Pages

Thursday, March 16, 2023

2023-03-16

*** denotes well-worth reading in full at source (even if excerpted extensively here)


Economic and Market Fare:


Last week, US Fed Chair Jay Powell gave testimony to the US Congress on inflation and Fed monetary policy.  He spooked financial markets when he appeared to say that the latest data on the economy would probably require further interest-rate hikes and at a faster pace.  Powell argued that although the headline inflation rate had fallen back, the ‘core’ inflation rate, which excludes energy and food prices, remained ‘sticky’.  Also, the US labour market still seemed exceptionally strong, justifying the need to control the impact of any wage rises.  He again suggested that it would be necessary to hike further the Fed’s policy rate (which sets the floor for all other borrowing rates) until wage costs came under control.

Once again, Powell, like other central bank governors, claimed that inflation was being driven by ‘excessive demand’ and also by the risk of rising wages causing a ‘wage-price’ spiral.  But there is plenty of evidence that it is not excessive demand or wage-push that has caused the acceleration of inflation.  I have offered such evidence in several previous posts.  And in a recent post, I recounted a long study by Joseph Stiglitz that offered comprehensive data showing that inflation was caused by supply-side shortages not ‘excessive demand’. Since then, more evidence has appeared backing up the supply story .......


Aftershock: Life After Silicon Valley Bank
While headlines of bank failures and bailouts consume the media, few are contemplating the economic and financial aftershocks that will follow.
Hockey great Wayne Gretzky famously commented, “I skate to where the puck is going to be, not where it has been.” Let’s take his advice and consider where the economic puck will be tomorrow.
The Silent Bank Run
The banking sector was experiencing a silent bank run well before Silicon Valley Bank made the headlines. ....................
Zombie Companies at Risk
The graph below shows there are about 600 zombie companies out of the approximate 3000 companies in the Russell 3000 small-cap index. One in five companies in the index does not produce enough profit to pay interest on their debt. They must continually borrow to remain a growing concern. Many of these and smaller mom-and-pop companies will either pay much higher interest rates for working capital or not get needed funding. In either case, higher unemployment and bankruptcies are sure to follow. ...............
If banks significantly tighten standards, the Fed may be dealing with disinflationary pressures sooner than expected. Banks, not the Fed, create money as they make loans. If fewer loans are made, less money is created. Subsequently, the nation’s money supply will decline further. Yes, we said, “further.” The year-over-year change in the money supply has declined for the first time since the Depression, as the re:venture consulting graph shows. Each previous decline was met with an economic depression or financial crisis. ..........


Why the Silicon Valley Bank Crisis is a seminal event into a new economic era
In last week’s post I described how several adverse dynamics now align for the US economy to create a cliff-like moment where economic activity markedly drops. These include depleting consumer excess savings, in particular for the “lower 80%”, a slowdown in previously elevated goods demand and likely higher unemployment from overstaffed cyclical sectors. This all coincides with monetary policy that is historically tight for the current stage of the economic cycle. Silicon Valley Bank (SVB) is the first major casualty of this policy stance. Its demise likely accelerates the economic downturn
The acceleration is less due to SVB’s case itself, which has been solved with the government bailout. It is because this episode alerted millions of Americans to the fact that (1) their deposits pay nothing and (2) are possibly unsafe. This realisation increases deposit costs especially for US regional banks, and in turn lowers their willingness to lend. The result is a classic credit crunch which likely amplifies the deflationary trends already underway. ............
But why is this deposit flight from US regional banks bad for the economy? It’s simple: In aggregate, these banks are a critical credit provider to the US economy
- 37% of all bank lending, 28% of corporate, 53% of residential and 67% of commercial real estate lending is done by US regional banks
Due to the SVB crisis, they now need to (1) pay more for deposits and (2) assume that their deposit base is less sticky than thought. What does that mean? ..........
Finally, we have to remember that this credit crunch coincides with an increasingly ailing consumer, as recent near-time retail data continues to confirm
Conclusion:
  • The SVB crisis will lead to tighter credit standards and lower credit growth than already the case. The dynamics resemble a credit crunch that is deflationary as it shrink the amount of “money” in the economy
  • At its origin lie decades of misguided monetary policy, with QE at its heart. The same monetary policies created the post-Covid consumer boom that is now abating, to coincide with said slowdown in credit creation
  • The US economy faces enormous headwinds that just intensified with SVB. It likely soon needs renewed provision of liquidity to fight of a deflationary bust
  • With the Fed looking to fight the inflation fires in the rear view mirror, this liquidity provision likely only comes when much more damage is done. And looking at past recessions, a tremendous amount of liquidity is likely needed to turn the ship around

In Part 1 of Pandemic Economics, Housing and Monetary Policy I noted that pandemic economic outcomes were frequently largely unexpected. And that this has been especially true for housing.
Housing is the key transmission mechanism for monetary policy. And we need to be on the lookout for pandemic distortions to normal economic patterns - especially in housing - and hope that the Federal Open Market Committee (FOMC) will adjust monetary policy accordingly.
Many analysts are puzzled about why the economy hasn’t slowed quicker given the rapid increase in the Fed Funds rate over the last year. Some analysts are even concerned about “premature reacceleration”. ........
............. This suggests that the employment indicator is currently “stuck” - due to lingering pandemic impacts - and that the housing related job losses are already in train and will likely start in the 2nd of 2023. It appears to me that the lag from changes in monetary policy to unemployment are currently longer than normal. This is an out of consensus view, but likely correct. 


via the Bond Beat: Nomura: The Fed Likely Considers Rate Cuts and the Halt of QT as Financial Turmoil Continues

We expect a 25bp rate cut and a halt of balance sheet reduction in March while a new lending facility is possible.

… Also, the fact that other banks are facing a serious bank run risk suggests an increasing risk of over-tightening by the Fed, which also supports a rate cut in the near term. As we argued, the cumulative rate hikes are disproportionately reducing the supply of credit through bank loans relative to financial market conditions (for more details please refer to Higher Fed Funds Rate May Spur Deeper Recession , 3 March 2023) (Fig. 2 ). The lagged impact of past rate hikes could now materialize in a draconian way. We believe a tightening of financial conditions through bank loans could potentially steer the economy into a recession starting in H2 2023. However, the process might be accelerating, potentially moving forward a recession and exerting disinflationary pressures with some lag. At this point, the Fed could become more forward-looking in a sense that it might put more weight on the inflation outlook as opposed to waiting for realized inflation to come down materially. In this regard, although we expect a solid 0.4% m-o-m core CPI inflation in the February CPI report on Tuesday 14 March (for more details on our CPI forecast, please refer to our February CPI Preview , 9 March 2023), we think financial stability risks are quickly becoming a dominating factor for monetary policy.

also ...










Banking Fare:


The great unwashed American public is being subjected to yet another round of “Cream for me, crumbs for thee” in the form of a bailout of Silicon Valley Bank, Signature Bank, and the creation of a facility to shore up uninsured deposits at other wobbly institutions.

This tender concern for spillover effects in the economy comes a mere five days after Fed Chairman Jerome Powell told the Senate Banking Committee that the central bank was likely to change course at its next policy meeting on March 21 and 22 and go back to larger rate hikes, after moderating at its last meeting. .......

......... 
One of the effects of a program that gives banks a back door for getting out of losses resulting from interest rate increases. If the Fed and Treasury can manage to calm depositors’ rattled nerves, it will have created a mechanism that will spare banks from Fed induced damage, the better to crush ordinary workers. Another effect is to incentivize banks to make stupid bets, or more charitably, Hail Mary passes. ........




The FDIC will provide unlimited deposit insurance for Silicon Valley Bank and Signature Bank and the Fed will accept depreciated securities at par value from banks seeking emergency funding.

It is interesting to contemplate how much crazier financial panics would be if markets were open constantly without interruption. In our technologically advanced age, there is nothing to prevent markets from operating continually. But markets were closed over the weekend and politicians had ample time to contemplate how to address the loud tantrums of fragile crony capitalists reacting to the failure of Silicon Valley Bank. Despite the spin from politicians, the answer was yet another massive bailout for the financial system — a giant band aid on a gaping systemic wound.

......... The FDIC’s action to fully protect deposits means that uninsured deposits will now receive full and immediate recovery with losses borne by the entire banking system (and, by extension, the real economy) through a special FDIC assessment.

I will not reiterate my comments from yesterday’s article other than to say that government officials offered no argument for citing the systemic risk exception, nor was any insight provided into why the FDIC radically changed its approach to the situation between Friday afternoon and Sunday evening.

In the coming days, we will likely learn far more about the behind the scenes lobbying and other political maneuvering that took place to achieve this result. It will also be interesting to see which politicians and regulators involved in last night’s decisions are financially rewarded by the industry with cushy sinecures such as board seats or lucrative speaking fees at venture capital conferences. Chances are that the saviors of the industry will receive more than fleece vests with venture capital firm logos. .....



The collapses of Silvergate and Silicon Valley Bank are like icebergs calving off from the Antarctic glacier. The financial analogy to the global warming causing this collapse of supporting shelving is the rising temperature of interest rates ...........

....... Any bank has a problem of keeping its asset valuations higher than its deposit liabilities. When the Fed raises interest rates sharply enough to crash bond prices, the banking system’s asset structure weakens. That is the corner into which the Fed has painted the economy

.................. The obvious question is why the Fed doesn’t simply bail out banks in SVB’s position. The answer is that the lower prices for financial assets looks like the New Normal. For banks with negative equity, how can solvency be resolved without sharply reducing interest rates to restore the 15-year Zero Interest-Rate Policy (ZIRP)?

There is an even larger elephant in the room: derivatives. ........

So far, the stock market has resisted following the plunge in bond prices. My guess is that we will now see the Great Unwinding of the great Fictitious Capital boom of 2008-2015. So the chickens are coming hope to roost – with the “chicken” being, perhaps, the elephantine overhang of derivatives fueled by the post-2008 loosening of financial regulation and risk analysis.



......... Notwithstanding Fed members jettisoning stock in junk banks days ahead of collapse, most pundits are calling these bank failures a Black Swan event, meaning none of them saw it coming. And yet this bank collapse was totally predictable in the context of central banks tightening into an incipient credit crisis - which itself was the direct result of the super stimulus global central banks used during the pandemic. Central banks caused this crisis from over-easing to over-tightening. 




........... Over my three decades of surfing crises on Wall Street. The one unifying thread that connects all of the major events is just how little we know as they unfold, and how much we learn in the ensuing months and years. The first draft of history is typically emotional, rarely accurate and often conflicted.
Recall the Thai Baht Crisis, Russian Ruble collapse (& LTCM), dotcom implosion, analysts’ scandals, IPO spinning, accounting frauds, the Great Financial Crisis, the Flash Crash (2010), Covid Crash, and now the latest SVB/Signature Bank collapse, and all of these follow the same pattern.
I was less impressed by the breaking news at the time of each of these and more impressed by what we learned subsequently. Lest you doubt this, consider these deeply reported books on major market issue





....... Exhibit 3: Wells Fargo
If you were running one of the US's largest banks, would you see the worst US banking crisis since 2008 as an ideal time to announce your intention to issue lots more debt? No, me neither. But Wells Fargo's management did. On Tuesday 14th March, as the flames rose round the US's regional banks, it filed for a mixed shelf offering of up to $9.5 bn of assorted types of debt security. 

.......... there was something of a kerfuffle on Twitter from people who mistook the shelf offering for an emergency capital raise and thought it meant Wells Fargo was in trouble. Fortunately it doesn't seem to have come to anything, but given how easily misinformation spreads on social media, this could have ended very badly for Wells Fargo - and blown up a much larger financial crisis than the one currently engulfing the US's regional banks. Careless talk costs money. Do better, bank executives. 






Commodity futures are far and away the most effective hedge against inflation. It's time to learn how to navigate...

...... The big one - the Global Financial Crisis of 2008 - happened eight months after the Bear Stearns crisis with the “sudden” failure of Lehman Brothers. But I do not believe that failures of the Silicon Valley Bank and Signature Bank will trigger a cascading avalanche as the Bear Stearns hedge funds triggered 14 years ago. This time, it's different. Recall, back in 2008 the Fed was not able to bail out the banking system without Congressional approval. Treasury Secretary Hank Paulson had to beg for a $700 billion bailout of "too big to fail" banks literally on his knees. But such prostration is no longer necessary: today the Fed has full discretion to bail out banking institutions as needed. And the need is far greater than it was in 2008

The system is well and truly broken; US banks have accumulated massive losses on their bond investments, and without a bailout they might be forced to sell assets on their books. That would precipitate a crisis much worse than what we experienced in 2008. This is that "seed of doom," which is baked into the fractional reserve banking equation from the get go: the bank failures are only a matter of time.

But in a world where central banks have the facility to "print" infinite amounts of currency to backstop the losses of the corporate and banking system, failed banks can continue to operate, undead for years and perhaps decades. The current crisis will probably used to consolidate the industry and we might see many small regional banks fail or be absorbed as the monopolists gobble up competition, but a failure of the system will not be allowed.



......... Bair told Reuters that the "one-off" deposit guarantees for Silicon Valley Bank and Signature have left depositors elsewhere fearing for safety and fleeing to larger institutions"

The main issue, as I wrote in my Minsky blog post is that wealthy investors and companies with deposits > $250k don't know if they will get bailed out when the next bank fails. The FDIC fund has very limited funds that will be depleted by the blanket bailout of SVG and Signature. And, in order to guarantee ALL bank deposits without limit, the FDIC would need a vote from Congress. Which is very likely NOT forthcoming. Which is why the exodus has begun: ....





Quotes of the Week:

Roberts: The events of Silicon Valley Bank should not be a surprise. As noted over the past year, there has never been a “soft landing” in the economy. Notably, this is not the first banking crisis the Fed has caused.


Pilkington: Let’s be honest. This is just the beginning. In the next 12 months - possibly the next 12 days - there’ll be plenty more chaos and interventions. Our STARTING POINT is bailing out start-ups that couldn’t manage excess deposit insurance. Care to guess where we end up?


Klein: Banks are speculative investment funds grafted on top of critical infrastructure. This structure is designed to extract subsidies from the rest of society by threatening civilians with crises if the banks’ bets are ever allowed to fail. The U.S. government’s response to the collapses of Silicon Valley Bank and Signature Bank—effectively removing the $250,000 cap on deposit insurance while letting lenders borrow relatively cheaply against fictitious asset values—is a reminder that those threats usually work


Massie: Understand what’s happening at FDIC: They’re taking the insurance premiums that were paid in to protect depositors under $250,000 (little guys) and using it to cover deposits of the very rich. They argue it benefits everyone to go “all in” on the first few banks.


Kayfabe: After reading through about the new facility, our glorious central planners have unsurprisingly failed at the first hurdle at returning to non-brazenly corrupt policies. I will admit to having had a glimmer of hope that they would have learned something post-GFC and were not as captured and corrupt as I've long thought. I blame this ordeal on the effects of daylight savings. My sincerest apologies for the moment of delusion.


Das: The moral hazards around bailouts are well known. It seems now that tech start-ups like banks, auto businesses and anybody with an effective lobbyists are too big to fail even if they are too difficult to understand or to properly manage. As Herbert Spencer put it: “The ultimate result of shielding men from the effects of folly, is to fill the world with fools.” Over the last decade and a half, the economic system and financial practices have become geared around low rates, abundant liquidity and the authorities underwriting risk taking. Moving away from this state of affairs was never going to easy, that is, if it is possible at all.


Hussman: The largest bank failure in U.S. history - Washington Mutual - is unmemorable because it was resolved correctly. The FDIC under Sheila Bair, took receivership. Depositors lost nothing. Stockholders and unsecured creditors weren't bailed out by a hyperactive Federal Reserve.


Romanchuk: I am seeing a lot of attempts to argue in favour of major changes to banking because of what happened with Silicon Valley Bank. Although I see a chance that Congress might reconsider the lax regulations of regional banks in the same category as Silicon Valley Bank, it is going to be hard to get too much momentum for broad reforms. The actions of everyone involved was breathtakingly stupid, and it is going to be hard to replicate that level of stupid at any other bank of a similar size.


Donovan: Will bank runs impact future inflation? They could. Aside from the fictional housing price data and energy prices, US inflation is mainly about profit margin expansion. That reverses if consumers stop believing price increases are fair, or if consumer demand falls. If banks tighten lending standards, the loss of credit will reduce consumer demand. After such a long period of catastrophically negative real wages, US consumers have used credit card borrowing to maintain living standards. Higher interest rates do little to deter this borrowing. Tighter lending standards stop it abruptly


Clark: However, to my surprise when I woke up this mornings, 30 year JGB yields have plummeted. I also won’t lie, this put the fear of god into me. JGBs have been a very good lead on treasuries, and for good reason. If Japanese yields fall, Japanese investors will start buying treasuries, forcing yields down. And every major deflationary event I know off begins with JGB yields falling.


I hate when I agree with P.S., which thankfully is rare enough, but, here is something that, to his credit, he said in June 2022:
Schiff: Thanks to the Federal Reserve, everybody has so much debt that we can’t afford to pay an interest rate high enough to fight inflation. But it is going to be high enough to cause a massive recession and another financial crisis that’s worse than the one we had in 2008.

and, fwiw, what he is saying now: 
Now, all of these institutions are insolvent at higher interest rates. We have a bigger debt crisis now than the one we had in 2008, which was also caused by the artificially low interest rates that followed the bursting of the NASDAQ bubble when the Fed kept interest rates at 1%. That inflated the housing bubble. But this time, zero percent inflated a much bigger bubble, which is why we are now having a much bigger financial crisis.


Rosengren: Financial crises create demand destruction.  Banks reduce credit availability, consumers hold off large purchases, businesses defer spending.  Interest rates should pause until the degree of demand destruction can be evaluated


DiMartinoBooth: LIQUIDITY? Is everyone on Twitter 12? Every heard of the Great Financial Crisis, the last time the Discount Window spiked which was indicative of
LIQUIDITY DRYING UP.
Securitization is under siege. Lending standards are being clamped down.



Vid Fare:


and, for fun:

1: 
2:
6: 
7: 
 




...


(not just) for the ESG crowd:

Posted by at

No comments:

Post a Comment

Subscribe to: Post Comments (Atom)