Tuesday, May 22, 2012
May 22, 2012 Neither the Fed Nor the ECB Will Be Able to Stop What's Coming
Today, we are witnessing the investment world's slow awakening to the
fact that the monetary actions taken by the world's Central Banks have
not in fact solved the issues leading up to the 2008 Crisis.
In point of fact, the Central Banks' actions have exacerbated
pre-existing problems (excessive leverage) while simultaneously
creating new problems (inflation).
This slow awakening has taken much longer than I would have expected,
but with tens of thousands of careers on the line (financial
professionals) as well as tens of trillions of dollars in portfolios at
risk, the vast majority of professional market participants were highly
incentivized not to realize these issues.
However, at this point, it is becoming clear that not only are financial
professionals slowly realizing that 2008 was actually "the warm up,"
but that Central Banks themselves are aware that they've:
1) Failed to solve the issues leading up to 2008.
2) Created other unforeseen problems.
Indeed, this process of realization first began in the US where we had
signs as far back as April 2011 that the Federal Reserve was aware that
QE (AKA monetization of US debt) was less "attractive" as a policy
(read: not such a good idea).
The vast majority of the media and Wall Street analysts failed to recognize this, though Bernanke himself admitted it in public:
Q. Since both housing and unemployment have not recovered sufficiently,
why are you not instantly embarking on QE3? -- Michael A. Kamperman,
Waco, Tex.
Mr. Bernanke: "Going forward, we'll have to continue to make judgments about whether additional steps are warranted, but as we do so, we
have to keep in mind that we do have a dual mandate, that we do have to
worry about both the rate of growth but also the inflation rate...
"The trade-offs are getting -- are getting less attractive at this point.
Inflation has gotten higher. Inflation expectations are a bit higher.
It's not clear that we can get substantial improvements in payrolls
without some additional inflation risk. And in my view, if we're
going to have success in creating a long-run, sustainable recovery with
lots of job growth, we've got to keep inflation under control. So we've got to look at both of those -- both parts of the mandate as we -- as we choose policy"
This admission marked the beginning of a process through which the US
Federal shifted its policies from those of aggressive monetization to
those of verbal or symbolic intervention.
I addressed this at length in previous articles.
But the main issue is that the Fed backed off from rampant monetization
and began to simply issue verbal statements that it would ease if
needed, thereby getting the same impact (boosting stock prices) without
actually having to monetize debt/ print more money.
Indeed, the only monetary change the Fed has made in nearly a year was
the launch of Operation Twist 2 in October 2011. However, even this
policy was more about meeting immediate debt issuance needs in the US
rather than printing money to prop up the market.
Operation Twist 2 was a policy through which the Fed would sell its
short-term Treasury holdings and use the proceeds to buy longer-term
Treasuries. The purpose of this policy was two fold:
1) To make up for the lack of foreign demand in long-term Treasuries.
2) To provide capital to banks by permitting them to unload their long-term Treasury holdings in exchange for new cash.
Regarding #1, the Fed is now obviously aware that the policies it has
pursued in tandem with the Federal Government, namely maintaining low
interest rates while running massive deficits and increasing the Federal
Debt to the tune of $100-200 billion per month, have severely damaged
the US Treasury market.
This is only common sense. By running Debt to GDP and Deficit to GDP
ratios that are on par with the European PIIGS, the US has made it clear
that those investors who lend to it for the long-term (20+ years) are
likely going to experience a haircut or bond restructuring much as
Greece bondholders recently experienced.
Because of a lack of foreign interest in long-term Treasuries, the Fed
decided to step in to pick up the slack. As a result of this, the US
Federal Reserve has accounted for 91% of all new debt issuance in the
20+years bracket. Put another way, the US Federal Reserve is now
effectively the long-end of the US debt market.
Operations Twist 2 has also allowed US commercial banks to unload their
long-term Treasury holdings in exchange for new capital: something most
of the Primary Dealers are in dire need of. This in turn helps to
explain why the US stock market has advanced despite the fact that
retail investors have been pulling out of the market in droves.
Put another way, the markets have been ramped higher by more juice from
the Fed (and corporate buybacks). However, the fact remains that this
juice has come from the Fed reallocating its current portfolio holdings,
NOT printing more money outright to monetize US debt via QE.
So while the media and 99% of analysts believe the Fed is and can
continue to act aggressively to prop up the markets, the fact is that
the Fed has been reining in its monetary stimulus over the last nine
months, largely relying on verbal intervention from Fed Presidents to
push stocks higher.
We have known this for some time. But the
general public and financial media are only just starting to realize
that the Fed, in some ways, is at the end of its rope in terms of
monetary intervention. This has become increasingly clear in the Fed
FOMC statements.
Consider the latest FOMC statement released a few weeks ago...
Fed Signals No Need for More Easing Unless Growth Falters
The Federal Reserve is holding off on increasing monetary
accommodation unless the U.S. economic expansion falters or prices rise
at a rate slower than its 2 percent target.
"A couple of members indicated that the initiation of additional
stimulus could become necessary if the economy lost momentum or if
inflation seemed likely to remain below" 2 percent, according to minutes
of their March 13 meeting released today in Washington. That contrasts
with the assessment at the FOMC's January meeting in which some Fed
officials saw current conditions warranting additional action "before
long."
Ignore the verbal obfuscation here. The Fed knows that inflation is higher than 2%. It also knows
that US growth is faltering. The above announcement is the Fed
essentially admitting its hands are tied regarding more easing due to:
- Gas being at $4 and food prices not far from record highs.
- This being an election year and the Fed now politically toxic.
- Growing public outrage over the Fed's actions (secret loans, etc.) in the past.
Again, we are in a process of slow awakening to the fact that the Fed
has not solved the problems that caused 2008. Instead, the Fed has
exacerbated these problems (excess leverage) and created new problems in
the process (inflation).
Fortunately for the Fed, the European Central Bank has picked up the
intervention slack since the Fed began pulling back in mid-2011. Indeed,
between July 2011 and today, the ECB has expanded its balance sheet by
an incredible $1+ trillion: more than the Fed's QE 2 and QE lite
combined (and in just a nine month period).
The two largest interventions were the ECB's LTRO 1 and LTRO 2, which
saw the ECB handing out $645 billion and $712 billion to 523 and 800
banks respectively.
As a result of this, the ECB's balance sheet exploded to nearly $4
trillion in size, larger than the GDPs of Germany, France, or the UK.
This rapid and extreme expansion of the ECB's balance sheet (again it
was greater than QE lite and QE2 combined... in nine months) indicates
the severity of the banking crisis in Europe. You don't rush
this much money out the door this fast unless you're facing something
very, very bad.
This rapid expansion has also resulted in the ECB obtaining a similar
political toxicity to that of the US Federal Reserve. Indeed, those
European banks that participated in the LTRO schemes have found their
Credit Default Swaps exploding relative to their non-LTRO participating
counterparts.
The reason for this is obvious: any bank that participated in either
LTRO implicitly announced that it was in dire need of capital. As a
result of this the markets have stigmatized those banks that
participated in the schemes, thereby:
1) Diminishing the impact of the ECB's moves.
2) Indicating that the ECB is now politically toxic in that those EU
financial institutions that rely on it for help are punished by the
markets.
Thus the two biggest market props of the last two years: the Fed and the
ECB have found their hands tied. What will follow will make 2008 look
like a joke. On that note, if you have not taken steps to prepare for
the end of the EU (and its impact on the US and global banking system),
you NEED TO DO SO NOW!
Labels: collapse, Crash, credit, Crisis Crash, Debt crisis, Default, Dollar, Euro Collapse, Euro crisis, Euro default
Monday, April 30, 2012
April 30, 2012 The Secrets of the Spanish Banking System That 99% of Analysts Fail to Grasp
Spain is a catastrophe on such a level that few analysts even grasp it.
Indeed, to fully understand just why Spain is such a catastrophe, we need to understand Spain in the context of both the EU and the global financial system.
The headline economic data points for Spain are the following:
- Spain's economy (roughly €1 trillion) is the fourth largest in Europe and the 12th largest in the world.
- Spain sports an official Debt to GDP of 68% and a Federal Deficit between 5.3-5.8% (as we'll soon find out the official number)
- Spain's unemployment is currently 24%: the highest in the industrialized world.
- Unemployment for Spanish youth is 50%+: on par with that of Greece
The answer to these questions lies within the dirty details of Spain's economic "boom" of the 2000s as well as its banking system.
For starters, the Spanish economic boom was a housing bubble fueled by Spain lowering its interest rates in order to enter the EU, not organic economic growth.
Moreover, Spain's wasn't just any old housing bubble; it was a mountain of a property bubble (blue line below) that made the US's (gray line below) look like a small hill in comparison.
In the US during the boom years, it was common to hear of people quitting their day jobs to go into real estate. In Spain the boom was so dramatic that students actually dropped out of school to work in the real estate sector (hence the sky high unemployment rates for Spanish youth).
Spanish students weren't the only ones going into real estate. Between 2000 and 2008, the Spanish population grew from 40 million to 45 million (a whopping 12%) as immigrants flocked to the country to get in on the boom.
In fact, from 1999 to 2007, the Spanish economy accounted for more than ONE THIRD of all employment growth in the EU.
This is Spain, with a population of just 46 million, accounting for OVER ONE THIRD of the employment growth for a region of 490 million people.
This, in of itself, set Spain up for a housing bust/ banking Crisis worse than that which the US faced/continues to face. Indeed, even the headline banking data points for Spain are staggeringly bad:
- Spanish banks just drew €227 billion from the ECB in March: up almost 50% from its February borrowings
- Spanish banks account for 29% of total borrowings from the ECB
- Yields on Spanish ten years are approaching 7%: the tipping point at which Greece and other nations have requested bailouts
Spain's banking system is split into two tiers: the large banks (Santander, BBVA) and the smaller, more territorial cajas.
The caja system dates back to the 19th century. Cajas at that time were meant to be almost akin to village or rural financial centers. As a result of this, the Spanish country is virtually saturated with them: there is approximately one caja branch for every 1,900 people in Spain. In comparison there is one bank branch for every 3,130 people in the US and one bank branch for every 6,200 people in the UK.
Now comes the bad part...
Until recently, the caja banking system was virtually unregulated. Yes, you read that correctly, until about 2010-2011 there were next no regulations for these banks (which account for 50% of all Spanish deposits).
They didn't have to reveal their loan to value ratios, the quality of collateral they took for making loans... or anything for that matter.
As one would expect, during the Spanish property boom, the cajas went nuts lending to property developers. They also found a second rapidly growing group of borrowers in the form of Spanish young adults who took advantage of new low interest rates to start buying property (prior to the housing boom, traditionally Spanish young adults lived with their parents until marriage).
In simple terms, from 2000 to 2007, the cajas were essentially an unregulated banking system that leant out money to anyone who wanted to build or buy property in Spain.
Things only got worse after the Spanish property bubble peaked in 2007. At a time when the larger Spanish banks such as Santander and BBVA read the writing on the wall and began slowing the pace of their mortgage lending, the cajas went "all in" on the housing market, offering loans to pretty much anyone with a pulse.
To give you an idea of how out of control things got in Spain, consider that in 1998, Spanish Mortgage Debt to GDP ratio was just 23% or so. By 2009 it had more than tripled to nearly 70% of GDP. By way of contrast, over the same time period, the US Mortgage Debt to GDP ratio rose from 50% to 90%. Like I wrote before, Spain's property bubble dwarfed the US's in relative terms.
The cajas went so crazy lending money post-2007 that by 2009 they owned 56% of all Spanish mortgages. Put another way, over HALF of the Spanish housing bubble was funded by an unregulated banking system that was lending to anyone with a pulse who could sign a contract.
Indeed, these banks became so garbage laden that a full 20% of their assets were comprised of loan payments being made by property developers. Mind, you, I'm not referring to the loans themselves (the mortgages); I'm referring to loan payments: the money developers were sending in to the banks.
To try and put this into perspective, imagine if Bank of America suddenly announced that 20% of its "assets" were payments being sent in by borrowers to cover mortgage debts. Not Treasuries, not mortgages, not loans... but payments being sent in to the bank on loans and mortgages.
This is the REAL problem with Spain's banking system. It's saturated with subprime and sub-subprime loans that were made during one of the biggest housing bubbles in the last 30 years.
Indeed, to give you an idea of how bad things are with the cajas, consider that in February 2011 the Spanish Government implemented legislation demanding all Spanish banks have equity equal to 8% of their "risk-weighted assets." Those banks that failed to meet this requirement had to either merge with larger banks or face partial nationalization.
The deadline for meeting this capital request was September 2011. Between February 2011 and September 2011, the number of cajas has in Spain has dropped from 45 to 17.
Put another way, over 60% of cajas could not meet the capital requirements of having equity equal to just 8% of their risk-weighted assets. As a result, 28 toxic caja balance sheets have been merged with other (likely equally troubled) banks or have been shifted onto the public's balance sheet via partial nationalization.
On that note, I fully believe the EU in its current form is in its final chapters. Whether it's through Spain imploding or Germany ultimately pulling out of the Euro, we've now reached the point of no return: the problems facing the EU (Spain and Italy) are too large to be bailed out. There simply aren't any funds or entities large enough to handle these issues.
Labels: collapse, Crash, credit, Crisis Crash, Default, depression, Euro default, Euro finished, Spain
Tuesday, August 19, 2008
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Labels: borrowing, credit, financing, lending, loan, moneyloans
