The 2015 Financial Meltdown & More

This week, I had the pleasure of being interviewed by Greg Hunter at USA Watchdog regarding my thoughts on the state of the global markets, economies and commodities into 2015.  Here are some key points we covered. For more detail, please check out the video of our interview here.

1) On the Market Meltdown: When I spoke with Greg about 9 months ago, I said that based on logic and the political-economic history I had explored for All the Presidents’ Bankers, there should have already been another major implosion following the 2008 financial crisis. However, there is an element of history that is unprecedented and which has acted as a barrier, albeit tenuous and fabricated, to another full-blown, transparent crisis. The scope of the zero-interest-rate policy and QE programs that emanated from the US Federal Reserve and have unfolded throughout the world are artificially bolstering market and financial interests as populations falter. In the US, this has been greeted by proclamations of economic victory from the Obama administration. In Europe, it’s harder to tweak the employment stats enough to declare the same thing, and hence, official QE programs there are ongoing. At any rate, this prolonged policy of injecting cheap money into the banks and markets, funded by the public due to the very nature of debt-creation and the purchasing of government and asset-backed debt securities, now surpasses any past measures of such activities in terms of scope and length.

The fact that these policies lasted for six years has inflated and distorted bond and stock markets, as well as the books of the world’s largest financial institutions to such an extent, that inherent ‘value’ in any of these areas is impossible to determine. We are living with the instability of a system that is supported by central bank maneuvers and the leveraging of them, not by anything organic or independently sustainable. Because rates are so low, any establishment with access to this cheap capital, or that has other people's money to burn, is creating bubbles by reaching for returns anywhere - in government bonds, stock markets, leveraged loans in debt-intensive firms like oil and gas, and in complex derivative products consisting of currency, commodity and credit elements.

The idea of funding the entire financial system with no exit plan for any non-crisis producing dissolution or resolution for such support boggles the mind.  This global QE period is larger and more insane that ever in history.  Because SO much cheap money is sloshing around the system at its top echelons, not through the real economy, the false appearance of stability has been perpetuated longer than logic would dictate.  But since global QE is not yet over, its benefits will continue to accrue to the same institutions that are already benefitting from it (the ones that leverage capital or sell bonds) until all the QE plans are over - not tapered, but unwound and done. While this transpires, a meltdown will unfold, but slowly. Meanwhile, this next phase of ECB QE will provide markets and banks more temporary solvency. So will the Bank of Japan’s money supply expansion and the People’s Bank of China version. 

2) On Volatility:  Market and economic volatility will increase this year – punctuated with media headlines like ‘unexpected’.  Last year, we had volatility spikes in August, October and December.  This year, we’ve already had spikes in January.  So, the shocks are coming in more closely and the downsides are deeper.  That’s why we are in a transitioning down period.  At the end of this year, we will have a lower bond and stock market.  The financial system will start to unravel more visibly and in a more sustained manner. The Federal Reserve won’t raise rates (or if they do, it will be at the end of the year, and only once, as it will have a brutal impact) because there is no reason to. Real inflation of people’s costs of living might be higher, but with global QE keeping a lid on rates and a boost on bonds, and with the dollar still strong, Janet Yellen will just continue using terms like ‘patiently.’ Every time major market participants get remotely nervous, the market will dump, and the next FOMC meeting’s language will be conciliatory to assuage the nerves of this flawed system.

3) On the US Dollar: The reason the dollar has remained strong, and the reason it will continue to stay strong for now is not because the ZIRP and QE policies are good, not because so much debt on the books of the country is prudent, and not because our debt to GDP ratio is cost-effective.  Printing cheap money to sustain a system for six years is a negligent policy.  Using money to plaster over a banking system that doesn’t work and has only become more concentrated is not a stability-increasing policy.  Nor has any of this cheap money trickled down to the average person. All those things are horrific.  But, what the dollar has going for it is the unique collaboration and power-position of the US government, private banks and the Fed.  The US had a first mover advantage compared to the rest of the world.  Its QE policies were biggest.  The dollar is propped up artificially by these alliances and ongoing maneuvers. Every other country is doing so badly and will continue to, that the dollar has, and will have, a relatively better value for now.  Eventually, this madness has to play out and the dollar will weaken, but we won’t see a “plunge” in the near term because every other country is struggling. Any downside to the dollar will thus be part of a slower meltdown punctuated by extra volatility.

4) On Gold: The same reason the dollar has stayed strong is why gold hasn’t had a major outbreak to the upside. With so much artificial stimulus and systemic manipulation, the paper-dollar and hard-asset gold are behaving in a zero-sum game relationship where real value or economic measures are meaningless. That said, gold prices will increase this year– but also only gradually, just as the dollar will not dump but will decrease gradually, as all of these QE maneuvers continue to play out.  Again, the stock and bond markets will decline as this artificial aid eventually does, and the movements will be marked by volatility to the downside. But since the artificial aid isn’t actually over, the price direction of everything will remained tempered. We have been underestimating the effect of all the support that has been lavished on the markets and into the banks.  That’s why considering the timing of this next phase is critical. There’s going to be a downward impact on markets.  There’s going to be an upward impact on gold.  It’s just not going to be as huge this year.  It’s going to be a more gradual kind of a year.

5) On the Swiss Central Bank Float Move: The Swiss deciding to detach from pegging to the Euro must be looked at from two perspectives that together characterize the kind of volatility and stab in the dark policies in operation this year. On the one hand, the Swiss rejected the idea of increasing gold reserves last year (indicating, among other things, hesitancy and uncertainty in general,) and the SCB has imposed negative interest rates (as has the ECB.) Both of these move are related to global QE. On the other hand, the Swiss don't want to be pegged to a declining Euro that will result from the next round of more ECB bond buying to be announced by Mario Draghi on January 22nd.  In general, these central banks don’t really know what will happen in the short or long term as these QE and bank-supportive policies play out.  The Swiss can opt out of part of these measures, but have no choice on the rest.  To a large extent, their move was a way to balance both sides.

6) On Ongoing Bank Risk and Concentration: The largest 30 global banks (dubbed “GSIB’s” or globally systemically important banks) control 40 percent of lending and 52 percent of assets worldwide. In the US, since the financial crisis, the Big Six banks’ share of assets has increased by 41.4 percent and their share of deposits has increased by 82.4 percent. Because of the largesse of government and Fed policy, that gets spun as economically beneficial to the American population. The Big Six stockpile of cash meanwhile, which is doing nothing for the public, has nearly quadrupled in size. 

In addition, just 10 US banks hold 97 percent of all bank-trading assets. Of those, JPM Chase holds 43.8 percent and Citigroup holds 24.5 percent.  Then, there’s leveraged loans, the 2010s equivalent of subprime loans. The 2014 issuance of collateralized loan obligations, or CLOs, eclipsed that of pre-crisis 2006, run by the same cadre of big banks. In November 2014, regulators found that 1/3 of the $767 billion loans they examined in their annual bank loan review showed “lax reviews of potential borrowers and poor risk management.” Nothing was done about it. Oil and gas loans ($250 billion of them) remain primed for defaults and catalyzing more volatility. Adding to the risk, the top four US derivatives trading banks (JPM Chase, Citigroup, Goldman Sachs and Bank of America) hold $219 trillion of $237 trillion, or 93 percent, of US derivatives. 

That kind of consolidation, nationally and globally is why we’ve had six years of artificially stimulated markets. Those figures are why the benefits of these policies go to the most powerful players but not to anyone else. They are why instability is here to stay and grow.

Why the Financial and Political System Failed and Stability Matters

The recent spike in global political-financial volatility that was temporarily soothed by European Central Bank (ECB) covered bond buying and Bank of Japan (BOJ) stimulus reveals another crack in the six-year-old throw-money-at-the-banks strategies of politicians and central bankers. The premise of using banks as credit portals to transport public funds from the government to citizens is as inefficient as it is not happening. The power elite may exude belabored moans about slow growth and rising inequality in speeches and press releases, but they continue to find ways to provide liquidity, sustenance and comfort to financial institutions, not to populations.

The very fact - that without excessive artificial stimulation or the promise of it - more hell breaks loose - is one that government heads neither admit, nor appear to discuss. But the truth is that the global financial system has already failed. Big banks have been propped up, and their capital bases rejuvenated, by various means of external intervention, not their own business models.

In late October, the Federal Reserve released its latest 2015 stress test scenarios. They don’t even exceed the parameters of what actually took place during the 2008-2009-crisis period. This makes them, though statistically viable, completely irrelevant in an inevitable full-scale meltdown of greater magnitude. This Sunday, the ECB announced that 25 banks failed their tests, none of which were the biggest banks (that received the most help). These tests are the equivalent of SAT exams for which students provide the questions and answers, and a few get thrown under the bus for cheating to make it all look legit. 

Regardless of the outcome of the next set of tests, it’s the very need for them that should be examined. If we had a more controllable, stable, accountable and transparent system (let alone one not in constant litigation and crime-committing mode) neither the pretense of well-thought-out stress tests making a difference in crisis preparation, nor the administering of them, would be necessary as a soothing tool. But we don’t. We have an unreformed (legally and morally) international banking system still laden with risk and losses, whose major players control more assets than ever before, with our help.  

The biggest banks, and the US and European markets, are now floating on more than $7 trillion of Fed and ECB intervention with little to show for it on the ground and more to come. To put that into perspective – consider that the top 100 global hedge funds manage about $1.5 trillion in assets. The Fed’s book has ballooned to $4.5 trillion and the ECB’s book stands at $2.7 trillion – a figure ECB President, Mario Draghi considers too low. Thus, to sustain the illusion of international systemic health, the Fed and the ECB are each, as well as collectively, larger than the top 100 global hedge funds combined. The BOJ has joined the fray wit its own path to QE. 

Providing ‘liquidity crack’ to the global financial system has required heightened international government and central bank coordination to maintain an illusion of stability, but not true stability. The definition of instability is this epic support network. It is more dangerous than in past financial crises precisely because of its size and level of political backing.

During the Panic of 1907, President Teddy Roosevelt’s Treasury Secretary, Cortelyou announced the first US bank bailout in the country’s history. Though not a member of the government, financier J.P. Morgan was chosen by Roosevelt to deploy $25 million from the Treasury. He and a team of associates decided which banks would live or die with this federal money and some private (or customers’) capital thrown in.

The Federal Reserve was established in 1913 to back the private banking system in advance from requiring future such government injections of capital. After World War I, a Laissez Faire policy toward finance and speculation, but not alcohol, marked the 1920s. before the financial system crumbled under the weight of its own recklessness again. So on October 24, 1929, the Big Six bankers convened at the Morgan Bank at noon (for 20 minutes) to form a plan to 'save' the ailing markets by injecting their own (well, their customer’s) capital.  It didn’t work. What transpired instead was the Great Depression.

After the Crash of 1929, markets rallied, and then lost 90% of their value. Liquidity froze. Credit for the masses was as unavailable, as was real money. The combined will of President FDR and the key bankers of the day worked to bolster people’s confidence in the system that had crushed them - by reforming it, by making the biggest banks smaller, by separating bet-taking arms from those in which people could store, and borrow money from, safely. Political and financial leaderships collaboratively ushered in the reform measures of the Glass-Steagall Act.  As I note in my most recent book, All the Presidents' Bankers, this Act was not merely a piece of legislation passed in spirited bi-partisan fashion, but it was also a means to stabilize a system for participants at the top, middle and bottom of it. Stability itself was the political and financial goal.

Through World War II, the Cold War, and Vietnam, and until the dissolution of the gold standard, the financial system remained fairly stable, with banks handling their own risks, which were separate from the funds of citizens. No capital injections or bailouts were required until the mid-1970s Penn Central debacle. But with the bailout floodgates reopened, big banks launched a frenzied drive for Middle East petro-dollar profits to use as capital for a hot new area of speculation, Third World loans.

By the 1980s, the Latin American Debt crisis resulted, and with it, the magnitude of federally backed bank bailouts based on Washington alliances, ballooned. When the 1994 Mexican Peso Crisis hit, bank losses were ‘handled’ by President Clinton’s Treasury Secretary (and former Goldman Sachs co-CEO) Robert Rubin and his Asst. Treasury Secretary, Larry Summers via congressionally approved aid.

Afterwards, the repeal of the Glass Steagall Act, the mega-merging of financial players, the explosion of the derivatives market, and the rise of global ‘competition’ amongst government supported gambling firms, lead to increase speculative complexity and instability, and the recent and ongoing 2008 financial crisis.  

By its actions, the US government (under both political parties) has chosen to embrace volatility rather than stability from a policy perspective, and has convinced governments in Europe to follow suit. Too big to fail has been replaced by bigger than ever.

Today, the Big Six US banks are mostly incarnations of the Big Six banks in 1929 with a few add-ons due to political relationships (notably that of Goldman Sachs, whose past partner, Sidney Weinberg struck up lasting relationships with FDR and other presidents.) 

We no longer have a private financial system responsible for its own risk, regardless of how it’s computed or supervised. We have a system whose risk is shouldered by the federal government and its central bank entities, and therefore, the people whose deposits seed that risk and whose taxes and futures sustain it.

We have a private financial system that routinely commits financial crimes against humanity with miniscule punishments, as approved by the government. We don’t even have a free market system based on the impossible notion of full transparency and opportunity, we have a publicly funded betting arena, where the largest players are the most politically connected and the most powerful politicians are enablers, contributors and supporters. We talk about wealth inequality but not this substantial power inequality that generates it. 

Today, neither the leadership in Washington, nor throughout Europe, has the foresight to consider what kind of real stress would happen when zero and negative interest rate and bond-buying policies truly run their course and wreak further havoc on their respective economies, because the very banks supported by them, will crush people, now in a weaker economic condition, more horrifically than before.

The political system that stumbles to sustain the illusion that economies can be built on rampant financial instability, has also failed us. Past presidents talked of a square deal, a new deal and a fair deal. It’s high time for a stability deal that prioritizes the real financial health of individuals over the false one of financial institutions.

As the World Crumbles: the ECB spins, FED smirks, and US Banks Pillage

Often, when I troll around websites of entities like the ECB and IMF, I uncover little of startling note. They design it that way. Plus, the pace at which the global financial system can leverage bets, eviscerate capital, and cry for bank bailouts financed through austerity measures far exceeds the reporting timeliness of these bodies.

That’s why, on the center of the ECB’s homepage, there’s a series of last week’s rates – and this relic - an interactive Inflation Game (I kid you not)  where in 22 different languages you can play the game of what happens when inflation goes up and down. If you’re feeling more adventurous, there’s also a game called Economia, where you can make up unemployment rates, growth rates and interest rates and see what happens.

What you can’t do is see what happens if you bet trillions of dollars against various countries to see how much you can break them, before the ECB, IMF, or Fed (yes, it'll happen) swoops in to provide “emergency” loans in return for cuts to pension funds, social programs, and national ownership of public assets. You also can’t input real world scenarios, where monetary policy doesn’t mean a thing in the face of  tidal waves of derivatives’ flow. You can’t gauge say, what happens if Goldman Sachs bets $20 billion in leveraged credit default swaps against Greece, and offsets them (partially) with JPM Chase which bets $20 billion, and offsets that with Bank of America, and then MF Global (oops) and then…..you see where I’m going with this.

We're doomed if even their board games don’t come close to mimicking the real situation in Europe, or in the US, yet they supply funds to banks torpedoing local populations with impunity. These central entities also don’t bother to examine (or notice) the intermingled effect of leveraged derivatives and debt transactions per country; which is why no amount of funding from the ECB, or any other body, will be able to stay ahead of the hot money racing in and out of various countries.  It’s not about inflation - it’s about the speed, leverage, and daring of capital flow, that has its own power to select winners and losers. It's not the 'inherent' weakness of national economies that a few years ago were doing fine, that's hurting the euro. It's the external bets on their success, failure, or economic capitulation running the show. Similarly, the US economy was doing much better before banks starting leveraging the hell out of our subprime market through a series of toxic, fraudulent, assets.

Elsewhere in my trolling, I came across a gem of a working paper on the IMF website, written by Ashoka Mody and Damiano Sandri,  entitled ‘The Eurozone Crisis; How Banks and Sovereigns Came to be Joined at the Hip” (The paper does not 'necessarily represent the views of the IMF or IMF policy’. )

The paper is full of mathematical formulas and statistical jargon, which may be why the media didn't pick up on it, but hey, I got a couple of degrees in Mathematics and Statistics, so I went all out.  And it’s fascinating stuff.

Basically, it shows that between the advent of the euro in 1999, and 2007, spreads between the bonds of peripheral countries and core ones in Europe were pretty stable. In other words, the risk of any country defaulting on its debt was fairly equal, and small. But after the 2007 US subprime asset crisis, and more specifically, the advent of  Federal Reserve / Treasury Department construed bailout-economics, all hell broke loose – international capital went AWOL daring default scenarios, targeting them for future bailouts, and when money leaves a country faster than it entered, the country tends to falter economically. The cycle is set. 

The US subprime crisis wasn’t so much about people defaulting on loans, but the mega-magnified effects of those defaults on a $14 trillion asset pyramid created by the banks. (Those assets were subsequently sold, and used as collateral for other borrowing and esoteric derivatives combinations, to create a global $140 trillion debt binge.) As I detail in It Takes Pillage, the biggest US banks manufactured more than 75% of those $14 trillion of assets. A significant portion was sold in Europe – to local banks, municipalities, and pension funds – as lovely AAA morsels against which more debt, or leverage, could be incurred. And even thought the assets died, the debts remained.

Greek banks bought US-minted AAA assets and leveraged them. Norway did too (through the course of working on a Norwegian documentary, I discovered that 8 tiny towns in Norway bought $200 million of junk assets from Citigroup, borrowed money from local banks to pay for them, and pledged 10 years of power receipts from hydroelectric plants in return. The AAA assets are now worth zero, the power has been curtailed for residents, and the Norwegian banks want their money back--blood from a stone.) The same kind of thing happend in Italy, Spain, Portugal, Ireland, Holland, France, and even Germany - in different degrees and with specific national issues mixed in.  Problem is - when you’ve already used worthless collateral to borrow tons of money you won’t ever be able to repay, and international capital slams you in other ways, and your funding costs rise, and your internal development and lending seize up, you’re screwed - or rather the people in your country are screwed.

In the IMF paper, the authors convincingly make the case that it wasn’t just the US subprime asset meltdown itself that initiated Europe’s implosion, but the fact that our Federal Reserve and Treasury Department adopted a reckless don't-let-em-fail doctrine. Even though Bear Stearns and Lehman Brothers failed, their investors, the huge ones anyway, were protected. The Fed subsidized, and still subsidizes, $29 billion of risk for JPM Chase's acquisition of Bear. The philosophy of saving banks and their practices poisoned Europe, as those same financial firms played euro-roulette in the global derivatives markets, once the subprime betting train slowed down.

The first fatal stop of the US bailout mentaility was the ECB’s 2010 bailout of Anglo Irish bank, which got the lion’s share of the ECB's Irish-bailout: $51 billion euro of ELA (Emergency Loan Assistance) and $100 billion euro of regular lending at the time. 

After the international financial community saw the pace and volume of Irish bank bailouts, the game of euro-roulette went turbo, country by country.  More 'fiscally conservative' governments are replacing any semblance of population-supportive ones. The practice of  extracting ‘fiscal prudency’ from people and providing bank subsidies for bets gone wrong has infected all of Europe. It will continue to do so, because anything less will threathen the entire Euro experiement, plus otherwise, the US banks might be on the hook again for losses, and the Fed and Treasury won’t let that happen. They’ve already demonstrated that. It'd be just sooo catastrophic.

In the wings, the smugness of Treasury Secretary Tim Geithner and Fed Chairman, Ben Bernanke is palpable – ‘hey, we acted heroically and "decisively" to provide a multi-trillion dollar smorgasbord  of subsidies for our biggest banks and look how great we  (er, they) are doing now? Seriously, Europe – get your act together already, don't do the trickle-bailout game - just dump a boatload of money into the same banks – and a few of your own before they go under  – do it for the sake of global economic stability. It’ll really work. Trust us.’

Most of the media goes along with the notion that US banks exposed to the ‘euro-contagion’ will hurt our (nonexistent) recovery. US Banks assure us, they don't have much exposure - it's all hedged. (Like it was all AAA.) The press doesn't tend to question the global harm caused by never having smacked US banks into place, cutting off their money supply, splitting them into commercial and speculative parts ala Glass-Steagall and letting the speculative parts that should have died, die, rather than enjoy public subsidization and the ability to go globe-hopping for more destructive opportunity, alongside some of the mega-global bank partners.

Today, the stock prices of the largest US banks are about as low as they were in the early part of 2009, not because of euro-contagion or Super-committee super-incompetence (a useless distraction anyway) but because of the ongoing transparency void surrouding the biggest banks amidst their central-bank-covered risks, and the political hot potato of how many emergency loans are required to keep them afloat at any given moment.  Because investors don’t know their true exposures, any more than in early 2009. Because US banks catalyzed the global crisis that is currently manifesting itself in Europe. Because there never was a separate US housing crisis and European debt crisis. Instead, there is a worldwide, systemic, unregulated, uncontained,  rapacious need for the most powerful banks and financial institutions to leverage whatever could be leveraged in whatever forms it could be leveraged in. So, now we’re just barely in the second quarter of the game of thrones, where the big banks are the kings, the ECB, IMF and the Fed are the money supply, and the populations are the powerless serfs. Yeah, let’s play the ECB inflation game, while the world crumbles.