Wall Street’s House of Cards

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I’ve always disliked gambling. I tell myself I have enough vices already, but the truth is that I’m just conservative with money. Informed investment is one thing; shooting craps is another. It seems silly to risk one’s wealth that way — especially once you know the true odds.

I also don’t care much for the modern financial system. I don’t dislike the principle of profit-seeking financiers. It’s just that today’s crop has gone well beyond market returns and now basically writes their own rules, the rest of us be damned.

One of the objectives of Wall Street’s control of the rules is to conceal the true odds of their bets. In the Great Crash of 2008, what looked like a solid counterparty system tuned out to be a house of cards cleverly designed to look like a skyscraper.

The rules are a tiny bit tighter now, so Wall Street has decided to build its house of cards elsewhere … but it could still collapse, taking you down with it.

A Rose By Any Other Name

Derivatives have been around as long as finance itself. They are basically second-tier contracts that derive their value from the performance of an underlying asset, index, currency or interest rate. Insurance is a form of derivative, as are futures, options and swaps.

Starting in 1994, Wall Street began to shift derivatives away from hedging — such as when a lender takes out a credit default swap against a loan made to another party — and toward speculation.


For example, a modern derivative can be “naked” — i.e., taken out by a party who has no insurable interest in a transaction at all. If you borrow money from someone, I can enter into a derivative contract with someone else to receive payments if you default on your loan.

The critical feature of the modern derivative is that it allows separation of ownership of an asset and benefit from its market value. The most dangerous forms of derivatives allow people to profit from economic processes and events in which they have no role or interest at all. In other words, gambling.

And it’s a big casino. According to the Bank for International Settlements, the total estimated value of derivative contracts around the world is an astounding $710 trillion ($710,000,000,000,000). Other estimates put the total at over a quadrillion dollars. The top 25 banks in the United States alone have more than $236 trillion of exposure to derivatives.

To make matters worse, the majority of derivatives are traded over the counter, where details about pricing, risk measurement and collateral, if any, are secret.

A Private Casino in the Caribbean

Most of us can recall movie scenes in which James Bond struts up to a baccarat table in a Caribbean casino for a game of chemin de fer.

Those sorts of retail-level casinos are small change compared to the mega-casinos on some of the Caribbean islands. For example, Wells Fargo now has almost $2 trillion worth of derivatives stored in an off-balance sheet subsidiary registered in the Cayman Islands — basically, just a P.O. box. Bank of America has almost a billion, and other big Wall Street banks have large amounts as well.

The funny thing is that the official value of derivatives held by U.S. institutions has fallen dramatically since the implementation of the Dodd-Frank Act in 2013. Trillions of dollars of trades seemingly vanished.

But there was no magic trick. U.S. megabanks simply moved a big chunk of their derivatives off their own balance sheets and onto those of offshore subsidiaries. They accomplished this thanks to a loophole won by a former Enron lobbyist.

When Dodd-Frank was under debate, a Republican congressman, Rep. Spencer Bachus of Alabama, proposed that banks’ overseas operations be outside the new rules. To avoid that, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler drafted language that said the CFTC would only intervene if U.S. banks’ overseas operations “have a direct and significant connection with activities in, or effect on, commerce of the United States.”

So the banks and their lawyer friends mobilized the troops. When the CFTC wrote the Dodd-Frank implementation rules in 2013, the banks sweet-talked CFTC Commissioner Mark Wetjen, a longtime aide to Democratic Senator Harry Reid. He used his influence to insert language that says that U.S. banks do not “guarantee” the derivatives held by their offshore subsidiaries.

So offshore they went.

If You Believe This, I’ve Got a Bridge to Sell You

Thanks to the bipartisan efforts of Wall Street’s buddies in Washington, the trillions of dollars’ worth of derivatives held by offshore subsidiaries officially don’t have any “connection with activities in, or effect on” the U.S. banking system.

Riiiight. And the Pope ain’t Catholic.

Here’s the real deal. 1.) The U.S. financial system is secretly leveraged to the hilt, and just as likely to collapse as it was in 2008 — probably more so. 2.) Very few people are aware of this because lobbyists have succeeded in hiding it. 3.) When it goes down, some offshore jurisdictions are going to go down with it.

If you prefer investment to gambling, by all means go offshore … but do it my way, not the Wall Street way.

Kind regards,
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Ted Bauman
Offshore and Asset Protection Editor