This Goldman Sachs Chart Explains Why Wall Street Is Still a Dangerous High-Stakes Casino

Source: Financial Crisis Inquiry Commission

OTC derivatives were at the center of the 2008 financial crisis. And they’re just as likely to be at the center of the next one.

By Pam Martens and Russ Martens and cross-posted from Wall Street on Parade

If you want to very quickly understand why banks stopped lending to one another in 2008, credit markets froze, bank stock prices collapsed, and the Federal Reserve secretly pumped $16 trillion into banks, just take a few moments to study this chart from the Financial Crisis Inquiry Commission of the derivatives casino that Goldman Sachs and the major banks on Wall Street had become in June of 2008. Wall Street banks knew they had created a collapsing house of cards but they didn’t know just how much exposure each bank had or which bank would fail first, so they simply stopped lending to each other, causing a run on the banks.

Now, take a deep breath, because we have to tell you that if there was a derivatives graph of every other major Wall Street bank in June of 2008, you would see the same handful of bank counterparties to tens of trillions of dollars more in opaque over-the-counter derivatives. A small handful of Wall Street banks and their global counterparts were on the hook for hundreds of trillions of dollars in derivatives without anywhere near the capital to make good on these casino bets.

Now take another deep breath because the tragic truth is that little has materially changed in this situation today — even after the crisis has been studied and examined for a decade; after the massive Dodd-Frank financial reform legislation has been enacted; and after new Federal bodies like the Office of Financial Research and the Financial Stability Oversight Council have been created to prevent another financial crisis.

Although Wall Street’s lobbyists and the banks’ global public relations flacks have worked hard at keeping the word “derivatives” out of today’s headlines and out of any historical narrative about what caused the 2008 financial collapse to be as severe as it was, the evidence is clear: opaque over-the-counter derivatives played a major role in what became the worst financial collapse in the U.S. since the Great Depression.

In 2010, the Chairman of the Commodity Futures Trading Commission, Gary Gensler, put the financial collapse squarely at the feet of derivatives. Speaking at Chatham House in London, Gensler said:

“OTC derivatives were at the center of the 2008 financial crisis. They added leverage to the financial system with more risk being backed up by less capital. U.S. taxpayers bailed out AIG with $180 billion when that company’s ineffectively regulated $2 trillion derivatives portfolio, managed from London and cancerously interconnected to other financial institutions, nearly brought down the financial system. As we later learned, much of the bailout money flowed through AIG to U.S. and European banks. These events demonstrate how over-the-counter derivatives – initially developed to help manage and lower risk – can actually concentrate and heighten risk in the economy and to the public.”

But AIG was clearly just a cover story and the tip of the iceberg. Just look at the graph above. AIG wasn’t even among Goldman Sachs’ top 10 counterparties for credit derivatives

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