November 30, 2012

Gold: The Solution To The Banking Crisis?

The Basel Committee on Banking Supervision is an exclusive and somewhat mysterious entity that issues banking guidelines for the world’s largest financial institutions. It is part of the Bank of International Settlements (BIS) and is often referred to as the Central Banks’ central bank. Ever since the financial meltdown four years ago, the Basel Committee has been hard at work devising new international regulatory rules designed to minimize the potential for another large-scale financial meltdown. The Committee’s latest ‘framework’, as they call it, is referred to as “Basel III”, and involves tougher capital rules that will force all banks to more than triple the amount of core capital they hold from 2% to 7% in order to avoid future taxpayer bailouts. It doesn’t sound like much of an increase, and according to the Basel group’s own survey, the 100 largest global banks will only require approximately €370 billion in additional reserves to comply with the new regulations by 2019. Given that the Spanish banks alone are believed to need well over €100 billion today simply to keep their capital ratios in check, it is hard to believe €370 billion will be enough protect the world’s “too-big-to-fail” banks from future crises, but it is indeed a step in the right direction.

Initial implementation of Basel III’s capital rules was expected to come into effect on January 1, 2013, but US banking regulators issued a press release on November 9th stating that they wouldn’t meet the deadline, citing a large volume of letters (ie. complaints) received from bank participants and a “wide range of views expressed during the comment period”. It has also been revealed that smaller US regional banks are loath to adopt the new rules, which they view as overly complicated and potentially devastating to their bottom lines. The Independent Community Bankers of America has even requested a Basel III exemption for all banks with less than $50 billion in assets,“in order to avoid large-scale industry concentration that would curtail credit for consumers and business borrowers, especially in small communities.” The long-term implementation period for all Basel III measures actually extends to 2019, so the delays are not necessarily meaningful news, but they do illustrate the growing rift between the US banking cartel and its European counterpart regarding the Basel III framework. JP Morgan’s CEO Jamie Dimon is on record having referred to Basel III regulations as “un-American” for their favourable treatment of European covered bonds over US mortgage-backed securities. Readers may also remember when Dimon was caught yelling at Mark Carney, Canada’s (soon to be former) Central Bank Governor and head of the Financial Stability Board, during a meeting in Washington to discuss the same topic. More recently, Deutsche Bank’s co-chief executive Juergen Fitschen suggested that the US regulators’ delay was “hurting trans-Atlantic relations” and creating distrust... stating, “when the whole thing is called un-American, I can only say in disbelief, who can still believe in this day and age that there can be purely European or American rules.” Suffice it to say that Basel III implementation has not gone as smoothly as planned.

One of the more relevant aspects of Basel III for our portfolios is its treatment of gold as an asset class. Documents posted by the Bank of International Settlements (which houses the Basel Committee) and the United States FDIC have both referenced gold as a “zero percent risk-weighted item” in their proposed frameworks, which has launched spirited rumours within the gold community that Basel III may define gold as a “Tier 1” asset, along with cash and AAA-government securities. We have discovered in delving further that gold’s treatment in Basel III is far more complicated than the rumours suggest, and is still, for all intents and purposes, very much undecided. Without burdening our readers with the turgid details, it turns out that the reference to gold as a “zero-percent risk-weighted item” only relates to its treatment in specific Basel III regulation related to the liquidity of bank assets vs. its liabilities. (For a more comprehensive explanation of Basel III’s treatment of gold, please see the Appendix). But what the Basel III proposals do confirm is the regulators’ desire for banks to improve their liquidity position by holding a larger amount of “high-quality”, liquid assets in order to improve their overall solvency in the event of another crisis.

Herein lies the problem, however: the Basel III regulators have stubbornly held to the view that AAA-government securities constitute the bulk of those high quality assets, even as the rest of the financial world increasingly realizes they are anything but that. As banks move forward in their Basel III compliance efforts, they will be forced to buy ever-increasing amounts of AAA-rated government bonds to meet post Basel III-compliant liquidity and capital ratios. As we discussed in our August newsletter entitled, “NIRP: The Financial System’s Death Knell”, the problem with all this regulation-induced buying is that it ultimately pushes government bond yields into negative territory - as banks buy more and more of them not because they want to but because they have to in order to meet the new regulations. Although we have no doubt in the ability of governments’ issue more and more debt to satiate that demand, the captive purchases by the world’s largest banks may turn out to be surprisingly high. Add to this the additional demand for bonds from governments themselves through various Quantitative Easing programs… AND the new Dodd Frank rules, which will require more government bonds to be held on top of what’s required under Basel III, and we may soon have a situation where government bond yields are so low that they simply make no sense to hold at all. This is where gold comes into play.

If the Basel Committee decides to grant gold a favourable liquidity profile under its proposed Basel III framework, it will open the door for gold to compete with cash and government bonds on bank balance sheets – and provide banks with an asset that actually has the chance to appreciate. Given that US Treasury bonds pay little to no yield today, if offered the choice between the “liquidity trifecta” of cash, government bonds or gold to meet Basel III liquidity requirements, why wouldn’t a bank choose gold? From a purely ‘opportunity cost’ perspective, it makes much more sense for a bank to improve its balance sheet liquidity profile through the addition of gold than it does by holding more cash or government bonds – if the banks are given the freedom to choose.

The world’s non-Western central banks have already embraced this concept with their foreign exchange reserves, which are vulnerable to erosion from ‘Central Planning’ printing programs. This is why non-Western central banks are on track to buy at least 500 tonnes of net new physical gold this year, adding to the 440 tonnes they collectively purchased in 2011. In the un-regulated world of central banking, gold has already been accepted as the de-facto forex diversifier of choice, so why shouldn’t the regulated commercial banks be taking note and following suit with their balance sheets? Gold is, after all, one of the only assets they can all own simultaneously that will actually benefit from their respective participation through pure price appreciation. If banks all bought gold as the non-Western central banks have, it is likely that they would all profit while simultaneously improving their liquidity ratios. If they all acted in concert, gold could become the salvation of the banking system. (Highly unlikely… but just a thought).

So far there have only been two banking jurisdictions that have openly incorporated gold into their capital structures. The first, which may surprise you, is Turkey. In an unconventional effort to increase the country’s savings rate and propel loan growth, Turkish Central Bank Governor Erdem Basci has enacted new policies to promote gold within the Turkish banking system. He recently raised the proportion of reserves Turkish banks can keep in gold from 25 percent to 30 percent in an effort to attract more bullion into Turkish bank accounts. Turkiye Garanti Bankasi AS, Turkey’s largest lender, now offers gold-backed loans, where “customers can bring jewelry or coins to the bank and take out loans against their value.” The same bank will also soon “enable customers to withdraw their savings in gold, instead of Turkish lira or foreign exchange.” Basci’s policies have produced dramatic results for the Turkish banks, which have attracted US$8.3 billion in new deposits through gold programs over the past 12 months - which they can now extend for credit. Governor Basci has even stated he may make adjusting the banks’ gold ratio his main monetary policy tool.

The other banking jurisdiction is of course that of China, which has long encouraged its citizens to own physical gold. Recent reports indicate that the Shanghai Gold Exchange is planning to launch an interbank gold market in early December that will “pilot with Chinese banks and eventually be open to all.” Xie Duo, general director of the financial market department of the People’s Bank of China has stated that, “[China] should actively create conditions for the gold market to become integrated with the international gold market,” which suggests that the Chinese authorities have plans to capitalize on their growing gold stockpile.

It is also interesting to note that China, of all countries, has been adamant that its 16 largest banks will meet the Basel III deadline on January 1, 2013. We can’t help but wonder if there is any connection between that effort and China’s recent increase in physical gold imports. Could China be positioning itself for the day Western banks finally realize they’d prefer gold over Treasuries? Possibly – and by the time banks figure it out, China may have already cornered most of the world’s physical gold supply.

If global banks’ are realistically going to improve their balance sheet diversification and liquidity profiles, gold will have to be part of that process. It is ludicrous to expect the global banking system to regain a sure footing through the increased ownership of government securities. If anything, we are now at a time when banks should do their utmost to diversify away from them, before the biggest “crowded trade” of all time begins to unravel itself. Basel III liquidity rules may be the start of gold’s re-emergence into mainstream commercial banking, although it is still not guaranteed that the US banking cartel will adopt all of the Basel III measures, and they still have years to hammer out the details. If regulators hold firm in applying stricter liquidity rules, however, gold is the only financial asset that can satisfy those liquidity requirements while freeing banks from the constraints of negative-yielding government bonds. And while it strikes us as somewhat ironic that the banking system may be forced to turn to gold out of sheer regulatory necessity, that’s where we see the potential in Basel III. After all – if the banks are ultimately interested in restoring stability and confidence, they could do worse than holding an asset that has gone up by an average of 17% per year for the last 12 years and represented ‘sound money’ throughout history.
Appendix: Gold’s treatment in Basel III

Basel III is a much more complex “framework” than Basel I or II, although we do not claim to be experts on either. It should also be mentioned that Basel II only came into effect in early 2008, and wasn’t even adopted by the US banks on its launch. Post-meltdown, Basel III is the Basel Committee’s attempt to get it right once and for all, and is designed to provide an all-encompassing, international set of banking regulations designed to avoid future bailouts of the “too-big to fail” banks in the event of another financial crisis.

Without going into cumbersome details, under the older Basel framework (Basel I), the lower the “risk weighting” regulators applied to an asset class, the less capital the banks had to set aside in order to hold it. CNBC’s John Carney writes, “The earlier round of capital regulations… government-rated bonds rated BBB were given 50 percent riskweightings. A-rated bonds were given 20 percent risk weightings. Double A and Triple A were given zero risk weightings — meaning banks did not have to set aside any capital at all for the government bonds they held.” Critics of Basel I argued that the risk-weighting system compelled banks to overweight their exposure to assets that had the lowest riskweightings, which created a herd-like move into same assets. This was most evident in their gradual overexposure to European sovereign debt and mortgage-backed securities, which the regulators had erroneously defined as “low-risk” before the meltdown proved them to be otherwise. The banks and governments learned that lesson the hard way.

Basel III (and Basel II) takes the same idea and complicates it further by dividing bank assets into two risk categories (credit and market risk) and risk-weighting them depending on their attributes. Just like Basel I, the higher the “riskweight” applied to an asset class, the more capital the bank is required to hold to offset them.

It is our understanding that gold’s reference as a “zero percent risk-weighted asset” in the FDIC and BIS literature only applies to gold’s “credit risk” - which makes perfect sense given that gold isn’t anyone’s counterparty and cannot default in any way. Gold still has “market-risk” however, which stems from its price fluctuations, and this results in the bank having to set aside capital in order to hold it. So for banks who hold physical gold on their balance sheet (and we don’t know of any who do, other than the bullion dealers), the gold would not be treated the same as cash or AAA-bonds for the purposes of calculating their Tier 1 ratio. This is where the gold community’s conjecture on gold as a “Tier 1” asset has been misleading. There really isn’t such a thing as a “Tier 1” asset under Basel III. Instead, “Tier 1” is merely the ratio that reflects the capital supporting a bank’s risk-weighted assets.

HOWEVER, Basel III will also be adding an entirely new layer of regulation concerning the relative liquidity of the bank’s assets and liabilities. This will be reflected in two new ratios banks must calculate starting in 2015: the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).

Just as Basel III requires risk-weights for the asset side of a bank’s balance sheet (based on credit risk and market risk), Basel III will also soon require the application of risk-weights to be applied to the LIQUIDITY profile of both the assets and liabilities held by the bank. The idea here is to address the liquidity constraints that arose during the 2008 meltdown, when banks suffered widespread deposit withdrawals just as their access to wholesale funding dried up.

This is where gold’s Basel III treatment becomes more interesting. Under the proposed LIQUIDITY component of Basel III, gold is currently labeled with a 50% liquidity “haircut”, which is the same haircut that is applied to equities and bonds. This implicitly assumes that gold cannot be easily converted into cash in a stressed period, which is exactly the opposite of what we observed during the crisis. It also requires the bank to maintain a much more stable source of funding in order to hold gold as an asset on its balance sheet. Fortunately, there is a strong chance that this liquidity definition for gold may be changed. The World Gold Council has in fact been lobbying the Basel Committee, the Federal Reserve and the FDIC on this issue as far back as 2009, and published a paper arguing that gold should enjoy the same liquidity profile as cash or AAA-government securities when calculating Basel III’s LCR and NSFR ratios. And as it turns out, the liquidity definitions that will guide banks’ LCR and NSFR calculations have not yet been finalized by the Basel Committee. The Basel III comment period that ended on October 22nd resulted in the deadline being pushed back to January 1, 2013, and given the recent delays with the US bank regulators, will likely be postponed even further next year. Of specific interest to us is how the Basel Committee will treat gold from a liquidity-risk perspective, and whether they decide to lower gold’s liquidity “haircut” from 50% to something more reasonable, given gold’s obvious liquidity superiority over that of equities and bonds.

The only hint we’ve heard thus far has come from the World Gold Council itself, which suggested in an April 2012 research paper, and re-iterated on a recent conference call, that gold will be given a 15% liquidity “haircut”, but we have not been able to confirm this with either the Basel Committee or the FDIC. In fact, all inquiries regarding gold’s treatment made to those groups by ourselves, and by other parties that we have spoken with, have been met with silence. We get the sense that the regulators have no interest in stirring the pot by mentioning anything related to gold out of turn. Given our discussion above, we can understand why they may be hesitant to address the issue, and only time will tell if gold gets the proper liquidity treatment it deserves.

November 29, 2012

Goldman Wins Again As European Union Court Rules To Keep ECB Involvement In Greek Debt Fudging A Secret

Three years ago, a hard fought landmark FOIA lawsuit was won by the great Bloomberg reporter, the late Mark Pittman, in which the Fed was forced to disclose a plethora of previously secret bailout information, which in turn spurred the movement to "audit the Fed" and include a variety of largely watered down provisions in the Frank-Dodd bill. This victory came despite extensive objections by the Fed and the threat that the case may even escalate to the highly politicized Supreme Court, which lately has demonstrated conclusively that not only is justice not blind, but goes to the highest ideological bidder. Moments ago, Europe just learned that when it comes to secrecy of its supreme monetary leaders, in this case all originating from Goldman Sachs and defending data highly sensitive to the same Goldman Sachs, the European central bank's secrecy is not only matched by that of the Fed, but even more engrained in the "judicial" system of the Eurozone, after the European Union General Court in Luxembourg just announced that the European Central Bank will be allowed to refuse access to secret files showing how Greece used derivatives to hide its debt. Why? Simple: recall that it was Goldman Sachs who was the primary "advisor" on a decade worth of FX swaps-related deals which allowed Greece to outright lie about both its fiscal deficit and its total debt levels, and that it was a Goldman alum who became head of the same Greek debt office just before the country imploded. And certainly the ECB was involved and knew very all about the Greek behind the scenes shennanigans. And who happens to be head of the ECB? Why yet another former Goldman worker, of course. Mario Draghi.

And with yet another ex-Goldmanite taking over the BOE, any hopes of bank transparency in the UK have just been crushed as well. Goldman is taking over the world one central bank, and Supreme Court at a time, and leaving not a trace behind, even as it manages to create ever more debt out of thin air to keep the population occupied chasing trinkets, gadgets, and other unneeded stuff, while the real wealth plunder by Goldman et al enters its terminal phase.

From Bloomberg:
Disclosure of those documents would have undermined the protection of the public interest so far as concerns the economic policy of the EU and Greece,” the European Union General Court in Luxembourg said today, rejecting a challenge by Bloomberg News. The news organization initially sought the documents in August 2010.
The same excuse always and forever: the common man should not know what is truly going on behind the scenes, as the truth would "undermine protection of the public interest" - just leave it to the smart men in tweed suits to fret about the details; it is best if the general ignorant herd remains in the dark, or else its "protection" may be impaired...
Today’s ruling by three judges denies European taxpayers, on the hook for the cost of Greece’s 240 billion-euro ($311.5 billion) bailout, the opportunity to see whether EU officials knew of irregularities in Greece’s public accounts before they became public in 2009.

The decision underscores the lack of accountability at the ECB as it expands its powers to become the region’s lender of last resort and chief banking regulator. The central bank, which puts greater limits on its disclosures about its decision making than its British and U.S. equivalents, is under pressure from policy makers including governing council member Erkki Liikanen to boost transparency. ECB President Mario Draghi last month defended the Frankfurt-based bank, telling reporters it was already a “very transparent” institution.

Bloomberg News sought two internal papers drafted for the central bank’s six-member Executive Board. The first document is entitled “The impact on government deficit and debt from off- market swaps: the Greek case.” The second reviews Titlos Plc, a structure that allowed National Bank of Greece SA (ETE), the country’s biggest lender, to borrow from the ECB by creating collateral.
And just to complete the farce, perhaps the Fed will tell us how its own investigation launched in February of 2010(!) looking at Goldman's behind the scenes involvement in faking the Greek debt numbers for a decade, is going. Recall: "We are looking into a number of questions related to Goldman Sachs and other companies and their derivatives arrangements with Greece," Bernanke said in testimony before the Senate Banking Committee. It is now nearly three years later and still nothing...

Naturally, we won't hold our breath.

Sadly, little can be added here: Goldman wins again, and justice for the common man is long dead.


November 28, 2012

The Giant Currency Superstorm That Is Coming To The Shores Of America When The Dollar Dies

By recklessly printing, borrowing and spending money, our authorities are absolutely shredding confidence in the U.S. dollar. The rest of the world is watching this nonsense, and at some point they are going to give up on the U.S. dollar and throw their hands up in the air. When that happens, it is going to be absolutely catastrophic for the U.S. economy. Right now, we export a lot of our inflation. Each year, we buy far more from the rest of the world than they buy from us, and so the rest of the world ends up with giant piles of U.S. dollars. This works out pretty well for them, because the U.S. dollar is the primary reserve currency of the world and is used in international trade far more than any other currency is. Back in 1999, the percentage of foreign exchange reserves in U.S. dollars peaked at 71 percent, and since then it has slid back to 62.2 percent. But that is still an overwhelming amount. We can print, borrow and spend like crazy because the rest of the world is there to soak up our excess dollars because they need them to trade with one another. But what will happen someday if the rest of the world decides to reject the U.S. dollar? At that point we would see a tsunami of U.S. dollars come flooding back to this country. Just take a moment and think of the worst superstorm that you can possibly imagine, and then replace every drop of rain with a dollar bill. The giant currency superstorm that will eventually hit this nation will be far worse than that.

Most Americans don't realize that there are far more dollars in use in the rest of the world than in the United States itself. The following is from a scholarly article by Linda Goldberg...
The dollar is a major form of cash currency around the world. The majority of dollar banknotes are estimated to be held outside the US. More than 70% of hundred-dollar notes and nearly 60% of twenty- and fifty-dollar notes are held abroad, while two-thirds of all US banknotes have been in circulation outside the country since 1990
For decades we have been exporting gigantic quantities of our currency.

So what would happen if that process suddenly reversed and massive piles of dollars started coming back into the country?

It is frightening to think about.

Well, I guess the key is to get the rest of the world to continue to have confidence in the U.S. dollar so that will never happen, right?

Unfortunately, there are lots of signs that the rest of the world is accelerating their move away from the U.S. dollar.

For example, it was recently announced that the BRICS countries are developing their own version of the World Bank...
The BRICS (Brazil, Russia, India, China and South Africa) bloc has begun planning its own development bank and a new bailout fund which would be created by pooling together an estimated $240 billion in foreign exchange reserves, according to diplomatic sources. To get a sense of how significant the proposed fund would be, the fund would be larger than the combined Gross Domestic Product (GDP) of about 150 countries, according to Russia and India Report.
And as I noted in a previous article, over the past few years there have been a whole host of new international currency agreements that encourage the use of national currencies over the U.S. dollar. The following are just a few examples...

1. China and Germany (See Here)

2. China and Russia (See Here)

3. China and Brazil (See Here)

4. China and Australia (See Here)

5. China and Japan (See Here)

6. India and Japan (See Here)

7. Iran and Russia (See Here)

8. China and Chile (See Here)

9. China and the United Arab Emirates (See Here)

10. China, Brazil, Russia, India and South Africa (See Here)

Will this movement soon become a stampede away from the U.S. dollar?

That is a very important question.

But you don't hear anything about this in the U.S. media and our politicians are not talking about this at all.

Meanwhile, our "leaders" seem to be doing everything that they can to destroy confidence in the U.S. dollar. The Federal Reserve is printing money like there is no tomorrow, and the federal government continues to run up trillion dollar deficits year after year.

They do not seem to understand that they are systematically destroying the U.S. financial system.

Other world leaders get it. For example, Russian President Vladimir Putin once said the following...
"Unreasonable expansion of the budget deficit, accumulation of the national debt – are as destructive as an adventurous stock market game.
During the time of the Soviet Union the role of the state in economy was made absolute, which eventually lead to the total non-competitiveness of the economy. That lesson cost us very dearly. I am sure no one would want history to repeat itself.”

Why can't most of our politicians see how destructive debt is?

What the federal government continues to do is absolutely insane. The national debt increased by more than 24 billion dollars on the day after Thanksgiving this year. But utter disaster has not struck yet, and most Americans are not really that concerned about the debt. So things just keep rolling along.

And of course our national debt of $16,309,738,056,362.44 is nothing when compared to the future liabilities that our federal government is facing. Just check out what a recent article in the Wall Street Journal had to say about all this...
The actual liabilities of the federal government—including Social Security, Medicare, and federal employees' future retirement benefits—already exceed $86.8 trillion, or 550% of GDP. For the year ending Dec. 31, 2011, the annual accrued expense of Medicare and Social Security was $7 trillion. Nothing like that figure is used in calculating the deficit. In reality, the reported budget deficit is less than one-fifth of the more accurate figure.
Other economists paint an even gloomier picture. According to economist Niall Ferguson, the U.S. government is facing future unfunded liabilities of 238 trillion dollars.

So where are we going to get all that money?

Well, why don't we just print more money than ever before so that the U.S. government can borrow and spend more money than ever before?

Don't laugh. That is actually what some of the top economists in the country are actually recommending.

The most famous economic journalist in the entire country, Paul Krugman of the New York Times, is boldly proclaiming that the solution to all of our problems is to print, borrow and spend a lot more money. He insists that there is no reason to fear that the giant mountain of debt that we are accumulating will someday collapse the system...
For we have our own currency — and almost all of our debt, both private and public, is denominated in dollars. So our government, unlike the Greek government, literally can’t run out of money. After all, it can print the stuff. So there’s almost no risk that America will default on its debt — I’d say no risk at all if it weren’t for the possibility that Republicans would once again try to hold the nation hostage over the debt ceiling.
But if the U.S. government prints money to pay its bills, won’t that lead to inflation? No, not if the economy is still depressed.

Now, it’s true that investors might start to expect higher inflation some years down the road. They might also push down the value of the dollar. Both of these things, however, would actually help rather than hurt the U.S. economy right now: expected inflation would discourage corporations and families from sitting on cash, while a weaker dollar would make our exports more competitive.
Of course what he is prescribing is complete and utter madness.

At some point this con game is going to collapse and the rest of the world is going to say a big, fat, resounding "NO" to the U.S. dollar.

Why should they continue to use a currency that is becoming extremely unstable and that is constantly being manipulated?

And when the rest of the world rejects the U.S. dollar, the value of the dollar will drop like a rock because there will be far less global demand for it.

In addition, if the rest of the world is not using the U.S. dollar for trade any longer, other nations will cease to soak up our excess currency and huge mountains of our currency that are floating around out there will start flooding back to our shores.

At that point we will be looking at inflation unlike anything we have ever seen before. The era of cheap imports will be over and we will pay far more for everything from oil to the foreign-made plastic trinkets that we buy at Wal-Mart.

Most Americans don't even know what a "reserve currency" is, but when the U.S. dollar loses reserve currency status it is going to unleash a nightmare that most economists cannot even imagine.

So enjoy this holiday season while you can. There are still lots and lots of cheap imports filling the shelves of our stores.

Once the coming giant currency superstorm strikes, we will dearly wish for the good old days of 2012.

Yes, the U.S. dollar is alive and ticking for now. But at the pace that our authorities are abusing it, I would not say that things are looking good for a long and healthy lifespan.


November 27, 2012

Ex-Goldman Sachs banker appointed as new governor at Bank of England

Today the chancellor confirmed that there will be no real change at the Bank of England. There will be no change to the Treasury and Bank of England’s obsession with inflation targeting and “price stability”. Above all, he confirmed that there will be no reining-in of the banks; that banks will not be re-structured – to separate the retail and investment arms, and ensure that banks are no longer too big to fail.

He confirmed this by appointing an ex-Goldman Sachs banker, Mark Carney, as governor of the Bank of England.

The FT was right when in January this year it described Carney as [FT paywall] ”the leading example of a new breed of ambitious, internationally focused central bankers who view regulatory and monetary policy issues through a more market-based lens”. He favours an “open and resilient financial system” – code for giving the banks free rein in global capital markets. And like many of his peers he believes that the key to recovery lies in all western economies “capitalising on the immense opportunity that emerging markets in general and China in particular represent”. Like others, he prefers exports over the expansion and strengthening of domestic markets.

So be very afraid. Business-as-usual will prevail. And nothing will be done to constrain the City, and therefore to prevent the next collapse of the financial system.

Carney is a central banker steeped in the culture and practices of Goldman Sachs’s investment banking arm. Before becoming Canada’s central bank governor, he spent 13 years with Goldman Sachs in its London, Tokyo, New York and Toronto offices. He held a range of senior positions. The most significant was as managing director of investment banking.

In a speech made recently Carney made the right noises. He complained of ”a system that privatises gains and socialises losses” and endorsed the approach that sets capital and leverage ratios for banks. He’s even commended the Occupy movement for being “constructive”.

But there is nothing in his speeches that indicates that he will help give Britain’s real economy the protection it needs from its over-mighty – and still very dangerous – banking sector. Nothing, in other words, that indicates the real economy – the productive sector – will be given priority over the City’s preference for reckless global speculation.

Instead like many others who adopt a “market-based” approach to regulation, Carney prefers to tinker – retrospectively – with the capital ratios of banks. This is because he and many others in central bank circles know that most of the Britain’s banks are very highly leveraged. That without the support of the Bank of England’s quantitative easing programme, and its very low lending rates – all effectively backed by British taxpayers – Britain’s banks would effectively be insolvent.

And so Carney will continue with quantitative easing – which has provided British banks with the liquidity needed to indulge in speculative activity both at home and abroad, speculative activity that bears a scary resemblance to that undertaken before the crisis.

He is unlikely to pressure his friends in the City’s commercial banks to lend at low sustainable rates to Britain’s productive sector. He is therefore most unlikely to reverse the most bizarre and historically unprecedented aspect of today’s British banking system: the fact that those of us in the real economy are lending to banks. Their original mission – of lending into the real economy – has been turned on its head. Today Britain’s banks are recipients of loans (deposits) from those active in the real economy – and subsidies from taxpayers.


November 26, 2012

On Artificial Interest Rates And The Forfeiture Of Growth For Dividends

Diapason Commodities' Sean Corrigan provides an insightful introduction to the critical importance of a market-set rate of interest and central banks' manipulated effect on the factors of production.
"Fixated with using their illusory ‘wealth effect’ to avoid a full realization of the losses we have all suffered in a boom very much of those same central bankers’ creation - or else cynically trying to achieve the same denial of reality by driving the income-poor into accepting utterly inappropriate levels of financial risk - they are destroying both the integrity and the signalling ability of those same capital markets which are the sine qua non of a free society."
As Ron Paul also confirms in the clip below "with artificial interest rates, we get an artificial economy driven by mal-investment leading to the inevitable bubbles" and while central banks hope for this 'created credit/money' to flow into productive means (Capex), instead it has (in today's case where QE is no longer working) created an investor-class demand for yield - implicitly driving management to forfeit growth-and-investment for buybacks-and-dividends.

Ron Paul's interview with Laisses Faire outlines the impact an artificial interest rate has on the economy...

and Sean Corrigan of Diapason Commodities provides a more in-depth look at the process by which a manipulated interest rate impacts the factors-of-production (or the risks and rewards of the real business cycle)...
What is not to be overlooked is that the applicable rate of interest is not some abstract entity, utterly variable according to the whim of the banking system, but rather is one of the fundamental ratios prevailing in the vast, interconnected topology of exchange - in this case, between the value put on goods available at once and on those only accessible at some future date...

Take the act of deciding upon the launch of a new or expanded line of business. Obviously the entrepreneur will make his best guess as to the stream of revenues he may gather and will set these off against his estimates of what it will cost him to achieve them. Thus it is, of course, that a lowering of the rate of generally accepted rate of interest makes his challenge seem a less daunting one: our man will not only have less to pay out on any hired capital he requires, but the possibility of earning a greater return in some other fashion...Yet - whether he recognises this or no - his reckoning is intimately bound up with the information which the interest rate is conveying with regard to the likely relative abundance of his inputs and the relative demand for his outputs over the entire investment horizon of his project...

It should be all too apparent by now that if we are to enjoy conditions which are favourable to both the greatest degree of co-ordination between the market’s multitude of actors; if we are to remove all impediments to the early recognition of such lapses from that co-ordination as must inevitably occur in a shifting world of imperfect knowledge and changing tastes, then any interference with the spontaneous, holistic formation of prices is not to be countenanced, much less embraced as a tool of dirigisme.

Rather, it is vital that the myriad interactions between buyer and seller, producer and consumer, saver and spender, employer and employee should be allowed to make its due contribution to the universal field of prices thence to reveal how best to marshal our limited resources in order to deliver more of what appears to be the more urgently required and to expend fewer efforts on the less. This is not true only in the here and now, but also over time.
Clearly, we have no gold standard to impose discipline on either the ruling elite or the bankers who are their political symbionts... granted, we have a wider range of non?bank and other credit instruments to confuse the issue; but none of them alter the fact that investment is best undertaken when both the money and the means corresponding to that money have been voluntarily set aside to finance it, or that, conversely, investment is worst entered upon when it is launched on a soon cresting wave of counterfeit capital, conjured up by the banks or the government printing press.

which leads to the current remarkably non-traditional text-book situation that Citi describes - where equities are now the yield-providing asset as management is punished for spending capital on growth or investment and is praised for buybacks and dividends as the Fed's artificial premise in which we live has created a monster...
Policy-makers have adopted aggressive methods to push interest rates and bond yields down to unprecedented levels. It is hoped that these low rates will trigger a stronger recovery in corporate capex and jobs. Evidence of this remains sketchy...

We think that QE may be having the opposite impact to that intended. Instead of encouraging capex and job creation, ultra low interest rates are bringing yield-starved capital into the global equity market. These investors are more interested in dividends and share buybacks than corporate expansion. Those CEOs who give them what they want should be rewarded by share price outperformance. Those who do not may find themselves replaced.
If we are to salvage any residue of our liberty, restore any semblance of our prosperity, and again secure to ourselves the right to enjoy our property, this [manipulation] must be ended before it consumes our capital...

If all this means that we have fewer projects underway at any one time, so be it: we will waste far less of what we hold scarce and end up holding fewer things as scarce as we do now.

The Garden of Eden may well be denied us, but that does not mean the only remaining choices are the debtor’s gaol or the soft totalitarianism of de Tocqueville’s worst imaginings... is saving that makes us rich, not spending, and it is only by saving – not through authoritarian fiat ? that a naturally lowered interest rate confers a lasting aid to capital formation.
If policymakers hope that listed companies can help drive down current high levels of unemployment then it could be a long wait. Corporate expansion plans are likely to remain constrained by uncertainties about the global economy and a shareholder base that is more interested in share buybacks and dividends than capex and job creation.

November 23, 2012

Goldman Sachs's "Porous Safety Net"

Goldman Sachs is something else. It tries to revise history; it makes ridiculous suggestions; it makes horrific predictions; it should be ashamed of itself.

The following excerpt is from a Forbes article quoting Goldman Sachs:

Why did household formation collapse? Goldman’s research team suggests the headship rate, or the percentage of people that are heads of a household, broke down as immigration flows to the U.S. slowed and young people either stayed with their parents for longer or “doubled up” with relatives and roommates.
Such revisionism brings to mind 1984 and Winston Smith's "job to re-write past newspaper articles so that the historical record always supports the current party line." In the present instance, it is the banks' line that they had nothing to do with creating the sub-prime mortgage and securitization frauds that brought down the financial system, that foreclosed on millions of people who were sold inappropriate mortgages so that the banks could earn substantial profits, which in turn gave the executives huge salaries and munificent bonuses based on their egregious unearned profits. Unemployment caused foreclosures during the financial crisis that Goldman helped create. But Goldman recalls its own bad deeds as "the heads of a household" breaking down as immigration flows slowed! How nice to revise history in your own favor or more accurately, of putting your past into a "memory hole." The two histories, the one that no longer exists for Goldman and the one that it re-writes above, are excellent examples of "doublethink."

Then as to Mr. Blankfein's ridiculous suggestions, those can be found on the CBS blog by Scott Pelley;

Here Blankfein says that the people should not expect to get the entitlements of Social Security, Medicare and Medicaid. He wants people to lower their expectations for retirement and health benefits that should be "slowed down and contained" because the government can no longer afford them.

It is ridiculous to say that the government cannot afford Social Security. Any sovereign government that has its own currency can afford to pay whatever it chooses to pay for!

Here's what Joe Firestone says:
– Social Security has no solvency or “running out of money” problems. The SS crisis is a phoney one. No solution to this “fiscal crisis,” bipartisan or partisan, is needed. What is needed is a solution to the political problem of getting SS’s funding guaranteed in perpetuity by Congress, just the way it guarantees funding for Medicare Parts B and D.

– The same applies to the so-called Medicare crisis. It too is phoney, and can be solved easily by Congress guaranteeing funding in perpetuity to Medicare Parts A and C.

– More generally, there is no entitlement funding crisis in the United States, except a political crisis where US politicians are determined to ignore their constituents and cut back on an already inadequate safety net either because they believe in, or want others to believe in false ideas about fiscal responsibility and nature of the Government as a giant household. (from an article in New Economics Perspectives by Joe Firestone)
Finally, Blankfein makes a horrific prediction for the future of others: that society should be one where "the safety net would be more porous and lower to the ground."

And for him I would wish that his safety net be high and porous: no more taxpayer bailouts; no more huge unearned salaries; no more big bonuses; no more bets against the economy and finally, full prosecution under the law for accounting control fraud--soon.


November 21, 2012

They Are Going To Make It Nearly Impossible To Pass On A Farm Or A Business To Your Children

If you have a farm or a small business, would you like to pass it on to your children when you die?  Well, unless Congress does something, it is going to become much, much harder to do that starting next year.  Right now, there is a 5 million dollar estate tax exemption and anything above that is taxed at 35 percent.  But on January 1st, the exemption will go down to 1 million dollars and the tax rate will go up to 55 percent.  A lot of liberals are very excited about this, because they believe that the government will be soaking wealthy people like Warren Buffett and Bill Gates.  But the truth is that a lot of farms, ranches and small businesses will be absolutely devastated by this change in the tax law.  There are many farmers and ranchers out there today that do not make much money but are sitting on tracts of land that are worth millions of dollars.  According to the American Farm Bureau, approximately 97 percent of all farms and ranches in the United States would be subject to the estate tax if the exemption was reduced to just a million dollars.  That means that the children of these farmers and ranchers would be faced with a very cruel choice when it is time to inherit these farms and ranches.  Either they come up with enough money to pay the government about half of what the farm or ranch is worth, or they sell the farm or ranch that may have been in their family for generations.  Needless to say, most farm and ranch families do not have that kind of cash lying around.  Most of them are just barely making it from year to year.  So this change in the tax law is going to greatly accelerate the death of the family farm in America.  This is also going to devastate many family-owned small businesses.  Many small businesses don't make much money, but they have buildings or land or assets worth millions of dollars.  Children that may have wanted to continue the family legacy will be forced to sell because of the massive tax bill that they get from Uncle Sam.  This is an insidious cruelty, and it shows just how broken our system has become.

The desire to leave the wealth that you have worked so hard to accumulate all your life to your children is something that is common to virtually all human societies.  We want to know that future generations will be taken care of.

It is simply immoral for the federal government to swoop in and tax farms, ranches and small businesses that were intended to be passed down from parents to their children at a 55 percent tax rate.

A lot of the people that are going to be affected by this change are not "wealthy" at all.  A recent Fox News report examined what this change in the law is going to mean for rancher Kevin Kester and his family...
Rancher Kevin Kester works dawn to dusk, drives a 12-year-old pick-up truck and earns less than a typical bureaucrat in Washington D.C., yet the federal government considers him rich enough to pay the estate tax -- also known as the "death tax."
Kester told Fox News that he has no doubt that his ranch will have to be sold when he dies just to pay the tax bill...
"There is no way financially my kids can pay what the IRS is going to demand from them nine months after death and keep this ranch intact for their generation and future generations," said Kester, of the Bear Valley Ranch in Central California.
Two decades ago, Kester paid the IRS $2 million when he inherited a 22,000-acre cattle ranch from his grandfather. Come January, the tax burden on his children will be more than $13 million.
Reading that should make you angry.  Every single year, thousands upon thousands of farms, ranches and small businesses are going to be lost to the federal tax monster.

It is almost as if the federal government does not want income-producing assets to remain in the hands of the "little guy".

What in the world are we supposed to do?

It isn't as if all of those farmers and ranchers can go off to the big cities and find good jobs.  As I wrote about yesterday, our politicians are standing aside as millions of our good jobs are shipped out of the country.

The cold, hard truth is that our system does not work for average Americans any longer.  Those that roll out of bed every morning, work hard and never complain always seem to get the short end of the stick.
The people that are the backbone of America are the ones that the government is always the hardest on.
Unfortunately, we have gotten to a point where the government is searching for more "revenue" from anywhere it can because it desperately needs more money.  U.S. government finances are a complete and total mess and we are drowning in the biggest ocean of debt the world has ever seen.

We are more than 16 trillion dollars in debt and there are more than 100 million Americans that are enrolled in at least one welfare program.

Someday has to pay for all this.

Middle class Americans are already hit with dozens of different taxes each year, and you can be certain that our politicians will continue to invent ways to extract even more "revenue" out of us.

And of course our politicians will never stop their wild spending.  Despite all of the negotiations that have taken place over the past couple of years, our spending problems just continue to grow.  For example, the federal budget deficit for the month of October was $120 billion, which was more than 20 percent larger than the federal budget deficit for October 2011 was.

So what is the solution?

Well, Treasury Secretary Timothy Geithner now says that he wants to eliminate the debt ceiling entirely.  He says that we should just have no limit and that the federal government should just be able to go into debt as much as it wants.

In the end, all of this debt is going to absolutely crush us.  We have literally destroyed the future of America, and yet most of the country still seems clueless about all of this.  The blind are leading the blind, and we are headed straight for complete and utter disaster.

One day, when people look back on this period in American history, what do you think people are going to say about us?


November 20, 2012

Mortgage Settlement Monitor “Progress” Report Gooses Numbers to Hide Lack of Real Relief to Homeowners

As we and others have written at considerable length, the mortgage settlement was a big exercise in optics. The $26.1 billion number sounds impressive until you compare it to the size of the housing market and the damage done to homeowners. 40% of the value of the settlement can come from junk credits, things the banks would have done anyhow or should be doing in the normal course of business, like razing vacant homes, short sales, and giving homes to charities. And of the remaining part, which was a relatively small amount of actual cash payment ($5.8 billion, but that included over a billion of fines federal regulators rolled into that total), the rest is supposed to be reduction of mortgage principal. Oh, but wait, they can take credit for modifying OTHER PEOPLE’S MORTGAGES, meaning those owned by investors. And they’ve been doing that in more than half the cases. As the Financial Times reported last week:
Investors in US mortgage securities have been forced to absorb large writedowns in response to a deal between leading financial groups and government agencies over the “robosigning” scandal….

The banks – JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Ally Financial – agreed to forgive billions of dollars worth of distressed borrowers’ mortgage principal in exchange for waivers from potential liability.

On Wednesday, BofA said that 60 per cent of the $4.75bn in first-lien mortgage principal it has thus far agreed to forgive would come from non-government guaranteed loans that were packaged into bonds and sold to investors.

Of JPMorgan’s $3bn in forgiven mortgage debt, slightly less than half has come from investors’ holdings, a person familiar with the matter said. The other three banks either declined to provide numbers or did not respond to requests for comment.
The Charlotte Bank has far and away the biggest settlement obligation, $8.5 billion versus $4.3 billion for Wells and $4.2 billion for Chase, the next two in size rank. Remember also that banks were offering principal mods on loans in their portfolio before the settlement; it’s a no-brainer that most if not all of the mods on bank owned loans were ones they would have done anyhow.

Today, the settlement monitor Joseph Smith released another PR piece, um, progress report. These reports are already sus since the monitor isn’t require to say anything about his work until first quarter 2013. So this looks like an exercise in messaging over moving the ball forward (reports like this take a lot of work and divert resources from oversight).

We can see with this report that more effort has gone into creative accounting to make the results look better than they really are. Smith’s first progress report gave prominent play to this chart, which was troubling. Despite the claim, taken up by the media, that borrowers got “relief”, what it showed instead is that they got overwhelmingly was short sales:

We weren’t alone in criticizing the prevalence of short sales, which results in borrowers losing their homes, over various forms of relief, most important, deep principal mods, which keep them in place. Even with the housing market bounce, losses on foreclosures are so high (70%+ of mortgage value) that a deep mod (30% to 50%) is a win-win if the borrower has an adequate level of income.
Dave Dayen hits this issue hard:
$13.13 billion of the $26.11 billion in relief stated here comes from short sales. Not much of this will actually count toward the settlement, so I don’t know why they keep including this number. And it’s not what anyone means when they talk about a settlement that “helps keep people in their homes.” Short sales do the opposite of that. They’re a sale, often a forced sale, of the home. Katie Porter [settlement monitor for California's side deal] notes:

Um, not to the degree you’d think. Notice the dark grey area, the “Active Trial in Progress”? They were not included in the chart in the first report. And there’s no reason they should be. Those are trial modifications. And there is no assurance these will lead to permanent mods; banks have been known to call payment catch up plans, in which borrowers try to make up for missed payments or clear out late and related junk fees, as “trial mods” even though they result in higher, not lower, monthly payments.

Back that out and you have short sales at 59% of the total of the latest version of the pie chart. Yes, that is still a meaningful improvement compared to the 82% it was last time. But this little trick shows how the monitor’s priority is be making the program look successful, as opposed to getting tough with the servicers (which might mean calling them out on lack of progress, what a thought!).

Oh, and even better: the amount of relief from these “maybe they’ll get done, maybe they won’t” mods is $4.118 billion, versus actual completed principal mods of only $2.53 billion.

And get a load of this doozy, from Smith’s cover letter (emphasis mine):
As was the case with my prior report, the consumer relief activities discussed in this report represent gross dollars that have not been subject to calculation under the crediting formulas in the settlement agreement. Therefore, the $26.11 billion in cumulative consumer relief reported here cannot be used to measure progress toward the $20 billion obligation in the settlement. As also was outlined in my first report, neither I nor the professionals working with me have confirmed these figures. No credit will be awarded to a servicer until I, as Monitor, am satisfied that the servicer has met its obligations.
Again, why is Smith wasting money when:
• The figures haven’t been verified and hence who knows how good they are (given the terrible state of servicer information systems, significant misreporting is a real risk)

• He hasn’t/can’t be bothered preparing a pro forma of how these self-reported figures track against the total required by the settlement?
There are additional tidbits in the report that aren’t too pretty. We had flagged that banks were certain to modify high dollar value mortgages, which means fewer people would be helped, and the ones who got help would be the more affluent. Why would they target bigger mortgages? A mod is pretty much the same amount of work regardless of loan balance. So you get to the total required by the settlement faster and cheaper if you modify big mortgages rather than small ones. And we see that in the report:
21,833 borrowers successfully completed a first lien modification and received $2.55 billion in loan principal forgiveness, averaging approximately $116,929 per borrower.
20% is a good guess as to the typical amount of principal reduction (trust me, the average will be well under 50%). So that gives you an average mortgage balance of $585,000.

And the mortgages getting trial mods are likely even bigger:
30,967 borrowers are in active first lien trial modifications as of September 30, 2012, the total principal value of which is $4.19 billion. This represents potential relief of $135,223 per borrower if the trials are completed.
If we use the same 20% principal mod guesstimate, the average mortgage balance is $676,000.

We see the same pattern on the second liens:
Second lien modifications and extinguishments were provided to 50,025 borrowers, representing approximately $2.78 billion in total relief. The average amount of relief for borrowers whose second liens were modified or extinguished was approximately $55,534.
To put none too fine a point on this, $55,534 is a big second lien, and since some were modified rather than wiped out, the actual average amount is even larger.

So this sorry settlement is playing out as predicted: relief for only a small number of borrowers, and then mainly better off ones, with the banks getting a huge “get out of liability” card on the cheap. And to add insult to injury, we have to read colored pie charts doctored to make a bad story look a smidge less awful. 
Short sales should be reserved for homeowners who couldn’t afford to live in a home even with a lower principal or for people who need to move, said UC Irvine law professor Katherine Porter, who was appointed by the state attorney general’s office to monitor the deal.

“I am pushing hard to make sure that … short sales are being used for families for whom other options are really not available,” Porter said.
It’s difficult to see whether that’s the case.
Yves again. So if you look at the updated version of the chart, things look much better, right? I mean, that big green area which is short sales, is still more than half, but at least it’s a much smaller percentage of the total pie than it was the last time. So the servicers are moving in the proper direction, right?


November 19, 2012

Global Shadow Banking System Rises To $67 Trillion, Just Shy Of 100% Of Global GDP

Earlier today, the Financial Stability Board (FSB), one of the few transnational financial "supervisors" which is about as relevant in the grand scheme of things as the BIS, whose Basel III capitalization requirements will never be adopted for the simple reason that banks can not afford, now or ever, to delever and dispose of assets to the degree required for them to regain "stability" (nearly $4 trillion in Europe alone as we explained months ago), issued a report on Shadow Banking. The report is about 3 years late (Zero Hedge has been following this topic since 2010), and is largely meaningless, coming to the same conclusion as all other historical regulatory observations into shadow banking have done in the recent past, namely that it is too big, too unwieldy, and too risky, but that little if anything can be done about it.

Specifically, the FSB finds that the size of the US shadow banking system is estimated to amount to $23 trillion (higher than our internal estimate of about $15 trillion due to the inclusion of various equity-linked products such as ETFs, which hardly fit the narrow definition of a "bank" with its three compulsory transformation vectors), is the largest in the world, followed by the Euro area with a $22 trillion shadow bank system (or 111% of total Euro GDP in 2011, down from 128% at its peak in 2007), and the UK in third, with $9 trillion. Combined total shadow banking, not to be confused with derivatives, which at least from a theoretical level can be said to offset each other (good luck with that when there is even one counterparty failure), is now $67 trillion, $6 trillion higher than previously thought, and virtually the same as global GDP of $70 trillion at the end of 2011.

Of note is that while the US shadow banking system has been shrinking (something our readers are aware of, and a fact which in our opinion implies there is nearly $4 trillion more in Fed monetization still to come, as Bernanke has no choice but to offset the credit destruction within shadow conduits, which in turn are deleveraging to the tune of nearly $150 billion per quarter), that of Europe has been increasing.
The result:
Aggregating Flow of Funds data from 20 jurisdictions (Argentina, Australia, Brazil, Canada, Chile, China, Hong Kong, India, Indonesia, Japan, Korea, Mexico, Russia, Saudi Arabia, Singapore, South Africa, Switzerland, Turkey, UK and the US) and the euro area data from the European Central Bank (ECB), assets in the shadow banking system in a broad sense (or NBFIs, as conservatively proxied by financial assets of OFIs15) grew rapidly before the crisis, rising from $26 trillion in 2002 to $62 trillion in 2007. The total declined slightly to $59 trillion in 2008 but increased subsequently to reach $67 trillion in 2011.

And while the the bulk of the shadow activity is contained within the 3 well-known jurisdictions (US, Europe, UK) whose credit creation capacity in the traditional banking system appears to have ground to a halt, especially in Europe where unencumbered collateral is virtually nil (thus forcing credit creation in the deposit-free, unregulated shadow space), the FSB also found previously unexplored shadow banks in some brand news venus including Switzerland, China and Hong Kong:
Expanding the coverage of the monitoring exercise has increased the global estimate for the size of the shadow banking system by some $5 to 6 trillion in aggregate, bringing the 2011 estimate from $60 trillion with last year’s narrow coverage to $67 trillion with this year’s broader coverage. The newly included jurisdictions contributing most to this increase were Switzerland ($1.3 trillion), Hong Kong ($1.3 trillion), Brazil ($1.0 trillion) and China ($0.4 trillion).
Not unexpectedly, the FSB focuses mostly on Europe, and provides the following color:
The size of the shadow banking system (or NBFIs), as conservatively proxied by assets of OFIs, was equivalent to 111% of GDP in aggregate for 20 jurisdictions and the euro area at end-2011 (Exhibit 2-3), after having peaked at 128% of GDP in 2007.

The summary is by now well-known to most who realize that the primary driver of marginal credit money creation (in Europe) and destruction (in the US) is none other than the world's shadow banking system. As per Bloomberg:
The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector.

“Appropriate monitoring and regulatory frameworks for the shadow banking system needs to be in place to mitigate the build-up of risks,” the FSB said in the report published on its website.
Sadly, shadow banking, like every other unsustainable aspect of the foundering "modern" financial system, will not be fixed, resolved, or in way improved or made sustainable until the entire system crashes.
What is notable, is that for the first time, the issue that is the lynchpin of virtually infinite shadow banking asset "creation" courtesy of rehypothecation, a topic that came to prominence with the MF Global collapse, and which allows infinite ownership chains on the same asset to be created as long as the counterparties are solvent, to fall under the spotlight, especially the legal loophole to create infinite rehypothecation chains with zero haircuts in the UK (hence geographic arbitrage as noted below). To wit:
Requirement on re-hypothecation

“Re-hypothecation” and “re-use” of securities are terms that are often used interchangeably; they do not have distinct legal interpretations. WS5 finds it useful to define “re-use” as any use of securities delivered in one transaction in order to collateralise another transaction; and “re-hypothecation” more narrowly as re-use of client assets.

Re-use of securities can be used to facilitate leverage. WS5 notes that if re-used assets are used as collateral for financing transactions, they would be subject to the proposals on minimum haircuts in section 3.1 intended to limit the build-up of excessive leverage, subject to decisions taken on the counterparty scope and collateral type (sections 3.1.4 (ii) and 3.1.4 (iii), respectively).

WS5 believes more safeguards are needed on re-hypothecation of client assets:
  • Financial intermediaries should provide sufficient disclosure to clients in relation to re-hypothecation of assets so that clients can understand their exposures in the event of a failure of the intermediary. This could include, daily, the cash value of: the maximum amount of assets that can be re-hypothecated, assets that have been re-hypothecated and assets that cannot be re-hypothecated, i.e. they are held in safe custody accounts.
  • Client assets may be re-hypothecated by an intermediary for the purpose of financing client long positions and covering short positions, but they should not be re-hypothecated for the purpose of financing the intermediary’s own-account activities.
  • Only entities subject to adequate regulation of liquidity risk should be allowed to engage in the re-hypothecation of client assets.
Harmonisation of client asset rules with respect to re-hypothecation is, in principle, desirable from a financial stability perspective in order to limit the potential for regulatory arbitrage across jurisdictions [ZH: ahem UK]. Such harmonised rules could set a limit on re-hypothecation in relation to client indebtedness. WS5 thinks that it was not in a position to agree on more detailed standards on re-hypothecation from the perspective of client asset protection. Client asset regimes are technically and legally complex and further work in this area will need to be taken forward by expert groups.
That the FSB has no idea how to regulate infinite rehypothecation should come as no surprise to anyone. After all, enforcing limits on creating "assets" out of thin are would limit the amount of millions Wall Street CEO can pay themselves in exchange for creating soon to be vaporized ledger entries, which they "do not recall" how those got there upon Congressional cross examination.
Finally, perhaps the most important section of all deal with what the FSB terms "Facilitation of credit creation."
Facilitation of credit creation

The provision of credit enhancements (e.g. guarantees) helps to facilitate bank and/or non-bank credit creation, may be an integral part of credit intermediation chains, and may create a risk of imperfect credit risk transfer. Non-bank financial entities that conduct these activities may aid in the creation of excessive leverage in the system. These entities may potentially aid in the creation of boom-bust cycles and systemic instability, through facilitating credit creation which may not be commensurate with the actual risk profile of the borrowers, as well as the build-up of excessive leverage. Credit rating agencies also facilitate credit creation but are outside the scope as they are not financial entities.

Examples may include:
  • Financial guarantee insurers that write insurance on financial products (e.g. structured finance products) and consequently facilitate potentially excessive risk taking or may lead to inappropriate risk pricing while lowering the cost of funding of the issuer relative to its risk profile. – For example, financial guarantee insurers may write insurance of structured securities issued by banks and other entities, including asset-backed securitisations, and often in the form of credit default swaps. Prior to the crisis, US financial guarantee insurers originated more than half of their new business by writing such insurance. While not all structured products issued in the years leading up to the financial crisis were insured, the insurance of structured products helped to create excessive leverage in the financial system. In this regard, the insurance contributed to the creation of large amounts of structured finance products by lowering the cost of issuance and providing capital relief for bank counterparties through a smaller capital charge for insured structures than for non-insured structures. Because of large losses on structured finance business, financial guarantee insurers have in some cases entered into settlement agreements with their counterparties under which, for the cancellation of the insurance policies, the counterparties accepted some compensation from the insurer in lieu of full recovery of losses. In other cases, financial guarantee insurers have been unable to pay losses on insured structured obligations when due. These events exacerbated the crisis in the market.
  • Financial guarantee companies whose funding is heavily dependent on wholesale funding markets or short-term commitment lines from banks – Financial guarantee companies may provide credit enhancements to loans (e.g. credit card loans, corporate loans) provided by banks as well as non-bank financial entities. Such financial guarantee companies may be prone to “runs” if their funding is heavily dependent on wholesale funding such as ABCPs, CPs, and repos or short-term bank commitment lines. Such run risk can be exacerbated if they are leveraged or involved in complex financial transactions.
  • Mortgage insurers that provide credit enhancements to mortgages and consequently facilitate potentially excessive risk taking or inappropriate pricing while lowering the cost of funding of the borrowers relative to their risk profiles – Mortgage insurance is a first loss insurance coverage for lenders and investors on the credit risk of borrower default on residential mortgages. Mortgage insurers can play an important role in providing an additional layer of scrutiny on bank and mortgage company lending decisions. However, such credit enhancements may aid in creating systemic disruption if risks taken are excessive and/or inappropriately reflected in the funding costs of the banks and mortgage companies.
Why is this section so imporant? Because recall that in a Keynesian system, credit creation = money creation = growth. Without "facile" credit creation, there is no growth period. The problem, however, is that the world is approaching its peak credit capacity across the various verticals: sovereign, financial, corporate non-financial, shadow, and of course, household. The reality is that unless some existing debt is not eliminated to make space for future "credit creation", there simply can not be growth, and the problem is that wiping out credit, means the equity tranches below it are worthless. And that is the Catch 22, because wiping out equity somewhere in the world, would have dramatic implications not only on the wealth of the 0.0001% but on credit and faith in a system, which only operates due to the inherent "credit" (hence the name) and "faith" in it. Without those, ultra-modern finance crumbles like a house of cards.

In other words, while the FSB, like any other prudent regulator, is diligently warning about the dangers associated with unprecedented leverage across shadow, and all other systems, in reality what it is saying is that the only way to resolve a record debt problem is... with more debt.

And so we are back to square zero, only this time we are a few trillions dollars closer to complete systemic debt saturation.

November 16, 2012

The Sucking Sound of (At Least Some) Skilled Workers Leaving the US

Defenders of the Obama Administration’s indifference to high levels of unemployment often claim the problem isn’t readily remedied because the US suffers from “structural unemployment”. That’s really wonkese for blaming the victim. No sirreebob, the problem isn’t that there aren’t enough jobs, but that the workers are no damned good, as in they don’t have the right skills for our new super duper information based economy! In mainstream media outlets, claims like this are usually followed by a business owner saying there clearly aren’t enough skilled employees, he can’t hire any good machinists for $13 an hour. Generally speaking, Mr. Complaining Boss is offering below the going rate, but why let pesky details spoil a good narrative?

You don’t have to look hard to find evidence against this argument. Unemployment is high among new college grads, normally one of the most sought after types of job candidates. Unemployment is also high across pretty much all job categories; you’d expect to see pockets of strength if there was a skills mismatch. Revealingly, you’ll hear Obama administration types say we need more engineers, when engineers will tell you the pay is too low relative to the cost of getting educated these days (unless you decide to get a law degree too and become a patent lawyer). If engineers really were scare, you’d expect pay scales to reflect that fact. Both the Economic Policy Institute and CEPR have published more rigorous debunkings.
Earlier this year, Australia started looking to hire skilled workers from the US. From Newsmax:
Australia has made a plea for American plumbers, electricians and builders to move downunder to fill chronic shortages of skilled workers as the economy struggles to keep up with a resources boom fuelled by demand from China.
Industry projections from Australia’s employment department show Australia will need 1.3 million extra workers over the next five years, including almost 200,000 more workers for the construction sector.
Australia will also need around 320,000 more health care and social assistance workers.
Australia has been running immigration seminars in India and Europe to attract skilled workers, and will now target the United States for the first time, with a skills expo set for Houston in Texas on May 19 and 20.
These are the sort of “middle class jobs” that people like Gene Sperling of the National Economic Council say they want to create. At the same time, when I once saw Sperling speak about “middle class job”, it was hard not to see that he viewed the “middle class” as a remote, but important object of concern, as opposed to a group he was part of.

Although Australia is at risk of being pulled down by slowing growth in China (the indicators are mixed), Canada has also started looking for experienced workers, in its case, in the oil industry. From OilPrice:
Canada is predicting a doubling of oil production by the end of this decade. This means it will have to secure its workforce to the tune of tens of thousands of new laborers. So if you want a job in the energy sector, try your northern neighbor.
Since 2010 alone, Canadian officials say that some 35,000 US laborers have obtained permits to work in Canada, and there are plans in the works to make permits even easier to obtain. In the meantime, Canadian head hunters are stepping up their efforts at recruitment—taking advantage of the number of jobless in the US.
Oh, and these jobs tend to come along with an attractive salary, free healthcare, stability and bonuses.
In other words, America’s continuing push to treat workers as disposable puts US companies at a disadvantage relative to employers in economies where for legal and cultural reasons, employees are treated better than in US. Now admittedly, this trend is taking place only in certain job categories, but twenty years ago, you would have been laughed out of the room if you had suggested that laborers like electricians and plumbers would have a better financial future if they left the US. And with college costs skyrocketing, you can expect to see more American students get their degrees overseas and that will increase the odds that some of them will wind up working abroad. American exceptionalism allows America’s leaders to keep pretending we are number one and use that as an excuse for inaction, when the evidence on the ground calls that into question.

November 15, 2012

House Republicans Find Corzine Guilty Of MF Global Collapse, Missing Funds; Democrats Refuse To Endorse Findings

It appears that these days not even the Corzining of client money can happen without it being split across furiously polarized party lines. As it turns out hours ago, the Committee on House Financial Services released an advance glimpse into a report to be released in its entirety tomorrow, which puts the blame for the collapse of not only MF Global, but also the disappearance of millions in client money, right where it belongs: the firm's then CEO Jon Corzine.

As Bloomberg summarizes, "The summary reflects conclusions reached by Republicans, who hold a majority on the panel and were in contact with Democrats during the investigation, according to Jeff Emerson, spokesman for the Financial Services Committee. The investigation included three congressional hearings, more than 50 interviews and a review of documents from MF Global, former brokerage employees and regulators, according to the summary."

Yet that Corzine corzined millions, leaving clients scrambling in bankruptcy court in an attempt to recover what should have been segregated money from the very beginning, and also just happened to blow up one of the 21 Fed-anointed Primary Dealers, is not surprising: this has been long known by everyone. Those who need a refresher are urged to recall the Honorable's testimony before the House... or maybe not: after all it is not as if Corzine himself could recall a whole lot. Where it gets interesting is that the former Democratic governor, and senator, not to mention primary bundler for president Obama, is, in the eyes of the members of the committee, innocent: All the democrats on the Investigations Subcommittee refused to sign off on the findings, meaning that to them, Corzine is completely innocent. That this is purely a political move is glaringly obvious. It is also abhorrent, because as long as political ideology gets in the way of pursuing and imposing justice, the Banana States of America will remain just that.

From The Committee on Financial Services:

Subcommittee Investigation Reveals Decisions by Corzine Led to MF Global Bankruptcy and Missing Customer Funds

Full report of Financial Services Oversight and Investigations Subcommittee
to be released Thursday

WASHINGTON – Decisions by Jon Corzine to chart a radically different course for MF Global and try to turn the 230-year-old commodities broker into a full-service investment bank were the cause of the firm’s bankruptcy and failure to protect customer funds, Republican members of a congressional subcommittee will report this week.

The House Financial Services Subcommittee on Oversight and Investigations, chaired by Rep. Randy Neugebauer, will release the full results of its year-long staff investigation into the collapse of MF Global on Thursday.

“Our investigation is essentially an autopsy of how MF Global came to its ultimate demise and what can be done to prevent similar customer losses in the future,” said Chairman Neugebauer.

Corzine, a former co-chairman of Goldman Sachs who later became a U.S. senator and governor of New Jersey, resigned from MF Global on November 4, 2011, almost 20 months after becoming the firm’s Chairman and CEO. The brokerage had declared bankruptcy four days earlier and its collapse revealed a $1.6 billion shortfall in customer funds.

“Choices made by Jon Corzine during his tenure as chairman and CEO sealed MF Global’s fate,” Chairman Neugebauer stated. “Farmers, ranchers and other customers may never get back over $1 billion of their money as a result of his decisions. Corzine dramatically changed MF Global’s business model without fully understanding the risks associated with such a radical transformation.”

The Subcommittee’s staff investigation of MF Global involved three hearings, more than 50 witness interviews, and the review of more than 243,000 documents obtained from MF Global, its former employees, federal regulators and other sources.

“By expanding MF Global into new business lines without first returning its core commodities business to profitability, Corzine ensured that the company would face enormous resource demands and exposed it to new risks that it was ill-equipped to handle,” the subcommittee report states.

In order to generate the revenue needed to fund MF Global’s transformation, Corzine invested heavily in the sovereign debt of struggling European countries. These investments, which carried enormous default and liquidity risks, were a “prime focus” of Corzine’s attention and he failed to develop a corporate strategy for managing the risks, the subcommittee majority staff found.

Authoritarian atmosphere

Those risks were exacerbated by an authoritarian atmosphere Corzine created at the firm where “no one could challenge his decisions,” the subcommittee report reveals.

Corzine made significant changes to MF Global’s senior management, including the hiring of Bradley Abelow, his former gubernatorial chief of staff, as the firm’s chief operating officer.

When MF Global’s chief risk officer disagreed with Corzine about the size of the company’s European bond portfolio, Corzine directed him to report to Abelow rather than to MF Global’s board of directors. “This change effectively sidelined the most senior individual charged with monitoring the company’s risks and deprived the board of an independent assessment of the risks that Corzine’s trades posed to MF Global, its shareholders and its customers,” the report declares.

Corzine insulated trading activity from review process

In addition, the subcommittee’s report reveals that Corzine acted as MF Global’s “de facto chief trader” and insulated his trading activities from the company’s normal risk management review process. This enabled Corzine to quickly build the company’s European bond portfolio “well in excess of prudent limits without effective resistance.”

Rather than hold the European bonds on MF Global’s books, which could expose the company to earnings volatility, Corzine chose to use these bonds as collateral in repurchase-to-maturity (RTM) transactions. This permitted the company to book quick profits while keeping the transactions off its balance sheet.

Failure to initially disclose extent of risks

Since MF Global did not initially disclose the full extent of its European bond holdings, federal regulators and the investing public were not aware of all the risks facing the company.

The belated disclosure in October 2011 of its extensive European RTM portfolio – which amounted to 14 percent of MF Global’s total assets – combined with poor earnings news prompted credit rating agencies to downgrade the company’s credit rating to junk status.

The downgrade set off a “run on the bank” by MF Global’s investors, customers and counterparties that created a liquidity crisis during what would turn out to be the company’s final days.

Because Corzine had failed to integrate systems and controls for managing the company’s liquidity and protecting customer funds, the company could not fully assess and anticipate its liquidity needs during the crisis, nor could it coordinate its cash management, liquidity monitoring and regulatory compliance functions.

Liquidity crisis prompts withdrawal of customer funds

“As the company struggled to find additional liquidity,” the subcommittee reports, “company employees identified excess company funds held in customer accounts. However, because they did not have an accurate accounting of the amount of customer funds the company held, they withdrew customer funds as well as company funds.”

The subcommittee notes that it will be up to prosecutors and regulators to determine whether MF Global or its employees violated laws or regulations when these withdrawals of customer funds were made.

‘Dereliction of duty

“However, the responsibility for failing to maintain the systems and controls necessary to protect customer funds rests with Corzine,” the report maintains. “This failure represents a dereliction of his duty as MF Global’s chairman and CEO.”

In its report, the subcommittee recommends that Congress consider legislation to impose civil liability on the officers and directors of futures commission merchants (FCMs) like MF Global who sign financial statements or authorize transfers from customer segregated accounts. Such legislation could “restore investor confidence in the derivatives markets and ensure that an FCM does not misuse customer funds in the future,” the Subcommittee report said.

Other findings of investigation to be released

In addition to its findings that Corzine’s decisions led to MF Global’s downfall, the Subcommittee report is expected to address regulatory agencies’ failure to share critical information with each other about MF Global, failures by credit rating agencies to sufficiently review MF Global’s public filings, and concerns about the New York Federal Reserve’s decision to designate MF Global as a “primary dealer” despite the company’s troubled financial situation.