©2012 Hera Research, LLC
3On the surface, the fallout from the 2008 financial crisishas beeneffectively managed, but anotherfinancial crisisseemsinevitable.Developing mechanisms to manage a crisis similar to that of 2008 andpreventing another crisis are fundamentally different propositions. The basic causes of the 2008financialcrisis have not beenfully addressed.The lines between depository institutions and securities firms,erased in the U.S. by the final repeal of the Glass-Steagall Act in 1999, have not been restoredand the
U.S. Financial Accounting Standards Board’s (FASB) mark
-to-market rulehas yet to bereinstated.Although bank capital ratios have improved, leverage remains excessive, balance sheet assets remaintroubled and, arguably, risk levels are higher than in 2008 because economic conditions have deterioratedcompared to the pre-crisis period.
Banks deemed “too big to fail” in 2008 h
avesincebecome bigger andthegross credit exposure associated withrisky OTC derivativesis nearly aslargeasit was before the2008financialcrisis.History has shown thatOTC derivativesincreaseleverageand riskin the financial system.OTCderivatives arelikely to result in bankor hedge fund failures andtocontribute to another financial crisis.According to the International Swaps and Derivatives Association (ISDA),OTC derivatives risk is widelymisunderstood becausethenet notional amountsof OTC derivatives, such as credit default swaps (CDS),total only about 10% of the gross notional amounts. In other words, grossnotional amounts, totalingroughly$700 trillion,are not a direct measure ofcredit exposure. Ifthe same percentages applyforall
OTC derivatives, the net exposure of market participants, e.g., “too big to fail” banks,
isless than $70trillion.Although$70 trillion is
approximately equal to the world’s total gross domestic product
(GDP),it is unlikely that all counterparties would fail simultaneously or that all losses would be 100%.Nonetheless, the failure of major financial institutions in connection with OTC derivatives risk could leadto another financial crisis which would accelerate the disintegration of the U.S. dollar system.While increased liquidity makes a stock market crash less likely, it remains unclearwhere earningsgrowth will come fromfor many U.S. companies.Ongoing monetization has elevated U.S. stocks aheadof the economic recovery and economic data have been disappointing, making a correction logical.
Additionally, by the end of 2013, the Federal Reserve’s balance sheet will have exceeded $3.4 trillion andthe Federal Reserve’s intention to eventually unwind its positions could become less cre
U.S. Leads Global Slowdown
For 2012, the International Monetary Fund (IMF) projects2.2% growth inJapan and the United Statesand3.5% growth globally.Based on the Baltic Dry Index (BDI), which reflectsthe price of movingmajor raw materials by sea, the global economy slowed significantlyin 2012and showed fewsigns of recovery. Nonetheless, there has been overall improvement in comparison to the depths of the globalrecession in 2009.