How Strong Are Big American Banks in 2017?
Times are complicated for those who like investing in the markets. The way the Dow has shot up in the months after Donald Trump won the presidential election has made investing seem as easy as pointing a mouse on a stock symbol on the screen and collecting your winnings. But there are risks. A banking crisis is coming and there are many risks for American banks in 2017.
Any list of American banks based on the level of risk exposure must consider derivatives. The well-known slogan “too big to fail” used to apply to everything but banks before September 2008. Then Lehman Brothers Holdings Inc. went bust, pulverizing that long-held opinion. Still, Lehman’s collapse did serve a valuable purpose.
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The list of “too big to fail” American banks keeps growing for a simple reason. The market and regulatory conditions in which they operate present more risks. To capture the essence of that risk in a single word, “derivatives” should come to mind first and second. Altogether, the top 25 U.S. banks or holding companies had some $252.0 trillion in derivatives exposure as of June 2016. (Source: “Shhh! Don’t Tell this Bank Regulator We’ve Got a Derivatives Problem,” Wall Street on Parade, December 28, 2016.)
Derivatives Exposure for the Big American Banks Is at Epidemic Level
These same 25 banks only had $14.0 trillion in assets. That’s almost a 20:1 ratio for derivatives exposure. The top six alone, the ones vying for “too big to fail” status, had about $229 trillion. Consider the chart of the largest U.S. banks by asset representing top American bank holdings. Note, the amounts are in billions of dollars. (Source: Ibid, last accessed April 13, 2017.)
Why should you be concerned about derivatives? American banking systems might face a total regulatory reversal in 2017 if Trump goes through with a major reform. In truth, it’s not much of a reform. The word usually applies to a process of improvement. This would be expected, if not implied.
|
Rank |
Bank |
State |
Assets |
Derivatives |
|
1 |
Citigroup Inc |
NY |
$1,818 |
$53,593 |
|
2 |
JPMorgan Chase & Co. |
NY |
$2,446 |
$52,702 |
|
3 |
Goldman Sachs Group Inc |
NY |
$896.8 |
$51,918 |
|
4 |
Bank of America Corp |
NY |
$2,189 |
$42,314 |
|
5 |
Morgan Stanley |
NY |
$828.8 |
$39,653 |
|
6 |
HSBC North America Holdings Inc. |
NY |
$295.3 |
$10,566 |
In the case of banks, given the experience of the financial crash of 2008 and the Great Recession, most hearing the word “reform” might expect an effort to limit banks’ risks. Instead, the reform aims to wildly increase the banks’ abilities to take risks. Indeed, they would not just take risks with their own money, but also with yours and your neighbors’.
What other risks, you ask? Wall Street has been flying to new heights. There’s an impression that all you have to do is pick a company—the more tech-oriented the better—wait, and reap the rewards. It sounds as easy as preparing a cup of coffee to make money. But the markets have not taken the major risk of a U.S. banking crisis in 2017 into account.
Derivatives Are Biggest Risk Factor for a Financial Crisis Now
A number of factors can spark a crisis. But derivative exposure is one of the biggest. Most people have no idea that Wall Street has become a gigantic casino. It’s fitting that Trump, as a casino owner, is president. But Wall Street banks are making billions of dollars with the derivatives market. Clearly, nobody wants the party to end.
The term “derivative” may seem complicated. But it’s not that difficult to get what they do and the risks they provoke. A derivative is essentially a highly leveraged side bet. That’s the problem; a derivative bet that goes wrong can cost much more than the original investment.
Originally, these bets have been designed to cover the risk, but today the derivatives market has grown into a mountain of speculation, unlike anything the world has ever seen before, as you can see from the above table.
At this point, the derivatives have gone totally out of control. Side bets were made on just about anything you can imagine, and the major Wall Street banks are making a lot of money with this. This system is almost entirely unregulated and is totally dominated by the large international banks. Over the past two decades, the derivatives market has multiplied.
Everything is fine, so long as there is an equilibrium. But once you lose it, financial meltdowns will multiply and no government in the world will be able to solve it. A crisis of 2017/2018 could be far worse than 2007/2008.
Indeed, Wall Street appears to have ignored the fact that financial institutions’ risk exposure is such as to cause a global banking crisis. U.S. banks are not the only ones put in danger by derivatives and other high risk instruments. Deutsche Bank AG has some $47.0 trillion in derivatives. Moreover, there are banks that could collapse in many parts of Europe.
A Banking Crisis Cannot Avoid Going Global
These banks are not just Italy, Spain, or Greece, which have seen some of the largest bank failures. They are also in Germany, as Deutsche Bank suggests. The problem is, as economics professor and former Italian Prime Minister Romano Prodi has pointed out, quite simple.
Banks have continued to consider “credit risk.” But they have failed to take strong measures against market risk. (Source: “Europe ignoring market risks from banks’ derivatives, says Romano Prodi,” ItalyEurope24, January 17, 2017.) Nothing spells market risk more than derivatives. It so happens that American banks might be the most exposed to derivatives as a group.
The term banking crisis is deceptive. In fact, any banking crisis—especially the type that comes on a huge scale—causes a market crash. Depending on the depth of that banking crisis, the market crash can lead to economic collapse and deep recession. For those who want proof, just consider any analysis of the Great Crash of 1929 and the Great Depression or the 2008 Crash and the Great Recession.
The reason why banking crises and economic recessions and depressions are related is the following. Without functioning and solvent banks, there is little or no credit available to finance growth. In other words, if individuals and companies cannot get access to credit, they cannot expand, they cannot hire more people, they cannot invest in new equipment, and they cannot increase production.
Banks are at the heart of the modern financial system in capitalist economies. Even China, of a handful of states still proclaiming to be Communist, relies on banks to keep the markets and the economy running. Thus, everyone should fear a banking crisis. Most of all, they should fear a U.S. banking crisis in 2017 because it inevitably sets off a global domino effect.
That domino effect might look something like this. Donald Trump said he wants to unburden banks from the very regulations that constrain U.S. bankers and financiers from taking too many speculative risks. That’s the key that would open Pandora’s box of risk. Trump wants to undo the Dodd-Frank Wall Street Reform and Consumer Protection Act. This, since 2009, has prevented commercial banks from taking risks with their customers’ savings in the financial markets—and often in hazardous derivatives.
Add to that the context in which Trump’s proposed scrapping of the Dodd-Frank might occur. Britain is about to leave the European Union. This will no doubt shift the center of gravity of European finance from London to Frankfurt, Paris, or Milan. The U.K. is still in the European Union, thus the risk the shift away could have on the British economy is unclear.
This conjunction of circumstances raises questions about what is really happening in global finance. How will the push for deregulation affect bank’s investment practices? Will they engage in the same actions that caused the crisis—or even more—that shook the world in 2008? Can the global banking system withstand that level of risk?
Of course, the main question most people are worried about is how deep the coming banking crisis might be and how deep the next financial crisis will go. Indeed, there’s little doubt another financial crisis is coming. Unless you have parked your savings in certain defense sector stocks, Trump’s performance as POTUS has been all but predictable.
Trump Has Turned the Tables on “America First”
The markets have taken off on the assumption that Trump was going to “Make America Great Again.” Instead, barely two full months on the job, Trump has made a complete 180-degree turn. He appears to be re-engaging an American imperial project. Far from being Putin’s lackey, relations between Washington and Moscow have not been this bad since the 1980s.
Meanwhile, Trump wants to take some kind of action in North Korea, a country which may have nuclear weapons. The president has sent warning shots to Russia and Syria, launching a missile strike against a Syrian airbase. He has also sent some of the U.S Navy’s largest vessels to the Eastern Pacific.
As a clear message, on April 13, 2017, Trump authorized the Air Force to drop the largest bomb (MOAB) in the U.S. arsenal over an ISIS tunnel complex in Afghanistan.
Trump’s new militarism can be confusing for the markets. For starters, it could boost energy costs for average consumers. Given the fact that salaries have not increased in years, any increase to the basic cost of living could ruin the already fragile employment growth of the past few months.
It could also cause more uncertainty in the markets, triggering nothing short of a reality check after weeks of Dow Jones records resting on nothing but expectations and thin air. Indeed, the financial crisis train is moving at full speed. Unbridled speculation means that many assets are hiding a potential toxicity. And all the while, America’s public debt (over 110% of GDP) shows no signs of slowing down.
Trump’s newfound militarism does not agree very well with his proposed fiscal reform. That fiscal reform was predicated on tax cuts, but who might pay for the new wars in which that the White House intends to engage? Meanwhile, the banking crisis of 2007/2008, fueled by nothing else than the explosive combination of greed and risk, has not taught any lessons.
Even, if Trump decides to avoid deregulating Obama-era efforts to rein in speculation, the risk of a banking crisis—or a bank fueled crisis—remains. The large global or system banks (Citi, Goldman Sachs, HSBC, JPMorgan Chase, BNP Paribas SA, Bank of America, Deutsche Bank, etc.) have done little but to protect their own balance sheets.
The danger for the global financial system represented by derivatives is so great that Warren Buffett once called them “financial weapons of mass destruction.” For now, the financial powers are trying to keep the derivatives train on rails, but it is inevitable that at some point it will derail.
When it does, it will spark a banking crisis that could destroy the entire global financial system. You can protect your savings. Not all banks are the same. Some have taken the right steps, find out which. Read our – You’ll Never Guess Which BIG American Bank is Going Bankrupt NEXT
