There’s a hole in the bucket…

This morning, I watched congress grilling US banking exec’s about the need to get money flowing again.  Watching this session run in circles, it reminded me of a simple song my mother used to sing about a “hole in a bucket”, and the cascading flow of suggested fixes, with each leading to another, but none of them fixing the original problem (see song here)


While it may seem important to pressure banks to lend more (and it may look good on camera to appear tough on bankers)… pressuring the “traditional” banks to lend more won’t fix the problem of “deleveraging” of global financial system.

The problem with contraction of credit lies outside of the traditional commercial banking realm, and instead can be found in the (forced) contraction of the “shadow banking market“  (comprising hedge funds, broker-dealers, private equity funds, structured investment vehicles and conduits and money market funds, etc..). Shadow Market troubles…

The traditional banks may be lending, but even if the traditional commercial banks were to open up the gates, and let their capital flow,  they can’t make up for the massive-gaping-hole that is missing from the “shadow banking” market that has gone “missing in action” (or, off the cliff)…

Securitization has for several years exceeded bank loans as a percentage of private credit market debt.


In contrast to recent headlines, however, banks have been picking up their lending, but it has been the “shadow banks” that have faltered.

Banks have been recapitalized – yes – and banks have cautiously started to lend. But shadow banks are still delevering due to disappearing and unavailable fresh capital and, as they do, they continue to drag asset prices with them…

…while new loans can be and are being advanced via the banking system, it’s a much more difficult task to force shadow banks to lend. That lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist

source: PIMCO

How big could the “hole” be?

Estimates are all over the board, so rather than try to make my own guess as to the size of the liability, Im going to share with you some of the more educated guesses Ive seen recently, and let you draw your own conclusions:

in January 2008 the International Monetary Fund published its $1tn estimate for the losses (that number has been revised upwards).  Newer estimates look much worse…..according to Martin Wolf: “The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.

Derivatives Market size…

If you look at global derivatives markets, according to the BIS, you see that there was

  • Notional amounts outstanding:  June’08 = $683,725 billion
  • Gross market values =   $20,353 billion   (approx $20 Trillion USD!!)
Notional  vs  Gross
  • “Notional” value is the “maximum losses in case of a meltdown” ….and gives an idicator of the market’s size
  • “gross market values” tells you the scale of financial risk transfer taking place in derivatives markets.”

Lets use the smaller number in this discussion.  If you round down to $20 trillion, thats an incredible amount of money.   The size of this mountain of “side-bets” (or “weapons of mass distruction, as Warren Buffet called them) is difficult to really put in personal terms.  I found a great description of the magnitude of the mountain here:

  • U.S. annual gross domestic product is about $15 trillion
  • U.S. money supply is also about $15 trillion
  • Current proposed U.S. federal budget is $3 trillion
  • U.S. government’s maximum legal debt is $9 trillion
  • U.S. mutual fund companies manage about $12 trillion
  • World’s GDPs for all nations is approximately $50 trillion
  • Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
  • Total value of the world’s real estate is estimated at about $75 trillion
  • Total value of world’s stock and bond markets is more than $100 trillion
  • BIS valuation of world’s derivatives back in 2002 was about $100 trillion
  • BIS 2007 valuation of the world’s derivatives was a whopping $516 trillion
  • June ‘08…it grew to $683,000,000,000,000  (yes, thats Trillion, with a “T”)
  • source:  PIMCO

A massive “hole in the bucket”

You see, there’s a “hole in the bucket, deal Liza” (see video below here, if you dont know this one).  And, no quantity of extra lending from traditional banks will fill that hole. Links for more (from GloboTrends):

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Originally published at Globo Trends and reproduced here with the author’s permission.