What – again? Top bankers putting global financial system at risk.

Why collateral transformation is the new UXB

Since the US Dodd-Frank Act of 2010, punters and investors making derivative bets have needed to show genuine collateral – to ensure that any debt dominoes can be stopped at a certain point. The Dodd Act can’t address the remaining toxic bets from before then, of course; but on the whole, it is an entirely sensible  piece of legislation.

As always, however, the definition of what genuine collateral (ie, something secured against the bet) really is becomes important. Employing the Russian definition would be less than useless, as much of the toxic lending undertaken beyond the Urals was for things that don’t exist, let alone collateral that’s dodgy. If the rules about what represents real security are lax, then the 2010 Act becomes something of a Maginot Line. This will become more important still next year when (assuming Obama is re-elected) new Dodd-Frank rules designed to prevent another meltdown will force traders themselves to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets.

The bottom line, in short, is that making derivatives sales has been tougher, and is about to get tougher still; while the effects on cashflow for a provider of having to back everthing have been negative.

So you’ll be less than surprised to learn that a number of banks and Wall Street firms are busily engaged in showing folks where each end of the Maginot Line is in order to boost sales. It’s very profitable for the providers…..but obviously very dangerous for the stability of the already unstable global financial construct – that construct being a 28-high pyramid of motor bikes, atop which sits a large oil tanker.

The new wheeze has one of those names just waiting to become next year’s headline: collateral transformation. The name even has a ring of Alchemy about it: like transmuting lead into gold. Otherwise called ‘impossible’. Not so, says Jennifer Zuccarelli, a spokeswoman for New York-based JPMorgan. You’d never have guessed Morgan would be into this gambit, would you? “Collateral transformation is a client service that does not hide risk,” she avers, “It is a form of short-term secured lending, which has always been an important part of capital markets, subject to tight capital and liquidity rules, and fully transparent to regulators.”

She’s right, it doesn’t hide risk – it makes it bloody obvious. “We just keep piling on lots of operational risk as we convert one form of collateral into another,” said Richie Prager, global head of trading at New York-based BlackRock, the world’s largest asset manager.

This is what he means: at least seven banks plan to let customers swap lower-rated securities that don’t meet the Dodd-Frank standards…in return for a loan of Treasuries or similar holdings that do qualify. Essentially, the firms will be taking on toxic assets, and losing good stuff, to make the sale. I bet you can’t guess who’ll have to swallow the toxicity some day further down the line.

The new sector resembles the existing $5.5 trillion repurchase market, known as repo, where banks and investors can temporarily pledge their bonds to other lenders or mutual funds in exchange for cash loans. The sudden withdrawal of some participants from that market in 2008, partly because of concerns about the quality of collateral, contributed to the near-collapse of Bear Stearns Cos. and led the Fed to create a $148 billion emergency-lending program to backstop other Wall Street firms that depended on the financing.

But here we are, four years on, doing it again. With the same list of suspects involved.

No doubt the Mayor of London Boris Johnson would approve of this as a splendid example of free-market ingenuity getting round all the bureaucratic red tape. As for the rest of us, we can only sit in awe of the psychopathy involved here – and wait for the inevitable day of reckoning.

29 thoughts on “What – again? Top bankers putting global financial system at risk.

  1. Truly astounding and utterly predictable as the greed will always drive these scumbags to find ways of flouting legislation knowing that they will not be the ones to pick up the tab when it all goes pear shaped. It’s a ‘Heads we win, Tails you lose’ situation. Business as usual folks.


  2. Completely off topic but, anybody else seen this?
    ‘Baroness Ashton will apparently be the Commander-in-Chief of a European Army under the proposed new arrangements.’
    As succinctly put by another, the woman couldn’t pour piss out of a Wellington boot with the instructions written on the heel.


  3. “No doubt the Mayor of London Boris Johnson would approve of this as a splendid example of free-market ingenuity getting round all the bureaucratic red tape.”

    Perhaps Mr Johnson would think so, but banking has nothing, >nothing< to do with the free market. It is problematic because it is not free and fair. It is a hideous and comfortable arrangement between politicians and financial institutions.


  4. I think its a brilliant strategic move – no opposing commander would ever be able to fathom wtf was going on in her mind!


  5. How do these people sleep at night? Oh, that’s how. If I want to be a sociopath, are there courses available or is it just something they’re born with?

    A psychopathic pleb hears voices in his head telling him to murder someone. A more “upmarket” member of society can do so with impunity to potentially millions of people and get away with it, again and again.


  6. And where best to do all this ‘economically important’ activity in derivatives? London of course where they can re-hypothicate the treasuries, and other so called good collateral, to infinity rather than the US where they are limited to only 140 %, in this fantasy game


  7. JW-pre-2008, there were lots of players who bought funny bits of paper on borrowed money. The funny bits of paper were AAA rated and the investment bank was happy to accept them as collateral.

    This game changed, because there is now very little in the way of acceptable collateral. The demand for US treasuries is enormous, partly because it is one of the few assets now regarded as safe.

    Unsurprisingly, given that there is a shortage of acceptable collateral, people will get up to all sorts of funny stuff.

    There will be a market for borrowing it, by pledging suitable amounts of inferior paper. There will also be scams where collateral is pledged twice.

    I will defer to any experts, but I think the reason that this absurd situation persists is that the US has had low savings ratio and their companies have a large demand to borrow. Companies borrow via the bond market and their bonds are bought using leverage.

    Thus, the US banking system (and credit creation) is the ultimate source of lending to US companies. In the middle are a chain of intermediaries that are exposed to substantial risk.

    It seems like a crazy system to me.


  8. “…..that construct being a 28-high pyramid of motor bikes, atop which sits a large oil tanker.”

    A Puch Maxi is not a motorbike… neither is a Raleigh Wisp. A Velo Solex, on the other hand… is not a motorbike either.


  9. Personally, I reckon the High Frequency Trading thing is pretty amoral, too. Why? Because the traders put a nice little algorithm to work for them and shove off to the restaurant/Riviera/Cayman islands and gloat. Not fair, is it? I’m sat here typing, drinking cold coffee, while they’re knocking back the Krug on a golden beach. We need legislation against that!


  10. Maybe John Terry could get a new job as a banker, seeing as he is now less internationally footballist.

    I actually found what I understand is a leaked letter from the Footballists Association to Mr Terry on his resignation from the international stage.

    It reads as follows

    Dear John Terry

    Good Riddance.


    So that’s nice


  11. Some football pundit or other on LBC this morning said that in his view JT literally threw himself into every melee on the field which, he took to prove that JT was courageous. Shows just how little I know, I’d thought it might just have easily shown what a gormless thug he was. Mind you I could be wrong, after all he has 78 Caps and he wouldn’t have won them if he was just a gormless whatsit, would he?


  12. Absolutly right a Velosolex is NOT a motorbike, I know I own one and no way is it anything like any of the ‘proper’ motorcycles I own.


  13. “Ask G Brown, he’s her sponsor.”

    And I think proof, if such were needed, that his sole mission in life was to do as much as he could to destroy the future of England, never mind that in doing so he would damage the rest of the UK, including Scotland.


  14. Ah yes, caught it last week in a french rag. You couldnt make it up. But, a perfect candidate to follow orders from TPTB, providing someone tells her who’s who in the first place.


  15. Pingback: GREEK DEBT: under-reported in 2007, over-reported in 2009, and indeterminate in 2012. | A diary of deception and distortion

  16. Pingback: Infowars Wexford | What – again? Top bankers putting global financial system at risk.

  17. JW, using Government Bonds as security is a great idea. I have a £1.00 Premium Bond and it could, with luck make me a millionare. How do you rate my chances of getting a loan from the Banks using this as security?


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