Type to search

Are We There Yet? The Next Big Crash Might Be Around the Corner

Economy Memo Pad

Are We There Yet? The Next Big Crash Might Be Around the Corner


We probably aren’t at the cusp of the next financial crisis, but we can’t be sure, given the pathetic nature of the financial-market “reforms” that are already being curtailed even before taking full effect.

As we enjoy a rare market gift to the masses, the first sub-$3 gasoline in several years, we might want to temper our holiday cheer just a bit. Not because cheaper gas doesn’t help “everyman,” but because the presence of rapid price swings in one market can quickly turn into disaster for all markets.

It’s not that market volatility is in itself contagious. It’s the fact that there’s a hidden part of our financial system that works behind the scenes and takes advantage of opportunities in the market. Even if those opportunities benefit only them, and hurt the rest of us.

Remember how the last crisis went global? And how some said we should blame the banks (liberals cheer) or the bad borrowers (conservatives applaud) or even decades of government policy (libertarians blow their horns)? And everybody blamed subprime mortgage lending?

What few realize is that in September of 2008, actual realized credit losses from subprime mortgage foreclosures was a small fraction of the derivative losses sustained at just one company, AIG, which became synonymous with the word “bailout.”  And AIG wasn’t even in the subprime mortgage business.

Before the crisis, AIG was the world’s largest AAA-rated insurance company, with around $200 billion in market capitalization. AIG lost all their shareholders’ capital, and still sucked up nearly $190 billion in cash, government asset purchases and spinoffs. What did an AAA-rated insurance company have to do with mortgages, mortgage bonds or investing in mortgage bonds? Actually, nothing. Instead, AIGs connection to the mortgage crisis was a special kind of bond insurance.  It wasn’t regulated as insurance. In fact, it wasn’t regulated at all.

That insurance, called Credit Default Swaps (CDS), rightly has been addressed in the new regulations that implement the Dodd-Frank financial reforms. Delay and “pushback” on those regulations has already defanged them, but the anti-regulation crowd isn’t done yet.

Last year, the House passed a bill (designated HR-4413) to take care of the regulation problem.  Ironically titled “Customer Protection and End User Relief Act,” it made sure that anyone wanting to take speculative positions large enough to bankrupt any bank on Earth could do so without the irritating presence of examiners or capital regulations. All that was required was the assurance that they were “hedging their portfolios.”

Or they could escape scrutiny by being “end users.” When the regulations were first drafted, end users were defined as companies with less than $100 million in derivatives on their books. Above the limit would define a dealer. That limit was temporarily raised to $8 billion to give smaller banks or investment firms a chance to put systems in place. HR-4413 would make that limit permanent. The workaround for derivatives dealers in end users’ clothing couldn’t be simpler: Just put $7.9 billion in CDS bets in a number of separate companies.

What does this all have to do with cheap gas in your tank? A lot. Because the same CDS bets that nearly brought down the global economy once aren’t limited to mortgage bonds. If you’re one of the group that gambles with everyone’s future, you can do it in any sector. Like energy company bonds.

There isn’t any way to tell how big the CDS bets are in energy right now. The “reforms” have ensured that. The best we can do is look at the Office of the Comptroller of the Currency (OCC) report on derivatives after each quarter end, and find out that, as of the end of Q2, 2014, there were approximately $2.77 trillion of below-investment grade (junk) CDS outstanding in the American part of the global banking system. Almost all of it was on the books of the five largest taxpayer-insured banks.

To be fair, those banks do the best they can to pair off their CDS exposure, finding bullish investors to offset the bearish bets. Unfortunately, even the best hedges are never a perfect match. The “matched books” the banks run depend on both the bulls and the bears having enough money to pay when the time comes.

Let’s hope that time doesn’t come anytime soon.  We’re still recovering from the last crisis.

Howard Hill is a former investment banker who created a number of groundbreaking deal structures and analytic techniques on Wall Street, and later helped manage a $100 billion portfolio. His book Finance Monsters was recently published.

Photo: Mike Peel via Wikimedia Commons



  1. Dominick Vila December 9, 2014

    Cheap gas prices are great for consumers, but they are the kiss of death for oil companies, a fact that may contribute to a drop in oil production and that may have preclude our ability to achieve sustainable energy independence. On the short term, however, savings at the pump translate to more disposable income and spending, which is good for the economy at large.
    Some economists have been talking about an imminent economic collapse for years. In the absence of deregulation, corporate excesses and greed, and fiscal irresponsibility, such as deficit spending and accumulation of debt by our government, our economy will remain on solid ground and will continue to grow. As opposed to countries like Russia, Venezuela, Saudi Arabia and other oil producing countries, the USA economy does not depend strictly on oil production and exports. Ours is a diversified economy, our GDP is second to none, government deficit spending has been reduced by 2/3, the DOW has been at record levels during the past couple of years and continues to rise, economic growth has been very strong during the past few quarters, unemployment is dropping and good jobs are being created, and we are no longer spending trillions of dollars in crusades that benefit only the arms industry, a few corporations, and some of our “allies”.
    The goal of the naysayers is to make themselves sound relevant, deflect attention from their economic failures, and deny those responsible for the prosperity we are now enjoying the credit they deserve.

    1. highpckts December 10, 2014

      And we all know that this could not have happened without a Black man in office acting all uppity and forcing some issues!! They will NEVER give credit where credit is due! The outcome would have been many times better if there had been a white, Republican in office! Whatever!

  2. Eleanore Whitaker December 9, 2014

    The reality is that Americans know for certain that the high handed Big Oil states have held them hostage for far too long. With hybrid cars coming down in price, the idea of Big Oil is to encourage more production of gas guzzlers….and the minute car manufacturers do that…watch Big Oil jump the prices again.

    Obviously, the cowboys in Big Oil states think all Americans are too stupid to figure out this skanky little plan. Oil prices are only coming down to entice a return to gas guzzlers. Once that happens, gas goes through the roof again.

    1. Dominick Vila December 9, 2014

      There is no doubt that affordable gas prices at the pump may encourage many Americans to go back to our old preference and start buying powerful gas guzzlers again, and that such decision would result in immediate gas price hikes, but the reason for the dramatic drop in oil prizes is what it has always been: the law of supply and demand. The economic crisis in China has reduced their demand for oil imports. Oil production in OPEC and non-OPEC countries has remained constant. Last but not least, oil production in the USA is at an all time high, and has reduced our dependence on oil imports. All these factors have contributed to a global oil glut, that is likely to last until China and most Western European countries overcome the effect of the global Great Recession, and demand for oil increases.

      1. Eleanore Whitaker December 9, 2014

        I am very reluctant to go with that old saw “supply and demand.” I agree that oil production is at an all time high. But, when you consider the reasons why it is at an all time high, it doesn’t have anything to do with supply and demand, as such.

        It has more to do with imposing use of gasoline on the public by enticing them to pay in tax dollars tens of billions to Big Oil every year. Since 2001, Big Oil Tax subsidies have increased by one billion dollars a year.

        To most Americans, this is an unseen part of the cost they pay at the pumps. If you pay tax dollars that in 2014 amounted to $14 billion to Big Oil, this industry is forced to make it appear they are not greedy by lowering prices at the pump.

        What they lose at the pumps is more than recouped by them from taxpayers who are also consumers.

        The reality is that there won’t be an end to the global recession. Why would there be? If the top 1% are benefiting from this recession the most, what would make anyone think they are in a hurry to stop their Gravy Train in its tracks?

        In today’s glut of greed, supply and demand is “created” by the use of finely crafted media and fearmongering. It’s easy to say that Americans are demanding more gasoline when that’s not the truth.

        Unfortunately, lies and deception is the tribute paid to corruption and greed.

        1. Dominick Vila December 9, 2014

          The real reason for the significant increase in oil production in the USA is due to the development of the Bakken oil fields in North Dakota.
          Other factors include effective regulation, more energy efficient vehicles, and drivers more conscious of the cost of filling up.

          1. Eleanore Whitaker December 10, 2014

            If you study who has been involved in the Bakken oil fields in ND, you find Koch stamped all over it. Pilgrim Energy is owned by the Koch bois.

            The Founding Fathers didn’t intend for the word “united” in naming this country to mean that a majority of states under a single culture and ideology has the right to dump on individual states.

            All that “states’ rights the south and midwestern states push so hard for is hypocrisy reincarnate. Bakken oil fields and the Pilgrim Oil can’t keep the oil in their state. So, they transport it across the US to northeastern states by rail in tank cars and truck transports, careless of what happens the minute their filthy oil leaves ND…so what if people living in northeastern states end up dead from the tank car explosions? There were 2 oil tankers in NJ last week that crashed into each other sending plumes of petrochemical carcinogens into the air streams for hours after in Union County NJ, one of the most densely populated areas of the country. Can NJ bill Bakken for the cost of that clean-up?

            Lies, deception and Big Oil are one and the same. Those 2 tankers that exploded were not for use in NJ. They were headed to ports north where they’d be shipped out.

            YOu can only imagine what would happen if these tankers explode near NY City…9/11 all over again.

          2. Dominick Vila December 10, 2014

            My post referred only to what I believe contributed to increased oil production and lower gas prices in the USA. It was not meant to be an endorsement of fossil fuels as the preferred energy source. I support greater emphasis on solar and wind energy, more energy efficient vehicles, and research of new energy sources to ultimately end our reliance on oil and carbon, not so much because who owns those industries, but because of the damage they cause to our environment.

          3. Eleanore Whitaker December 10, 2014

            Like you, I am a environmentally conscious. I worked for 24+ years in an environmental engineering company that involved building new and more sophisticated pollution controls and also provided environmental compliance consulting for our clients.

            In retrospect, the push today is to deregulate when and where ever possible industries we know cost taxpayers in terms of repayment of EPA fines and clean up. No one knows this better than I, having seen how hardheaded some businesses can be when profit is more important than environmental responsibility.

            The problem with Big Oil is that it is trying, yet again, to manipulate Americans they’ve held hostage so long that we are moving on to “greener” pastures.

            Yet, they continue to reduce prices in hopes of enticing not just more gas guzzlers to be manufactured but also to regain their former market share.

            According to the DOE, the US already has more than 1.2 million miles of pipeline underground. The reality is that Big Oil wants desperately to keep drilling no matter what the reason. That’s industry. Industry doesn’t like when their Gravy Train is over. So they will do what they must to pay off politicians to keep drilling until every last inch of US underground soil has a pipeline.

            The reality is that solar energy is here to stay. Oddly, AZ is No. 1, replacing CA in solar energy production. My state (NJ) is No. 3 with more than half a million solar energy customers.

            Change is difficult for those in profitable industries like Big Oil, Big Pharma and Big Insurance. They don’t like losing market share when Americans move onward, forward and upward to new innovations for cleaner energy, higher quality healthcare and highest quality education.

          4. highpckts December 10, 2014

            Yes and if the GOP controlled Senate and House have their say those “regulations” will go away!

          5. Dominick Vila December 10, 2014

            …and another 2007 Great Recession would be around the corner, not to mention lots of ENRONs, AIGs, Lehman Brothers, and a resumption of chemical dumping in our rivers and lakes, and increased air pollution. All in the name of the Almighty dollar.

      2. highpckts December 10, 2014

        I say that all these specualtion traders that “buy” oil should be made to take delivery! Just like any other product. What happens after that is their problem!

        1. Dominick Vila December 10, 2014

          That would stop stock market drops such as the one today, which was influenced by speculation on oil futures, based on guesses regarding oil production levels next year.

    2. charleo1 December 9, 2014

      My wife, and I just enjoyed a trip across half the Country visiting relatives. And I found gas prices, while relatively cheap by recent standards, to reek of opportunism, price manipulation, and make absolutely no sense in terms of any market force I could discern. Except being geared directly to the prices the vendors estimated their particular customer base could afford. On the major interstates, the prices varied from as high as $2.99 in Northern Fl. to $2.45 in TX. In the suburbs of Houston, they varied by as much as .30 cents a gallon! Sometimes in the span of no more than three city blocks. From a high of about $2.55, to as low as $2.25. In OK. and MS. Two of the Country’s poorest States per capita. I found it dismaying to find the highest overall average in gas prices, in and close, to both small towns, large cities, and on the interstate. And I thought at these prices, these people, in these bright Red States, must really think Obama is punishing them by not okaying the XL Pipeline. Yes, I, “felt,” as though there must be some real concerted manipulation between the politicians, and big oil going on. If admittedly by no
      other information I possessed than my nose, and eliminating all other possible factors that could account for the .50 cent difference. Of course these solid Republican Legislatures in these solid Red States, could be imposing an added tax on gasoline, and diesel, to cut consumption for environmental purposes. Or, extracting a billion dollars of expendable income out of their State’s economy for every
      penny increase in gas prices to intentionally keep their populations
      poor, and disgruntled with the Democratic Party. For which they consistently blame for the pathetic condition of their respective economies. But that would make them real perverted, and spineless little creatures. Caring nothing for the people who blindly go to the polls and vote them in office, against their own best interests, now would’t it?

  3. idamag December 9, 2014

    The president puts some band aids on the problem or we would already be in one of the worst depressions ever. Deregulating the financial industry caused them to get greedy. We need some intelligence in the Congress or we will fail.

  4. 14hei December 9, 2014

    After the nation has experienced the worst financial downturn since the Great Depression, we are ready to return to the same madness. Where are the new financial trading rules of Dodd-Frank. I find it very hard to believe that any individual or organization would invest in CDS, Credit Default Swaps,. This form of unregulated insurance investment is what caused the Great Recession of 2008. An now there writing CDS’s for oil and gas futures. Isn’t the pollution from oil and gas development enough? I hope that these recent financial moves by Wall Street and big banks has convinced people to invest locally. In small credit unions, local banks, and local business. Support the community in which you live. Because it is where you live!


Leave a Comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.