By Stephen Blumenthal, CEO, CMG Capital Management Group
Have you watched any of the great Netflix TV series House of Cards? Set in present-day Washington, D.C., House of Cards is the story of Frank Underwood (Kevin Spacey), a Democrat from South Carolina’s 5th congressional district and House majority whip who, after being passed over for an appointment as Secretary of State, initiates an elaborate plan to get himself into a position of power. The series is primarily about ruthless pragmatism, manipulation, power, and doing bad things for the greater good.
Kevin Spacey is simply amazing. I love it when he looks into the camera and speaks directly to us, revealing who’s paying off whom or how much pork is needed to secure a particular vote. I can’t help but wonder how close this is to today’s reality given last week’s passing of legislation that puts banks’ future derivatives losses squarely on your back and mine (the U.S. taxpayer).
With this win in hand, the few big banks with the greatest derivative exposures step toward 2015 with their own version of stop-loss protection more securely in place. Washington has a culture of deal making and demands from third-party interests. I can hear my old man whispering in my ear, “Watch what they do and not what they say.” I include some great data on just how much derivative exposure exists, how it compares to where we were in 2008, and how it compares to the amount of money in stocks, bonds, and money market funds today.
Imagine Kevin Spacy looking into the camera telling us, “Sneaked it in when you were sleeping” as he slowly turns away with a smug smile.
Derivatives – Some Hard Data
“We’ve reformed nothing. We have more leverage and more derivatives risk than we’ve ever had,” says Janet Tavakoli, president of Tavakoli Structured Finance. To this statement I agree. Here is some hard data:
- The notional amount of outstanding derivative contracts totaled $691 trillion at end-June 2014
BIS Bank for International Settlements. Source
- This is $200 trillion more than the total value of all derivatives in 2007 – the top of the great financial crisis.
- There is $237 trillion in U.S. total derivatives (Total Notional Amount of Derivatives Contracts at all U.S. Commercial Banks). Most of that is concentrated in just four large banks.
• The total estimated exposure at the top four banks is $219 trillion. Source
• JPMorgan alone has $70 trillion in derivatives on their books.
• There is $1 trillion of equity in the U.S. banking system.
• The Global Economy is roughly $70 trillion.
• The U.S. economy is roughly $17.5 trillion.
• Total U.S. Stock Market Capitalization is $23.5 trillion as of December 1, 2014 (NDR estimate of 4100 U.S. common stocks).
• Total Credit Market Debt is $57 trillion as of June 30, 2014
• Total Money Market Funds is $2.66 trillion as of November 25, 2014. Source
• Total World Equity Market Capitalization was $64 trillion in U.S. dollar terms at the end of 2013.
• Total world-wide debt was $80 trillion 9 years ago. There is approximately $212 trillion total world-wide debt today.
• When the big banks collapsed in 2008, the Fed was able to bail them out by printing trillions and buying up their bad assets. Then, they had a strong balance sheet.
• Unfortunately, the Fed is now leveraged 80-1. They hold $80 dollars in debt for every $1 dollar of capital on their balance sheet. The size of the Fed’s balance sheet is over $3 trillion. Today, that balance sheet is weak.
• In short, there is not enough money to bail out the big banks if they blow up again. You and I are now on the hook.
Capitalism without bankruptcy is simply not possible. What large bank needs bankruptcy when the U.S. taxpayer is put on the hook to bail them out? What does that mean psychologically to the traders looking to enhance their year-end bonuses?
See the full story and important disclosures in On My Radar: A “House of Cards” – Looking Ahead To The Year That Interest Rates Will Finally Rise
Steve Blumenthal is CEO and Chief Investment Officer of CMG Capital Management Group. CMG manages tactical portfolios and strategies for advisors, individuals, and institutions. The objective behind all of Mr. Blumenthal’s work is to help advisors build better portfolios by allocating with a long-term game plan that is risk sensitive and properly diversified. Mr. Blumenthal is a self-proclaimed “quant geek,” with an analytical mind for the markets that helps him connect with everyday investors and industry experts alike.