Wednesday, October 15, 2008

Docking The Hindenberg

How much trouble is our banking system in? Visualizing data can be helpful, so here we go.....


First, the US economy has been a consumer driven economy as has the world for the last 20+ years. here is the result: (click to enlarge)

You may want to note that this chart is almost perfectly exponential! Consumer credit in the USA has been growing exponentially for decades. The ultimate implications of this are that no matter how hard the government may try, they will not be able to restart the consumer economy. It was entirely based on deficit spending at the consumer level and now the consumers are spent as economic engines.

Now for the topic of the year, derivatives. Banks have used derivatives to leverage themselves to insane heights hoping to drive their returns ever higher without accounting for the related level of risk involved. How deep in did the banks go? JP Morgan Chase alone, has 91 Trillion in derivatives and only 1 trillion in assets. But wait, don't forget that a certain chunk of those assets are mark-to-model, not mark-to-market. The real value of JPM Chase's assets is less then the stated value. How much is anyone's guess. The following chart shows the exposure of the top 25 commercial banks. The top 25 banks account for 97.7% of all exposure. Total exposure amongst the top 25 banks in the US, is currently $181 Trillion ($181,669,224,000,000)

(click charts to enlarge)

Exposure by Percentage:

Source Data for the above charts (
The damage to the banking system goes even further. As of November 2007, 100% of all required cash reserves held by US banks were borrowed, loaned to the banks by the Federal Reserve.

The banks have been burning through cash just to maintain daily operations. This is the first time since the data has been recorded (1959) that Non-Borrowed reserves has gone negative. The best part of the deal is that since the bailout was passed, the federal Reserve now pays the individual banks interest on the BORROWED reserves! To bad American Express wont pay me interest on monthly credit card balances. (data source:

One of the current debates that is still heard in the mainstream media is whether or not we are in a recession. The answer depends on who's calculated GDP numbers you prefer, the government's or independent groups. Independent calculations show the growth of GDP has been negative for over a year now. (see

Another indicator that can be more direct then looking at commodities is the Baltic Dry Index (BDI). The Baltic Dry Shipping Index (BDI) is a key gauge of shipping rates for the world's busiest 24 key shipping routes.

The Baltic Dry Index is a daily average of prices to ship raw materials. It represents the cost paid by an end user to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The Baltic Exchange is similar to the Nymex Holdings (NMX) in that it is a medium for buyers and sellers of contracts and forward agreements (futures) for delivery of dry bulk cargo. The Baltic is owned and operated by the member buyers and sellers. The exchange maintains prices on several routes for different cargoes and then publishes its own index, the BDI, as a summary of the entire dry bulk shipping market. This index can be used as an overall economic indicator as it shows where end prices are heading for items that use the raw materials that are shipped in dry bulk. A drop in shipping is the first sign of the national and global economy slowing down.

A drop in shipping rates is the first sign of a national and global slow down. here is a chart of recent BDI rates. The BDI has fallen through the floor since June of this year.

The end result is that the consumer economy is over. It worked great for a decade or so, but the American consumer has now taken on staggering levels of debt, The top 25 banks combined carry $181 trillion in outstanding derivatives ( 14 times the US GDP) and one bank alone, JPM Chase, has $91 trillion in outstanding derivatives (7 times the US GDP). While all of these derivatives will not lose money, even a small loss to a bank that is leveraged to 7 times the entire US GDP can and will be devastating.

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