NEW YORK (Reuters) – Wall Street banks are facing a "systemic margin call" that may deplete banks of $325 billion of capital due to deteriorating subprime U.S. mortgages, JPMorgan Chase & Co (JPM.N), said in a report late on Friday.
"A systemic credit crunch is underway, driven primarily by bank writedowns for subprime mortgages," according to the report co-authored by analyst Christopher Flanagan. "We would characterize this situation as a systemic margin call."
"Systemic Margin Call" – that's rich.
A margin call happens when you are trading "on leverage" and the money in your account falls below a critical level and you get a call from your broker saying "Hey! Put more money in your account or we're going to sell your positions for wherver we can get for them!".
It works like this. Suppose the margin requirement to trade a single gold contract is $5,000 and the contract is for 100 ounces of gold, or ~$100,000. That is, with a $5,000 investment you are tied to $100,000 of gold. So your leverage is 100,000/5,000 or 20 times.
Now further suppose that gold falls a bit in price and now your formerly $100,000 in gold is worth only $90,000. To maintain the $5,000 margin you'd have to put $10,000 into your account…or your account will be liquidated, your original $5,000 investment completely lost PLUS you'd get a bill for the remaining $5,000 that was lost.
And that's what is being described here but on a much, much larger scale and the problem with things at this scale is really this; who exactly is going to buy the assets being liquidated to meet the margin call?
Where we would find a ready buyer for a 100 ounces of gold, we might find zero buyers for $325 billion in dodgy debt which means we'd face the very real prospect that the losses would multiply and ripple through the system.
The term I used, and still use, in my seminars is "cascading cross defaults".
As the name implies, because party A is wiped out, party B gets wiped out and so party C gets taken down and so on without end until you hit bottom. that's what we're facing here and is why you should plan on the Federal Reserve doing everything it can to prevent that occurance.