For Anyone That Still Believes Collapsing Oil Prices Are Good For The Economy

Are much lower oil prices good news for the U.S. economy?  Only if you like collapsing capital expenditures, rising unemployment and a potential financial implosion on Wall Street.  Yes, lower gasoline prices are good news for the middle class.  I certainly would rather pay two dollars for a gallon of gas than four dollars.  But in order to have money to fill up your vehicle you have got to have an income first.  And since the last recession, the energy sector has been the number one creator of good jobs in the U.S. economy by far.  Barack Obama loves to stand up and take credit for the fact that the employment picture in this country has been improving slightly, but without the energy industry boom, unemployment would be through the roof.  And now that the “energy boom” is rapidly becoming an “energy bust”, what will happen to the struggling U.S. economy as we head into 2015?

At the start of this article I mentioned that much lower oil prices would result in “collapsing capital expenditures”.

If you do not know what a “capital expenditure” is, the following is a definition that comes from Investopedia…

“Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. This type of outlay is made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building a brand new factory.”

Needless to say, this kind of spending is very good for an economy.  It builds infrastructure, it creates jobs and it is an investment in the future.

In recent years, energy companies have been pouring massive amounts of money into capital expenditures.  In fact, the energy sector currently accounts for about a third of all capital expenditures in the United States according to Deutsche Bank…

US private investment spending is usually ~15% of US GDP or $2.8trn now. This investment consists of $1.6trn spent annually on equipment and software, $700bn on non-residential construction and a bit over $500bn on residential. Equipment and software is 35% technology and communications, 25-30% is industrial equipment for energy, utilities and agriculture, 15% is transportation equipment, with remaining 20-25% related to other industries or intangibles. Non-residential construction is 20% oil and gas producing structures and 30% is energy related in total. We estimate global investment spending is 20% of S&P EPS or 12% from US. The Energy sector is responsible for a third of S&P 500 capex.

These companies make these investments because they believe that there are big profits to be made.

Unfortunately, when the price of oil crashes those investments become unprofitable and capital expenditures start getting slashed almost immediately.

For example, the budget for 2015 at ConocoPhillips has already been reduced by 20 percent…

ConocoPhillips is one of the bigger shale players. And its decision to slash its budget for next year by 20% is raising eyebrows. The company said the new target reflects lower spending on major projects as well as “unconventional plays.” Despite the expectation that others will follow, it doesn’t mean U.S. shale oil production is dead. Just don’t expect a surge in spending like in recent years.

And Reuters is reporting that the number of new well permits for the industry as a whole plunged by an astounding 40 percent during the month of November…

Plunging oil prices sparked a drop of almost 40 percent in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007.

Data provided exclusively to Reuters on Tuesday by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October.

If the price of oil stays this low or continues dropping, this is just the beginning.

Meanwhile, the flow of good jobs that this industry has been producing is also likely to start drying up.

According to the Perryman Group, the energy sector currently supports 9.3 million permanent jobs in this country…

According to a new study, investments in oil and gas exploration and production generate substantial economic gains, as well as other benefits such as increased energy independence. The Perryman Group estimates that the industry as a whole generates an economic stimulus of almost $1.2 trillion in gross product each year, as well as more than 9.3 million permanent jobs across the nation.

The ripple effects are everywhere. If you think about the role of oil in your life, it is not only the primary source of many of our fuels, but is also critical to our lubricants, chemicals, synthetic fibers, pharmaceuticals, plastics, and many other items we come into contact with every day. The industry supports almost 1.3 million jobs in manufacturing alone and is responsible for almost $1.2 trillion in annual gross domestic product. If you think about the law, accounting, and engineering firms that serve the industry, the pipe, drilling equipment, and other manufactured goods that it requires, and the large payrolls and their effects on consumer spending, you will begin to get a picture of the enormity of the industry.

And these are good paying jobs.  They aren’t eight dollar part-time jobs down at your local big box retailer.  These are jobs that comfortably support middle class families.  These are precisely the kinds of jobs that we cannot afford to lose.

In recent years, there has been a noticeable economic difference between areas of the country where energy is being produced and where energy is not being produced.

Since December 2007, a total of 1.36 million jobs have been gained in shale oil states.

Meanwhile, a total of 424,000 jobs have been lost in non-shale oil states.

So what happens now that the shale oil boom is turning into a bust?

That is a very good question.

Even more ominous is what an oil price collapse could mean for our financial system.

The last time the price of oil declined by more than 40 dollars in less than six months, there was a financial meltdown on Wall Street and we experienced the deepest recession that we have seen since the days of the Great Depression.

And now many fear that this collapse in the price of oil could trigger another financial panic.

According to Citigroup, the energy sector now accounts for 17 percent of the high yield bond market.

J.P. Morgan says that it is actually 18 percent.

In any event, the reality of the matter is that the health of these “junk bonds” is absolutely critical to our financial system.  And according to Deutsche Bank, if these bonds start defaulting it could “trigger a broader high-yield market default cycle”…

Based on recent stress tests of subprime borrowers in the energy sector in the US produced by Deutsche Bank, should the price of US crude fall by a further 20pc to $60 per barrel, it could result in up to a 30pc default rate among B and CCC rated high-yield US borrowers in the industry. West Texas Intermediate crude is currently trading at multi-year lows of around $75 per barrel, down from $107 per barrel in June.

“A shock of that magnitude could be sufficient to trigger a broader high-yield market default cycle, if materialized,” warn Deutsche strategists Oleg Melentyev and Daniel Sorid in their report.

If the price of oil stays at this level or continues to go down, it is inevitable that we will start to see some of these junk bonds go bad.

In fact, one Motley Fool article recently stated that one industry analyst believes that up to 40 percent of all energy junk bonds could eventually go into default…

The junk bonds, or noninvestment-rated bonds, of energy companies are also beginning to see heavy selling as investors start to worry that drillers could one day default on these bonds. Those defaults could get so bad, according to one analyst, that up to 40% of all energy junk bonds go into default over the next few years if oil prices don’t recover.

That would be a total nightmare for Wall Street.

And of course bond defaults would only be part of the equation.  As I wrote about the other day, a crash in junk bonds is almost always followed by a significant stock market correction.

In addition, plunging oil prices could end up absolutely destroying the banks that are holding enormous amounts of energy derivatives.  This is something that I recently covered in this article and this article.

As you read this, there are five “too big to fail” banks that each have more than 40 trillion dollars in exposure to derivatives.  Of course only a small fraction of that total exposure is made up of energy derivatives, but a small fraction of 40 trillion dollars is still a massive amount of money.

These derivatives trades are largely unregulated, and even Forbes admits that they are likely to be at the heart of the coming financial collapse…

No one understands the derivative risk positions of the Too Big To Fail Banks, JP Morgan Chase, Citigroup, Bank of America, Goldman Sachs or Morgan Stanley. There is presently no way to measure the risks involved in the leverage, quantity of collateral, or stability of counter-parties for these major institutions. 

To me personally they are big black holes capable of potential wrack and ruin. Without access to confidential internal data about these risky derivative positions the regulators cannot react in a timely and measured fashion to block the threat to financial stability, according to a National Bureau of Economic Research study.

So do we have any hope?

Yes, if oil prices start going back up, much of what you just read about can be averted.

Unfortunately, that does not seem likely any time soon.  Even though U.S. energy companies are cutting back on capital expenditures, most of them are still actually projecting an increase in production for 2015.  Here is one example from Bloomberg…

Continental, the biggest holder of drilling rights in the Bakken, last month said 2015 output will grow between 23 percent and 29 percent even after shelving plans to allocate more money to exploration.

Higher levels of production will just drive the price of oil even lower.

At this point, Morgan Stanley is saying that the price of oil could plummet as low as $43 a barrel next year.

If that happens, it would be absolutely catastrophic to the most important industry in the United States.

In turn, that would be absolutely catastrophic for the economy as a whole.

So don’t let anyone tell you that much lower oil prices are “good” for the economy.
That is just a bunch of nonsense.

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Not Just Oil: Guess What Happened The Last Time Commodity Prices Crashed Like This?…

It isn’t just the price of oil that is collapsing.  The last time commodity prices were this low was during the immediate aftermath of the last financial crisis.  The Bloomberg Commodity Index fell to 110.4571 on Monday – the lowest that it has been since April 2009.  Just like junk bonds, industrial commodities are a very reliable leading indicator.  In other words, prices for industrial commodities usually start to move in a particular direction before the overall economy does.  We witnessed this in the summer of 2008 when a crash in commodity prices preceded the financial crisis in the fall by a couple of months.  And right now, we are witnessing what may be another major collapse in commodity prices.  In recent weeks, the price of copper has declined substantially.  So has the price of iron ore.  So has the price of nickel.  So has the price of aluminum.  You get the idea.  So this isn’t just about oil.  This is a broad-based commodity decline, and if it continues it is really bad news for the U.S. economy.

Of course most Americans would much rather read news stories about Kim Kardashian, but what is happening to the prices of these industrial metals at the moment is actually far more important to their daily lives.  For example, when the price of iron ore goes down that is a strong indication that economic activity is slowing down.  And that is why it is so troubling that the price of iron ore has almost sunk to a five year low.  The following comes from an Australian news source…

The price of iron ore has held below $US70 a tonne in overnight trade, leaving its five-year low within reach. 

At the end of the latest offshore session, benchmark iron ore for immediate delivery to the port of Tianjin in China was trading at $US69.40 a tonne, down 0.4 per cent from its previous close of $US69.70 a tonne and only 2 per cent above the five-year low of $US68 reached a fortnight ago. 

This week’s dip back under $US70 a tonne has followed revised forecasts from JPMorgan that suggest the commodity will average just $US67 a tonne next year, about $US20 below the investment bank’s previous expectation.

Copper is probably an even better economic indicator than iron ore is.  Economists commonly refer to it as “Dr. Copper”, and there is a really good reason for that.  Looking back over history, the price of copper often makes a significant move in one direction or the other before the economy does.  And now that the price of copper just hit the lowest level that we have seen since the last financial crash, alarm bells are going off.  The following comes from an article by CNBC contributor Ron Insana…

Copper prices are now below $3 a pound and there’s an expression that “the economy is topped with a copper roof.” More simply put, copper tends to top out in price, before it becomes obvious that, in this case, the global economy is about to weaken.

So is the global economy heading for rough waters?

Could 2015 be a very rough year economically?

According to Insana, the signs are all around us…

We already have evidence that the commodity crash has ominous portents for the rest of the world: 

* Japan’s recession is deeper than previously thought. 

* China’s demand for basic materials, amid a glut of uneconomic construction projects, appears to be plummeting.

* Russia’s ruble has collapsed and the country is on the brink, if not already in, a recession.

* India’s economic recovery is beginning to look shaky.

* Europe’s growth rate and inflation rate, for the next two years, were just revised downward by the European Central Bank, suggesting that Europe’s economic crisis is far from over. In fact, at least one former European leader with whom I recently spoke, believes the crisis in Europe may just be in its early stages.

* Brazil and other emerging market nations are struggling with a variety of issues, from recessions at home, to the rising value of the dollar, which is complicating how emerging markets conduct economic policies at home, given how closely their currencies are tied to the greenback.

In addition, the Baltic Dry Index is now at the lowest point that we have seen at this time of the year since 2008…

Simply put, with collapsing commodity prices (iron ore for instance) and massive fleets of credit-driven mal-investment-based vessels, it should surprise no one that the shipping index just plunged back below 1000, now at its lowest for this time of year since 2008. Furthermore, the seasonal bounce always seen in Q3 was among the weakest ever.

What does all of this mean?

It is commonly said that those that do not learn from history are doomed to repeat it.

So many of the exact same patterns that we witnessed leading up to the financial crash of 2008 are happening again.

Unfortunately, very few people saw the last crash coming, and this next crash will take most Americans by surprise as well.

I have written more than 1,200 articles about the economy on my website since 2009, and right now our financial system is more primed for a crash than at any other time since I started The Economic Collapse Blog.

Hopefully we have at least a couple more months of relative stability, but without a doubt 2015 is shaping up to be the most “interesting” year that we have seen in the financial world in a very long time.

All of the signs are there.  But most people choose to believe that everything is going to be okay somehow.  When the next crash comes, those people are going to be absolutely blindsided by it.

When you see storm clouds on the horizon, the logical thing to do is to prepare.  And the number one thing that most people should be working on is an emergency fund.  So don’t be frittering your money away on frivolous things.  In the early stages of this next crisis, you are going to need money to pay the mortgage, to put food on the table and to take care of your family.

Just remember what happened back in 2008.  A lot of middle class families were living on the financial edge every month, and because they didn’t have any cushion to fall back on, millions of those families ended up losing their homes when their jobs disappeared.

You need to have an emergency fund that can cover at least six months of expenses.  You don’t want a job loss or a major emergency to put you into a situation where your family could be put out into the street.

And for those that still have lots of money invested in the stock market – I really hope that you know what you are doing.

The market giveth, and the market taketh away.

And when the market taketh away, the consequences can often be exceedingly cruel.

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NIRP Arrives In The US: TBTF Banks Tell Customers To Move Their Cash Or Be Charged Fees

Back in June, the world was speechless when Goldman's head of the ECB, Mario Draghi, stunned the world when he took Bernanke's ZIRP and raised him one better by announcing the ECB would send deposit rates into negative territory, in the process launching the Neutron bomb known as N(egative)IRP and pushing European monetary policy into the "twilight zone", forcing savers to pay (!) for the privilege of keeping the product of their labor in the form of fiat currency instead of invested in a global ponzi scheme built on capital market so broken even the BIS can no longer contain its shocked amazement.

Well, the US economy may be "decoupling" (just as it did right before Lehman) and one pundit after another are once again (incorrectly) predicting that the Fed may raise rates, but when it comes to the true "value" of money, US banks have just shown that when it comes to spread between reality and the economic outlook, the schism has never been deeper.

Enter US NIRP.

As the WSJ reports, far from paying for the privilege of holding other people's cash (and why would they with nearly $3 trillion in positive carry excess reserves sloshing around) US banks - primarily of the TBTF variety - "are urging some of their largest customers in the U.S. to take their cash elsewhere or be slapped with fees, citing new regulations that make it onerous for them to hold certain deposits."

The banks, including J.P. Morgan Chase & Co., Citigroup Inc., HSBC Holdings PLC, Deutsche Bank AG and Bank of America Corp. , have spoken privately with clients in recent months to tell them that the new regulations are making some deposits less profitable, according to people familiar with the conversations.

In some cases, the banks have told clients, which range from large companies to hedge funds, insurers and smaller banks, that they will begin charging fees on accounts that have been free for big customers, the people said. Bank officials are also working with these firms to find alternatives for some of their deposits, they said.

The change upends one of the cornerstones of banking, in which deposits have been seen as one of the industry’s most attractive forms of funding, said more than a dozen corporate officials, consultants and bank executives interviewed by The Wall Street Journal.

One bank that is aggresively turning money away is the same bank for whom criminality is now an ordinary course of business, and has spent over $30 billion in recent years on legal charges and settlements: JPM.

J.P. Morgan told some clients of its commercial bank recently that it would begin charging monthly fees on deposit accounts from which clients can withdraw money at any time. The new charges will start Jan. 1 for U.S. accounts, according to an Oct. 21 memo reviewed by the Journal, and later for international accounts.

“New liquidity and capital requirements have changed the operating environment and increased the cost of doing business with financial institutions,” the memo read.

While ZH readers (and especially Cyprus residents) are quite familiar with the logic behind bank deposits, especially in a fractional-reserve banking system, some WSJ readers may not quite understand why this move is so profound:

Deposits have traditionally been a crucial growth engine for banks. Banks generally pay depositors one interest rate and then make loans with higher rates, often collecting fees in the process. But deposits also can be withdrawn at any time, potentially leaving a bank short of cash if too much money is removed at once.

The new rule driving the action is part of a broader effort by U.S. regulators and policy makers to make the financial system safer. But the move may inconvenience corporations that now have to pay new fees or look for alternatives to their bank.

Sal Sammartino, vice president of banking at Stewart Title, a unit of Stewart Information Services Corp. , a global title insurance company based in Houston, said he has had sleepless nights in recent weeks as he has negotiated with large banks to try to keep the firm’s deposits there. He declined to name the banks.

“Ultimately my balances aren’t as profitable for the banks, and that’s going to impact my business,” he said.

Dear Sal, if you want to complain to someone, complain to the Fed, whose trillions in bank excess reserves pumped in the system have made America's deposit base completely irrelevant on the margin, and thus give banks full liberty to do with the trillions in excess cash they have on their books as they will, even if it means chasing it out.
What is the official explanation for this dramatic monetary escalation that has so far glided under everyone's radar?

U.S. banking rules set to go into effect Jan. 1 compound the issue, especially for deposits that are viewed as less likely to stay at the bank through difficult times.
The new U.S. rules, designed to make bank balance sheets more resistant to the types of shocks that contributed to the 2008 financial crisis, will likely have little effect on retail deposits, insured up to $250,000 by federal deposit insurance. But the rules do affect larger deposits that often come from big corporations, smaller banks and big financial firms such as hedge funds. Hundreds of companies and other bank customers with deposits that exceed the insurance limits could be affected by the banks’ actions. 

Overall, about $4 trillion in deposits at banks in the U.S. were uninsured, covering more than 3.5 million accounts, according to Federal Deposit Insurance Corp. data.

Source 

New Law Would Make Taxpayers Potentially Liable For TRILLIONS In Derivatives Losses

If the quadrillion dollar derivatives bubble implodes, who should be stuck with the bill?  Well, if the “too big to fail” banks have their way it will be you and I.  Right now, lobbyists for the big Wall Street banks are pushing really hard to include an extremely insidious provision in a bill that would keep the federal government funded past the upcoming December 11th deadline.  This provision would allow these big banks to trade derivatives through subsidiaries that are federally insured by the FDIC.  What this would mean is that the big banks would be able to continue their incredibly reckless derivatives trading without having to worry about the downside.  If they win on their bets, the big banks would keep all of the profits.  If they lose on their bets, the federal government would come in and bail them out using taxpayer money.  In other words, it would essentially be a “heads I win, tails you lose” proposition.

Just imagine the following scenario.  I go to Las Vegas and I place a million dollar bet on who will win the Super Bowl this year.  If I am correct, I keep all of the winnings.  If I lose, federal law requires you to bail me out and give me the million dollars that I just lost.
Does that sound fair?

Of course not!  In fact, it is utter insanity.  But through their influence in Congress, this is exactly what the big Wall Street banks are attempting to pull off.  And according to the Huffington Post, there is a very good chance that this provision will be in the final bill that will soon be voted on…

According to multiple Democratic sources, banks are pushing hard to include the controversial provision in funding legislation that would keep the government operating after Dec. 11. Top negotiators in the House are taking the derivatives provision seriously, and may include it in the final bill, the sources said.

Sadly, most Americans don’t understand how derivatives work and so there is very little public outrage.

But the truth is that people should be marching in the streets over this.  If this provision becomes law, the American people could potentially be on the hook for absolutely massive losses…

The bank perks are not a traditional budget item. They would allow financial institutions to trade certain financial derivatives from subsidiaries that are insured by the Federal Deposit Insurance Corp. — potentially putting taxpayers on the hook for losses caused by the risky contracts.

This is not the first time these banks have tried to pull off such a coup.  As Michael Krieger of Liberty Blitzkrieg has detailed, bank lobbyists tried to do a similar thing last year…

Five years after the Wall Street coup of 2008, it appears the U.S. House of Representatives is as bought and paid for as ever. We heard about the Citigroup crafted legislation currently being pushed through Congress back in May when Mother Jones reported on it. Fortunately, they included the following image in their article:

Unsurprisingly, the main backer of the bill is notorious Wall Street lackey Jim Himes (D-Conn.), a former Goldman Sachs employee who has discovered lobbyist payoffs can be just as lucrative as a career in financial services. The last time Mr. Himes made an appearance on these pages was in March 2013 in my piece: Congress Moves to DEREGULATE Wall Street.

Fortunately, it was stopped in the Senate at that time.

But that is the thing with bank lobbyists.  They are like Terminators – they never, ever, ever give up.

And they now have more of a sense of urgency then ever, because we are moving into a period of time when the big banks may begin losing tremendous amounts of money on derivatives contracts.

For example, the rapidly plunging price of oil could potentially mean gigantic losses for the big banks.  Many large shale oil producers locked in their profits for 2015 and 2016 through derivatives contracts when the price of oil was above $100 a barrel.  As I write this, the price of oil is down to $65 a barrel, and many analysts expect it to go much lower.

So guess who is on the other end of many of those trades?

The big banks.

Their computer models never anticipated that the price of oil would fall by more than 40 dollars in less than six months.  A loss of 40, 50 or even 60 dollars per barrel would be catastrophic.

No wonder they want legislation that will protect them.

And commodity derivatives are just part of the story.  Over the past couple of decades, Wall Street has been transformed into the largest casino in the history of the world.  At this point, the amounts of money that these “too big to fail” banks are potentially on the hook for are absolutely mind blowing.

As you read this, there are five Wall Street banks that each have more than 40 trillion dollars in exposure to derivatives.  The following numbers come from the OCC’s most recent quarterly report (see Table 2)…

JPMorgan Chase

Total Assets: $2,520,336,000,000 (about 2.5 trillion dollars)

Total Exposure To Derivatives: $68,326,075,000,000 (more than 68 trillion dollars)

Citibank

Total Assets: $1,909,715,000,000 (slightly more than 1.9 trillion dollars)

Total Exposure To Derivatives: $61,753,462,000,000 (more than 61 trillion dollars)

Goldman Sachs

Total Assets: $860,008,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $57,695,156,000,000 (more than 57 trillion dollars)

Bank Of America

Total Assets: $2,172,001,000,000 (a bit more than 2.1 trillion dollars)

Total Exposure To Derivatives: $55,472,434,000,000 (more than 55 trillion dollars)

Morgan Stanley

Total Assets: $826,568,000,000 (less than a trillion dollars)

Total Exposure To Derivatives: $44,134,518,000,000 (more than 44 trillion dollars)

Those that follow my website regularly will note that the derivatives exposure for the top four banks has gone up significantly since I last wrote about this just a few months ago.

Do you want to be on the hook for all of that?

Keep in mind that the U.S. national debt is only about 18 trillion dollars at this point.
So why in the world would we want to guarantee losses that could potentially be far greater than our entire national debt?

Only a complete and utter fool would financially guarantee these incredibly reckless bets.
Please contact your representatives in Congress and tell them that you do not want to be on the hook for the derivatives losses of the big Wall Street banks.

When this derivatives bubble finally implodes and these big banks go down (and they inevitably will), we do not want them to take down the rest of us with them.

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Could Falling Oil Prices Spark A Financial Crisis?

The oil and gas boom in the United States was made possible by the extensive credit afforded to drillers. Not only has financing come from company shareholders and traditional banks, but hundreds of billions of dollars have also come from junk-bond investors looking for high returns.

Junk-bond debt in energy has reached $210 billion, which is about 16 percent of the $1.3 trillion junk-bond market. That is a dramatic rise from just 4 percent that energy debt represented 10 years ago.

As is the nature of the junk-bond market, lots of money flowed to companies with much riskier drilling prospects than, say, the oil majors. Maybe drillers were venturing into an uncertain shale play; maybe they didn’t have a lot of cash on hand or were a small startup. Whatever the case may be, there is a reason that they couldn’t offer “investment grade” bonds. In order to tap the bond market, these companies had to pay a hefty interest rate.

For investors, this offers the opportunity for high yield, which is why hundreds of billions of dollars helped finance companies in disparate parts of the country looking to drill in shale. When oil prices were high and production was relentlessly climbing, energy related junk bonds looked highly profitable.

But junk bonds pay high yields because they are high risk, and with oil prices dipping below $70 per barrel, companies that offered junk bonds may not have the revenue to pay back bond holders, potentially leading to steep losses in the coming weeks and months.

The situation will compound itself if oil prices stay low. The junk bond market may begin to shun risky drilling companies, cutting off access to capital. Without the ability to finance drilling, smaller or more indebted oil companies may not have a future. The Wall Street Journal profiled a few fund managers who are beginning to steer clear of smaller oil companies. Moody’s Investors Service downgraded the oil and gas sector on November 25 to a “negative” outlook because of falling oil prices.

If oil prices stay at $65 per barrel for three years, 40 percent of all energy junk bonds could be looking at default, according to a recent JP Morgan estimate. While that is a long-term and uncertain scenario, the pain is being felt today. The FT reported that a third of energy debt issued in the junk-bond market is currently in “distressed” territory.

That begs the question; could a shakeout of the oil industry spark a broader financial crisis? Banks and other financial institutions could be overly exposed to energy debt. The Telegraph paints a dire scenario in which the debt bubble bursts because of low oil prices, leading to a cascading 2008-style financial collapse, at least in the junk bond market.

Such a scenario may be a bit overblown. Persistently low interest rates keep demand for junk bonds high, meaning oil companies will probably be able to restructure their debt and continue to access capital. Also, drillers will not immediately face an existential crisis because many have hedged themselves, locking in prices for a certain amount of production.

But a junk bond crisis could become more likely if oil prices stay low for an extended period of time. Once a few companies begin to default, the problem could quickly spread. Another variable is how quickly the U.S. Federal Reserve will raise interest rates, which could significantly affect the attractiveness of the junk bond market.

Local and regional banks could be highly exposed as well, especially if energy loans make up a large share of their lending portfolio. The Wall Street Journal pointed out that banks like Oklahoma-based BOK Financial – with 19 percent of its loan portfolio made up of energy loans – could be the most vulnerable. Moreover, an economic downturn in regions that depend heavily on energy, such as Texas or North Dakota, could see a broader decline in demand for loans of all kinds. That could add to the pain for local banks.

Low oil prices are not just a problem for oil companies. Investment funds, hungry for yield in a low interest rate environment, have poured money into oil and gas. To be sure, we are far from a crisis at this point, but if oil prices don’t rebound, a lot of people are going to lose a lot of money.

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Plummeting Oil Prices Could Destroy The Banks That Are Holding Trillions In Commodity Derivatives

Could rapidly falling oil prices trigger a nightmare scenario for the commodity derivatives market?  The big Wall Street banks did not expect plunging home prices to cause a mortgage-backed securities implosion back in 2008, and their models did not anticipate a decline in the price of oil by more than 40 dollars in less than six months this time either.  If the price of oil stays at this level or goes down even more, someone out there is going to have to absorb some absolutely massive losses.  In some cases, the losses will be absorbed by oil producers, but many of the big players in the industry have already locked in high prices for their oil next year through derivatives contracts.  The companies enter into these derivatives contracts for a couple of reasons.  Number one, many lenders do not want to give them any money unless they can show that they have locked in a price for their oil that is higher than the cost of production.  Secondly, derivatives contracts protect the profits of oil producers from dramatic swings in the marketplace.  These dramatic swings rarely happen, but when they do they can be absolutely crippling.  So the oil companies that have locked in high prices for their oil in 2015 and 2016 are feeling pretty good right about now.  But who is on the other end of those contracts?  In many cases, it is the big Wall Street banks, and if the price of oil does not rebound substantially they could be facing absolutely colossal losses.

It has been estimated that the six largest “too big to fail” banks control $3.9 trillion in commodity derivatives contracts.  And a very large chunk of that amount is made up of oil derivatives.

By the middle of next year, we could be facing a situation where many of these oil producers have locked in a price of 90 or 100 dollars a barrel on their oil but the price has fallen to about 50 dollars a barrel.

In such a case, the losses for those on the wrong end of the derivatives contracts would be astronomical.

At this point, some of the biggest players in the shale oil industry have already locked in high prices for most of their oil for the coming year.  The following is an excerpt from a recent article by Ambrose Evans-Pritchard…

US producers have locked in higher prices through derivatives contracts. Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015. 

Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production.

So they are protected to a very large degree.  It is those that are on the losing end of those contracts that are going to get burned.

Of course not all shale oil producers protected themselves.  Those that didn’t are in danger of going under.

For example, Continental Resources cashed out approximately 4 billion dollars in hedges about a month ago in a gamble that oil prices would go back up.  Instead, they just kept falling, so now this company is likely headed for some rough financial times…

Continental Resources (CLR.N), the pioneering U.S. driller that bet big on North Dakota’s Bakken shale patch when its rivals were looking abroad, is once again flying in the face of convention: cashing out some $4 billion worth of hedges in a huge gamble that oil prices will rebound. 

Late on Tuesday, the company run by Harold Hamm, the Oklahoma wildcatter who once sued OPEC, said it had opted to take profits on more than 31 million barrels worth of U.S. and Brent crude oil hedges for 2015 and 2016, plus as much as 8 million barrels’ worth of outstanding positions over the rest of 2014, netting a $433 million extra profit for the fourth quarter. Based on its third quarter production of about 128,000 barrels per day (bpd) of crude, its hedges for next year would have covered nearly two-thirds of its oil production.

Oops.

When things are nice and stable, the derivatives marketplace works quite well most of the time.

But when there is a “black swan event” such as a dramatic swing in the price of oil, it can create really big winners and really big losers.

And no matter how complicated these derivatives become, and no matter how many times you transfer risk, you can never make these bets truly safe.  The following is from a recent article by Charles Hugh Smith…

Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but as I have noted many times, risk cannot be disappeared, it can only be masked or transferred to others.

Relying on counterparties to pay out cannot make risk vanish; it only masks the risk of default by transferring the risk to counterparties, who then transfer it to still other counterparties, and so on. 

This illusory vanishing act hasn’t made risk disappear: rather, it has set up a line of dominoes waiting for one domino to topple. This one domino will proceed to take down the entire line of financial dominoes. 

The 35% drop in the price of oil is the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.

In recent years, Wall Street has been transformed into the largest casino in the history of the world.

Most of the time the big banks are very careful to make sure that they come out on top, but this time their house of cards may come toppling down on top of them.

If you think that this is good news, you should keep in mind that if they collapse it virtually guarantees a full-blown economic meltdown.  The following is an extended excerpt from one of my previous articles…

For those looking forward to the day when these mammoth banks will collapse, you need to keep in mind that when they do go down the entire system is going to utterly fall apart.

At this point our economic system is so completely dependent on these banks that there is no way that it can function without them.

It is like a patient with an extremely advanced case of cancer.

Doctors can try to kill the cancer, but it is almost inevitable that the patient will die in the process.
The same thing could be said about our relationship with the “too big to fail” banks.  If they fail, so do the rest of us.

We were told that something would be done about the “too big to fail” problem after the last crisis, but it never happened.

In fact, as I have written about previously, the “too big to fail” banks have collectively gotten 37 percent larger since the last recession.

At this point, the five largest banks in the country account for 42 percent of all loans in the United States, and the six largest banks control 67 percent of all banking assets.

If those banks were to disappear tomorrow, we would not have much of an economy left.

Our entire economy is based on the flow of credit.  And all of that debt comes from the banks.  That is why it has been so dangerous for us to become so deeply dependent on them.  Without their loans, the entire country could soon resemble White Flint Mall near Washington D.C….

It was once a hubbub of activity, where shoppers would snap up seasonal steals and teens would hang out to ‘look cool’. 

But now White Flint Mall in Bethesda, Maryland – which opened its doors in March 1977 – looks like a modern-day mausoleum with just two tenants remaining. 

Photographs taken inside the 874,000-square-foot complex show spotless faux marble floors, empty escalators and stationary elevators. 

Only a couple of cars can be seen in the parking lot, where well-tended shrubbery appears to be the only thing alive.

I keep on saying it, and I will keep on saying it until it happens.  We are heading for a derivatives crisis unlike anything that we have ever seen.  It is going to make the financial meltdown of 2008 look like a walk in the park.

Our politicians promised that they would do something about the “too big to fail” banks and the out of control gambling on Wall Street, but they didn’t.

Now a day of reckoning is rapidly approaching, and it is going to horrify the entire planet.

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5 Complete Lies About America's New $18 Trillion Debt Level

On October 22, 1981, the government of the United States of America accumulated an astounding $1 TRILLION in debt.

At that point, it had taken the country 74,984 days (more than 205 years) to accumulate its first trillion in debt.

It would take less than five years to accumulate its second trillion.

And as the US government just hit $18 trillion in debt on Friday afternoon, it has taken a measly 403 days to accumulate its most recent trillion.

There’s so much misinformation and propaganda about this; let’s examine some of the biggest lies out there about the US debt:

1) “They can get it under control.”

What a massive lie. Politicians have been saying for decades that they’re going to cut spending and get the debt under control.

FACT: The last time the US debt actually decreased from one fiscal year to the next was back in 1957 during the EISENHOWER administration.

FACT: For the last several years, the US government has been spending roughly 90% of its ENTIRE tax revenue just to pay for mandatory entitlement programs and interest on the debt.

This leaves almost nothing for practically everything else we think of as government.

2) “The debt doesn’t matter because we owe it to ourselves.”

This is probably the biggest lie of all. Two of the Social Security trust funds alone (OASI and DI) own $2.72 trillion of US debt.

The federal government owes this money to current and future beneficiaries of those trust funds, i.e. EVERY SINGLE US CITIZEN ALIVE.

I fail to see the silver lining here. How is it somehow ‘better’ if the government defaults on its citizens as opposed to, say, banks?

3) “They can always ‘selectively default’ on the debt”

Another lie. People think that the US government can pick and choose who it pays.

They could make a bing stink about China, for example, and then choose to default on the $2 trillion in debt that’s owed to the Chinese.

Nice try. But this would rock global financial markets and destroy whatever tiny shred of credibility the US still has.

Others have suggested that the government could selectively default on the Federal Reserve (which owns $2.46 trillion of US debt).

Again, possible. But given that the Fed (the issuer of the US dollar) would become immediately insolvent, the resulting currency crisis would be completely disastrous.

4) “It’s the NET debt that’s important”

Analysts often pay attention to a country’s “net debt” instead of its gross debt. If you have a million bucks in debt, and a million bucks in cash, then your ‘net debt’ is zero. It washes out.

Problem is, the US government doesn’t have any cash. The Treasury Department opened its business day on Friday morning with just $71.9 billion in cash, or just 0.39% of its total debt level.

Apple has more money than that.

5) “They can fix it by raising taxes”

No they can’t. Just look at the numbers. Since the end of World War II, US government tax revenue has consistently been roughly 17% of GDP.

They can raise tax rates, but it doesn’t move the needle in terms of revenue as a percentage of GDP.
In other words, the government’s ‘slice of the pie’ is pretty consistent.

You’d think with this obvious data that, rather than try to increase tax rates (ineffective), they’d do everything they can to help make a bigger pie.

Or better yet, just leave everyone the hell alone so we’re free to bake as much as we can.

But no. They have to regulate every aspect of people’s existence: How you are allowed to educate your children. What you can/cannot put in your body. How much interest you are entitled to receive on your savings.

All of this costs time, money, and efficiency. So do never-ending wars. The bombs. The drones. The airstrikes.

This isn’t about any single person or President. The problem is with the system itself.

History shows that every leading superpower from the past almost invariably fell to the same fate.
Great powers often feel that their wealth and success entitles them to spend recklessly and wage endless, arrogant wars. The Romans. The Ottoman Empire. The British.

History may not repeat but it certainly rhymes. And the lesson here is very clear: debt weakens a nation. It weakens a society.

Generations that will not even be born for decades will inherit these debts by complete accident of birth.

And the people in charge of the system have backed themselves into a corner where there is no way out other than to default– either on their creditors (creating a global financial crisis), the central bank (creating a currency crisis), or on the citizens themselves (creating an epic social crisis).

Bottom line: this is not a consequence-free environment. And while you can’t fix the debt problem, you can certainly reduce your own exposure to what happens next.

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Reuters Discovers the Great Convergence of Global Stock Market Stimulation

Stock markets set to take off as Europe, Asia abandon austerity ... The Great Divergence is a term coined by economic historians to explain the sudden acceleration of growth and technology in Europe from the 16th century onward, while other civilizations such as China, India, Japan and Persia remained in their pre-modern state. This phrase has recently acquired a very different meaning, however, more relevant to global economic and financial conditions today ... Far more important than a likely difference next year of a quarter or half a percentage point between short-term interest rates on both sides of the Atlantic, though, is the convergence of economic philosophies and objectives for the first time since the 2008 economic crisis. In the past two months, Japan, Europe and China all moved toward further aggressive monetary stimulus and reversed previous commitments to fiscal austerity. – Reuters 

Dominant Social Theme: Stock markets are value-based environments that go up when economies rev. 

Free-Market Analysis: This Reuters article states clearly what we've been pointed out in our Wall Street Party meme: It's not just a US phenomenon. 

 We noted this as quantitative easing began several years ago in the US. The EU, too, was stimulating European economies at the time as best it could, especially Southern European ones. China meanwhile printed massive amounts of money to counteract the 2008 crisis, and then continued to do so even after officials said monetary policy had turned less aggressive. 

Eventually Japan joined in with Abenomics, which was a form of the same Keynesian economics being applied in the US and Europe. Thus, the world's major economies for the most part were harmonized, and that harmony was constructed around printing billions and trillions of dollars. 

Reuters has now observed the same phenomenon. 

The important trends today, especially after October policy changes in Japan and Europe, are not divergence but convergence. 

This Great Convergence of macroeconomic policies between the United States and the rest of the world will drive financial markets and dominate business conditions in the year ahead. It is not yet reflected, however, in asset prices or market trends. Investors continue to obsess about the tiny gap that may or may not open up between U.S. and European policies sometime next year, when the Fed starts gently raising interest rates. 

Though it is true that these global policy shifts coincided with the end of the Fed's quantitative-easing program, this accident of timing does not imply that the United States is diverging from Europe and Asia. What is really happening is that Europe and Asia are finally — and reluctantly — following Washington's road map out of the Great Recession. 

In the eurozone, Britain and China, hawkish central bankers have been silenced and monetary policy has been reset for full-scale stimulus — most recently by the European Central Bank, which has belatedly accepted the principle of U.S.-style quantitative easing. In Japan, where money-printing presses were already running at full throttle, they have speeded up even more. 

... The upshot is that every advanced economy is now following broadly the same macroeconomic policies as the United States: maximal monetary stimulus combined with fiscal neutrality and the suspension of counterproductive budget rules. 

Assuming that Europe and Japan continue to pursue with conviction these Washington-style expansionary policies, they should eventually achieve similar results — gradual improvements in employment and financial conditions, powered by faster economic growth. This trend was confirmed in the United States again this week by the upward revision of 3rd-quarter gross domestic product growth to 3.9 percent. 

While agreeing with the thrust of the Reuters article, we "diverge" when it comes to this last paragraph. Whatever so-called improvements are generated by monetary stimulation will be neither longlasting nor fundamental. 

Instead, like the tech boom of the 1990s or the low-end mortgage boom of the early 2000s, the gains made economically or in stock averages will surely, eventually, be given back, at least in large part. The mainstream media will begin to debate about various bubbles and then the discussion will proceed, futilely as always, to who is to blame. 

The kind of bubble economy that is present around the world today is extremely wasteful and prone to destructive consolidations of power and wealth. Printing more money can certainly stimulate industry but the stimulation will generate products and services that will be seen sooner or later as in part unnecessary or over-expanded. 

This is, of course, a description of the modern business cycle itself. Over-printing money causes tremendous booms and busts and we've seen two of them occur in the past 15 years, first in 2001 and then in 2008. 

We've also predicted that the current harmonizing of countries and monetary policy will eventually create an extraordinary financial disaster ... though not yet. But the Wall Street Party we've been writing about is going to lapse at some point and when it does the unraveling could be significant indeed. 

In the meantime, this sort of harmonization may well drive markets around the world to new heights. Monetary stimulation's main impact, in fact, is usually on securitized assets. The Reuters article recognizes this possibility: 

Stock markets around the world would start to perform better than Wall Street if investors became convinced that Europe, Japan and China were as committed as Washington is to expansionary policies. The first signs of this sentiment shift could be detected in Japan, after Abe's reflationary measures in late October, and in China, after the surprise monetary easing last week. If ECB President Mario Draghi can convince investors that he has political support for aggressive monetary stimulus, European equities could also start to outperform. 

This is all fairly transparent, is it not? We're supposed to believe that stock markets are indicators of prosperity but the current upturn is an orchestrated one that began in the US with low rates and regulatory revisions that supported investor activity, especially when it came to IPOs. 

Now the orchestration is spreading around the world and a new meme is being developed: The current market upsurge is just beginning. 

This is a typical VESTS conundrum. Does one trust one's eyes and ears when it comes to this ongoing market upsurge or does one accept that those who are orchestrating this rise are in control of it, at least for the near term? 

We've suggested that fighting the trend may be futile, for now at least, if one wants to participate in profits that continue to be made. Prudent hedging, diversification and a concentration on certain equities and IPOs may be one way to play this equity surge ... bearing in mind that the market is at heights that can precipitate a significant downturn. 

But what we see in terms of memes and market manipulation leads us to suspect that there are immensely powerful forces committed to continued market gains. The real question is not whether this bias exists but for how long it can play out. 

Higher averages need not lull the senses. Instead, if you wish, approach the market in a prudent way. A disciplined strategy is called for and a commitment to participate within the context of an "exit" plan. 

Conclusion But this market could continue it seems for another year or two, or perhaps longer, hard as that is to fathom. And then again, well ... perhaps it won't. But the meme that is being constructed seems to focus on the longer term. That's something to consider within a larger VESTS construct. 

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Guess What Happened The Last Time The Price Of Oil Crashed Like This?…

There has only been one other time in history when the price of oil has crashed by more than 40 dollars in less than 6 months.  The last time this happened was during the second half of 2008, and the beginning of that oil price crash preceded the great financial collapse that happened later that year by several months.  Well, now it is happening again, but this time the stakes are even higher.  When the price of oil falls dramatically, that is a sign that economic activity is slowing down.  It can also have a tremendously destabilizing affect on financial markets.  As you will read about below, energy companies now account for approximately 20 percent of the junk bond market.  And a junk bond implosion is usually a signal that a major stock market crash is on the way.  So if you are looking for a “canary in the coal mine”, keep your eye on the performance of energy junk bonds.  If they begin to collapse, that is a sign that all hell is about to break loose on Wall Street.

It would be difficult to overstate the importance of the shale oil boom to the U.S. economy.  Thanks to this boom, the United States has become the largest oil producer on the entire planet.

Yes, the U.S. now actually produces more oil than either Saudi Arabia or Russia.  This “revolution” has resulted in the creation of  millions of jobs since the last recession, and it has been one of the key factors that has kept the percentage of Americans that are employed fairly stable.

Unfortunately, the shale oil boom is coming to an abrupt end.  As a recent Vox article discussed, OPEC has essentially declared a price war on U.S. shale oil producers…

For all intents and purposes, OPEC is now engaged in a “price war” with the United States. What that means is that it’s very cheap to pump oil out of places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. The result? Oil prices will stabilize and OPEC maintains its market share.

If the price of oil stays at this level or continues falling, we will see a significant number of U.S. shale oil companies go out of business and large numbers of jobs will be lost.  The Saudis know how to play hardball, and they are absolutely ruthless.  In fact, we have seen this kind of scenario happen before…

Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the US shale oil sector.” Even legendary oil man T. Boone Pickens believes Saudi Arabia is in a stand-off with US drillers and frackers to “see how the shale boys are going to stand up to a cheaper price.” This has happened once before. By the mid-1980’s, as oil output from Alaska’s North Slope and the North Sea came on line (combined production of around 5-6 million barrels a day), OPEC set off a price war to compete for market share. As a result, the price of oil sank from around $40 to just under $10 a barrel by 1986.

But the energy sector has been one of the only bright spots for the U.S. economy in recent years.  If this sector starts collapsing, it is going to have a dramatic negative impact on our economic outlook.  For example, just consider the following numbers from a recent Business Insider article…

Specifically, if prices get too low, then energy companies won’t be able to cover the cost of production in the US. This spending by energy companies, also known as capital expenditures, is responsible for a lot of jobs. 

“The Energy sector accounts for roughly one-third of S&P 500 capex and nearly 25% of combined capex and R&D spending,” Goldman Sachs’ Amanda Sneider writes.

Even more troubling is what this could mean for the financial markets.

As I mentioned above, energy companies now account for close to 20 percent of the entire junk bond market.  As those companies start to fail and those bonds start to go bad, that is going to hit our major banks really hard…

Everyone could suffer if the collapse triggers a wave of defaults through the high-yield debt market, and in turn, hits stocks. The first to fall: the banks that were last hit by the housing crisis. 

Why could that happen? 

Well, energy companies make up anywhere from 15 to 20 percent of all U.S. junk debt, according to various sources.

It would be hard to overstate the seriousness of what the markets could potentially be facing.

One analyst summed it up to CNBC this way…

“This is the one thing I’ve seen over and over again,” said Larry McDonald, head of U.S strategy at Newedge USA’s macro group. “When high yield underperforms equity, a major credit event occurs. It’s the canary in the coal mine.“

The last time junk bonds collapsed, a major stock market crash followed fairly rapidly.
And those that were hardest hit were the big Wall Street banks…

During the last high-yield collapse, which centered around debt tied to the housing sector, Citigroup lost 63 percent of its value in the following 60 days, Kensho shows. Bank of America was cut in half.

I understand that some of this information is too technical for a lot of people, but the bottom line is this…

Watch junk bonds.  When they start crashing it is a sign that a major stock market collapse is right at the door.

At this point, even the mainstream media is warning about this.  Just consider the following excerpt from a recent CNN article…

That swing away from junk bonds often happens shortly before stock market downturns. 

“High yield does provide useful sell signals to equity investors,” Barclays analysts concluded in a recent report. 

Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.

If you have been waiting for the next major financial collapse, what you have just read in this article indicates that it is now closer than it has ever been.

Over the coming weeks, keep your eye on the price of oil, keep your eye on the junk bond market and keep your eye on the big banks.

Trouble is brewing, and nobody is quite sure exactly what comes next.

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