Saturday, June 29, 2013

Collateral Transformation: The Latest, Greatest Financial Weapon Of Mass Destruction

Back in 2002 Warren Buffet famously proclaimed that derivatives were ‘financial weapons of mass destruction’ (FWMDs). Time has proven this view to be correct. As The Amphora Report's John Butler notes, it is difficult to imagine that the US housing and general global credit bubble of 2004-07 could have formed without the widespread use of collateralized debt obligations (CDOs) and various other products of early 21st century financial engineering. But to paraphrase those who oppose gun control, "FWMDs don’t cause crises, people do." But then who, exactly, does? And why? And can so-called 'liquidity regulation' prevent the next crisis? To answer these questions, John takes a closer look at proposed liquidity regulation as a response to the growing use of 'collateral transformation' (a topic often discussed here): the latest, greatest FWMD in the arsenal.
Submitted by John Butler of The Amphora Report,
Back in 2006, as the debate was raging whether or not the US had a mortgage credit and housing bubble, I had an ongoing, related exchange with the Chief US Economist of a large US investment bank. It had to do with what is now commonly referred to as the ‘shadow banking system’.
While the debate was somewhat arcane in its specifics, it boiled down to whether the additional financial market liquidity created through the use of securities repo and other forms of collateralized lending were destabilizing the financial system.
The Chief US Economist had argued that, because US monetary aggregates were not growing at a historically elevated rate, the Fed was not adding liquidity fuel to the house price inflation fire and that monetary policy was, therefore, appropriate. (Indeed, he denied that the rapid house price inflation at the time was cause for serious concern in the first place.) I countered by arguing that these other forms of liquidity (eg. securities repo) should be included and that, if they were, then in fact the growth of broad liquidity was dangerously high and almost certainly was contributing to the credit+housing bubble.
We never resolved the debate. My parting shot was something along the lines of, “If the financial markets treat something as a money substitute—that is, if the incremental credit spread for the collateral providing the marginal liquidity approaches zero— then we should treat it as a form of de facto money.”
He dismissed this argument although I’m not sure he really understood it; at least not until there was a run on money-market funds in the wake of the Lehman Brothers bankruptcy in November 2008. It was at that point that economic officials at the Fed and elsewhere finally came to realize how the shadow banking system had grown so large that it was impossible to contain the incipient run on money-market funds and, by extension, the financial system generally without providing explicit government guarantees, which the authorities subsequently did.
This particular Chief US Economist had previously worked at the Fed. This was and remains true, in fact, of a majority of senior US bank economists. Indeed, in addition to a PhD from one of the premiere US economics departments, a tour of duty at the Fed, as it were, has traditionally been the most important qualification for this role.
Trained as most of them were, in the same economics departments and at the same institution, the Fed, it should perhaps be no surprise that neither the Fed, nor senior economists at the bulge-bracket banks, nor the US economic academic and policy mainstream generally predicted the global financial crisis. As the discussion above illuminates, this is because they failed to recognize the importance of the shadow banking system. But how could they? As neo-Keynesian economists, they didn’t—and still don’t—have a coherent theory of money and credit.[1]


Time marches on and with lessons learned harshly comes a fresh resolve to somehow get ahead of whatever might cause the next financial crisis. For all the complacent talk about how the “recovery is on track” and “there has been much economic deleveraging” and “the banks are again well-capitalized,” the truth behind the scenes is that central bankers and other economic officials the world over remain, in a word, terrified. Of what, you ask? Of the shadow banking system that, I believe, they still fail to properly understand.
Two examples are provided by a recent speech given by Fed Governor Jeremy Stein and a report produced by the Bank of International Settlements (BIS), the ‘central bank of central banks’ that plays an important role in determining and harmonising bank regulatory practices internationally.
The BIS report, “Asset encumberance, financial reform and the demand for collateral assets,” was prepared by a “Working Group established by the Committee on the Global Financial System,” which happens to be chaired by none other than NYFed President William Dudley, former Chief US Economist for Goldman Sachs. (No, he is not the Chief US Economist referred to earlier in this report, although as explained above these guys are all substitutes for one another in any case.) [2]
In the preface, Mr Dudley presents the report’s key findings, in particular “evidence of increased reliance by banks on collateralized funding markets,” and that we should expect “[t]emporary supply-demand imbalances,” which is central banker code for liquidity crises requiring action by central banks.
He also makes specific reference to ‘collateral transformation’: when banks swap collateral with each other. This practice, he notes, “will mitigate collateral scarcity.” But it will also “likely come at the cost of increased interconnectedness, procyclicality and financial system opacity as well as higher operational, funding and rollover risks.”
Why should this be so? Well, if interbank lending is increasingly collateralized by banks’ highest quality assets, then unsecured creditors, including depositors, are being de facto subordinated in the capital structure and are highly likely to ‘run’ at the first signs of trouble. And if banks are holding similar types of collateral that suddenly fall in value, then they can all become subject to a run at the same time, for the same reason.
Collateral transformation is thus a potentially powerful FWMD. But don’t worry, the BIS and other regulators are on the case and doing the worrying. As a belated response to the financial crisis that they all failed to foresee, the latest, greatest trend in financial system oversight is ‘liquidity regulation’. Fed Governor Jeremy Stein explains the need for it thus:
[A]s the financial crisis made painfully clear, the business of liquidity provision inevitably exposes financial intermediaries to various forms of run risk. That is, in response to adverse events, their fragile funding structures, together with the binding liquidity commitments they have made, can result in rapid outflows that, absent central bank intervention, lead banks to fire-sell illiquid assets or, in a more severe case, to fail altogether. And fire sales and bank failures–and the accompanying contractions in credit availability–can have spillover effects to other financial institutions and to the economy as a whole. Thus, while banks will naturally hold buffer stocks of liquid assets to handle unanticipated outflows, they may not hold enough because, although they bear all the costs of this buffer stocking, they do not capture all of the social benefits, in terms of enhanced financial stability and lower costs to taxpayers in the event of failure. It is this externality that creates a role for policy. [3]
Ah yes, wouldn’t you know it, that ubiquitous, iniquitous enigma: market failure. Regulators have never found a market that doesn’t fail in some way, hence the crucial need for regulators to prevent the next failure or, at a minimum, to sort out the subsequent mess. In the present instance, so the thinking behind liquidity regulation goes, prior to 2008 the regulators were overly focused on capital adequacy rather than liquidity and, therefore, missed the vastly expanded role played by securitised collateral in the international shadow banking system. In other words, the regulators now realise, as I was arguing back in the mid-2000s, that the vast growth in shadow banking liquidity placed the stability of the financial system at risk in the event that there was a drop in securitised collateral values.
In 2007, house prices began to decline, taking collateral values with them and sucking much of the additional, collateral-based liquidity right back out of the financial system, unleashing a de facto wave of monetary+credit deflation, resulting in the subsequent financial crisis. But none of this was caused by ‘market failure’, as Governor Stein contends. Rather, there is another, simpler explanation for why banks were insufficiently provisioned against the risk of declining collateral values, yet it is not one that the regulators much like to hear, namely, that their own policies were at fault.
In one of my first Amphora Reports back in 2010 I discussed in detail the modern history of financial crises, beginning with the 1980s and concluding with 2008. A pattern rapidly becomes apparent:
[Newton’s] third law of universal motion was that for each and every action there is an equal and opposite reaction. While applicable to the natural world, it does not hold with respect to the actions of financial markets and the subsequent reactions of central banks and other regulators. Indeed, the reactions of regulators are consistently disproportionate to the actions of financial markets. In sinister dialectical fashion, the powers assumed and mistakes made by policymakers tend to grow with each crisis, ?thereby ensuring that future crises become progressively more severe...

[W]as the Fed’s policy reaction to the 1987 crash proportionate or even appropriate? Was it “an equal but opposite reaction” which merely temporarily stabilised financial markets or did it, in fact, implicitly expand the Fed’s regulatory role to managing equity prices? Indeed, one could argue that this was merely the first of a series of progressively larger “Greenspan Puts” which the Fed would provide to the financial markets during the 18 years that the so-called “Maestro” was in charge of monetary policy and, let’s not forget, bank regulation...

By the late 1980s, a huge portion of the S&L industry was insolvent. The recession of 1990-91, made a bad situation worse. FSLIC funds were rapidly depleted. But a federal guarantee is supposed to be just that, a guarantee, so Congress put together a bailout package for the industry. A new federal agency, the Resolution Trust Corporation (RTC), issued bonds fully backed by the US Treasury and used the proceeds to make insolvent S&L depositors whole...

In retrospect, the entire S&L debacle, from its origins in regulatory changes and government guarantees, through the risky lending boom, bust, credit crunch and fiscal and monetary bailout can be seen as a precursor to the far larger global credit bubble and bust of 2003-2008: Just replace the S&Ls with Fannie/Freddie and the international shadow banking system. But there is no need to change the massive moral hazard perpetrated by incompetent government regulators, including of course the Fed, and the reckless financial firms who played essentially the same role in both episodes.[4]
Notwithstanding this prominent pattern of market-distorting interest-rate manipulation, guarantees, subsidies and occasional bailouts, fostering the growth of reckless lending and other forms of moral hazard, the regulators continue their self-serving search for the ‘silver bullet’ to defend against the next ‘market failure’ which, if diagnosed correctly as I do so above is, in fact, regulatory failure.
Were there no moral hazard of guarantees, explicit or implicit, in the system all these years, the shadow banking system could never have grown into the regulatory nightmare it has now become and liquidity regulation would be a non-issue. Poorly capitalised banks would have failed from time to time but, absent the massive systemic linkages that such guarantees have enabled—encouraged even—these failures would have been contained within a more dispersed and better capitalised system.
As it stands, however, the regulators’ modus operandi remains unchanged. They continue to deal with the unintended consequences of ‘misregulation’ with more misregulation, thereby ensuring that yet more unintended consequences lurk in the future.


In his speech, Governor Stein also briefly mentions collateral transformation, when poor quality collateral is asset-swapped for high quality collateral. Naturally this is not done 1:1 but rather the low quality collateral must be valued commersurately higher. In certain respects these transactions are similar to traditional asset swaps that trade fixed for floating coupons and allow financial and non-financial businesses alike to manage interest rate and credit risk with greater flexibility. But in the case of collateral transformation, what is being swapped is the principal and the credit rating it represents, and one purpose of these swaps is to meet financial regulatory requirements for capital and, in future, liquidity.
An obvious consequence of such collateral transformation is that it increases rather than decreases the linkages in the financial system and thus in effect replaces firm-specific, idiosyncratic risk with systemic risk, exactly the opposite of what the regulators claim they are trying to do by increasing bank regulatory capital ratios. Liquidity regulation is an attempt to address this accelerating trend and the growing systemic risks it implies.
Those financial institutions engaging in the practice probably don’t see things this way. From the perspective of any one institution swapping collateral in order to meet changing regulatory requirements, they see it as necessary and prudent risk management. But within a closed system, if most actors are behaving in the same way, then the net risk is not, in fact, reduced. The perception that it is, however, can be dangerous and can also contribute to banks unwittingly underprovisioning liquidity and undercapitalizing against risk.
Viewed system-wide, therefore, collateral transformation really just represents a form of financial alchemy rather than financial engineering. It adds no value in aggregate. It might even detract from such value by rendering opaque risks that would otherwise be more immediately apparent. So I do understand the regulators’ concerns with the practice. I don’t, however, subscribe to their proposed self-serving remedies for what they perceive as just another form of market failure.


Already plagued by the ‘Too Big to Fail’ (TBTF) problem back in 2008, the regulators have now succeeded in creating a new, even more dangerous situation I characterise as MAFID, or ‘Mutual Assured FInancial Destruction.’ Because all banks are swapping and therefore holding essentially the same collateral, there is now zero diversification or dispersion of financial system risk. It is as if there is one massive global bank with thousands of branches around the world, with one capital base, one liquidity ratio and one risk-management department. If any one branch of this bank fails, the resulting margin call will cascade via collateral transformation through the other branches and into the holding company at the centre, taking down the entire global financial system.
Am I exaggerating here? Well, if Governor Stein and his central banking colleagues in the US, at the BIS and around the world are to be believed, we shouldn’t really worry because, while capital regulation didn’t prevent 2008, liquidity regulation will prevent the scenario described above. All that needs to happen is for the regulators to set the liquidity requirements at the right level and, voila, financial crises will be a thing of the past: never mind that setting interest rates and setting capital requirements didn’t work out so well. Setting liquidity requirements is the silver bullet that will do the trick.
Sarcasm aside, it should be clear that all that is happening here is that the regulators are expanding their role yet again, thereby further shrinking the role that the markets can play in allocating savings, capital and liquidity from where they are relatively inefficiently utilized to where they are relatively more so. This concept of free market allocation of capital is a key characteristic of a theoretical economic system known as ‘capitalism’. But capitalism cannot function properly where capital flows are severely distorted by regulators. Resources will be chronically misallocated, resulting in a low or possibly even negative potential rate of economic growth.
The regulators don’t see it that way of course. Everywhere they look they see market failure. And because Governor Stein and his fellow regulators take this market failure as a given, rather than seeking to understand properly how past regulatory actions have severely distorted perceptions of risk and encouraged moral hazard, they are naturally drawn to regulatory ‘solutions’ that are really just plagiarised copies of an old playbook. What is that definition of insanity again, about doing the same thing over and over but expecting different results?

[1] Neo-Keynesians will deny this, claiming that their models take money and credit into account. But they do so only to a very limited extent, with financial crises relegated to mere aberrations in the data. The Austrian economic school of Menger, Mises, Hayek, etc, by contrast, has a comprehensive and consistent theory of money and credit that can explain and even predict financial crises.
[2] The entire paper can be found at the link here (PDF).
[3] This entire speech can be found at the link here.
[4] FINANCIAL CRISES AND NEWTON’S THIRD LAW, Amphora Report Vol. 1 (April 2010). The link is here.

Thursday, June 27, 2013

Europe Make Cyprus "Bail-In" Regime Continental Template

Turns out that for Europe, Cyprus was a "bail-in" template after all, and following an agreement reached early this morning, Europe now has a joint failed-bank resolution mechanism. Several hours ago, EU finance ministers announced that they had reached agreement on the principles governing the imposition of losses on creditors in bank 'bail ins'. Having already agreed to establish "depositor preference" in the pecking order of creditors at risk, the stumbling block to agreement was the availability of flexibility at the national level to complement the bail in with injections of funds from other sources. Under the compromise achieved overnight, once a bail in equivalent to 8% of total liabilities has been implemented, support from other sources can be used (up to 5% of total liabilities) with approval from Brussels.
So investors (i.e. yield chasers) and not taxpayers will foot the cost of bank bailouts going forward for a change? Maybe on paper: "From 2018, the so-called “bail-in” regime can force shareholders, bondholders and some depositors to contribute to the costs of bank failure. Insured deposits under €100,000 are exempt and uninsured deposits of individuals and small companies are given preferential status in the bail-in pecking order." In reality, last night's agreement is the usual fluid melange of semi-rigid rules filled with loopholes designed to benefit large banks whose impairment may be detrimental to "systemic stability".
To wit, from the FT: "While a minimum bail-in amounting to 8 per cent of total liabilities is mandatory before resolution funds can be used, countries are given more leeway to shield certain creditors from losses in defined circumstances." In other words, here is the bail in regime... which we may decide to ignore under "defined circumstances."
Next, since the "package must be agreed with the European parliament, a process that could stretch until the end of 2013" we urge no breath holding, especially since it was in late 2012 that news of a joint European bank regulator was announced, and one year later this concept has crashed and burned. In fact the bail-in deal will "open debate on further stages of financial integration, including on establishing a central authority to shut down eurozone banks" and "Germany is strongly resisting centralising such important powers to shut down banks under existing treaties."
In other words, yet another European agreement that is at best worth the price of the paper it is printed on. In the meantime, if indeed some of the systemic European banks keel over and die - say Credit Lyonnaise, Natexis or Deutsche - the last thing that anyone will think about to avoid a systemic collapse will be impairing even more banks. As a reminder, these are the most undercapitalized banks in Europe as reported by Goldman yesterday:

But golf clap to Europe for finally admitting that reason and logic also apply to the most banana continent of all: after all, it took years of legislating to realize that the insolvency impairment waterfall, a concept rooted in logic and not in political BS, applies in Europe as it does everywhere else in the world too (except for the TBTFs in the US of course).
And all of the above, from a slightly less jaded perspective, via Reuters:
The European Union agreed on Thursday to force investors and wealthy savers to share the costs of future bank failures, moving closer to drawing a line under years of taxpayer-funded bailouts that have prompted public outrage.

After seven hours of late-night talks, finance ministers from the bloc's 27 countries emerged with a blueprint to close or salvage banks in trouble. The plan stipulates that shareholders, bondholders and depositors with more than 100,000 euros ($132,000) should share the burden of saving a bank.

The deal is a boost for EU leaders, who meet later on Thursday in Brussels, and can show that they are finally getting to grips with the financial crisis that began in mid-2007 with the near collapse of Germany's IKB.

"For the first time, we agreed on a significant bail-in to shield taxpayers," said Dutch Finance Minister Jeroen Dijsselbloem, referring to the process in which shareholders and bondholders must bear the costs of restructuring first.

The rules break a taboo in Europe that savers should never lose their deposits, although countries will have some flexibility to decide when and how to impose losses on a failing bank's creditors.

"They can affect German savers just as well as they can affect any other investor in the world," German Finance Minister Wolfgang Schaeuble said after the meeting.

* * *

But thorny issues lie ahead, not least whether countries or a central European authority should have the final say in shutting or restructuring a bad bank.

The European Commission, the EU executive, is expected to unveil its proposal for a new agency to carry out this task of "executioner" as early as next week, officials said.

"The most important discussion has yet to start and that is how decisions on restructuring will be made," said Nicolas Veron, a financial expert at Brussels-based think tank Bruegel. "It's premature to say that Europe is getting its act together."

Many Europeans remain angry with bankers and the easy credit that helped create property bubbles in countries including Ireland and Spain, which then burst and plunged Europe into a recession from which it has yet to recover.

Wednesday, June 26, 2013

Some Hard Numbers On The Western Banking System

Submitted by Simon Black via Sovereign Man blog,
At our Offshore Tactics Workshop in Santiago three months ago, Jim Rickards (author of the acclaimed Currency Wars) told the audience of roughly 500 people– (paraphrased)
‘If one of you stands up right now and heads for the exit, the rest of the audience probably won’t pay much attention. If ten of you do it, one or two people may notice and follow. But if 400 of you suddenly head for the exit, the rest of the audience would probably follow quickly.’
It’s a great metaphor for how our financial system works. The entire system is based on confidence. And as long as most people maintain this confidence, everything is fine.
But as soon as a critical mass of people loses confidence in the system, then it starts a chain reaction. More people start heading for the exit. Which triggers even more people heading for the exit.
This is the model right now across the system. And it’s especially pervasive in the banking system.
Modern banking is based on this ridiculous notion that banks don’t actually have to hang on to their customers’ funds.
Banks in the United States typically hold less than 10%, and even less than 5%, of their customers’ savings. This is particularly true among smaller regional banks.
As an example, BB&T bank is holding about $3.2 billion in cash equivalents on $131 billion in customer deposits. That’s a ratio of just 2.4%.
The rest of customer deposits are mostly invested in residential mortgage backed securities (similar to those which collapsed in 2008) and commercial loans. In fact, the bank’s loan portfolio exceeds total customer deposits. Not exactly the picture of financial health.
In the UK, the situation has become so absurd that British regulators are allowing some banks (Lloyds, Royal Bank of Scotland) to plug their gaping capital deficits with FUTURE earnings.
Now, I’m not trying to badmouth any particular bank here; these example are representative of the entire western financial system.
Yet few people give much thought to where they park their hard-earned savings. We’re deluded into believing that our bank is safe. It must be, after all. It’s a bank! And… it’s backed by the government!
Sure, never mind that the balance sheets of insurance funds and sovereign governments are in even worse shape.
That this system is still functioning at all is due almost entirely to confidence. There is no fundamental support propping it up. And a system built exclusively on confidence can unravel quickly.
This is why it’s so important to give a lot of thought to your financial partner. Do they have a fundamentally safe balance sheet? Or is it just smoke and mirrors?
Take a look at your own bank’s balance sheet. How much cash do they hold as a percentage of deposits? How big is the loan portfolio as a percentage of deposits? How much equity does the bank have as a percentage of deposits?
If you’re not satisfied, find another bank. And you may have to look overseas at stronger jurisdictions.
Singapore is one place where I’m happy to park capital. OCBC for example, holds a whopping 38% of customer deposits in cash equivalents… ten times as much as many banks in the West.
Its total loan portfolio is far less than customer deposits. Total equity exceeds assets by a margin of 2:1. And it resides in a nation with effectively no net debt.
I’m not necessarily endorsing OCBC, but rather citing it as an example of what a healthy bank balance sheet is supposed to look like. Many banks in Singapore hold similar figures.
Bottom line, it matters where you hold your savings. Balance sheet fundamentals are critical.
And moving your hard-earned savings to a well-capitalized, highly liquid bank is one of those things that makes sense, no matter what.
If nothing happens, you won’t be worse off for it. Yet if the confidence game collapses, you’ll be one of the few left standing with your savings intact.

Major Chinese Banks Stop Lending

Industrial and Commercial Bank of China Ltd
Bank of China Ltd
Bank of China Ltd
Loans to businesses and individuals will resume according to the Bank of China on July 15th. The Industrial and Commercial Bank of China has stated that it is normal for them to put limits on the amount of lending that they do and those limits are set each month. Cases of where the bank has to interrupt their lending have already occurred. However, it would appear that the amount of lending was reduced in comparison with previous months by the banks head office for June. Apparently, the credit line will be reopened in July, but it will be only for a few days as they do not have enough deposits. On June 23rd, the Industrial and Commercial Bank’s customers had trouble withdrawing cash from cash machines and they also did not see bank transfers going through on their accounts on time. The Bank of China suffered the same setbacks on June 24th. Today they have cut loans heightening worry both inside and outside of China as to the stability of the banks. Statements were issued by the banks giving upgrades in IT services as the reason. Rather strange, however, that both banks updated their systems at the same time and suffered the same glitch in the system.
There are two other banks that have interrupted their mortgage loans also: CITIC Bank and Huxua Bank.
Analysts have always stated that the larger banks have stopped lending to smaller banks as they are worried about liquidity and there are deposit issues, but they seem to believe that the large banks will not stop lending to individuals and businesses. Only smaller banks will suffer from the credit crunch taking place in China right now. But, the banks that have halted lending today are not in line with that thinking. The Bank of China, which has existed since 1905, is the 2nd largest lender in China at the present time. It is the 5th largest bank in the world in terms of market capitalization. It employs nearly three hundred thousand people and has total assets to the value of CN¥ 11.829 trillion. That doesn’t sound very much like a small bank. It also has branches in 27 countries around the world. The knock-on effect in those countries will surely be felt too. Investors are not worried for the moment as share value rose today by 3.3%. But, will that continue?
The Industrial and Commercial Bank of China is also one of China’s big four banks (Bank of China, Agricultural Bank of China, and China Construction Bank). It is the largest bank in the world with regard to profit and market capitalization and was listed by Forbes Global 2000 in number one position as the world’s largest public company. It employs four hundred thousand people. In 2010 net lending of the bank stood at 70 billion Yuan, meaning that it lent than any other bank in China. 20% of its lending goes to manufacturing industry and personal loans are over 15% of its business also. It was the world’s largest Initial Public Offering at US$21.9 billion when it was listed on the Hong Kong Stock Exchange and the Shanghai Stock Exchange simultaneously in 2006. However, the news doesn’t seem to worry investors for the moment as share value rose by 6.82% today to 4, 700HKD (up 0.3 points).
This is all cause for major concern however. It will be an issue in the coming days, in particular in light of the People’s Bank of China’s recent statements that there was ‘reasonable’ liquidity statement that was issued a couple of days ago. The ‘reasonable’ turned into ‘ample’. Share value is still rising for the moment for both banks, but the Bank of China is below what it was just a few days ago as can be seen in the chart.
Bank of China Ltd
Bank of China Ltd
The Bank of China had already tightened lending in early 2010 in a bid to increase deposits and liquidity. But today the reining in of loans is in a different set of circumstances. The entire banking sector in China is currently strapped for cash and not just one bank.
How much the People’s Bank of China will be able to ward of accusations that there is indeed a big liquidity problem in China today is far from certain.
So, the options that are open to businesses and individuals? Unless the People’s Bank of China comes up with some cash to unfreeze the situation and double-quick, the Chinese (but, unfortunately, not only the Chinese) had better start popping down to the pawnbrokers and speaking to Uncle. Otherwise it looks as if they are in for a rough time. If money dries up in those two banks and continues, then small and medium sized businesses are likely to suffer and there will be a bank-run on. Don’t envy them at all for that. We could always send Ben Bernanke, couldn’t we? He will sort the problem out in true Federal-Reserve fashion. Uncle Ben would be a better option than the pawnbrokers maybe for some!  He may be looking for a short stopover in Shanghai when his stint at the Federal Reserve is up in 2014.

Tuesday, June 25, 2013

"Time Is Running Out Fast" For Italy

Everyone knows Europe is insolvent; the only question is "when" will Europe be forced to finally admit this truism. The long overdue house of cards may start toppling in as little as 6 months, as The Telegraph reports,Mediobanca's 'index of solvency risk' suggests "time is running out fast" for Italy. With the breakdown in Eurozone talks on a banking union and the Fed's shift in policy, Europe "has become a dangerous place," warns RBS. Unless Italy can count on low borrowing costs and a broad recovery, it will "inevitably end up in an EU bailout." The current situation is as bad as when the country was blown out of the ERM in 1992 as "the Italian macro situation has not improved...rather the contrary; with 160 large corporates in Italy now in special crisis administration." If the ECB doesn’t act, one analyst warns (pleads) it could see all the gains of the past nine months vanish in two weeks. Mediobanca said the trigger for a blow-up in Italy could be a bail-out crisis for Slovenia or an ugly turn of events in Argentina, which has close links to Italian business. "Argentina in particular worries us, as a new default seems likely."

“Time is running out fast,” said Mediobanca’s top analyst, Antonio Guglielmi, in a confidential client note. “The Italian macro situation has not improved over the last quarter, rather the contrary. Some 160 large corporates in Italy are now in special crisis administration.”

The report warned that Italy will “inevitably end up in an EU bail-out request” over the next six months, unless it can count on low borrowing costs and a broader recovery.

Emphasising the gravity of the situation, it compared the crisis with when the country was blown out of the Exchange Rate Mechanism in 1992 despite drastic austerity measures.


“The European Central Bank needs to take very aggressive steps to offset this,” said Marchel Alexandrovich from Jefferies Fixed Income. “We have a sell-off across the board. If the ECB doesn’t act, it could see all the gains of the past nine months vanish in two weeks, taking the eurozone back to square one.”


“We have clear signs in global finance of a generalised meltdown in assets right now.”


Mediobanca said the trigger for a blow-up in Italy could be a bail-out crisis for Slovenia or an ugly turn of events in Argentina, which has close links to Italian business. “Argentina in particular worries us, as a new default seems likely.”

Mr Guglielmi said Italy’s industrial output has slumped 25pc from its peak in the past decade, while disposable income has dropped 9pc and house sales have dropped to 1985 levels.

The 1992 crisis was defused by a large devaluation, allowing Italy to restore trade competitiveness at a stroke. Mediobanca said: “The euro straitjacket is clearly not providing a similar currency flexibility today. With the lira devaluation Italy managed to inflate debt away, which it cannot do today. It could take more than 10 years to revert to pre-crisis output levels.

Monday, June 24, 2013

Bank Of China Declares Moratorium On Transfers, Online Banking; Counters Inoperable

From Caijing, google translated. We hope the gist of the narrative in Mandarin is far less scary, because if the translation is even remotely accurate, then all hell may be about to break loose in China.
From CaijingBank of China, Bank of suspension of transfers morning counters were unable to apply for online banking
Update: Customer service said, now silver futures transfer service has been fully suspended, online banking, the counter can not be handled, and now has the background system response, recovery time is not yet known
Following the ICBC, the Bank of China also go awry again. This morning, the Bank of China Bank moratorium on transfers, online banking, counters are inoperable.
10:00 many, many people began to receive messages sent to the Bank of China, "the end result of the Bank of China Bank failures, bank customers can not carry on through the Bank transfers, please Bank online banking, bank counter or use of other bank transfer system, Bank system will be restored promptly notify you." large number of transfer business banking needs of the people turned to online banking, counter, but according to the instructions of the public still found text messages can not handle.
Reporters call the BOC, customer service said, now silver has been fully suspended phase transfer services, online banking, the counter can not be handled, and now has the background system response, recovery time is not yet known.
As of 12:00, the Bank customer service said handle part of the user's online banking has been restored.
Just yesterday, 10:35, Shanghai and other places ICBC system failures, ATM machines, POS machines, online banking appeared paralyzed more than 50 minutes, all kinds of businesses can not properly handle.
The ICBC bank system failure comes trouble "money shortage", inevitably lead to speculation that many people guess the bank is not money.
To solve this problem, ICBC relevant person in charge told reporters that morning, business process slow, the analysis on the host software upgrade, emergency treatment, 11:27 various businesses all returned to normal.
As for speculation that the crash might be the last two days the inter-bank "money shortage" relevant, ICBC has denied
h/t Sean Corrigan

Sunday, June 23, 2013

BIS says central banks must stop supporting economy

The Bank for International Settlements (BIS) says banks have done their bit to help economic recovery and governments must do more.
The Basel-based organisation - usually dubbed the "central banks' central bank" says it is time for them to stop pumping funds into their economies.
Markets are already bracing themselves for a world without central bank help.
Last week the US central bank said it planned to stop pumping money into the economy, sparking market volatility.
In its annual report, the BIS said the world's central banks had done their bit to offset the worst effects of the six-year long global credit crisis.
As the credit crunch bit, central banks tried a number of tactics to try to keep the money flowing, initially cutting interest rates and later adding in quantitative easing, buying in assets and releasing vast sums into the banking system.
The BIS said it was now the turn of governments to oil the economic wheels.
It said this should be done through labour market reforms to increase productivity.
It said they should undertake a "forceful programme" of "repair and reform", as this was the only way to bring about a lasting economic revival.
It said: "Although six years have passed since the eruption of the global financial crisis, robust, self-sustaining growth still eludes the global economy.
"During this time, central banks in advanced economies have been forced to look for ways to increase their degree of accommodation. But central banks cannot solve the structural problems that are preventing a return to strong and sustainable growth."
The BIS said central bank action had borrowed "time for others to act, allowing them to repair balance sheets, to consolidate fiscal balances, and to enact reforms to restore productivity growth".
But Stephen Cecchetti, the head of the BIS monetary and economic department, said this had made it easy for the private sector to put off reforms and for governments to finance deficits more cheaply thanks to the low interest rates their actions had introduced.
Mr Cecchetti said central banks must return their focus to maintaining financial stability and encouraging reforms, rather than "retarding them with near-zero interest rates and purchases of ever larger quantities of government securities".
The BIS was founded in 1930 and is the world's oldest international financial institution.
Its 60-strong membership includes the Bank of England, the European Central Bank, the US Federal Reserve, the People's Bank of China and the Bank of Japan.

Thursday, June 20, 2013

Liquidation - Stocks, Bonds, Commodities Collapse

As we warned earlier in the week, Greece is notably missing its Troika goals and the issue just became a lot more critical. AsThe FT reports, the IMF is preparing to suspend aid payments to Greece over what it claims is a EUR 3-4 billion shortfall that has opened up. Between healthcare budget shortfalls, central banks refusing to roll-over Greek bonds, and amid signs that even the scaled-back privatization plans that Athens had agreed to being behind schedule, the IMF -following its own admissions of mistakes in the Greek bailout, has warned EU officials the shortfall will require it to stop aid payments by the end of July. The equity market is already reacting (as is EURJPY - EUR weakness against the big carry pair) to this re-awakening of EU event risk (and the awkward timing with Merkel's election so close) - with the Fed's comfort blanket somewhat removed.

Via The FT,
The International Monetary Fund is preparing to suspend aid payments to Greece by the end of next month unless eurozone leaders plug a €3bn-€4bn shortfall that has opened up in Greece’s €172bn rescue programme, according to officials involved in management of the bailout.

The gap emerged after eurozone central banks refused to roll over Greek bonds they hold, and comes amid signs that even the scaled-back privatisation plan Athens agreed to last year is falling behind schedule.


The shortfall will force eurozone finance ministers to discuss “alternate sources” of funding


But the timing is particularly awkward as Germany is holding parliamentary elections on September 22. In the run-up to polling day Chancellor Angela Merkel will be loath to submit any further aid request to the Bundestag where it would likely be highly controversial.


the IMF has warned EU officials the gap will require it to stop aid payments at the end of July, said a person involved in the discussions.

Under its rules, governments must have at least 12 months of financing in place to receive IMF disbursements under a bailout programme. This latest shortfall of €3bn-€4bn means that Greece’s financing needs are only covered up to the end of July 2014.

What The Recent Surge In Rates Means For Your Home Purchasing Power

Contrary to what one may have read in the financial tabloids, a houseing market does not recover thanks to Fed-subsidzed REO-to-Rent loans used by the biggest private equity firms to buy up distressed property on the margin, by foreign oligrachs buying Manhattan triplexes sight unseen just to park 'tax-evaded' cash courtesy of the NAR's anti money-launderingexemption, and by foreclosure stuffing from the big banks desperate to subsidze the market higher before the sell into it. The recovery comes from the average consumer, who has disposable income and savings (in a hypothetical scenario of course) and who can buy houses based on a given monthly budget - a budget which must provide a better deal to own than to rent.
The problem with such a budget is that first and foremost its purchasing power is dependent on interest rates, and in an economy in which leverage is everything, rising rates mean a collapse in purchasing powerHere is a glimpse of what has happened to the mortgage rates in the past month alone: from Bloomberg's Jody Shenn:
Wells Fargo & Co., the largest U.S. mortgage lender, is offering 30-year fixed-rate loans at 4.5 percent, according to its website, up from 4.13 percent on June 18 and 3.88 percent on May 22, when comments by Bernanke to lawmakers and the release of the minutes of the last Fed meeting caused bonds to plummet. Freddie Mac’s survey, which is lagging behind the bond slump because it reflects originator responses through yesterday, showed average rates falling to 3.93 percent this week.
So in one month, the average 30 year fixed rate mortgage has jumped by over 60 basis points. What does this mean for net purchasing power? Well, as the chart below shows, assuming a $2000/month budget to be spent on amortizing a mortgage (or otherwise spent for rent), it means that suddenly instead of being able to afford a $425K house, the average consumer can buy a $395K house.
This means that, all else equal, housing just sustained a 7% drop in the average equlibrium price based on what buyers can afford.
But assuming the current selloff in rates continues, things are going to get much worse: we may be seeing 5%, 5.5% even 6% and higher mortgages in the immediate future.
It also means that a buyer who could previously afford a $506K house with a $2,000 monthly budget at an interest rate of 2.5% will be able to afford only $316K if and when the average 30 Year fixed hits 6.5%: a 40% drop in affordability based on just a 4% increase in interest rates!
And this is bullish for the economy?

Imminent US real estate market crash

Imminent US real estate market crash

  1. Lumber is near term low, which usually tracks with homebuilders.  Very simple to understand, lumber is still primary material to build houses.  Housing recovery built on faith
  2. Institutional players entered market such as BlackRock and JPMorgan (and many others) now exiting.  Smart money getting out of stocks and real estate These new investor buyers have been artificially inflating the market in many areas.
  3. Fed policy – Fed will stop buying mortgage securities  This will drive the cost of financing through the roof.
  4. Demographic shift, baby boomers retiring and new generation not buying more houses.
  5. Lack of foreign support – Due to a global tax witch hunt, and a European banking crisis, foreigners who previously supported US market will support to lesser extent
  6. Job crisis – while unemployment figures officially claim we have a job recovery, companies are laying off workers in record amounts.  Unemployed people don’t buy houses.  Workers who are laid off may have to sell their house.
  7. Bond market collapse – For those retirees who keep their money in bonds, with the pending bond market crash they will have less money to pay for their houses.

Wednesday, June 19, 2013

Fed much more upbeat about outlook

WASHINGTON (MarketWatch) — The Federal Reserve on Wednesday signaled greater optimism about the economic outlook, forecasting that the unemployment rate could fall to 6.5% by 2014, one year sooner than the central bank had previously estimated.
In its policy statement, the Fed said downside risks to the outlook had diminished and that the labor market had shown further improvement.

Rick Santelli Rages: "What Is Bernanke So Afraid Of?"

The following three minutes of absolute perfection uttered by CNBC's Rick Santelli is dangerous for anyone living in Kyle Bass' "intellectually dishonest" alter-world of denial and "unicorns and rainbows" as the Chicagoan goes off on theignorance of everyone in these so-called markets. When every talking head is bullish and the world is going so great that we should all "buy stocks," Santelli demands we ask Bernanke - "what are you scared of," that keeps you pumping this much money into the system for this long? Simply put, Santelli's epic rant is the filter that every investor (or member of the public) should be viewing financial media and the Fed today (or in fact every day).
On CNBC and all the channels that cover business, we have person after person after person, buy side, sell side, upside, downside:
  • How is the economy? Economy is great.
  • What about stocks? You got to buy them.
  • What if they break? You have to buy the dips.
  • What's wrong with the economy? I don't hear these people saying anything is wrong with the economy.
So what's wrong, Ben? Why can't we get out of crisis management mode?

There's always going to be something.


Why don't these people kick the tires?

They take a press release from the Federal Reserve and they think it was written by God.

One of Rick's most epic rants to date:

Bankers: Do not Pass GO, Do Not Collect millions and Go Directly to Jail!

A new banking report is published today in the UK.
There are jobs that nobody wants to do really, aren’t there? As your kids are growing up, you hope they don’t ask you one day to come and sit down as they have something serious to talk to you about. Dread! You know what’s coming: “Hey, mom, dad, I’m…I’m going to be a…a banker!”. Then, your whole life falls apart. It’s like being on a par with gutting social-unacceptable jobs like debt-collector and bailiff, isn’t it? The money might be there, but the morals aren’t?
Well, George Osborne, Chancellor of the Exchequer of the UK, has all eyes focused on him with the idea of the century, it seems. A banking commission headed by Conservative MP, Andrew Tyrie has made 80 recommendations to make the banking sector the place you want your kids to work in when they grow up. Morals will change and the banking will be a good job to have!
George Osborne is giving the Mansion-House (residence of the Lord Mayor of London) speech to the city tonight, an annual speech in which the Chancellor of the Exchequer traditionally gives his impression of the state of the British economy. It seems rather unlikely that he will announce some of the recommendations to the bankers that will be seated at the tables in front of him, however. Not unless he wants them to choke on the spicy ingredients that he have been concocted. These include making bankers wait up to ten years to receive bonuses and going to prison. Heard it all before? Thought it? Dreamt of it? The Report did it.
George Osborne, Mansion House Speech
George Osborne, Mansion House Speech
The report is a hefty two-volume reader’s digest of what to do and what not to do in the banking system, entitled “Changing Banking for Good”. Snazzy little tittle that can be read in two different ways as well. Well done Mr. Tyrie. Only a few pages into the report it states that past regulations and supervisory controls had:
  • “little realistic prospect of effective enforcement action, even in many of the most flagrant cases of failure”.
It goes on to state that:
  • “remuneration has incentivised misconduct and excessive risk-taking, reinforcing a culture where poor standards were often considered normal”.
To take out the excessive risk-taking from the lives of bankers in the workplace, the report puts forward the suggestion not only that the bankers should receive the bonuses after a period that could last up to ten years (now that’s time to forget what you have actually done to get the bonus, isn’t it?) but also that the remuneration be in bail-bonds. It also suggests that for wider cases of misconduct remuneration should be cancelled and that if the taxpayer has to foot the bill, then they should definitely not be made. We know from a recent report from the Chartered Institute of Personal Development also that the majority of bankers are in agreement. They think that they are paid excessive amounts and sometimes they don’t know why they get all the money they do. So, if we all agree, let’s cut the bonuses and improve regulation. What are we waiting for?
Bankers: Bonuses
Bankers: Bonuses
The report states that banks have failed the UK in ‘many respects’. £133 billion have had to be injected in bail-outs, amounting to £2, 000 per every person in the UK today. But, it seems that it is also the shareholders that have been let down too. They have had ‘poor long-term returns’.
Excessive risks that were taken in the period leading up to the financial crisis were not down to miscalculation of mathematical equations that boiled down to the bankers getting their sums wrong, but to the fact that the banks were and still are too big to fail. They are able to take greater risks because they are too complex and too enormous. We can’t let them fail and that they know only too well. It’s all very well saying ‘yes, let them fail and then they will see’. But, what will the average person be eating then? Bread and water will be more than just dietary supplements, they will become the staples. Banks today have access to cheaper credit. Their success is determined not so much by the careful and planned placing of financial equity, but the guarantee that lies steadfastly behind them.
The report clearly states that bankers should not flippantly refuse to accept that public anger at high salaries is purely jealousy-driven or petty ignorance. “Rewards have been paid for failure”. Bonuses may have fallen, although the report points out that this has been off-set by fixed-pay rises.
It has also been suggested that there needs to be greater equality in terms of employing women. Women take fewer risks traditionally on the trading floor and so the report asks for employment policy to be changed in banks.
Senior bankers have also come in for a belting from the report, accused of wearing blindfolds as to their responsibility. They are accused of being so far removed from the misconduct that they have ended up being admonished of all responsibility. The report suggests that a prison sentence would certainly make senior officials think about what is being done. The report states that it would “give pause for thought to the senior officers of UK banks”. However, to what extent would senior officials of any bank really consider their potential criminal liability? It also raises the question as to what extent it would be possible to actually see a conviction and criminal liability recognized in a court of law?  Hard to prove.
The reports can be found here.  Enjoy! If anything actually gets done. Previous suggestions were already ignored by the British government with regard to changes in the banking sector and the report states that it is “disappointed” that this has happened. Aren’t we all?
However, clearly the report states quite a few home truths; things that the average citizen has been feeling and voicing for many a year now. But, until now that has been largely left just as words from angry and jealous members of the public that also want to strike it rich and get paid for doing wrong. Now though, how long will the suggestions that have been made be ignored and how long will the Chancellor of the Exchequer be able to turn a deaf ear to what is being said? The report comes at a timely moment; Mr. Osborne looks like he may still have time to rectify his speech for tonight’s dinner!
The report states “An important lesson of history is that bankers, regulators and politicians alike repeatedly fail to learn the lessons of history”. This time it is (apparently) different. Bankers and everyone else have learned the lessons. Have they?

What do you think? Are bankers going to repeat history or have they learned from their mistakes?