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In an interview with the German finance newspaper Handelsblatt, former Secretary of the Treasury Hank Paulson expressed his concern that there will be another financial “firestorm” in the near future.

Paulson names several factors that could play a significant role in another crisis:

Ballooning derivatives markets, unregulated shadow banks, too big to fail banks, and Fannie Mae and Freddie Mac’s growing influence. Here are the figures, according to Yahoo! Finance, that are worrying Mr. Paulson:

Derivatives Market

Derivatives are investments that only get their value from the value of something else. They are extremely volatile and mostly unregulated. The 2007 market crisis was caused mainly by a breakdown in the derivatives market, specifically groups of mortgages and credit cards that were bundled and sold as investment vehicles. Currently, this market has ballooned from $586 trillion in 2007 to almost $633 trillion today.

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Shadow Banks

Shadow banks are mostly made up of hedge funds, private equity funds, and money market funds and are largely unregulated as well. Meaning they are not subject to capital requirements, making them extremely risky. Shadow banks are now half as big as regulated banks, with assets of $67 trillion, an obviously unstable situation.

Too Big To Fail Banks

When a bank gets “too big to fail,” it can start taking risks that, if they backfire, can send the economy into a tailspin. The five largest banks in the United States have over $8.3 trillion in assets, which is $2.5 trillion more than in 2007. These are the same banks that were mostly responsible for 2008’s crash and now they are bigger than ever. It’s easy to see why this would worry Mr. Paulson.

Fannie Mae and Freddie Mac

The final situation leading Hank Paulson to make his dire statements is the growing influence of the government controlled Fannie Mae and Freddie Mac.

Currently over 90% of mortgages are guaranteed by one of these two government agencies, which means that the government is determining the price and rules of mortgages, not the marketplace. The concern is that when the time-tested rules of supply and demand are not used to determine mortgage prices, the chance of another bubble forming increases dramatically.

Paulson said in his interview that “every financial crisis is the result of failed political measures, which lead to economic and financial bubbles.”

If Hank Paulson is correct, and another bubble is forming, then now would be a good time to start hedging investments with physical investments like gold coins. Gold finished today at a price of $1,313.30 an ounce.

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