Chasing derivatives: Is the problem with money really one of politics?

9 Biggest Banks' Derivative Exposure

9 Biggest Banks' Derivative Exposure, photo courtesy Demonocracy

 

Longtime Public Bank advocate Frank Sanitate writes an opinion article in the Santa Barbara News-Press that peels back the curtain shrouding the obscure, unregulated quadrillion-dollar derivatives market and asks what are the big four banks — foundations of our financial world — really doing with the money.

“U.S. banks held $172 trillion in derivatives at the end of 2017. This amount is 11 times the value of all the assets all the U.S. banks own. …

“Playing in derivatives is no longer investing, but trading. In other words, banks are not lending money to create goods or services, but trading it with each other to try to win from each other. If they win their bets, it adds nothing to the real economy, or to depositors — only to bigger profits for the bank owners — $5 billion in the 4th quarter of 2017. Trading is non-productive money. It adds no goods or services to the economy.

Reprinted with permission: 

Four of your five page 1 articles in Sunday Voices (7-8-18) had to do with money and politics. Your readers may be interested in digging more deeply into how money really works, not just how it affects current politics or vice-versa. Take a short, common sense journey with me.

The Quarterly Report on Bank Trading and Derivatives Activities - a little-known report from the Office of the Comptroller of the Currency (OCC)  came out recently. I am sure 99% of our population has never heard of it. However, doesn’t the title alone pique some interest: Banks do trading? They trade derivatives? There’s a report on it? By our government?  Every quarter?

I spent some time looking through the report. I share four scary points about it and banking:

1. U.S. banks held $172 trillion in derivatives at the end of 2017. This amount is 11 times the value of all the assets all the U.S. banks own.

First, what are derivatives? Author Les Leopold says, “Derivatives are complex financial instruments that allow banks and wealthy investors to make bets worth trillions of dollars on such events as whether or not a company’s bonds will fail. If these bets were considered insurance policies, which they obviously are, then they would be subject to regulations insuring that buyers and sellers had enough reserves to cover losses, just like any insurance company.” So, the banks are placing $172 trillion in bets on these “instruments” called derivatives, but they don’t have the reserves to cover them.

To be fair, that $172 trillion is called the “notional value” of the derivatives, the amount banks would have to come up with if they actually had to buy or sell the underlying asset or debt of every derivative they hold at full value. Under normal circumstances that is unlikely. So the OCC tried to come up with a more realistic way to quantify risk. They call it “Value at Risk” (VaR), a figure much lower than the notional value. Its definition still mystifies me. However, an earlier OCC Report indicates it still mystifies them too! It says: “Banks use VaR to quantify the maximum expected loss over a specified time period and at a certain confidence level in normal markets. VaR is not (emphasis mine) the maximum potential loss.” In the 1929 and 2008 crashes, banks counted on a “certain confidence level in normal markets.” Who knew markets would be abnormal and “confidence” way out of whack? (Actually, some did, and they profited immensely from it!)

Further, banks are supposed to be depositories who keep our money safe, and who make loans based on that money. Why are they doing all this gambling? They are “hedging” their bets. Playing in derivatives is no longer investing, but trading. In other words, banks are not lending money to create goods or services, but trading it with each other to try to win from each other. If they win their bets, it adds nothing to the real economy, or to depositors – only to bigger profits for the bank owners – $5 billion in the 4th quarter of 2017. Trading is non-productive money. It adds no goods or services to the economy.

2. The four largest U.S. banks (JPMorgan Chase, Citibank, Goldman Sachs, Bank of America,) hold 90% of all derivatives traded by U.S. banks! The largest 25 banks account for nearly 100%!

So, the derivatives game is one banks play solely with each other. What’s wrong with this picture? They are using the public’s deposits as security to gamble for their own profit. This gambling has nothing to do with helping the economy, depositors or borrowers. Have you tried getting a mortgage or business loan from one of the big four lately? Isn’t that why we gave banks the privilege of being able to lend up to 9 times the capital they actually have in the first place – to facilitate the exchange of goods and services among people by making loans?

3. According to the Bankruptcy Act of 2005, in a bank crash, derivative holders stand in front of depositors to be paid off!

In other words, if a bank makes enough bad bets and it crashes, it can take what’s in our checking or savings accounts to pay off its derivative debts – which would be to other banks. It can even legally take what is in our safe deposit boxes! In short, banks can take our money to pay off their gambling debts to each other! Not only does bank gambling add nothing to depositors; it actually puts us at risk.

4. Jim Rickards in The Death of Money says: “Financial institutions prefer derivative strategies using swaps and options to achieve the targeted returns, since derivatives are recorded off balance sheet and do not require as much capital as borrowings.” Excuse me, “off balance sheet”? What else could that mean other than bank balance sheets are unreliable? They do not tell us the full story. And, the derivatives they trade require “less reserve capital”? How does this deliberate lack of transparency build our confidence in banks? I am grateful we at least have the Office of the Comptroller of the Currency reporting on them, even though it does nothing to stop then altogether.

Gambling by the banking casino is unproductive money; it produces no goods or services for us. So, yes, the problem of money actually is political, going back to how the Fed and banking was set up in 1913, and the laws enacted by subsequent Congresses to legitimize bank gambling.
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Frank Sanitate is a writer who lives in Santa Barbara. This article is part of his “Frank Spanks the Banks” series. 

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