Something Blew Up In The Global Financial System

Investment Research Dynamics

Earlier this week I suggested, based on the sudden big spike up in Fed reverse repos in mid-September that there was some kind of derivatives accident that required the Fed to flood the global financial system with Treasury collateral, which is used to satisfy derivatives margin calls.

This was likely connected to everything that has cratered in value since June 2014, when the price of oil crashed:    high yield bonds, industrial commodities, emerging market currencies, biotech stocks, Glencore, Volkswagen and now Deutsche Bank.

Glencore was originally said to have $30 billion of debt.  However, that number did not include the $50 billion in bank credit lines outstanding plus an undetermined amount of unsecured trade finance deals.  The total exposure to Glencore debt by banks and investors is now estimated to be as high as $100 billion – LINK.

To put this in perspective, Enron had $13 billion in debt at the time of its collapse.  Moody’s continued to assign a triple-A debt rating to Enron until shortly before it filed for bankruptcy.  I mention this to illustrate the unreliability of “expert” hear-say analysis.

With Glencore the hidden OTC derivatives skeletons are likely much more lethal to the financial system than has been estimated.   Just ask AIG and Goldman Sachs about that.

I would suggest that the record spike up in reverse repos and the plunge in Glencore stock, after it had previously lost 56% of its value since the beginning of May, was not coincidental.

On that list of asset sectors that have imploded in price, Glencore has exposure to industrial commodities, oil and EM currencies.  It also is exposed to the price of silver and gold.  Ironically, its precious metals assets seem to be getting by far the most attention from potential buyers (royalty stream investors) as a source of cash.

But Glencore is only part of the story.  Today Deutsche Bank announced a $7 billion quarterly loss from impaired asset write-downs litigation reserves.  Some reporters have suggested this was “kitchen sink” event in which Deutsche Bank piles all of its potential losses from bad investments and business lines into one quarter in order to make its results going forward look better.

But there’s no way a “kitchen sink” maneuver will come even remotely close to covering DB’s exposure to toxic assets.   For starters, the bank has heavy exposure to Glencore.  It also is the largest lender to Volkswagon and Volkswagons suppliers. It also has rather  large exposure to emerging market currencies and related derivatives.

Deutsche Bank, at $75 trillion in holdings, is the largest derivatives player in the world now.  This amount of derivatives is 20x greater than the GDP of Germany.   And that’s DB’s “net” exposure.   As counterparties default, that $75 trillion blossoms at a geometric rate. Deutsche Bank is too big for the German Government to bail-out without implementing Weimar-era money printing.  It’s balance sheet is a nuclear cesspool of toxic assets.

The $7 billion charge to earnings this quarter is unequivocally not  “kitchen sink” accounting gamesmanship.  It was either wishful thinking by upper management – not likely – or it was the result of a concerted effort by the bank to put out a shock-value number that reflected the expectation by analysts and investors that DB would have to admit to a large loss this quarter given the nature of its assets. I would suggest that it a mere fraction of the true mark to market losses sitting on and off DB’s balance sheet.  For me it’s a number so unrealistic that it’s silly.

As of its June 30 “interim” financial report, DB had $1.51 trillion in assets supported by a razor thin $67 billion of book value.  That’s 22x leverage.   This number does not reflect a realistic assessment of the value of its derivatives.  At 22x leverage, DB’s balance sheet in and of itself is massive OTC derivative.  

DB is not only now the lethal sovereign risk of Germany, it is the sovereign risk of the entire EU. Whereas Bear Stearns the Lehman triggered the Great Financial Collapse in the U.S., Deutsche Bank could potentially trigger the collapse of the global financial system.

The graph above is evidence that a massive monetization operation was implemented by the Fed in mid-September in an effort to contain the damage from something big that has blown  up behind the facade of fraud that has been erected over several years by western Central Banks and their Too Big To Fail appendages.

All Ponzi schemes eventually fail.  The global financial Ponzi scheme, of which the U.S. financial system is the largest contributor, will end in some sort of financial Apocalypse…