Like a Mafia Don protecting his “family,” the Fed is implementing another layer of “protection” from collapse for the Too Big To Fail Banks. This latest deal will prevent bank counter-parties from pulling collateral from a collapsing bank. The installation of this law is a warning signal that the global banking system is barreling toward another devastating financial collapse.
The cover story for this scheme is that it will prevent another “Lehman” event from taking down the entire financial system. But it wasn’t Lehman, per se, that caused the 2008 collapse. Bear Stearns lit the fuse, Lehman was selectively thrown into the explosives mix and AIG/Goldman sprayed napalm into the explosion.
My source for this information of this is this article from Bloomberg: More Fed Protection For Big Banks. I had to read the article carefully a few times to fill-in between the lines, as Bloomberg kept referencing the new rule as a “proposal” and either white-washed or misrepresented the facts.
The new rule will prevent the TBTF bank counter-parties from taking their collateral away from the bank when the bank is collapsing. When a fund enters into a derivatives trade with a bank the fund is required to put up collateral, generally in the form of Treasuries. The bank is then free to hypothecate that collateral, or make use of it for its own purpose. But if the bank collapses and the fund is in a “winning” position on its derivatives trade with the bank, it’s in the fund’s best interest to withdraw its collateral. The new Fed rule will prevent this. The rule extends beyond derivatives, to securities lending agreements and repo transactions. But the truth is that this Fed rule is aimed squarely at derivatives.
The implementation of this new regulation, at best, extends the bail-in concept to TBTF “big boy” counter-parties, like hedge funds, insurance companies and pensions. The wellspring for this new banking rule is the Financial Standards Board, a key policy arm of the BIS. The FSB is the entity that drafted the bail-in regulation, which has been largely implemented in Europe. Bail-in regulations are now methodically being installed in the U.S. banking system.
In its essence, this “collateral freeze” regulation will eventually morph into a de facto bail-in mechanism and serves the purpose of transferring wealth from the banks’ counter-parties to the banks. At the very least, this collateral freeze regulation adds yet another layer of moral hazard into the banking system, as banks are incentivized to underwrite even riskier derivatives transactions with knowledge that the risk of collapse is further minimized.
Interestingly, this new law is “asymmetrical.” If the bank fails, it gets to keep all counter-party collateral locked-up. But if the bank’s counter-party fails, that counter-party has no ability to freeze the collateral it put up with the bank. The bank has possession of that collateral. This is what happened in the MF Global collapse, where JP Morgan seized all of MF Global’s collateral, at the detriment of MF Global’s customers. At the time JPM’s move was illegal but the judicial system looked the other way.
While the funds doing derivatives business with these banks will suffer irreconcilable damage from the new rule, at the end of the day, it will be the investors who have their money with hedge funds, insurance companies and pension funds that will bear the greatest expense of this de facto bail-in law. That would be you, the public. Once again the public gets screwed by the financial system in a way that is being enabled by the Government.
The only way to protect yourself from this is to remove as much of your wealth from financial custodians as possible. Not only is the new regulation a clear warning bell of another financial collapse coming, the Fed and the Government are making it even easier to trap your wealth. The financial system is one giant roach motel – you can check-in but eventually your money will never check-out.
But who will save them all from the guillotines.
Will not be I, as I am now a certified “Guillotine Operator 2nd.-Class.” Moving to 1st.-Class involves an apprenticeship of 2 years, or 247 heads, which ever comes first. I’ll be a 1st.-Class pretty quick, I’m sure.
An American citizen, not US subject.
Will the funds that play in the derivatives markets be more or less inclined to participate with these new rules in place? Or will they view the change as neutral, because as you state, it is the funds customers who get left holding the bag?
Would we expect the price of these “insured” derivatives to change? Since the bank can prevent withdrawal, shouldn’t the premiums on derivatives be reduced to compensate funds for the additional risk? Or do the rules just change without any consideration for the banks’ customers?
Nothing will change until the investors in these funds pull their money.
I saw Max Kaiser today talking about how Goldman is now opening deposit accounts with only a minimal of $1 required. You used to have to have a minimum of $10 million to open an account there. Now any clown can get a Goldman account. Jeez, they must be desperate for cash. It’s like a giant fly trap. (Or cash trap) Max Kaiser said this is all to do with their derivative positions. They need the cash.
It is beyond me why anyone with any wealth would give these charlatans any money to invest. And yet some of the richest people in the world trust them with their fortunes.
Dave, great article on a super important piece of news.
In theory, this rule change should lead to a repricing of derivatives and/or unwillingness of funds to purchase the “insurance” or hedging provided by derivatives, because this rule effectively transforms them into unsecured obligations of the issuing banks. The hedge funds and probably most of the insurance companies will be smart enough to realize this, assuming the rule change does not escape their attention. This should all lead to a material decline in the amount of derivatives banks will be able to issue, which will in turn lead to a material decline in revenues they receive on these derivatives. What good is an unsecured obligation of the issuing bank? The heads I win, tails you lose nature of the asymmetric collateral rule change should crush demand for these instruments. The question for funds that hold these positions now should be what are the exit fees?, because my “protection” has just disappeared!
Over time – assuming that there is enough time before the next financial system implosion for the effects of this rule change to roll out – one would expect that this rule change will lead to major decline in the amount of derivatives.
The rule change will create difficulties for fidcuiaries managing money. Derivatives permit them to now invest in risky high return investments like high yield junk bonds and cover their asses with the owners of the funds they invest by hedging against the risk with a CDS or interest rate swap. This prevents the fund managers from being sued for negligence or worse. I have often wondered how much of the derivative market is based on pure CYA need of professional money managers. Now that the protection afforded by derivatives will be even more illusory, the CYA coverage provided by derivatives will also be substantially diminished. Try explaining to your investors that, yes, I invested your money in a high-risk investment, but don’t worry! I hedged it with an unsecured promise from a bank whose balance sheet is totally opaque! Imagine the fun the lawyers will have with that one.
Simultaneously, the fact that these “insurance” contracts have now become near worthless, thanks to this rule change, should also increase the risk of the risky assets that the existence of derivatives now offsets. I.e., yields on risky assets should reprice higher, because there is substantially less protection avaiable for hedging their risk. In other words, this rule change reduces the ability of insurance companies, pension funds and hedge funds to “chase yield” because they won’t be able to hedge the risk. Exacerbating the problems at insurance companies and pension plans, for sure.
Unless the implosion is very near, the “success” of this rule change for the banks will depend on keeping this rule change below the radar. Any money manager who knows about this rule will have to completely change its investment strategy and reprice risk assets accordingly. In other words, if money managers grok the full significance of this rule change, this rule change alone could lead to substantial turmoil in the markets.
How and does this affect people with trading accounts? If large brokers are actively trading and holding up collateral themselves, could we see our trading accounts “disappeared”?
Yes, eventually. The safest custodians are the ones not connected to banks, like Schwab and Fidelity
Dave, A follow up on another caravan. No it’s not snakes on a plane. This time it’s Tanks on a Train.
Right thru the middle of Houston Texas, looking like something is setting up to go hot.
A mile long caravan of UN vehicles going north along the east coast from S Carolina and now tanks rolling through Houston. Something fucked up is coming…
“This is what happened in the MF Global collapse, where JP Morgan seized all of MF Global’s collateral, at the detriment of MF Global’s customers. At the time JPM’s move was illegal but the judicial system looked the other way.”
Isn’t that what happened to Gerald Celente’s silver contracts he had with MFGlobal (MoFoGlobal)? They even asked him to pay up on his contract he was never going to get.
If memory serves you are right. Save/invest in physical is the lesson imo.
If you have so much and want riskier [but may pay off big time and with an income stream] look at miners; in silver only the primary silver miners.