The Coming Financial Meltdown
We all remember how in late 2008, staggering losses on risky derivatives nearly brought down our entire financial system.
With 43 members of the House and the Senate hammering out a final version of the financial-reform bill, one of the biggest contentions remains what to do about the mind-boggling, vast, and opaque derivatives market owned by the nation's too-big-to-fail megabanks.
The problem is getting worse. Notional amounts of derivatives held by federally insured banks have risen to more than $200 trillion.
No matter how you measure it, this is a ton of risk, and it's concentrated in five hands: JPMorgan Chase, Bank of America, Goldman Sachs , Citigroup, and Wells Fargo.
There are at least three problems with this picture:
1. This is crazy.
At 14 times the size of the U.S.'s gross domestic product, if even a fraction of these opaque and convoluted instruments blow up, as they did in 1998 and again in 2008, it would be bad news bears for everyone who doesn't live on roots and berries.
2. They're too big to fail.
The chief selling point of the financial-overhaul bill is that it somehow reduces the problem of too big to fail. Whether or not you believe that it does (it does not), one thing is for certain: The liquidation authority that is supposed to restore discipline and end moral hazard in financial markets is unlikely to work so long as derivatives traders continue to use American families' deposits as human shields. Derivatives collateral gets paid out before deposits, so the next time a megabank melts down, the Federal Deposit Insurance Corp. could be left holding the bag in liquidation.
3. We're subsidizing them.
Market-making can sometimes be socially useful, while gambling billions of dollars on interest-rate movements is probably less so, and given the dangers, may be socially detrimental. But none of these risky activities needs to be subsidized by our FDIC-insured deposits, 0% Federal Reserve liquidity guarantees, and the prospect of future bailouts. Continuing to do so will only encourage the market to grow larger and more dangerous, and siphon capital away from more legitimate activities like, say, lending money to support an economic recovery.
What you can do about it
One section of the financial-reform bill being debated now would end subsidies for derivatives trading.
Section 716, "Prohibition Against Federal Bailouts of Swaps Entities," is a flat ban on federal assistance to derivatives casinos. Banks could still use derivatives to hedge their own risk, but they would have to fund derivatives trading operations with their own money instead of ours.
Wall Street is furious. It apparently feels entitled to gamble with our savings.
Read the rest here