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DANGER: Unknown Size, Location of Financial WMD

Posted by Larry Doyle on February 20, 2014 6:31 AM |

If there are hackers in far off countries who can figure out how to penetrate the computer systems of our nation’s banks and retailers, how is it that a full 5 years after the greatest crisis since the Depression that our financial regulators are not able to properly monitor the financial weapons of mass destruction, aka derivatives contracts, running throughout our system?

I will tell you how. Because the ‘too big to fail’ banks have zero interest in making that happen. If anybody needed any further reason to break up our ‘too big to fail’  banking oligopoly, Bloomberg provides it in this recent editorial:

The recent turmoil in emerging markets raises an urgent question: If things get worse, if markets plunge or a government defaults, do regulators know which banks, hedge funds or other institutions are most at risk? 

Almost six years after the crash, with financial regulation overhauled in the U.S. and elsewhere, you’d expect the answer to be yes. Actually, the short answer is no. Regulators charged with overseeing the financial system have vastly more data than they did before the last crisis, but not much more of a clue.

Five years ago, the extent and concentration of international exposure to the U.S. real estate bubble caught authorities everywhere off guard and almost sent the world into another depression. With precious little information on the investments and derivative contracts that connected financial institutions to one another, regulators were reduced to the role of firefighters. With little understanding of how far the damage could spread, governments had no choice but to risk trillions of taxpayer dollars on emergency guarantees and bailouts.

The experience led authorities to build better monitoring systems. One global initiative aims to gather real-time data on all derivative contracts, compiling the numbers in a way that would allow regulators to spot dangerous concentrations of risk. Another requires the world’s 20 or so largest financial institutions to report on their counterparties, so regulators can better understand how distress at one company could affect others.

Problem is, neither project is anywhere near completion. On derivatives, national regulators (and in many cases numerous separate regulators within countries) have focused on their own narrow areas of authority, creating a supervisory Babel. Some 22 repositories collect data in 11 different jurisdictions, all with their own reporting requirements, formats and mandates.

In the U.S., for example, the Securities and Exchange Commission is responsible for credit derivatives that insure against defaults on individual bonds, while the Commodity Futures Trading Commission handles the indexes that traders often use to hedge their bets on such derivatives.

Asking the big financial institutions about their counterparties is also problematic, because the institutions either don’t know or won’t say. (LD’s highlight: here it is folks, Wall Street owns Washington!!)

report last month from the Senior Supervisors Group, which includes regulators from 10 countries, voiced exasperation: “Five years after the financial crisis, firms’ progress toward consistent, timely, and accurate reporting of top counterparty exposures fails to meet both supervisory expectations and industry self-identified best practices.” The report said that banks provided data riddled with preventable errors, and had difficulty reconciling information from different parts of their operations.

The upshot is that no single authority has a complete view of the obligations that connect companies around the world. Suppose U.S. hedge funds sold default insurance on a bunch of European banks that were up to their eyeballs in emerging-market debt: Nobody would see the whole picture or understand the risks. Last year, a CFTC official said that the available derivatives data was such a mess that the agency couldn’t see the enormous “London Whale” trades that led to more than $6.2 billion in losses at JPMorgan Chase & Co. in 2012.

Regulators are trying to put this right. The CFTC has a team working on how to make sense of all its data. The Financial Stability Board, a forum set up by the Group of 20 developed and developing nations, is considering a global hub to put back together the derivatives data that regulators have pulled apart. This necessary integration won’t be possible, though, unless individual regulators make unprecedented efforts to coordinate their work, harmonize their rules and gather information in compatible formats.

Governments ought to make this work a priority. The Feb. 22-23 meeting of Group of 20 finance ministers and central-bank governors in Sydney would be a good place to start. And the first step is to acknowledge that the current state of affairs is unacceptable.

Which institutions dominate the derivatives markets with an approximate 95% market share? Goldman Sachs, JP Morgan, Bank of America, Wells Fargo, and Citigroup.

These banks should not be in a position to hold our markets, our economy, and ultimately our nation hostage.

Break up these banks.

I call for that reform and many others in my recently released book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy.

Larry Doyle

Please order a hard copy or Kindle version of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy.

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The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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