Starting next year, new rules designed to prevent another meltdown will force traders to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets. The change takes effect as the $10.8 trillion market for Treasuries is already stretched thin by banks rebuilding balance sheets and investors seeking safety, leaving fewer bonds available to backstop the $648 trillion derivatives market.
The solution: At least seven banks plan to let customers swap lower-rated securities that don’t meet standards in return for a loan of Treasuries or similar holdings that do qualify, a process dubbed “collateral transformation.” That’s raising concerns among investors, bank executives and academics that measures intended to avert risk are hiding it instead.
Why don’t we just call it what it is: Legalized accounting fraud.
Every time you think there’s a step that has been taken to reduce risk and leverage in the system, improving stability, you find a bank that has determined some means by which it can (and does) cheat, circumventing the rules. They find a loophole in the law and exploit it, making billions and reversing the alleged “stability” that was supposed to be provided.
Remember that the genesis of this change in the law was AIG, which had a ridiculous amount in derivative trades outstanding backed by nothing but hot air. They had structured the business such that they were effectively providing no collateral other than their “name”; when they were unable to meet margin calls the government stepped in to “rescue” them.
One Dollar of Capital would have prevented this. In fact, it’s the only thing that prevents this sort of game, as we continue to see that any attempt to impose discipline by other means is immediately evaded by the firms involved.
This sort of shenanigan must be prohibited and One Dollar of Capital appears to be the only means that will be effective, backed with criminal sanction for those firms and individuals that attempt to circumvent it.