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Could Falling Oil Prices Create The Next Financial Disaster For Mom And Pop Investors?

December 2, 2014 Blog

While consumers and the media seem euphoric over falling oil and gasoline prices, the crash in the oil market is a true cause for concern for America’s already beleaguered investing public.

The implications of falling oil – down 30% since June – is far reaching, both nationally and overseas. Wall Street banks and community banks are huge lenders for companies whose fortunes are tied to oil revenues. Indeed, Wall Street and smaller lenders have hitched themselves to the boom in the U.S. energy industry, underwriting billions in dollars of bonds issued by energy companies to fuel an unprecedented expansion in the energy sector.

Repercussions from the decline in the price of crude are spreading beyond the energy sector, hitting currencies, national budgets and energy company shares.

Just as real estate values were bound to collapse, so was the price of oil. What comes up must come down, a child’s lesson that the geniuses on Wall Street seemingly can’t master.

And just like the mortgage crisis, collapsing oil prices could result in massive loan defaults that will burn Mom and Pop investors in high-yield junk bonds of energy companies and ETFs. The fledgling oil shale boom in the Dakotas and the development of the Keystone Pipeline could also be casualties of the oil collapse, resulting in employment retrenchment.

Just this summer, big banks were betting heavily on the U.S. energy boom, just as they once bet big on mortgages.

“Wells Fargo & Co is angling to cash in on the U.S. energy boom, as the fourth-largest U.S. bank looks for new avenues of revenue growth to overcome a slump in mortgage lending, its traditional driver of profits,” according to a July report from Reuters.

Doesn’t this sound strangely familiar? Substitute the phrases “oil and gas” and “petroleum” with “real estate,” and shivers go up the spine. According to Reuters, “The bank is increasingly looking for lending, investment banking and investing opportunities in the oil and gas sector. It says it now employs the largest staff of petroleum engineers of any U.S. bank.”

Fast forward five months, and the forecast is far less rosy. “Banks including Barclays and Wells Fargo are facing potentially heavy losses on an $850 million loan made to two oil and gas companies, in a sign of how the dramatic slide in the price of oil is beginning to reverberate through the wider economy,” according to a report last week by Tracy Alloway of the Financial Times.

“Details of the loan emerged as delegates of OPEC, the oil producers’ cartel, gathered in Vienna to address the growing glut in the supply of oil,” Alloway reported. “Several OPEC members have been calling for a production cut to shore up prices, but Saudi Arabia, OPEC’s leader and largest producer, signaled that it would not push for a big change in the group’s output targets.”

And to make matters worse, investors in high-yield junk bond mutual funds – a popular product pushed by financial advisors – are extremely exposed. For example, nearly thirty percent of the distressed debt in the Merrill Lynch high-yield bond index was issued by energy companies.

Could a crash in oil prices result in a widespread financial calamity similar to the one that followed the 2008 Lehman Brothers bankruptcy? Or will it be a more contained and focused threat to investors, like those who purchased Puerto Rico government bonds packaged by investment bank UBS? Time will tell, but one thing is for certain, low gas prices are pleasing at the pump, but potentially catastrophic for Mom and Pop investors.

Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions.