The Ultimate Wall Street Nightmare

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Martin D. Weiss, Ph. D. discusses how Federal Reserve Chairman Bernanke and Secretary Paulson are acting as if the Lehman Brother's demise is no great trauma. In this issue of Money and Markets, Dr. Weiss explains how the collapse of America's third-largest brokerage operation is such a serious problem.

Martin D. Weiss, Ph. D. discusses how Federal Reserve Chairman Bernanke and Secretary Paulson are acting as if the Lehman Brother's demise is no great trauma. Dr. Weiss explains how the collapse of America's third-largest brokerage operation is such a serious problem.

If the Fed openly admitted that the Lehman collapse will paralyze Wall Street, torpedo the stock market and sink the economy, they'd have to come up with $100 billion or more to support it. Instead, their agenda has been to push big banks to put up the money. Either way, there's no denying that the Lehman debacle is a massive and immediate threat to U.S. and global markets. At the latest reckoning, Lehman had $691 billion in assets. Lehman's debts at $668.6 billion are also enormous. Among brokers, there are only two other U.S. firms that beat Lehman in the debt category: Morgan Stanley with $1 trillion, and Merrill Lynch with $988 billion. The collapse of America's third-largest brokerage operation is very serious business with equally serious consequences. The primary concern is defaults on derivatives.

Derivatives are essentially bets on interest rates, foreign currencies, stocks or specific events like the bankruptcy of a particular company. The interest rate-related bets are by far the biggest, but the bets on bankruptcies, called credit default swaps, are the fastest growing and the most volatile. These derivatives were originally designed to help hedge investments reduce risk, like insurance policies. But in practice, they've been increasingly used to leverage investments, increasing the risks of participants. The following facts illustrate the enormity of the problem:

  •     The total face value of derivatives held by U.S. banks is $180 trillion; it's three times that much globally. This figure is said to overstate the actual market risk, but it does not overstate the risk of defaults such as those that could be triggered by the failure of a company the size of Lehman Brothers.
  •     Over 90% of all derivatives are traded outside of regulated exchanges. Consequently, other than very general information, the authorities have no mechanism for keeping track let alone efficiently cleaning up the mess in the wake of a giant failure.
  •     Some companies report nothing more than the total value of their derivatives in footnotes to their financial statements. Others don't report at all. Consequently, the actual risk, amounts and even the very existence of derivatives is often poorly disclosed to investors.
  •     Disclosure in the brokerage industry is especially bad. Many brokerages are private and do not disclose more than their rank and serial number. The SEC collects sparse data and does not publish it. So it's very difficult to figure out how much derivates risk your broker is exposed to.
  •     Nearly 97% of all U.S. bank-held derivatives are concentrated in the hands of just five major U.S. banks: JPMorgan Chase, Citibank, Bank of America, Wachovia and HSBC.
  •     The pile up of derivatives greatly exceeds the total assets of the firms. At the same time, in most cases, the default risk related to these holdings greatly exceeds the banks' capital.
  •     Big brokers are also loaded with derivatives. Merrill Lynch has $4.2 trillion. Morgan Stanley has $7.1 trillion. As best we can determine, Lehman Brothers has significantly less, $729 billion. But in proportion to its dwindling capital, its exposure seems to be among the worst.
  •     The capital of major firms has been further weakened by recent losses and the failure to raise enough capital to cover them.

"Consistently, in bank after bank, the losses suffered from the mortgage and credit crisis have exceeded the amount of new capital they could raise. This was true when investors still had confidence in their ability to overcome the difficulties, and it is true now. Here's the great dilemma: The tangled web of bets and debts linking each of these giant players to the other is so complex and so difficult to unravel, it may be impossible for the Fed to protect the financial system from paralysis if just one major player defaults. And if Lehman is not that player, the next one will be," Dr. Weiss states.

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Martin D. Weiss, Ph.D., founder and president of Weiss Research, Inc. and a leading advocate for investor safety, is a nationally recognized expert on domestic and international financial markets. With more than 35 years of experience, including many years in Latin America and Asia, Dr. Weiss has helped empower millions of investors to make better financial decisions through his monthly Safe Money Report and daily Money and Markets.

Dr. Weiss' keen understanding of foreign markets and the global economy has earned him a reputation for thoughtful, in-depth analysis that investors can rely upon to make informed financial decisions. Regularly called upon by the media for his independent investing guidance, he has been featured in publications nationwide, including The Wall Street Journal, The New York Times, Chicago Tribune, Investor's Business Daily, and Forbes and has also appeared on CNN and CNBC.

Throughout his career, Dr. Weiss has been an advocate for consumers and investors in the insurance, banking and brokerage industries, dedicating his time and resources providing analysis and data for Congressional testimony, constructive proposals for reforms in the securities industry and legislation for full financial disclosure as well sound accounting and fiscal policy. In November 2004, he launched the Sound Dollar Committee, a nonprofit organization dedicated to building a network of investors seeking to protect the nation's future by demanding honesty in government accounting, a balanced budget and sound economic policy.

Dr. Weiss is author of The New York Times best-seller, The Ultimate Safe Money Guide, which gave baby boomers a road map to grow their wealth safely. It was listed on the New York Times Business, Wall Street Journal, and BusinessWeek best-seller lists, as well as the Barron's Roundup for 2002.

Dr. Weiss holds a bachelor's degree from New York University, a Ph.D. from Columbia University and is fluent in eight European and Asian languages.

Money and Markets ( is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit


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