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Everything that has happened since 2007, every Central Bank move, ever
major political decision regarding the big banks, every trend, have all been
focused solely on one issue.
That issue is collateral.
What is collateral?
Collateral is an underlying asset that is pledged when a party enters into
a financial arrangement. It is essentially a promise that should things
go awry, you have some “thing” that is of value, which the other party can
get access to in order to compensate them for their losses.
You no doubt are familiar with this concept on a personal level: any time
you take out a bank loan the bank wants something pledged as collateral
should you fail to pay the money back. In the case of property, the property
itself is usually the collateral posted on the mortgage. So if you fail to
pay your mortage, the bank can seize the home and sell it to recoup the
losses on the mortgage loan (at least in theory).
In this sense, collateral is a kind of “insurance” for any financial
transaction; it is a way that the parties involved mitigate the risk of their
deal not working out.
As many of you know, our entire global financial system is based on
leverage or borrowed money. Collateral is what allows this to work. Without
collateral, there is no trust between financial institutions. Without trust
there is no borrowed money. And without borrowed money, money does not enter
the financial system.
In this sense, collateral is the “reality” underlying the “imaginary” or
“borrowed” component of leverage: the asset is real and can be used to
back-stop a proposed deal/ trade that has yet to come to fruition.
For finacial firms, at the top of the corporate food chain,
sovereign bonds are the senior-most form of collateral.
Modern financial theory dictates that sovereign bonds are the most “risk
free” assets in the financial system (equity, municipal bond, corporate
bonds, and the like are all below sovereign bonds in terms of risk profile).
The reason for this is because it is far more likely for a company to go
belly up than a country.
Because of this, the entire Western financial system has sovereign bonds
(US Treasuries, German Bunds, Japanese sovereign bonds, etc.) as the senior
most asset pledged as collateral for hundreds of trillions of
Dollars worth of trades.
Indeed, the global derivatives market is roughly $700 trillion
in size. That’s over TEN TIMES the world’s GDP. And sovereign bonds…
including even bonds from bankrupt countries such as Spain… are one of, if
not the primary collateral underlying all of these trades.
How did the world get this way?
Back in 2004, the large banks (think Goldman, JP Morgan, etc.) lobbied the
SEC to allow them to increase their leverage levels. In very simple terms,
the banks wanted to use the same collateral to backstop much
larger trades. So whereas before a bank might have $1 worth of collateral for
every $10 worth of trades, under the new regulation, banks would be able to
have $1 worth of collateral for every $20, $30, even $50 worth of trades.
Another component of the ruling was that the banks could abandon “mark to
market” valuations for their securities. What this means is that the banks no
longer had to value what they owned accurately, or based on what the “market”
would pay for them.
Instead, the banks could value everything they owned, including their
massive derivatives portfolios worth tens of trillions of Dollars using
in-house models… or basically make believe.
This is getting a bit technical so let’s use a real world example. Imagine
if you had $100,000 in savings in the bank. Then imagine that the bank let
you use this $100,000 to buy millions and millions of dollars worth of real
estate. Then imagine that the bank told you, “we aren’t going to have our
analysts independently value your real estate, you can simply tell us what
you think it’s worth.”
In this set up, you would potentially buy $10 million worth of real estate
or more… using just $100,000. But what if your newly purchased real estate
drops in value to $5 million? No worries, you could simply tell the bank, “my
analysis indicates that the properties are worth $20 million.” The bank
believes you so you continue to buy more properties.
This sounds completely ludicrous, but that is precisely the environment
that banks operated in post-2004. As a result, today US banks alone are
sitting on over $200 TRILLION worth of derivates trades. These are trades
that the banks can value at whatever valuation they want.
Now, every large bank/ broker dealer knows
that the other banks/dealers are overstating the value of their securities.
As a result, these derivatives trades, like all financial instruments,
require collateral to be pledged to insure that if the trades blow up,
the other party has access to some asset to compensate it for the loss.
As a result, the ultimate backstop for the $700+ trillion derivatives
market today is sovereign bonds.
When you realize this, the entire picture for the Central Banks’ actions
over the last five years becomes clear: every move has been about
accomplishing one of two things:
1) Giving the over-leveraged banks access to cash for
immediate funding needs (QE 1, QE 2, QE3 and QE 4 in the US… and LTRO 1, LTRO
2 in the EU.)
2) Giving the banks a chance to swap out low grade
collateral (Mortgage Backed Securities and other garbage debts) for
cash that they could use to purchase higher grade collateral (QE 1’s MBS
component, Operation Twist 2 which lets bank their long-term Treasuries and
buy short-term Treasuries, QE 3, etc).
All of this is a grand delusion meant to draw attention away from the
fact that the financial system is on very, very thin ice due to the fact that
there is very little high quality collateral backstopping the $700+ trillion
derivatives market.
Indeed, if you want further evidence that the financial elites are already
preparing for a default from Spain and a collateral crunch, you should
consider that the large clearing houses (ICE, CEM and LCH which oversee the
trading of the $700+ trillion derivatives market) have ALL begun accepting
Gold as collateral.
Gold as Collateral Acceptable for Margin Cover Purposes
From 28 August 2012 unallocated Gold (Loco London) will be
accepted by LCH.Clearnet Limited (LCH.Clearnet) as collateral for margin
cover purposes.
This addition to acceptable margin collateral will be subject to the
following criteria;
Available for members clearing OTC precious metals forwards (LCH EnClear
Precious Metals division) or precious metals contracts on the Hong Kong
Mercantile Exchange. Acceptable to cover margin requirements for all markets
cleared on both House and ‘Segregated’ omnibus Client accounts.
http://www.lchclearnet.com/member_notices/cir.../2012-08-21.asp
CME Clearing Europe to Accept Gold as Collateral on Demand
CME Clearing Europe will accept physical gold as collateral, extending the
list of assets it’s prepared to receive as regulators globally push more
derivatives trading through clearing houses.
CME Group Inc. (CME)’s European clearing house, based in London, appointed
Deutsche Bank AG (DBK), HSBC Holdings Plc and JPMorgan Chase & Co. as
gold depositaries. There will be a 15 percent charge on the market value of
gold deposits and a limit of $200 million or 20 percent of the overall
initial margin requirement per clearing member based on whichever is lower,
Andrew Lamb, chief executive officer of CME Clearing Europe, said today.
“We started with a narrow range of government securities and are now
extending that,” Lamb said in an interview today. “We recognize there
will be a massive demand for collateral as a result of the clearing mandate.
This is part of our attempt to maintain the risk management standard and to
offer greater flexibility to clearing members and end clients.”
http://www.bloomberg.com/news/2012-08-17/c...-demand-1-.html
It is no coincidence that this began only when the possibility of a
sovereign default from Greece or Spain began. The large clearinghouses see
the writing on the wall (that defaults are coming accompanied by a mad scramble
for collateral) and so are moving away from paper (sovereign bonds) into hard
money to attempt to stay afloat.
The most telling item is that clearinghouses now view Gold as money.
Indeed, you can see this fact in other stories indicating that various entites
are concerned about having their gold stored “inhouse” if the stuff ever hits
the fan.
Heck, even the Alan Greenspan, the man most responsible for the 2008
financial crisis, has admitted that “gold is money.” Of course, he couldn’t
admit this until he’d left the Fed. But this is a man who knows all too well
just how the financial system works.
Take note, Gold is officially money for the most powerful entities in the
world. They are not only accepting Gold as collateral but are openly trying
to insure that they have their own Gold in safe custody.
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