Economic Collapse Part 2: Goldman and the Full Monti
Goldman Sachs just got it’s third appointee into the Trump administration, it’s stock value has climbed more than 50% over the last half of the year, and it’s executives (along with high level bankers at other major institutions) are dumping their portfolios at a dizzying speed. They aren’t selling because they’re fools, they’re selling because bankers expect a collapse. As discussed in my first banking post major financial institutions are on the precipice of collapse and preemptively seeking bailout funds, and factors like the impending implosion of Italian bank Monte di Paschi, Goldman is re-releasing the most dangerous financial product in the history of the world, and the inflation of asset prices in the absence of a meaningful economic recovery are all hastening and worsening the crisis to come. The last crisis was a manifestation of banks betting against the economy at large and there is no reason to expect anything different this time around.
The Stage is Set
As mentioned in my previous article regarding impending collapse major European banks have become dangerously unstable, and much of the reason for this instability has been the accumulation of debt instruments from periphery European economies like Spain, Greece, and Italy. These banks often carry balance sheets in which their underlying capital (the money they hold and can guarantee to their clients) is less than a 40th of the value of the assets and financial products they hold. This is problematic because their asset pools are traded at “market values” and are therefore subject to rapid changes in value. At a capital to asset ratio of 40 to 1 a 2.5% decrease in the value of their assets completely wipes out the value of a bank rendering it insolvent (unable to pay its debts).
In the 2007 crisis we saw the value of housing drop because homeowners who were locked into risky and fraudulent mortgages were unable to pay off their houses leading to the aforementioned asset value decrease. In order to remain solvent banks began selling their mortgage based assets, when they sold housing the value dropped so they needed to sell other assets to cover their debts. This cycle of selling the next asset as the previous asset collapsed led to a situation in which the value of all assets across all sectors simultaneously collapsed, thus the crisis.
The Full Monti
The possible collapse of the Monti di Paschi, the world’s oldest bank and third largest bank in Italy, threatens the value of those periphery bonds that banks like Deutsche, Societe Generale, and Barclays hold presents a significant risk of causing the asset value of those big shaky banks. In order to shore up its balance sheets Monti has been asking foreign investors for €5 billion in cash infusions. These stabilizing transfers have been made all but impossible because recently the Italians refused a Brexit style constitutional referendum leading to the removal of their current prime minister. That political instability has scared off major investors like Qatar and left the bank scrambling. In order to deal with the disappearance of investors Monti is asking for extensions on its repayments, but the European Central Bank (ECB) has refused an extension.
These problems may be compounded by the fact that Mario Draghi, the head of the ECB, has publicly stated that he’s going to be halving quantitative easing (central bank purchasing of securities to infuse cash into economies). The ECB run quantitative easing has proved to be an invaluable stopgap (albeit one that has infuriated the Germans to no end) in preventing another banking collapse. Unfortunately the combination of bailouts and easing haven’t been enough to restart Europe’s miserable periphery economies. No amount of central bank assistance can compensate for the fact that the fundamentals of nearly every European economy are dead or dying.
In order to pay of the debts incurred by the banking crisis in 2007 Europe’s periphery nations have been slashing government spending, government employment, and social safety nets. This has reduced the purchasing power of most of the populace in the periphery. This problem is exacerbated by the refusal of banks to lend to new entrepreneurs because lending is less profitable than investing in risky securities. In short, there are no jobs because people can’t afford things, people can’t afford things because there are no jobs, banks won’t lend to entrepreneurs because starting businesses in a failing economy is risky, and the longer no jobs and business are created the riskier it becomes to start new ones. This catch 2222 has led to situations in which economies all over the EU are contracting, some by more than 25%.
This becomes even more frightening because if economies continue to contract the bonds issued by those periphery nations become less and less likely to be repaid. When the core banks in Europe have around 20% of their asset pools locked up in European periphery debts it means that as the periphery nations contract, the likelihood of the German and French economies imploding grows.
Goldman Enters Stage Right
At this point it should become obvious as to why bankers at Goldman are dumping their stocks. The dot com bubble, the oil bubble, and the 2007 crisis were all in large part created by banks like Goldman betting against the economy and their customers. These collapses all hit on the end of a sudden expansion in asset and stock values in the absence of new and meaningful growth in the economy. These bubbles were all in large part designed or enabled by former Goldman employees like Robert Rubin and Hank Paulson holding influential government positions. Right now there are three Goldman executives in the Trump white house. The stock market is surging despite little in the way of serious growth, and bankers are running the show and dumping their stocks. History doesn’t repeat itself, but it often rhymes.
All of this is compounded by the fact that right now Goldman is reissuing a risky financial tool called synthetic CDOs. These instruments were the worst offenders in the 2007 crisis. The first step in creating a synthetic CDO is to create a normal CDO. The way a CDO works is a person sells the rights to the future value of some assets, i.e. they sell a bet. By combining the future income streams of several assets into a single product it makes the single product less risky on its own, but it means that a problem with one part of CDO can drag down the value of other parts of the CDO and other CDOs as well. This pooling of other assets into a single instrument also makes it more difficult to accurately assess the risk of the CDO. This repackaging also multiplies the perceived value of the asset leading to the previously mentioned problem of asset to capital ratios. To make a synthetic CDO you redo everything but this time you use CDOs as the base for the next CDO. This exponentially multiplies the risk and the yield on the original investment, and if the asset was dangerous to begin with you have a serious problem.
Right now the economy is in serious peril. Institutions are risky, the economic serial arsonists at Goldman are running the wealthiest nation in the world, the stock market is surging without any meaningful economic improvement to backstop the surging asset values, the Eurozone is steadily marching towards its own demise, and the synthetic CDO is being reissued by Goldman to wreak havoc on markets. Bankers are selling their stocks because they can smell a fire, and they can smell a fire because they’re the ones with the torch and gasoline.
Image of the Genoa Stock Exchange via Wikimedia commons thanks to © José Luiz Bernardes Ribeiro /