Too Big To Fail Casino Banks Make $518 Billion Bet On PIIGS Sovereign Debt

The “Too Big To Fail Banks” are at it again, making huge speculative bets on the odds of sovereign default by Portugal, Italy, Ireland, Greece and Spain.  The costly lessons of the derivatives debacle of 2008 have apparently been forgotten.

In 2008, the Too Big To Fail banks bought massive amounts of credit default swaps (CDS) to protect themselves from loss on their huge holdings of subprime mortgages.  By purchasing CDS from institutions such as insurance giant AIG, the banks were able to convince regulators that their net exposure to losses on holdings of toxic mortgage instruments was minimal.  So how did that work out?

As the mortgage market collapsed in 2008, AIG’s payoff liability on the CDS it wrote soared. AIG was forced to post additional collateral with counterparties as its credit rating was downgraded and the company faced collapse.  If AIG had been allowed to collapse, the too big to fail banks who thought they were hedged, would have instead faced losses in the hundreds of billions.  The failure of AIG would have resulted in huge losses to the banks and AIG bondholders.

Instead of being allowed to fail, AIG was  bailed out by both the U.S. Treasury and the Federal Reserve who agreed to a financial commitment of up to $182 billion.  The final amount lent or invested to bail out AIG by the Treasury and the Fed ultimately totaled $140 billion.  AIG still owes the U.S. Treasury almost $50 billion according to which tracks the cost of taxpayer financed bailouts.

It wasn’t until a year and a half later that the full truth about the AIG bailout was revealed.  In January 2010, the NY Fed was forced to release documents showing that over $100 billion of the taxpayer bailout funds given to AIG were transferred to major financial institutions such as Goldman Sachs, Deutsche Bank and Merrill Lynch to make them whole on credit default swaps with AIG.

Federal Reserve Chairman Ben Bernanke, commenting on the AIG bailout, made the specious argument that the AIG bailout was necessary since the Feds had no authority to close AIG.  “If a federal agency had (appropriate authority) on September 16, (2008), they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders, and impose haircuts on creditors and counterparties as appropriate. That outcome would have been far preferable to the situation we find ourselves in now.”

AIG further infuriated taxpayers by sending its executives to a posh California retreat one week after the bailout, at a cost of almost $500,000.  In early 2009, mere months after the bailout, AIG had the audacity to announce bonuses of $450 million for its financial unit and company wide bonuses totaling $1.2 billion.

Has anything changed since the outrageous bailout of the banks and AIG in 2008 at taxpayer expense?  The answer is yes – things have gotten worse.  Consider U.S. Banks Guarantee More European Debt.

As the European financial crisis worsened during the first half of 2011, U.S. banks increased sales of insurance against credit losses to holders of Greek, Portuguese, Irish, Spanish, and Italian debt. Guarantees provided by U.S. lenders on government, bank, and corporate debt in those countries rose by $80.7 billion, to $518 billion, according to the Bank for International Settlements.

BIS doesn’t report which firms sold how much or to whom. Almost all of those guarantees are credit-default swaps, according to two people familiar with the numbers who asked not to be identified because they weren’t authorized to speak. Five banks—JPMorgan (JPM), Morgan Stanley (MS), Goldman Sachs (GS), Bank of America (BAC), and Citigroup (C) — write 97 percent of all credit-default swaps in the U.S., according to the Office of the Comptroller of the Currency. A credit-default swap is a contract that requires one party to pay another for the face value of a bond if the issuer defaults.

The five U.S. banks had net exposure of $45 billion to the debt of Greece, Portugal, Ireland, Spain, and Italy, according to disclosures the companies made at the end of the third quarter. In earnings reports and conference calls, the banks say their net positions are relatively small because they purchase swaps to offset ones they’re selling. In theory, if a bank owns $50 billion of Greek bonds and has sold $50 billion of credit protection on that debt to clients while buying $90 billion of swaps from others, its net exposure would be $10 billion.

Yet that math doesn’t tell the whole story. With banks on both sides of the Atlantic relying on derivatives to hedge their risks, potential losses in the event of a default aren’t being reduced, says Frederick Cannon, director of research at New York investment bank Keefe, Bruyette & Woods (KBW). “Risk isn’t going to evaporate through these trades,” Cannon says. “The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who’s ultimately going to pay for the losses?”

JPMorgan Chief Executive Officer Jamie Dimon said last month that the bank hedges its exposure to European sovereign debt through contracts with lenders in other countries, including Germany and France…Ruth Porat, Morgan Stanley’s chief financial officer, said during a call with investors after the company’s earnings report last month that the data on European guarantees compiled by regulators didn’t take into account short positions, offsetting trades, or collateral collected from trading partners.

That’s how some Wall Street banks tried to protect themselves from subprime mortgages before the 2008 crisis. Goldman Sachs and other lenders had purchased swaps from American International Group (AIG), so when they reported subprime exposure they could reduce the amount by the CDS holdings on their books.


The quaint notion that banks should be a conservative steward of depositor funds and make sound loans with federally insured deposits died many years ago. What in the world are banks doing making speculative multi-billion dollar bets on the odds of European debt defaults and why in the world are regulators allowing this type of activity to occur?

The specious argument that the banking industry’s exposure from exotic derivatives on foreign debt is “only” $45 billion provides little comfort after the AIG fiasco of 2008.  Large losses by one financial institution can quickly lead to counterparty failure.  Other institutions who thought they were “hedged” then become fully exposed to significant losses.

If the banks only have a small net exposure on credit default swaps due to offsetting swaps, then why engage in what is basically a zero sum game?

Do the “Too Big To Fail Banks” really have a full understanding of the risks involved on their trillions of dollars of risky derivative contracts?  In 1998 Warren Buffett purchased insurer General Re which held 23,000 derivative contracts.  After  unwinding the derivatives and losing $400 million in the process, Buffett concluded that “I could have hired 15 of the smartest people, you know, math majors, Ph.D.’s. I could have given them carte blanche to devise any reporting system that would enable me to get my mind around what exposure that I had, and it wouldn’t have worked.  Can you imagine 23,000 contracts with 900 institutions all over the world with probably 200 of them names I can’t pronounce?”

Does anyone really believe that the Casino Banks are acting in the public’s best interest?  Does anyone doubt that the Casino Banks will again be bailed out when their derivative portfolios blow up?

More on this topic:

Bank of America Saddles FDIC with Liability Greater Than Every Economy on Earth…Combined



  1. robertsgt40 says

    Gee, I wonder who will be on the hook for the losses when the house of cards collapses?

  2. Name Required says

    All the questions above are easily answered when one realizes that what is happening in the world is by deliberate design and not just the results of unforeseen circumstance.

    Does no one who writes these article recognize that the Western world is being led by the nose into further debt slavery in order to achieve a nefarious end that would never be accepted by people under normal circumstance.

    Its the old tactic of create a crises, wait for the public response, offer a (predetermined) solution. What one should be looking at is what is their end goal – WW3, global currency, world government?

  3. Bud Budley says

    Journalists put the best bits aside for the blockbuster book. they only publish the garbish and disinfo that the advertisers-management will permit.

    Sic transit gloria mundi

  4. Gene Colburn, Spokane, WA says

    The sheeple will continue to run towards the cliff even after the first few million jump off. We are being conditioned to accept what we see.

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