The Fed Is More Leveraged Than Lehman Brothers Was

The 2008 Crisis occurred when private US banks became so distrustful of one another’s balance sheet risk that interbank liquidity dried up triggering a systemic implosion in the unregulated derivatives market, particularly in Credit Default Swaps (which was a $50-60 trillion market at the time).

The Federal Reserve dealt with this situation by suspending accounting policies (permitting banks to lie about their true balance sheet risk), offering to backstop those banks with the greatest derivative exposure - JP Morgan (JPM), Bank of America (BAC), Goldman Sachs (GS), and Citigroup (C) - shifting trillions of dollars’ worth of toxic debt to the US balance sheet and then funneling trillions of new dollars into the banks most at risk of a derivative collapse (the banks I listed before).

From a philosophical perspective, the Fed removed the notion of “risk of failure” from Wall Street’s collective mind. As anyone who’s studied human behavior can tell you, without consequence for one’s actions most people will take their bad behaviors to the limit.

As a result of this, Wall Street went back to doing what caused the Financial Crisis in the first place: increasing leverage, fleecing clients, and paying its employees’ excessive salaries. Today the financial system is once again overleveraged. In fact, leverage levels today exceed those that occurred during the 2008 Tech Bubble, the large banks continue to be insolvent due to their gargantuan derivative exposure.

Put another way, the financial system is primed for another 2008 episode. The very same issues that caused 2008 remain in place. Leverage is far too high. And the unregulated derivatives market remains a multi-hundred trillion dollar problem.

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