Don’t let this happen – it is wrong in its own right and it is a microcosm of what is happening across the world. Let this be a warning of things to come that is heeded and addressed correctly.

Worldwide, there are $70 trillion worth of derivatives in play at the moment – be they on mortgages, sovereign debt, currencies etc. At this scale of gambling it will not take a lot to bring the whole system down again.

Many hundreds of billions of pounds of derivatives have been made on the default possibilities for European national debts including Greece.

If any systemically important organisation (bank, country, insurer, etc) triggers a “default event” it is very easy to start a chain reaction. This is what caused the credit crunch in 2008 when interbank lending dried up due to fear of the chain reaction.

For every person that takes one side of a derivative such as a CDO or CDS somebody else takes the other. Once a payment is triggered by organisation “A” defaulting, organisations with losing side CDO/CDSs taken out against “A” then have to pay their counterparts -the winning sides. If some organisations (“B” and “C” for example) have gambled too wildly and the cost of honouring the derivatives triggered by “A” is too high then B and C may go bankrupt too- triggering the next layer of events a D and E and so on.

In practice it is much scarier than this as derivatives are not traded on open exchanges. They are over the counter and there is no public declaration anywhere of who has taken what derivative bets or who their counterparts are.

This is appalling because it means whenever there is a realistic risk of a “default trigger” on any large systemic organisation (e.g. one that a large number of derivative bets have been taken out on) in the world the interbank lending market will dry up. All the banks and insurance companies with their $70 trillion gambles will refuse to lend to each other. Quiet frankly they all become terrified that the domino default effect will occur. The fear is that any money lent to anybody else might never get repaid. Size is no protection – the bigger you are, the more derivatives you might have bought and the more chance you might collapse.

As banks operate by fractional reserve banking they only hold deposits that cover a tiny fraction (perhaps one fortieth if the shadow banking is included) of their total liabilities. Real world depositors know this – they know that if banks are scared enough of domino defaults that they won’t lend to each other that there is a real risk that only the first customers that withdraw their money from a bank are going to get anything out. After the first 2.5% of the total savings in the bank are withdrawn the bank is effectively insolvent.

As the interbank market has dried up, the banks are unable to use their usual defence again this and cannot borrow from each other to cover any “temporary” shortfalls – liquidity needs.

We are now entering the second stage of the world financial crisis and there are real risks that Greece is going to trigger the interbank market to dry up. No way, if that happens, will there be any taxpayer bail outs of the banks this time. Game over for the existing world financial system.

Governments throughout the World will, as we speak, be looking up Modern Monetary theory and Full Reserve Banking. You and I, just in case, had better get some tinned food and bottled water in.

If the feared second stage doesn’t come to pass it is ridiculous that we didn’t learn the lessons in 2008 and we miss the chance to learn them in 2011. We need proper and real reform of the banking system. The risk of another collapse are real and we have been negligent allowing our politicians, who are funded by the bankers, to prevaricate and avoid enacting the reforms that will make us safe.

We need a transaction tax on financial activity.

We must have derivatives banned from being traded outside regulated exchanges.

Retail banks and Investment Casinos must be separated not just with Chinese firewalls but by separate ownership.

Bank contingent capital must be very significantly increased (to over 20%).

Bonuses must be taxed very heavily.

Full reserve banking and Functional Finance reforms need to be considered to allow proper democratically accountable control of the money supply.

June 22, 2011 at 11:38 pm

Post by Jamie


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