Wall Street: Whistling Past the Debt Graveyard While Too Scared To Whistle

A warning that the oil debt crisis is likely to repeat the financial crash of 2008 appeared in the Financial Times Jan. 25; actually the more serious for its comical attempts to disguise itself as a “reassurance” that this is not likely to occur. “Oil Price Slide Is Not Akin to Subprime Fiasco” was the name of the column, also republished in Oil & Companies News Jan. 26 and elsewhere. Most notably, the article was clearly based on a worried presentation by a Bank of Canada governor at a recent “energy markets” meeting in Wisconsin.

“Last decade, investors learnt a nasty lesson about contagion,” the article begins.

“When the price of mortgage bonds and related derivatives plunged in the summer of 2007, it initially seemed to be an isolated problem. Ben Bernanke, then Federal Reserve governor, declared that losses on subprime mortgages would be limited to $25 billion. But in the event, the panic spread to infect the whole financial system. Losses were 100 times higher.

“Could the same thing happen again, as a result of plunging oil prices? Timothy Lane, deputy governor of the Bank of Canada, told an energy conference in Wisconsin that it could, and that central bankers are alert to the possibility that financial linkages could transmit stress from oil markets to the financial system.

“Meanwhile, big investors are pondering those parallels with subprime. Chris Flanagan, head of securitization at Bank of America Merrill Lynch, recently compared the trajectory of the Brent crude oil price to the ABX index of subprime mortgage derivatives in 2007. He found that the patterns were almost identical. ‘As mortgage analysts, our concern with the disorderly downside scenario [to oil prices] perhaps is heightened by our experience with the subprime crisis,’ he wrote. `We feel that we may have seen this movie before.'”

The nature of the “reassuring statements” offered, is indicated by this one: After citing “big differences” from 2008, the article proffers that regulators are much more mobilized now; the Bank of Canada is doing stress tests on $35/barrel oil. This is laughable after the Wall Street banks’ roughshod ride over the U.S. Congress and “regulators” regarding derivatives in December.

Then this:

“There is a third difference, too: the dispersion of infected assets. Back in 2007, losses on mortgage-related assets created a chain reaction because these bonds and derivatives were spread across the system. Not only were they scattered across the portfolios of many investors; they were also used as collateral to underpin trillions of dollars of financial deals. There is no denying that bonds and derivatives whose value is linked to the oil price make up a noticeable chunk of the financial universe. They account for about one-sixth of risky American corporate debt, and sit inside many investor portfolios. But, unlike 2007, they are not widely used to underpin other financial deals.”

And if that doesn’t let the reader whistle past Lehman’s grave, this: “Whereas the banks that got into trouble in 2007 were the bedrock of the entire financial system, energy companies and commodity trading houses are not. True, if oil companies start defaulting on their bonds, the effects will ripple through the financial system….”

And finally: “The pattern could become more pernicious if it turns out that there are big financial interconnections that regulators cannot see. This scenario cannot be ruled out, given that these two corners of the financial system are murky. There is limited public data, for example, about what is happening inside the gigantic trading houses or how they are entwined with investment banks.”

Wall Street: Whistling Past the Debt Graveyard While Too Scared To Whistle

Share this:

Leave a ReplyCancel reply