8/10/2014: IMF GFSR: That Battleship Potemkin Moment...

In the previous post (http://trueeconomics.blogspot.ie/2014/10/8102014-imf-gfsr-oh-dear-its-headless.html) I covered some of the IMF's discoveries concerning the risks present in financial markets.

Irony aside, the Fund does provide a handy map to these risks. Here it is:

The closer things are to the centre of the spiderweb, the lower are the associated risks. Which is preciously funny, if you are into morbid sense of humour.

You see, here's the same map from October 2013:

First thing first: let's take a look at Risks:

• Emerging Markets risks have scaled up in 12 months through April 2014 and then stayed where they were through October 2014. 
• Credit Risks have gone down - undoubtedly the result of just one thing: write down and insolvencies waves that swept across primarily the US and UK and to a lesser extent (due to slower response) through the EU banking systems.
• Market and Liquidity Risks - the wonder sparks of the Central Banks' attention - have grown, and by much. Now, recall that the entire first stage of the crisis was about providing liquidity. ECB is still forcing more and more liquidity into the system… and the risks are rising, not subsiding.
• Macroeconomic Risks - the gold dust of the Governments and Central Bankers - is not budging. Not a notch decline in these risks for all the efforts over the last 18 months.

Now look at the underlying Conditions:

• Monetary and Financial conditions have eased through April 2014 and then got stuck in the same spot.
• Risk Appetite conditions have improved a little in 6 months through October 2013, then grounded to a halt through April 2014 and deteriorated since back to where they were in April 2013. 18 months of going nowhere policies.

This really does make you wonder - all the heroic efforts of the Central Bankers, Treasuries, Governments and international agencies, all the push for more cash, more 'reforms', more 'deleveraging'... and what? Swimming harder to stand still?..

Mommy, the pram is still rolling moment from Battleship Potemkin anyone?..

8/10/2014: IMF GFSR: Oh dear, financial markets are headless chickens...

Financial markets are headless chickens rampaging across the risks landscape, says IMF. This being hardly surprising, the IMF goes on to astonish us all by admitting that the beheadings were the job of the Central Bankers and international policy advisers... aka, the IMF...


IMF's Global Financial Stability Report published today offers some very uneasy reading on the topic of the global financial system risks, both in terms of the evolution of these risks over time and the sources of the risks.

Per IMF: "Easy money continues to increase global financial stability risks. Accommodative policies aimed at supporting the recovery and promoting economic risk taking have facilitated greater financial risk taking."

In other words, instead of reducing the overall level of risks accumulated in the financial system, monetary and regulatory policies deployed since the onset of the Global Financial Crisis (GFC) have resulted in an increase in these risks. Why? Because the entire response since the start of the GFC was focused on priming the debt pump. This manifested itself in record low rates charged by Central Banks on funding they supply into the banking system; in massive waves of liquidity injected by the Central Banks into the sovereign and private debt markets; in incessant pressure to accumulate credit placed on the economies from the policymakers irrespective of the debt levels already present; in wilful reduction of the debt repayment capacity of the households via increased taxation by the insolvent states and so on. All of this has meant that while economic fundamentals (the Great Recession and debt overhang) should have led to a reduction in credit supplied into the global financial system, the opposite took place.

Asset bases of the banks grew, on the aggregate, Central Banks balance sheets swell and asset markets boomed. As IMF notes: "This has resulted in asset price appreciation, spread compression, and record low volatility, in many areas reaching levels that indicate divergence from fundamentals." In other words: as companies managed no significant gains in their productive capacity, their capital valuation exploded. Solely because the hurdle rate on investment (the cost of investment) collapsed. Never mind there is no new demand for companies' output. When money is cheap, it pays to borrow. So asset prices appreciated. Meanwhile, the risk spreads between various quality borrowers have become much tighter. During the crisis, we saw massive widening of risk premia that lower quality (higher risk) borrowers (sovereign, corporate and household) had to pay to secure credit. Now, with money being given away at negative real prices, no one gives a damn is one borrower is less likely to repay than the other: risks are misplaced once again. You don't have to look any further for the evidence of this than the Euro area sovereign yields. When Italy borrows in the markets at negative rates, you know the jig is up. Surprisingly, all of this: irrationally easy credit and outright bubbly assets valuations, coincided with a decline in markets volatility. In other words, markets are now acting as if their participants are 100% (or close) certain the trend is only up for asset prices. And worse, this applies to all asset classes: from housing to bonds to VCs to Private Equity.

IMF notes that "What is unusual about these developments is their synchronicity: they have occurred simultaneously across broad asset classes and across countries in a way that is unprecedented." The word *unprecedented* should ring the alarm bells. We are deep into the monetary policy corner (zero rates, massive liquidity pumping programmes) and fiscal policy corner (debt levels carried by the sovereigns are now breaking all-time records). Should the *unprecedented* start unwinding, what stands between here and a full blow disaster?

Nothing. Worse than nothing.

Most certainly not the fabled 'reformed' banking systems with all the layers of new supervisors and rules mounted on top of their crumbling strategies is no solution, despite all the European chatter about Banking Union and joint supervision and macro prudential risks oversights and so on… All of this is pure blabber. For as the IMF states: "Capital markets have become more significant providers of credit since the crisis, shifting the locus of risks to the shadow banking system. The share of credit instruments held in mutual fund portfolios has been growing, doubling since 2007, and now amounts to 27 percent of global high-yield debt." So risks have: (1) risen, and (2) migrated into the less manageable, more poorly monitored and understood sub-system.

"At the same time, the fund management industry has become more concentrated. The top 10 global asset management firms now account for more than $19 trillion in assets under management." So risks have: (3) concentrated behind fewer black boxes of management strategies.

With (1)-(3) above you have: "The combination of asset concentration, extended portfolio positions and valuations, flight-prone investors, and vulnerable liquidity structures have increased the sensitivity of key credit markets, increasing market and liquidity risks."

That's IMF-speak for 'sh*t about to hit the fan'. In more academic terms, Nassim Taleb - in 2011 article in Foreign Affairs said: "Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems."


In 2008-2011 GFC, global economy had a buffer: the Emerging Markets. These fared better than advanced economies precisely because regionalisation has enabled them to offset the risk transmission channels that globalisation has created. But what about now? This time around, the buffer is no longer there. Quoting IMF: "Emerging markets are more vulnerable to shocks from advanced economies, as they now absorb a much larger share of the outward portfolio investment from
advanced economies. A consequence of these stronger links is the increased synchronization of asset price movements and volatilities." Translation: if sh*t does hit the fan, there won't be an umbrella big enough to cover everyone… nay, anyone…


But IMF does another useful thing in its GFSR report. It evaluates the impact of the credit risks present. "To illustrate these potential risks to credit markets, this report examines the impact of a rapid market adjustment that causes term premiums in bond markets to revert to historic norms (increasing by 100
basis points) and credit risk premiums to normalize (a repricing of credit risks by 100 basis points)." Now, note - they are not suggesting any risk-run on the markets, nor change in sentiment of any variety. They are just measuring what will happen if *historical norms* were to prevail (for comparison, however, that norm in the euro area implies credit risks and term premia repricing by more like 200 basis points).

"Such a shock could reduce the market value of global bond portfolios by more than 8 percent, or in excess of $3.8 trillion. If losses on this scale were to materialize over a short time horizon, the ensuing portfolio adjustments and market turmoil could trigger significant disruption in global markets." You don't say… sure they will. Remember that the ECB is hoping to deliver roughly USD1 trillion addition to its balance sheet through extraordinary measures, such as TLTROs and ABS purchases. And the shock is almost 4 times that of the ECB extraordinary efforts. What happens, then, with the euro area banks that are so stuffed with Government bonds and corporate debt they are making even thick-necked ECB squirm? Oh, right, they will need to either absorb these losses (which can be of the size of the GFC-induced write downs) or pretend that their bonds holdings are not subject to risks, just as the entire world will see them as being subject to huge risks. Take your pick - either we have an insolvent banking system or we have a dishonest banking system… or may be both… or may be we already have instead of *will have*…


The IMF is always keen on suggesting what needs to be done. But, alas, the Fund has now been devoid of any new ideas on all policy fronts for some time. Ditto on the topic of global financial stability. IMF says: "Managing risks from an ongoing overhaul in bank business models to better support economic risk taking. The policy challenge is to remove impediments to economic risk taking and strengthen the transmission of credit to the real economy." Wait, what? Superficial risk taking stimulation that the IMF said above is the cause of the imbalances is now also the solution to the built up imbalances? Yep, you've heard it right: hair of the dog to the power of 10. "Cure the hangover from 10 pints by downing 10 bottles of vodka…", says Doc. IMF.

But more on the banks in the next post…

2/10/2014: IMF Report: Risk Taking Behaviour in Banks

As some of you might have noticed, I started to contribute regularly to Learn Signal Blog last week. This week, my post there covers IMF Global Financial Stability Report update released this week, dealing with the drivers for risk taking behaviour of the banks prior to and since the Global Financial Crisis: http://blog.learnsignal.com/?p=46

24/12/2013: Should Government Do More on Credit Supply? Or Do Better?

We commonly hear about the need for the Government to do something about 'credit supply' to the real economy and 'fixing the bad loans' problem in the banks. Alas, as per the IMF assessment shown in the chart below, Ireland is already well ahead of the majority of its euro area counterparts (save Spain and Slovenia) in terms of policies aimed at supporting supply of credit. And we are way ahead of everyone else in terms of policies that are designed to address the issue of bad loans.

Given having policies ≠ having effective policies or allowing policies on the books to be implemented in the real world. So may be the Government shouldn't be 'doing more' to fix credit supply and demand, but instead 'do better'?

Note: Policies aimed at enhancing credit supply include: fiscal programmes on credit (e.g. credit support schemes, etc), supportive financial regulation, capital markets measures (e.g. funding via state agencies etc), and bank restructuring (that the IMF and the Irish Government often confuse for repairing). Supporting credit demand policies include policies aimed at facilitating corporate debt restructuring and household debt restructuring.

19/10/2013: Debt Bias and Wealth Taxes: Pesky IMF Ideas...

Nasty little bit from the IMF Fiscal Monitor - a box-out on page 49 of the report...

So the IMF basically reminds us that once things get desperate, wealth taxes (err... Irish pensions levy anyone?) or put differently - expropriation of private wealth - can be contemplated...

Reinhart and Rogoff have warned us all about the Financial Repression coming, so no surprise here. What is, however, surprising is the IMF estimate at the end of the box-out. "The tax rates needed to bring public debt to precrisis levels... are sizeable: reducing debt ratios to end-2007 levels would require (for a sample of 15 euro area countries) a tax rate of about 10 percent of households with positive net wealth".

Give it a thought - 10 percent on average for the euro area... for Ireland? 20%? 30%?.. And, of course, what will that do to households' debt?.. oh, wait, that does not matter in Europe...


Oh, and while on the topic of debt. I wrote recently (here) about the issue of 'debt bias' (incentives to hold debt over equity) in tax systems... Here's a chart from the same report (page 45) showing the impact of eliminating 'debt bias' in tax system on systemic stability of the country financial system:

Of course, Irish policymakers are keen to eliminate the bias - not because it can help repair the systemic instability of our financial system, but because eliminating the bias will increase state yields from debt-funded property loans (via closing of the mortgages interest relief).

Once again, the problem is that of legacy - what do such closures of 'debt bias' do to sustainability of mortgages debt already carried in the system? Once again, no one pays any attention to the issue...

10/10/2013: IMF's GFSR October 2013: More Focus on Banks

Now, back to GFSR and banks. I covered some of the IMF findings on banks here: http://trueeconomics.blogspot.ie/2013/10/10102013-imfs-gfsr-october-2013-focus_10.html

This time, let's take a look at what IMF unearthed on funding side of the banking systems. Fasten your seat belts, euro area folks…

Euro area banks have shallower deposits base than US banks… but, wait… euro area banks are supposedly 'universal' model, so supposed to have MORE deposits, than the originate and distribute model of the US banks… Oops… Euro area banks like holding banks deposits - just so contagion gets a bit more contagious. Euro area banks hold tiny proportion of equity, lower than that of the US banks.

By all means, this is a picture of weaker euro area banks than US banks - something I noted here: http://trueeconomics.blogspot.ie/2013/10/9102013-leveraged-and-sick-euro-area.html

Another chart, more bumpy road for euro area:

Per above, there is a massive problem on funding side for euro area banks in the form of huge reliance on debt (both secured and unsecured). The US banks are much less reliant on secured debt (they can issue real paper and raise securitised funding) and they rely less overall on borrowing.

Chart below shows the structure of secured bank debt. Euro area again stand out with huge reliance on covered bonds. US stands out in terms of its continued reliance on MBS. The crisis focal point of the latter did not go away… and the crisis focal source of contagion - banks debt funding - has not gone from euro area's 'reformed' banks.

Happy times... Mr Draghi today expressed his conviction that euro area banks have been cured from their ills... right... hopium-783 is the toast of Frankfurt.

10/10/2013: IMF's GFSR October 2013: Focus on Lending

More interesting analysis from the IMF's GFSR (previously covered topics: banks and corporate debt overhang are linked here: http://trueeconomics.blogspot.ie/2013/10/10102013-imfs-gfsr-october-2013-focus_10.html).

This time around: lending to the economy. One chart:

Note that Ireland is a euro area outlier in terms of the huge extent of policy supports one demand side for credit and simultaneously above average support on supply side of credit:

Puzzled? Me too. Yes, we have huge number of various programmes, grants, schemes, incentives for funding supply and demand. Most of it is not in the form of credit, but rather equity - e.g. Enterprise Ireland funding. No, we don't have much of credit supply supports when it comes to policies or institutions relating to banks. We have lots of hot air talking about the need for banks to lend, more hot air on various 'checks' as to whether banks are lending or not… etc. So let's take a look at the table where the IMF gets its ideas on the above policies existence:

Per table above, Ireland has produced policies of Household Debt Restructuring. Wake me up here, folks, cause I am apparently living in some different Ireland from the one visited by the IMF. Oh, and yes, we also have put in place new policies on Corporate Debt Restructuring. What are these? Hiding our heads in the sand as companies go to the wall? Or may be these are policies promised on dealing with upward-only rent reviews which have driven thousands of companies into the ditch?

I think the IMF folks need to get out a bit more often… before compiling reports...

10/10/2013: IMF's GFSR October 2013: Focus on Banks

As promised in the earlier post, focusing on Corporate Debt Overhang (http://trueeconomics.blogspot.ie/2013/10/10102013-imfs-gfsr-october-2013-focus.html), I am covering in a series of posts the latest IMF GFSR.

Let's take a look at the banking sector focus within the GFSR:

Note the relatively healthy position of the euro area banks on the basis of Tier 1 capital ratios. However, when it comes to leverage, the chart below shows a ratio of tangible equity to tangible assets (the so-called Tangible Leverage ratio). The higher the number in the first chart above, the lower is the capital ratio ('bad thing'), the higher the number is in the chart below, the higher is the ratio of equity to assets ('good thing'):

So euro area banks are doing fine by Tier 1 capital, but are not fine by leverage... As the rest of the IMF analysis highlights, much of this aberrational result arises from the nature of the euro area banking model (assets-heavy 'universal banking' model), plus, as IMF politely puts:

"The conflicting signals also highlight the  importance of restoring investor confidence in the accuracy and consistency of bank risk weights. This also suggests that risk-weighted capital ratios should be supplemented by leverage ratios, as proposed in the Basel III framework."

No comment on the above...

GFSR is deadly on profitability of banks and equity valuations. Here's the key chart:

Notice the concentration of euro area banks at the bottom of the distribution. Still think Irish banks shares held by the Exchequer are worth EUR11 billion?.. really?.. By the chart above, they should be valued at around 2-3% of their tangible assets... which would be what? Close to EUR6 billion, maybe EUR9 billion. Which refers to all Irish banks. Listed, unlisted, foreign, domestic... And to all their equity... not just the equity held by the Exchequer.

Never mind. Like Irish banks, euro area banks are going to continue dumping assets... err... deleverage...

"European banks have been deleveraging in response to market and regulatory concerns about capital levels, and may continue to do so. ...a combination of market and regulatory
concerns about bank capitalization has already led to an increase in capital levels at EU banks. …Over the period 2011:Q3–2013:Q2, large EU banks reduced their assets by a total of $2.5 trillion on a gross basis — which includes only those banks that cut back assets — and by $2.1 trillion on a net basis."

So you thought it was surprising/unusual/unexpected that the banks are not lending? Every policymaker harping on about banks credit 'growth' should have known this deleveraging is ongoing and with it, no new credit growth will occur… I mean USD2.5 trillion!

"…About 40 percent of the reduction by the banks in the EU as a whole was through a cutback in loans, with the remainder through scaling back noncore exposures and sales of some parts of their businesses… As discussed in the April 2013 GFSR, banks have been concentrating on derisking their balance sheets by reducing capital-intensive businesses, holding greater proportions of assets with lower risk weights (such as government bonds), and optimizing risk-weight models."

Put differently, to beef up capital ratios, the banks shed primarily riskier loans. Now what these might be? Oh, yes, SMEs and non-financial corporate loans in general… So that 'credit growth' to SMEs?..

"The capital ratio projection exercise previously discussed suggests that some banks will need to continue raising equity or cutting back balance sheets as they endeavor to repair and strengthen their balance sheets."

Read my lips: no new credit growth… QED…

You can read the entire GFSR here: http://www.imf.org/External/Pubs/FT/GFSR/2013/02/pdf/text.pdf

Note: my recent article on European banks is here: http://trueeconomics.blogspot.ie/2013/10/9102013-leveraged-and-sick-euro-area.html

16/7/2012: GFSR July 2012 - more alarm bells for European banks

IMF published Global Financial Stability Report update for June 2012, titled “Intense Financial Risks: Time for Action”

Per report: “Risks to financial stability have increased since the April 2012 Global Financial Stability Report (GFSR).

• Sovereign yields in southern Europe have risen sharply amid further erosion of the investor base.
• Elevated funding and market pressures pose risks of further cuts in peripheral euro area credit.
• The measures agreed at the recent European Union (EU) leaders’ summit provide significant steps to address the immediate crisis. Aside from supportive monetary and liquidity policies, the timely implementation of the recently agreed measures, together with further progress on banking and fiscal unions, must be a priority.
• Uncertainties about the asset quality of banks’ balance sheets must be resolved quickly, with capital injections and restructurings where needed.
•  Growth prospects in other advanced countries and emerging markets have also weakened, leaving them less able to deal with spillovers from the euro area crisis or to address their own home-grown fiscal and financial vulnerabilities. 
•  Uncertainties on the fiscal outlook and federal debt ceiling in the United States present a latent risk to financial stability."

Aside from the headlines, some interesting points from the report are:

• Market conditions worsened significantly in May and June, with measures of financial market stress reverting to, and in some cases surpassing, the levels seen during the worst period in November last year.  (see Figure 1)

•   The 3-year LTROs helped support demand for peripheral sovereign debt but that positive effect has waned. Private capital outflows continued to erode the foreign investor base in Italy and Spain (see Figures 3 and 4)

An interesting point on Euro area banking sector [emphasis mine]: “Notwithstanding the ample liquidity provided by the ECB’s refinancing operations, funding conditions for many peripheral banks and firms have deteriorated. Interbank conditions remain strained, with very limited activity in unsecured term markets, and liquidity hoarding by core euro area banks. Bank bond issuance has dropped off precipitously, with little investor demand even at higher interest rates.

“Banks in the euro area periphery have had to turn to the ECB to replace lost funding support, as cross-border wholesale funding dried up, and deposit outflows continue. The April 2012 GFSR noted that EU banks are under pressure to cut back assets, due to funding strains and market pressures, as well as to longer-term structural and regulatory drivers. The sharp reduction in bank balance sheets in the fourth quarter of 2011 continued, albeit at a slower pace, in the first quarter of 2012.

Growth in euro area private sector credit diverged significantly. While credit has contracted in Greece, Spain, Portugal and Ireland, it has remained more stable in some core countries.

Survey data on bank lending conditions show that credit supply remains tight, albeit less so than at the end of 2011, but that demand has also weakened more recently.

Deleveraging is also a concern for many peripheral corporations, given their historic dependence on bank funding and the risk that credit downgrades and diminished investor appetite could drive borrowing costs higher, even for high credit quality issuers.”

Now, here’s an interesting point not raised in the GFSR, but linked to the above observations: equities issuance accounts for roughly 55% of total corporate capital in US and EU. However, because the US corporates issue more bonds-backed debt than their EU counterparts, banks lending accounts for 40% of the European corporate funds raised, against 20% in the US. Which means that banks credit is about twice more important in Europe than in the US in terms of funding corporate capex. In fact, recent research from BCA clearly links US corporates ability to raise direct market funding by-passing banks to faster economic recovery in the US than in EU or Japan.

Add to this equation that European banks are worse capitalized than their US counterparts and that they are more leveraged than their US counterparts and you have a bleak prospect for the EU economy. BCA recently estimated that to bring Euro zone banks’ capital ratios to the levels comparable with the US average, the largest EU banks will have to raise some USD900 billion worth of new capital or cut their assets base by a whooping USD 9 trillion.

But wait, there’s more – you’ve heard about the latest report in the WSJ that Mario Draghi proposed to bail-in senior bondhodlers in Spanish banks? Much of the Irish commentary on this was positive, suggesting that Ireland is now in line for a retrospective deal from the ECB to recover some of the funds we paid to senior bondholders in Anglo and INBS. Setting aside the ‘wishful thinking’ nature of such comments – look at Draghi’s idea implications for EU economic activity. If bail-in does make it to the policy tool of European authorities, funding for the EA17 banks will only become more expensive in the medium and long term (risk premium on ‘bail-in probability’), which, in turn will mean even less credit for corporates, which will mean even less capex, and thus even lower prospect of recovery.

You know the story – pull one end of the carriage out of the quicksand pit, the other end sinks deeper… Let me quote BCA: “In Japan, credit contraction lasted well over nine years in the aftermath of the asset bubble bust. During that time, deflation prevailed and economic growth averaged a measly 0.5% annual pace.” Much of hope for Europe then? Not really. Recall that Japan had aggressive fiscal and monetary policies at its disposal plus booming global markets when it was undergoing credit bust. We, however, have psychotic monetary policy, no fiscal policy room and are running debt deflation cycle amidst global economic slowdown.

IMF is also on the note here: “Policymakers must resolve the uncertainty about bank asset quality and support the strengthening of banks’ balance sheets. Bank capital or funding structures in many institutions remain weak and insufficient to restore market confidence. In some cases, bank recapitalizations and restructurings need to be pursued, including through direct equity injections from the ESM into weak but viable banks…”