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"Macro" Musings


giofranchi

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I think this is very similar to what Mr. Ray Dalio has recently warned us against:

 

1) With interest rates negative or at zero, and each round of money printing ever less effective, what policy tool will be left, to fight an eventual slowdown in the economy? And it is already 4 years the economy is growing (even though barely…).

 

2) When interest rates finally do rise, all assets will be automatically repriced down. Because interest rates are what we use to calculate the present value of their future cash flows, and so to make capital allocation decisions.

 

As always, I am the pessimist here… but it really seems to me that our economic system right now resembles a person who contracted AIDS… with very weak or completely suppressed immune abilities… Until you don’t get a cold, everything will work out just fine. But, as soon as you get a cold (and eventually you will), a crisis will unfold…

Let’s hope I am dead wrong! Anyway, we have to deal with risks, not certainties.

 

giofranchi

What_Will_Happen_When_We_Hit_the_Cliff.pdf

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Sin comes first, always. If we suffered before we sinned, we wouldn’t sin. If the pleasure and pain of monetary overstimulation were coterminous, there would be no inflation, no fast-climbing public debt and no exploding asset bubbles. The cost of over-cranking the presses would be just as obvious, and just as immediate, as the thrill induced by the monetary pick-me-up. As it is, the pleasure is immediate, the pain prospective.

 

Looking back at today’s ultra-low interest rates, investors will think of the fable of the boiled frog and belatedly realize that they were the duped amphibians.

- James Grant, via The View from the Blue Ridge

 

giofranchi

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Basel III will do much of this for him.

 

Get too big & you get designated a Globally Systemic Important Bank.  A G-SIB is defined as a financial institution whose distress or disorderly failure, because of its size, complexity and systemic inter-connectedness, would cause significant disruption to the wider financial system and economic activity. Their are similar designations (D-SIB) in play at the sovereign level as well. The penalty is the requirement to put up more capital than your competitors, which lowers your RAROC, & makes you a less attractive investment. As most would prefer to spin off the riskier portions of their bank to avoid the G-SIB designation - the result is a global financial system a little easier to manage.

 

Not touted is that if you seek the G-SIB as a business strategy, your bank becomes a fortress - & significantly less risky than your competitors. Future, lower, earnings discount at a lower rate - but you end up trading higher than your competitors as the global environment gets increasingly risky. Rather than pay the German government to take your money (bundt purchases), you buy the G-SIB's paper & get paid instead. The G-SIB gets access to almost unlimited funding, and at a cost slightly above the GLOBAL central bank rate.

 

Also not touted is that if you spin off too much, the stub business could end up with a D-SIB designation. Significantly reduces the systemic risk in the domestic economy, but reduces the earnings of those with D-SIB designations.   

 

Fits nicely within the SML construct but is not what an I-Banker wants to hear - as it systematically lowers earnings & sucks the glamour out of the business. An I-Bankers comp is based in part on their glamour client earning as much as possible, & the bankers access to those glamour 'names'. Stodgy bank, & a higher cost of funds for his glamour clients, is not high on the list - hence the resistance.

 

SD 

 

 

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I've been a little puzzled by Basel 2.5 and 3. It doesn't seem to solve the weakest link problem to me, but has added huge additional costs to the financial system. Based on my understanding, all the calculations focus on first order exposures and say nothing about exposures between counterparties. So an individual Bank's exposure numbers assumes that the rest of the cast of characters behave themselves, and of course the small detail of whether the calculations are up to the task of managing even the first order risks. So to me, it seems a big presumption that if everyone individually manages exposures with these IMM models, then the system as a whole will be okay. I think it's important to note too, that probably all the models are basically the same, and use very similar data - so they may all have the same blindspot(s) that folks are currently unaware of (but will be fixed in Basel 4). The Fed or other regulators must try to amalgamate this data somehow; I’d be interested to know how they use it.

 

It’s easy to knock the method, but of course harder to come up with alternatives. Probably the Fed etc already do this, but I’d be more inclined to run a dozen or so much simpler jump-to-default type scenarios to get the top-of-the-house look.

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The weak links are actually very well known, it is just that Basel III is unevenly implemented across the various nations as it is does not carry force of law. Each national regulator has to codify the Basel principles into their own banking regulation ... & some think they are special (US). 

 

Implementation is also problematic.

 

Imagine Switzerland without UBS, Germany without Deutsche Bank, England without Barclays, .... the US without maybe CitiBank & BoA. Regulators essentially have to let them make enough to pay the multi BILLION dollar fines for their prior wrong-doing .... because if they did not ... the fine would drain so much of their capital that it would trigger the banks collapse.

 

Basel liquidity standards were postponed for 2 years on Jan 06. If they had gone through ... some of the above would have had to either almost double their equity in < 12 months, or call in almost every workout loan on their books. Most of the money raised would also have gone to maybe 3 country's, & their negative 'risk free' yields would have risen quite a bit. If you want to kneecap a recovery .....

 

Most nations require authorities to initiate prosecution within a set time period, otherwise the authority is deemed to have agreed with the practice. Notice that LIBOR prosecutions were fines for wrong-doing ... the redressment of client interest over/under payments was skipped over ... & it appears that some prominent European central banks were trying to run out the clock on prosecution. Maybe why they have a new central banker?

 

Most European banks are also extremely weak, at around only 20-25% of the financial strength of the typical Canadian Sched-A. They are very limited in what they can absorb.

 

The good news is that the payments indicate progress, & nobody else blew up is what has been very trying circumstance. Once the banking system has strengthened sufficiently, the scores will be settled, & many a bank head will be persuasively shown the wall - or a graceful retirement by date XX.

 

SD

 

 

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Richard W. Fisher (Federal Reserve Bank of Dallas) on ending "too big to fail".

 

giofranchi

 

This is a pretty good read. A breakup of the Banks could potentially be quite good for shareholders (he sort of implies a breakup, but I guess doesn't say this quite so explicitly). If my memory is right, Rockefeller didn't get really really rich (in the marketable sense) until Standard Oil was broken up by regulators. Maybe the dynamic of the Banking industry would be different though, depending on how many supposed synergies/economies of scale truly exist.

 

It's interesting in my view that even Fisher, who is apparently outspoken, doesn't touch executive compensation. I think adjustments to this could be more effective than, or at least compliment, incentives from "removing" federal support for shadow banking activities.

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