The last financial Tsunami was a doozer that almost destroyed the global financial system. It was the collapse of the Wall Street Mortgage Backed Securities bubble in March 2007. The results of that collapse are still very much with the world today. Never in the one hundred some years of the Federal Reserve Bank has the Fed held interest rates at an artificial near-zero level for what is soon to mark eight years duration. Not even during the 1930’s Great Depression were rates kept so low so long. It is not a sign of a healthy banking system, friends.
Now a new Financial Tsunami is beginning, this one, of all places, in the Texas, North Dakota and other USA shale oil regions. Like the so-called US sub-prime real estate crisis, the oil shale junk bond default crisis is but the cutting front of the first wave of what promises to be a far more dangerous series of financial Tsunami long waves.
Banking system vulnerability greater
I say more dangerous because of what governments in the USA, EU and elsewhere did after 2007 to make sure no repeat of that bubble-cum-collapse-of bubble cycle could repeat.
In a word, they did nothing. What they did do—explode US Federal debt and bloat the credit of the central bank to historic highs leave the USA in far worse shape to deal with the unfolding crisis.
Aside from a few cosmetic face-saving new laws, they have done nothing. No CEO of a major criminal Wall Street bank went to prison. No mega-bank, “too big to fail” was forced to break up their trillion dollar balance sheet as they were after 1933 when the Congress passed the Glass-Steagall Act forcing banks to divest their in-house stock and bond securities businesses to avoid the same conflicts of interest that reemerged after Bill Clinton signed the Glass-Steagall repeal in 1999 and banks and insurance companies and investment firms merged into giants so large Congress was terrified to touch them. No law has been passed forcing disclosure of the off-balance-sheet bank derivatives positions. Like in 2007 it is all opaque, like bankers prefer.
But something has changed. More than $700 billion of US taxpayer dollars were donated to the health and welfare of the six or seven criminal institutions called Wall Street banks. Four of those Wall Street banks—JP MorganChase, Citigroup, Goldman Sachs, Bank of America—hold 93% of the total USA banking industry notional amounts of derivative contracts, a market that in April 2014 was valued grossly or notionally at $231 trillion, yes, trillion. Were the offsetting derivatives contracts netted out, the bank risks of those four Wall Street banks would still be $279 billion of credit risk bank exposure, all concentrated in the four largest US banks.
In a full-blown meltdown or Tsunami like 2008, when no bank dared trade with any other bank for fear it would default, all calculations are out the window as there is no derivative or hedge against a systemic meltdown. In 2007-2015 the Fed reacted with unprecedented money printing to feed the brain-dead Wall Street banks. It was called Quantitative easing or QE.
The Fed created out of thin air more than $3.3 trillion worth of what they call Reserve Bank Credit after September 2008. In the QE process the Fed bought financial assets from commercial banks, mainly the Big Four or top 25 banks and other private institutions like Fannie Mae or Freddie Mac mortgage companies. The Fed bought US government bonds from the private banks, the heart of the corrupt Federal Reserve private bank system. And more recently the fed has bought $1.7 trillion of toxic mortgage backed securities from the same banks. That Fed buying called QE pumped urgently need liquidity on to those mega banks.
Only this is not 1986 and the US banking system and US economy is not comparable to that in 1986. Today the US Government is choking in $18 trillion in Federal debt. In 1986 it was a “mere” $2 trillion. The US economy in 1986 still produced manufacturing jobs that employed real working people. Today those jobs have been outsourced through to places like Mexico or China or Vietnam or even, yes, Russia. And the banking system of the USA is on year seven of artificial life support known as Quantitative Easing.
According to John Williams who produces a widely-regarded invaluable independent check on government statistical lying in his Shadow Government Statistics, the true unemployment rate in the United States in the beginning of 2015 is not the politically rigged 5% President Obama so proudly points to. Rather is is over 23%, Great Depression levels, and more than double the 12% he reckoned just before the 2007 crisis began.
What have the banks done with the Fed money? They have flooded the stock markets, emerging markets like Brazil or India or even Russia, all in search of new gains just as they flooded into junk real estate loans after the collaose of the dot.com IT bubble in 2000. And they have poured hundreds of billions of dollars into the US shale oil bonanza, creating a new bubble, much like the 1999-2000 dot.com bubble or the 2004-2007 sub-prime bubble. Now that US shale oil bubble is beginning to deflate, fast.
The Saudis strike
Recall that in September 2014, in a misguided attempt to up the heat on the Russian economy and weaken Vladimir Putin, Secretary of State John Kerry flew to Saudi Arabia to meet with the dying King Abdullah. Kerry reportedly proposed the Saudis dump oil, then selling for around $100 a barrel, onto the market at drastically lower prices. It was crude, in the sense not of crude oil but of a poorly thought-out crude rerun of a tactic then Vice President Bush and Secretary of State George Schultz made with the Saudis in 1986 when oil prices plunged to below $10 a barrel and prepared the financial backdrop for the collapse of the Soviet Union three years later.
What Kerry and the Washington neo-conservatives neglected to look at was the double agenda of those sly Saudi Wahhabite royals. They gleefully agreed to Help Washington deepen Russia’s financial crisis and to hitting their Shi’ite foe Iran by hitting oil. But they also saw a golden chance to rid themselves of their new rival for global oil supremacy, namely, the United States, specifically the shale oil sector.
A Sorcerer’s Apprentice
Owing to the geology in extracting gas from shale rock interstices by underground fracturing or fracking, by pumping millions of gallons of chemicals into the rocks, shale oil and gas deposits deplete far far more rapidly than conventional gas or oil deposits. That has meant shale companies had to borrow more and more to drill new wells in order to maintain oil volumes. So long as oil was above $100 a barrel, it was still a profit bonanza for banks as for shale oil companies.
Those new shale oil wells cost money. After 2011 Wall Street banks hungry for new profit in a depressed economy teamed up with shale oil drilling companies in what soon became a remake of the Goethe Sorcerer’s Apprentice, where this time he can’t stop the flow of oil. As a result of shale oil, the USA has surpassed Saudi Arabia to become the world’s largest oil producer, but the rising oil supply is worsening the US oil industry crisis.
When Fed interest rates were zero, Wall Street liquidity seemingly unlimited and oil prices well above $100 a barrel as they were since 2011, the money flowed into shale gas until the gas supplies collapsed the price. At that point, around 2011 shale drilling shifted to far more profitable shale or tight oil drilling. Here the debt began to rise like in every previous speculative bubble. Bankers have short memory on Wall Street when they know the Government will always be there because they are “too big to fail.” So they have created the shale oil bubble with no regard to risk.
Since the shale oil boom took flight in 2011 Wells Fargo and JP Morgan have both issued shale oil company loans of $100 billion.There has been a huge rise in high risk high return bonds, so called “junk bonds.” They earned the appropriate name because in event of a company’s going bankrupt, they become just that—junk. The bonds have been issued by Wall Street banks to shale oil and gas companies since the bubble started in 2011. The US oil and gas industry share of junk bonds has been the fastest growing portion of the overall US junk bond sector of the bond market.
Now as oil prices hover around $49 a barrel, the shale oil companies that indebted themselves with junk bonds to finance more drilling are themselves facing bankruptcy or default more and more every additional day the US crude oil price remains this low. Their shale projects were calculated when oil was $100 a barrel, less than a year ago. Their minimum price of oil to avoid bankruptcy in most cases was $65 a barrel to $80 a barrel. Shale oil extraction is unconventional and more costly than conventional oil. Douglas-Westwood, an energy advisory firm, estimates that nearly half of the US oil projects under development need oil prices greater than $120 per barrel in order to achieve positive cash flow.
Now as the Saudi oil price operation enters its eighth month with no end in sight, the shale oil dominoes are beginning to fall. US shale oil producers Quicksilver Resources, American Eagle Energy, Saratoga Resources and BPZ Resources all missed interest payments this year. Houston oil field service firm Cal Dive International just filed for Chapter 11 bankruptcy. Moody’s Investors Service just downgraded Swiss oil rig contractor Transocean’s $9.1 billion in debt.
The US energy sector’s high-yield bonds – so-called “junk bonds” considered at risk of default – have climbed to $247 billion. But the implosion of the shale oil bubble and its debt is just beginning. Because the shale oil producers are desperately trying to stay afloat and hope for higher oil prices to stay alive they are forced into the paradoxical position of pumping as much oil as possible in order to service their debt to the banks to avoid default. That has meant record volumes of oil flooding the US market in recent months, pushing prices even lower.
And to make the oil glut even worse, the Saudis have apparently no intention of easing on the price of oil until far more blood flows in the streets of Laredo and across Wall Street. In the first week of April the US crude oil inventories surged 11 million barrels – three times more than expected – to a modern-day record 482 million barrels, the biggest one-week increase since 2001. Stockpiles in Cushing, Oklahoma, rose by 1.2 million barrels, far more than expected. On top of the flood of oil in the US led by increasingly strapped shale oil producers, Saudi oil production rose to 10.3 million barrels per day in March, their highest monthly total on record.
Saudi oil minister Ali al-Naimi said he was ready to “improve” prices only if producers outside the Organization of the Petroleum Exporting Countries (OPEC) joined the effort. But even in OPEC Iran is boosting oil sales to China and Japan despite sanctions, with prospect of a possible, if increasingly unlikely, US lifting of Iran sanctions in July, bringing a big increase of Iran oil on the market. Iraq and Libya also increased their output in March and Russia is pumping all it can, meaning the world oil glut will likely run to at least end of 2015 according to Olivier Jakob at Swiss-based Petromatrix. The US Energy Department EIA estimates US oil prices will fall now another $5 to $15 a barrel to levels around $35 to $45 a barrel because of the glut continuing, which in turn will trigger a chain reaction of shale oil sector bankruptcies and loss of tens of thousands of well-paying US oilrig jobs from Pennsylvania to Texas to North Dakota to Arizona to California.
There is a symbiotic bond between the shale oil industry and the Wall Street banks that financed the shale bonanza. The banks have an estimated $498 billion in loan exposure to the US energy sector. Wells Fargo bank got 15 percent of its investment banking fee revenue in 2014 from the oil and gas industry. At Citigroup, the business accounted for roughly 12 percent, according to Dealogic. Now, as the problems mount, the Wall Street banks that financed the shale energy deals are having trouble offloading the debt as news of the deepening crisis spreads. This time Wall Street may have trouble finding naïve Chinese bankers willing to buy US toxic waste oil loans as they were lured into buying toxic waste real estate sub-prime mortgage debt before 2008.
It isn’t only oil companies that are beginning to go under. The entire infrastructure of the USA energy boom, one of the only growth areas in a depressed economy, has financed new homes by oil employees, oil company office buildings from Houston Texas to North Dakota, creating growth pockets amid the larger Detroit-like depression regions. Now bank lenders are reassessing risks in shale energy towns as roughly $1.1 trillion of property loans come due across the US over the next three years, according to real estate debt analyst Richard Hill at Morgan Stanley.
The collapse of the shale oil junk bond market will be the start of the next Tsunami underwater financial earthquake. The entire Junk Bond market has boomed as banks in the USA and even in the EU and elsewhere assumed so long as the Fed kept rates at zero, and so long as oil was at $100 a barrel. Bank risk was zero and rewards were double digit interest rates on junk. In the end that junk, shale and other, is now in an early wave Tsunami despite zero fed interest rates, because of the falling oil prices. Martin S. Fridson, a prominent analyst of the high-yield junk bond market, sees as much as $1.6 trillion in high-yield defaults coming in a new wave he expects to begin shortly.
Fridson said that five months ago. The “shortly” has now arrived. The next months promise a bare knuckle ride in the rotted debt-bloated US financial sector that will promise an even more dangerous rerun of the global crisis after 2008. The banks most exposed are JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co.—the same criminal enterprises that created the 2007 mortgage-backed-securities collapse and virtually every financial collapse crisis since 1907. Some might think it high time soon to consider another banking model for the USA, perhaps bringing the CEOs responsible before the courts, nationalizing the banks too big to fail, breaking them up into “bite sized” pieces, removing at least that cancer from the economy to let healthy investment resume by honest banks in honest people in America once more as we did only some sixty years ago.
F. William Engdahl is strategic risk consultant and lecturer, he holds a degree in politics from Princeton University and is a best-selling author on oil and geopolitics, exclusively for the online magazine “New Eastern Outlook”.