Do you want to know the real reason banks aren't lending and the PIIGS have control of the barnyard in Europe?.
It's because risk in the $600 trillion derivatives market
isn't evening out. To the contrary, it's growing increasingly concentrated
among a select few banks, especially here in the United States.
In 2009, five banks held 80% of derivatives in America.
Now, just four banks hold a staggering 95.9% of U.S. derivatives, according to
a recent report from the Office of the Currency Comptroller.
The four banks in question: JPMorgan Chase & Co.
(NYSE: JPM), Citigroup Inc. (NYSE: C), Bank of America Corp. (NYSE: BAC) and
Goldman Sachs Group Inc. (NYSE: GS).
Derivatives played a crucial role in bringing down the
global economy, so you would think that the world's top policymakers would have
reined these things in by now - but they haven't.
Instead of attacking the problem, regulators have let it
spiral out of control, and the result is a $600 trillion time bomb called the
derivatives market.
Think
I'm exaggerating?
The notional value of the world's derivatives actually is
estimated at more than $600 trillion. Notional value, of course, is the total
value of a leveraged position's assets. This distinction is necessary because
when you're talking about leveraged assets like options and derivatives, a
little bit of money can control a disproportionately large position that may be
as much as 5, 10, 30, or, in extreme cases, 100 times greater than investments
that could be funded only in cash instruments.
The world's gross domestic product (GDP) is only about
$65 trillion, or roughly 10.83% of the worldwide value of the global
derivatives market, according to The Economist. So there is literally not
enough money on the planet to backstop the banks trading these things if they
run into trouble.
Compounding the problem is the fact that nobody even
knows if the $600 trillion figure is accurate, because specialized derivatives
vehicles like the credit default swaps that are now roiling Europe remain
largely unregulated and unaccounted for.
Tick...Tick...Tick
To be fair, the Bank for International Settlements (BIS)
estimated the net notional value of uncollateralized derivatives risks is
between $2 trillion and $8 trillion, which is still a staggering amount of
money and well beyond the billions being talked about in Europe.
Imagine the fallout from a $600 trillion explosion if
several banks went down at once. It would eclipse the collapse of Lehman
Brothers in no uncertain terms.
A governmental default would panic already anxious
investors, causing a run on several major European banks in an effort to
recover their deposits. That would, in turn, cause several banks to literally
run out of money and declare bankruptcy.
Short-term borrowing costs would skyrocket and liquidity
would evaporate. That would cause a ricochet across the Atlantic as the
institutions themselves then panic and try to recover their own capital by
withdrawing liquidity by any means possible.
And that's why banks are hoarding cash instead of lending
it.
The major banks know there is no way they can
collateralize the potential daisy chain failure that Greece represents. So
they're doing everything they can to stockpile cash and keep their trading under
wraps and away from public scrutiny.
What really scares me, though, is that the banks think this is an acceptable risk because the
odds of a default are allegedly smaller than one in 10,000.
But haven't we heard that before?
Although American banks have limited their exposure to
Greece, they have loaned hundreds of billions of dollars to European banks and
European governments that may not be capable of paying them back.
According to the Bank of International Settlements, U.S.
banks have loaned only $60.5 billion to banks in Greece, Ireland, Portugal,
Spain and Italy - the countries most at risk of default. But they've lent
$275.8 billion to French and German banks.
And undoubtedly bet trillions on the same debt.
There are three key takeaways here:
There is not enough capital on hand to cover the possible
losses associated with the default of a single counterparty - JPMorgan Chase
& Co. (NYSE: JPM), BNP Paribas SA (PINK: BNPQY) or the National Bank of
Greece (NYSE ADR: NBG) for example - let alone multiple failures.
That means banks with large derivatives exposure have to
risk even more money to generate the incremental returns needed to cover the
bets they've already made.
And the fact that Wall Street believes it has the risks
under control practically guarantees that it doesn't.
Seems to me that the world's central bankers and
politicians should be less concerned about stimulating "demand" and
more concerned about fixing derivatives before this $600 trillion time bomb
goes off.