Wall Street Behemoths Dangerously Linked by Derivatives

The last few days’ decline in the broader averages looks tame compared to what happened to some of the biggest banks on Wall Street and their derivative counterparties.

By Pam Martens and Russ Martens of Wall Street on Parade.

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

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