By Pam Martens and Russ Martens: November 5, 2021 ~
Yesterday, the S&P 500 and Nasdaq set new record highs for the sixth straight trading session. The Dow Jones Industrial Average, however, closed in the red. That’s because two high-priced bank components of the Dow, Goldman Sachs and JPMorgan Chase, closed in the red and helped to pull the index into negative territory. (The Dow Jones Industrial Average is a price-weighted index.)
As the chart above indicates, the declines in Goldman and JPMorgan were part of a major bank selloff yesterday – a striking and disturbing divergence from the broader indices. It would be impossible to have a healthy stock market going forward if the mega banks that finance the bulk of corporate activity descend into a downward spiral.
Among the worst bank performers yesterday were three foreign global banks that have a heavy presence on Wall Street: the British bank, Barclays (BCS), lost 5.56 percent; Swiss bank, Credit Suisse (CS), gave up 4.73 percent; while German mega bank, Deutsche Bank (DB), closed down 4.64 percent.
Foreign global banks are heavily interconnected to U.S. mega banks via derivatives. The banks serve as counterparties to each other in making private contract derivative bets on everything from credit defaults to equities to foreign exchange. These private contracts are known as bilateral over-the-counter (OTC) derivative trades and lack a central party clearing platform to stand behind the wager. This is what led to the collapse of the giant insurer, AIG, in 2008 and resulted in it being nationalized for a time by the U.S. government.
That type of derivatives hubris was supposed to have been reformed under the Dodd-Frank legislation of 2010 but, in reality, very little has meaningfully changed.
Causing particular angst in the banking sphere is the situation with Credit Suisse, Switzerland’s second-largest bank. It announced yesterday that it will close the bulk of its prime brokerage business that makes leveraged loans to hedge funds. The announcement comes after Credit Suisse owned up earlier this year to suffering $5.5 billion in losses when Archegos Capital Management, a family office hedge fund, blew itself up in March. (See our report: Archegos: Wall Street Was Effectively Giving 85 Percent Margin Loans on Concentrated Stock Positions – Thwarting the Fed’s Reg T and Its Own Margin Rules.)
In just the past year, Credit Suisse has been hit with the Archegos scandal; it paid $547 million to settle with criminal and civil authorities in the U.S. and U.K. for making an $850 million fraudulent loan in Mozambique where a significant part of the funds went for kickbacks to Credit Suisse employees and Mozambique government officials; it is being sued by investors for selling them billions of dollars of Greensill Capital debt as low risk – Greensill filed for insolvency in March. Just last month, the Swiss bank regulator, FINMA, reported that Credit Suisse had engaged in seven separate spying operations on its Board members, former employees and third parties.
Adding to banking woes is the fact that the Federal Reserve announced on Wednesday afternoon that it will begin this month to take away its bond-buying punch bowl (that has been suppressing interest rates) to the tune of $15 billion each month beginning in November. The Fed has been buying $80 billion a month in Treasury securities and $40 billion a month in agency Mortgage-Backed Securities (MBS) for a total of $120 billion each month.
The Fed left the door open “to adjust the pace of purchases if warranted by changes in the economic outlook.”
Also adding to bank stock concerns yesterday was an 8:30 a.m. report from the Labor Department showing that weekly jobless claims registered just 269,000 last week, the lowest showing since March of 2020. Investors holding bank stocks see this as evidence of a tightening labor market and a potential contributor to inflation that could force the Fed to hike interest rates earlier than anticipated.
Other central banks are already tightening via interest rate increases. On September 23, Norway’s Norges Bank became the first major G10 central bank to hike rates, imposing a quarter-point increase from its record low zero interest rate. It has indicated that another hike is likely in December.
South Korea’s central bank hiked rates in August by a quarter point to 0.75 percent, for the first time in three years. Brazil’s central bank lifted its key interest rate by 1.50 percent on Wednesday of last week – a half point more than anticipated by market watchers and the largest percentage increase since 2002.
This week saw more central bank action. After surprising markets in October by raising its interest rate by 40 basis points to 0.50 percent, on Wednesday of this week Poland’s central bank hiked rates by another 75 basis points to 1.25 percent. Yesterday, the Czech Republic raised its benchmark interest rate by 125 basis points to 2.75 percent.
And while the Bank of England surprised markets this week by keeping interest rate increases on hold, both the BOE and the Bank of Canada have signaled that rate hikes are coming sooner than previously expected.
Also impacting mega bank stock prices are news and rumors that hedge funds are taking losses on wrong-way bets on which way interest rates would move. Mega banks finance the highly-leveraged trading by hedge funds through their prime broker operations.