The PJ Tatler

Big Banks Hold $222 Trillion in Risky Derivatives

What would happen if we had another financial meltdown? Odds are pretty good that it would be much worse than what occurred in September, 2008. And the reason for that is the amount of derivatives being held by America’s big banks.


In case anyone cares whether Dodd-Frank or the Volcker Rule defused those financial weapons of mass destruction known as derivatives, they can start worrying. Not only have the rules failed to curtail the risky FWMD, but they are larger than at the height of the financial crisis. And they are concentrated in four banks: JPMorgan Chase (ticker: JPM), Citigroup’s Citibank (C), Bank of America (BAC), and Goldman Sachs (GS).

That’s according to the second-quarter derivatives report of the Office of the Comptroller of the Currency. It tallied $222.5 trillion of notional derivatives held by insured U.S. commercial banks and savings associations, compared with $203.5 trillion in the second quarter of 2009.

“It’s outrageous,” says Lawrence Parks, executive director of the Foundation for the Advancement of Monetary Education, who included the statistics in a recent presentation. “If these guys were making bets with their own money, go to it. But don’t come to me after you’ve lost and say, ‘I’m too big to fail, give me money without limit.’ ”

To be sure, new Dodd-Frank rules on swaps dealers just took effect on Friday. But Sheila Bair, the former head of the FDIC who now chairs the Systemic Risk Council, says in an e-mail that, while some derivatives are ordinary hedges, their sheer magnitude, complexity, and opacity “creates an almost impenetrable web of interconnections that makes our global financial system vulnerable to systemic shocks.” Her advice? Rules to get risky derivatives out of federally insured banks.

No one knows what kind of shock would set off another financial meltdown. A Greek exit from the euro, a war in the Middle East, perhaps the US tumbling off the fiscal cliff — what is certain is that in any crisis, the Fed and the US Treasury would have a lot less leeway to bail out these banks.

First of all, the banks are much larger than they were in 2008. Secondly, the level of US debt has grown substantially during the Obama administration and any kind of bailout would necessarily mean adding to a massive problem. Third, despite the fact that inaction might bring on a genuine 1930’s style depression, there is little political appetite for a bailout of companies who continue to put the nation’s economy at risk with their profligate and risky ventures.

The Obama administration and the Democrats in Congress had an opportunity to rein in the banks and prevent the kind of bailouts that occurred in 2008. But industry lobbying watered down provisions in Dodd-Frank that would have lessened the risk to taxpayers while rejecting all attempts to make the derivatives market more transparent.

But derivatives are not really the problem. The banks need these derivatives as a hedge against risky investments — investments that drive innovation and create wealth. But the creative ways in which the banks chop up and sell derivatives makes a hedge into an unconscionably crapshoot.

The banks don’t want the derivatives market any more regulated than it is now. This would be fine — if they could prove to us that they are responsible managers and not given to using the US taxpayer to pay for their gambling. Apparently, the big banks have learned very little from the last crisis — except that crying “Too Big To Fail” works.

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