January 2, 2015 EIR Economics 25
Oil Prices, Derivatives Light
Fuse on Wall Street Time Bomb
by Paul Gallagher
Dec. 30—It is becoming clear to more experts on debt
in the trans-Atlantic banking system, that the outrageous
mid-December power play by which Wall Street
banks forced Congress to grant FDIC insurance to their
commodity and credit derivatives, was directly linked
to the oil and gas price collapse. This outrage in Congress
may lead to the government bailing out Wall
Street banks in crisis, sooner than any of the suborned
members of Congress thought when they went along
with urgent telephone calls from JPMorgan Chase CEO
Jamie Dimon and from the Obama White House. The
impact of the oil price collapse in the derivatives markets
is a time-bomb for an already bankrupt Wall Street.
That mid-December bribery-and-corruption orgy
was led by Citigroup, JPMorgan Chase, and Morgan
Stanley banks (along with their stickman, Barack
Obama). Those three banks, along with Goldman
Sachs, are the most exposed to oil/gas sector debt—
which has been ballooning by an average $100 billion
in net new debt per year for a decade—and to $20 trillion
in risky commodity derivatives exposure which
has now put them in trouble. Citibank has the largest oil
debt exposure, approximately 7% of its total asset book,
and Citi was at the center of the “budget bill” wing-ding
which put the Federal government back on the hook for
the coming commodity derivatives losses by these
banks. Citigroup is now the target of a “break up Citigroup”
campaign proposed by MIT economist Simon
Johnson and which will have some bipartisan support
in the Senate of the new Congress.
The oil price collapse began in late October as the
collusion by U.S. officials with Saudi Arabia’s monarchy
to hit Russia with an “oil sanction”; but it has gone
out of their control. Notably, on Dec. 20, it was not
Russia whose credit was downgraded, but the European
oil majors BP, Total, and Shell, all placed on negative
credit watch by Standard and Poor’s. The oil majors
have been loading up with debt for a decade, with an
emphasis on paying dividends and buying back their
own stock. That debt was piled up despite the fact that
demand for oil and gas, throughout the trans-Atlantic
economies, has become more and more depressed since
the 2007-08 financial collapse. The sector now has
roughly $1.6 trillion in debt with—if oil prices remain
in the $50 per barrel range—not much more than $300
billion in revenues, a highly leveraged situation. Keep
in mind that during December, the natural gas price has
also plunged by a third, down to the range of $3/cubic
foot.
Junk Debt Markets Shake
The “front end” of this debt bubble problem is in the
North American shale sector, whose production of oil
and gas is less efficient, more expensive, and more environmentally
damaging than the industry as a whole.
Here bankruptcies of drilling and rig companies are already
occurring and the debt in trouble is highly leveraged
and high-interest (junk bonds and leveraged
loans). It is, along with long-term, high-interest auto
loans, essentially the banks’ subprime debt bubble of
EIR Economics
26 Economics EIR January 2, 2015
this decade. These two subprime sectors have been
dominating new capital investment and employment
creation in the U.S. economy. The Wall Street Journal
on Dec. 17, in “Junk Bond Worries Spread Beyond
Oil,” reported that these sectors of debt, totalling about
$2.4 trillion, have actually started to contract, after
rising sharply from 2011 through mid-2014.
London Telegraph financial analyst Andrew
Critchlow warned already on Nov. 14 that oil shale
drillers had come to be nearly one-third of all “highyield,
sub-investment grade” (subprime) borrowers in
the United States. He estimated that if the oil price
stayed in the $60s (it has been in the $50s for more than
a month), 30% of high-yield B- and CCC-grade (energy)
borrowers would default. “A shock of that magnitude
could be sufficient to trigger a broader high-yield
market default cycle,” Critchlow warned.
That the Wall Street banks are being hit by this, was
shown by the end-of-November report—ironically, put
out by Citibank’s research team—that the U.S. banking
sector’s revenue had dropped by 17% in the third quarter,
and its loan revenue, the area which has been dominated
by high-interest lending to the energy sector, had
dropped by 60%. At the same time, the banking sector’s
exposure to foreign exchange derivatives rose by 90%,
and to commodity derivatives by 40%.
This highly dangerous situation for the banks goes
back to the Federal Reserve’s allowing the big Wall
Street banks to own commodities and commodities infrastructure
(warehouses, tankers, electric utility plants,
etc.), by giving them waivers of the Bank Holding
Company Act in the 2002-05 period.
This ownership of commodities by banks—which
are also controlling the debt, futures, and derivatives
markets for the same commodities at the same time—
was the subject of highly condemnatory hearings in Sen.
Carl Levin’s (D-Mich.) Permanent Investigations Subcommittee
in the waning days of the 113th Congress.
These Wall Street practices, which the Glass-Steagall
Act also prohibited to commercial banks, allowed
the big banks to run up key commodity prices and, at
the same time, collect large secondary profits (from derivatives
markets) on the commodity prices they were
manipulating.
They also put the banks in danger of being hit by
huge losses in case of certain “commodity catastrophes,”
like the breakup of a large oil tanker with a massive
oil leak, for example.
Wearing Heavy ‘Collars’
But a very large price shock for which the banks’
trading programs are not prepared, is the biggest danger
to them.
In 2012 the Federal Reserve began publicly “debating”
the possibility of forcing the banks out of commodities
and infrastructure holdings, but did nothing
about it. The Fed “advised” the Wall Street banks to get
out of commodity holdings; the banks ignored this.
While JPMorgan Chase exited some commodity holdings
which had just cost it large fines for market manipulation,
Goldman, Citi, and Morgan Stanley went
deeper into commodity holdings.
In 2013, the Fed started jawboning Wall Street to
stop making massive amounts of “leveraged loans,”
which were going most heavily to energy firms related
to the “shale boom” or to similarly inefficient
wind power and solar power schemes. The Fed has admitted
publicly that the banks ignored this “advice” as
well.
With the collapse of the oil price by 50% in the
second half of 2014, the banks have found that a widespread
type of commodity derivative known as a “threeway
collar” has become very dangerous to them. As the
price has declined, from $110/barrel for West Texas Intermediate
Crude all the way down to below $55/barrel
now, these derivatives have compelled the banks not
only to buy more leveraged debt paper, but to buy more
oil and gas futures as well.
According to financial experts, the immediate prospect
of losses from defaulting debt in the leverage loan
and junk bond markets, together with the only slightly
longer-term prospect of huge losses in the derivatives
markets, have put the Wall Street banks in trouble. The
latter’s losses could be in the hundreds of billions in
total, given that this derivatives exposure of Wall Street
is in the trillions.
The biggest U.S. banks, which now reportedly have
some $240 trillion in derivatives exposure, have been
allowed to pile up almost all of it on their FDIC-insured
commercial banking units since Glass-Steagall was
eliminated in the 1990s. But due to their extreme risk,
these commodity derivatives were among the few types
that could not be in those depository units—until the
banks ran roughshod over Congress in mid-December.
Now, with potentially huge losses looming, those trillions
in derivatives are subject to a crisis Federal bailout.
Oil Prices, Derivatives Light
Fuse on Wall Street Time Bomb
by Paul Gallagher
Dec. 30—It is becoming clear to more experts on debt
in the trans-Atlantic banking system, that the outrageous
mid-December power play by which Wall Street
banks forced Congress to grant FDIC insurance to their
commodity and credit derivatives, was directly linked
to the oil and gas price collapse. This outrage in Congress
may lead to the government bailing out Wall
Street banks in crisis, sooner than any of the suborned
members of Congress thought when they went along
with urgent telephone calls from JPMorgan Chase CEO
Jamie Dimon and from the Obama White House. The
impact of the oil price collapse in the derivatives markets
is a time-bomb for an already bankrupt Wall Street.
That mid-December bribery-and-corruption orgy
was led by Citigroup, JPMorgan Chase, and Morgan
Stanley banks (along with their stickman, Barack
Obama). Those three banks, along with Goldman
Sachs, are the most exposed to oil/gas sector debt—
which has been ballooning by an average $100 billion
in net new debt per year for a decade—and to $20 trillion
in risky commodity derivatives exposure which
has now put them in trouble. Citibank has the largest oil
debt exposure, approximately 7% of its total asset book,
and Citi was at the center of the “budget bill” wing-ding
which put the Federal government back on the hook for
the coming commodity derivatives losses by these
banks. Citigroup is now the target of a “break up Citigroup”
campaign proposed by MIT economist Simon
Johnson and which will have some bipartisan support
in the Senate of the new Congress.
The oil price collapse began in late October as the
collusion by U.S. officials with Saudi Arabia’s monarchy
to hit Russia with an “oil sanction”; but it has gone
out of their control. Notably, on Dec. 20, it was not
Russia whose credit was downgraded, but the European
oil majors BP, Total, and Shell, all placed on negative
credit watch by Standard and Poor’s. The oil majors
have been loading up with debt for a decade, with an
emphasis on paying dividends and buying back their
own stock. That debt was piled up despite the fact that
demand for oil and gas, throughout the trans-Atlantic
economies, has become more and more depressed since
the 2007-08 financial collapse. The sector now has
roughly $1.6 trillion in debt with—if oil prices remain
in the $50 per barrel range—not much more than $300
billion in revenues, a highly leveraged situation. Keep
in mind that during December, the natural gas price has
also plunged by a third, down to the range of $3/cubic
foot.
Junk Debt Markets Shake
The “front end” of this debt bubble problem is in the
North American shale sector, whose production of oil
and gas is less efficient, more expensive, and more environmentally
damaging than the industry as a whole.
Here bankruptcies of drilling and rig companies are already
occurring and the debt in trouble is highly leveraged
and high-interest (junk bonds and leveraged
loans). It is, along with long-term, high-interest auto
loans, essentially the banks’ subprime debt bubble of
EIR Economics
26 Economics EIR January 2, 2015
this decade. These two subprime sectors have been
dominating new capital investment and employment
creation in the U.S. economy. The Wall Street Journal
on Dec. 17, in “Junk Bond Worries Spread Beyond
Oil,” reported that these sectors of debt, totalling about
$2.4 trillion, have actually started to contract, after
rising sharply from 2011 through mid-2014.
London Telegraph financial analyst Andrew
Critchlow warned already on Nov. 14 that oil shale
drillers had come to be nearly one-third of all “highyield,
sub-investment grade” (subprime) borrowers in
the United States. He estimated that if the oil price
stayed in the $60s (it has been in the $50s for more than
a month), 30% of high-yield B- and CCC-grade (energy)
borrowers would default. “A shock of that magnitude
could be sufficient to trigger a broader high-yield
market default cycle,” Critchlow warned.
That the Wall Street banks are being hit by this, was
shown by the end-of-November report—ironically, put
out by Citibank’s research team—that the U.S. banking
sector’s revenue had dropped by 17% in the third quarter,
and its loan revenue, the area which has been dominated
by high-interest lending to the energy sector, had
dropped by 60%. At the same time, the banking sector’s
exposure to foreign exchange derivatives rose by 90%,
and to commodity derivatives by 40%.
This highly dangerous situation for the banks goes
back to the Federal Reserve’s allowing the big Wall
Street banks to own commodities and commodities infrastructure
(warehouses, tankers, electric utility plants,
etc.), by giving them waivers of the Bank Holding
Company Act in the 2002-05 period.
This ownership of commodities by banks—which
are also controlling the debt, futures, and derivatives
markets for the same commodities at the same time—
was the subject of highly condemnatory hearings in Sen.
Carl Levin’s (D-Mich.) Permanent Investigations Subcommittee
in the waning days of the 113th Congress.
These Wall Street practices, which the Glass-Steagall
Act also prohibited to commercial banks, allowed
the big banks to run up key commodity prices and, at
the same time, collect large secondary profits (from derivatives
markets) on the commodity prices they were
manipulating.
They also put the banks in danger of being hit by
huge losses in case of certain “commodity catastrophes,”
like the breakup of a large oil tanker with a massive
oil leak, for example.
Wearing Heavy ‘Collars’
But a very large price shock for which the banks’
trading programs are not prepared, is the biggest danger
to them.
In 2012 the Federal Reserve began publicly “debating”
the possibility of forcing the banks out of commodities
and infrastructure holdings, but did nothing
about it. The Fed “advised” the Wall Street banks to get
out of commodity holdings; the banks ignored this.
While JPMorgan Chase exited some commodity holdings
which had just cost it large fines for market manipulation,
Goldman, Citi, and Morgan Stanley went
deeper into commodity holdings.
In 2013, the Fed started jawboning Wall Street to
stop making massive amounts of “leveraged loans,”
which were going most heavily to energy firms related
to the “shale boom” or to similarly inefficient
wind power and solar power schemes. The Fed has admitted
publicly that the banks ignored this “advice” as
well.
With the collapse of the oil price by 50% in the
second half of 2014, the banks have found that a widespread
type of commodity derivative known as a “threeway
collar” has become very dangerous to them. As the
price has declined, from $110/barrel for West Texas Intermediate
Crude all the way down to below $55/barrel
now, these derivatives have compelled the banks not
only to buy more leveraged debt paper, but to buy more
oil and gas futures as well.
According to financial experts, the immediate prospect
of losses from defaulting debt in the leverage loan
and junk bond markets, together with the only slightly
longer-term prospect of huge losses in the derivatives
markets, have put the Wall Street banks in trouble. The
latter’s losses could be in the hundreds of billions in
total, given that this derivatives exposure of Wall Street
is in the trillions.
The biggest U.S. banks, which now reportedly have
some $240 trillion in derivatives exposure, have been
allowed to pile up almost all of it on their FDIC-insured
commercial banking units since Glass-Steagall was
eliminated in the 1990s. But due to their extreme risk,
these commodity derivatives were among the few types
that could not be in those depository units—until the
banks ran roughshod over Congress in mid-December.
Now, with potentially huge losses looming, those trillions
in derivatives are subject to a crisis Federal bailout.
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