Could Volcker Rule Precipitate Next Financial Crisis?

December 17, 2013

I am not certain how we should react out of the gate to the situation with Zions Bancorp. Utah’s largest banking group revealed that it will take a one-time $387 million post-tax charge, based on its interpretation of the Volcker rule. Essentially, Zions believes that the Volcker rule dictates that it can no longer hold CDOs of bank and insurer-issued trust preferred securities (TruPS).

Zions anticipates that in the fourth quarter of 2013 it will reclassify all covered CDOs that currently are classified as “Held to Maturity” into “Available for Sale,” and that all covered CDOs, regardless of the accounting classification, will be adjusted to Fair Value through an Other Than Temporary Impairment non-cash charge to earnings.

The size of the write down is “more than Zions has earned for any calendar year since 2007,” according to Bloomberg. If Zions is interpreting the rule correctly, the assets in question would have to be divested by July 21, 2015 (with the possibility of a 2-year extension), so the actual loss by the time the asset is disposed of could be far larger.

One can also be reasonably assured that the crack legal teams at all the other banks are closely examining the Volcker Rule to determine the possible implications. I have always felt that if the banks were forced to mark their derivatives to market rather than carrying them at cost, it could precipitate another financial crisis. As many of you already know, derivatives risks can quickly roll from one institution to the next as margin calls are made and securities dumped to meet them. That is why Warren Buffett once called derivatives ‘financial weapons of mass destruction.” The effect is like a nuclear chain reaction that could get out of control.

Zions movement of these questionable assets into the “Available for Sale” category is the first step toward dumping them, but one has to wonder who — if anyone — might be a buyer. This is not a situation where you want to be the last one out the door, and so there is the risk that this becomes a self-fulfilling prophecy even before there is any kind of final interpretation of the Volcker rule as it relates to such assets.

Bloomberg’s Jonathan Weil summed it up thusly:

“In other words, the accounting rules had been letting Zions maintain a fiction. The bonds didn’t refrain from falling in value just because they were classified as held-to-maturity. A bond doesn’t care what its owner intends to do with it.”

There are trillions of dollars worth assets sloshing around the U.S. and global financial systems that are marked-to-fiction. If there is a mad dash to dump these assets, the beating the balance sheet of Zions is taking will look like child’s play.

Could a rule designed to re-instill confidence in the U.S. financial system instead end up shaking it to its very foundation? We smell smoke, so there very well could be a fire here. We will be monitoring this story closely in the weeks ahead.

Many of you will remember that the financial crisis of 2008 began quietly and then quickly spun out of control. This is exactly why our clients prefer to hold some of their wealth in a physical asset with no counter-party risk. That asset is of course gold. When I first read of Zions Bancorp and began to think abut the possible repercussions, I was reminded of a quote from Richard Russell posted here recently:

“A few thoughts about gold. Never buy gold for a profit, gold is a measure of wealth. Count your gold holdings in the number of ounces, not the current worth in dollars. You don’t price the home you live in every day, or with each passing week. Nor should you price your gold holdings in dollars with each passing day. Gold is a timeless wealth asset; an asset that will have a value with the passing of time.

Remember this: Of the original issues that made up the Industrial Average, only one remains. And that stock is General Electric. And what happened to all the rest? In investing, nothing is permanent except gold. But remember, do not buy gold with the idea of making a profit. Buy gold because it is pure wealth, and may be the last man standing.”

It is the part about the last man standing that I think is worth passing along again today in light of breaking events.

To get you on track with this situation, here are several good takes on the story:

As First Volcker Rule Victim Emerges, Implications Could “Roil The Market” from ZeroHedge

Zions bank becomes early Volcker casualty from The FT

Volcker Rule Blame Game Begins from Bloomberg

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(Courtesy of http://www.usagold.com )

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