Election 2016: Too Big To Fail

We don’t like it, but certain big banks won’t be allowed to fail.

When I was working on Wall Street, I saw the inner behavior of how bankers react in a crisis. Here’s the most important lesson that I can pass on to you from my time there: Bankers don’t care about how their actions impact you.

At Bear Stearns and Goldman Sachs, we never worried about how our practices might affect the world at large. The game was to do whatever was possible to make money, as quickly as possible, and stay within the legal confines.

Of course that has changed dramatically since I left the industry in 2002. Many bankers don’t worry about “legal confines” today. Why would they? Those goalposts are flimsy at best.

These banksters break the law, get fined, and repeat, again and again. Yet, the rigged political-financial system continues to turn a bipartisan blind eye to those crimes. Politicians try to convince the public that supporting these banks, at any cost, is necessary to maintain the financial system we operate under.

Elite bankers always try to truncate a collapse at the earliest stage possible. This is for their benefit — not yours.

These bankers lean on politicians and line up with central bankers’ dubious policy. This has been particularly true in the wake of the 2008 financial crisis. In addition, this system promotes the creation of more risk, predicated on the deposits and other bank accounts of everyday people.

Truncation of bank problems runs up to the White House. The results of this election may bring about minor differences in how each administration would handle financial distress, but not many.

Here’s a look at how bankers and politicians enable crises — in their attempt to prevent the escalation of global financial distress.

The Consequences of Cheap Money

In the wake of the 2008 financial crisis, the trio of U.S. bailout architects acted in concert. This trio consisted of Treasury Secretary Hank Paulson, New York Federal Reserve President (and then Treasury Secretary) Tim Geithner, and Federal Reserve Chairman Ben Bernanke.

The bailout boys did not save the economy as they advertised. Rather, they bolstered the biggest U.S. banks from an insolvency crisis of their own creation. Those banks were, and remain, too big to fail. Their CEOs are too connected to jail.

But as in Fight Club, the first rule of big bank survival is not to talk about it publicly. All federal and central bank support are downplayed. The byproduct of 8 years of zero to near-zero interest rates has benefitted banks, but it’s not meant to be talked about. Meanwhile banks get to overvalue any securities on their books (because when rates are low, prices on bonds are higher).

This is an implicit aid to these government-subsidized financial institutions. Bank chiefs like Deutsche Bank head, John Cryan, might publicly disparage the European Central Bank (ECB) for its QE policy, but the bank has been a beneficiary of it.

In 2008, banks like Bear Stearns and Lehman Brothers were allowed to die. (I can tell you from working at these two, they had nowhere near the political and power connections that the surviving banks did). Meanwhile, politicians and central bankers enabled the Big Six banks to thrive.

The leaders of the major U.S. banks oversaw multi-trillion dollar enterprises that committed fraud, lost other peoples’ money, harassed public service members, and fired thousands of low-level employees. Worst of all, they have put the entire financial system and markets at the edge of ruin again.

Today, the mentality remains the same. Big banks know they will have political and Federal Reserve support. They have taken this as a license to gamble large.

By rescuing and supporting the big banks’ dangerous behavior, such crimes have been not only condoned but encouraged. Every instance that a central bank (or government using taxpayer money) has to bail out, bail in, or act in an emergency capacity has put us at greater risk.

By supporting actions that threaten the FDIC insurance pool backing our deposits, our ability to withdraw cash, and overall confidence in markets, these bankers have ultimately harmed those savers who “play by the rules.”

The Fed and ECB policies of lavishing cheap money on the banking system through bond purchases have floated the biggest financial players. We’re seeing the consequences now with Wells Fargo and Deutsche Bank. These are two of the Global Systemically Important Banks (G-SIBs). You’ve probably seen both in the news recently.

Wells Fargo is the second largest U.S. bank in terms of assets. Wells Fargo Global Financial Institutions (GFI) is “one of the world’s largest providers of foreign exchange (FX), treasury management, and trade-processing services.” It ranks among the top 20 largest firms by market capitalization globally.

Deutsche Bank is Germany’s largest bank and the 4th largest bank in Europe. Its stock plummeted 7.5% percent following German Chancellor Angela Merkel announcement that she is ruling out a bailout before the election next year.

Hedge and investment funds began dumping Deutsche Bank precipitously due to many ailments, including lack of transparency, onerous derivatives positions and its entanglement with the U.S. Department of Justice over mortgage-related frauds. Shares of Deutsche Bank got bashed 7.6% on October 12th alone. Shares are down 67% since April 2015 and over 40% during 2016.

Both of these banks are being propped up by governments and central banks to truncate financial distress. As Jim points out, this is the standard elite response. But the problem with this plan is that it just creates more distress at a later date (or as I like to think of it, kicking the can down the road.)

Because bank behavior hasn’t changed, the problems aren’t going away.

Deutsche Bank: Europe’s Ticking Bomb

In 2008, the U.S. bailout boys helped German giant, Deutsche Bank (DB) stay alive. Why? Because it was entangled in the same mess as the big U.S. banks who had bought insurance for their toxic assets from AIG.

As it faced collapse, DB received $12 billion from the bailout given to AIG. It was a recipient of the same kind of help that Goldman Sachs, Merrill Lynch, and Morgan Stanley received.

The simple reason is that all of their positions were co-dependent financial dominos. If one went down, they’d all go down. Between 2007–10, DB ranked 9th in total emergency loans received from the Fed.

Today, DB’s total derivatives figure is around $47 trillion. This is down from $55 trillion in 2013, but at more than 12 times the size of the German economy, it’s still too high. Rather than chopping derivative positions — which are entangled with other global mega banks — DB plans to cut thousands of jobs to compensate for the shortfall.

This is also how Germany’s second largest bank, Commerzbank, is reacting. (DB’s derivatives are caught up with, among others, Bank of America’s, which has cut more than 70,000 jobs since 2010.)

The argument these big banks make about their mega derivatives positions is that they are “hedged.” In other words, though the total (or “notional”) figure is large, most of the long and short positions net out against each other.

The problem with that assessment is that the big banks take long and short positions against each other. They have set themselves up again in domino fashion. If there’s too much stress on one side, as we saw in the financial crisis of 2008, then liquidity dries up and crisis occurs. That’s when central banks and governments step in to contain — rather than fix — the core of the mess.

The recent trouble for DB was stirred up on September 15. The DOJ announced it was considering fining DB $14 billion. This is for civil claims regarding DB’s shady activity related to residential mortgages during the 2005-07 pre-crisis period. (Its market value is about $18 billion.)

The problem is that DB only set aside $6.2 billion to cover legal ramifications. That doesn’t account for reserves required to cover a major failure or emergency situation—and both are real possibilities as we face the next recession.

In addition, DB failed the past two stress tests of the Federal Reserve. It has not done much between them to improve its capital shortfall.

Draghi allowed DB to cheat on its stress tests. According to the Financial Times, ECB regulators allowed DB to consider a pending sale as counting towards its capital for stress tests purposes in 2015. DB was still able to raise $4.5 billion from investors. But $3 billion of that is senior debt issued at junk bond interest rates during just the past two weeks.

Cheating enabling aside, ECB head Mario Draghi claimed he wouldn’t give DB special treatment. While in Washington, D.C. for an IMF-World Bank conference Oct. 7, Draghi also denied that low rates enable such big banks to remain liquid despite faulty positions.

As he said, “If a bank represents a systemic threat for the euro zone, this cannot be because of low interest rates — it has to do with other reasons.” That’s simply not true. Low or negative rates provide banks access to cheap capital if they need it, which encourages greater recklessness than if they had to “pay” more for it.

The ECB is truncating this threat of financial distress. While there’s no way that DB would be allowed to fail, the stock could still get battered further from where it is now. The only way DB will be able to raise enough capital to regain solvency will be if the ECB and German government oversee a “bail in” that dilutes the claims of today’s DB shareholders into oblivion.

We’re seeing a similar situation in America with Wells Fargo.

Wells Fargo

Wells Fargo CEO and Chairman John Stump recently addressed both the U.S. House and the Senate. After his address, Massachusetts Senator Elizabeth Warren told him he should resign.

This occurred after the disclosure that 5,300 Wells Fargo employees had created about 2 million fake credit card and deposit accounts, scamming about $2.4 million off existing customers in fees for those accounts. Wells was fined $185 million for those crimes.

Stumpf admitted responsibility for the crimes of his employees. They were fired. He’s been asked to give up about $41 million out of his $247 million in stock awards. However, it’s stock he doesn’t own yet, so he can’t use it anyway.

This type of slap on the wrist is a sign of truncating financial distress.

Since the 2008 crisis, Wells Fargo (like other big U.S. banks) has copped to multiple crimes that took place under Stumpf’s leadership, totaling $10 billion in fines and settlements. They range from defrauding the U.S. government (for which we, as taxpayers, foot the bill), to pillaging minority customers and misleading shareholders.

If these crimes were committed by a bank without Wells’ expansive size and connections, it would be toast by now.

Though Wells Fargo’s stock lost value during the hearings, the majority of investors don’t care — most notably Warren Buffett. The “Oracle of Omaha” lost around $1.5 billion in personal wealth in one day due to the Wells Fargo scandal, but recovered $1.7 billion after the heat died down.

He’s still down around $4.7 billion on Wells in general. His company, Berkshire Hathaway, owns about 10 percent of the shares in Wells and applied in July to buy more. When Jim Rickards and I discussed this, he noted that Buffett has a history of being a “white knight” to financial institutions in distress and turning them around. He did this at Salomon in 1991 and Goldman in 2008.

This is one way that the acceleration of a market collapse can be pulled up short. “Strong hands” step in as buyers to prevent financial distress from gaining more momentum and being transmitted to other markets.

The public scrutiny and the resultant stock price downturn in is a better entry point for the Buffett. Shares of Wells Fargo are down nearly 17% this year and off 10% since the settlement with the Consumer Financial Protection Bureau.

In the wake of the scrutiny, John Stumpf resigned from his post on October 12. His number two, Timothy Sloan, himself a 29-year Wells veteran, became CEO immediately.

The Next President Will Endorse Recklessness

There’s no reason for us to expect the pattern of truncation to stop with the next president, no matter who wins the election.

Since the 2008 crisis, the U.S. national debt has skyrocketed from $10.6 trillion to more than $19.5 trillion today. Much of that debt is directly related to the bank-catalyzed crisis and the aftermath of sustaining Wall Street under the guise of helping Main Street.

Add household, corporate and bank debt, and the grand total was a mind-boggling $199 trillion in mid-2014, up 40% since 2007, according to a 2015 study by McKinsey Global Institute.

A dangerous concentration of assets, $10 trillion, sits on the books of the Big Six U.S. banks. These banks have copped to settlements involving upwards of $150 billion worth of fines for a range of criminal behavior, from manipulating public markets to committing fraud against the American public.

That means in the coming months, the Fed will stay vigilant about the capital positions of banks, but keep the cheap money flowing. It might put added pressure on the DOJ to give DB a pass on its settlement amount to avoid contagion to U.S. banks.

Meanwhile, whoever wins, the White House will not promote a modern Glass Steagall to separate our deposits from riskier big bank bets. Trump mentioned it in passing during the Republican Convention to get Bernie Sanders supporters on his side (and it remains on the GOP platform). Since then, he has talked about more deregulation in general, which would give banks a freer rein to commit acts of risk against the public.

Hillary won’t do anything to upset the mega-bank applecart or her Wall Street friends, and big donors. Earlier this month, WikiLeaks  released transcript information from Hillary’s speeches to Goldman Sachs, including two speeches which netted her an estimated $225K per speech (she bagged over $22 million in total speaking fees from when she was Secretary of State to running for President, nearly $3 million from Wall Street.)

She has repeatedly touted her husband’s record on the economy, including in the second presidential debate. That record entailed repealing Glass Steagall in 1999. She’s not turning that back.

We can expect more rescuing of the Big Six U.S. banks, while smaller ones take the fall in the next crisis.


Nomi Prins, @nomiprins
for The Daily Reckoning

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