A Curious Collapse

 

wizard bank 2

 

Ever since the ECB has begun to implement its assorted money printing programs in recent years – lately culminating in an outright QE program involving government bonds, agency bonds, ABS and covered bonds – bank reserves and the euro area money supply have soared. Bank reserves deposited with the central bank can be seen as equivalent to the cash assets of banks. The greater the proportion of such reserves (plus vault cash) relative to their outstanding deposit liabilities, the more of the outstanding deposit money is in fact represented by “covered” money substitutes as opposed to fiduciary media.

 

1-TMS- euro areaEuro area true money supply (excl. deposits held by non-residents) – the action since 2007-2008 largely reflects the ECB’s money printing efforts, as private banks have barely expanded credit on a euro area-wide basis since then- click to enlarge.

 

Many funny tricks have been employed to keep euro area banks and governments afloat during the sovereign debt crisis. Essentially these consisted of a version of Worldcom propping up Enron, with the central bank’s printing press as a go-between.

As an example here is how Italian banks and the Italian government are helping each other in pretending that they are more solvent than they really are: the banks buy government properties (everything from office buildings to military barracks) from the government, and pay for them with government bonds. The government then leases the buildings back from the banks, and the banks turn the properties into asset backed securities. The Italian government then slaps a “guarantee” on these securities, which makes them eligible for repo with the ECB. The banks then repo these ABS with the ECB and take the proceeds to buy more Italian government bonds – and back to step one. Simply put, this is a Ponzi scheme of gargantuan proportions.

Still, in view of these concerted efforts to reliquefy the banking system, one would expect that European banks should be at least temporarily solvent, more or less. Since they have barely expanded credit to the private sector, preferring instead to invest in government bonds, the markets should in theory have little to worry about.

 

2-NFC loans, euro areaEuro area bank loans to non-financial corporations, with annual growth rate (blue line) – click to enlarge.

 

In fact, on account of new capital regulations, European banks are almost forced to amass government securities – as government bonds have been declared to represent “risk-free” assets, which reveals an astounding degree of chutzpa on the part of European authorities in the wake of the sovereign debt crisis.

This makes one wonder why the Euro Stoxx Bank Index suddenly looks like this:

 

3-Euro-Stoxx Banks-1The Euro Stoxx bank index has been in free-fall since July – click to enlarge.

 

Clearly, something is rotten here – but what?

 

Bail-Ins, Dud Loans, Insolvent Zombies and Hidden Risks

Back in September last year, with the bank index still close to its highs of the year, we referred to European banks as “Insolvent Zombies”. This may have sounded a bit uncharitable at the time, but it is beginning to look like an ever more accurate description by the day. In December, we reminded readers that European banks are still sitting on €1 trillion in non-performing dud loans (see “Still Drowning in Bad Loans” for details).

In January we finally got around to write about the new European “bail-in” regulations, noting that these were bound to bring about unintended consequences. We pointed out that while there is absolutely nothing wrong with exposing bank creditors to risk and sparing taxpayers from involuntarily shouldering same, such an approach would over time likely prove completely incompatible with a fractionally reserved banking system – especially one as highly leveraged and teetering on the brink as that in a number of European countries.

We moreover pointed out that some governments have begun to apply the new regulations in rather arbitrary fashion – for instance as a means to escape guarantees they themselves have extended to creditors. Two recent bank collapses in Portugal and the still festering Heta (formerly HAA) wind-down in Austria served as recent examples.

This seems indeed to be on the minds of investors, who have begun to sell convertible and subordinated bank bonds left and right. And in concert with the decline in bonds and stocks, risk measures like CDS spreads on senior bank debt have begun to surge. Below are several charts we have taken from a recent article by Peter Tchir, who has commented on the situation at Forbes.

 

4-ITRAXX-SNR-FIN-1200x515I-Traxx senior financials CDS index – this index tracks CDS spreads on the senior debt of 30 major financial institutions – click to enlarge.

 

5-DB-Coco-1200x515Deutsche Bank CoCos: these convertible bonds have special features that allow for “automatic” conversions and the suspension of coupon payments, making them eligible as tier 1 capital under Basel 3. Investors have liked this instruments – until they suddenly stopped liking them.

 

Mr. Tchir agrees that the arbitrary manner in which bail-ins have been pursued – especially the overnight bail-in of senior creditors of BES by the Portuguese government’s decision to reassign five different bonds from the “good bank” to the “bad bank” ad hoc – must have contributed to investors getting cold feet.

However, he also argues that Mr. Draghi can surely be relied upon to keep Europe’s zombie banks in a state of suspended animation, and that the surge in CDS spreads is so far not much to worry about, at least if compared to where they went in the last crisis period – as the long term chart below shows:

 

6-Bank-5-Year-CDS-1200x6115 year CDS spreads on senior bank debt, long term: Deutsche Bank (yellow line), Mediobanca (green line), Credit Suisse (orange line) and Societe Generale (blue line) – click to enlarge.

 

We would however note that this is precisely how it started last time around as well. The fact that CDS spreads have not yet moved even higher doesn’t seem a good reason not to be concerned. As far as Mr. Draghi’s abilities to keep the zombies staggering about are concerned, point taken – they are certainly formidable, as demonstrated by the Italian snow-job we have described above.

However, the ECB can certainly not jump in and “rescue” individual institutions that are in trouble – it can merely hope to keep up confidence in the debt-laden system as a whole. Banks that are beneath its notice due to not being regarded as “systemically relevant” are out of luck in any case – they are prime bail-in material, as Italian bank creditors have just found out to their chagrin.

Many of said creditors in Italy were small savers who were talked into buying subordinated bank bonds by their own house banks (the same thing has previously happened in Spain as well). Why have their banks talked them into taking such risks? The new bank regulations are in fact the main reason! European regulators have wittingly or unwittingly promoted the transfer of bank risk to widows and orphans – literally.

 

7-Italy, TARGET balancesItaly’s negative TARGET-2 balances have begun to deteriorate sharply again, likely indicating growing capital flight – click to enlarge.

 

We confess we are a bit more worried than Mr. Tchir seems to be at the current juncture. After all, we regard the euro area crisis as being in suspended animation as well, in a sense. The essential problems haven’t been resolved, they have merely been papered over – with truly staggering amounts of paper and promises. In the course of this giant contingent liabilities have piled up on the balance sheets of euro area governments, several of which are guaranteeing the debt of others while being the subjects of debt guarantees at the same time, due to their de facto insolvency.

However, this is not the only thing that worries us. Apart from the astonishing €1 trillion in dud loans that remain on European bank balance sheets in spite of serial bail-outs and the erection of numerous “bad bank” structures into which such loans are “disappeared” so as not to mar the statistics any longer, one must keep in mind that economic confidence has been crumbling for almost two years:

 

8-gold-commoditiesThe huge increase in the ratio of gold to commodities, which has begun to rise concurrently with the beginning of the sharp rise in junk bond yields, is a sign that economic confidence is crumbling – click to enlarge.

 

Prior to the last crisis, European banks were known to be among the largest financiers of commodity traders and Asian emerging market companies. We have a strong suspicion that this hasn’t magically changed in recent years, especially as the EM and commodity universe seemed to be fine again for several years once Mr. Bernanke started up his printing press and China pumped up its money and credit supply like a drunken sailor in the wake of the 2008 crisis.

Well, they are no longer fine. In fact, the debt of commodity producers and emerging market companies has been plunging to distressed levels at warp speed since the middle of last year. This is likely to get worse if China is forced to “let the yuan go” (just to be safe, put down your coffee before clicking on the link).

Then there is the fact that banks perforce remain exposed to what occurs in financial markets. Their proprietary portfolios have shrunk, but that doesn’t mean they don’t remain intertwined with the markets through all sorts of funding channels, including numerous opaque ones in the shadow banking system. The problem with this is that confidence is very fragile, and credit stress often emerges from entirely unexpected places (as e.g. happened in 2008).

 

Conclusion

It is possible that we are worrying too much – after all, both European and US banks have certainly taken a lot of action to shore up their capital. However, it seems to us that the next wave of economic troubles is already washing ashore before they had a chance to fully recover from the last crisis. Obviously, not all banks are affected by this to the same extent, but the banking system is deeply interconnected, so even institutions that appear relatively insulated from the currently brewing set of problems may actually suffer damage if things get out of hand.

All signs are that things are in fact in danger of getting out of hand, even if it seems to us as though it is time for at least a brief pause in the mini panic in risk assets we have observed in recent weeks. This is just a reminder that oil prices and the yuan are not the only things on the minds of market participants at the moment. As is seemingly always the case, when it rains, it pours.

 

Charts by: ECB, BigCharts, Peter Tchir / Bloomberg, StockCharts

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “The Walking Dead: Something is Rotten in the Banking System”

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • India: The World’s Fastest Growing Large Economy?
    Popular Narrative India has been the world’s favorite country for the last three years. It is believed to have superseded China as the world’s fastest growing large economy. India is expected to grow at 7.5%. Compare that to the mere 6.3% growth that China has “fallen” to.   India's quarterly annualized GDP growth rate since 2008, according to MOSPI (statistics ministry) - click to enlarge.   The IMF, the World Bank, and the international media have celebrated...
  • Gold Sector Update – What Stance is Appropriate?
      The Technical Picture - a Comparison of Antecedents We wanted to post an update to our late December post on the gold sector for some time now (see “Gold – Ready to Spring Another Surprise?” for the details). Perhaps it was a good thing that some time has passed, as the current juncture seems particularly interesting. We received quite a few mails from friends and readers recently, expressing concern about the inability of gold stocks to lead, or even confirm strength in gold of...
  • Don’t Blame Trump When the World Ends
    Alien Economics There was, indeed, a time when clear thinking and lucid communication via the written word were held in high regard. As far as we can tell, this wonderful epoch concluded in 1936. Everything since has been tortured with varying degrees of gobbledygook.   One should probably not be overly surprised that the abominable statist rag Time Magazine is fulsomely praising Keynes' nigh unreadable tome. We too suspect that this book has actually lowered the planet-wide IQ –...
  • What is the Best Time to Buy Stocks?
      Chasing Entry Points Something similar to the following has probably happened to you at some point: you want to buy a stock on a certain day and in order to time your entry, you start watching how it trades. Alas, the price rises and rises, and your patience begins to wear thin. Shouldn't a correction set in soon and provide you with a more favorable buying opportunity?   Apple-Spotting – a five minute intraday chart showing the action in AAPL on February 1, 2017 - an...
  • Incrementum Advisory Board Meeting, Q1 2017 and Some Additional Reflections
      Looming Currency and Liquidity Problems The quarterly meeting of the Incrementum Advisory Board was held on January 11, approximately one month ago. A download link to a PDF document containing the full transcript including charts an be found at the end of this post. As always, a broad range of topics was discussed; although some time has passed since the meeting, all these issues remain relevant. Our comments below are taking developments that have taken place since then into...
  • Trump and the Draining of the Swamp
      Swamp Critters BALTIMORE – The Dow is back above the 20,000-point mark. Federal debt, as officially tallied, is up to nearly $20 trillion. The two go together, egging each other on. The Dow is up 20 times since 1980. So is the U.S. national debt. Debt feeds the stock market and the swamp. What’s not up so much is real output, as measured by GDP. It’s up only 6.4 times over the same period. Debt and asset prices have been rising three times as fast as GDP for 36 years! Best...
  • Gold and Silver Divergence – Precious Metals Supply and Demand
      Gold and Silver Divergence – Precious Metals Supply and Demand Last week, the prices of the metals went up, with the gold price rising every day and the silver price stalling out after rising 42 cents on Tuesday. The gold-silver ratio went up a bit this week, an unusual occurrence when prices are rising. Everyone knows that the price of silver is supposed to outperform — the way Pavlov’s Dogs know that food comes after the bell. Speculators usually make it...
  • Making America Great Again – How to Judge Policy
      A Simple Formula MIAMI – How do we know if new programs will make the economy better... or worse? Here’s a simple formula:   W = rv (w-w – w-l)   That is, wealth is equal to the real value of win-win exchanges minus the loss from win-lose exchanges. Yes, dear reader, it’s as simple as that. Like a whittler working on a piece of wood, we’ve shaved so much off, there is nothing left of it... except the essential heartwood.   When devising a win-win,...
  • When Trumponomics Meets Abenomics
      Thirty Year Retread What will President Trump and Japanese Prime Minister Shinzo Abe talk about when they meet later today? Will they gab about what fishing holes the big belly bass are biting at? Will they share insider secrets on what watering holes are serving up the stiffest drinks? [ed. note: when we edited this article for Acting Man, the meeting was already underway]   Japan's prime minister Shinzo Abe, a dyed-in-the-wool Keynesian and militarist, meets America's...
  • The Great Wailing
      Regret and Suffering BALTIMORE – Victoribus spolia... So far, the most satisfying thing about the Trump win has been the howls and whines coming from the establishment. Each appointment – some good, some bad from our perspective – has brought forth such heavy lamentations.   Oh no! Alaric the Visigoth is here! Hide the women and children! And don't forget the vestal virgins, if you can find any...   You’d think Washington had been invaded by Goths, now...
  • Receive a One Percent Gift When Buying or Selling a Home
      How to Save Money When Buying or Make More When Selling a Home In your professional capacity and perhaps also in your private life, you may be closely involved with financial and commodity markets. Trading in stocks, bonds or futures is part of your daily routine.  Occasionally you probably have to deal with real estate as well though – if you e.g. want to purchase an apartment or a house, or if own a home you wish to sell.   The people who took this photograph probably want to...
  • Silver Futures Market Assistance – Precious Metals Supply and Demand
      Silver Is Pushed Up Again This week, the prices of the metals moved up on Monday. Then the gold price went sideways for the rest of the week, but the silver price jumped on Friday.   Taking off for real or not? Photo credit: NASA   Is this the rocket ship to $50? Will Trump’s stimulus plan push up the price of silver? Or just push silver speculators to push up the price, at their own expense, again? This will again be a brief Report this week, as we are busy...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com