Quora Answer: Have We Seen the Last Banking Crash for a While?

The following is my answer to a Quora question: “Have we seen the last banking crash for a while, or are people already betting against stability?”

Market crashes, the collapse of commodities prices and their sudden rise; they are not accidental.  They are planned, often to advance a specific geopolitical agenda.  An example would be the record low oil prices.  Antagonists of the United States who are dependent on the energy sector, and need the funds to grow their economy are Russia, Iran and Venezuela.  They have all been adversely affected.  This is not some conspiracy theory.  The evidence, the testimony, is there for those who know where to look, and have the wherewithal to wade through hundreds of pages of dry reports.

There is a very interesting report called Examining Financial Holdings Companies: Should Banks Control Power Plants, Warehouses & Oil Refineries.  It began when Senator Sherrod Brown, the chair of the Senate Banking Subcommittee on Financial Institutions & Consumer Protection, opened a hearing to probe into the connectedness major Wall Street banks to the holding of physical oil assets in July 2013.  This pertained to the ability of these companies to manipulate oil prices.  And we have not considered other commodities.  The findings of the hearing were damning.  This prompted an investigation by the Senate’s Permanent Subcommittee on Investigations, which was published as “Wall Street Bank Involvement with Physical Commodities.”

Highlighting only Morgan Stanley as an example, the report stated, “One of Morgan Stanley’s primary physical oil activities was to store vast quantities of oil in facilities located within the United States and abroad.  According to Morgan Stanley, in the New York-New Jersey-Connecticut area alone, by 2011, it had leases on oil storage facilities with a total capacity of 8.2 million barrels, increasing to 9.1 million barrels in 2012, and then decreasing to 7.7 million barrels in 2013.  Morgan Stanley also had storage facilities in Europe and Asia.  According to the Federal Reserve, by 2012, Morgan Stanley held ‘operating leases on over 100 oil storage tank fields with 58 million barrels of storage capacity globally.’”  With more than 68 million barrels of storage capacity, and their control of financial derivatives, it is inconceivable that there is no market manipulation.

We have not fully quantified the actual holdings of major Wall Street banks.  Likely, the numbers would be staggering.  They are in a position to significantly affect global prices on an unprecedented scale using supply and demand levers, derivatives, and other bank instruments to control fund movements.  They control the physical commodity, the logistics, the physical funds, and the financial instruments that dictate the movement and availability of funds.

And yet, this report has not been mentioned in any major news source.  This despite the report stating, “Due to their physical commodity activities, Goldman, J. P. Morgan, and Morgan Stanley incurred increased financial, operational, and catastrophic event risks, faced accusations of unfair trading advantages, conflicts of interest, and market manipulation, and intensified problems with being too big to manage or regulate, introducing new systemic risks into the U.S. financial system.”

In January 2014, Norman Bay, director of the Office of Enforcement, the Federal Energy Regulatory Commission, testified before the Committee on Banking & Financial Institutions & Consumer Protection Subcommittee, “A fundamental point necessary to understanding many of our manipulation cases is that financial and physical energy markets are interrelated: physical natural gas or electric transactions can help set energy prices on which financial products are based, so that a manipulator can use physical trades (or other energy transactions that affect physical prices) to move prices in a way that benefits his overall financial position.  One useful way of looking at manipulation is that the physical transaction is a ‘tool’ that is 5 used to ‘target’ a physical price.  For example, the physical tool could be a physical power flow scheduled in a day ahead electricity market at a particular ‘node’, and the target could be the day ahead price established by the market operator for that node.  Or, the physical tool could be a purchase of natural gas at a trading point located near a pipeline, and the target could be a published index price corresponding to that trading point.  The purpose of using the tool to target a physical price is to raise or lower that price in a way that will increase the value of a ‘benefitting position’ (like a Financial Transmission Right or FTR product in energy markets, a swap, a futures contract, or other derivative).”

And this is extended to other major commodities as well.  The Senate Subcommittee report noted right at the beginning, “Goldman Sachs, in its own words, now engages in the production, storage, transportation, marketing, and trading of numerous commodities, including crude oil products, natural gas, electric power, agricultural products, metals, minerals, including uranium, emission credits, coal, freight, liquefied natural gas, and related products.  This expansion of our financial system into traditional areas of commerce has been accompanied by a host of anti-competitive activities, speculation in oil and gas markets, inflated prices for aluminium and, we learned, potentially copper and other metals, and energy manipulation.”

For specific examples of market manipulation, I suggest reading “Testimony of Norman C. Bay Director, Office of Enforcement Federal Energy Regulatory Commission before the Committee on Banking, Financial Institutions & Consumer Protection Subcommittee, United States Senate, 15th January, 2014.”

Aside from market manipulation, there is another risk factor that most people would not be aware of.  As the Senate subcommittee report stated, “This traditional economic efficiency-based argument, however, misses or ignores a crucial fact--namely, that running a physical commodities business also diversifies the sources and spectrum of risk to which FHCs become exposed as a result.  Let us imagine, for example, that an accident or explosion on board an oil tanker owned and operated by one of Morgan Stanley's subsidiaries causes a large oil spill in an environmentally fragile area of the ocean.  As the shocking news of the disaster spreads, it may lead Morgan Stanley's counterparties in the financial markets to worry about the firm’s financial strength, and creditworthiness.  Because the full extent of Morgan Stanley's clean-up costs and legal liabilities would be difficult to estimate upfront, it would be reasonable for the firm's counterparties to seek to reduce their financial exposure to it.  In effect, it could trigger a run on the firm’s assets, and bring Morgan Stanley to the verge of liquidity crisis or collapse.

But there is more.  What would make this hypothetical oil spill particularly salient is a shocking revelation that the ultimate owner of the disaster-causing oil tanker was not Exxonmobil, or Chevron, but Morgan Stanley, a major U.S. banking organisation not commonly associated with the oil business.  That revelation, in and of itself, could create a far broader controversy that would inevitably invite additional public scrutiny of the commodity dealings of Goldman, JPMC, and other Wall Street firms.  Thus, in effect, an industrial accident could potentially cause a major systemic disturbance in the financial markets.  These hidden contagion channels make our current notion of interconnectedness in financial markets seem rather quaint by comparison.  FHCs’ expansion into the oil, gas, and other physical commodity businesses introduces a whole new level of interconnections, and vulnerabilities into the already fragile financial system.”

In summary, all it takes is that one major disaster, that one shock that is not planned, that would make those who are aware nervous, leading them to take a position to limit their exposure to the bank affected.  This sudden tightening in credit would have a tremendous cascading effect that would bring down the bank affected, the banks and financial institutions exposed to the bank affected, and by extension, most of the US economy, followed by the rest of the world.  This is the scale of that house of cards. 

Making this more relevant, we consider the recent downward pressure on the Indonesian rupiah and other regional currencies.  This is not simply because of weaknesses in their economy, but a concerted effort to lower the value of assets in these countries so that these same major banking entities, and funds can pick up bargains.  It is a business strategy.  It does not help, of course, that the Indonesian are idiots, for example.  What they can simply do is defer payments to raise their current account surplus and ease that pressure.  Instead, they proposed tariffs against India and others, inviting retaliatory tariffs, which increased that pressure: Trade War Puts Indonesia & India at Risk. 

In contrast, Singapore had Singtel and other government-linked entities issue bonds: Singtel Sells US500m of 10-Year Bonds @ 3.875% Coupon.  It is not as if these companies need the money.  What they are doing is sending a message that the central bank is aware of this intent to force an auction of assets by artificially distressed economies.  These bonds serve to stabilise the market, by locking funds into the region.  The coupon offered is above market expectation, but the intent is not to raise funds, but to stabilise the value of assets in the region denominated in vulnerable currencies. 

We have a 20-year cycle of boom and bust, and it has been just over 10 years since Lehman Brothers collapsed, in September 2008.  The market will recover, despite the short-term trends caused by temporary trade wars, and political aggrandisement.  And then, we will have another collapse.  Because it is predicted and predictable, it allows those of us who understand the market at a deeper level to take advantage, and continue to make a profit.