Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable

The world’s scariest story: trading in derivatives

Bad as these scandals are and vast as the money involved in them is by any normal standard, they are mere blips on the screen, compared to the risk that is still staring us in the face: the lack of transparency in derivative trading that now totals in notional amount more than $700 trillion. That is more than ten times the size of the entire world economy. Yet incredibly, we have little information about it or its implications for the financial strength of any of the big banks.

.. Public confidence in banks is now at a record low. According to Gallup, in the late 1970s, around 60 percent of Americans said they trusted big banks “a great deal” or “quite a lot.” In June 2012, less than 25 percent of respondents told Gallup they had faith in big banks.

But it’s not just public confidence. Specialists are equally bewildered. The Atlantic cites:

  • Ed Trott, a former Financial Accounting Standards Board member, when asked whether he trusted bank accounting, he said, simply, “Absolutely not.”
  • Several financial executives told The Atlantic that they see the large banks as “complete black boxes.”
  • A chief executive of one of the nation’s largest financial institutions considers banks “uninvestable,” a Wall Street neologism for “untouchable.”
  • Paul Singer, who runs the influential investment fund Elliott Associates, wrote to his partners this summer, “There is no major financial institution today whose financial statements provide a meaningful clue” about its risks.
  • Arthur Levitt, the former chairman of the SEC, lamented to us in November that none of the post-2008 remedies has “significantly diminished the likelihood of financial crises.”
  • A recent survey by Barclays Capital found that more than half of institutional investors did not trust how banks measure the riskiness of their assets.
  • When hedge-fund managers were asked how trustworthy they find “risk weightings”—the numbers that banks use to calculate how much capital they should set aside as a safety cushion in case of a business downturn—about 60 percent of those managers answered 1 or 2 on a five-point scale, with 1 being “not trustworthy at all.” None of them gave banks a 5.
  • A disturbing number of former bankers have recently declared that the banking industry is broken, including Herbert Allison, the ex-president of Merrill Lynch and former head of the Obama administration’s Troubled Asset Relief Program, Philip Purcell (ex-CEO of Morgan Stanley Dean Witter), Sallie Krawcheck (ex-CFO of Citigroup), David Komansky (ex-CEO of Merrill Lynch), and John Reed (former co-CEO of Citigroup) and Sandy Weill, another ex-CEO of Citigroup. The Atlantic notes that “this newfound clarity typically follows their passage from financial titan to rich retiree.”

The House Financial Services Committee aka “Money Committee”

One of the stories that I did was looking at the House Financial Services Committee and how seats on that committee ..  It’s sometimes called the “money committee” or the “cash committee” because it draws more money from lobbying and from corporate players that any other committee because it is the committee that regulates Wall Street; and so freshmen are put on that committee because it’s a great way for them to raise a lot of money quickly and to defend their seat after their first term.  As a member of Congress you are most vulnerable, after you’ve gotten elected, in your second election and if you win your second election, unless you do something really bad or there’s a major change in the politics of the United States, you’re pretty safe, so Freshmen are put on Financial Services because they want to quickly raise money.

.. The freshmen who are on financial services who are busy raising money from Wall Street, most of them went along with the provisions that would change Dodd Frank (and ease restrictions on the banks).  The more senior members by and large Democrats ,along with the administration spoke out against … (voted against)

.. There’s intense pressure on them to raise money but they must raise money from the same world that they are supposedly regulating.  And so how do you you raise money from Wall Street and yet at the same time be tough on them?  And so if you look at some of the votes that they’ve taken the folks that under the most pressure to raise money tend to be the folks that are voting in favor of the legislation that the lobbyist on Wall Street are pushing.

(31 -34 min)