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By Addison Wiggin | Forbes Wed, Nov 16, 2011
There is definitely going to be another financial crisis around the corner,"
says hedge fund legend Mark Mobius, "because we haven't solved any of the
things that caused the previous crisis."
We're raising our alert status for the next financial crisis. We already raised
it last week after spreads on U.S. credit default swaps started blowing out. We
raised it again after seeing the remarks of Mr. Mobius, chief of the $50
billion emerging markets desk at Templeton Asset Management.
Speaking in Tokyo, he pointed to derivatives, the financial hairball of
futures, options, and swaps in which nearly all the world's major banks are
tangled up.
Estimates on the amount of derivatives out there worldwide vary. An oft-heard
estimate is $600 trillion. That squares with Mobius' guess of 10 times the
world's annual GDP. "Are the derivatives regulated?" asks Mobius. "No. Are you
still getting growth in derivatives? Yes."
In other words, something along the lines of securitized mortgages is lurking
out there, ready to trigger another crisis as in 2007-08.
What could it be? We'll offer up a good guess, one the market is discounting.
Seldom does a stock index rise so much, for so little reason, as the Dow did on
the open Tuesday morning: 115 Dow points on a rumor that Greece is going to get
a second bailout.
Let's step back for a moment: The Greek crisis is first and foremost about the
German and French banks that were foolish enough to lend money to Greece in the
first place. What sort of derivative contracts tied to Greek debt are they
sitting on? What worldwide mayhem would ensue if Greece didn't pay back 100
centimes on the euro?
That's a rhetorical question, since the balance sheets of European banks are
even more opaque than American ones. Whatever the actual answer, it's scary
enough that the European Central Bank has refused to entertain any talk about
the holders of Greek sovereign debt taking a haircut, even in the form of
Greece stretching out its payments.
That was the preferred solution among German leaders. But it seems the ECB is
about to get its way. Greece will likely get another bailout 30 billion euros
on top of the 110 billion euro bailout it got a year ago.
It will accomplish nothing. Going deeper into hock is never a good way to get
out of debt. And at some point, this exercise in kicking the can has to stop.
When it does, you get your next financial crisis.
And what of the derivatives sitting on the balance sheet of the Federal
Reserve? Here's another factor behind our heightened state of alert.
"Through quantitative easing efforts alone," says Euro Pacific Capital's
Michael Pento, "Ben Bernanke has added $1.8 trillion of longer-term GSE debt
and mortgage-backed securities (MBS)."
Think about that for a moment. The Fed's entire balance sheet totaled around
$800 billion before the 2008 crash, nearly all of it Treasuries. Now the Fed
holds more than double that amount in mortgage derivatives alone, junk that the
banks needed to clear off their own balance sheets.
"As the size of the Fed's balance sheet ballooned," continues Mr. Pento, "the
dollar amount of capital held at the Fed has remained fairly constant. Today,
the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet.
"Prior to the bursting of the credit bubble, the public was shocked to learn
that our biggest investment banks were levered 30-to-1. When asset values fell,
those banks were quickly wiped out. But now the Fed is holding many of the same
types of assets and is levered 51-to-1! If the value of their portfolio were to
fall by just 2%, the Fed itself would be wiped out."
Mr. Pento's and Mr. Mobius' views line up with our own, which we laid out
during interviews on our trip to China this month.
An Eye on the Next Financial Crisis by Addison Wiggin originally appeared in
the Daily Reckoning.