For the first time in history, U.S. banks have suffered large, ominous losses in a giant sector that, until now, they thought was solid: bets on interest rates.
In a moment, I’ll explain what this means for your savings and your stocks.
But first, here’s the alarming news: According to the fourth quarter reportjust released this past Friday by the Comptroller of the Currency (OCC), commercial banks lost a record $3.4 billion in interest rate derivatives, or more than seven times their worst previous quarterly loss in that category.1
And here’s why the losses are so ominous:
Until the third quarter of last year, the banks’ losses in derivatives were almost entirely confined to credit default swaps — bets on failing companies and sinking investments.
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But credit default swaps are actually a much smaller sector, representing only 7.8 percent of the total derivatives market.
Now, with these new losses in interest rate derivatives, the disease has begun to infect a sector that encompasses a whopping 82 percent of the derivatives market.2
Thus, considering their far larger volume, any threat to interest rate derivatives could be far more serious than anything we’ve seen so far.
Meanwhile, time bombs continue to explode in the credit default swaps as well, delivering another massive loss of nearly $9 billion in the fourth quarter.
And remember: These represent the aggregate total for the entire banking industry, after netting out the results of banks with profitable trading.
Why This Crisis Could Be Nearly as
Bad as the Banking Crisis of 1929-31
Yes, I know the standard argument: In 1929, bank regulation and depositor protection was primarily run by state governments. Now, with the FDIC, the OCC, and more direct Federal Reserve intervention, it’s far more centralized.
But offsetting that strength are serious weaknesses in the banking system that did not exist in the 1930s:
• In 1929, there were fewer giant banks. They controlled a smaller share of the total market. And they were generally stronger than the thousands of community banks around the country. Today, by contrast, the nation’s high-roller megabanks dominate the market.
• In 1929, derivatives were virtually nonexistent. Not today! U.S.
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