Is The Financial Sector Under Siege? - Financial Giants Vs. The Dodd Frank Act

by: Michael Filighera

Is the Status Quo being challenged?

What is a social movement? More often than not it pertains to an issue of sizeable magnitude that has grown over time and includes measurable societal swings of the current culture. Both socially and economically.

George H.W. Bush's 1989 Presidential Inaugural Address included the following:

"I have spoken of a thousand points of light, of all the community organizations that are spread like stars throughout the Nation, doing good. We will work hand in hand, encouraging, sometimes leading, sometimes being led, rewarding. We will work on this in the White House, in the Cabinet agencies. I will go to the people and the programs that are the brighter points of light, and I will ask every member of my government to become involved. The old ideas are new again because they are not old, they are timeless: duty, sacrifice, commitment, and a patriotism that finds its expression in taking part and pitching in." - President George H.W. Bush "Inaugural Address, January 1989.

The message behind the speech was ingenious, so veiled and secreted that ultimately only 1% of the population would be allowed to participate and benefit from it. This cycle of right sided ideology, has continued to pick up momentum albeit deceivingly quiet and extremely patient for the last twenty-three years and counting. The plan has been slowly but faithfully implemented in a three giant leaps forward, one small step back, five giant leaps forward, three teensy little steps back, thirteen gigantic obviously purchased at the expense of the ninety-nine percent leaps forward - forgive me for leaning towards the extreme with that analogy.

The pattern continues until the impetus diminishes and the weight of the pendulum drives momentum in the opposite direction. The power of a pendulum this big swinging from the right peak to the middle trough to the left peak, most often goes un-noticed for the better part of the directional change.

But change it does.

Clark Kerr, the first Chancellor of UC Berkeley is credited with saying:

The status quo is the only solution that cannot be vetoed.

-Meaning that the status quo cannot simply be decided against;action must be taken if it is to change.

The current status quo is no longer sustainable. The game of musical chairs has dwindled to less than a handful of players. Has the direction changed - yes. And change of this magnitude does not require societal co-operation of or adherence to in order to be successful. And that is applicable in both directions of the swings. Socioeconomic trends do cycle some faster than others, and some larger than others.

TBTF sectors under siege -

According to a 2012 Fitch Ratings report JP Morgan, Bank of America, Goldman Sachs, Citigroup, Morgan Stanley, and Wells Fargo hold over 75% of the total derivatives assets and liabilities from a review of 100 large corporations spread across the major industry groups.

At the end of 2011 the notional amount * of all derivatives held by the 100 companies was $300 trillion, which has remained constant give or take $10 trillion since 2009. During the same period (2009-2011) credit derivatives, the ultimate patsies for the most recent economic crisis, declined by 40% to $21.6 trillion.

* - Webster's defines notional as:

  • abstract, theoretical, or speculative, as reflective thought.
  • not real or actual; ideal or imaginary: to create a notional world for oneself.

On a financial instrument it is the nominal or face value that is used to calculate payments and generally does not change hands.

Generally, as in the Mexican (Peso) financial crisis of 1994, the Thai Baht crisis of 1997, or mother of all crisis the financial collapse of 2008. Ok, so generally does not imply always. Fact is that the derivative market carries a "nominal value" of close to $800 trillion globally. I don't know about you but I feel better sleeping at night knowing that most of that $800 trillion will never change hands. Who would have thought that the world's largest financial players are not "really" taking that much risk -- I mean come on it's only Monopoly money!

Research and Analysis

The Dodd Frank Act (DFA) is slated to significantly alter the regulatory landscape for OTC derivatives once it is fully implemented. An interesting observation by Fitch is that once the smoke clears it will be non-financial firms that take the brunt of increased collateral requirements and the cost of compliance.

The Volcker Rule is also being finalized with expectations for full implementation by 2014. The impact to the derivatives activities within the TBTF financial institutions is anticipated to be minimal via the DFA (Push out provision) and while still uncertain via the Volcker Rule it is expected to be more "constraining".

Implementation of DFA rules as it pertains to derivative clearing organizations and in its current form may fail to accommodate all of the major counterparties by reducing the ability of the DCOs to offset their derivative exposures.

Taken a look at the chart(s) of JP Morgan (NYSE:JPM), Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), Wells Fargo (NYSE:WFC), the Chicago Mercantile Group (NASDAQ:CME), New York Stock Exchange Group (NYSE:NYX), or Nasdaq OMX (NASDAQ:NDAQ) lately? Looks grim in comparison to the Dow Jones Industrial Average (DJIA), S&P 500 (SPX), or Russell 2000 (RUT). Anybody else want to venture a guess as to why?

Currently, the uncertainty is verifiable. Until the reasons are resolved managing risk is paramount.

Chicago Mercantile Group

The pattern in progress, which began off of the 2009 lows should still have upside life to it. Resistance at the 330.40 area may contain upside and pinpoint the turn. The larger trend in play which began at the 2007 high points to another "slap down" taking place. The previous produced inflicted a 77% decline. The long term picture for the CME would have to include the potential for a 330 area top followed by a tumble to the 100 area.

New York Stock Exchange Group

Not a pretty picture for the NYSE! Short term additional upside momentum should begin to wane around the 31 to 35 area. Thus far though the NYX has been unable to retrace even 38% of its decline from the 2007 high to the 2009 low. The mid to long-term prognosis would remain negative even if prices were to spike towards 40 or 50. The 2007 - 2009 decline stripped 87% off of prices. Is it possible this could happen again - should it - look out below. Sure support should be found at 21, 20, 14, and 12 -- but the measured move indicates 5.


After losing 72% of its value in 2008-2009, the Nasdaq is the only exchange of the 3 presented that managed to regain at least 38% of the 2008-20009 decline reaching 29.71 back in February 2011. And that point may mark the mid to long-term high for now. If this is the case look for the bottom channel line to be easily rendered useless as prices break below 20.

JP Morgan Chase

JPM seemed to be the stalwart defender of the banking sector until its recently "dethroning" by a $2 billion and growing derivatives trading loss. Even before that revelation though,it would appear that the trade for the last 5 years has been write covered calls using the 50 strike price. The near term picture should include a continued "bounce" off the "revelation" decline. Resistance at the 36.80 to 40 area should hold before another leg down begins. Will JPM revisit the 12 to 15 area - it is highly probable.

Bank of America

On a technical basis it would appear that BAC holds the strongest potential for any long term gain(s). While the chart pattern does suggest and leave open the potential for a finishing decline to drop prices below 4.91 (and likely closer to if not below 2009's amazing 2.49 low) it appears that most of the price damage has been seen during BAC's initial fall from grace in 2008-2009 when BAC lost approximately 95% of its value. Near term a break below 6.71 would give credence to the "finishing" decline to be underway and 4.90 should not hold. A break above 10 does not sound the "all-clear". The stock would need to break above 20 for that to be registered.

Wells Fargo Bank

After losing 80% of its value in 2008-2009 WFC has been one of the few financial institutions to rebound exceeding 62% of its decline. While the last couple of years have basically produced a 12 point range bound area of trade, it appears that this will be broken over the longer term. Near-term though, don't rule out yet the potential for WFC to turn and zip towards resistance at the 36 to 37 area. Should that occur, and be the launching point for a stronger down leg the road lower will be similar to what was seen in 2008-2009. Downside estimates include an ultimate revisit if not break below the 7.50 low seen in March 2009.

Goldman Sachs

The price action for GS is not a strong testament for the company. After losing 80% of its value GS did put in a stellar recovery reaching what looks to be a longer term high in 2010 at 188.19. The deck appears to be stacked against the company with a major component of that being a strong loss of buying support. The technical picture suggests a break below 90 would clear the path for retest of the 2008 lows. Should this occur don't expect GS to give up without a "fight" as volatility gets kicked up through the roof.


The implementation of the Dodd Frank Act and the Volcker Rule continues. When it will be fully implemented is still a best guess. At the moment a December 2012 deadline is still being used. But that doesn't seem possible since several aspects of both the DFA and the Volcker Rule will take an additional 2 years before full compliance is reached.

The publicly traded companies listed within the body of this article are valued in the trillions of dollars. Yes, they truly are too big to fail. Current market action in these companies suggests many are already giving a no-confidence vote. Will JPM, BAC, WFC, C, GS and MS be able to off load or spread $300 trillion worth of risk? That is the question. Each of these companies could sustain major losses in excess of what just took place at JP Morgan.

A short 4 years ago the same crowd was saying there was "No way, Lehman, Bear Stearns, or Merrill Lynch could fail". Yet all did. The "what if" would become reality if these huge financial conglomerates can't shift their risk or close the positions. If implementation of DFA and the Volcker Rule force the issue - who will be willing to take the other side of the trade? Who is big enough? Unfortunately, my guess is the poor taxpayer and of course this would be after the current Congress gives additional tax cuts to the top tier. The same tier of decision makers that created, implemented and walked away without taking any responsibility or accountability for the financial ruin of generations to come.

Evaluating and hedging risk can be a difficult task. But one that should not go undone. The current climate is changing. The status quo is changing. Personally, I prefer not to fight the trend whether I agree with it or not. Denial is a never a winning position. Limiting risk and hedging against the "what if's" until the global economies get back on track will keep you in the game and hopefully add to your winning streak!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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