Basel Archives - The Automatic Earth

While President Trump is expected to tout his administration’s accomplishments one month into his term during a speech before a joint session of Congress Tuesday night, former Reagan Budget Director David Stockman said he doesn’t see much progress being made. “I’ve thrown in the towel because he’s not paying attention and he’s not learning anything and he’s making ridiculous statements,” Stockman told the FOX Business Network’s Neil Cavuto. During the address, Trump is expected to talk about the new budget blueprint, which Stockman said doesn’t add up. “We don’t need a $54 billion increase in defense when the budget already is ten times bigger than that of Russia. We don’t need $6 trillion of defense spending over the next decade because China is going nowhere except trying to keep their Ponzi scheme together.”

President Trump will also talk about the GOP replacement for Obamacare. Stockman said he wasn’t sold on Speaker Ryan’s plan. “If you look at the Ryan draft that came out over the weekend, it’s basically Obamacare-like. It’s not really repealing anything,” he said. “It’s basically reneging and turning the Medicaid expansion into a block grant, turning the exchanges into tax credits [and] it’s still going to cost trillions of dollars.” Last week, Trump’s Treasury Secretary Steven Mnuchin, told FOX Business the administration is “focused on an aggressive timeline” to produce a tax reform plan by August, but in Stockman’s opinion, tax reform won’t happen this year. He also warned that the administration’s run up against the debt ceiling this summer could lead to a debt crisis. “I don’t think we will see the tax cuts this year at all,” he said. “There is going to be a debt ceiling crisis like never before this summer and that’s what people don’t realize. They’ve burned up all the cash that Obama left on the balance sheet for whatever reason.”

“..the question is not what could go wrong since it is guaranteed that all these liabilities will implode at some point. And when they do, it will bring misery to the world of a magnitude that no one could ever imagine.”

• The End Of A 100 Year Global Debt Super Cycle Is Way Overdue (EC)

Central banks are designed to create debt, and since 1913 the U.S. national debt has gotten more than 6800 times larger. But of course it is not just the United States that is in this sort of predicament. At this point more than 99% of the population of the entire planet lives in a nation that has a debt-creating central bank, and as a result the whole world is drowning in debt. When people tell me that things are going to “get better” in 2017 and beyond, I find it difficult not to roll my eyes. The truth is that the only way we can even continue to maintain our current ridiculously high debt-fueled standard of living is to grow debt at a much faster pace than the economy is growing. We may be able to do that for a brief period of time, but giant financial bubbles like this always end and we will not be any exception.

Barack Obama and his team understood what was happening, and they were able to keep us out of a horrifying economic depression by stealing more than nine trillion dollars from future generations of Americans and pumping that money into the U.S. economy. As a result, the federal government is now $20 trillion in debt, and that means that the eventual crash is going to be far, far worse than it would have been if we would have lived within our means all this time. Corporations and households have been going into absolutely enormous amounts of debt as well. Corporate debt has approximately doubled since the last financial crisis, and U.S. consumers are now more than $12 trillion in debt. When you add all forms of debt together, America’s debt to GDP ratio is now about 352%. I think that the following illustration does a pretty good job of showing how absolutely insane that is…

If your brother earns $100,000 in annual income and borrowed $10,000 on his credit card, he could consume $110,000 worth of stuff. In this example, his debt to his personal GDP is just 10%. But what if he could get more credit year after year and reached a point where his total debt reached $352,000 but his income remained the same. His personal debt-to-GDP ratio would now be 352% If he could borrow at super low interest rates, maybe he could sustain the monthly loan payments. Maybe? But how much more could he possibly borrow? What lender would lend him more? And what if those low rates began to rise? How much debt can his $100,000 income cover? Essentially, he has reached the end of his own debt cycle.

The United States is certainly not alone in this regard. When you look all over the industrialized world, you see similar triple digit debt to GDP figures. When this current debt super cycle ultimately ends, it is going to create economic pain on a scale that will be unlike anything that we have ever seen before. The following comes from King World News…

“That is the inevitable consequence of 100 years of credit expansion from virtually nothing to $250 trillion, plus global unfunded liabilities of roughly $500 trillion, plus derivatives of $1.5 quadrillion. This is a staggering total of $2.25 quadrillion. Therefore, the question is not what could go wrong since it is guaranteed that all these liabilities will implode at some point. And when they do, it will bring misery to the world of a magnitude that no one could ever imagine. It is of course very difficult to forecast the end of a major cycle. As this is unlikely to be a mere 100-year cycle but possibly a 2000-year cycle. It is also impossible to forecast how long the decline will take. Will it be gradual like the Dark Ages, which took 500 years after the fall of the Roman Empire? Or will the fall be much faster this time due to the implosion of the biggest credit bubble in world history? The latter is more likely, especially since the bubble will become a lot bigger before it implodes.”

The next two items struck me as a combination: income goes up (take that with a truckload of salt), but spending goes down. Confidence indicator?!

• US Personal Income Climbs 0.4% In January, More Than Expected (RTT)

While the Commerce Department released a report on Wednesday showing a slightly bigger than expected increase in U.S. personal income in the month of January, the report also showed that personal spending rose by less than expected. The report said personal income climbed by 0.4% in January after rising by 0.3% in December. Economists had been expecting another 0.3% increase. Disposable personal income, or personal income less personal current taxes, rose by 0.3% for the second straight month. Real spending, which is adjusted to remove price changes, actually fell by 0.3% in January after rising by 0.3% in December. With income rising faster than spending, personal saving as a percentage of disposable personal income ticked up to 5.5% in January from 5.4% in December. A reading on inflation said to be preferred by the Federal Reserve showed that core consumer prices were up 1.7% year-over-year in January, unchanged from the previous month.

What made Americans stop spending? I thought Trump made them feel so good?

• US Real Personal Spending Crashes Most Since 2009 (ZH)

While the key number analysts were looking for in today’s Personal Spending data was the PCE Price Index, both headline and core, which rose by 1.9% and 1.7% respectively, the latter coming in as expected, just shy of the Fed’s 2.0% inflation target, the internals on US incomes and spending were just as notable. Here, the silver lining of a rise in incomes (+0.4% MoM vs +0.3% exp) was dashed by a disappointingly slow growth in spending (+0.2% vs +0.5% prev). With incomes rising more than spending, the savings rate predictably ticked up from multi year lows, rising from 5.4% to 5.5% in January.

On the income side, the increase in personal income was almost entirely from service-producing industries wages, which increased by $22.5BN, while Goods-producing was higher by just $4 billion. Additionally, Social Security transfer benefits added another $9 billion. However, for the ‘average joe’, facing a rising cost of goods, real personal spending plunged 0.3% in January: the biggest drop since September 2009.

Finally, as a result of surging inflation, and disposable incomes suddenly unable to keep up, the real annual growth in disposable income per capita fell to just 1.5%, the weakest in over 3 years and a red flag for those calling for another renaissance for US consumers.

It’s about the Fed.

• Will Trump Build A Wall Protecting US Banks From Global Rules? (Davies)

As President Trump struggles to staff his administration with sympathisers who will help transpose tweets into policy, the exodus of Obama appointees from the federal government and other agencies continues. For the financial world, one of the most significant departures was that of Daniel Tarullo, the Federal Reserve governor who has led its work on financial regulation for the last seven years. It would be a stretch to say that Tarullo has been universally popular in the banking community. He led the charge in arguing for much higher capital ratios, in the US and elsewhere. He was a tough negotiator, with a well-tuned instinct for spotting special pleading by financial firms. But crocodile tears will be shed in Europe to mark his resignation.

European banks, and even their regulators, were concerned by his enthusiastic advocacy of even tougher standards in Basel 3.5 (or Basel 4, as bankers like to call it), which would, if implemented in the form favoured by the US, require further substantial capital increases for Europe’s banks in particular. In his absence, these proposals’ fate is uncertain. But Tarullo has also been an enthusiastic promoter of international regulatory cooperation, with the frequent flyer miles to prove it. For some years, he has chaired the Financial Stability Board’s little-known but important Standing Committee on Supervisory and Regulatory Cooperation. His commitment to working with colleagues in international bodies such as the FSB and the Basel Committee on Banking Supervision, to reach global regulatory agreements enabling banks to compete on a level playing field, has never been in doubt.

Already, some of those who criticised him most vocally in the past are anxious about his departure. Who will succeed him? The 2010 Dodd-Frank Act created a vice-chair position on the Federal Reserve Board – which has never been filled – to lead the Fed’s work on regulation. Will that appointee, whom Trump now needs to select, be as committed as Tarullo to an international approach? Or will his principal task be to build a regulatory wall, protecting US banks from global rules? We do not yet know the answers to these questions, but Fed watchers were alarmed by a 31 January letter to Fed chair Janet Yellen from Representative Patrick McHenry, the vice-chairman of the House committee on financial services. McHenry did not pull his punches. “Despite the clear message delivered by President Donald Trump in prioritising America’s interest in international negotiations,” McHenry wrote, “it appears that the Federal Reserve continues negotiating international regulatory standards for financial institutions among global bureaucrats in foreign lands without transparency, accountability, or the authority to do so. This is unacceptable.”

In her reply of 10 February, Yellen firmly rebutted McHenry’s arguments. She pointed out that the Fed does indeed have the authority it needs, that the Basel agreements are not binding, and that, in any event, “strong regulatory standards enhance the stability of the US financial system” and promote the competitiveness of financial firms. But that will not be the end of the story. The battle lines are now drawn, and McHenry’s letter shows the arguments that will be deployed in Congress by some Republicans close to the president. There has always been a strand of thinking in Washington that dislikes foreign entanglements, in this and other areas. While Yellen’s arguments are correct, the Fed’s entitlement to participate in international negotiations does not oblige it to do so, and a new appointee might argue that it should not.

Nice piece. What you see when you take a step back. And this is from WaPo.

• Once Again, Trump Succeeded Where He Was Supposed To Fail (WaPo)

There’s a confusion at the heart of every presidential address to Congress. It’s supposed to be a grave occasion of solidarity around the principles of our shared republic, but it has the cheesy and disingenuous air of a campaign event. The address combines the solemnity of ceremony with mindless hyperpartisan hoopla — the shouting and booing, the symbolic gimmickry and, above all, the absurd tradition of signifying one’s agreement or displeasure by either standing to applaud or remaining seated after every phrase of the speech. The address is designed for a traditional Democratic or Republican president. He’s meant to embolden his party and browbeat the opposition, with a few light gestures at unity and consensus. His allies are supposed to look gleeful and applaud his every gesture; his opponents are supposed to sit glumly on their hands and show the nation that they, at least, aren’t engaging in this misguided hysteria.

The address is designed, in other words, for a more or less ideologically coherent speech. But Donald Trump, as everybody knows, doesn’t care about ideological coherence. His ideas don’t fall along recognizable philosophical lines, with the result that his audience of lawmakers, ready to boo or cheer in the usual ways, often seemed unsure how to respond. Once again, then, Trump succeeded in a setting where nearly everybody — including me — thought he would fail. The Democrats looked especially awkward. So much of their detestation of Trump arises not from policy differences but from horror at his gaucherie and bizarre rhetorical excesses. But none of that is relevant in a State of the Union-style address. Subtract the issues of Obamacare repeal, immigration and the president’s hard-line policies on domestic security — the latter two of which don’t lend themselves to clear ideological allegiances — and much of what Trump had to say could have been said by any Democratic president.

Even on the topic of health care, Trump offered several proposals that, taken on their own, most Democrats probably wouldn’t object to, hence making it rather difficult for them to do what they would have preferred to do, namely glower at the president’s let-them-eat-cake obstructionism. What were Democrats supposed to do when, for instance, Trump vowed “to make child care accessible and affordable, to help ensure new parents have paid family leave, to invest in women’s health, and to promote clean air and clear water, and to rebuild our military and our infrastructure”? I guess … we’ll applaud? Clap, clap? Republicans, meanwhile, found themselves applauding for something not very unlike President Obama’s stimulus plan of 2009. “To launch our national rebuilding,” Trump said, “I will be asking the Congress to approve legislation that produces a $1 trillion investment in the infrastructure of the United States — financed through both public and private capital — creating millions of new jobs.”

I’m not sure what “financed through both public and private capital” means, but Trump’s jobs plan sounded to my ear like some socialist Five-Year Plan from the 1970s — making it all the more entertaining to watch congressional Republicans cheering like football fans who misheard the penalty call. I wonder if Tuesday night’s address was a kind of adumbration of Trump’s presidency — his adversaries deprived of half their reasons for hating him, his allies stupidly wondering what happened to their principles, the nation’s commentators once again explaining why the president succeeded when he was supposed to fail, and voters reluctantly appreciating this hyperactive agitator who — for all his problems — at least keeps things interesting.

Give Greece full access to all European finance tools while it’s in the eurozone, or at some point it won’t be.

• Greece’s Latest Drama Imperils Banks’ Baby Steps Toward Recovery (BBG)

Since the last eruption of Greece’s long-running crisis in 2015, banks in Europe’s most troubled economy have shored up capital, staunched losses and set up a plan to reduce their mountains of bad debt. Now, fresh tensions over the country’s bailout are putting that progress at risk. About 1.3% of deposits were pulled from the banks in January, while bad loans crept higher, an increase Bank of Greece Governor Yannis Stournaras blamed on borrowers using the deadlock with creditors as an excuse to avoid making their payments. Greek officials are meeting in Athens this week with representatives of the euro area and IMF to set out the policies Greece must undertake to unlock more loans. The government foresees an accord in March or early April, but the scale of pending issues raises concerns they may be politically hard to sell at home.

“The longer it takes for the impasse to be concluded, the more damaging it will be for the banks,” said Federico Santi, an analyst with Eurasia Group. The biggest lenders – Piraeus Bank, National Bank of Greece, Eurobank and Alpha Bank – made headway since 2015, when 26% of total deposits fled on concern Greece might abandon the single currency. That run was only halted when the banks were shut for three weeks, controls were placed on withdrawals and the movement of money abroad and Greece agreed to an €86 billion bailout, its third since 2010. A €14.4 billion recapitalization in November 2015 by the government-owned Hellenic Financial Stability Fund and private investors strengthened the banks’ balance sheets. The HFSF – funded through euro-area loans – remains the largest investor in all but one of the banks.

For the first time since 2010, three of the four are expected to report an annual profit when they announce results starting next week. Crucially, the banks are embarking on a three-year plan, overseen by regulators, to shrink their bad loans. [..] Until the banks begin offloading this bad debt, there’s scant chance they’ll be able to provide businesses with the credit they need to grow. “These NPLs are clogging the wheels of the entire economy,” said Paris Mantzarvas, an analyst at Athens-based Pantelakis Securities.

“I’m the most popular European politician in Greece.”

• Juncker: Greek Prime Minister Loves Me Deeply, And So Do Greeks (KTG)

European Commission President Jean-Claude Juncker said on Wednesday he is the most popular European politician in Greece during a joint press conference with European Parliament President Antonio Tajani in Brussels, following the presentation of the Commission’s “White Paper” on the future of the EU. Asked by a journalist why he does not comment on France’s domestic politics where presidential hopeful Marine Le Pen has announced a referendum for an exit from the EU if elected, when he had intervened dynamically against the position of Greek Premier Alexis Tsipras when he announced a referendum in 2015, Juncker replied:

“You’re the only person in Europe who believes I was among those who criticized the Greek prime minister. The Greek prime minister loves me deeply, and so do Greeks. I’m the most popular European politician in Greece. You should have known that, if you have seen by relationship with the Greek prime minister, who I greatly value. Just as I have deep sympathy or even love for the Greek people.” He then pointed at Commission spokesman Margaritis Schinas and said he is briefed by him on daily developments in Greece. Concerning Le Pen, Juncker said he doesn’t want to become part of her propaganda.

[..] Outlining the five options of Europe’s future, Juncker acknowledged the existential struggle the EU is facing due to crises over Brexit, migration and the eurozone. He said it was not a “definitive view” from the Commission but a way to “make clear what Europe can and cannot do.” Among others, Juncker said: “The future of Europe should not become hostage to elections, party political or short term views of success.” “However painful Brexit may be, it will not stop the EU as it moves forward into the future.” “Summit after summit we promise we will bring down the unemployment figures, particular youth unemployment … but the EU budget provides only 0.3% of European social budgets: 99.7% is with the national governments.” “We must make clear what Europe can and cannot do.” “Permanent Brussels-bashing makes no sense because there is no basis for it.”

It’s falling apart in his hands.

• Jean-Claude Juncker Sets Five Paths For EU’s Future (BBC)

European Commission President Jean-Claude Juncker has revealed his five future “pathways” for the European Union after Brexit. His white paper looks at various options, from becoming no more than a single market to forging even closer political, social and economic ties. The 27 leaders of EU countries will discuss the plans, without Britain, at a summit in Rome later this month. The meeting will mark the EU’s 60th anniversary. Germany’s foreign minister, Sigmar Gabriel, has already responded to dismiss the idea of the EU purely being a single market.

Path one: ‘Carrying on’ – The remaining 27 members stick on the current course, continuing to focus on reforms, jobs, growth and investment. There is only “incremental progress” on strengthening the single currency. Citizens’ rights derived from EU law are upheld.

Path two: ‘Nothing but the single market’ – The single market becomes the EU’s focus. Plans to work more on migration, security or defence are shelved. The report says this could lead to more checks of people at national borders.Regulation would be reduced but this could create a “race to the bottom” as standards slip, it says. It becomes difficult to agree new common rules on the mobility of workers, so free movement of workers and services is not fully guaranteed.

Path three: ‘Those who want to do more’ – If member countries want to work more with others, they can. Willing groups of states can form coalitions on key areas, such as defence, internal security, taxation and justice. Relations with outside countries, including trade negotiations, remain managed at EU level on behalf of all member states.

Path four: ‘Doing less, more effectively’ – The EU focuses on a reduced agenda where it can deliver clear benefits: technological innovation, trade, security, immigration, borders and defence. It leaves other areas – regional development, health, employment, social policy – to member states’ own governments.EU agencies tackle counter-terrorism work, asylum claims and border control. Joint defence capacities are established. The report says all this would make a simplified, less ambitious EU.

Path five: ‘Doing much more together’ – Feeling unable to meet the today’s challenges alone or as part of the existing group, EU members agree to expand the union’s role. Members agree “to share more power, resources and decision-making across the board”. The single currency is made central to the project, and EU law has a much larger role.

Great piece of history from my place of birth. Well, bit bloody…

• They Really Knew How to Do Populist Revolts in 1672 (BBG)

Johan de Witt, the boy wonder who effectively ran the Republic of the Seven United Netherlands from 1653 to 1672, was an early believer in inbox zero. In his office in the westernmost corner of the Binnenhof, the complex of buildings in The Hague that is still the nerve center of the Dutch government, Johan worked until his desk was empty: the official letters that he had read aloud during the meeting, the envelopes from relatives, friends and other contacts, his list of decisions taken and his notes from the last meeting. He didn’t go home until everything had been dealt with. As soon as a note was finished, he scattered sand over the lines to dry the ink, and he hung it on a wall-mounted wire – many of Johan’s surviving letters have holes in them. This hanging stack, called a lias, also had the advantage that everything was arranged nicely together and finished work wasn’t in the way.

When Johan was finished, the clerks could go to work copying everything according to his strict instructions. That’s my translation of a passage from Dutch journalist-turned-historian Luc Panhuysen’s 2005 double biography of De Witt and his older brother and right-hand-man, Cornelis. The book is titled “De ware vrijheid,” which means “the true freedom,” Johan de Witt’s term for the two decades during which he managed his country on behalf of its merchant class, and the noble House of Orange had no say. The brilliant, hard-working, hyper-organized Johan used that freedom to build what in modern parlance we might call a meritocratic technocracy, bent on globalization and economic growth. For a while, it was spectacularly successful. It didn’t end well, though! The brothers were killed not far from the Binnenhof in August 1672 and cut to pieces by an angry mob, with body parts finding their way to buyers as far away as England.

In these days of populist revolts against globalizing technocratic elites, the De Witts’ story seemed like it might be worth revisiting. That, and it provided a great excuse to walk around The Hague on Tuesday with the erudite and engaging Panhuysen, who has gone on to write books about the “disaster year” of 1672 and the long-running conflict, beginning the same year, between Dutch prince (and eventual English king) William III and French King Louis XIV. “What Johan and Cornelis de Witt had to deal with was that they were regular civilian boys who at the same time had to govern and exude authority,” Panhuysen said. Political opponents could say: “God sent us the House of Orange to break us free from the Spanish. Who are these De Witt brothers?”

The De Witt boys weren’t self-made men – their father was a successful wood merchant who bought his way into government – but Johan in particular did rise to the top largely on merit. He was a brilliant mathematician, a translator and elaborator of the geometry of Rene Descartes. A government report that he wrote on annuity pricing is now seen as one of the founding documents of both actuarial science and financial economics. In 1650, at age 25, Johan was chosen as raadpensionaris – a sort of city manager – of his hometown of Dordrecht, the oldest city in Holland, which was by far the richest and most powerful of the seven Dutch provinces. In 1653, representatives of Holland’s other cities asked him to become the province’s raadpensionaris, sometimes translated as grand pensionary. After taking 10 days to think it over, he accepted.

The secret of life will never cease to fascinate.

• World’s Oldest Fossils -4 Billion Years- Found In Canada (G.)

Scientists say they have found the world’s oldest fossils, thought to have formed between 3.77bn and 4.28bn years ago. Comprised of tiny tubes and filaments made of an iron oxide known as haematite, the microfossils are believed to be the remains of bacteria that once thrived underwater around hydrothermal vents, relying on chemical reactions involving iron for their energy. If correct, these fossils offer the oldest direct evidence for life on the planet. And that, the study’s authors say, offers insights into the origins of life on Earth. “If these rocks do indeed turn out to be 4.28 [bn years old] then we are talking about the origins of life developing very soon after the oceans formed 4.4bn years ago,” said Matthew Dodd, the first author of the research from University College, London.

With iron-oxidising bacteria present even today, the findings, if correct, also highlight the success of such organisms. “They have been around for 3.8bn years at least,” said the lead author Dominic Papineau, also from UCL. The team says the new discovery supports the idea that life emerged and diversified rapidly on Earth, complementing research reported last year that claimed to find evidence of microbe-produced structures, known as stromatolites, in Greenland rocks, which formed 3.7bn years ago. However, like the oldest microfossils previously reported – samples from western Australia dating to about 3.46bn years ago – the new discovery is set to be the subject of hot debate.

The discovery of the structures, the authors add, highlights intriguing avenues for research to discover whether life existed elsewhere in the solar system, including Jupiter’s moon, Europa, and Mars, which once boasted oceans. “If we look at similarly old rocks [from Mars] and we can’t find evidence of life, then this certainly may point to the fact that Earth may be a very special exception and life might just have arisen on Earth,” said Dodd. Published in the journal Nature by an international team of researchers, the new study focuses on rocks of the Nuvvuagittuq supracrustal belt in Quebec, Canada.

When I read things like this: ‘A live shark is worth over a million dollars in tourism revenue over its lifespan’, I lose all hope. It’s valuing nature in dollars that dooms it. And then you get this from the guys trying to save it.

• Overfishing Wipes Out 90% Of Caribbean Predatory Fish (DM)

While predatory fish are key to the Caribbean’s ecosystem and coastal economy, researchers have worryingly found that 90% have been wiped out by over-fishing. But experts say there is hope for Caribbean reefs yet, as they have identified large reefs, known as ‘supersites’, which can support huge numbers of predatory fishes. If the dwindling fish species are reintroduced, they could help repair the damage inflicted by over-fishing. ‘A live shark is worth over a million dollars in tourism revenue over its lifespan because sharks live for decades and thousands of people will travel and dive just to see them up close,’ said study coauthor and marine biologist Dr Abel Valdivia. ‘There is a massive economic incentive to restore and protect sharks and other top predators on coral reefs.’

The University of North Carolina team’s work suggests that supersites – reefs with many nooks and crannies on their surface that act as hiding places for prey – should be prioritised for protection. Other features that make a supersite are the amount of available food, size of the reef and proximity to mangroves. ‘On land, a supersite would be a national park like Yellowstone, which naturally supports an abundance of varied wildlife and has been protected by the federal government,’ said coauthor and marine biologist Professor John Bruno. The team surveyed 39 reefs across the Bahamas, Cuba, Florida, Mexico and Belize to determine how many fish had been lost.

They compared fish biomass on pristine sites to fish biomass on a typical reef. They then estimated the biomass in each location and found that 90% of predatory fish were gone due to over-fishing. What they didn’t expect to find was a ray of hope – a small number of reef locations that, if protected, could help the predatory fish populations recover. ‘Some features have a surprisingly large effect on how many predators a reef can support,’ said study coauthor Dr Courtney Ellen Cox. For example, researchers believe that the Columbia Reef within the fisheries closures of Cozumel, Mexico, could support an average of 10 times the current level of predatory fish if protected.

Debt Rattle September 16 2016

Sep 162016

September 16, 2016 Posted by Raúl Ilargi Meijer at 8:56 am Finance Tagged with: Basel, Brexit, China, cold war, debt, deplorables, Deutsche, EU, Fraud, pensions, war on drugs 3 Responses »

DPC Maumee River waterfront, Toledo, OH 1910

• Many Presidential Swing States Lag Behind in Income Gains (WSJ)

• Mediocre Fundamentals Mean Meteoric Markets Are 70% Overvalued (GMO)

• US Seeks $14 Billion From Deutsche Bank Over Mortgage Securities Fraud (AFP)

• Deutsche Bank Shares Plunge After Rebuffing $14 Billion US Fine (BBG)

• Observations About US Corporate Debt (ZH/Kestel)

• This is How You Will Bail Out Municipal Pension Funds (WS)

• The Next Bubble: China’s Housing Gets Scarily Expensive (Balding)

• Europe, Japan Banking Sectors Threaten Revolt Over Basel Rules (BBG)

• It’s A Long Way Down In Australia’s Looming Apartment Fall (Aus.com.au)

• EU Leaders Search For Way Out Of ‘Existential Crisis’ (R.)

• Greece Raids Home Of Central Bank Head (ZH)

• Jay Z: ‘The War on Drugs Is an Epic Fail’ (NYT)

• Les Déplorables (WSJ)

• The Cold War Is Over (Hitchens)

This is it. This will decide the US elections the same way it did Brexit, and many European elections over the next 2 years and change.

• Many Presidential Swing States Lag Behind in Income Gains (WSJ)

Key swing states such as Nevada, North Carolina and Florida have seen some of the weakest income growth in the country since the last non-incumbent presidential contest in 2008, new census figures show. A Wall Street Journal analysis of state-by-state income data set for release on Thursday shows that more than half of the 13 states where the presidential race appears closely contested have seen below-average income growth since 2008. Among the eight laggards, three states saw the lowest wage growth in the U.S. during that time—Nevada, Georgia and Arizona. The new data show how America’s uneven economic recovery is adding another layer of unpredictability to an already volatile electoral map.

The traditional realm of battleground states has expanded, putting into play states such as Arizona and Georgia, which haven’t gone to a Democratic presidential candidate in at least 20 years. The Census Bureau also said income inequality across the country increased in 2015. The recovery’s income gains have been concentrated in central cities, with suburbs and rural areas largely lagging behind for years. “You actually see the bottom and the top pulling apart a little bit more in some of these keys states,” said David Damore, professor of political science at the University of Nevada Las Vegas. On a national basis, most states still haven’t seen income recover to pre-recession levels. Americans’ median household income in 2015 was 2.6% lower than in 2008, census figures show.

“Much of the run-up over the past few years has been primarily about multiple expansions. And the scary thing about multiple expansions is that they are reliably mean-reverting—if they run too far, the market always takes it back, sometimes with a vengeance. And we are currently almost 70% too far.”

• Mediocre Fundamentals Mean Meteoric Markets Are 70% Overvalued (GMO)

While all eyes were on Federal Reserve Chair Janet Yellen in Jackson Hole, we were watching something else. In August, the Shiller P/E, a well-regarded metric for measuring the valuation of U.S. equities, breached 27. Given that its normal range is something a bit above 16, valuations are looking rather stretched. Further, the last time the Shiller P/E was above 27 was in October … 2007. And we all know how that movie ended. While nobody here at GMO is saying that a crash is imminent (and there’s no law that says stocks cannot become even more expensive), we continue to maintain our bias against U.S. stocks. We will also take this end-of-summer moment to point out the yawning disconnect between fundamentals (of the U.S. economy and even corporate America) and their stocks. It really is a tale of two cities, one of mediocre fundamentals versus a meteoric rise in markets (see the chart below).

We pulled together some meaningful metrics on the health of the economy and some top-line/bottom-line numbers on the S&P 500 Index: GDP growth, productivity, and household income, as well as a few others, including revenue and earnings for U.S. stocks, for good measure. It is a tale of mediocrity, at best. Then, we contrasted those with the actual market returns of the S&P 500 Index over the past five years. Truly meteoric. (As an aside, we at GMO have always been leery of drawing too many investment conclusions from staring at economic data—we are more valuation-oriented, after all—but even we are struck by the divergence.) Which brings us back to the Shiller P/E. Much of the run-up over the past few years has been primarily about multiple expansions. And the scary thing about multiple expansions is that they are reliably mean-reverting—if they run too far, the market always takes it back, sometimes with a vengeance. And we are currently almost 70% too far.

“Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited..” “..the bank is aiming for an amount between $2 billion and $3 billion..”

• US Seeks $14 Billion From Deutsche Bank Over Mortgage Securities Fraud (AFP)

Authorities in the US are seeking as much as $14 billion from Deutsche Bank to resolve allegations stemming from the sale of mortgage securities in the 2008 crisis, the German financial giant confirmed Thursday. The payout would be the largest ever inflicted on a foreign bank in the United States, easily surpassing the $8.9 billion that French bank BNP Paribas paid in 2014 for sanctions violations. But in a quick reaction, Deutsche Bank rejected the $14 billion figure, which the bank said was an opening proposal in settlement talks with US prosecutors. “Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited,” the statement said. “The negotiations are only just beginning. The bank expects that they will lead to an outcome similar to those of peer banks which have settled at materially lower amounts.”

The US investment bank Goldman Sachs in April agreed to pay more than $5 billion to settle similar allegations. US authorities have accused major banks of misleading investors about the values and quality of complex mortgage-backed securities sold before the 2008 financial crisis. Much of the underlying lending was worthless or fraudulent, delivering billions of dollars in losses to holders of the mortgage bonds when the housing market collapsed, bringing down numerous banks and touching off the country’s worst recession since the 1930s. According to securities filings, Deutsche Bank as of June 30 had set aside $5.5 billion to resolve pending legal matters. In the mortgage-backed securities matter, the bank is aiming for an amount between $2 billion and $3 billion, according to knowledgeable sources.

“They have declined about 46% this year.”

• Deutsche Bank Shares Plunge After Rebuffing $14 Billion US Fine (BBG)

Deutsche Bank shares slumped after receiving a $14 billion claim from the U.S. Justice Department to settle an investigation into the firm’s sale of residential mortgage-backed securities, a figure the German lender said it won’t pay. “Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited,” the company said in a statement early Friday in Frankfurt. “The negotiations are only just beginning. The bank expects that they will lead to an outcome similar to those of peer banks which have settled at materially lower amounts.” Bank of America paid $17 billion to reach a settlement in a similar case in 2014, the biggest such accord to date.

Goldman Sachs agreed to a $5.1 billion settlement with the U.S. earlier this year, including a $2.4 billion civil penalty and $875 million in cash payments, to resolve U.S. allegations that it failed to properly vet mortgage-backed securities before selling them to investors as high-quality debt. The settlement included an admission of wrongdoing. “Overall it’s very negative for the share price if you look at the Justice Department figure but you don’t know where it will end up,” said Andreas Plaesier at Warburg Research with a hold recommendation on the shares. “If you come down to the Goldman amount they may not need to do much in terms of reserves.” The shares dropped as much as 8.2% and were down 7.8% at 12.08 euros at 9:04 a.m. in Frankfurt. They have declined about 46% this year.

“..we project global corporate credit demand (flow) of $62 trillion over 2016-2020, with new debt representing two-fifths and refinancing the rest.”

• Observations About US Corporate Debt (ZH/Kestel)

Extraordinary low interest rates around the world have delivered a monumental blow to many investors. Falling interest rates have translated into rising liabilities for (defined benefit) pension plans and, secondly, millions of retirees, who depend on income from savings to take them through retirement, are struggling to make a decent living. Consequently, investors take risks that they weren’t previously prepared to take. Take US corporate high yield bonds. The prevailing view seems to be that US corporates (ex. energy) are in very good shape with loads of cash on their balance sheet, and that they therefore offer a relatively attractive, and a comparatively safe, investment opportunity. I beg to disagree. Firstly, we are late in the economic cycle, and it is usually a bad idea to buy corporate high yield bonds late in an economic upturn. Secondly, let me share some facts with you that undermine the perception outlined above:

The 1% most cash-rich of all US companies control over 50% of all US corporate cash.

The five most cash-rich US companies (Apple, Microsoft, Google, Cisco and Oracle) control 30% of all US corporate cash.

Total US corporate debt (the other side of the balance sheet) was $5.03 trillion at the end of 2015- up from $2.62 trillion at the end of 2007.

Net debt (i.e. debt ex. cash) amongst US corporates was $3.39 trillion at the end of 2015 vs. $1.88 trillion at the end of 2007.

US corporate debt has risen by $2.8 trillion over the last five years, while corporate cash has only risen by $600 billion.

If you back out the top 1% referred to in (1) above, the cash holdings of the remaining 99% fell 6% in 2015 to stand at just $900 billion by the end of December vs. $6.6 trillion of debt.

Based on those numbers, I think it is fair to say that, with the exception of a few extremely cash-rich companies, corporate America is increasingly indebted and not at all as cash-rich as widely perceived. This also explains why corporate investments in the US are at a 60-year low.

Governments globally are persisting with monetary expansion to support economic growth and prop up inflation, to the detriment of credit quality, particularly for over-indebted Chinese corporates and U.S.leveraged borrowers. In our base-case scenario, we project global corporate credit demand (flow) of $62 trillion over 2016-2020, with new debt representing two-fifths and refinancing the rest. Outstanding debt would expand by half to $75 trillion, with China’s share rising to 43% from 35%.

We estimate that two-fifths (43%) to half (47%) of nonfinancial corporates (unrated and rated) are highly leveraged-of which 2% to 5% face negative earnings or cash flows, based on a sample of about 14,400 corporates. With weakened borrower credit quality, a credit correction is inevitable. Our base case is for an orderly credit slowdown stretching over several years (‘slow burn’ scenario), but a series of major economic or political shocks, such as the recent Brexit vote in the U.K., could trigger a more system-wide credit contraction (‘Crexit’ scenario).

I see big protests in the offing as public pensions get bailed out by taxpayers who see their private plans left to die.

• This is How You Will Bail Out Municipal Pension Funds (WS)

[..] the beneficiaries are voters and employees of the government, and politicians of all stripes bought their votes with promises of low contributions and rising benefits. They got away with it for decades because no one cares about “underfunded pensions.” Even the term makes people’s eyes glaze over. But someone is going to pay. And it’s not going to be the politicians. This is how they will pay for it in Chicago – the city whose credit rating Moody’s cut by two notches to junk in April last year, and whose interest payments, despite historically low interest rates, have continued to skyrocket as it borrows more and skids deeper into the sinkhole of its own making.

On Wednesday, the City Council approved Mayor Rahm Emanuel’s scheme to bail out its largest and worst-off pension fund, the Municipal Employees’ Annuity and Benefit fund, which would otherwise be insolvent within ten years – and a lot quicker if markets have a hissy fit. Despite seven years of rampant asset price inflation, and asset bubbles nearly everywhere, the fund’s obligations are only 20% funded. It forms part of Chicago’s $34 billion in retirement debt, accumulated over the decades by politicians making promises to buy votes and support from special interest groups. But neither the beneficiaries nor taxpayers via the city contributed enough to pay for those promises.

To save this one pension fund out of its four pension funds from insolvency, the city is jacking up water and sewer levies by 33%, phased in over a few years. Property owners in Chicago will pay, one way or the other, $3 billion into the fund by 2022, up from $1 billion under the prior scheme. Despite these billions of dollars involved, the fund covers only 77,000 workers and retirees.

“A 100-city index compiled by SouFun surged by a worrisome 14% in the last year.”

• The Next Bubble: China’s Housing Gets Scarily Expensive (Balding)

For many years, China’s authorities took a Goldilocks approach to housing prices: They wanted a market that was neither too hot nor too cold, and took measures as needed to control prices. Although an explicit asset-price target was never announced, it was widely assumed that the government wanted home prices to grow in line with the rate of economic growth. To accomplish this, technocrats in Beijing deployed a combination of monetary stimulus and regulatory measures. When prices overheated, they put the brakes on credit growth, required higher down payments for mortgages and placed administrative restrictions on who could buy in which cities. When prices started to drop, they tried loosening credit and boosting the number of units people could own.

But in the past few years, with economic growth sluggish, the planners became much more tolerant of rising prices, even as signs of a bubble emerged. Official data shows the price-to income-ratio hitting 9.2 at the end of 2015; housing prices have continued to rise significantly since. All this has led to some widespread distortions. China’s homeowners have come to see near double-digit real-estate returns as a birthright, a bet on par with death and taxes. According to one study, more than 70% of Chinese household wealth is in housing. Investors believe there’s an implicit guarantee that the government won’t let home prices drop, even as many buildings sit empty.

Meanwhile, banks have gone on a lending spree: Total outstanding mortgage loans rose more than 30% and new mortgage growth clocked in at 111% in the past year. Since June 2012, outstanding mortgage loans have grown at an annualized rate of 30%. Predictably, that’s pushed prices higher and higher. In urban China, the average price per square foot of a home has risen to $171, compared to $132 in the U.S. In first-tier cities such as Beijing and Shenzhen, prices have increased by about 25% in the past year. A 100-city index compiled by SouFun surged by a worrisome 14% in the last year. Developers are buying up land in some prime areas that would need to sell for $15,000 per square meter just to break even.

Break their power!

• Europe, Japan Banking Sectors Threaten Revolt Over Basel Rules (BBG)

Europeans told the world’s top banking regulator that they’ve had enough. In two heated meetings in the past week, regulators from countries including Germany and Italy told the Basel Committee on Banking Supervision that proposed changes to how banks assess credit, market and operational risks must be scaled back and slowed down, according to two people with knowledge of the matter. Some European officials went so far as to say they wouldn’t adopt the proposals on the table, according to the people, who asked not to be identified because the deliberations were private. If the EU – home to nearly half of the world’s most systemically important banks – balks at implementing the Basel Committee’s rules, it could undermine the global regulator’s authority and contribute to fragmentation of the industry.

The Basel Committee is racing to finish work on the post-crisis capital framework known as Basel III by the end of the year, and it’s under instructions not to increase capital requirements significantly in the process. The debate in Basel pits bank regulators from Tokyo to Frankfurt against a U.S.-backed push for stiffer standards, which take effect when they’re implemented by national governments. The industry says the proposed revisions to risk-assessment rules and limits on banks’ use of their own models to make these calculations would send capital requirements spiraling. Key policy makers have heeded their message. German FinMin Schaeuble last week insisted that the Basel Committee not only keep any overall increase in capital requirements to a minimum, but also ensure the rules have no “particularly negative consequences for specific regions,” such as Europe.

Shunsuke Shirakawa, vice commissioner for international affairs at Japan’s Financial Services Agency, has said the regulator needs to “make adjustments” to bring the new rules in on target. The Basel Committee’s members include Japan’s FSA, Germany’s Bundesbank and the U.S. Federal Reserve. Large European banks may be more vulnerable than their global peers to the changes under discussion. The biggest European banks had an average common equity Tier 1 capital ratio – a key measure of financial strength – higher than their global peers at end-2015, according to data from the European Banking Authority and the Basel Committee.

“..mass failure of many Chinese buyers to settle on apartment contracts..”

• It’s A Long Way Down In Australia’s Looming Apartment Fall (Aus.com.au)

While Australia debates its interest rate policy, the mass failure of many Chinese buyers to settle on apartment contracts is looming as a much bigger catastrophe than markets are expecting. This emerged from the comments of a reader to my commentary yesterday on the Sydney and Melbourne apartment markets. One of my readers who did not allow his full name to be published but used the name “James” complained that I had grossly understated the problem. James revealed that he owned and ran a debt and equity funding business that is on the frontline of the apartment settlement problem. His business deals with the developers of the apartment complexes rather than rather than the investors. James describes what is ahead this way:

“The problem is much worse than what you have described. Our analysis of every development in the country suggests that settlement failures will be between $1 billion and $1.5bn every month for the next 12 months. This is from the Chinese alone, but when settlement prices start coming more than 10% under purchase prices, we will also start to see local buyers attempting to walk away from settling. As Julius Caesar famously said: ‘the die is cast.’” To understand the implication of what James’ analysis reveals we need to step back and see how the apartment boom was funded. Most developers of apartments in Australia collect their Chinese off-the-plan deposits and then use them to gain security for a bank loan. Those bank loans can constitute 40, 50 or even 60% of the cost of the apartment complex.

The developers obtain the rest of their funding from businesses like those operated by James. This is an area of finance which we know very little about because it is hidden from public view. The banks feel they are safe in their loans to developers because there is a big difference between their loans and the cost of the buildings. But the banks are often funding other players in the apartment development. Apart from the developer, the people at risk include unsecured suppliers and the enterprises that are providing the second mortgage funding. If the Chinese fail to settle on the scale that Harry Triguboff is warning about, then there will be a deep problem. But if James’ study is correct that deep problem will develop into an economic catastrophe.

It’s over. Wind it down peacefully please.

• EU Leaders Search For Way Out Of ‘Existential Crisis’ (R.)

Shaken by Britain’s decision to leave the European Union, the leaders of its other 27 countries meet on Friday to try to inject new momentum into their ailing communal project amid deep-seated divisions over migration and economic policy. The Brexit vote in June ended more than half a century of EU enlargement and closer integration. Long seen as a guarantor of peace and prosperity, the bloc is now struggling to convince its citizens that it remains a force for good. Years of economic and financial crisis have pushed up unemployment in many member states, while a spate of attacks by Islamist militants and a record influx of refugees from the Middle East and Africa have unsettled voters, who are turning increasingly to populist, anti-EU parties.

“After the vote in the UK the only thing that makes sense is to have a sober and brutally honest assessment of the situation,” European Council President Donald Tusk told reporters in Bratislava on the eve of the meeting. “We must not let this crisis go to waste.” European Commission President Jean-Claude Juncker said earlier this week the EU was in an “existential crisis”. Despite the pressure to lay out a new vision, leaders have played down expectations of real breakthroughs in the Slovak capital, in part because of intractable differences on the biggest issues, notably how to handle the influx of migrants.

Instead they are expected to focus on areas where there is common ground, pledging closer defence cooperation, bolstering security at the EU’s external borders and boosting the capacity of an EU investment fund meant to generate growth and jobs. The aim is to present more concrete proposals at a summit in March of next year that coincides with the 60th anniversary of the bloc’s founding Rome Treaty. But some officials admit in private that major initiatives may not be possible until elections in the Netherlands, France and Germany are out of the way by late 2017.

Many Greeks accuse Stournaras of exaggerating deficits in order to bring in the Troika.

• Greece Raids Home Of Central Bank Head (ZH)

While the US the media lashes out at Trump every time he dares to tell the truth that the central bank is a biased, engaged, political member of the decision-making landscape, other “developed” countries are happily willing to demonstrate just how apolitical the central bank truly is. Take Greece, for example, where today the chief prosecutor ordered a raid of the home of the governor of the Greek central bank, Yannis Stournaras and the company office of his wife, Lina. The searches were part of a probe conducted by the Financial Police in connection to the alleged mismanagement of more than €1 million in state funding by the Hellenic Center for Disease Control and Prevention, KEELPNO.

The investigation related to funds that KEELPNO allegedly received through a company owned by Nikolopoulou as well as complaints regarding the disappearance of documents tied to the case. According to the WSJ, the raid was part of a continuing investigation into business Stournaras’ wife has done with a state entity, officials said, in a probe that may heighten tension between the top bank official and the left-wing government. Lina Nikolopoulou-Stournaras, the wife of central bank Governor Yannis Stournaras and owner of an communications company specializing in the medical sector, is under investigation from Greek authorities for business she has done with the Hellenic Center for Disease Control and Prevention, or Keelpno.

Any and all wars declared on nouns are epic fails. But follow the money.

• Jay Z: ‘The War on Drugs Is an Epic Fail’ (NYT)

This short film, narrated by Jay Z (Shawn Carter) and featuring the artwork of Molly Crabapple, is part history lesson about the war on drugs and part vision statement. As Ms. Crabapple’s haunting images flash by, the film takes us from the Nixon administration and the Rockefeller drug laws – the draconian 1973 statutes enacted in New York that exploded the state’s prison population and ushered in a period of similar sentencing schemes for other states – through the extraordinary growth in our nation’s prison population to the emerging aboveground marijuana market of today. We learn how African-Americans can make up around 13% of the United States population – yet 31% of those arrested for drug law violations, even though they use and sell drugs at the same rate as whites.

Quite a statement for the Wall Street Journal to publish.

• Les Déplorables (WSJ)

To repeat: “racist, sexist, homophobic, xenophobic, Islamophobic.” Those are all potent words. Or once were. The racism of the Jim Crow era was ugly, physically cruel and murderous. Today, progressives output these words as reflexively as a burp. What’s more, the left enjoys calling people Islamophobic or homophobic. It’s bullying without personal risk. Donald Trump’s appeal, in part, is that he cracks back at progressive cultural condescension in utterly crude terms. Nativists exist, and the sky is still blue. But the overwhelming majority of these people aren’t phobic about a modernizing America. They’re fed up with the relentless, moral superciliousness of Hillary, the Obamas, progressive pundits and 19-year-old campus activists.

Evangelicals at last week’s Values Voter Summit said they’d look past Mr. Trump’s personal résumé. This is the reason. It’s not about him. The moral clarity that drove the original civil-rights movement or the women’s movement has degenerated into a confused moral narcissism. One wonders if even some of the people in Mrs. Clinton’s Streisandian audience didn’t feel discomfort at the ease with which the presidential candidate slapped isms and phobias on so many people. Presidential politics has become hyper-focused on individual personalities because the media rubs them in our face nonstop. It is a mistake, though, to blame Hillary alone for that derisive remark. It’s not just her.

Hillary Clinton is the logical result of the Democratic Party’s new, progressive algorithm—a set of strict social rules that drives politics and the culture to one point of view. A Clinton victory would enable and entrench the forces her comment represents. Her supporters say it’s Donald Trump’s rhetoric that is “divisive.” Just so. But it’s rich to hear them claim that their words and politics are “inclusive.” So is the town dump. They have chopped American society into so many offendable identities that only a Yale freshman can name them all. If the Democrats lose behind Hillary Clinton, it will be in part because America’s les déplorables decided enough of this is enough.

Lovely piece.

• The Cold War Is Over (Hitchens)

Perhaps we would understand Russia’s situation better if we imagined that NATO has been dissolved and that the Confederate States and the territories conquered in the Mexican-American War have declared independence. The U.S. retains a precarious hold on the naval station at San Diego, sharing it with the Mexican Navy on an expensive lease that Mexico regularly threatens to cancel. Americans still living in San Diego are compelled to adopt Spanish names on their drivers’ licenses, and movie theaters are instructed to show films only in Spanish. Schools teach anti-American history. Quebec has seceded from Canada, and is being wooed by a Russo-Chinese economic union, with a pact including military and political clauses.

Russian politicians are in the streets of Montreal, urging on a violent anti-American mob, which eventually succeeds in overthrowing Quebec’s pro-American president and replacing him with a pro-Russian one—violating Quebec’s constitution in the process. This brings military forces aligned with Russia right up to the border with New York, Maine, New Hampshire, and Vermont. In such a case, I cannot see the U.S. sitting about doing nothing, especially if it had repeatedly warned in major diplomatic forums against this expansion of Russian power on its frontiers, and been repeatedly ignored over fifteen years or so. If a Marxist takeover in Grenada was considered good enough reason for military action, what would these circumstances provoke?

Mikhail Gorbachev’s feline spokesman, Gennadi Gerasimov, once teased suspicious Western correspondents by sneering at them in the early days of the great perestroika and glasnost experiment, “We have done the cruelest thing to you that we could possibly have done. We have deprived you of an enemy.” He was laughing at us, but he was dead right. The Cold War was a period of moral clarity when the other side really was an evil empire, and when armed resolve for once succeeded in defeating the expansion of evil in the world. It allowed my own poor country to feel more important than it really was, and it suppressed the seething impulses and rivalries of the European continent.