By Pam Martens: March 26, 2019 ~

The House Financial Services Committee, chaired by Democrat Maxine Waters,  has announced a hearing scheduled for 9:00 a.m. on Wednesday, April 10, titled Holding Megabanks Accountable: A Review of Global Systemically Important Banks 10 Years after the Financial Crisis.

The title of the hearing is certain to bring sweat to the brows of the CEOs of the five largest Wall Street banks that still hold monster amounts of derivatives: JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley.

Have the CEOs of the mega banks agreed to testify or have they offered up a subordinate to launch a charm offensive at the hearing? Or will it simply be progressive academics opining on how dangerous the banks remain or Koch-funded think tanks arguing for more deregulation of the bloated behemoths? Details on who will testify have not yet been provided.

There’s no longer any question or debate as to what needs to be put under a microscope at this hearing. That debate ended last Friday when the Federal regulator of national banks, the Office of the Comptroller of the Currency (OCC), released its quarterly report for the fourth quarter of last year. The data clearly demonstrated how little progress has been made in reducing the dangers the Wall Street banks pose to the U.S. economy since the passage of the Dodd-Frank financial reform legislation in 2010. It also showed that the banks are still gambling inside their federally-insured depository banks, thus putting taxpayers at risk for another epic bailout.

The official report from the Financial Crisis Inquiry Commission that investigated the 2008 Wall Street crash named derivatives as a key factor in the severity of the crisis, writing that “when the housing bubble popped and crisis followed, derivatives were in the center of the storm. AIG, which had not been required to put aside capital reserves as a cushion for the protection it was selling, was bailed out when it could not meet its obligations. The government ultimately committed more than $180 billion because of concerns that AIG’s collapse would trigger cascading losses throughout the global financial system. In addition, the existence of millions of derivatives contracts of all types between systemically important financial institutions—unseen and unknown in this unregulated market—added to uncertainty and escalated panic, helping to precipitate government assistance to those institutions.”

In fact, a major part of the $180 billion assistance provided to AIG went out the backdoor to pay off the Wall Street banks and hedge funds that had used the insurance company as their counterparty for their credit default swap derivatives.

The Dodd-Frank legislation spelled out in Section 716 that the credit default swaps, with their inherent ability to rapidly spread financial panic, had to be either centrally-cleared at a clearinghouse or had to be removed from the Federally-insured banks after a period of two years, with a possible one year extension if granted by their Federal regulator.

Dodd-Frank was signed into law by President Obama on July 21, 2010. That meant that by July 21, 2013, all credit default swaps should have either been centrally cleared or moved out of the insured depository bank. But according to the latest OCC report, here’s where things stand today: “The bank-held credit derivative market remained largely uncleared, as 29.3 percent of credit derivative transactions were centrally cleared during the fourth quarter of 2018.”

Just how much exposure to credit default swaps do the biggest banks have? According to the latest OCC report, Citibank N.A., has $1.8 trillion in notional (face) amount of credit derivatives (the vast majority being credit default swaps) of which just $320 billion is centrally cleared. (See Graph 15 of the report.)

Citibank is the federally insured commercial bank of Citigroup, the Wall Street bank that blew itself up in 2008 and received the largest taxpayer bailout in global banking history. Its federal regulators have been watching it scale up its risks for years. (See our 2016 report Bailed-Out Citigroup Is Going Full Throttle into Derivatives that Blew Up AIG.)

In terms of moving all types of derivatives from secretive over-the-counter contracts to a central clearing facility, the OCC reports the following: “In the fourth quarter of 2018, 39.8 percent of banks’ derivative holdings were centrally cleared…From a market factor perspective, 51.0 percent of interest rate derivative contracts’ notional amounts outstanding were centrally cleared, while very little of the FX [Foreign Exchange] derivative market was centrally cleared.”

Foreign Exchange trading also just happens to be the trading area where four banks were charged with criminal felonies on May 20, 2015 for their roles in rigging the market. One might think that federal regulators would feel compelled to shed some sunshine on why those derivatives remain off centrally-cleared facilities.

The OCC report also shows that JPMorgan Chase Bank N.A., the federally insured commercial bank of the Wall Street behemoth, lost $644 million in cash trades of stock or stock derivatives. Why is that level of stock trading occurring in JPMorgan’s federally-insured bank instead of it using its own capital in its investment bank? The filing that JPMorgan Chase made with the Federal Deposit Insurance Corporation (FDIC) for the period ending December 31, 2018 showed that its federally-insured bank had $264 billion tied up in trading assets as of that date.

It would be well for the House Financial Services Committee to remember that JPMorgan’s trading within its insured bank was the subject of a 9-month investigation in 2012 and 2013 by the U.S. Senate’s Permanent Subcommittee on Investigations. That trading, known as the London Whale scandal, resulted in the bank losing an astonishing $6.2 billion of its depositors’ money. The 300-page report issued by the Subcommittee found the following:

“The Subcommittee’s investigation has determined that, over the course of the first quarter of 2012, JPMorgan Chase’s Chief Investment Office used its Synthetic Credit Portfolio (SCP) to engage in high risk derivatives trading; mismarked the SCP book to hide hundreds of millions of dollars of losses; disregarded multiple internal indicators of increasing risk; manipulated models; dodged OCC oversight; and misinformed investors, regulators, and the public about the nature of its risky derivatives trading. The Subcommittee’s investigation has exposed not only high risk activities and troubling misconduct at JPMorgan Chase, but also broader, systemic problems related to the valuation, risk analysis, disclosure, and oversight of synthetic credit derivatives held by U.S. financial institutions.”

Unfortunately for the American people, under Republican leadership, the Senate Permanent Subcommittee on Investigations sees itself as a policeman of the Federal government and is completely ignoring the fact that Wall Street continues to hold the power to blow up the U.S. economy at any moment.

Another critical area that the House Financial Services Committee needs to address at the April 10 hearing is why these same Wall Street banks are allowed to operate their own internal, unregulated, quasi stock exchanges known as Dark Pools where they make thousands of trades in their own bank stocks as well as the bank stocks of their competitors. See our report Wall Street Banks Are Trading in their Own Company’s Stock: How Is this Legal?

While Wall Street had the benefit of the public’s attention being diverted by the Mueller investigation into President Trump’s political campaign and Russian interference in the 2016 Presidential election, it has seized the opportunity to dramatically increase its risk to financial stability.

Maxine Waters has a herculean job on her hands to present those risks in a clear manner to the American people. Unfortunately, the alternative choice is to allow those risks to remain in darkness, thus inviting Wall Street to surprise the country again with another epic, economy-crushing implosion.