EC Will Derivatives Be The Next Black Swan?

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"It's déjà vu all over again." - Yogi Berra

The stock market has long been classified by economists as a leading indicator of the economy. It tracks and reflects the nation’s economy and industry fundamentals. The market often seems able to anticipate positive or negative change before it happens. Since the beginning of the bear market in August of 2015, the prices of many bank stocks, especially European and Japanese banks, have declined steadily and precipitously. Deutsche Bank has lead the way by dropping below the level it reached in 2009. Shares of HSBC, Citibank, Bank of America, Credit Suisse, Goldman Sachs as well many other big banks have also taken a beating of 25-45%.

What are bank stocks trying to tell us?

Some analysts suggest low interest rates are a problem for the banks along with flattening yield curves that suppress their profitability; or slow economic growth together with the sharp decline in oil prices and drilling activities are placing pressure on the credit quality of banks’ loan portfolios. Upon closer examination, we think neither of these issues is creating monumental problems for banks. As a matter of fact, the banks are doing just fine at the moment. Earnings are coming in above expectations and anecdotal evidence suggests that all is well on Wall Street. Young bankers who live in the tri-state area continue to drive luxurious European cars, live in multi-million dollar houses, and earn high salaries and huge bonuses. There are no recent layoffs by banks and not even a scent of trouble being detected.

We think the banks are faced with two fundamental problems; both need to be fixed immediately. The first problem is philosophical: if the banks continue to treat their customers unjustly and unfairly by not paying out interest on deposits, they will surely lose their customers and hurt their businesses. Common sense dictates that they must follow the basic business principle of placing clients first and employees second. After all, over the last eight years, the banks have made billions of dollars on credit card loans, mortgages, consumer installment loans, commercial and industrial loans plus government bailouts. Why don't banks start paying interest to their depositors? The banks in the U.S. alone withheld $1 trillion of interest payments from their customers. What‘s their excuse? None whatsoever.

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Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the ...

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Doug Wakefield 3 years ago Contributor's comment

Samson. I remember in the fall of 2006 one of the rating agencies giving a CDO bundling CDOs a rating of A+. The following spring in 2007, just as the banks were topping there was an SEC release which explained how the big banks had their own risk models, and thus regulated themselves based on these models. We know how that turned out in 2008. The big banks started down in February 2007, and the markets rolled over between 8-9 months later. June and July 2015 were the highest peaks since 2008 for the 6 largest Wall Street Banks. JPM is the only one close to its summer 2015 high. With the Dow closing over 18,000 only five days this April after leaving this level on July 20th last year, it would seem the efforts to levitate US stocks is running out and the broader indices will start catching up with the big bank stocks, as well as the other major equity markets.. Thanks for the informative article.

Moon Kil Woong 3 years ago Contributor's comment

Derivatives vary from mild to toxic. Sadly we don't hear about the toxic ones until too late. Likewise, many of those insuring or covering derivatives are not solvent if derivatives they insure go under. This is not a mistake, they are like this for the exact reason that they exist. To make money insuring and limit loss by going under when the insurance fails. Sadly, many say most of these have been created by banks to limit their liability and hide their risk.

Derivatives would be fine if there was no counter party risk and all those selling and insuring the sellers were solvent. However, if they were, what would be the fun of that. It would suck up massive amounts of capital. In fact, more capital that the whole world. Which underlies the very illogic in many derivatives games going on right now. It is a game of liars poker which TBTF banks have done all they can to put the cost onto taxpayers as the dumbest people in the room because their caretakers, politicians, could care less what happens to them.

Gary Anderson 3 years ago Contributor's comment

Just as small businesses buy insurance against derivatives loss, they always seem to lose. And betting on the high fixed rates on derivatives is a losing trade almost every time.

Moon Kil Woong 3 years ago Contributor's comment

Sadly banks have figured a way around. They make risky best that usually win, crate companies to insure them when they lose, underfund them because its actually them, then when it loses their losses are limited, the backing company's losses are limited because they are underfunded, and the taxpayer gets the bill because they claim the financial system will collapse if they don't pay out. This is the whole premise around too big to fail and why every TBTF bank wants to get bigger and remain TBTF.

It's a scam to screw Americans.

Gary Anderson 3 years ago Contributor's comment

It is likely the largest financial scam in the history of mankind, Moon.

Gary Anderson 3 years ago Contributor's comment

It is likely the largest financial scam in the history of mankind, Moon.

Gary Anderson 3 years ago Contributor's comment

I think that the central bankers are very comfortable with derivatives. That is a place where we need a fly on the wall, at Basel meetings talking about derivatives. Basel is seeking more collateral for derivatives and is succeeding somewhat. But unfortunately, it causes bonds to be in ever more massive demand as collateral. But it is a little collateral for a whole lot of derivatives, so, there could be something that the central banks cannot deal with. However, they planned and took down the housing bubble so they probably think they can control derivatives as well. JMO.

Doug Wakefield 3 years ago Contributor's comment

Gary and Moon. As maddening as the time we are all living in, it always encourages me to find individuals seeing the same big issues as I see. Thanks for your comments.