“These bailouts are like steroids…”

“How Long Would a Global Banking Shutdown Last?

No one can say with certainty. But based on other banking holidays in modern history, it’s safe to conclude that it could last for quite some time and cause severe hardship for hundreds of millions of savers around the world.

The first and most obvious hardship is that you could be denied immediate access to most or all of your money for an indefinite period. What about government agency guarantees like FDIC insurance? A large proportion of those guarantees, unfortunately, would have to be suspended in order to give banking regulators the time they need to sort out the mess.

It is simply not reasonable to expect that governments will have the resources to immediately meet the demands of thousands of institutions and millions of individuals if they all want their money back at roughly the same time.

“Your money is still safely guaranteed,” banking officials will declare. “You just can’t have it now.”

The second and more long-lasting hardship is the possibility that, by the time you do regain access to your money, you will suffer losses. In this scenario, the government would likely create a rehabilitation program for the nation’s weakest banks, giving depositors two choices:

* Opt in to the program by leaving your funds on deposit at your bank for an extended period of time, earning below-market interest rates. The bank is then allowed to use the extra interest to recoup its losses over time — income that, by rights, should have been yours.

* Opt out of the program and withdraw your funds immediately, accepting a loss that approximately corresponds to the actual losses in the bank’s investment and loan portfolio.

Needless to say, neither the opt in nor the opt out choice is a good one:

If you opt in, you take the chance that the government’s rehab program may not work on the first attempt and that it will be replaced by another, even tougher program in the future. Moreover, even if it works out as planned, you will suffer a continuing loss of income and access to your cash over an extended period of time.

If you opt out, instead of lost income, you suffer an immediate loss of principal. Moreover, in order to discourage savers from opting out, the government would typically structure the program so that everyone demanding immediate reimbursement suffers an additional penalty.

Again you ask, “What about government guarantees?” By rights, in a fair plan, insured depositors would suffer less severely than uninsured depositors. And if the plan is structured properly, those in strong banks should come out whole, or almost whole, while those in weaker banks should suffer the larger losses. That’s how it should be handled. But there’s no guarantee that’s how it will be handled.

To avoid all of these risks, I recommend seriously considering moving (a) nearly all of your bank deposits and accounts, plus (b) a modest portion of the money you currently have invested in securities to the safest and most liquid place for your money in the modern world:
Short-Term U.S. Treasury Securities

Martin Weiss, Money Markets

“Mafia knows all about systemic meltdowns of gambling networks…”

On October 11, 2008…“Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.”

This statement was not the random rant of a gloom-and-doomer on the fringe of society. Nor was it excerpted from a twentieth century history book about the Great Depression. It was the serious, objective assessment announced at a Washington, D.C. press conference…The unmistakable implication: So many of the world’s largest banks were so close to bankruptcy, the entire banking system was vulnerable to a massive collapse. The primary underlying cause: Derivatives.

The Mafia knows all about systemic meltdowns of gambling networks. In the numbers racket, for example, players place their bets through a bookie, who, in turn is part of an intricate network of bookies. Most of the time, the system works. But if just one big player fails to pay bookie A, that bookie might be forced to renege on bookie B, who, in turn stiffs bookie C, causing a chain reaction of payment failures.

The bookies go bankrupt. The losers lose. And even the winners get nothing. Worst of all, players counting on winnings from one side of their bets to cover losses in offsetting bets are also wiped out. The whole network crumbles — a systemic meltdown.

To avert this kind of a disaster, the Mafia henchmen know exactly what they have to do, and they do it swiftly: If a gambler fails to pay once, he could find himself with broken bones in a dark alley; twice, and he could wind up in cement boots at the bottom of the East River.

Unlike the Mafia, established stock and commodity exchanges, like the NYSE and the Chicago Board of Trade, are entirely legal. But like the Mafia, they understand these dangers and have strict enforcement procedures to prevent them. When you want to purchase 100 shares of Microsoft, for example, you never buy directly from the seller. You must always go through a brokerage firm, which, in turn is a member in good standing of the exchange. The brokerage firm must keep close tabs on all its customers, and the exchange keeps close track of all its member firms. If you can’t come up with the money to pay for your shares, the broker is required to promptly liquidate your securities, literally kicking you out of the game. And if the brokerage firm as a whole runs into financial trouble, it meets a similar fate with the exchange. Very, very swiftly!

…the key: For the most part, the global derivatives market has no brokerage, no exchange, and no equivalent enforcement mechanism. In fact, among the $181.2 trillion in derivative bets held by U.S. banks at mid-year 2008, only $8.2 trillion, or 4.5%, was regulated by an exchange. The balance — $173.9 trillion, or 95.5% — was bets placed directly between buyer and seller (called “over the counter”). And among the $596 trillion in global derivatives tracked by the BIS at year-end 2007, 100% were over the counter. No exchanges. No overarching enforcement mechanism.

This is not just a matter of weak or non-existent regulation. It’s far worse. It’s the equivalent of an undisciplined conglomeration of players gambling on the streets without even a casino to maintain order. Moreover, the data compiled by the OCC and BIS showed that the bets were so large and the gambling so far beyond the reach of regulators, all it would take was the bankruptcy of one of the lesser derivatives players — such as Lehman Brothers — to throw the world’s credit markets into paralysis.

That’s why the world’s highest banking officials were so panicked when Lehman Brothers failed in the fall of 2008. As the IMF managing director himself admitted, the threat was not stemming from just one bank in trouble; it was from many; and those banks weren’t lesser players; they were among the largest in the world. Which U.S. banks placed the biggest bets? Based on mid-year 2008 data, the OCC provided some answers:

Citibank N.A., the primary banking unit of Citigroup, held $37.1 trillion in derivative bets. Moreover, only 1.7% of those bets were under the purview of any exchange. The balance — 98.3% — was direct, one-on-one bets with their trading partners outside of any exchange.

Bank of America was a somewhat bigger player, holding $39.7 trillion in derivative bets, with 93.4% traded outside of any exchange.

But JPMorgan Chase was, by far, the biggest of them all, towering over the U.S. derivatives market with more than double BofA’s book of bets — $91.3 trillion worth. This meant that JPMorgan Chase controlled half of all derivatives in the U.S. banking system — a virtual monopoly that tied the firm’s finances with the fate of the U.S. economy far beyond anything ever witnessed in modern history. Meanwhile, $87.3 trillion, or 95.7% of Morgan’s derivatives, were outside the purview of any exchange.

One bank! Making bets of unknown nature and risk! Involving a dollar amount equivalent to six years of the total production of the entire U.S. economy! In contrast, Lehman Brothers, whose failure caused such a large earthquake in the global financial system, was actually small by comparison — with “only” $7.1 trillion in derivatives.

The potential havoc that might be caused by a Citigroup failure, with bets that involve five times more money than Lehman’s — and the financial holocaust that might be caused by a JPMorgan failure with close to 13 times more than Lehman — boggles the imagination. How bad could it actually be? No one knows, and therein lies one of the primary dangers. In the absence of oversight, the regulators simply do not collect the needed who-when-what information on these bets.

In an attempt to throw some light on this dark-but-explosive scene, the OCC uses a formula for estimating how much risk each major bank is exposed to in just the one particular aspect I cited a moment ago — the risk that some of its trading partners might default and fail to pay up on their gambling debts. Bear in mind: We still don’t now how much they are risking on market moves against them. All the OCC is estimating is how much they’re risking by making bets with potentially shaky betting partners, regardless of the outcome on each bet — win, lose or draw.

At Bank of America, the OCC calculated that, at mid-year, the bank was exposed to the tune of 194.3% of its capital. In other words, for every $1 of capital in the kitty, BofA was risking $1.94 cents strictly on the promises made by its betting partners. If about half of its betting partners defaulted, the bank’s capital would be wiped out and it would be bankrupt. And remember: This was in addition to the risk that the market might go the wrong way, and on top of the risk it was taking with its other investments and loans,

At Citibank, the risk was even greater: $2.58 cents in exposure per dollar of capital.

And if you think that’s risky, consider JPMorgan Chase. Not only was it the largest player, but, among the big three U.S. derivatives players, it also had the largest default exposure: For every dollar of capital, the bank was risking $4.30 on the credit of its betting partners.

This is why JPMorgan was so anxious to step in and grab up outstanding trades left hanging after the fall of Bear Stearns and Lehman Brothers: It could not afford to let those trades turn to dust. If it did, it would be the first and biggest victim of a chain reaction of failures that could explode all over the world.

This is why super-investor Warren Buffett once called derivatives “financial weapons of mass destruction.” This is why the top leaders of the world’s richest countries panicked after Lehman Brothers failed, dumping their time-honored, hands-off policy like a hot potato, jumping in to buy up shares in the world’s largest banks, and transforming the world of banking literally overnight…This is also why you must now do more than just find a strong bank.

You also must find a safe place that has the highest probability of being immune to these risks. The reason: As I warned at the outset, at some point in the not-too-distant future, governments around the world may have no other choice but to declare a global banking holiday — a shutdown of nearly every bank in the world, regardless of size, country, or financial condition.

What could happen in the banking holiday? In the past, we’ve seen some financial shutdowns that eventually helped resolve the crisis. And we’ve seen others that only made it worse. Often, savers are forced to leave their money on deposit, giving up a substantial portion of their interest income for many years. And, in other cases, the only way they can get their money back sooner is by accepting an immediate loss of principal. But no matter how it’s resolved, when banks have made big blunders and suffered large losses, it’s the multitude of savers that are invariably asked to make the biggest sacrifices and pay the biggest price. No one else has the money.

Martin Weiss, MoneyMarkets