New Derivatives Rules Rescinded To Help Banks Make More Money

The rules originally established to help protect the system from bank greed and fraud connected to derivatives were just rescinded by the same Basel Committee that drafted the original blueprint – article link.  The original rules would have significantly curtailed the ability of banks to underwrite the derivatives they sell to pension funds and hedge funds. It would have required that the banks put up a lot more in reserve capital, which in turn would have forced the banks to charge a much higher premium – or cost to the buyers – for the derivatives it sells. Make no mistake about it, AIG and Goldman would not have blown up if both parties had been forced to properly reserve against their derivatives contracts.

The financial collapse in 2008 was largely triggered because banks systematically under-priced the risk premium built-in to derivatives.  The original rules were designed to help limit the disaster caused by the under-reserved derivatives which blew up Lehman, AIG and Goldman and triggered the massive bailouts.  If the risk premium had been properly priced in a way that reflected the degree of risk embedded in the derivatives deals, it would have made most derivative contracts unaffordable to the end-user – pensions, hedge funds, municipalities, insurance companies etc. In other words, the new rules were established to protect the system from extreme greed and risk.

But if banks were forced to properly put up reserve capital to protect against the risks for which derivatives are used, most end-users would never buy them. This in turn would shut off the spigot to Wall Street’s most profitable business line. The change in the rules now means that the banks can party on as usual and make huge profit spreads on the derivative ticking time bombs they dump into  the financial system.

Again, make no mistake about it, this rule change is going to lead to another financial system collapse.  Only this time everyone will be forced to contribute directly to the bailout of the big Wall Street banks in the form of “bail-ins.”  Now we know why the bail-in rules are being transitioned and we know why big banks are moving their derivatives exposure up to their bank holding company level.

Anyone who understands what is going on here and continues to keep their money inside the financial system is either extremely naive or tragically stupid.  Forewarned is forearmed.

10 thoughts on “New Derivatives Rules Rescinded To Help Banks Make More Money

        1. THAT was the only out of character comment from Rust in the entire series. It was disappointing lol. It was like the way The Road ended. I think Rust was still all giddy from the demerol the hospital gave him.

      1. Dave ,

        Your new site is great for getting out fresh material !

        Events are rolling in faster and increasing in nature.
        Up to the moment is becoming a very important issue.

        There’s not much out there with the same kind of “heads up”
        indication that you offer.

        Thanks !

  1. What Awaits Banks After the Leverage Ratio
    New York Times – 09 April 2014
    “The Basel Committee is considering rules that will affect banks’ business strategies significantly and continue to influence how they strengthen their auditing and compliance teams for years…”
    Dave, swaps dealers got a break for some trades. Other larger players and hurdles await.
    This NYT reporter summarizes half a dozen or so new laws and regulations for LARGE banks for 2014, listing the best and worst prospects. More than window dressing, dressing up a corpse comes to mind as she is questioning their efficacy, risk, even their toxicity.
    Better still, gold along with cash and high grade bonds will be the permitted loan loss reserves/collateral ( sixth paragraph) under one of the likely scenarios.
    And as you say, soon after will be struggles over inheritance of the deceased estate.
    Rest in pieces…

  2. The bail-in model can only work to paper over a relatively small systemic derivatives-based problem. Basic math. Once counter-party dominoes start to fall, it will not take long before there simply isn’t enough depositor (or otherwise) equity to backstop busted derivatives’ liability, notional value be damned. I often wonder just what policy makers are thinking with the bail-in model. It’s like a band-aid that can work for small implosions. But it will never “fix” anything.

    I operate under a working hypothesis that those at the top of the financial oligarchy damn well know that there are only a limited set of options going forward, including: 1) proactively re-liquify the global financial system with a reset to vastly higher priced gold; 2) let everything crash, profit from further wealth and political consolidation, and then do some form of reset. Thus far, the West seems to be operating under a combination of #2 and indifference. The bail-in model will never work for anything other than small disruptions.

    I’ll be reading Nomi Prins’ new book, “All The Presidents Bankers” and interviewing her later this month. Looking forward to her take on all this because she’s mostly in camp #2.

    Dave, keep up the great work!

  3. “AIG and Goldman would not have blown up if both parties had been forced to properly reserve against their derivatives contracts”

    Is this a typo, Dave? Shouldn’t the word “not” be stricken from the above sentence? Sorry to be a nitpicker, just trying to understand being the layman I am.

    1. You’re right, it could be a typo. I should have clarified the statement. “If they had been forced to properly reserve against their derivatives positions from the beginning, they would never have been able to take on the amount of derivatives exposure that blew them up.”

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