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The Next Crisis Is Just Around the Corner, Says Billionaire Investor

Written by Gary North on November 21, 2011

Addison Wiggin and I both are part of the Agora publishing firm. I have been with Agora for 15 years.

Recently, he reported on a lecture in Tokyo given by Mark Mobius, the legendary hedge fund investor. “There is definitely going to be another financial crisis around the corner, because we haven’t solved any of the things that caused the previous crisis.” Mobius runs a $50 billion fund — not chump change!

The problem remains the same: derivatives. Warren Buffett calls them “financial weapons of mass destruction.” They are highly leveraged “bets” on the movement of interest rates. The major banks are deeply invested in them. So was MF Global.

Estimates vary from $600 trillion worth to twice that. No one knows. This unregulated market is growing, Mobius said.

Wiggin commented: “In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.”

The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place. What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn’t pay back 100 centimes on the euro?

That’s a rhetorical question, since the balance sheets of European banks are even more opaque than American ones. Whatever the actual answer, it’s scary enough that the European Central Bank has refused to entertain any talk about the holders of Greek sovereign debt taking a haircut, even in the form of Greece stretching out its payments.

That was the preferred solution among German leaders. But it seems the ECB is about to get its way. Greece will likely get another bailout — 30 billion euros on top of the 110 billion euro bailout it got a year ago.

It will accomplish nothing. Going deeper into hock is never a good way to get out of debt. And at some point, this exercise in kicking the can has to stop. When it does, you get your next financial crisis.

He then quotes Michael Pento on the Federal Reserve’s leverage.

“As the size of the Fed’s balance sheet ballooned, the dollar amount of capital held at the Fed has remained fairly constant. Today, the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet.

“Prior to the bursting of the credit bubble, the public was shocked to learn that our biggest investment banks were levered 30-to-1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51-to-1! If the value of their portfolio were to fall by just 2%, the Fed itself would be wiped out.”

Of course, the FED, being a central bank with government backing, cannot go bankrupt. There is no one who could legally foreclose. But it’s interesting that the FED has done what commercial banks have done: gotten maximum leverage. It gets “more bang for its buck.” But commercial banks are playing the same game. They can go belly-up.

The pursuit of leverage is the Achilles heel of the banking sector. As Mobius said, derivatives are growing. Leverage is therefore growing. Risk is therefore growing.

Risk for you and risk for me.

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