{"id":1451233,"date":"2024-01-18T07:05:13","date_gmt":"2024-01-18T07:05:13","guid":{"rendered":"https:\/\/dissidentvoice.org\/?p=147524"},"modified":"2024-01-18T07:05:13","modified_gmt":"2024-01-18T07:05:13","slug":"casino-capitalism-and-the-derivatives-market-time-for-another-lehman-moment","status":"publish","type":"post","link":"https:\/\/radiofree.asia\/2024\/01\/18\/casino-capitalism-and-the-derivatives-market-time-for-another-lehman-moment\/","title":{"rendered":"Casino Capitalism and the Derivatives Market: Time for Another \u201cLehman Moment\u201d?"},"content":{"rendered":"

Reading the tea leaves for the 2024 economy is challenging. On January 5th, Treasury Secretary Janet Yellen said we have\u00a0achieved a \u201csoft landing<\/a>,\u201d with wages rising faster than prices in 2023. But\u00a0critics are questioning<\/a>\u00a0the official figures, and prices are still high. Surveys show that\u00a0consumers remain apprehensive<\/a>.<\/p>\n

There are other concerns. On December 24, 2023, Catherine Herridge<\/a>, a senior investigative correspondent for CBS News<\/em> covering national security and intelligence, said on \u201cFace the Nation<\/a>,\u201d \u201cI just feel a lot of concern that 2024 may be the year of a black swan event. This is a national security event with high impact that\u2019s very hard to predict.\u201d<\/p>\n

What sort of event she didn\u2019t say, but speculations have included a\u00a0major cyberattack<\/a>; a\u00a0banking crisis<\/a>\u00a0due to a wave of defaults from high interest rates, particularly in commercial real estate; an\u00a0oil embargo<\/a>\u00a0due to war; or a civil war<\/a>. Any major black swan could prick the massive derivatives bubble, which the Bank for International Settlements put at\u00a0over one quadrillion (1,000 trillion) dollars<\/a>\u00a0as far back as 2008. With\u00a0global GDP<\/a>\u00a0at only $100 trillion, there is not enough money in the world to satisfy all these derivative claims. A derivative crisis helped trigger the 2008 banking collapse, and that could happen again.<\/p>\n

The dangers of derivatives have been known for decades.\u00a0Warren Buffett wrote in 2002<\/a>\u00a0that they were \u201cfinancial weapons of mass destruction.\u201d\u00a0James Rickards wrote<\/a>\u00a0in\u00a0U.S. News & World Report<\/em>\u00a0in 2012 that they should be banned. Yet Congress has not acted. This article looks at the current derivative threat, and at what might motivate our politicians to defuse it.<\/p>\n

What Regulation Hath Wrought<\/strong><\/p>\n

Derivatives are basically just bets, which are sold as \u201cinsurance\u201d \u2014 protection against changes in interest rates or exchange rates, defaults on loans and the like. When one of the parties to the wager has a real economic interest to be protected \u2013 e.g. a farmer ensuring the value of his autumn crops against loss \u2014 the wager is considered socially valuable \u201chedging.\u201d But most derivative bets today are designed simply to make money from other traders, degenerating into what has been called \u201ccasino capitalism.\u201d<\/p>\n

In 2008,\u00a0derivative trading brought down<\/a>\u00a0investment bank Bear Stearns and international insurer A.I.G. These institutions could not be allowed to fail because the trillions of dollars in credit default swaps on their books would have been wiped out, forcing the counterparty banks and financial institutions to write down the value of their own risky and now \u201cunhedged\u201d loans. Bear and A.I.G. were\u00a0bailed out<\/a>\u00a0by the taxpayers; but the Treasury drew the line at Lehman Brothers, and the market crashed.<\/p>\n

Under the rubric of \u201cno more bailouts,\u201d\u00a0the Dodd Frank Act of 2010<\/a>\u00a0purported to fix the problem by giving derivatives special privileges. Most creditors are \u201cstayed\u201d from enforcing their rights while a firm is in bankruptcy, but many derivative contracts are exempt from these stays. Counterparties owed collateral can grab it immediately without judicial review, before bankruptcy proceedings even begin. Depositors become \u201cunsecured creditors\u201d who can recover their funds only after derivative, repo and other secured claims, assuming there is anything left to recover, which in the event of a major derivative crisis would be unlikely. We saw this\u00a0\u201cbail-in\u201d policy<\/a>\u00a0play out in Cyprus in 2013.<\/p>\n

That\u2019s true for deposits, but what of stocks, bonds and money market funds? Under the Uniform Commercial Code (UCC) and the Bankruptcy Act of 2005,\u00a0derivative securities also enjoy special protections<\/a>. \u201cSafe harbor\u201d is provided to privileged entities described in court documents as \u201cthe protected class.\u201d Derivatives enjoy \u201cnetting\u201d and \u201cclose-out\u201d privileges on the theory that they are a major source of systemic risk, and that allowing claimants to jump ahead of other investors in order to net and close out their bets reduces that risk. However,\u00a0critical analysis has shown<\/a>\u00a0that derivative \u201csuper-priority\u201d in bankruptcy can actually increase risk and propel otherwise viable financial entities into insolvency.<\/p>\n

It is also highly inequitable. The collateral grabbed to close out derivative claims may be\u00a0your<\/em>\u00a0stocks and bonds. In a 2016\u00a0American Banker<\/em>\u00a0article called \u201cYou Don\u2019t Really Own Your Securities; Can Blockchains Fix That?<\/a>\u201d, journalist Brian Eha explained:<\/p>\n

In the United States, publicly traded stock does not exist in private hands.<\/p>\n

It is not owned by the ostensible owners, who, by virtue of having purchased shares in this or that company, are led to believe they actually own the shares. Technically, all they own are IOUs. The true ownership lies elsewhere.<\/p>\n

While private-company stock is still directly owned by shareholders, nearly all publicly traded equities and a majority of bonds are owned by a little-known partnership, Cede & Co., which is the nominee of the Depository Trust Co., a depository that holds securities for some 600 broker-dealers and banks. For each security, Cede & Co. owns a master certificate known as the \u201cglobal security,\u201d which never leaves its vault. Transactions are recorded as debits and credits to DTC members\u2019 securities accounts, but the registered owner of the securities \u2014 Cede & Co. \u2014 remains the same.<\/p>\n

What shareholders have rather than direct ownership, then, \u201cis a [contractual] right against their broker\u2026. The broker then has a right against the depository institution where they have membership. Then the depository institution is beholden to the issuer. It\u2019s [at least] a three-\u200bstep process before you get any rights to your stock.\u201d<\/p>\n

This\u00a0attenuation of property rights<\/a>\u00a0has made it impossible to keep perfect track of who owns what.<\/p><\/blockquote>\n

Fifty Years of Dematerialization<\/strong><\/p>\n

In a 2023 book called\u00a0The Great Taking<\/a>\u00a0(available for free online), Wall Street veteran David Rogers Webb traces the legislative history of these developments. The rules go back 50 years, to when trading stocks and bonds was done by physical delivery \u2013 shuffling paper certificates bearing titles in the names of the purchasers from office to office. In the 1970s, this trading became so popular that the exchanges could not keep up, prompting them to turn to \u201cdematerialization\u201d or digitalization of the assets.<\/p>\n

The\u00a0Depository Trust Company (DTC)<\/a>\u00a0was formed in 1973 to alleviate the rising volumes of paperwork. The DTCC was established in 1999 as a holding company to combine the DTC and the National Securities Clearing Corporation (NSCC).<\/p>\n

The DTCC is a central clearing counterparty (CCP) sitting at the top of a pyramid of banks, brokers and exchanges. All have agreed to hold their customers\u2019 assets in \u201cstreet name,\u201d collect those assets in a fungible pool, and forward that pool to the DTCC, which then trades pooled blocks of stock and bonds between brokers and banks in the name of its nominee Cede & Co. The DTCC, a private corporation, owns them all. This is not a mere technicality.\u00a0Courts have upheld<\/a>\u00a0its legal ownership, even in\u00a0a dispute with client purchasers<\/a>.\u00a0According to the DTCC website<\/a>, it provides settlement services for virtually all equity, corporate and municipal debt trades and money market instruments in the U.S., and central safekeeping and asset servicing for securities issues from 131 countries and territories, valued at $37.2 trillion. In 2022 alone, the DTCC processed\u00a02.5 quadrillion dollars in securities<\/a>.<\/p>\n

The governing regulations are set out in Uniform Commercial Code (UCC) sections 8 and 9, covering investment securities and secured transactions. The UCC is a set of rules produced by private organizations without an act of Congress. It is not itself the law but is only a recommendation of the laws that states should adopt; but the UCC has now been adopted by all 50 U.S. states and has been \u201charmonized\u201d with the rules for trading securities in Europe and most other countries.<\/p>\n

The\u00a0Wikipedia summary<\/a>\u00a0of the relevant UCC provisions concludes:<\/p>\n

The rights created through these links [up the collateral chain] are purely contractual claims \u2026.\u00a0 This decomposition of the rights organized by Article 8 of the UCC results in preventing the investor to\u00a0revindicate<\/a>\u00a0[demand or take back] the security in case of bankruptcy of the account provider [the broker or bank], that is to say the possibility to claim the security as its own asset, without being obliged to share it at its prorate value with the other creditors of the account provider.<\/p><\/blockquote>\n

You, the investor, have only a contractual claim against your broker, who no longer holds title to your stock either, since title has been transferred up the chain to the DTCC. Your contractual claim is only to a pro rata share of a pool of the stock designated in street name, title to which is held by Cede & Co.<\/p>\n

Rehypothecation: The Problem of Multiple Owners<\/strong><\/p>\n

The\u00a0Wikipedia<\/em>\u00a0entry adds:<\/p>\n

This re-characterization of the proprietary right into a simple contractual right may enable the account provider [the \u201cintermediary\u201d broker or bank] to \u201cre-use\u201d the security without having to ask for the authorization of the investor. This is especially possible within the framework of temporary operations such as\u00a0security lending<\/a>,\u00a0option to repurchase<\/a>,\u00a0buy to sell back<\/a>\u00a0or\u00a0repurchase agreement<\/a>.<\/p><\/blockquote>\n

\u201cSecurity lending\u201d by your broker or other intermediary may include lending your stock to short sellers bent on bringing down the value of the stock against your own financial interests.\u00a0Illegal naked short selling is also facilitated<\/a>\u00a0by the impenetrable shield of the DTCC, and so is lending to \u201cshadow banks\u201d for the re-use of collateral. As Caitlin Long, another Wall Street veteran,\u00a0explains<\/a>:<\/p>\n

[T]he shadow banking system\u2019s lifeblood is collateral, and\u00a0the issue is that market players re-use that same collateral over, and over, and over again, multiple times a day, to create credit. The process is called \u201crehypothecation<\/a>.\u201d Multiple parties\u2019 financial statements therefore report that they own the very same asset at the same\u00a0time. They have IOUs from each other to pay back that asset\u2014hence, a chain of counterparty exposure that\u2019s hard to track. Although improving, there\u2019s still little visibility into how long these \u201ccollateral chains<\/a>\u201d are.<\/p><\/blockquote>\n

It is this reuse of the collateral to back multiple speculative bets that has facilitated the explosion of the derivatives bubble to ten times the GDP of the world. It should be the collateral of the actual purchaser, but you, the purchaser, are at the bottom of the collateral chain. Derivative claims have super priority in bankruptcy, ostensibly because the derivative edifice is so risky that their bets need to be cleared.<\/p>\n

What About the “Customer Protection Rule”?<\/strong><\/p>\n

Broker-dealers argue that their customers\u2019 assets are protected under the \u201cCustomer Protection Rule\u201d of the Securities Investor Protection Corporation (SIPC). The SIPC provides insurance for stocks similar to FDIC insurance for bank deposits, maintaining a pool that can be tapped in the event of a member bankruptcy. But a 2008\u00a0memorandum on The Customer\u00a0Protection\u00a0Rule<\/a>\u00a0from the law firm Willkie Farr & Gallagher asserts:<\/p>\n

With respect to cash and securities not registered in the name of the customer, but held by the broker- dealer for the customer\u2019s benefit, the customer would receive a pro rata portion of the aggregate amount of the cash and securities actually held by the broker- dealer. If there is a remaining shortfall, SIPC would cover a maximum of $ 500,000, only $ 100,000 of which may be a recovery for cash held at the broker- dealer.<\/p>\n

\u2026 [M]ost securities are held by broker-dealers in street name and would be available to satisfy other customers\u2019 claims in the event of a broker- dealer\u2019s insolvency.<\/p><\/blockquote>\n

If the member has a large derivatives book (JPMorgan holds<\/a>\u00a0$54.4 trillion in derivatives and a mere $3.4 trillion in assets), derivative customers with priority could wipe out the pool and the SIPC fund as well.<\/p>\n

What Webb worries about, however, is the bankruptcy of the DTCC itself, which could wipe out the entire collateral chain. He says the DTCC is clearly under-capitalized, and that the startup of a new Central Clearing Counterparty is already planned and pre-funded. If the DTCC fails, certain protected creditors can take all the collateral, upon which they will have perfected legal control.<\/p>\n

Defensive Measures<\/strong><\/p>\n

In the event of a cyberattack that destroys the records of banks and brokers, there could be no way for purchasers to prove title to their assets; and in the event of a second Great Depression, with a wave of 1930s-style bank bankruptcies, derivative claimants with super-priority can take the banks\u2019 assets without going through bankruptcy proceedings. In today\u2019s fragile economy, these are not remote hypotheticals but are real possibilities, which can wipe out not just the savings of middle class families but the fortunes of billionaires.<\/p>\n

And there, argues Webb, is our opportunity. The system by which Cede & Co. holds title to all \u201cdematerialized\u201d securities is clearly vulnerable to being exploited by \u201cthe protected class,\u201d and Congress could mitigate those concerns by legislation. If our representatives realized that they are not the owners of record of their assets but are merely creditors of their brokers and banks, they might be inspired to hold some hearings and take action.<\/p>\n

The first step is to shine a light on the obscure hidden workings of the system and the threat they pose to our personal holdings. Popular pressure moves politicians, and the people are waking up to many issues globally, with\u00a0protests on the rise everywhere<\/a>\u00a0\u2014 economic, political and social. Possible action that could be taken by Congress includes\u00a0reversing the \u201cspecial privileges\u201d<\/a>\u00a0granted to the derivatives casino in the form of \u201csuper priority\u201d in bankruptcy. A\u00a00.1% Tobin tax or financial transaction tax<\/a>\u00a0is another possibility. For protecting title to assets, blockchain is a promising tool, as discussed by Brian Eha in the\u00a0American Banker<\/em>\u00a0article quoted above. These and other federal possibilities, along with potential solutions at the local level, will be the subject of a followup article.<\/p>\n

\u2022 Article was first published on \u00a0<\/em>ScheerPost<\/em><\/a>.<\/em><\/p>The post Casino Capitalism and the Derivatives Market: Time for Another \u201cLehman Moment\u201d?<\/a> first appeared on Dissident Voice<\/a>.\n

This post was originally published on Dissident Voice<\/a>. <\/p>","protected":false},"excerpt":{"rendered":"

Reading the tea leaves for the 2024 economy is challenging. On January 5th, Treasury Secretary Janet Yellen said we have\u00a0achieved a \u201csoft landing,\u201d with wages rising faster than prices in 2023. But\u00a0critics are questioning\u00a0the official figures, and prices are still high. Surveys show that\u00a0consumers remain apprehensive. There are other concerns. On December 24, 2023, Catherine [\u2026]<\/p>\n

The post Casino Capitalism and the Derivatives Market: Time for Another \u201cLehman Moment\u201d?<\/a> first appeared on Dissident Voice<\/a>.<\/p>\n","protected":false},"author":127,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1871,58571],"tags":[],"_links":{"self":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts\/1451233"}],"collection":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/users\/127"}],"replies":[{"embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/comments?post=1451233"}],"version-history":[{"count":1,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts\/1451233\/revisions"}],"predecessor-version":[{"id":1451234,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts\/1451233\/revisions\/1451234"}],"wp:attachment":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/media?parent=1451233"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/categories?post=1451233"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/tags?post=1451233"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}