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Sunday, March 19, 2023

2023-03-19

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


Economic and Market Fare:



US Leading Economic Indicators Tumble For 11th Straight Month, Signal Recession Imminent
....This is the 11th straight monthly decline in the LEI (and 12th month of 14) -  the longest streak of declines since 'Lehman' (22 straight months of declines from June 2007 to April 2008)
 


***** Joshi: How The "Most Anticipated Recession" Is Still Unanticipated
Exactly one year ago today, the US Federal Reserve embarked on the most aggressive tightening cycle in modern history. It comes as no surprise then that the US has just passed two of the three staging posts to recession.
The first staging post is a housing recession. US residential fixed investment (home building) has slumped by a fifth. This is significant because post-1970 housing recessions have predicted economic recessions with a perfect four out of four success rate: 1974; 1980; 1990; and 2007

The second staging post is bank failures. Banks tend to fail just before recessions begin. Ahead of the recession that began in December 2007, no US bank failed in 2005 or 2006. The first three bank failures happened in February, September, and October of 2007, just before the recession onset.
.... To be clear, it is not the direct impact of the housing recession or the bank failures that causes the economic recession. The housing recession and bank failures are simply the early warning signs – the ‘canaries in the coal mine’ – that tell us that high interest rates are killing the economy.
The US Economy Has Passed Two Staging Posts To Recession. Here’s The Third ...
........... In the financial markets, the deeply inverted US yield curve means that the bond market is forecasting aggressive rate cuts – around 200 basis points through the next two years. As the Fed only cuts aggressively in a recession, the bond market is anticipating a recession.
That said, the forecasted pace of cutting, at 25 basis points per quarter, is too low – given that in previous recessions the pace of cutting has been 80-150 basis points per quarter. Meaning, the bond market is not fully anticipating a recession 


Grannis: More thoughts on the banking crisis

By calling into question the value of a significant portion of the country's bank deposits, the recent failure of one or more regional banks is equivalent to a sudden tightening of monetary policy, in which the supply of money is perceived to have contracted while the demand for the remaining portion has increased. ...

...... Therefore, we might say that the current banking crisis is being caused by the perception that some portion of M2 (e.g., bank deposits in regional banks) may lose—or may have already lost—value in the event of a bank failure or expected bank failures. That perception automatically triggers an increased demand for the rest of M2. Together, this has the same effect as a sudden tightening of monetary policy; the supply of money has decreased at the same time the demand for money has increased.

If the Fed does not offset this effective tightening by reducing interest rates, things could get ugly. Reducing interest rates does two things: 1) it makes holding money less attractive on the margin, and 2) it makes borrowing money more attractive on the margin. This serves to reduce the demand for money while at the same time increasing the supply of money (because an increase in loans expands the supply of money). Together they amount to a relaxing of monetary policy, and that is the appropriate response to a sudden and unexpected tightening of monetary policy.

The Federal Open Market Committee (FOMC) meets on Wednesday, March 22, at which time they are expected to make what is now an extremely important decision: will they raise rates, hold rates steady, or cut rates? The market seems to expect they will most likely hold rates steady. I would argue they should cut rates, as my argument above suggests, and I hope they do. ...


Wilson: "Why On Earth Did US Stocks Rally Last Week?"

.............. Only $12B was lending through its new Bank Term Funding Program (BTFP), which is viewed as more permanent but also unlikely to end up converting into new loans in the near term. In short, none of these reserves will likely transmit to the economy as bank deposits normally do. Instead, we believe the overall velocity of money in the banking system is likely to fall sharply and more than offset any increase in reserves, especially given the temporary/emergency nature of these funds. Moody’s recent downgrade of the entire sector will likely contribute further to this deceleration.

Over the past month, the correlation between stocks and bonds has reversed and is now negative. In other words, stocks go down when rates fall and vice versa. This is in sharp contrast to most of the past year when stocks were more worried about inflation, the Fed’s reaction to it, and rates going higher. Instead, the path of stocks is now about growth, and our conviction that earnings forecasts are 15-20% too high has increased. From an equity market perspective, the events of the past week mean that credit availability is decreasing for a wide swath of the economy, which may be the catalyst that finally convinces market participants the equity risk premium (ERP) is way too low. We have been waiting patiently for this acknowledgment because with it comes the real buying opportunity. Just to remind readers, the S&P 500 ERP is currently 220bp. Given the risk to the earnings outlook, risk/reward in US equities remains unattractive until the ERP is at least 350-400bp, in our view.


Fed Panics, Announces "Coordinated" Daily US Dollar Swap Lines To Ease Banking Crisis



A perfect storm of food-stamp cuts and low tax refunds is looming — and discount chains like Dollar General and Big Lots could feel the pain



Banking Fare:


Before we turn to the story about how the Federal Reserve helped to blow up Silicon Valley Bank (SVB), let’s take a step back. It really is just another case of history repeating itself. ......




Alden Newsletter: A Look at Bank Solvency
...... While this particular bank had a solvency problem, and some others like it also have a solvency problem, the majority of U.S. banks are still solvent. It’s the liquidity that is the key problem for most of them, especially for small and medium-sized banks, and that situation may keep deteriorating for them.
Large banks in general are better-positioned, including to take some market share from those smaller banks.
This newsletter issue covers some of the nuances of what has been going on in the banking sector, and how to navigate some of the potential landmines among banks going forward.
Fractional Reserve Banking 101
In the United States, the banking system as a whole has $22.9 trillion in assets and $20.7 trillion in liabilities. The problem, of course, is that their assets are riskier and less liquid than their liabilities, and so they face both liquidity risks and solvency risks if things aren’t managed well, or if they face external shocks that are larger than they can deal with. ....
Deposits are fractionally-reserve bank IOUs; when you see $10,000 in your account balance for example, that figure is not actually backed up by dollars. Instead, that figure is backed up by a broad mix of less-liquid assets including Treasuries, mortgage loans, credit card loans, business loans, a bunch of other assets, and then a small percentage of actual dollars.
Banks currently have just $3 trillion in cash to back up their $17.6 trillion in deposits. The majority of this cash is just a ledger entry with the U.S. Federal Reserve, and so it is not tangible. Somewhere around $100 billion of it ($0.1 trillion) is held by banks in the form of actual physical banknotes in vaults and ATMs. So, the $17.6 trillion in deposits are backed up by just $3 trillion in cash, of which perhaps $0.1 trillion is physical cash. The rest is backed up by less liquid securities and loans.
Back in 2008, banks had 23 dollars of deposit liabilities for every dollar they had in liquid cash, which is insanely leveraged and illiquid. Due to quantitative easing and a slew of new requirements, their ratios aren’t that high anymore, and so it’s more like a 5x or 6x ratio these days.
From a depositor perspective, banks are basically highly-leveraged bond funds with payment services attached, and we treat it as normal to keep our savings in them.
To help normalize that and make it seem less weird, the FDIC provides insurance against deposit losses up to $250,000 which mitigates some of the risk. However, at any given time, FDIC only has about 1% of bank deposits’ worth of insurance in their fund. They can protect depositors against individual bank failures, but they don’t have enough to prevent against system-wide banking failures, unless they draw in aid from elsewhere or are backstopped by Congress with a fiscal bailout.
Some banks, such as TNB Inc. and others, have attempted to make bank models that just store all of their assets as cash at the Federal Reserve and therefore operate full-reserve banks, but they have not been allowed by the Federal Reserve to exist. This would basically be the safest possible bank, but if it were allowed to exist it could suck deposits out from other banks, threaten the whole fractional-reserve banking model, and reduce the Federal Reserve’s ability to control monetary policy.
So ironically, regulators want banks to be reasonably safe, but not “too safe”. They want all banks to be leveraged bond funds to a certain degree, and won’t allow safer ones to exist. ......




.............. Remember that banks are essentially black boxes – we really don’t know what their exact assets and liabilities are. Meanwhile, each subsequent rate hike pushes the system closer to a tipping point. After flooding the system with liquidity, sucking it out through tightening will always come at steep costs.
As the underrated Austrian economist – Ludwig Von Mises – once said, “there is no means of avoiding the final collapse of a boom brought about by credit expansion.” The black swans are lurking.


"A disturbing discovery that offers plenty of answers, but no solutions."

Figuring out that the whole centuries-old Anglo-American financial operating system is deeply broken and cannot, by any means short of a military coup, be repaired, is like being an 11-year-old and figuring out that your parents are alcoholics: a disturbing discovery that offers plenty of answers, but no solutions.

Larry Summers, god-emeritus of the Treasury, has some answers. He says:

In general, bank accounting probably doesn’t fully capture some of the risks associated with this pattern of borrowing short and lending long.

You don’t say? Dr. Summers could try reading my 15-year-old blogpost, or even this 80-year-old book. He is probably a little busy for blogposts and books, though. Sad. Note to Big Larry: borrowing short and lending long (maturity transformation) is what an Anglo-American bank does. And has been doing for 300 years and change. And in that time, there have been… a number of crises. The last one, they tell us, has happened. .........

....... That would be capitalism. This is not how our financial system works. Our financial system is powered by continuously increasing systemic debt which is never repaid:
What this graph means is that the whole economy chronically loses money. Notice those moments where debt goes flat or even down? These are called “recessions.” When any system, big or small, goes tits up unless it can keep borrowing, it is losing money. .........

........................... But this is in a fantasy world of true capitalism which we simply can’t get to from here—not without somehow using $5T of actual dollars to repay $125T of financial assets. Which would involve a certain amount of… repricing. Of… everything. ........


Stoller: Fire the Fed
Key bad guys in the Silicon Valley Bank saga are at the Federal Reserve. It's time to end the era of central bank supremacy and fire the Fed as our most important bank regulator.

........... Indeed, nearly all of my contacts in bank regulation are uniform in hating the Fed, which is composed of, as one of them told me, “arrogant patronizing fucks who are not any good at their jobs.” The closer you get to the facts the worse it looks. ......

The reason the Fed screwed up is ideological. Regulators there simply do not believe in placing constraints over banks, for fear they will hinder American strength. The era of Fed independence occurred in part because of our national strategy; America in the 1980s shifted from a nation whose power came from its manufacturing base and towards a nation whose power came solely from its control over the global financial order, with the trade deficit that implied. ..............



Update (10:30am ET):  So much for Credit Suisse thinking it has leverage by balking at the proposed CHF0.25 offer from UBS. Just hours after it was floated that UBS could buy Credit Suisse for $1BN, a proposal which the bank's shareholders balked at, Bloomberg reported that authorities are now considering a full or partial nationalization of Credit Suisse - an outcome which would wipe out the equity and bail-in bondholders - as the only other viable option outside a UBS Group AG takeover. And yes, 0.25 is still more than 0.0.



Quotes of the Week:

Coppola: Liquidity can't solve a solvency problem.

Heisenberg: We just saw the 16th & 29th largest US banks fail. The 14th largest on the brink. The largest crypto bank fail in SI. And a large global bank in CS on life support. All in weeks. And yet somehow the $SPX manage to squeeze out a positive week and is barely down for the month.

Snider: The economic fallout from this week is going to be harsh and it will take some time to really hit. Thus, WTI contango is now spread down to September and even October. Things are much worse a week after SVB, no surprise.

Snider2: I've said it before and I'll keep saying it. One of the most serious warning signs you'll see is a China RRR cut. Global monetary warning.

Aldasoro: Schrodinger’s solvency: if you open the box (htm->afs) you are insolvent. As long as you don’t open the box, you are both potentially insolvent and effectively solvent. Why open the box? Cause you need liquidity.

Field: You do not restore "trust in the banking system" by merging one opaque bank with another.  You restore trust by requiring banks provide #transparency.  With this info investors and their advisors can Verify banks are solvent and can continue in operation.

Perkins: The only way "higher for longer" can work is if central banks can retain a degree of control over credit conditions - which they can't observe in real time. If not, they are going to be cutting rates soon. There is good chance they've already messed up their "landing"

Kobeissi: Yesterday, WSJ said that 186 banks are facing the same risks as Silicon Valley Bank. Today, a coalition of 110 banks are asking for FDIC insurance on all deposits for 2 years. Every hour counts right now as hundreds of banks face the same issue. Panic is spreading quickly.

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.

Tooze: This Sunday is looking like it will be a very stressful day for anyone involved in the financial markets. As I hit “publish” on this newsletter, negotiators are still haggling over the future of Credit Suisse, once a top ten global bank. As Bloomberg reported, bond traders at Goldman Sachs and Morgan Stanley have canceled their weekend plans. For corporate and other bonds they make over the counter deals. Markets will open in Asia, early-evening of Sunday on the East Coast, at which point, the forest fire of uncertainty and contagion will again begin circling the globe. Or it will not. It depends on what happens in Switzerland. The next 12 hours matter.

diMartinoBooth: History sure is rhyming and spookily in sync. "On this day in 2008 Bear Stearns was bailed out by JP Morgan and The Federal Reserve at $2 per share."

Pomboy: ya know what’s keeping me up at night? Thinking about the unseen exposure by NONbank finl institutions to things far riskier than the stuff bringing down the banks.  Esp, the prospect that some insurer (&counterparty in the giant mkt of credit derivatives) is  about to go toes up



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Vid:
the first 9 minutes are a little slow while they try to figure out how to show Black's slide-deck, but if you can persevere through that, once he does get his deck going, his blunt commentary makes it worth a watch:



(not just) for the ESG crowd:

“Environmental, social, and governance” investors ditch the make-believe, but it was fun while it lasted.
............. It’s self-evident that the excellent performance of oil and gas stocks during the last two years was one big reason why investors are once again paying attention to them. Another reason is the emergence of doubts and misgivings about the profitability of ESG investments.
Returns have been called into question, as have the green credentials of companies advertising as ESG-friendly. Not everyone is convinced that ESG investing is the only true path to the future world of profits. Not everyone appears to even be sure what ESG actually is amid the heated debate about ESG investing in the U.S. And this may lead to lawsuits.
According to this report in Responsible Investor, the debate could unleash a wave of litigation as investors seek clarity about the nature of ESG or seek to get compensation for unprofitable decisions made by their financial advisers on ESG grounds. .........


Exceptional temperature increase in Arctic hotspot
The Barents area is the fastest warming place on the planet. A new study shows that the warming is happening twice as fast as previously thought.


The Biden Administration approved ConocoPhillips' Willow Project this week, which will use "thermosyphons" to freeze melting permafrost.







Other Fare:


.............. This implies that common sense is correct and that individual students have their own natural or intrinsic level of academic potential, which we have no reason to believe we can dramatically change. I believe that we can change large group disparities in education (such as the racial achievement gap) by addressing major socioeconomic inequalities through government policy. But even after we eliminate racial or gender gaps, there will be wide differences between individual students, regardless of pedagogy or policy. ........



This Friday, March 17, is World Sleep Day, an annual event that aims to raise awareness of the importance of getting a good night's sleep. ........



Pic of the Wee:



Fun Tweets of the Week:

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