Submitted by Peter Tchir of TF Market Advisors,

Volcker Rule – Who cares?  I know we are supposed to care more about this convoluted rule, but we just can’t.

The concept that somehow “prop” trading brought down the banks seems silly.  The idea that market making desks were a dangerous part of the equation is ludicrous.

They could have fixed this with a few simple changes, but that would have meant some blame would have had to be shifted onto the regulators…

The inability of regulators to communicate and create consistent rules had more of an impact than anything else.  The single biggest problem was that the insurance rules and bank rules did not line up.  Banks could load up on AAA tranches of ABS CDO’s (including sub-prime) and buy protection for companies that could never hope to pay it off if it went wrong and attract almost no regulatory capital.  The entity that sold it would run some actuarial models and also have no regulatory capital.  At some point the regulators allowed some AAA risk, which should have attracted significant capital, to attract none.  Making the insurance regulators and bank regulators communicate and close loopholes would be a simpler and more effective solution than Volcker.

The rest could be fixed by a few simple hires.

First, hire a junior person from the risk management side of any mediocre hedge fund.  They would immediately want to put in place some limits on gross notionals.  Yes, hedging and relative value is potentially profitable, but you still want to limit the size.  That would reduce curve trades, the unnecessary proliferation of back to back derivative trades, etc.  It would help ensure that the “worst case” isn’t so bad or so convoluted that investors get too nervous.

 

Second, hire a junior level accountant.  They could quickly realize that when some massive percentage of the P&L is driven by model risk (correlation trading for example) you should be nervous.  Limit the amount of risk offset that can be derived from models and do the same with P&L.  It is great that banks can use their models for capital requirements and to a large degree it makes sense, but models are notoriously wrong – sometimes by accident, sometimes because no one knows better, and sometimes on purpose.  Don’t eliminate the use of models, but keep it to a size that is reasonable.

 

Third, hire someone from the IRS.  Make a “progressive” capital system.  Charge more as the size of a position increases.  Owning $25 million, $100 million and $250 million of the bond is not usually linear.  In most cases owning $250 million is more than 10 times riskier than owning just $25 million.  This applies to individual holdings and a portfolio.  Too big to fail would yelp but that is the reality and would be much simpler than what we got.

 

Fourth, hire a retired mid-level commercial banker from the 80’s.  They can remind everyone that lending is risky and that banks have blown up in the past based on dumb loans, no mark to market accounting, and inadequate reserves.  Banks don’t need these newfangled inventions to blow themselves up – they were capable of blowing themselves up in the exact sort of environment Volcker seems intent on dragging them back into.

 

Five, fire 1,250 lawyers.  The ratio of lawyers to people who know their way around trading or risk is absurd.

In the end, banks are taking less risk because they don’t want to.  If and when they want to, they can probably find a way.  The Volcker rule is overly complex.  Banks will shy away from activities for now.  That is probably bad for bank stocks at the margin but remains good for bank credit as tail risk is pushed off (at least until they get bloated on bad loans, but that is years away).

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Introduction

I don’t have an official definition of a market bubble, but we can probably all agree on this: stock prices are currently divergent not only from the economy but from the underlying market fundamentals. So if you think the current stock run is justified, then you likely believe that stocks are forecasting better growth in the economy or market fundamentals (i.e., earnings) will improve or that there will be some catalyst that justifies the price ramp. The best and most easily identifiable catalyst has been Federal Reserve largesse, and this has done little for the economy. In addition, market intervention has distorted normal market signals. Federal Reserve policy doesn’t improve investment in the real economy but rather diverts investment capital away from the economy and into risky assets. Like so many things about the years since the financial crisis, it creates the illusion of wealth without a sound underpinning. I have no doubt that keeping interest rates artificially low has a positive effect on those sectors of the economy that are interest rate sensitive, but all this does is pull demand forward like the “cash for clunkers” program. Is there demand for homes because wages and salaries are growing or because interest rates are a great deal? I would argue that it is the latter. It just doesn’t seem intuitively correct that you can print your way to prosperity.

Continue reading “Weekly Sentiment Report: The Biggest Bubble”

Back in September, courtesy of an unprecedented discrepancy between the JOLTS “net turnovers” (or hires less separations) print, which traditionally has been the equivalent of the NFP’s establishment survey monthly job additions, we highlighted just what happens when the BLS has caught itself in a estimation lie, and is forced to adjusted the data set both concurrently and retroactively to correct for cumulative error.

We suggested that as a result of this public humiliation, the BLS would have no choice but to ramp up its monthly net turnovers print in order to “catch up” to what the monthly payrolls survey indicated is America’s “improving” jobs picture.

Sure enough, when moments ago the latest October JOLTS survey was released, the October “net turnovers” number soared from 155K in September to a whopping 260K in October, more than eclipsing the revised NFP print of 200K job gains in October, and leading to the second highest JOLTS turnover print since February’s 271K, and before that – going back all the way to the 287K in February of 2012. And yes, this was in the month when the government had shut down and the result was supposedly major, if temporary, job losses.

Today’s number also means that the YTD monthly average job gain based on either the payroll data or the JOLTS survey has declined to just 24K (160K for JOLTS, 184K for NFP), the lowest average difference in 2013.

Finally, this is how the difference between the two time series on a monthly snapshost basis looks:

Why is any of this important? Because to Janet Yellen, the JOLTS survey has traditionally been an important secondary metric for the jobs market, and judging by the huge jump in implied job gains, if indeed the Fed was in a tapering mood, the December FOMC meeting looks increasingly like the day when a Taper may be announced. Of course, that ignores how a very illiquid market would react, and is perhaps the reason why December’s final, massive double POMO is on the day just after the FOMC announcement.

 

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We can only imagine the upward revisions to GDP that will occur due to the largest mal-investment-driven wholesale inventory build in over 2 years. The 1.4% MoM gain is over 4x the expectation and biggest beat since Q4 2011, when – just as now – a mid-year plunge was met by a rabid over-stocking only to see the crumble back into mid 2012. As we noted previously, 56% of economic "growth" this year was inventory accumulation (cough auto channel stuffing cough) and this print merely confirms "hollow growth" continues.

 

 

 

As we noted previously,

So how does inventory hoarding – that most hollow of "growth" components as it relies on future purchases by a consumer who has increasingly less purchasing power – look like historically? The chart below shows the quarterly change in the revised GDP series broken down by Inventory (yellow) and all other non-Inventory components comprising GDP (blue).

But where the scramble to accumulate inventory in hopes that it will be sold, profitably, sooner or later to buyers either domestic or foreign, is seen most vividly, is in the data from the past 4 quarters, or the trailing year starting in Q3 2012 and ending with the just released revised Q3 2013 number. The result is that of the $534 billion rise in nominal GDP in the past year, a whopping 56% of this is due to nothing else but inventory hoarding.

 

The problem with inventory hoarding, however, is that at some point it will have to be "unhoarded." Which is why expect many downward revisions to future GDP as this inventory overhang has to be destocked.

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We can only imagine the upward revisions to GDP that will occur due to the largest mal-investment-driven wholesale inventory build in over 2 years. The 1.4% MoM gain is over 4x the expectation and biggest beat since Q4 2011, when – just as now – a mid-year plunge was met by a rabid over-stocking only to see the crumble back into mid 2012. As we noted previously, 56% of economic "growth" this year was inventory accumulation (cough auto channel stuffing cough) and this print merely confirms "hollow growth" continues.

 

 

 

As we noted previously,

So how does inventory hoarding – that most hollow of "growth" components as it relies on future purchases by a consumer who has increasingly less purchasing power – look like historically? The chart below shows the quarterly change in the revised GDP series broken down by Inventory (yellow) and all other non-Inventory components comprising GDP (blue).

But where the scramble to accumulate inventory in hopes that it will be sold, profitably, sooner or later to buyers either domestic or foreign, is seen most vividly, is in the data from the past 4 quarters, or the trailing year starting in Q3 2012 and ending with the just released revised Q3 2013 number. The result is that of the $534 billion rise in nominal GDP in the past year, a whopping 56% of this is due to nothing else but inventory hoarding.

 

The problem with inventory hoarding, however, is that at some point it will have to be "unhoarded." Which is why expect many downward revisions to future GDP as this inventory overhang has to be destocked.

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And so it is done (as we detailed here)… and due to be put in place as of April1st 2014 (rather ironically). The 100-plus-pages of rules and regulations prohibit two activities of banking entities: (i) engaging in proprietary trading; and (ii) owning, sponsoring, or having certain relationships with a hedge fund or private equity fund. But the kicker…

requires banking entities to establish an internal compliance program designed to help ensure and monitor compliance with the prohibitions and restrictions of the statute and the final rule.

Great! Because self-regulation worked so well in the past for the financial services industry.

Via Reuters,

• FEDERAL RESERVE EXTENDS VOLCKER RULE COMPLIANCE PERIOD TO JULY 2015 FROM JULY 2014 – FINAL VOLCKER RULE DOCUMENT
• RULE WOULD ALLOW HEDGING ACTIVITY THAT MITIGATES "SPECIFIC, IDENTIFIABLE RISKS OF INDIVIDUAL OR AGGREGATED POSITIONS" HELD BY THE BANK – REGULATORS
• BANKS COULD ENGAGE IN PROPRIETARY TRADING OF US GOVERNMENT DEBT AND, IN MORE LIMITED CIRCUMSTANCES, FOREIGN OBLIGATIONS UNDER VOLCKER RULE
• VOLCKER RULE ALSO BANS BANKS FROM OWNING AND SPONSORING "COVERED" HEDGE FUNDS AND PRIVATE EQUITY FUNDS – REGULATORS
• REGULATORS SAY FINAL RULE DEFINES "COVERED FUNDS" MORE NARROWLY THAN PROPOSAL WITH REGARD TO FOREIGN FUNDS AND COMMODITY POOLS
• U.S. REGULATORS SAY MOST COMMUNITY BANKS HAVE LITTLE OR NO INVOLVEMENT IN PROHIBITED ACTIVITIES, WOULD NOT HAVE TO COMPLY WITH RULES

 

Who will be most affected?

 

Some excellent color from Bloomberg,

Merriam-Webster’s Dictionary defines “speculation” in 31 words. The key ones are “risk of a large loss.” When Paul Volcker, the former U.S. Federal Reserve chairman, proposed banning speculation by federally insured banks to reduce risk to the world economy, he did it in one paragraph. Four years later, the nation’s regulators are poised to vote on Volcker’s proposal. The rule now runs close to 100 pages, with hundreds more in supporting material — and no one is quite sure how it would be enforced. It’s a lesson in how complicated simplifying Wall Street can be.

 

The Situation

 

The idea became law in the Dodd-Frank reforms of 2010, but turning it into regulations has been slowed by a lobbying onslaught. Already many banks have shut down or spun off the desks they used for trading that was clearly solely for their own account, what’s known as proprietary trading. Banks do other kinds of trading that can also make them money, or loses it: Some of the trades are to help clients, and others are to reduce the risks of their own lending or trading. Figuring out which trades fall into which category isn’t always easy, and deciding how much risk is too much for which kind of transaction may be even harder. On these issues, how regulators decide to enforce the rules may be as important as the rules themselves, particularly as responsibility will be split between five agencies set to announce the final rule on Tuesday. They have very different agendas: Some are primarily concerned with keeping markets working smoothly, while others worry mostly about keeping banks from blowing themselves up.

 

The Background

 

After the Great Depression, Congress created federal deposit insurance to prevent runs at commercial banks. In return, the banks had to concentrate on making loans and leave the fancy stuff to investment banks. That dividing line blurred in the ’90s and was erased entirely in 1999 when the Glass-Steagall Act was repealed at the behest of banks like Citigroup that promptly grew big trading operations. The financial crisis of 2008 had its seeds in bad mortgages, but what brought banks to the brink, Volcker noted when he proposed his idea, wasn’t bad loans but the exotic trades they had made around them. The six largest U.S. banks made $15.6 billion in trading profits during 13 of the 18 quarters that spanned mid-2006 to 2010. They racked up bigger losses during the five remaining quarters when their bets turned sour. Even after the meltdown and unpopular taxpayer bailouts, taking a step back toward Glass-Steagall met Wall Street resistance. That’s why when President Barack Obama adopted the idea he wrapped it in Volcker’s name, in the hope that the towering stature of the man who tamed 1970s inflation would lend it greater weight.

 

The Argument

 

Banks continue to insist that it’s impossible to distinguish between prop trades and what banks call market making — the steady stream of buying, selling and holding they do so their customers can always buy what they want to buy and sell what they want to sell. Jamie Dimon, the chief executive officer of JPMorgan Chase, said that every trader would need a psychologist and a lawyer by his side to make sure he wasn’t breaking the rule. Some regulators have grown wary of trades banks say they’re making to offset specific risks since JPMorgan Chase’s $6 billion London Whale losses, which Senate investigators saw as closer to gambling than to hedging the bank’s other bets. Volcker has said the rule could accommodate both kinds of trades and still stay fairly simple. “It’s like pornography,” Volcker said of prop trades. “You know it when you see it.”  Instead of blanket bans, however, regulators sought to define each situation and carve out a string of exemptions, which is how the rule grew and grew. A small but growing number of bipartisan voices in Washington say they may push for a more radical simplification — bringing back Glass-Steagall.

 

Volcker Main

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And so it is done (as we detailed here)… and due to be put in place as of April1st 2014 (rather ironically). The 100-plus-pages of rules and regulations prohibit two activities of banking entities: (i) engaging in proprietary trading; and (ii) owning, sponsoring, or having certain relationships with a hedge fund or private equity fund. But the kicker…

requires banking entities to establish an internal compliance program designed to help ensure and monitor compliance with the prohibitions and restrictions of the statute and the final rule.

Great! Because self-regulation worked so well in the past for the financial services industry.

Via Reuters,

• FEDERAL RESERVE EXTENDS VOLCKER RULE COMPLIANCE PERIOD TO JULY 2015 FROM JULY 2014 – FINAL VOLCKER RULE DOCUMENT
• RULE WOULD ALLOW HEDGING ACTIVITY THAT MITIGATES "SPECIFIC, IDENTIFIABLE RISKS OF INDIVIDUAL OR AGGREGATED POSITIONS" HELD BY THE BANK – REGULATORS
• BANKS COULD ENGAGE IN PROPRIETARY TRADING OF US GOVERNMENT DEBT AND, IN MORE LIMITED CIRCUMSTANCES, FOREIGN OBLIGATIONS UNDER VOLCKER RULE
• VOLCKER RULE ALSO BANS BANKS FROM OWNING AND SPONSORING "COVERED" HEDGE FUNDS AND PRIVATE EQUITY FUNDS – REGULATORS
• REGULATORS SAY FINAL RULE DEFINES "COVERED FUNDS" MORE NARROWLY THAN PROPOSAL WITH REGARD TO FOREIGN FUNDS AND COMMODITY POOLS
• U.S. REGULATORS SAY MOST COMMUNITY BANKS HAVE LITTLE OR NO INVOLVEMENT IN PROHIBITED ACTIVITIES, WOULD NOT HAVE TO COMPLY WITH RULES

 

Who will be most affected?

 

Some excellent color from Bloomberg,

Merriam-Webster’s Dictionary defines “speculation” in 31 words. The key ones are “risk of a large loss.” When Paul Volcker, the former U.S. Federal Reserve chairman, proposed banning speculation by federally insured banks to reduce risk to the world economy, he did it in one paragraph. Four years later, the nation’s regulators are poised to vote on Volcker’s proposal. The rule now runs close to 100 pages, with hundreds more in supporting material — and no one is quite sure how it would be enforced. It’s a lesson in how complicated simplifying Wall Street can be.

 

The Situation

 

The idea became law in the Dodd-Frank reforms of 2010, but turning it into regulations has been slowed by a lobbying onslaught. Already many banks have shut down or spun off the desks they used for trading that was clearly solely for their own account, what’s known as proprietary trading. Banks do other kinds of trading that can also make them money, or loses it: Some of the trades are to help clients, and others are to reduce the risks of their own lending or trading. Figuring out which trades fall into which category isn’t always easy, and deciding how much risk is too much for which kind of transaction may be even harder. On these issues, how regulators decide to enforce the rules may be as important as the rules themselves, particularly as responsibility will be split between five agencies set to announce the final rule on Tuesday. They have very different agendas: Some are primarily concerned with keeping markets working smoothly, while others worry mostly about keeping banks from blowing themselves up.

 

The Background

 

After the Great Depression, Congress created federal deposit insurance to prevent runs at commercial banks. In return, the banks had to concentrate on making loans and leave the fancy stuff to investment banks. That dividing line blurred in the ’90s and was erased entirely in 1999 when the Glass-Steagall Act was repealed at the behest of banks like Citigroup that promptly grew big trading operations. The financial crisis of 2008 had its seeds in bad mortgages, but what brought banks to the brink, Volcker noted when he proposed his idea, wasn’t bad loans but the exotic trades they had made around them. The six largest U.S. banks made $15.6 billion in trading profits during 13 of the 18 quarters that spanned mid-2006 to 2010. They racked up bigger losses during the five remaining quarters when their bets turned sour. Even after the meltdown and unpopular taxpayer bailouts, taking a step back toward Glass-Steagall met Wall Street resistance. That’s why when President Barack Obama adopted the idea he wrapped it in Volcker’s name, in the hope that the towering stature of the man who tamed 1970s inflation would lend it greater weight.

 

The Argument

 

Banks continue to insist that it’s impossible to distinguish between prop trades and what banks call market making — the steady stream of buying, selling and holding they do so their customers can always buy what they want to buy and sell what they want to sell. Jamie Dimon, the chief executive officer of JPMorgan Chase, said that every trader would need a psychologist and a lawyer by his side to make sure he wasn’t breaking the rule. Some regulators have grown wary of trades banks say they’re making to offset specific risks since JPMorgan Chase’s $6 billion London Whale losses, which Senate investigators saw as closer to gambling than to hedging the bank’s other bets. Volcker has said the rule could accommodate both kinds of trades and still stay fairly simple. “It’s like pornography,” Volcker said of prop trades. “You know it when you see it.”  Instead of blanket bans, however, regulators sought to define each situation and carve out a string of exemptions, which is how the rule grew and grew. A small but growing number of bipartisan voices in Washington say they may push for a more radical simplification — bringing back Glass-Steagall.

 

Volcker Main

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Despite the ratings agencies (Moody’s Dec 5th and S&P Nov 22nd) seemingly premature raising of the outlook for the nation’s sovereign credit rating (from negative to stable), economic hardship in Spain looks likely to continue as loan defaults surge and the unemployment rate remains the second highest in the EU.

 

25% of Working Population to Stay Unemployed

The IMF predicts Spain’s unemployment rate will remain at 25 percent or higher until 2018 even after the nation exited its recession in the third quarter. Spanish households’ average income fell to 23,123 euros per year in 2012, compared with 25,556 euros in 2008, the National Statistics Institute said on Nov. 20. That leaves 22.2 percent of the population at risk of poverty, according to Eurostat.

Bad Debts at Record High

Record bad loans may restrain the economic recovery. Spanish banks’ bad debt as a proportion of total lending rose to a record 12.68 percent in September, according to Bank of Spain data that began in 1962. Missed payments on mortgages are rising and defaults as a proportion of total mortgages jumped to 5.2 percent in the second quarter from 3.2 percent a year earlier.

House Prices May Fall Further

Banks are likely to remain under pressure as real estate values fall. House prices are down 28.2 percent from their peak. Fewer than 15,000 mortgages were granted in September, compared with about 129,000 at the September 2005 peak, according to the National Statistics Institute, pointing to more price declines. House prices may drop a further 13 percent by the end of 2014, S&P forecasts.

Corruption Levels Rise Most in Europe

Spain’s levels of perceived corruption rose the most in Europe last year, Transparency International’s annual rankings show. Spain fell six points to 59, ranking it 40th in the world. Only Syria fell by more. The so-called gray economy represents 18.6 percent of GDP according to analysis by Friedrich Schneider for the Institute of Economic Affairs. That is equivalent to about 183 billion euros.

But apart from that… it’s all good in Spain…

 

Source: Bloomberg Briefs

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