Risk of financial crisis 90% higher than previously estimated

[Eboard10]

A team of researches was able to estimate the systemic risk of another financial crisis due to the increased interconnectivity of the banking system by taking into account derivatives, securities and foreign exchange exposure on top of interbank loans. The study showed the risk to be 4 times higher than before the 2008 crisis and 90% higher than other studies that take into account only interbank loans, which is what the market bases its measures on. It goes on to say that the real systemic risk is likely to be even higher when including other measures such as overlapping portfolios and funding liquidity.

What it basically means is that when the next financial crisis hits the markets, the losses due to increased interconnectivity between financial institutions will be much bigger compared to the past, so be prepared for a recession that is going to be much worse than the last one and consider the possibility of not being able to retrieve your savings when planning for the future.

http://phys.org/news/2015-09-financial-crisis-higher-previously.html

The study, published in the journal Financial Stability, introduces a new method that allows researchers to estimate the systemic risk that emerge from multiple layers of connectivity.

"Systemic risk is the risk that a significant part of the financial system stops working—that it cannot perform its function," says IIASA Advanced Systems Analysis program researcher Sebastian Poledna, who led the study. For example if a major bank fails, it could trigger the failure of other financial institutions that are linked to it through loans, derivatives, securities, and foreign exchange exposure. The fear of such contagion is what drives governments to bail out banks.

"Previous studies of systemic risk had just examined one layer of this system, the interbank loans," says Poledna. The new study expands this to include three other layers of connectivity: derivatives, securities, and foreign exchange. By including the other layers, Poledna and colleagues found that the actual risk was 90% higher than the risk just from interbank loans.

Currently, financial regulators tend to use market-based measures to estimate systemic risk. The researchers find that these measures also underestimate the actual risk. In Mexico, which the researchers used as a case study, they found that systemic risk levels are about four times higher today than before the financial crisis—yet these risks are not reflected in market-based measures.

"Banks today are far more connected than they were before the financial crisis," explains Poledna. "This means that in a new crisis, the public costs for Mexico could be four times higher than those experienced in the last crisis,"

The new method would make it possible to create systemic risk profiles for markets and individual institutions, which could prove useful for financial regulators aiming to prevent future crises.
In addition, the methodology provides a way to estimate the cost and repercussions of a bank failure, which could help financial policymakers determine whether a bailout would be worth the cost. Bank bailouts come at a huge cost to taxpayers, yet until now, there has been no clear method of determining the cost to the system of not bailing out a failing bank.

Poledna points out that the new method may still underestimate systemic risk, as it leaves out two additional potential sources of risk - overlapping investment portfolios, and funding liquidity. The researchers are now working in collaboration with the IIASA Risk, Policy and Vulnerability program on a new study that brings in these additional layers.

The study relied on data from the Mexican banking system but the researchers say that the method could be used for any country, as long as the data were available.

Abstract of paper analysing data from the Mexican banking system between 2007-2013 to estimate systemic risk.

http://www.sciencedirect.com/science/article/pii/S1572308915000856

Abstract

The inability to see and quantify systemic financial risk comes at an immense social cost. Systemic risk in the financial system arises to a large extent as a consequence of the interconnectedness of its institutions, which are linked through networks of different types of financial contracts, such as credit, derivatives, foreign exchange, and securities. The interplay of the various exposure networks can be represented as layers in a financial multi-layer network. In this work we quantify the daily contributions to systemic risk from four layers of the Mexican banking system from 2007 to 2013. We show that focusing on a single layer underestimates the total systemic risk by up to 90%. By assigning systemic risk levels to individual banks we study the systemic risk profile of the Mexican banking system on all market layers. This profile can be used to quantify systemic risk on a national level in terms of nation-wide expected systemic losses. We show that market-based systemic risk indicators systematically underestimate expected systemic losses. We find that expected systemic losses are up to a factor of four higher now than before the financial crisis of 2007–2008. We find that systemic risk contributions of individual transactions can be up to a factor of one thousand higher than the corresponding credit risk, which creates huge risks for the public. We find an intriguing non-linear effect whereby the sum of systemic risk of all layers underestimates the total risk. The method presented here is the first objective data-driven quantification of systemic risk on national scales that reveal its true levels.

 

[Kisito]

_https://news.vice.com/article/islamic-state-claims-to-mint-gold-coins-in-effort-to-drive-us-to-financial-ruin

I heard that it will not be a single stock or financial Krak but also money. The global elite should know this, and there might have a connection with the new currency of the Islamic State! The elite prepares for the end of the system? In the competitor to gold, we might arrive at the final sprint.

 

[Jtucker]

IMO, Mike Whitney has been one of the best financial analysts over the past ten years. He started to pull together the indicators of the U.S. housing bubble in 2007 and tracked it to the 2008 crash.

Here's his latest article which I think lays out the underlying fallacies that have propped up asset prices in the market since their bull run 2011 until now.

http://www.globalresearch.ca/return-to-crisis-things-keep-getting-worse/5473321

There is NOTHING buttressing asset prices on the NYSE/TSX/S&P. These prices and indexes are bolstered by stock buy backs leveraged against zero interest loans that major share holders have taken out. This doesn't even take into account the magical, imaginary world of derivatives which are valued at triple global GDP. But even with a 1929/1987 level crash of the NY stock Exchange, this doesn't mean a global meltdown because it's not reality on the ground. The damage has already been done.

As Eboard mentioned, western markets rely on (plus China to a certain extent) "Inter-bank" trading of fake fiat currency. But from what I've experienced in transportation and manufacturing in North America for the past 20 years, is that there has been a mass de-industrialization and de-manufacturing starting with NAFTA in the 90's and rapidly accelerating since the 2008 crash.

Nothing has recovered since 2008 in reality. Only asset prices on stock indexes. Canadian and American news trumpeted GDP growth. But I believe it was all a renewed (time-loop?) love of resource extraction fueled by commodity prices that were directly inflated by fracking in North Dakota/Texas/Alberta - as well as new mountain top coal extraction in Appalachia. This was combined with taking Iran and Iraq offline to a certain extent.

Fracking can't actually work, because the volume of gas/oil it extracts exponentially declines after a short period. This had to be known by the investors as traditional oil patches in western Canada have been pumping since the 60's with no additional exploration or expansion of those initial wells. Harper must have known this and he combined his Ontario banking connections with Alberta oil barons to blow a completely imaginary bubble while also selling out manufacturing in Quebec (another long story in Canadian politics).

In terms of actual retail purchasing power in the USA, Wal-Mart is beginning to squeeze price points on suppliers like Nestle and Hershey because they are losing customers to Dollar General. So you have a population of people that were trying their best to shop for value and save money by patronizing Wal-Mart, that now can't afford it. There seems to me to be nowhere to go down from retail purchasing for staple goods than Dollar Stores.

That being said, I think the best indicator of "wealth" in North America is Food Bank participation. If you look at these stats for our local area, it's pretty shocking. http://winnipegharvest.org/winnipeg-harvest-statistics/

I can say from the people of my generation and my parents generation that this trend is directly related to wage decline against real inflation, loss of local democratic control, and an increase in big bank/financing as a part of government expenditures as well as personal debt.

 

[Eboard10]

Thanks for sharing your thoughts Jtucker and yes, I agree that the stock market isn't reflecting the true economy. What's driving stock price inflation is more likely increased liquidity due to the various QE programmes at near-zero interest rates, coupled with the current perception that the economy is recovery, which reduces investor's aversion to risk and encourages them to invest in certain assets and stocks.

Last year, I read an interesting article in which the author lays out the most probable reasons behind the ongoing asset price inflation, which is predominantly caused by a fall in liquidity preference, i.e. businesses and households reducing their liquidity balances due to a drop in risk aversion, and acquire other assets which then leads to an increase in demand for those assets and hence inflates the price, using basic supply and demand logic.

QE To Propel Market Treacherously Higher After Taper Ends

Summary

After the taper:

• Abnormally high supply of accumulated liquidity + normalization of liquidity preference = surging asset prices.
• Almost by definition, the taper will end just as risk aversion and liquidity preference have barely begun to normalize.
• In this context, stock prices will probably rise sharply for 1-2 more years, but with valuations already stretched, this will be an unprecedented and treacherous time in US history.

[...]

The effectiveness of monetary stimulus depends entirely on the evolution of liquidity preference (i.e. demand for liquidity). [...] Liquidity preference is largely a function of risk aversion. As confidence in the ongoing economic recovery deepens and consolidates, risk aversion on the part of households and businesses will tend to decline, and one symptom of this will be a decline in liquidity preference by these economic actors. What this means is that households and businesses will tend to feel like they don't need to hold as much of their assets in cash and a cash equivalents; they will prefer to hold less cash and more of other types of consumer and/or investment goods. [...] As liquidity preference normalizes (i.e. falls), the demand for certain types of goods and services will rise and inflation in the prices of these goods will tend to occur. This process has been going on with stock prices for some time now and it is likely to continue to occur as long as the total stock of money remains abnormally high and liquidity preferences continue to normalize.

 

[Niall]

90% higher?

I can assure you that a financial crisis is 100% guaranteed!

 

[Mr.Cyan]

90% higher?

I can assure you that a financial crisis is 100% guaranteed!

Yeah, fully second that !

Its amazing listening to the news daily, how ignorant some mainstreams analyst are - not sure if this is deliberate or accidental. Listening to the news and opinions of market analysts daily; although they admit to volatility and uncertainty, they are still trying to provide rational economic explanations - that means a majority are still thinking that whatever crisis down the line, it will be manageable, and just part of the normal economic cycles......sigh!

 

[Eboard10]

90% higher?

I can assure you that a financial crisis is 100% guaranteed!

Yeah, fully second that !

Its amazing listening to the news daily, how ignorant some mainstreams analyst are - not sure if this is deliberate or accidental. Listening to the news and opinions of market analysts daily; although they admit to volatility and uncertainty, they are still trying to provide rational economic explanations - that means a majority are still thinking that whatever crisis down the line, it will be manageable, and just part of the normal economic cycles......sigh!

I totally agree that the likelihood of another financial crisis to happen is 100% as it's a cyclical occurrence. In that sense, the title of the article in the OP is misleading as what the study is actually saying is that if a bank were to fail, a la Lehman Brothers, the risk that other financial institutions would be affected as badly is 90% higher than previously assumed, when taking into account financial instruments such as derivatives, securities and currency fluctuations.

 

[SeekinTruth]

Yup, a financial crisis IS 100% guaranteed. The way things are framed in the media, it's as if it's something that only happened once or twice. The fact is that we've been having perpetual financial crises, and they've just been getting worse. The whole financial and banking system is a scam and it's impossible NOT to have crises.

All that said, it's just about impossible to say exactly when the next dominoes will start to fall. Like in the 2007-2008 crisis, it's better to be anticipating it and getting ready for it as I was doing from 2005, than to be caught unprepared. Everything is pointing to the next crisis being MUCH worse than 2008....