Musical Snares

Here in the US, according to the Office of the Comptroller of the Currency, five of our largest banks (JPMorgan, Morgan Stanley, Goldman Sachs, Bank of America, and Citibank) write 97% of all insurance protecting investors against defaults on bonds.  Called Credit Default Swaps (CDS), they are a promise by the banks to make lenders whole if the issuer of a bond can’t repay the borrowed funds.  Amongst others, these policies cover debt issued by Greece, Italy, and Spain.  In recent disclosures, JPMorgan and Goldman Sachs alone said they have sold protection covering over $5 trillion of debt world-wide.  That sounds like a lot of money to me, but does it sound like a good idea?

The banks report they have established master netting agreements which theoretically transfer some or all of the risk to someone else.  In other words, they bought insurance to protect themselves against the insurance they sold.  They aren’t telling who those policies were purchased from, asking us instead to just trust them, so we are left to guess.  With about 74% of CDS trading taking place among 20 dealer-banks worldwide per data from the Depository Trust & Clearing Corp., we can whittle the list down substantially.  It seems to me the risk gets elevated proportionately as well.  If just two banks wrote over $5 trillion of these CDSs, what must the global total be?  And this same handful is buying protection from each other?  Geez, that’s what led to the collapse of Lehman, and that was on a much smaller scale!  Do you think somebody ought to say something?

If any one were to step forward and begin asking for a touch more disclosure, I would expect the inquiry to be led either by our Treasury Department or maybe the Federal Reserve.  Since both Secretary Geithner and Fed head Bernanke have recently gone on record saying they aren’t worried about U.S. bank exposure to European sovereign debt, maybe I should just go back to sleep.  But I’m still having restless nights.  Could a single default by any nation involved create a chain reaction of claims which couldn’t be met in a timely fashion, causing the global monetary network to seize up?  That’s what happened with Lehman and AIG.

This all reminds me of that game Musical Chairs I played as a kid where everyone paraded to music around a circle of chairs arranged facing outward.  When the music stopped, all the players tried to grab a seat.  The problem was there was always one more player than there were chairs, so every round another person was eliminated until just two players fought for the last seat.  That’s where the similarity ends.  No one seems to question that these institutions are too big to fail; they will still get the last chair.  Just like the last time, I suspect money will be created to keep them solvent.  This means that the last man standing will somehow be you.  Whether the end result proves inflationary or leads us instead into a deeper recession, we the people will ultimately get the bill if such a collapse occurs.