90 THE BiG DROP
You might be saying to yourself: “Aha, so the banks are
going to have all the losses.”
Not necessarily. The banks are just middlemen. They might
have written that guarantee to an oil company and have to
pay the $30 difference in my example. But the bank may have
also gone out and sold the contract to somebody else. Then it’s
somebody else’s responsibility to pay the oil company.
Who could that somebody else be? It could be an ETF. And
that ETF could be in your portfolio. This is where it gets scary
because the risk just keeps getting moved around broken up
into little pieces.
Citibank, for example, might write $5 billion of these deriva-
tives contracts to a whole bunch of oil producers. But then, they
may take that $5 billion and break it into thousands of smaller
one or ten million dollar chunks and spread that risk around in
a bunch of junk bond funds, ETFs or other smaller banks.
When many oil producers went for loans, the industry’s
models showed oil prices between $80 and $150. $80 is the low
end for maybe the most efficient projects, and $150 is of course
the high end. But no oil company went out and borrowed money
on the assumption that they could make money at $50 a barrel.
So suddenly, there’s a bunch of debt out there that produc-
ers will not be able to pay back with the money they make at
$50 a barrel. That means those debts will need to be written off.
How much? That’s a little bit more speculative.
I think maybe 50 percent of it has to be written off. But let’s
be conservative and assume only 20 percent will be written-off.
That’s a trillion dollars of losses that have not been absorbed or
been priced into the market.
Go back to 2007. The total amount of subprime and Alt-A
loans was about a trillion. The losses in that sector ticked well
above 20 percent. There, you had a $1 trillion market with
$200 billion of losses.
Here we’re talking about a $5 trillion market with $1 trillion