Fat Cats Gone Wild!

[credit: Mike Luckovich, Atlanta Journal-Constitution]

McClatchy News Service reports, based on quarterly financial reports as of Dec. 31 :

• JP Morgan has current derivative losses of $241.2 billion and future exposure of $299 billion more, much more than its total reserves of $144 billion;
• Citigroup has current losses of $140.3 billion exceeding its reserves of $108 billion, and future losses of $161.2 billion;
• Bank of America has only $80.4 billion in current losses below its reserve of $122.4, but it has $218 billion in total exposure;
• HSBC Bank USA has current losses of $62 billion, 3 times its reserves, and exposure of $95 billion;
• Wells Fargo has current losses of of $64 billion below its reserves of $104 billion, but total exposure of $109 billion
  

These five banks account for 95% of U.S. trading in complex derivatives like credit default swaps and collateralized debt obligations.  Here is what former CEO of the Federal Reserve Bank of New York, Timothy Geithner said about the shadow banking system in 2008: "The structure of the financing system changed fundamentally during the boom, with dramatic growth in the share of assets outside the traditional banking system....The parallel system financed some of these very assets (i.e. collateralized debt obligations) in the bilateral or tri-party repo market[1]....the variety of assets financed in this manner expanded beyond the most highly liquid securities (i.e. traditional Treasury bills) to include less liquid securities." His former bank, the New York Fed, and JP Morgan served as the primary clearing houses for repo financing of the less liquid instruments that are now close to worthless (about 5-35 cents on the dollar). Bottom line: A fox is in charge of the henhouse.  The Fed executive who played a key role in expanding the shadow banking system is now tasked with deconstructing it at taxpayers' expense.  The plan now is for the US to directly buy or finance the purchase of these securities at prices no one else will bid.  Clearly a more expensive route for the taxpayer and another unwarranted subsidy for fat Street cats[2].  Bonus anyone?

[1]Repo market or repurchase market is the private credit market where all financial institutions, regulated and unregulated, go to obtain short term financing (mostly overnight) to meet reserve requirements, obtain bridge loans, lend or purchase securities, hedge investments or invest on a short term basis. Traditionally only US Treasury bills and notes were accepted as collateral because they are considered safe.  In a tri-party repo the pledged securities are delivered to a third party bank for custody.   It is the primary form of repurchase agreement for securities dealers in the US.  The New York Fed and JP Morgan are the two main custodial banks.  Geithner admits, "the scale [of leveraging]...made many of the vehicles and institutions in this parallel financial system vulnerable to a classic type run, but without the protection such as deposit insurance that the [regulated] banking system has in place to reduce such risks." Translation:  when the Street woke up to the fact that pledged securities in the repo market were junk, shock waves ripped through the interconnected system.  Bear Sterns was the first money bag to drop. The buyout of Bear Sterns by the Fed and JP Morgan was more about shoring up the repo market for which these two banks are the main pillars.  One of the primary function of a clearing bank is to value and match securities tendered for cash borrowings.  If Bear Sterns' collateral was worthless, the integrity of both the New York Fed and JP Morgan would have been seriously impaired.  

[2]A word to the wise.  According to financial advisor Martin Weiss there is another credit default swap to watch:  contracts on the default of United States Treasury bonds!  Formerly an unthinkable concept, nevertheless, a small group of players are bidding up premiums on the contract to 14 times their 2007 level.  Its a warning flag of serious potential damage to the credit of the US government.  No one wonder China is worried.  It is the "come to Jesus moment" in America.  No manufactured rallies on the Street can change it.  No arm waiving stock tout can disguise it.  Failed institutions must be allowed to fail regardless of their political patronage.  We are either enlightened capitalists or bad socialists.