$4 Trillion Bank Sub-Investment Grade Derivatives Now More Than Financial Crisis Peak Part 2

Continued from Part 1

Just Who Will Be the Counterparty to These Credit Derivatives?

There are two sides to every trade conducted; a buyer and a seller. When you buy a share of XYZ Corporation, you assume there will be a liquid market to sell that share when you are happy with your profit or fed up with your loss. But what would happen if there was no counterparty to that transaction? What would happen to that share of XYZ stock if you couldn’t find a buyer? What if no one wanted your share of XYZ Corporation?

On that same note, who will be the buyer of the $1.89 sub-investment grade credit derivatives J.P. Morgan will be selling in the next 5 years? What about the other sub-investment grade derivatives from the other banks? Maybe they can get Iceland to buy some again! Just slap on another AAA rating and that will do the trick right?

Fool me once…

So far it seems that Bank of America (my speculation) has stepped in and bought some of J.P. Morgan’s credit derivatives since they had a substantial increase in the 1-5 year maturities and the greater than 5 year maturities categories. But where does Bank of America get the money from to buy these credit derivatives?

Banks Balance Sheets Tell the Real Story

Look no further than net borrowings of banks to see where the funds are coming from and how cash strapped these top banks still are as the following chart shows:

For the third quarter of 2010, J.P. Morgan Chase, Citibank, Bank of America, all had negative change in cash and cash equivalents, with Bank of America increasing their net borrowing by $41,432,000.

Let’s face if people, these banks are skating on thin ice.

Could It Get Worse for the Banks?

Can it get worse for the banks here in the U.S.? Unfortunately the answer is yes. The FDIC, the fund that all banks have been sending money into, including future years premiums paid in advaince, is $8 billion in the red. 157 banks failed this year, surpassing the 2009 number of 140 failed banks.

While there may be some larger, more stable banks to take over the failed ones, who will step in and rescue the FDIC should just one of these larger banks not find counterparties to their sub-investment grade credit derivatives?

There is only one answer to this question, and that’s the Federal Reserve via congress– in other words; We the People.

Congress To the Rescue Again?

Congress won’t allow these big banks to fail as it could trigger a run on the banks. In 2008, with the pleading from Secretary Snow, both sides of congress voted to provide funding to “save the system.” This won’t change come next year or subsequent years when congress will again be asked to vote on saving the banking system with Timothy Geithner and company playing the part of Chicken Little. Congress will always choose to support with bailouts rather than let the bad banks and other entities fail (think Fannie and Freddie here too).

In reality, the banks get to continue business as usual and Wall Street gets to pay its big bonuses, at least till they need even more bailouts. The rest of us lose jobs and declare bankruptcy.

How nice would it be for those who were on the verge of bankruptcy to receive a cash stimulus? But would they go out and create income to pay down that debt, or just use it to survive? Well, that’s all the banks are doing today; trying to survive.

Banks Get All the Breaks

Banks got the first reprieve from congress via TARP in 2008. This money was swallowed up by the banks and hoarded. Banks next reprieve came in 2009 when the Federal Accounting Standards Board (FASB) allowed them to mark to model their assets to fantasy valuations rather than to what the current market dictated (mark to market).

Further proof of the problems banks were having can be found in the record number of foreclosures occurring and the fact they wouldn’t even foreclose on people allowing them to stay in their homes for free. Add to this mortgage fraud lawsuits against Bank of America, the Bernie Madoff 6.4 billion lawsuit against J.P. Morgan, and we see the troubles never end for these large banks.

All the while, banks weren’t lending and still are not. Then recently, banks found a way to stop foreclosures completely led by who else, Bank of America and J.P. Morgan. If banks stopped foreclosing, then they wouldn’t have to mark to market any of those newly acquired low value assets on their books. How great is that for them?

What they hope to occur is for the economy to recover, housing to boom again and return to the glory days. This, of course, is pure fantasy.

We Haven’t Learned From the Past

We haven’t learned anything from the 1980’s Savings and Loan crisis and the failure of the FSLIC. We are going on 40 years of the U.S. dollar cutting ties with gold and a wild ride it’s been. We have had nothing but abuses of the banking system, brought to you most recently (current crisis) by Dodd, Schumer and Gramm who gave banks the ability to loan more than what had been the norm during the credit expansion with the passing of the bank deregulation bill.

Now the banks and everyone else are paying for these abuses by our congress. The attempted rescue/revival/stimulus by the Federal Reserve with their QE 1, QE 2 and QE infinity isn’t to help the People of America as much as it is to keep the faith in the banking system. The banks are everything. We lose them, we lose the economy.

The Humpty Dumpty Banks

The U.S. banks sat on a wall,
The U.S. banks had a great fall.
All the Fed’s horses, And all the Fed’s men
Couldn’t put the U.S. banks together again!

If you haven’t bought gold and silver to hedge these risks, then any forthcoming pullback might be the time to do so. Or you may want to now, if you think the information in this article paints a picture that might be clearer than the pretty faces on CNBC paint.

Now thems were hard times back in the eighties boys
People barely had enough to get by
But oh not me foot loose and fancy free
There was nothing to myself I’d deny
So fellas listen to my story now
Though you have heard this tale befo’
Take care of your needs and watch out for your greeds
Or that wolf will be at your door

Lyrics; I used to have money one time by Jimmy Buffet


Go To Buy Gold And Silver Safely Store
About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don’t trade with capital you can’t afford to lose. This is neither a solicitation nor an offer to Purchase/Sell futures or options. No representation is being made that any account will or is likely to achieve gains or losses similar to those discussed in this outlook. The past track record of any trading system or methodology is not necessarily indicative of future results.

All trades, patterns, charts, systems, etc. discussed in this outlook and the product materials are for illustrative purposes only and not to be construed as specific advisory recommendations. All ideas and material presented are entirely those of the author.

No Comments

Leave a Comment

Your email address will not be published. Required fields are marked *