Another Financial Crisis Is Possible. In Fact, It’s Probable

It was just about 10 years ago that a wildly overleveraged bank cracked. The bank was The Bear Stearns Companies, Inc. and its collapse marked the start of the 2008 financial crisis, which would then spawn the Great Recession. Bear Stearns had drunk a little too much from the sub-prime “Kool-Aid,” stuffing mortgages into securities—derivatives of some sort—and doubling down on the loans needed to sustain daily operations.

Bear Stearns was thinking very short-term. It did not have the capital to plan for next week, let alone next year. You would think that banks and institutions have now learned a thing or two about taking too many risks. You’d be wrong; the financial crisis could resume any moment. (Source: “10 years after the fall of Bear Stearns, D.C. is poised to cause another financial crisis,” Los Angeles Times, March 19, 2018.)

A False Sense of Safety Precedes Financial Collapse

While regulations can encourage a false sense of safety (that risks are under control and channeled in secure financial assets), they cannot contain greed indefinitely. The problem is that the big banks—and not just the American ones—remain massively overleveraged in derivatives. This is no tabloid exaggeration; a Boston research firm, Aite Group, LLC, noticed that, at the end of 2017, the largest American banks “owned” some $157.0 trillion worth of derivatives.

That’s over 10% more than they owned when Bear Stearns’s foundations started to collapse, triggering the 2008 financial crisis. Citigroup Inc (NYSE:C) tops the scales. It has some $44.0 trillion in derivatives exposure on the books. That’s 50% more than in 2008. (Source: “US bank derivatives books larger since rescue of Bear Stearns,” Financial Times, March 16, 2016.)

Banks Have Forgotten the Damage They Caused

Although the so-called Facebook Inc (NASDAQ:FB)/Cambridge Analytica“scandal,” involving phenomena that people are suddenly caring about (even as they willingly shared some of the most intimate aspects about themselves online), is the main news story these days, banks’ derivatives portfolios warrant more concern.

The facts should make you downright uncomfortable. The banks, perhaps encouraged by the winner-takes-all and anything-goes (as far as finance is concerned) attitude prevailing in Washington, must have forgotten the damage they caused in 2008.

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