No Surprise Here For Me

It was revealed yesterday that the Austrian bank - Erste Group - had $5.2 billion in undisclosed Credit Default Swap (CDS) derivative losses sitting on - or rather "off" - its balance sheet.  Here's a link from zerohedge.com if you would like to read about the details:  LINK

To zerohedge and its slavish readers, this is being described as a "stunner."  But I've been arguing all along that the big banks have off-balance-sheet problems that are potentially far bigger and more destructive than what is revealed by the "on-balance-sheet" public financials.  Indeed, this is no "stunner" to me - in fact I would bet good money that the true economic, what's the best bid for size/mark-to-market, losses are far larger than $5.2 billion.

What is a "stunner" to me is that the research arm of the Erste Group has written some of the most compelling and thorough research available in support of the precious metals market:  In Gold We Trust  One would think that an institution that so thoroughly understands the gold market and the dangers of the current fiat currency system would also understand the concept of "counter-party risk" and the fraud that belies the entire OTC derivatives market.

For some reason zerohedge wants to blame the Erste Group issue on its auditors.  To be sure, the auditors probably know a little about the true condition of the CDS portfolio.  But they operate within the confines of accounting and regulatory rules as set forth by the Government.  Furthermore, accountants are just counters.  It's not their job to go find out the true market values of these securities.  If they conduct a sample audit, that would just consist of calling up the CDS trading desk at maybe two or three trading firms that make markets in these securities and getting price indications.  Trust me, having traded junk bonds for 9 years, which are illiquid but considerably more liquid than CDS securities, a market "indication" often bears no resemblance to the true value of an OTC derivative, especially if the Erste Group (or fill in the bank U.S. TBTF bank) wanted to unload a big position in any specific security.  And THAT dynamic is one of biggest problems with accounting for these types of securities.  Its part of the massive accountability problem that has been destroying our system for quite some time.  One would have thought that this would have changed after the damage inflicted by Long Term Capital and Enron...

Now, with the Erste Group we're talking about $5.2 billion.  The Erste Group's balance sheet (assets/liabilities) is roughly $280 billion in size.  And Erste is not exactly a big player in the OTC derivatives market.  Let's look at one of the big U.S. TBTFs and just do a "broad stroke" comparison.  Bank of America, for example, has a $2 trillion dollar balance sheet - over seven times the size of Erste Group.  And Merrill Lynch - now owned by BAC, was one of the bigger players in the OTC derivatives market.  So just on a "scale" basis, it's very safe to say that BAC is likely sitting ten times the amount of undisclosed losses in its derivatives book as the Erste Group.  I would bet a lot of money that the actually losses are substantially larger than that.

But if you want to look at the work published by Wall Street research analysts showing the "financial ratios and condition" of U.S.  TBTFs, nowhere will you see anything mentioned about off-balance-sheet liabilities.  These wind-up circus monkeys simply transpose the GAAP balance sheet data onto a pretty spreadsheet and say "see, the water is fine, c'mon in."  And then this garbage gets regurgitated in the financial media and through the world of financial advisors and brokers who want to take your money as they mindlessly reference this highly flawed research and tell their clients that the U.S. banks are in good shape...it's pathetic.

But the golden truth of the matter is that lurking below the surface are financial nuclear bombs that could detonate at any time.  See Bear, Lehman, AIG for what this looks like.  And 2008 will have been "the good old days" once this daisy chain of disaster is triggered. Today there's not only the massive exposure to financial sector Credit Default Swaps, there's the massive exposure to sovereign debt CDS.  AND, the OTC derivatives holdings of the TBTFs are much larger than it was in 2008.

So yes, maybe the Erste Group disclosure was a bit of a surprise to some - and a "stunner" to the editor of zerohedge - but if we really dig for the truth and take a look at what's going on in our own backyard, there are not "stunners" buried, but massive catastrophes.