iftttwall

There’s a skeleton in everybody’s closet

I can think of one or two in my own room

But I would like to introduce them both to you

You’d shake their bony hands and so dispell the gloom

 

“The Ghosts That Haunt Me”

Brad Roberts/Crash Test Dummies (1991)

Once again it is time for the Federal Reserve stress tests for major US banks, which were released last week.  This exercise is not so much about financial stability, to borrow the title of my new upcoming book, as it is about “confidence.”  The Fed stress tests are mandated by the ill-considered “Dodd-Frank Wall Street Reform Act” or “DFA,” which is of course not about reform so much as about screwing up the US economy.  To get a sense for what  the DFA, as the Fed calls it, is doing to housing, have a look at my presentation to the Five Star Institute tomorrow.

http://tinyurl.com/lw2oxdw

The first hint of problems with the stress tests is the fact that the Fed is focused on capital instead of issues like transparency and fraud.  For those of you who were in cryogenic sleep during the 2008 financial crisis, the market breakdown was caused by securities fraud rather than a lack of capital.  As I discussed in Breitbart last week, “Washington & Wall Street–Memo to GOP: Fed Losses Are Good News.”

http://tinyurl.com/l837wlx

First and foremost, let’s talk about why the Fed has been buying hundreds of billions of dollars’ worth of Treasury paper and MBS for the past several years. Back in 2008, when the subprime crisis exploded into the consciousness of global investors, the markets suddenly realized that the U.S. balance sheet was out of balance to the tune of tens of trillions of dollars. Toxic subprime paper created by the monopoly of big banks and government-sponsored entities such as Fannie Mae and Freddie Mac, and hidden via “off balance sheet” fraud, suddenly came rushing back into view and onto the balance sheets of U.S. banks. 

Horrified investors fled the market for Treasury securities and MBS. Eventually, Fannie, Freddie, AIG, and, ultimately, Citigroup had to be rescued by the U.S. Treasury. The serious imbalance between assets and liabilities was illustrated by then-Treasury Secretary Hank Paulson, who famously announced in 2008 that Citigroup was insolvent and that we needed a “Super SIV” scheme to buy the toxic assets from the largest banks, including Citi, JPMorgan, and Bank of America.  

It was the fact of some $60 plus trillion in hidden, fraudulent toxic waste that nearly crated the global economy.  Capital in US banks had nothing to do with it.  Now that the FASB has essentially outlawed most (but not all) off-balance sheet games, the banks are earnings and revenue constrained.  The DFA restrictions on housing finance are a big part of why large bank earnings are going to be an ongoing disappointment.

The second clue that the DFA stress tests are a bad joke is the continued insistence by the Fed on using three macroeconomic scenarios to define the test process.  Anyone even vaguely familiar with financial analysis understands that you don’t need an economic narrative or an economist for that matter to stress test a financial institution.  You start with loss assumptions, examine capital, earnings and liquidity, and then assess the loss absorption potential of a given institution.  

The participating banks have noted in public comments on the DFA stress tests that the Fed and other agencies “do not have a strong record of identifying emerging risks in the past, and that the scenario variables were not sufficiently plausible to be useful as a risk management tool.”  These comments are well founded and illustrate the silly nature of this exercise.  The fact that the Fed has required bank management to spend time on this idiocy while closing year-end financial statements is just another piece of evidence that nobody at the Fed is living in the real world.

Another clue that the Fed stress tests are not to be taken seriously is the dependence upon risk modelling, a requirement that is designed to provide employment to economists, lawyers and risk managers.  Not only do the banks need to spend time and money modeling meaningless macroeconomic scenarios, but they are also meant to include “regional variables” in the analysis.  Since the “the paths of any additional regional or local variables that a company used would be expected to be consistent with the path of the national variables in the supervisory scenarios,” this whole process is ridiculous.  But, again, investors in large banks should bear in mind that this process is about “confidence,” not the ability to absorb loss.

The final indicator that the DFA stress tests are not to be taken seriously is that the inmates – that is, the large banks – are still being allowed by regulators to select the loss variables for the test.  Indeed, the stress tests manage to ignore truly relevant real world risks while pandering to the management of the largest banks.  

For example, a real world test would be to ask the top five banks to stress tests a 50% write down of all second lien exposures on 1-4 family mortgages over a 24 month period. Since the major rating agencies have already identified second liens as the next “surprise” for the big banks, you would think the good people at the Fed would be asking that question.  But no, the stress tests instead allow the participating banks to each select their own stress tests factors, thereby assuring that the tests will have no consistency or comparability from one bank to the next. 

Another area of stress that the Fed seems happy to ignore is interest rates,  a factor that is a direct result of quantitative easing or “QE.”  The US banking industry faces trillions of dollars’ worth of duration risk due to the Fed’s aggressive manipulation of interest rates over the past several years.  The baseline, adverse and severely adverse scenarios in the DFA stress tests do not begin to address this concern, but at least the regulators have asked the banks to structure their thinking accordingly.

Whether US banks are able to accurately model their interest rates risk as part of the DFA stress tests is not really a relevant question since the banks are probably no better at this sort of risk modeling than the regulators.  The relevant question is why neither the Fed nor their sponsors on Capitol Hill admit that the continued fiscal dissolution of the US government is the chief source of risk to the US economy.

It may not matter whether the Federal Reserve System loses money as a result of a gradual change in interest rates over the next year and more.  But you can be sure that the US equity markets are going to react – and probably soar – when the crowd of happy campers now packed tightly into the crowded trade in bonds starts to head for the exit. Concepts like option adjusted duration may even be heard again as banks manage the largest shift in interest rate risk seen the “sucker bond” trades of the 1990s.  Does Askin Capital Management or Kidder Peabody ring any bells?

But you can be sure that you won’t hear about second liens, interest rate risk or anything else of this nature before the fact from our beloved friends at the Federal Reserve Board. Remember, the definition of “systemic risk” is when markets are surprised.  But this reality, despite past experience,  does not seem to affect the thinking of the members of the Federal Open Market Committee, where ignorance is truly bliss.

via Zero Hedge http://ift.tt/1h0ulaO rcwhalen

HSBC's Flash China Manufacturing PMI printed at 48.1 (against a hope-strewn 48.7 bounce expectation). This is the lowest in 8 months and among the lowest prints since Lehman. Even the usually silver-lining-seeing HSBC Chief economist had little positive to add, "weakness is broad-based with domestic demand softening further." Early strength in CNY, stocks, and copper is eroding fast.

 

 

Copper was holding in early but is fading fast now…

 

The Yuan rallied out of the gate on a modestly higher fixing but is fading back fast post PMI…

 

And for everyone hoping that bad news is good news and stimulus is coming…

*CHINA MUST FACE `MORAL HAZARD' ISSUE, VICE MINISTER SAYS: CNBC

 

via Zero Hedge http://ift.tt/1dgrOd3 Tyler Durden

Having discussed the links between economic growth and energy resource constraints, and with the current geo-political fireworks as much about energy (costs, supply, and demand) as they are human rights, it would appear the following chart may well become the most-important indicator of future tensions…

 

Source: Goldman Sachs

This is not the first time we have discussed "self-sufficiency" – As none other than Bridgewater's Ray Dalio noted in a slightly different context:

"self-sufficiency encourages productivity by tying the ability to spend to the need to produce,"

 

"Societies in which individuals are more responsible for themselves grow more than those in which they are less responsible for themselves." The nine-factor gauge of self-sufficiency provides some interesting insights into those nations most likely to experience above-average growth going-forward and those that are not; as European countries, notably Italy, France, Spain, and Belgium, all ranking at the very bottom on self-sufficiency.

And here we discussed, What If Nations Were Less Dependent On One Another?

The ability to survive without trade or aid from other nations, for example, is not the same as the ability to reap enormous profits or grow one’s economy without trade with other nations. In other words, 'self-sufficiency' in terms of survival does not necessarily imply prosperity, but it does imply freedom of action without dependency on foreign approval, capital, resources, and expertise.

 

Freedom of action provided by independence/autarky also implies a pivotal reduction in vulnerability to foreign control of the cost and/or availability of essentials such as food and energy, and the resulting power of providers to blackmail or influence national priorities and policies.

 

…

 

Consider petroleum/fossil fuels as an example. Nations blessed with large reserves of fossil fuels are self-sufficient in terms of their own consumption, but the value of their resources on the international market generally leads to dependence on exports of oil/gas to fund the government, political elites, and general welfare. This dependence on the revenues derived from exporting oil/gas leads to what is known as the resource curse: The rest of the oil-exporting nation’s economy withers as capital and political favoritism concentrate on the revenues of exporting oil, and this distortion of the political order leads to cronyism, corruption, and misallocation of national wealth on a scale so vast that nations suffering from an abundance of marketable resources often decline into poverty and instability.

 

The other path to autarky is selecting and funding policies designed to directly increase self-sufficiency. One example might be Germany’s pursuit of alternative energy via state policies such as subsidies.

 

That policy-driven autarky requires trade-offs is apparent in Germany’s relative success in growing alternative energy production; the subsidies that have incentivized alternative energy production are now seen as costing more than the presumed gain in self-sufficiency, as fossil-fueled power generation is still needed as backup for fluctuating alt-energy production.

 

Though dependence on foreign energy has been lowered, Germany remains entirely dependent on its foreign energy suppliers, and as costs of that energy rise, Germany’s position as a competitive industrial powerhouse is being threatened: Industrial production is moving out of Germany to locales with lower energy costs, including the U.S.

 

The increase in domestic energy production was intended to reduce the vulnerability implicit in dependence on foreign energy providers, yet the increase in domestic energy production has not yet reached the critical threshold where vulnerability to price shocks has been significantly reduced.

 

…

 

America’s ability to project power and maintain its freedom of action both presume a network of diplomatic, military, and economic alliances and trading relationships which have (not coincidentally) fueled American corporation’s unprecedented profits.

 

The recent past has created an assumption that the U.S. can only prosper if it imports oil, goods, and services on a vast scale.

via Zero Hedge http://ift.tt/NI4s3T Tyler Durden

via Zero Hedge http://ift.tt/1f8inb4 williambanzai7

Submitted by Wei Zongyou via The Diplomat,

People around the world were astounded by Vladimir Putin’s rapid decision to annex Crimea in response to the latter’s referendum to secede from Ukraine and join Russia, which Kiev and the West view as illegal. The decision also drew worldwide criticism and vehement condemnation by the West and Ukraine, and triggered a second wave of economic sanctions from the United States, and soon afterwards Europe. Relations between Russia and the West are at their chilliest since the end of the Cold War.

So why has Putin risked Russia’s economic welfare and political space to swallow Crimea, push Ukraine out, and alienate the entire Western world? Is Putin “in another world” as German Chancellor Angela Merkel claimed he is? In my opinion, there are at least two considerations behind Putin’s decision.

The first is the realist, geo-political consideration. In Putin’s world, since the collapse of the former Soviet Union, Russia has lost nearly one fourth of its geography, one half of its population, and more than half of its GDP. Among the “lost” territories are those that are strategically important or militarily advanced, such as Ukraine and the Baltic states. With the eastward expansion of NATO, and the integration of former Soviet satellite states and republics in Eastern Europe and the Baltics into Europe, the traditional buffer zone between Russia and the West is increasingly squeezed and Russia’s space for strategic maneuvering becomes smaller with each year. When Russia craved for entry into the West, this might not have been particularly worrisome or embarrassing for Moscow. But since Russian leaders decided long ago that joining the West was neither particularly helpful to Russia’s political standing nor particularly attractive in terms of economic gains, it has begun to view the expansion of the West at its own strategic expense as both ill-intentioned and threatening.

Ukraine holds a unique position in Russia’s geo-strategic consideration. First, it is crucial territory in the passage of Russia’s oil exports to Europe. Each year more than one third of the oil Russia ships to Europe travels via the Ukraine pipeline. Second, Crimea gives Russia’s Black Sea Fleet access to the Black Sea. If the pro-West Kiev government were to have decided to end its lease to the Russian naval base in Crimea, Russia would have lost its strategic gateway to the Black Sea and the Mediterranean Sea. Third, Ukraine is deemed the most crucial member of Russia’s Eurasia Union project, an economic and strategic plan to closely connect Russia, Belarus, Ukraine, and Central Asia. If all goes according to plan, this union will integrate these former Soviet republics and now independent countries economically, politically, and diplomatically with Russia, and go some way to restoring the glory of the Soviet empire at its peak. The “coup d’état” in Kiev and the political orientation of the new government put all these things in jeopardy, if Russia remains disinterested and passive.

The second consideration is more psychological in nature. Following the end of Cold War, embracing the West was the first priority of Russian foreign policy. But to Moscow’s dismay, it found that the West still harbored strong reservations and considerable distrust. Years spent courting and wooing provided little of what Russia craved most: equal membership in the West and economic prosperity. Though Russia became part of the exclusive G8, it never enjoyed the full status and say of the other seven members, always remaining an “other.” Economically, the shock remedy proposed by the West and faithfully implemented by Boris Yeltsin didn’t bring the expected economic benefit. Instead, it took Russia’s economy into freefall, leaving the average Russian worse off than before. Russia’s look West ended in humiliation and disaster.

It was Putin who saved Russia from its miserable condition. He readjusted both Russia’s domestic and foreign policies, and distanced the country from the West, instead seeking opportunities to resurrect past Soviet glories. As the Russian economy improved, the West found that its time was passing. The 2008 economic crisis hit the U.S. and Europe hard and they found themselves more reliant on the emerging powers, Russia included. It is Britain, France, and even Germany who are now busy appealing to Russian oil bacons to buy more and invest more. The balance of power between Russia and the West has shifted. The small war in Georgia in the summer of 2008 only strengthened this trend and the response from the West impressed Russia greatly: Europe is rotten and the U.S. has become too weak to lead. Then came the Arab Spring and the Syria crisis. In the former case, the U.S. “led from behind,” and in the latter it was Russia that decided the course of the Syria civil war.

Russians, and especially Putin learned a hard lesson from the post-Cold War romance with the West: For all the talk of democracy and freedom, the fact remains that the strong dictate to the weak.

With Europe rotten and United States weakened, a resurgent and confident Russia will definitely not let a geo-strategically important former Soviet republic fall entirely into the West’s camp. By annexing Crimea, Putin not only secured Russia’s naval base and its strategic gateway to the Black Sea, he also sent a powerful message to Ukraine and the West: Ignore Russia’s legitimate strategic concerns at your own peril.

via Zero Hedge http://ift.tt/1pqmvYS Tyler Durden

This is the trillion-dollar question. From a common sense perspective, the simple answer is “absolutely!”

 

Since 1998, the markets have been in serial bubbles and busts, each one bigger than the last. A long-term chart of the S&P 500 shows us just how obvious this is (and yet the Fed argues it cannot see bubbles in advance?).

 

Moreover, we’ve been moving up the food chain in terms of the assets involved in each respective bubble and bust.

 

The Tech bubble was a stock bubble.

 

The 2007 bust was a housing bubble.

 

This next bust will be the sovereign bond bubble.

 

Why does this matter?

 

Because of the dreaded “C word” COLLATERAL.

 

In 2008, the world got a taste of what happens when a major collateral shortage hits the derivatives market. In very simple terms, the mispricing of several trillion (if not more) dollars’ worth of illiquid securities suddenly became obvious to the financial system.

 

This induced a collateral shortfall in the Credit Default Swap market ($50-$60 trillion) as everyone went scrambling to raise capital or demanded new, higher quality collateral on trillions of trades that turned out to be garbage.

 

This is why US Treasuries posted such an enormous rally in the 2008 bust (US Treasuries are the highest grade collateral out there).

 

Please note that Treasuries actually spiked in OCTOBER-NOVEMBER 2008… well before stocks bottomed in March 2009.

 

The reason?

 

The scrambling for collateral, NOT the alleged “flight to safety trade” that CNBC proclaims.

 

WHAT DOES THIS HAVE TO DO WITH TODAY?

 

The senior most assets backstopping the $600 trillion derivatives market are SOVEREIGN BONDS: US Treasuries, Japanese Government Bonds, German Bunds.

 

By keeping interest rates near zero, and pumping over $10 trillion into the financial system since 2007, the world’s Central Banks have forced investors to misprice the most prized collateral backstopping the entire derivatives system: SOVEREIGN BONDS.

 

SO what happens when the current bond bubble bursts and we begin to see bonds falling and yields rising?

 

Another collateral scramble begins… this time with a significant portion of the interest rate derivative market (over 80% of the $600 TRILLION derivative market) blowing up.

 

At that point, rising yields is the last thing we need to worry about. The assets backstopping a $600 trillion market themselves will be falling in value… which means that the real crisis… the crisis to which 2008 was the warm up, will be upon us.

 

This is why Central Banks are so committed to keeping rates low. This is also why all Central Bank policy has largely benefitted the large financial institutions (the Too Big To Fails) at the expense of Main Street…

 

THE CENTRAL BANKS AREN’T TRYING TO GROW THE ECONOMY, THEY’RE TRYING TO PROP UP THE FINANCIAL INSTITUTIONS’ DERIVATIVE TRADES.

 

To return to our initial question (is this just a temporary top in stocks or THE top?), THE top is what we truly have to watch out for because it will indicated that:

 

1)   The Grand Monetary experiment of the last five years is ending.

2)   THE Crisis (the one to which 2008 was just a warm up) is beginning.

 

For a FREE Investment Report outlining how to prepare for another market crash, swing by: http://ift.tt/RQfggo

 

Best Regards

 

Phoenix Capital Research

via Zero Hedge http://ift.tt/1f88H0d Phoenix Capital Research