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Banks Are Setting Us Up Again, This Time The Fall Could Be $2.6 Trillion or More

Just five years after they played a primary role in engineering the worst financial crisis since the Great Depression, America's big banks are quietly setting the world up to do it all over again.

Only this go-round the costs will be far higher and the damage much worse. This time the fall could be $2.6 trillion or more.

Let me explain.

It started back in the mid-2000s. Wall Street was busy packaging low-rated subprime loans into securitized offerings that were somehow worth more than the sum of their parts.

In reality, what they were doing was little more than laundering toxic debt while raking in obscene profits along the way.

You know the rest of the story as well as I do. Not long after, the stuff hit the proverbial fan and it was not evenly distributed.

Well here we go again…

Both JPMorgan and Bank of America are quietly marketing a new scheme designed to "transform" sub-par assets into quality holdings that will serve as treasury-quality collateral needed to meet the new capital requirements that come into effect in 2013 as part of the Dodd-Frank Act.

Wall Street Is Up to Its Old Tricks

This may sound complicated but it's not. It works like this.

When you trade on margin like these mega-institutions do, you are required to post collateral to offset counterparty risk. That way, if the trade busts and you are unable to deliver on your side of the trade, there is recourse.

If you have a mortgage or a car loan, you know what I'm talking about. Your lender can seize both if you default or otherwise fail to meet your payment obligations.

Trading collateral works the same way. In years past, trading collateral has most commonly taken the form of U.S. treasuries (or other securities) that meet stringent requirements with regard to ratings, liquidity, value and pricing.

However, since the financial crisis began, treasuries are in increasingly short supply. Investors and traders who have preferred safety over return are hoarding them.

Consequently, traders like JPMorgan's London-based "whale," Bruno Iksil, who want to write increasingly bigger, more sophisticated trades are in bind. They find themselves unable to trade because many times the clients they represent can't post the collateral needed to "gun" the trades.

As you might imagine, Wall Street doesn't like that because it means billions in profits and bonuses get lost as trading volumes drop.

So they've gone to the unregulated woodshed again and come up with yet more financial hocus pocus designed to circumvent rules in the name of profits.

At the same time, they're once again hiding the true extent of the risks they are taking – and that's the outrageous part.

These same banks that have already driven the world to the brink of financial oblivion and been bailed out once may need another $2.6 trillion dollars or more to backstop the unregulated $648 trillion derivatives playground they've created for themselves.

And don't think for a minute that your money isn't at risk either…

If you have a retirement fund, a money market fund or are invested in any sort of pension plan whatsoever, you are already involved in this game whether you signed up to play or not.

We're talking about trillions of dollars' worth of sovereign and agency debt. Think the United States, Japan, Italy, Spain, and Germany here, along with the bets on that debt — all of which has been "backed" by central bankers, effectively removing the risk of failure from the financial markets and specifically from the firms engaged in these kinds of trades.

Of course, Wall Street has just pulled the wool over everybody's eyes by marketing most of these derivatives as "insurance" against default. In reality, they are king-sized bets levered up to levels so high that they now place entire nations at risk of default, not just individual traders or institutions.

That's because derivatives allow traders to effectively bet on directional changes in everything from interest rates to markets and currencies. They also allow firms to effectively arbitrage the relative risks between various financial instruments or lock in specific prices on everything from bonds to commodities.

The Biggest Margin Call of All Time

Here's where we get to the meat of the matter.

As part of new rules driven by the 2010 Dodd-Frank Act, traders will have to drive the majority of privately-traded derivatives contracts through clearing houses like the Chicago based CME or the London based LCH.Clearnet, which was formerly known as the London Clearing House.

Previously they didn't because upwards of 90% of the derivatives were privately negotiated and therefore exempt from centralized exchange requirements, including margin.

In the process, they'll have to post additional collateral that can be "perfected," meaning seized and converted to cash, in the event of a counterparty failure or default.

As reported by Bloomberg, estimates from Morgan Stanley suggest the new requirements could mean the banks trading in derivatives have to come up with $481 billion in top-rated collateral on the low side to $2.6 trillion on the high side, which is what the Massachusetts-based Tabb Group projects.

My own estimate is somewhere in the $4-5 trillion range, because I believe the total value of the derivatives markets is still being understated by banks and trading houses not keen to let skeletons out of the proverbial closet.

And therein lies the problem. Neither the trading firms nor their clients have the additional collateral.

What's more, they likely won't be able to get it because the vast bulk of the $33 trillion in worldwide top-tier AAA- or AA-rated debt is already pledged as collateral or otherwise accounted for in separate transactions.

Were these banks and their clients living like the rest of us, they'd simply conclude they were "tapped out" and their resources exhausted because there would be nothing left.

But noooooo…… Under the terms of both the JPMorgan and Bank of America programs, clients not meeting the new collateralized quality standards can pledge other less-than-treasury-quality assets to the bank against a "loan" of Treasuries from the trading firm that's then posted by the trading firm as collateral acceptable to the clearing houses.

In other words, the trading firms are going to loan treasuries to clients who are incapable of meeting liquidity requirements while accepting lower grade assets in exchange. Details are hard to come by at the moment with regard to the fees they'll rake in, but you can bet "transforming" lemons into lemonade won't be cheap.

This is similar to what happens in the commercial "repo-market" where banks and trading firms temporarily pledge their assets in exchange for cash loans. Nor is it much different than pledging your paycheck at an instant loan store. In both cases, you are pledging assets against transactions that you wouldn't otherwise be able to conduct.

The fundamental question boils down to this: If we know that billions in improperly assessed risks led to the first blowup in 2007, how on earth could this be any different– especially with trillions now on the line?

You can't wave your hand over a pile of less-than-treasury-quality assets and have them suddenly, miraculously become treasury quality because they are grouped together.

Yet, this is exactly what Wall Street is doing here.

And just like before, Wall Street's latest scheme is expressly intended to disguise risk and circumvent the specific rules about to be put in place to prevent excess leverage from potentially destroying the world's financial system.

Is there a fix?

I can think of one, but it's from a source you'd never believe in a million years would come out of my mouth: Fed Chairman Ben Bernanke.

Congress can't balance its checkbook. Our politicians can't make tough decisions. Our regulators are out-lobbied and outmaneuvered at every turn. No president can ask his nation to take its medicine regardless of party affiliation.

But Bernanke can. Supposedly – emphasis on supposedly – he's apolitical.

Acting under the Fed's dual mandates of maintaining "monetary and credit aggregates commensurate with the economy's long-run potential," Chairman Bernanke could bypass the entire political, regulatory and lobbyist morass in one fell swoop by declaring that the United States government will not back any derivatives trades — or any firm that engages in them — worldwide in the event of default.

Not only would this re-introduce the concept of failure into capital markets but it would do what neither Congress nor our regulators have been able to do — put an immediate end to the kind of "profit at all cost regardless of risk behavior" that exemplifies everything wrong with Wall Street.

I can only imagine the disclaimer on one of those Uncle Sam posters more commonly associated with wartime military recruiting. It might read: "Counterparty Beware."

Until then, it's investors who should be "aware."

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at

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  1. A Donald - - Not The Donald | September 17, 2012


    Brilliant analysis of what's coming next. This kind of scrutiny of Wall Street and the Big Banks, is one of the reasons I am a subscriber.

    Keep up the good work!


  2. Mark Watson | September 17, 2012

    So who is NOT at risk? From this article it sounds like everyone should cash out and close their accounts. How do investors protect themselves and is it even possible to protect investors anymore?

  3. C Steve Kime | September 17, 2012

    Ben Bernanke is the same as "in God We Trust"? The Fed, a private entity run by the bankers for the bankers and of the bankers, will regulate this? Keith my man, please stop with the fairy tales. Buy metals people, gold, silver, & lead. Those will see you through what these "Master of Universe" have in store for you Sheeple!

  4. Kevin Beck | September 17, 2012

    Keith, that would be a wonderful thing to have happen; EXCEPT we have seen from the actions of MFGlobal and PFG Financial, the customers would be the ones suffering the risk, as their "deposits" will be stolen away to foreign nations to protect the counter-parties.

    If these bankruptcies had been handled the proper way, the customers would have been the ones protected, because the first rule of a fiduciary is to act in the best interest of the client/customer. The second rule is to not mix company and depositor funds. Both these rules seem to have been violated by the above-mentioned firms prior to their bankruptcies, and they were aided and abetted by the (corrupt) judicial system in their shenanigans.

    • Scott | September 18, 2012

      Its the John Corzine debacle that boggles the mind. The money disappeared, evaporated, mistakenly used, every description but the true one. Customer funds stolen to pay company debts. Betting on the Euro. He was right and the rest of the world was wrong. He had a better chance betting blind in a horse race.

  5. Paul G Huber | September 17, 2012

    Banks are setting us up again….You have out done your self. Tthat's certainly one of the more scary articles I've seen you write.

    So I'm not in a Managed Pension I'm all in self directed IRAs, Roths and an SEP-IRA and they are all in Gold & Silver Stocks, UpSteam and DownStream Oil Stocks, Gas Pipelines, Water Stocks, and a couple of Odds and end stocks like your CapStan and UEC.

    So, what's safe? Several Stocks I hold, I bought at the Obama bottom. Naturally I would expect them to find a new bottom in the Next Obama crisis. I've given thought to your stop loss suggestons but they all seem like a 30% haircut, which I suppose is better than losing 90%.

    I guess I am getting old and worry too much. I read you and other newsletters and no one seems real optimistic. Is this that wall of worry, Bull Markets climb?

    And then there's your darn Watch this Video or Kick Yourself Later….I really don't like your or anyone else's long and plodding videos. If you got something to say just say it. I'll choose kick myself later…hows that, I ain't clicking it and I am never clicking it again.

    Don't get me wrong, I like you guys, but I don't like those video things.

    Guns & Gold.
    Paul G Huber

  6. Dimi Chakalov | September 17, 2012

    The additional "perfected" collateral — from $2.6 trillion to "somewhere in the $4-5 trillion range" — is absolutely unattainable. Of course, "neither the trading firms nor their clients have the additional collateral." And Chairman Ben Bernanke could NOT re-introduce the concept of failure into capital markets, "by declaring that United States government will not back any derivatives trades or any firm that engages in them worldwide in the event of default" either.

    The end result is collapse of the bond market. The buck stops with those who will ruin it.

    Thank you, Keith.

    All the best,


  7. Diana | September 17, 2012

    I think that the article forgot to mentioned that major culprit in the morgage collapse of 2008 was Freddie Mac and Fannie Mae. Yes mentioned the chairman Barney Frank. Banks did also played primary role to the point of committing fraud by processing false documents.

  8. Taras Bulba (Nom de Plume for Taras Bunka) | September 17, 2012

    Sir, Yes, take away the federal guarantee to the parties involved in these "private derivatives deals"
    The deal was made in private, it'll be be settled in private, or go into bankruptcy. This whole thing
    is just a casino, and how much credit did you get there the last time you imbibed ?
    Taras Bulba

  9. Jack Williamson | September 17, 2012


    I'm interested in this: however
    1- it takes way too long to listen to.
    2- twice I was interrupted & I could not pause it.

    Could you send it in print so I can read it much faster and pause when I am interrupted. Otherwise I will not be able to respond to your presentations.

    Jack Williamson

  10. Tony Supak | September 17, 2012

    Don't believe for a second Mr. Ben and his team knows what they are doing? How can they reelect Mr Obama and make Amercia a third world nation any other way? Open your eyes, which I know you have done. There shouldn't be any suprises because Mr. Obama told us what he was going to do four years ago. I know because I kept up with his progress. And Mr. Obama will be our president for another four years. Oh how I wish I'm wrong.
    tony Supak

  11. jamesejeffinger | September 18, 2012

    The problem is that the government wants the banks to make more loans to home buyers – if the loans are riskier the insurance garenteeing the loan will be riskier

  12. BUFFALOKANDRAVI@AOL.COM | September 18, 2012

    I am still wondering about the reverse pipeline theory. it seemed to have reversed so much it does not get mentioned anymore the $3.82 tax or what ever that fill you vehicle up promo was. I see many MLP'S keep making the list but I wonder if EPD was a thought that Ben B already knew and now the shoe is not on the other foot, it is sholess maybe soaking the feet in a pond, please explain what the reason for the length of these predictions, something tells me if Dan Duncan was around he would have a couple of questions for you he was a straight up man and would get right to the point and not make a novel about this speculation. I am not discouraged but more like in the middle of this 101 MLP'S that keep popping up and not just in Money Map etc. but just some more specifics instead of what if's and but this new land underwater theory. I remember building his first govt EPA LINE OF CRAP SPILL CATCHER AT HIS MT. BELVIEW PLANT IN EAST HOUSTON JUST TO HEAR HIM SAY YOU MIGHT AS WELL KEEP THE EQUIPMENT ON THE JOB BECAUSE NEXT WEEK SOME AMBULANCE CHASING LAWYER WOULD BE HITTING UP ALL THE LAND OWNERS AROUND THE PLANT THAT THEY SHOULD INVENT A LINER FIRST SO IT DOES NOT GE T IN THE DRINKING WATER AND I SAID RIGHT THERE ON THE SPOT AT 95 DEGREES AND SWEAT ROLLING OFF OUR HEADS UNDER OUR HARD HATS THAT FOR A MIL I CAN GET LINER MATERIAL FROM GUNDLE THAT THEY WHERE LOADING AT THE AIRPORT IAH GOING TO IRAQ THAT THESE EPA GURU'S DO NOT KNOW ABOUT AND LINE IT ON THE WEEKEND AND THE SAND AND DIRT AND CLAY WAS RIGHT THERE TO CAP IT SO THEY WOULD NEVER SEE IT AND WHEN THEY CAME BACK WITH THERE NEW RULE BOOK 1000 PAGES LONG YOU COULD WATCH THEM SWEAT AND WONDER HOW YOU KNEW THAT WAS COMING AND DAN SAID DO IT WITH A COST PLUS PO# AND HE WOULD HAVE HIS SO CALLED SAFETY GURU'S ADD AN PAGE OR TWO, TWO WEEKS LATER AT THE TOWN HALL MEETING AFTER SOME BODY'S COW DIED HE WAS FRONT AND CENTER WITH HIS PAPERS TO GET THE LAWYERS TO CRAWL BACK IN THERE HOLE. so I can not call Dan no more and I liked your reverse theory about out cheap fill ups and have heard no more about EPD would you mind giving an update I know pretty much about all the other MLP'S but was curios on your spin on this 3dollar and some tax hole before it is a real archive.

  13. Gary Loest | September 18, 2012

    Our banking system has unfortunately morfed from a free enterprise investor controlled service, to a quasi governmentally controlled sector, that is a politically driven pawn of the federal government.

    If a bank is negligent in the manner it conducts business, which results in losses, then the stockholders (owners), not the taxpayers, should absorb the losses. There should be no counterparty insurance provided by the government.

    Risk taken by banks should be determined solely by the management or board of directors, not dictated by regulations of the US Government. Bank deposits should be insured by independent insurance carriers and the banks should pay the premiums as required by the bank regulators.

    The free markets should prevail, and we will avoid all of the manipulation by the government and their social agendas and related goals, that meet their end objectives.

    The banks created the Fed, and it has become the cookie jar that keeps them solvent, and the laundry that cleanses their misdeeds, and sanitizes their wounds when they turn excessive risk into loss …..all at the expense of the taxpayers.

  14. Fulon D Hill | September 19, 2012

    1. The federal reserve bank is a private organization, not a government agency.
    2. The charter states the chairman must be appointed from among the heads of the member banks. The president of the U.S. cannot appoint an honest outsider to the post. That's like having a law that the Attorney General must be appointed from among the heads of organized crime.
    3. On another subject entirely: if I pay the premiums on my health insurance, am I "entitled" to be reimbursed for covered medical expenses? REALLY? Then if I pay my FICA tax (as if there were a choice) am I "entitled" to collect Social Security in case I become old or disabled, or die leaving minor children (they collect, not I)? Then why is "entitlement" a dirty word? Because all the funds paid into FICA (see your check stub) have been used to pay for government services NOT paid for by the taxes NOT paid by the wealthy since the Reagan-Bush tax cuts. Now that the bill comes due, and the wealthy who own the government do not want to repay the "loan" they received, they want the payees to feel ashamed for expecting repayment. REALLY?
    4. We have a one-party political system. The "two" parties are really both branches of the Corporatist Party. Until we have instant runoff voting (like Australia), no real choice will be available. The "horse race" and the media feeding frenzy will continue and the people will continue to be deceived and fleeced.

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