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Financial weapons of mass destruction remain UK’s biggest unexploded bomb

derivatives wmd 1Despite the recent howls from the City of London about the new criminal offence of reckless misconduct by senior bank executives, little or nothing has been done to curb the very real and big risks associated with derivatives which were at the heart of the financial crash 6 years ago.

It is little understood that whilst banks have little interest in buying or selling commodities, they nevertheless spend vast sums speculating on the change in their prices. This not only drives up the price so that ordinary people have to pay more for electricity, gas, water, copper, wheat or whatever commodity they’re buying, but it also generates huge profits and losses.

This institutionalised gambling by the banks was famously described by the investment sage Warren Buffett as “financial weapons of mass destruction“. This is because the economic exposure of banks to derivatives, that is the hard cash needed to settle the outcome of the bets, is always highly uncertain until the contracts mature which could be 10-15 years into the future.

The danger signs have been there for years. At the critical moment in the 2008-9 cataclysm, the US bank Lehman Brothers collapsed with 1.2 million derivatives contracts which had a face value of £24.4 trillion. Its balance sheet boasted net derivatives assets of £14bn, but that turned out to be equivalent to the bookies’ receipts. Since the financial horses never reached the winning post, all of this became worthless junk and it faced claims from counter-parties of £188bn. Another example is the US bank Bear Stearns whose pre-tax profits for nearly 6 years before its collapse in 2008 came from speculative activities. It had shareholder funds of £7bn, debts of £240bn and a derivatives portfolio of £8 trillion.

One might have thought that examples like these were catastrophic enough to prompt early reform. Not a bit of it. By June 2013 the face value of over-the-counter derivatives had risen to £435 trillion – a figure to be compared with global GDP which is £47 trillion. If a financial meltdown occurs, it is unlikely that any government will be in a position to contain its impact.

In the case of the UK, the entire wealth of all British households is estimated to be about £7.3 trillion. Against that background, just 3 UK banks – Barclays, HSBCA and RBS – have a derivatives portfolio with a face value totalling nearly £100 trillion. Barclays alone has derivatives valued at £42 trillion, but capital of only £64bn, and a failed bet on its derivatives or a decline of less than 5% in its asset values would wipe out its entire capital.

The idea that the big banks are no longer ‘too big to fail’ or that they can in future if necessary be would down in orderly fashion through ‘living wills’ is a ridiculous fiction. Through their size, their inter-connections, their speculative greed and their continuing implicit reliance on the State to bail them out, they remain Britain’s biggest unexploded bomb.

Image credit: mbaskool

One Comment

  1. Bernie Evans says:

    Wrote this last week:
    Not only does the City minister say it`s time to “move away from banker-bashing”, the deputy governor of the Bank of England is “dismayed” the debate on bonuses” is so divorced from the heart of the matter which is approprite incentives”. Well, if he was referring to the working people`s need for “appropriate” pay at a time when real wages continue their downward spiral, he would have a point, but of course, like his friends in government, epitomised by Osborne`s frequent trips to Brussels to contest the bonus cap, he is arguing for the continuance of the ludicrous lie that the top paid will only work hard if they have a financial incentive to double their alredy obscenely high pay.
    This is the same deputy governor who recently complained that fines on banks for such things as mis-selling insurance policies to customers, fixing Libor rates and money-laundering drug money, were making it difficult for banks to re-capitalise! As £375bn was created by Quantitative Easing for the very purpose of bank recapitalisation, it appears of Bank of England managers seem to be ignoring the Bank`s founding charter which stated that its purpose was to “promote the public good and benefit of our people”. The Bank`s website even states that its aim today “reflects that vision”! You could have fooled me! Any chance of Labour promising to change things?

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