Wall Street Banks, Insurers Sell Off — Dangerously Linked by Derivative Trades

By Pam Martens and Russ Martens: February 25, 2020 ~

If the federal government wants to quarantine the most dangerous threat to the financial health of the United States, it will impose a lockdown and decontamination of the federally-insured banks that are holding tens of trillions of dollars in derivative trades. Yesterday, the stock market rout outed the worst of these actors.

While the Dow Jones Industrial Average fell a hefty 1,031.61 points, that was only a 3.56 percentage point loss. The S&P 500 was off by 3.35 percent. The decline in the broader averages looks tame compared to what happened to some of the biggest banks on Wall Street and their derivative counterparties.

Morgan Stanley tanked by 5.23 percent; Citigroup was off by 5.12 percent; while Bank of America closed down 4.74 percent. JPMorgan Chase and Goldman Sachs magically trimmed their losses during the trading day, closing down 2.69 percent and 2.64 percent, respectively. (Both JPMorgan Chase and Goldman are the targets of criminal probes by the U.S. Department of Justice, making their mild declines yesterday, compared to their peers, a bit hard to swallow. Both banks own Dark Pools where they are allowed to trade their own stocks.)

Why did the Wall Street banks trade so much worse than companies that are experiencing supply chain disruptions from the coronavirus? Other market activity strongly suggests that there is a critical problem with the banks’ counterparties to their tens of trillions in derivative trades.

The most recent report from the regulator of national banks, the Office of the Comptroller of the Currency (OCC), shows that as of September 30, 2019 these five Wall Street behemoths held the following amounts of notional derivatives (face amount): JPMorgan Chase held $54.9 trillion; Goldman Sachs Group accounted for $50 trillion; Citigroup $49.4 trillion; Bank of America $39.3 trillion while Morgan Stanley sat on $36.2 trillion. Just these five bank holding companies represented 85 percent of all derivatives held by the more than 5,000 Federally-insured banks in the U.S.

Wall Street banks’ interconnections to derivatives was a major cause of the financial collapse and freezing up of credit in 2008. Wall Street banks’ using the big life insurer, AIG, as a major derivatives counterparty (meaning it took the other side of their derivative bets) resulted in a $185 billion bailout of AIG by the federal government.

None of that, sadly, has enlightened Congress to reform the situation. According to the 2017 Financial Stability Report from the Office of Financial Research (OFR), the federal agency created under the 2010 Dodd-Frank financial reform legislation, these insurers are among those that have derivative ties to Wall Street: Lincoln National Corp., Ameriprise Financial, AIG, Prudential Financial, and Voya Financial. Three of those names experienced worse losses than even the Wall Street banks yesterday: Lincoln National dropped a whopping 7.81 percent; Ameriprise closed with a loss of 6.25 percent; AIG shed 5.97 percent; Voya gave up 5.16 percent; while Pru closed with a loss of 5.15 percent.

The 2017 OFR report explained the derivative linkages between the Wall Street banks and the insurers this way:

“…some of the largest insurance companies have extensive financial connections to U.S. G-SIBs [Global Systemically Important Banks] through derivatives. For some insurers, evaluating these connections using public filings is difficult. Insurance holding companies report their total derivatives contracts in consolidated Generally Accepted Accounting Principles (GAAP) filings. Insurers are required to report more extensive details on the derivatives contracts of their insurance company subsidiaries in statutory filings, including data on individual counterparties and derivative contract type. But derivatives can also be held in other affiliates not subject to these statutory disclosures, resulting in substantially less information about some affiliates’ derivatives than required in insurers’ statutory filings.”

The derivatives carnage yesterday didn’t stop at just the Wall Street banks and the insurers. It enveloped a foreign bank that is a major counterparty to Wall Street’s derivative trades – the big German lender, Deutsche Bank. Its stock closed down 5.86 percent yesterday. (For important background, see our report: The Repo Loan Crisis, Dead Bankers, and Deutsche Bank: Timeline of Events.)

The market sent a critical message to Congress yesterday: you have not fixed the dangerous contagion problem on Wall Street. Is Congress paying attention? If you look at the schedule of hearings for the House Financial Services Committee for the upcoming month of March, it apparently believes that the big threat to financial stability is Wells Fargo – a bank with a small derivatives footprint compared to JPMorgan Chase, Goldman Sachs, Citigroup, Bank of America and Morgan Stanley.

Maxine Waters, Chair of the House Financial Services Committee, who has otherwise done an outstanding job of conducting hearings on critical financial topics, has become lost in the weeds when it comes to Wells Fargo. She has scheduled three, repeat three, separate hearings this month on Wells Fargo. Is Wells Fargo a felon bank? No. However, JPMorgan Chase has pleaded guilty to three criminal felony charges in the past six years and is currently under a criminal investigation by the U.S. Department of Justice for running a racketeering enterprise out of its precious metals trading desk. Goldman Sachs, which ranks second to JPMorgan Chase for derivatives exposure, is also under a criminal investigation by the DOJ for its role in a bribery and embezzlement scheme in Malaysia known as 1MDB.

What Wells Fargo did in incentivizing its employees in such a way that they opened millions of unauthorized customer accounts in order to get bonuses was, indeed, a very bad thing. But it’s already been the subject of countless hearings and fines and recriminations. Wells Fargo’s historic pattern of misconduct pales in comparison to the proven criminality at JPMorgan Chase. It’s time for Congresswoman Waters to address the real ticking time bomb on Wall Street – the derivative holdings of the big five Wall Street banks and their fundamentally weak counterparties before there is another 2008-style Wall Street implosion that takes down the U.S. economy and catches Congress napping. 

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