A new Washington consensus is born

The conversion by the IMF and World Bank to the return of the activist state would put Saul of Tarsus to shame

Martin Sandbu

An activist dressed as Argentina’s Evita Peron takes part in a rally calling for debt reform during the IMF and World Bank spring meetings © AFP via Getty Images


Anyone who, like me, was a student in the 1990s will remember how international governing institutions were then the chic thing to demonstrate against.

One image that sticks with me is of a young woman carrying a figure of a three-headed troll, representing (as she earnestly told the media) the IMF, the World Bank and the World Trade Organization ravaging the world’s poor.

I wonder what she would think today. 

When the policy outlook on display at the recent IMF and World Bank spring meetings is compared to what drew student ire a quarter of a century ago, it amounts to a conversion that could put Saul of Tarsus to shame.

The World Bank and the fund were excoriated in the 1980s and ‘90s for making the poor pay for basic health provision or presuming that deficits were bad for growth. 

That is long gone. 

Here is the new Washington consensus:

Spend big on public health. 

Fiscal probity, long the core of IMF prescriptions (the joke was that the initials stand for “it’s mostly fiscal”), is no longer about reining in public spending but about getting value for money — and spending more where the value can be found.

That means doing whatever it takes to produce and deliver vaccines globally. 

The IMF’s Fiscal Monitor publication estimates that getting the pandemic under control everywhere would “yield more than $1tn in additional tax revenues in advanced economies, [cumulatively], by 2025, and save more in fiscal support measures”.

In other words, what governments spend on vaccinations can pay for itself many times over. 

The fund argues strongly for education spending, too, to make up for lost learning in the pandemic and help workers cope with structural changes going forward.

The multilateral institutions’ economists at times seem intensely relaxed about massive deficit spending by rich countries. 

The IMF takes a benign view of US President Joe Biden’s mammoth $1.9tn rescue package

Like other forecasters, it expects US national income to be higher next year than expected before the pandemic. 

And it sees insufficient demand stimulus as having permanent costs: countries whose governments spend less money will suffer more “scarring” that cuts long-term productive potential.

In parallel with all of this, the IMF continues to preach prudence, but that means something very different from a decade let alone a generation ago. 

Strikingly, the fund endorses “recovery contributions” — what others might call temporary solidarity surtaxes — from rich individuals and corporate windfall profits.

The message from the erstwhile headquarters of “neoliberalism” is that to make public finances sustainable, the wealthy and those who have profited from the pandemic should contribute more to the common cause. 

The IMF even suggested that rich countries could consider net wealth taxes, apparently channelling leftwing US senators Elizabeth Warren and Bernie Sanders. 

Concerns about inequality were everywhere at the spring meetings. 

The main policy challenge that the IMF chose to highlight was “managing divergent recoveries” — among countries and among groups within countries — due to the pandemic and in the new normal as economies recover from it.

Back in the ‘90s, it was a truism the Washington consensus reflected the aligned priorities of two DCs: the international institutions based there and the US government — with the latter to a significant degree driving the former.

That alignment remains. 

Multilateral calls for the return of an activist state role dovetail with Biden’s ambition to emulate Franklin Roosevelt’s New Deal reforms.

But it is hard to argue today that the IMF and the World Bank simply parrot US preferences, even if being on the same page as their biggest shareholder makes life easier. 

The shift in the thinking of the international economic policy community predated that of the US government.

And the relationship can flow both ways. 

The White House does not take directions from the multilateral institutions located a few city blocks to the west.

But it does not hurt Biden that the global guardians of economic orthodoxy have endorsed the most radical US programme in generations, especially when some Americans are engaging in friendly fire.

Politics is the art of the possible — but what is possible is often determined by what is conceivable. 

The new Washington consensus could prove as politically powerful as the old one.

The Challenge of Big Tech Finance

In an old parable about banks and regulators, the banks are greyhounds – they run very fast – while the regulators are bloodhounds, slow afoot but faithfully on the trail. In the age of the platform economy, the bloodhounds are at risk of losing the scent.

Barry Eichengreen


BERKELEY – In 2009, in the midst of the global financial crisis, Paul Volcker, the former Federal Reserve chair, famously observed that the only socially productive financial innovation of the preceding 20 years was the automated teller machine. 

One wonders what Volcker would make of the tsunami of digitally enabled financial innovations today, from mobile payment platforms to internet banking and peer-to-peer lending.

Volcker might be reassured: like the humble ATM, many of these innovations have tangible benefits in terms of lowering transactions costs. 

But as a critic of big financial firms, Volcker presumably also would worry about the entry of some very large technology companies into the sector. 

Their names are as familiar as their services are ubiquitous: e-commerce behemoth Amazon in the United States, messaging company Kakao in Korea, on-line auction and commerce platform Mercado Libre in Latin America, and the Chinese technology giants Alibaba and Tencent.

These entities now do virtually everything related to finance. 

Amazon extends loans to small and medium-size businesses. 

Kakao offers the full range of banking services. Alibaba’s Ant Financial and Tencent’s WeChat provide a cornucopia of financial products, having expanded so rapidly that they recently became targets of a Chinese government crackdown.

The challenges for regulators are obvious. 

Where a single company channels payments for the majority of a country’s population, as does M-Pesa in Kenya, for example, its failure could crash the entire economy. 

Regulators must therefore pay close attention to operational risks. 

They must worry about the protection of customer data – not just financial data but also other personal data to which Big Tech companies are privy.

Moreover, the Big Tech firms, because of their ability to harvest and analyze data on consumer preferences, have an enhanced ability to target their customers’ behavioral biases. 

If those biases cause some borrowers to take on excessive risk, Big Tech will have little reason to care if it is merely providing technology and expertise to a partner bank. 

This moral hazard is why Chinese regulators now require the country’s Big Techs to use their own balance sheets to fund 30% of any loan extended via co-lending partnerships.

Governments also have laws and regulations to prevent providers of financial products from discriminating on the basis of race, gender, ethnicity, and religion. 

The challenge here is distinguishing between price discrimination based on group characteristics and price discrimination based on risk.

Traditionally, regulators require credit providers to list the variables that form the basis for lending decisions so that the regulators can determine whether the variables include prohibited group characteristics. 

And they require lenders to specify the weights attached to the variables so that they can establish whether lending decisions are uncorrelated with ethnic or racial characteristics once conditioned on those other measures. 

But as Big Tech companies’ artificial intelligence-based algorithms replace loan officers, the variables and weights will be changing continuously with the arrival of new data points. It’s not obvious that regulators can keep up.

In algorithmic processes, moreover, the source of bias can vary. 

The data used to train the algorithm may be biased. 

Alternatively, the training itself may be biased, with the AI algorithm “learning” to use the data in biased ways. 

Given the black-box nature of algorithmic processes, the location of the problem is rarely clear.

Finally, there are risks to competition. 

Banks and fintechs rely on cloud computing services operated by the Big Tech firms, rendering them dependent on their most formidable competitors. 

Big Techs can also cross-subsidize their financial businesses, which are only a small part of what they do. 

By providing a range of interlocking services, they can prevent their customers from switching providers.

Regulators have responded with open banking rules requiring financial firms to share their customer data with third parties when customers consent. 

They have authorized the use of application programming interfaces that allow third-party providers to plug directly into financial websites to obtain customer data.

It is not clear that this is enough. 

Big Techs can use their platforms to generate large amounts of customer data, employ it in training their AI algorithms, and identify high-quality loans more efficiently than competitors lacking the same information. 

Customers may be able to move their financial data to another bank or fintech, but what about their nonfinancial data? 

What about the algorithm that has been trained up using one’s data and that of other customers? Without this, digital banks and fintechs won’t be able to price and target their services as efficiently as the Big Techs. 

Problems of consumer lock-in and market dominance won’t be overcome.

In an old parable about banks and regulators, the banks are greyhounds – they run very fast. 

The regulators are bloodhounds, slow afoot but faithfully on the trail. 

In the age of the platform economy, the bloodhounds are going to have to pick up the pace. 

Given that only three central banks report having dedicated fintech departments, there is reason to worry that they will lose the scent.


Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. He is the author of many books, including The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era. 

Inside the Fight for the Future of The Wall Street Journal

A special team led by a high-level manager says Rupert Murdoch’s paper must evolve to survive. But a rivalry between editor and publisher stands in the way.

By Edmund Lee

As of December 2020, The Journal had 2.46 million digital-only subscriptions. It aims to double that number by June 2024.Credit...Devin Oktar Yalkin for The New York Times


The Wall Street Journal is a rarity in 21st-century media: a newspaper that makes money. 

A lot of money. 

But at a time when the U.S. population is growing more racially diverse, older white men still make up the largest chunk of its readership, with retirees a close second.

“The No. 1 reason we lose subscribers is they die,” goes a joke shared by some Journal editors.

Now a special innovation team and a group of nearly 300 newsroom employees are pushing for drastic changes at the paper, which has been part of Rupert Murdoch’s media empire since 2007. 

They say The Journal, often Mr. Murdoch’s first read of the day, must move away from subjects of interest to established business leaders and widen its scope if it wants to succeed in the years to come. 

The Journal of the future, they say, must pay more attention to social media trends and cover racial disparities in health care, for example, as aggressively as it pursues corporate mergers.

That argument has yet to convince executives in the top ranks of the company.

The Journal got digital publishing right before anyone else. 

It was one of the few news organizations to charge readers for online access starting in 1996, during the days of dial-up internet. 

At the time, most other publications, including The New York Times, bought into the mantra that “information wants to be free” and ended up paying dearly for what turned out to be a misguided business strategy.

As thousands of papers across the country folded, The Journal, with its nearly 1,300-person news staff, made money, thanks to its prescient digital strategy. 

While that inoculated The Journal against the ravages wrought by an array of unlikely newcomers, from Craigslist to Facebook, it also kept the paper from innovating further.

The editor leading the news organization as it figures out how to attract new readers without alienating loyal subscribers is Matt Murray, 54, who got the top job in 2018. 

He has worked at The Journal for two decades, and his promotion was welcomed by many in the newsroom. 

Soon after, he assembled a strategy team focused on bringing in new digital subscribers. 

To oversee the group, Mr. Murray hired Louise Story, a journalist whose career included a decade at The New York Times.

She was given a sweeping mandate, marking her as a potential future leader of the paper. 

She commands a staff of 150 as chief news strategist and chief product and technology officer. 

Her team helped compile a significant audit of the newsroom’s practices in an effort to boost subscribers and now plays a key role in the newsroom as audience experts, advising other editors on internet-search tactics (getting noticed by Google) and social media to help increase readership.

As the team was completing a report on its findings last summer, Mr. Murray found himself staring down a newsroom revolt. 

Soon after the killing of George Floyd, staff members created a private Slack channel called “Newsroomies,” where they discussed how The Journal, in their view, was behind on major stories of the day, including the social justice movement growing in the aftermath of Mr. Floyd’s death. 

Participants also complained that The Journal’s digital presence was not robust enough, and that its conservative opinion department had published essays that did not meet standards applied to the reporting staff. 

The tensions and challenges are similar to what leaders of other news organizations, including The Times, have heard from their staffs.

In July, Mr. Murray received a draft from Ms. Story’s team, a 209-page blueprint on how The Journal should remake itself called The Content Review. 

It noted that “in the past five years, we have had six quarters where we lost more subscribers than we gained,” and said addressing its slow-growing audience called for significant changes in everything from the paper’s social media strategy to the subjects it deemed newsworthy.

The report argued that the paper should attract new readers — specifically, women, people of color and younger professionals — by focusing more on topics such as climate change and income inequality. 

Among its suggestions: “We also strongly recommend putting muscle behind efforts to feature more women and people of color in all of our stories.”

The Content Review has not been formally shared with the newsroom and its recommendations have not been put into effect, but it is influencing how people work: An impasse over the report has led to a divided newsroom, according to interviews with 25 current and former staff members. 

The company, they say, has avoided making the proposed changes because a brewing power struggle between Mr. Murray and the new publisher, Almar Latour, has contributed to a stalemate that threatens the future of The Journal.

Mr. Murray and Mr. Latour, 50, represent two extremes of the model Murdoch employee. 

Mr. Murray is the tactful editor; Mr. Latour is the brash entrepreneur. 

The two rose within the organization at roughly the same time. 

When the moment came to replace Gerry Baker as the top editor in 2018, both were seen as contenders.

The two men have never gotten along, according to people with knowledge of the matter. 

Or as an executive who knows both well put it, “They hate each other.” 

The digital strategy report has only heightened the strain in their relationship — and, with it, the direction of the crown jewel in the Murdoch news empire.

Their longstanding professional rivalry comes down to both personality and approach. 

Mr. Murray is more deliberative, while Mr. Latour is quick to act. 

But the core of their friction is still a mystery, according to people familiar with them.

Dow Jones, in a statement, disputed that characterization, saying there was no friction between the editor and publisher. It also cited “record profits and record subscriptions,” which it attributed to “the wisdom of its current strategy.” 

Both Mr. Murray and Mr. Latour declined to be interviewed for this article.

About a month after the report was submitted, Ms. Story’s strategy team was concerned that its work might never see the light of day, three people with knowledge of the matter said, and a draft was leaked to one of The Journal’s own media reporters, Jeffrey Trachtenberg. 

He filed a detailed article on it late last summer.

But the first glimpse that outside readers, and most of the staff, got of the document wasn’t in The Journal. 

In October, a pared-down version of The Content Review was leaked to BuzzFeed News, which included a link to the document as a sideways scan. (Staffers, eager to read the report, had to turn their heads 90 degrees.)

The leak angered Mr. Murray, people with knowledge of the matter said. But he offered an olive branch at the same time. 

“I’m very proud of the work being done by the strategy team across the newsroom,” he said, according to a recording of a meeting obtained by The Times. 

He added that the report’s recommendations — “some of which I disagree with” — required debate.

If subsequent debate has led to revisions or an updated strategy, the staff hasn’t been told. 

The Journal’s own story by Mr. Trachtenberg on The Content Review still has not run.

‘A broad cultural fear of change’

News Corp recorded a $1.1 billion loss last year.Credit...Sasha Maslov for The New York Times


The Journal isn’t the only media organization whose leaders have been challenged by its employees. 

Editors at The Times, The Los Angeles Times and Condé Nast have faced tough questions from staffers on how they have handled race coverage or issues of bias or problematic editorials.

What’s unusual about the recent events at The Journal is the public nature of the grievances. 

The Times, by contrast, is known for how its internal spats become public.  

At The Journal, workplace gripes tend to stay within the family. 

Mostly. (None of the people interviewed for this article work at The Times, which has recruited a sizable number of Journal employees.)

The Content Review didn’t pull any punches. 

“We have a broad cultural fear of change and we overweight the possibility of alienating some readers, compared to our opportunity cost of not changing and growing,” it read.

Change in any news organization is hard. 

When Mr. Murdoch bought the paper in 2007, the newsroom was on tenterhooks, worried he would destroy its culture. 

That didn’t happen. 

Instead, he expanded its coverage to compete more directly with The Times.  

But over time, the paper has retrenched. 

Now it’s more of a chimera; part punchy Murdoch, part old-school Journal.

News Corp, the parent company of Dow Jones, the publisher of The Journal, has put pressure on the paper to double the number of subscribers. 

But to meet that goal, it must “reach a sustained 100 million monthly unique visitors” by June 2024, according to the report, noting that its site has never attracted more than 50 million readers in a given month.

Dow Jones disputed that figure, saying that the site averaged about 55 million, with a peak of 79 million last March. (The Journal temporarily gave readers free access to its coverage of the coronavirus pandemic when it hit the United States more than a year ago.)

Earnings filings show The Journal had 2.46 million digital-only subscribers at the end of 2020, including 106,000 who came aboard in the year’s final quarter.

Early last year, as Ms. Story’s team was months away from making its recommendations, Mr. Murray was sanguine that its eventual report would be well received by Will Lewis, who was then the Dow Jones chief executive and The Journal’s publisher, according to several people who worked in the newsroom. 

But last spring Mr. Lewis suddenly stepped down. He was replaced in both jobs by Mr. Latour, who had won praise within the company for his digital know-how as the publisher of Dow Jones’s Barron’s Group.

Mr. Murray was not happy to learn of Mr. Latour’s appointment, according to five people with knowledge of the matter. 

That’s when his attitude toward the strategy team’s efforts changed, the people said.

They added that Mr. Murray was concerned that the group’s report, coupled with the staff unrest, would be taken as an indictment of his leadership, and that Mr. Latour might use its findings against him. 

The document called out Mr. Murray in one instance in which it observed that the traffic goals have “not been articulated well enough in the newsroom,” and added, “Unless Matt is abandoning that goal, it needs to be announced and explained robustly.”

Dow Jones disputed that characterization of Mr. Murray’s concern and said that he and Mr. Latour had gotten along and discussed the team’s work.

Mr. Latour had his own idea of how to goose The Journal’s readership, one built on more common traffic tactics that he had employed at the sister titles Barron’s and MarketWatch. 

A few people on the business side and some top editors who had seen the analysis by Ms. Story’s team dismissed it as a “woke” strategy, given its emphasis on appealing to underrepresented readers, the people said.

In a statement, Ms. Story said she was proud of her team’s work and their collaborative efforts across the newsroom, which “has led to great results.”

Leadership tensions stymie progress


    Rupert Murdoch in 2019.Credit...Mary Altaffer/Associated Press


News Corp looks like most aging media businesses: It’s shrinking. 

It recorded a $1.1 billion loss last year, and news revenues, with the exception of Dow Jones, continue to fall. 

Dow Jones operates The Journal and several other titles such as Barron’s and MarketWatch, but not News Corp’s Australian and British newspapers, which haven’t performed as well. 

(The company also owns a real estate listings business, TV stations in Australia and the book publisher HarperCollins.) 

News Corp recently hired the consulting firm Deloitte to work on a project to consolidate its many divisions, according to three people with direct knowledge of the matter. 

That would mean cost cuts and could lead to the loss of a significant number of jobs, the people said.

The Journal’s ambitious subscriber target is very much part of News Corp’s mission to stem the bleeding and find new areas of growth. 

But its editor and publisher, opposite in many ways, appear to have arrived at nearly opposite conclusions about the best way forward.

Mr. Latour, who grew up in the small village of Welten, the Netherlands, was known to have clocked more Page 1 stories than almost anyone else at the paper when he covered the European telecommunications industry. 

A graduate of Indiana University of Pennsylvania, he started his journalism career as an intern at The Washington Times, and exhibited the kind of scrappy drive prized by Mr. Murdoch.

Mr. Murray, who grew up in Bethesda, Md., is laid-back, amiable and sometimes awkward, colleagues said. 

He received his undergraduate and graduate degrees from Northwestern, is fascinated by the entertainment industry and is a Talking Heads fan.

Their strained relationship has gotten in the way of progress, people familiar with the matter say. 

In a mid-November meeting, people saw that firsthand when a disagreement flared up between Mr. Murray and Mr. Latour and one of his lieutenants, Dan Shar, two people with knowledge of the meeting said.

Mr. Shar described his strategy for increasing the number of monthly readers, a plan that differed significantly from the one laid out by Ms. Story’s team. 

At one point, the two people said, an exasperated Mr. Murray interjected: “But I’m the editor.” 

Mr. Shar laughed. 

Mr. Latour kept a straight face.

A spokesman for Dow Jones said in a statement that meeting participants did not recall that exchange.

The third character in the ongoing Journal drama is Ms. Story. 

She has tried to carefully nudge both Mr. Latour and Mr. Murray toward her vision, people around her say.

In her decade at The Times, Ms. Story covered the 2008 financial meltdown and was part of the 12-person group behind the Innovation Report, a 2014 manifesto that laid out the strategy that has helped The Times to thrive and the principal reason Mr. Murray hired her to run The Journal’s audit.

Ms. Story has recently been in discussions about an editor in chief role at both Reuters and The Washington Post, according to two people with knowledge of the matter. Ms. Story declined to comment.

What is The Wall Street Journal?

A copy of The Wall Street Journal on a newsstand in New York.Credit...Sasha Maslov for The New York Times


One of the key issues outlined in The Content Review was the need to retain younger readers. 

For years, The Journal attracted college students by offering them a reduced price; but once those offers expired, they quit the publication at a higher rate — over 70 percent — than any other group, the report said.

To help solve that issue, Ms. Story’s team launched Noted, a monthly digital magazine designed to appeal to readers under 35.

Noted was also partly the brainchild of Grace Murdoch, one of Rupert Murdoch’s daughters, who had interned with Ms. Story’s team in summer 2019 while in high school, according to two people familiar with the matter.

“We need to move beyond perceptions and embrace actual data about younger audiences, and that is what WSJ Noted will be providing,” the report read. 

This included “tailoring content” for younger readers; last year, a staff of 10 reporters, editors and designers were hired to start working on features about inequality in education, student debt and related topics.

The project ran into trouble once Mr. Murray saw the copy, according to four people with knowledge of the matter. 

He line-edited stories himself, rare for a top Journal editor. 

An article about a college campus movement to abolish sororities and fraternities in an effort to combat racism and homophobia was spiked, according to the people. 

Mr. Murray objected to terms such as “trans-phobia,” which was not in the paper’s style guide, referring to them as “jargon-y woke-isms,” they said. 

Dow Jones said that Mr. Murray and Ms. Story decided not to publish that article because other outlets had covered the topic.

Noted switched gears. 

Based partly on a suggestion from Mr. Latour, it focused entirely on practical pieces, such as “how to update your résumé” or “how to approach a job interview.” 

Two Noted editors left in the last week of March, and now there are only four people on its staff.

One goal put forth by The Content Review seemed more attainable to many inside the paper than conjuring millions of new subscribers overnight: a greater effort to appeal to readers of color. In a meeting between the strategy team and high-level editors, Ms. Story spoke about trying to track the racial diversity of people quoted in Journal coverage. 

Most of those gathered for the discussion were white.

Everyone at the meeting said they agreed that The Journal should include more diverse voices. 

But how? 

Should they survey subjects about their background?  

A senior editor expressed concern about such a tack, according to two people who were briefed on the event, saying he was worried the paper might be sued if it came out that its reporters were passing over white people to quote Black people. (The company disputes the characterization of the meeting.)

Such comments illustrate how difficult it will be rewiring the staff to more modern methods of news gathering.

In a Feb. 22 memo to the staff, Mr. Murray endorsed including a wider variety of people in The Journal’s coverage, pledging to “properly capture the diversity of our society and speak to as wide an audience as possible.”

Mr. Latour has also been talking about the need for change. 

In a series of companywide meetings that started last summer, he emphasized the importance of The Journal’s digital transformation, but repeated a phrase that many took to mean he wanted a continued focus on business leaders and Wall Street elites. 

“We need to be digging into the brand,” he said, according to several staff members.

Mr. Latour never asked for a copy of The Content Review, according to two people familiar with the matter. 

It’s still unclear if he’s read it.

If he has, he would know that one key message contradicts the very approach he’s favoring: “We can’t think we’ve got a comfy base of digital subscribers who will be satisfied if we just keep doing what we’re doing.”

Banking Risk—The Real Killer Virus

By Matthew Piepenburg



When it comes to the topic of banking risk, well…one can only lean back in a chair, sigh and say: “Where to begin?”

A Rich and Deep History of the Absurd

Banks, and hence banking risk, come in a wide variety of flavors, largely because bank mismanagement and short-sighted absurdity comes with equal frequency. 

As such, a fuller discussion on banking risk would necessitate hundreds of pages and hundreds of examples.

From the woefully arrogant and even more woefully mismanaged central banks, to the equally arrogant and mismanaged commercial banks, the long history of almost unbelievable hubris, risk, and over-bonused (and over-touted) bank leadership is almost endless.

Perhaps this is what prompted Henry Ford to observe that if ordinary citizens actually knew how banks operated (i.e. from fractional reserve banking to arms-length derivative deals with over-levered hedge funds), there would be immediate revolution in the streets.

Although such observations may seem like an exaggeration bordering upon the sensational, one only needs to look beneath the surface of things to realize that reality (and banking risk) is indeed stranger than fiction.

In prior reports, we’ve written about banking risks that date banks centuries, even millennia.

In short, it’s never difficult to put a finger on the map of history, locate any major moment of financial crisis and then find a banker (be he in a toga, French silk ruffles or an Armani suit) sulking in a corner somewhere, head down and hoping not to be recognized or caught.

This is simply because global history, as well as the history of bankers and major financial disasters, from the money lenders of the Old Testament to the S&L Crisis of the 1980’s or the Lehman Moments of 2008, are, sadly, all too common, all too familiar, and all too inevitable.

Again, volumes can be, and have been, written on such a sordid, but all-too-confirmed, trail of absurd banking practices leading to horrific consequences for nations, financial systems and of course, individual investors.

Modern Banking Risk: No Less Absurd

Today’s level of banking absurdity, and hence banking risk, of course is no exception.

The amount of non-performing loans (NPL’s) sure to stream out of the post-COVID (and self-inflicted) gunshot wound to small businesses and commercial real estate owners and tenants are just one among many risks facing the current banking system, which, as we’ve written elsewhere, is quietly (and not surprisingly) coming under greater and greater governmental command control.

In fact, the level of banking risk which lies beneath the so-called bank “recovery” from the Great Financial Crisis of 2008 is higher than most pundits, sell-siders and media pablum-sellers would otherwise have the vast majority of investors believe.

After all, good news, even artificial news and artificial bubbles, sell stocks and make investors (and bankers) happy.

The spin behind healthy banking news is no different, which is to say, no less mis-reported and bullishly comforting.

As all bankers wishing to remain employed know, the financial world spins on calming stories, tweaked data and comforting delusion. Today, such market delusion (in everything from Tesla stocks to negative yielding bonds), as well as banking risk, has never been higher.

As markets distorted by desperate central bank policies reach record highs on balance- sheet challenged, debt-soaked securities, the mad crowds continue to chase return, completely blind to risks hiding in plain sight.

In fact, and due to modern uses of leverage and equally modern weapons of mass destruction in the form of financial derivatives colliding with a central-bank-created debt tsunami the likes of which the world has never seen, banking risk has never, not ever been this high.

And yet the vast majority of TikTok savvy and Tweet-educated investors have zero idea of the risks lurking beneath the current market wave.

Market sentiment, despite a global pandemic and historically unprecedented debt crisis, has never been higher.

As I like to say: The ironies do abound.

But rather than pen hundreds of pages of this banking history here, let’s just consider one screaming, flashing, neon-red symbol of banking risk that is hiding in plain sight this very second.

That is, let’s toe-dip into that clever, banker-invented timebomb otherwise known as the global derivatives market.

The OTC Derivatives Trade: The Real Killer Virus

One does not need to pass a FINRA exam or spend years working the prop desks at a major commercial bank to understand the broad strokes of the otherwise extremely (and intentionally) complex, opaque and non-reported world of derivative instruments circulating like an Ebola virus through the modern banking system.

The fancy lads call this the OTC market—or “Over the Counter” derivatives trade.

“Over the Counter,” by the way, is just a euphemistic way of saying a highly, highly illiquid trade, one not executed on an exchange, but conducted instead among over-paid bankers and other institutional counter parties on a daily basis.

You know, the so-called “experts” …

The gross value of this OTC derivatives market is nearly impossible to define, as the various contracts, swaps and options that compose this tangled web of obfuscation and arbitraged markets are in fact valued (marked) by the banks and counterparties themselves, not the open market.

That’s clever, no?

But hey, if you’re going to be guarding (i.e. valuing) your own hen house, it helps to be a clever fox, and bankers are certainly foxy.

Keeping Derivatives Simple

Conservatively, however, it’s fair to say that the current OTC derivatives market is in the neighborhood of $1.5 quadrillion in size, a number I’m not even sure how to type on this page.

Yet despite such an almost fantastical valuation and size, none of these zeroes are reported on the balance sheets of the fancy banks who trade them. Like I said, bankers are clever little foxes.

So, how do these little foxes get away with this? 

How do they hide the risk and size of these trades from their own books?

This too, involves a bit of complicated banker (and book-keeping) lingo which would make both your eyes (and mine) glaze over if entirely unpacked here.

But as Einstein liked to say, if you can’t explain even the most complex concepts to a five-year-old, you aren’t a very good teacher.

Simple Arbitrage, Simple Leverage, Simply Crazy

First, we need to address that lovely little banking term known as “arbitrage,” which basically boils down to buying and selling the same asset simultaneously and pocketing the difference—hopefully, a profit.

Recently, for example, I purchased a horse saddle on line, and then decided to sell it to another buyer hours later for more than I originally contracted. Voila: arbitrage.

In that brief period, however, between when I bought the saddle for $X and then contracted to sell it for $X + $100, I was in what the fancy lads at places like Deutsche Bank or Goldman Sachs call an “open position”—or stated more simply: I was between trapezes.

That is, if I didn’t get the saddle delivered when I needed it, I’d fail on its subsequent delivery to the next buyer, who would be angry to say the least.

Such failure to perform is what those same fancy lad bankers call “counter-party risk.”

Fortunately, I delivered the saddle as contracted and the counter-party risk was minimal. Easy peasy.

It’s the same for banks buying and selling futures contracts, swaps, call options, put options and all those other shrewd derivative instruments they arbitrage to the tune of billions every second…but with one minor exception: Unlike my simple horse saddle purchase, those fancy lad bankers use 100:1 to 300:1 leverage to buy and sell their sexy little contracts.

A Side-Market Premised on Only Good Times

In normal market conditions, counterparties to these grossly levered derivatives perform as expected. 

All goes well, and trillions pass between computer screens on arbitrage desks from London to New York, Frankfurt to Tokyo.

But derivative trades are a lot like water skiers being dragged behind a speeding boat: If the boat rides straight and steady, and the water has no ripples, the skiers (i.e. counterparties) glide blissfully, rapidly and safely across a sea of easy money.

But this, of course, is where the entire concept as well as reality of the derivatives trade gets scary, and frankly, just plain absurd, for its entire survival and risk-less future assumes that speed boats never turn sharply, seas never get rough and accidents never happen.

In short, the derivatives trade depends on a best-case scenario of perpetually smooth riding and smooth seas to avoid fatal risk among counterparties.

But as anyone, and I mean anyone, who has traded or studied markets for more than a half hour knows, nothing about financial markets is a perpetually smooth ride free of frequent ripples or an occasional tidal wave.

Despite such obvious common sense, the entire derivatives market (and its buying and selling of premiums, counterparty-spreads etc.) is premised on the self-delusional fantasy that seas are always smooth and water skiers never fall.

A Ticking Timebomb

Thus, despite massive amounts of leverage, massively low “OTC” liquidity (every market crisis, by the way, is at heart a liquidity crisis), massive counterparty risk, and massively obvious macro risks (as evidenced in everything from broken central bank policies, supply chain disruptions, and geopolitical risks to zombie credit markets marching daily toward default), the un-noticed and un-reported ($1.5 quadrillion+) derivative trade just keeps ticking away at a major commercial bank near you—ticking, that is, like a financial timebomb.

Timebomb?

Yes. Time. Bomb.

But if this seems sensational, once again, let’s just do the math and resort to numbers not adjectives.

Take the example of Deutsche Bank, that oh-so notorious bad boy of the otherwise media-ignored derivatives sand lot.

Like all major commercial banks trading in home-made derivative instruments, Deutsche Bank values its exposure not based upon the leverage used or the true dollar amounts at risk, but rather based upon derivative contracts whose value, as well as risk, is not “marked” (i.e. placed on the balance sheet) until the contracts themselves are exercised.

The book keepers at banks like Deutsche Bank call this the “net” value of their derivative trade.

In the case of Deutsche Bank, whose overall balance sheet asset valuation last year was around $800B, the ledger regarding its “net” derivative exposure was a measly $1B. 

In short, not the least bit scary at all for a mega bank’s balance sheet or risk profile.

But here’s the rub: The “net” value of derivative exposure reported on the books by banks like Deutsche Bank deliberately and completely ignores the truer derivative exposure and valuation known among the fancy lads as the “gross” derivative value, which more accurately accounts for the actual amount of leverage, premium spreads and counterparty obligations behind their trades.

Again, this more accurate “gross” valuation (and risk exposure) is not marked on the balance sheets of these water-skiing banks…

Turning back to the Deutsche Bank example, we discover that this bank, with a total balance sheet asset value of $800B, marks its “net” derivative value down as $1B, yet neglects to report its “gross” derivative exposure of $40T.

Please: Read that last line again. 

It’s not a typo.

That right; the “gross” (yet legally unreported) derivative exposure at Deutsche Bank is $40T, despite an enterprise asset value of just $800B for the entire bank itself. 

In fact, Deutsche Bank’s derivatives exposure is greater than 3X total GDP for the entire European Union.


That’s Banking Risk

So, do you still think there’s no banking risk out there?

The horrific, yet entirely ignored reality is that the current banking system is literally nothing more than a balance-sheet mosquito roosting on a nuclear bomb of levered derivatives exposure set to explode the moment any number of potential and “nuclear” red buttons go off in an otherwise completely distorted global market.

In fact, the list of potential “red-button” moments pointed at this derivative mega-bomb is so long, that the odds of a derivatives implosion, and hence banking implosion, is not just high, it’s closer to 100%.

For the sake of brevity, just consider the following potential red-button triggers:

- Counter-party risk (mere hints of which we’ve seen at Long Term Capital Management, Lehman Brothers, AIG or Bear Sterns in the past, or more recently in headline-making leverage factories like Archegos Capital, whose recent derivative swap trade (co-authored by commercial banks) lost over $10B in shareholder money almost overnight.

- Supply Chain interruptions (as already hinted by oil futures trading negative, or actual gold deliveries failing in the COMEX market);

- Central Banks imploding under the weight of their own balance sheets and losing control of interest rates, which turn zombie bond pits into cemeteries;

- Any black swan, happening at any time.

In short, if there is any counter-party error (ripple or tidal wave) of any genuine and collective magnitude in this over-levered minefield known as the global derivatives market, the silly little net derivatives exposures on the seemingly yet deceptively “safe” balance sheets of the major commercial banks could morph into a gross exposure, and hence a gross loss, of greater than 5X the total valuation of the banks themselves.

After all, the Deutsche Bank is hardly the only bank playing this dangerous game of derivative-roulette. 

One can easily add JP Morgan, Goldman, Wells Fargo, Soc Gen, BNP or Morgan Stanley to the list.

Needless to say, the cost of bailing out these Too Big to Fail (TBTF) banks in such a derivative implosion would dwarf the TBTF bailouts of 2008, and force central banks to create even more currency destroying dollars out of thin air to save the banking sinners while leading to even more centralized, government control of our banking system.

When, not if, a crisis occurs in this toxic commercial banking system sitting above a home-made derivatives time bomb, do you want to hold your gold, or any precious metal asset, in such esteemed, globally recognized and balance-sheet savvy commercial banks?