Category Archives: Financial markets

ECB Tapering May Trigger “Disorderly Restructuring” of Italian Debt, Return to National Currency, by Don Quijones

An Italian banking system collapse still in one of the favorites for the catalyst that kicks of the next global debt crisis. From Don Quijones at

The only other option: “Orderly restructuring.”

Here’s the staggering scale of the Italian government’s dependence on the ECB’s bond purchases, according to a new report by Astellon Capital: Since 2008, 88% of government debt net issuance has been acquired by the ECB and Italian Banks. At current government debt net issuance rates and announced QE levels, the ECB will have been responsible for financing 100% of Italy’s deficits from 2014 to 2019.

But now there’s a snag.

Last month, the size of the balance sheet of the ECB surpassed that of any other central bank: At €4.17 trillion, the ECB’s assets have soared to 38.8% of Eurozone GDP. The ECB has already reduced the rate of purchases to €60 billion a month. And it plans to further withdraw from the super-expansionary monetary policy. To do this, according to Der Spiegel, it wants to spread more optimistic messages about the economic situation and gradually reduce borrowing.

Frantically sowing the seeds of optimism on Wednesday was Bruegel’s Francesco Papadia, formerly director general for market operations at the ECB. “On the economic front, things are moving in the right direction,” he told Bloomberg. The ECB will begin sending clear messages in the Fall that it will soon begin tapering QE, Papadia forecast. By the halfway point of 2018 the ECB would have completed tapering and it would then use the second half of the year to move away from negative interest rates.

So far, most current ECB members have shown scant enthusiasm for withdrawing the punch bowl. The reason most frequently cited for not tapering more just yet is their lingering concern about the long-term sustainability of the Eurozone’s recent economic turnaround.

To continue reading: ECB Tapering May Trigger “Disorderly Restructuring” of Italian Debt, Return to National Currency



Financial Weapons Of Mass Destruction: The Top 25 U.S. Banks Have 222 Trillion Dollars Of Exposure To Derivatives, by Michael Snyder

It is, as SLL has pointed out, somewhat misleading to list a financial institution’s gross exposure to derivatives without netting out offsetting positions (a long and a short of the same instrument). However, if case of systemic failure, if counterparties are unable to meet their commitments, net exposures can quickly become gross exposures. So read about banks’ gross exposures with a grain of salt, but realize the numbers are not completely irrelevant, especially in a financial crisis. From Michael Snyder at

The recklessness of the “too big to fail” banks almost doomed them the last time around, but apparently they still haven’t learned from their past mistakes.  Today, the top 25 U.S. banks have 222 trillion dollars of exposure to derivatives.  In other words, the exposure that these banks have to derivatives contracts is approximately equivalent to the gross domestic product of the United States times twelve.  As long as stock prices continue to rise and the U.S. economy stays fairly stable, these extremely risky financial weapons of mass destruction will probably not take down our entire financial system.  But someday another major crisis will inevitably happen, and when that day arrives the devastation that these financial instruments will cause will be absolutely unprecedented.

During the great financial crisis of 2008, derivatives played a starring role, and U.S. taxpayers were forced to step in and bail out companies such as AIG that were on the verge of collapse because the risks that they took were just too great.

But now it is happening again, and nobody is really talking very much about it.  In a desperate search for higher profits, all of the “too big to fail” banks are gambling like crazy, and at some point a lot of these bets are going to go really bad.  The following numbers regarding exposure to derivatives contracts come directly from the OCC’s most recent quarterly report (see Table 2), and as you can see the level of recklessness that we are currently witnessing is more than just a little bit alarming…


Total Assets: $1,792,077,000,000 (slightly less than 1.8 trillion dollars)

Total Exposure To Derivatives: $47,092,584,000,000 (more than 47 trillion dollars)

JPMorgan Chase

Total Assets: $2,490,972,000,000 (just under 2.5 trillion dollars)

Total Exposure To Derivatives: $46,992,293,000,000 (nearly 47 trillion dollars)

Goldman Sachs

Total Assets: $860,185,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $41,227,878,000,000 (more than 41 trillion dollars)

Bank Of America

Total Assets: $2,189,266,000,000 (a little bit more than 2.1 trillion dollars)

Total Exposure To Derivatives: $33,132,582,000,000 (more than 33 trillion dollars)

Morgan Stanley

Total Assets: $814,949,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $28,569,553,000,000 (more than 28 trillion dollars)

Wells Fargo

Total Assets: $1,930,115,000,000 (more than 1.9 trillion dollars)

Total Exposure To Derivatives: $7,098,952,000,000 (more than 7 trillion dollars)

Collectively, the top 25 banks have a total of 222 trillion dollars of exposure to derivatives.

To continue reading: Financial Weapons Of Mass Destruction: The Top 25 U.S. Banks Have 222 Trillion Dollars Of Exposure To Derivatives

What, We Worry? by Robert Gore


Crowd psychology, not news, drives markets.

SLL reviewed Robert Prechter’s The Socionomic Theory of Finance, the thesis of which is that financial markets, particularly equity markets, are driven by endogenous social mood, not news developments or other “fundamentals.” If ever a market session supported the socionomic hypothesis, yesterday’s did.

Over the weekend hundreds of thousands of computers around the world were afflicted by ransomware called WannaCry that encrypts files and makes them inaccessible unless the owner forks over a Bitcoin payment. The ransomware exploited a bug in Microsoft software of which the company was aware and for which it had made available a patch. However, users had to download the patch, and for an older version of software, users had to pay for it, so many computers were still vulnerable. Although the hackers who distributed the ransomware are unknown, apparently they used an exploit codenamed ETERNALBLUE, originally developed by the NSA, to penetrate Microsoft’s software.

A computer security expert discovered a kill switch in WannaCry that stopped the program from spreading by diverting it to a dead-end on the internet, but there may be a variant that does not have the kill switch. It is unknown how far the program will spread or what havoc it will ultimately wreak. What is crystal clear, however, is what many computer experts have warned of for years: many of the world’s computers and much of the infrastructure, including the internet, is highly vulnerable to disruption or outright shutdown.

This was just ransomware that hit Microsoft software, demanding $300 ransom per machine. It doesn’t take much imagination to envision scenarios where the ransom is say, $10 billion from a government, and the threat is that a substantial chunk of the Internet, electric grid, the government’s defense and intelligence systems, or some other critical function goes down. This cannot be dismissed as far-fetched because nobody on the planet knows but a small fraction of who has what hacking capability or access to what computers and networks, or what’s already been hacked. As the NSA just demonstrated, Intelligence agencies, who you might think have the best handle on the matter, have had their hacks hacked. (Wikileaks Vault 7 release disclosed the CIA’s hacking tools.)

How did the stock market react to this blatant demonstration of technological vulnerability? The Dow was up 89, the S&P up 11, and the Nasdaq composite was up 29. The stock market has been powered this year by Alphabet (Google), Amazon, Apple, Netflix, Facebook, and Microsoft. Any kind of extended disruption of the Internet or pervasive, disabling computer virus or worm would cost these companies billions of dollars and whack their share prices. Yet, Alphabet was up $4.08, Amazon down $3.98, Apple down $.45, Netflix down $.70, Facebook down $.13, and Microsoft up $.05. Hardly earth-shattering moves.

The legions of speculators, investors, and commentators who look for exogenous causes of stock market movements will perhaps say that WannaCry was dismissed because the damage was limited. However, the reported number of computers that have been affected rose all day, and there were news stories that at least one variation of the ransomware had no kill switch, which means it could proliferate unchecked. So during the trading day, nobody really knew how bad the damage was or how bad it would get. Also, while all the implications for computer and network security are not fully known, this incident, the worst of its kind so far, is a loud and clear warning of proliferating risks. Those risks are especially worrisome for companies whose business models depend on computers and the internet.

All of which was apparently irrelevant to the stock market yesterday, joining a lengthy historical list of exogenous factors that “should” have moved the market, but didn’t (see Prechter’s book for many more examples). Crowd psychology drives the market, not the news, and right now the crowd is manifestly bullish.

Disclaimer: Robert Gore has no position in any of the stock indexes or technologically vulnerable and richly valued companies mentioned in this article, and thinks anybody who does is living on borrowed time.





He Said That? 5/13/17

From Warren Buffett (born 1930), American business magnate, investor, and philanthropist, 2003 Berkshire Hathaway Annual Report:

I view derivatives as time bombs, both for the parties that deal in them and the economic system. Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values.

Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter-parties to them.

But before a contract is settled, the counter-parties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands. Reported earnings on derivatives are often wildly overstated. That’s because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.

The errors usually reflect the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid, in whole or part, on “earnings” calculated by mark-to-market accounting. But often there is no real market, and “mark-to-model” is utilized. This substitution can bring on large-scale mischief.

As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counter-parties to use fanciful assumptions. The two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear.

In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.

$500 Trillion in Derivatives “Remain an Important Asset Class”: Hilariously, the New York Fed, by Wolf Richter

The “good” news  is that the world doesn’t have quite as many financial derivatives as it did in 2013. The bad news is what it has is still seven times global GDP. From Wolf Richter at

Oh, and the unintended consequences of trying to regulate a monster.

Economists at the New York Fed included this gem in their report on a two-day conference on “Derivatives and Regulatory Changes” since the Financial Crisis:

Though the notional amount [of derivatives] outstanding has declined in recent years, at more than $500 trillion outstanding, OTC derivatives remain an important asset class.

An important asset class. A hilarious understatement. Let’s see… the “notional amount” of $500 trillion is 25 times the GDP of the US and about 7 times global GDP. Derivatives are not just an “important asset class,” like bonds; they’re the largest “financial weapons of mass destruction,” as Warren Buffett called them in 2003.

Derivatives are used for hedging economic risks. And they’re used as “speculative directional exposures” – very risky one-sided bets. It’s all tied together in an immense and opaque market interwoven with the banks. The New York Fed:

The 2007-09 financial crisis highlighted weaknesses in the over-the-counter (OTC) derivatives markets and the increased risk of contagion due to the interconnectedness of market participants in these markets.

This chart from the New York Fed shows how derivatives ballooned 150% – or by $360 trillion – in less than four years before the Financial Crisis. They ticked down during the Financial Crisis, then rose again during the Fed’s QE to peak at $700 trillion. After the end of QE, they declined, but recently ticked up again to $500 trillion. I added in red the Warren Buffett moment:

The vast majority of the derivatives are interest rate and credit contracts (dark blue). Banks specialize in that. For example, according to the OCC’s Q4 2016 Report on Derivatives, JPMorgan Chase holds $47.5 trillion of derivatives at notional value and Citibank $43.9 trillion. The top 25 US banks hold $164.7 trillion, or 8.5 times US GDP. So even a minor squiggle could trigger some serious heartburn.

To continue reading: $500 Trillion in Derivatives “Remain an Important Asset Class”: Hilariously, the New York Fed

Retail Meltdown Demolishes Mall Investors, by Wolf Richter

The share prices of retail mall operators are reflecting the burgeoning difficulties in that sector. From Wolf Richter at

Even the biggest.

The closure of thousands of retail chain stores last year and this year, with many more to come – from big anchor tenants such as Macy’s to smaller stores such as Payless Shoes – and the bankruptcies and debt restructurings ricocheting through the industry are having an impact on retail malls. And mall investors – that may include your retirement account – are getting crushed.

The commercial real estate industry has been claiming that these shuttered retail spaces are being converted into restaurants or fitness centers or smaller shops or whatever. And zombie malls are leasing out their parking lots to car dealers to store their excess new vehicle inventory, and that everything is going to be fine.

But investors in publicly traded Real Estate Investment Trusts that were for years among the stars in the S&P 500 are voting with their feet.

It’s not that these REITs are doing all that badly on an operational basis. They’re hanging in there. But many of the announced store closings and bankruptcies haven’t worked their way through the pipeline.

Shares of these REITs all peaked together at the very end of July 2016 and have since then plunged in unison.

Kimco Realty Corp (KIM) says it’s “one of North America’s largest publicly traded owners and operators of open-air shopping centers,” with “interests” in 517 shopping centers with 84 million square feet of retail space in 34 states and Puerto Rico. Shares fell 2.6% to $19.42 on Monday and 13% over the past month. They’re down 66% from the peak of $32.23 at the end of July 2016:

To continue reading: Retail Meltdown Demolishes Mall Investors

U.S. Stocks Are Disastrously Overvalued, by Bill Bonner

If there are any value investors left, US stocks do not currently represent good value. From Bill Bonner at

SALTA, ARGENTINA – Today, we write about corporate earnings.

Unless you’re playing the game of “greater fool” – buying in the hope that someone out there is willing to pay a higher price – the only reason to buy a stock is for its earnings.

As a shareholder, you participate in the business’s profits. All else being equal, as earnings rise, so do stock prices.

Weighing Machine

Investors have their moments of darkness and their periods of euphoria.

Over the short term, this changes the “multiple” investors are willing to pay for each dollar of earnings.

When investors expect higher future earnings, price-to-earnings (P/E) ratios rise. When they expect lower earnings ahead, P/E ratios fall.

But when all is said and done, hope and despair give way to the reality of earnings. You pay for a stock. You expect to get some money back.

Over the long run, stock markets rise and fall, more or less… sort of… on earnings.

Billionaire investor Warren Buffett famously described the stock market as a “voting machine” over the short run… and a “weighing machine” over the long run.

Earnings are what investors are putting on the scales.

According to figures from Yale economist Robert Shiller, over the history of the S&P 500, investors have paid an average of $15.65 for each dollar of underlying earnings.

With the S&P 500 trading at 25.4 times earnings, investors today are willing to pay 60% more than the historical average for each buck of earnings.

Fed Model

Is that “too high”?

The so-called Fed model – which compares how much investors are willing to pay for stock market earnings to how much they’re willing to pay for income on long-term government bonds – tells investors not to worry about it.

Because interest rates are so low, it makes sense that stocks should be high. If you have to pay $40 for every dollar of earnings from a government bond, you shouldn’t mind paying $25 for a dollar of corporate earnings.

That’s the theory.

But government bond yields are low because the Fed pushed them down by diktat. This pushed up the amount investors were willing to pay for stocks without any need for increased earnings.

Ultimately, prices are the only reliable measure of what a stock is worth. But they are subject to change without notice.

To continue reading: U.S. Stocks Are Disastrously Overvalued