Yesterday, the S&P 500 and Nasdaq set new record highs for the sixth straight trading session. The Dow Jones Industrial Average, however, closed in the red. That’s because two high-priced bank components of the Dow, Goldman Sachs and JPMorgan Chase, closed in the red and helped to pull the index into negative territory. (The Dow Jones Industrial Average is a price-weighted index.)
As the chart above indicates, the declines in Goldman and JPMorgan were part of a major bank selloff yesterday – a striking and disturbing divergence from the broader indices. It would be impossible to have a healthy stock market going forward if the mega banks that finance the bulk of corporate activity descend into a downward spiral.
Among the worst bank performers yesterday were three foreign global banks that have a heavy presence on Wall Street: the British bank, Barclays (BCS), lost 5.56 percent; Swiss bank, Credit Suisse (CS), gave up 4.73 percent; while German mega bank, Deutsche Bank (DB), closed down 4.64 percent.
Foreign global banks are heavily interconnected to U.S. mega banks via derivatives. The banks serve as counterparties to each other in making private contract derivative bets on everything from credit defaults to equities to foreign exchange. These private contracts are known as bilateral over-the-counter (OTC) derivative trades and lack a central party clearing platform to stand behind the wager. This is what led to the collapse of the giant insurer, AIG, in 2008 and resulted in it being nationalized for a time by the U.S. government.
That type of derivatives hubris was supposed to have been reformed under the Dodd-Frank legislation of 2010 but, in reality, very little has meaningfully changed.