If you were paying close attention to the financial carnage of 2008, then surely you’d remember Bear Stearns.
In what was to be their final annual report in January 2008, their books revealed $13.4 Trillion worth of derivatives exposure--futures, forwards, options, and swaps--obligations that had to be settled; obligations that far exceeded the limits of their collateral and capacity to cover such obligations.
Their exposure had increased by 50% in that year alone; their credit rating, subsequently downgraded by two notches.
One of the largest investment banks in the world, an equity trading house founded in 1923, a firm that not only survived the Crash of 1929 and Great Depression but powered its way to becoming a global financial behemoth, Bear Stearns, after its January report, would have only six weeks left before its terminal collapse.
Interestingly, Bear Stearns’ $13.4 Trillion derivatives exposure wasn’t what brought forth its demise, though it certainly helped finalize it.
What killed the firm was its excessive load of mortgage assets, right at a time when the housing market was crashing.
The derivatives were gasoline to fire.
Everyone--many of them hedge funds--ran for the exits. It was a classic bank run, but on steroids.
Between March 10 and March 14, Bear Stearns’ share price fell from $62 to $30.
Two days later, JPMorgan bought Bear Stearns for $2 a share.
So, what did banks learn about excessive derivatives exposure?
If you take a look at how banks are positioned today, a little more than a decade after Bear’s collapse, it’s apparent that banks have learned absolutely nothing.
In 2008, Bear Stearns held $13.4 Trillion worth of derivatives.
In 2018, the total book value of derivatives being held by five of the largest US banks is estimated to be over $157 Trillion!
$157 Trillion is more than twice the Global GDP.
So, what can go wrong here? When a financial crisis of considerable magnitude strikes, what takes over are not just regulatory procedures, automated stop-gap measures, or any legislative processes set in place to protect banks and their customers.
What takes over--and what overrides everything else--is something much more primal and exclusive: firms begin looking after themselves and their closest associates.
Counterparties simply refuse to pay. We saw this happen in 2008.
What was once a highly functional and cooperative system morphs into an “every-person-for-him/herself” arena.
Banks and their top executives begin looking out for themselves, their jobs, their take-home pay, and even their bonuses, if salvageable.
And what about the customers; the depositors?
Against their knowledge or will, customers automatically become “shareholders,” their funds confiscated and converted into equity for the purpose of a bank “bail-in.”
In other words, customers become financial casualties whose main purpose is none other than to provide the capital for banks to save themselves.
Granted, the largest banks have plenty more reserve capital than they had in 2008.
For example, last December, Citi had enough to meet a $446 Billion margin call, nearly forcing regulators to demand an increase in Citi’s collateral requirements.
But despite the extra capital requirements and the enhanced risk management procedures imposed across the board, the $157 Trillion exposure--again, an exposure that is more than twice the global GDP--should be large enough to worry anyone who can understand the gravity of its implications.
And if the largest banks appear to be exposing themselves to risks that are now far beyond their pre-2008 levels, it’s because they have the means to guarantee their survival.
They have the legal power to confiscate and utilize depositors’ funds to prop themselves up.
They exercise the privilege to make profits while the majority of their risks are transferred over to their depositors.
It’s a vicious apparatus, legally sanctioned. And the only way to shelter your money from its grasp is to own private assets beyond its range of confiscation.
Starting with privately-stored non-CUSIP gold and silver might be a good way to start.