivatives – the shadow market that nearly brought western capitalism to its knees last year. On lessons not being learned:
U.S. commercial banks earned $5.2 billion trading derivatives in the second quarter of 2009, a 225 percent increase from the same period last year, according to the Treasury Department.
More than 1,100 banks now trade in derivatives, a 14 percent increase from last year. Four banks control the market: JPMorgan Chase, Goldman Sachs, Bank of America and Citibank account for 94 percent of the total derivatives reported to be held by U.S. commercial banks, according to national bank regulator the Office of the Comptroller of the Currency.
The graph on the right is a nice example of the pool of money that is out there today.
- The red 1.9TRN represents the amount of USD that has been pledged in bailout money.
- The 0.845TRN represents all of the gold reserves in all of the central banks around the world
- The 3.9TRN represents the amount of paper money in existence
- The 39TRN represents all traditional financial reserves in the world
- The 62TRN represents “shadow banking assets” – this is where we find the chunk of money that may or may not exist in the real world that banks leverage on, which gets us into messes like the one currently being dealt with in this worldwide recession.
- The remaining 290TRN represents “other assets” in existence – this combined with the 62TRN of “shadow banking assets” represent a middle ground estimate in an enormously large, unregulated marketplace.
After playing with loaded dice and having it blow up in their collective faces a year ago, the same institutions – mostly headed by the same people – continue to gamble in the same ways, now gambling even more than before.
Why is this bad? Look to the distant 2008:
Simon Johnson, a professor at the Sloan School of Management at the Massachusetts Institute of Technology and former chief economist of the International Monetary Fund, said that the seeds of another collapse had already sprouted. If major banks are allowed to keep making bets that are ultimately backed by taxpayer guarantees, they will return to the practices that led them to underwrite trillions of dollars in bad loans, Professor Johnson said.
“They will run up big risks, they will fail again, they will hit us for a big check,” he predicted.
This is what keeps the banking system going at present
So far, one year into the crisis hitting the fan, major new regulations have not been leveraged against the financial industry – though the currents seem to be pointing in that direction. There is only one thing that can really put a stop to this, and that is a reinstating of the Depression-era Glass-Steagall Act. The 1933 law created the FDIC as we know it, and more importantly prevented a bank holding company from owning other financial companies. The separation of financial institutions allowed for companies to grow, but never become “too big to fail” – where the failure of a single company could potentially threaten to ruin the entire financial landscape. The Glass-Steagall Act was undone by the Gramm-Leach-Bailey Act of 1999 – which, for all intents and purposes, laid the ultimate groundwork for the asset bubble – and crash – of the last decade.
A re-institution of Glass-Steagall is nowhere on the horizon.
To prevent a replay of last year’s crisis, investors in financial institutions, especially bondholders, must believe that they will lose money if banks fail, said Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation. “You need to send that very strong, clear signal to restore market discipline,” Ms. Bair said.
But legislation that would allow regulators to close giant institutions in an orderly fashion has been stalled for months. So too have efforts to create a systemic regulator that would focus on the broader risk that might occur from the ripple effects caused by the failure of one major bank.
Another proposed change would require banks to list and trade derivatives through a central clearinghouse, just as stocks and options are traded through exchanges, but it has yet to go anywhere.
Until this changes, the risk for a repeat performance at some point in the future, or the risk for a deepening of the crisis to true depressionary status remain most assuredly on the table.
