23/10/16: Too-Big-To-Fail Banks: The Financial World 'Undead'

This is an un-edited version of my latest column for the Village magazine


Since the start of the Global Financial Crisis back in 2008, European and U.S. policymakers and regulators have consistently pointed their fingers at the international banking system as a key source of systemic risks and abuses. Equally consistently, international and domestic regulatory and supervisory authorities have embarked on designing and implementing system-wide responses to the causes of the crisis. What emerged from these efforts can be described as a boom-town explosion of regulatory authorities. Regulatory,  supervisory and compliance jobs mushroomed, turning legal and compliance departments into a new Klondike, mining the rich veins of various regulations, frameworks and institutions. All of this activity, the promise held, was being built to address the causes of the recent crisis and create systems that can robustly prevent future financial meltdowns.

At the forefront of these global reforms are the EU and the U.S. These jurisdictions took two distinctly different approaches to beefing up their respective responses to the systemic crises. Yet, the outrun of the reforms is the same, no matter what strategy was selected to structure them.

The U.S. has adopted a reforms path focused on re-structuring of the banks – with 2010 Dodd-Frank Act being the cornerstone of these changes. The capital adequacy rules closely followed the Basel Committee which sets these for the global banking sector. The U.S. regulators have been pushing Basel to create a common "floor" or level of capital a bank cannot go below. Under the U.S. proposals, the “floor” will apply irrespective of its internal risk calculations, reducing banks’ and national regulators’ ability to game the system, while still claiming the banks remain well-capitalised. Beyond that, the U.S. regulatory reforms primarily aimed to strengthen the enforcement arm of the banking supervision regime. Enforcement actions have been coming quick and dense ever since the ‘recovery’ set in in 2010.

Meanwhile, the EU has gone about the business of rebuilding its financial markets in a traditional, European, way. Any reform momentum became an excuse to create more bureaucratese and to engineer ever more elaborate, Byzantine, technocratic schemes in hope that somehow, the uncertainties created by the skewed business models of banks get entangled in a web of paperwork, making the crises if not impossible, at least impenetrable to the ordinary punters. Over the last 8 years, Europe created a truly shocking patchwork of various ‘unions’, directives, authorities and boards – all designed to make the already heavily centralised system of banking regulations even more complex.

The ‘alphabet soup’ of European reforms includes:

• the EBU and the CMU (the European Banking and Capital Markets Unions, respectively);
• the SSM (the Single Supervisory Mechanism) and the SRM (the Single Resolution Mechanism), under a broader BRRD (Bank Recovery and Resolution Directive) with the DGS (Deposit Guarantee Schemes Directive);
• the CRD IV (Remuneration & prudential requirements) and the CRR (Single Rule Book);
• the MIFID/R and the MAD/R (enhanced frameworks for securities markets and to prevent market abuse);
• the ESRB (the European Systemic Risk Board);
• the SEPA (the Single Euro Payments Area);
• the ESA (the European Supervisory Authorities) that includes the EBA (the European Banking Authority);
• the MCD (the Mortgage Credit Directive) within a Single European Mortgage Market; the former is also known officially as CARRP and includes introduction of something known as the ESIS;
• the Regulation of Financial Benchmarks (such as LIBOR & EURIBOR) under the umbrella of the ESMA (the European Securities and Markets Authority), and more.

The sheer absurdity of the European regulatory epicycles is daunting.

Eight years of solemn promises by bureaucrats and governments on both sides of the Atlantic to end the egregious abuses of risk management, business practices and customer trust in the American and European banking should have produced at least some results when it comes to cutting the flow of banking scandals and mini-crises. Alas, as the recent events illustrate, nothing can be further from the truth than such a hypothesis.


America’s Rotten Apples

In the Land of the Free [from individual responsibility], American bankers are wrecking havoc on customers and investors. The latest instalment in the saga is the largest retail bank in the North America, Wells Fargo.

Last month, the U.S. Consumer Financial Protection Bureau (CFPB) announced a $185 million settlement with the bank. It turns out, the customer-focused Wells Fargo created over two million fake accounts without customers’ knowledge or permission, generating millions in fraudulent fees.

But Wells Fargo is just the tip of an iceberg.

In July 2015, Citibank settled with CFPB over charges it deceptively mis-sold credit products to 2.2 million of its own customers. The settlement was magnitudes greater than that of the Wells Fargo, at $700 million. And in May 2015, Citicorp, the parent company that controls Citibank, pleaded guilty to a felony manipulation of foreign currency markets – a charge brought against it by the Justice Department. Citicorp was accompanied in the plea by another U.S. banking behemoth, JPMorgan Chase. You heard it right: two of the largest U.S. banks are felons.

And there is a third one about to join them. This month, news broke that Morgan Stanley was charged with "dishonest and unethical conduct" in Massachusetts' securities “for urging brokers to sell loans to their clients”.

Based on just a snapshot of the larger cases involving Citi, the bank and its parent company have faced fines and settlements costs in excess of $19 billion between the start of 2002 and the end of 2015. Today, the CFPB has over 29,000 consumer complaints against Citi, and 37,000 complaints against JP Morgan Chase outstanding.

To remind you, Citi was the largest recipient of the U.S. Fed bailout package in the wake of the 2008 Global Financial Crisis, with heavily subsidised loans to the bank totalling $2.7 trillion or roughly 16 percent of the entire bailout programme in the U.S.

But there have been no prosecutions of the Citi, JP Morgan Chase or Wells Fargo executives in the works.


Europe’s Ailing Dinosaurs

The lavishness of the state protection extended to some of the most egregiously abusive banking institutions is matched by another serial abuser of rules of the markets: the Deutsche Bank. Like Citi, the German giant received heaps of cash from the U.S. authorities.

Based on U.S. Government Accountability Office (GAO) data, during the 2008-2010 crisis, Deutsche was provided with $354 billion worth of emergency financial assistance from the U.S. authorities. In contrast, Lehman Brothers got only $183 billion.

Last month, Deutsche entered into the talks with the U.S. Department of Justice over the settlement for mis-selling mortgage backed securities. The original fine was set at $14 billion – a levy that would effectively wipe out capital reserves cushion in Europe’s largest bank. The latest financial markets rumours are putting the final settlement closer to $5.4-6 billion, still close to one third of the bank’s equity value. To put these figures into perspective, Europe’s Single Resolution Board fund, designed to be the last line of defence against taxpayers bailouts, currently holds only $11 billion in reserves.

The Department of Justice demand blew wide open Deutsche troubled operations. In highly simplified terms, the entire business model of the bank resembles a house of cards. Deutsche problems can be divided into 3 categories: legal, capital, and leverage risks.

On legal fronts, the bank has already paid out some $9 billion worth of fines and settlements between 2008 and 2015. At the start of this year, the bank was yet to achieve resolution of the probe into currency markets manipulation with the Department of Justice. Deutsche is also defending itself (along with 16 other financial institutions) in a massive law suit by pension funds and other investors. There are on-going probes in the U.S. and the UK concerning its role in channelling some USD10 billion of potentially illegal Russian money into the West. Department of Justice is also after the bank in relation to the alleged malfeasance in trading in the U.S. Treasury market.

And in April 2016, the German TBTF (Too-Big-To-Fail) goliath settled a series of U.S. lawsuits over allegations it manipulated gold and silver prices. The settlement amount was not disclosed, but manipulations involved tens of billions of dollars.

Courtesy of the numerous global scandals, two years ago, Deutsche was placed on the “enhanced supervision” list by the UK regulators – a list, reserved for banks that have either gone through a systemic failure or are at a risk of such. This list includes no other large banking institution, save for Deutsche. As reported by Reuters, citing the Financial Times, in May this year, UK’s financial regulatory authority stated, as recently as this year, that “Deutsche Bank has "serious" and "systemic" failings in its controls against money laundering, terrorist financing and sanctions”.

As if this was not enough, last month, a group of senior Deutsche ex-employees were charged in Milan “for colluding to falsify the accounts of Italy’s third-biggest bank, Banca Monte dei Paschi di Siena SpA” (BMPS) as reported by Bloomberg. Of course, BMPS is itself in the need of a government bailout, with bank haemorrhaging capital over recent years and nursing a mountain of bad loans. One of the world’s oldest banks, the Italian ‘systemically important’ lender has been teetering on the verge of insolvency since 2008-2009.

All in, at the end of August 2016, Deutsche Bank had some 7,000 law suits to deal with, according to the Financial Times.

Beyond legal problems, Deutsche is sitting on a capital structure that includes billions of notorious CoCos – Contingent Convertible Capital Instruments. These are a hybrid form of capital instruments designed and structured to absorb losses in times of stress by automatically converting into equity. In short, CoCos are bizarre hybrids favoured by European banks, including Irish ‘pillar’ banks, as a dressing for capital buffers. They appease European regulators and, in theory, provide a cushion of protection for depositors. In reality, CoCos hide complex risks and can act as destabilising elements of banks balancesheets.

And Deutsche’s balancesheet is loaded with trillions worth of opaque and hard-to-value derivatives. At of the end of 2015, the bank held estimated EUR1.4 trillion exposure to these instruments in official accounts. A full third of bank’s assets is composed of derivatives and ‘other’ exposures, with ‘other’ serving as a financial euphemism for anything other than blue chip safe investments.

The Financial Undead

Eight years after the blow up of the global financial system we have hundreds of tomes of reforms legislation and rule books thrown onto the crumbling façade of the global banking system. Tens of trillions of dollars in liquidity and lending supports have been pumped into the banks and financial markets. And there are never-ending calls from the Left and the Right of the political spectrum for more Government solutions to the banking problems.

Still, the American and European banking models show little real change brought about by the crisis. Both, the discipline of the banks boards and the strategy pursued by the banks toward rebuilding their profits remain unaltered by the lessons from the crisis. The fireworks of political demagoguery over the need to change the banking to fit the demands of the 21st century roll on. Election after election, candidates compete against each other in promising a regulatory nirvana of de-risked banking. And time after time, as smoke of elections clears away, we witness the same system producing gross neglect for risks, disregard for its customers under the implicit assumption that, if things get shaky again, taxpayers’ cash will come raining on the fires threatening the too-big-to-reform banking giants.


Note: edited version is available here: http://villagemagazine.ie/index.php/2016/10/too-big-to-fail-or-even-be-reformed/.

10/4/16: Russian Bonds Issuance: Some Recent Points of Pressure

Catching up with some data from past few weeks over a number of post and starting with some Russian data.

First, March issue of Russian bonds. The interesting bit relating RUB22.8 billion issuance was less the numbers, but the trend on issuance and issuance underwriting.

First, bid cover was more than four times the amount of August 2021 bonds on offer, raising RUB22.8 billion ($337 million) across

• fixed-rate notes (bids amounted to RUB47 billion on RUB11.5 billion of August 2021 bonds on offer)
• floating-rate notes (bids amounted to RUB25 billion on issuance of RUB9.33 billion of December 2017 floating coupon paper) and 
• inflation-linked securities (amounting to RUB2.01 billion)

This meant that Russia covered in one go 90 percent of its planned issuance for 1Q 2016, as noted by Bloomberg at the time - the highest coverage since 2011. With this, the Finance Ministry will aim to sell RUB270 billion in the 2Q 2016.

Bloomberg provided a handy chart showing as much:

Now, in 2011, Russian economy was still at the very beginning of a structural slowdown period and well ahead of any visibility of sanctions.

Sanctions are not directly impacting sales of Russian Government bonds, but the U.S. has consistently applied pressure on American and European banks attempting to prevent them from underwriting Moscow's Government issues (http://www.wsj.com/articles/u-s-warns-banks-off-russian-bonds-1456362124). Prior to the auction, Moscow invited 25 Western banks and 3 domestic banks to bid for USD3 billion worth of Eurobonds (the first issuance of Eurobonds by Russia since 2013). Despite the EU official statement that current sanctions regime does not prohibit purchases or sales of Government bonds, Western banks took to the hills (at least officially).

The point of the U.S. pressure on the European banks is a simple threat: in recent years, the U.S. regulators have aggressively pursued European banks for infringements on sanctions against Iran and other activities. In effect, U.S. regulatory enforcement has been used to establish Washington's power point over European banking institutions. And the end game was that, despite being legal, sale of Eurobonds was off limits for BNP Paribas, Credit Suisse, Deutsche Bank, HSBC, and UBS, not to mention U.S.-based Bank of America, Citi, Goldman Sachs, JP Morgan Chase, Morgan Stanley and Wells Fargo.

Another dimension of pressure is the denomination of the Eurobond. Moscow wanted Eurobond issued in dollars. However, dollar-issuance requires settlement via the U.S., enhancing U.S. authorities power to exercise arbitrary restriction on a deal that is legal under the U.S. laws (as not being officially covered by sanctions).

Beyond underwriters, even buy-side for Russian Government bonds is being pressured, primarily by the U.S., with a range of European and American investment funds getting hammered: http://www.bloomberg.com/news/articles/2016-03-24/russia-loses-buyside-support-for-eurobond-after-banks-balk.

Russian Government bonds (10 year benchmark) are trading at around 9.26-9.3 percent yield range, well down on December 2014 peak of over 14.09 percent, but still massively above bonds for countries with comparable macroeconomic performance statistics.

Interestingly, there is a huge demand in the market for Russian Eurobonds, as witnessed by mid-March issuance by Gazprom of bonds denominated in CHF (see: http://www.bloomberg.com/news/articles/2016-03-16/gazprom-taps-switzerland-with-russia-s-first-eurobond-this-year).

It is worth noting again that Russian Government bonds are not covered by any sanctions and are completely legal to underwrite and transact in.

Beyond this, the Western sanctions were explicitly designed to avoid placing financial pressures on ordinary Russians. Government bonds are used to fund general Government deficits arising from all lines of Government expenditure, including healthcare, social welfare, education etc, but also including military spending, while excluding supports for sanctioned enterprises and banks (the latter line of expenditure is linked to funds being sourced from the SWF reserves). Given this, the U.S. position on bonds issuance represents a potential departure from the U.S.-stated objective of sanctions and can be interpreted as an attempt to directly induce pain on ordinary Russians (the more vulnerable segments of the population, such as the elderly, children and those in need of healthcare, or as they are termed in Russian - budgetniki - those whose incomes depend on the Budgetary allocations).

This is a sad turn of events from markets and U.S. policy perspectives - placing arbitrary and extra-legal restrictions on transactions that are perfectly legal is not a good policy basis, unless the U.S. objective is to fully politicise financial markets in general. Neither is the U.S. position consistent with the ethical stance de jure adopted under the sanctions regime.

8/2/15: Reformed Euro Area Banks... Getting Worse Than 2007 Vintage?..

For all the ECB and EU talk about the need to increase deposits share of banks funding and strengthening the banks balance sheets, the reality is that Euro area banks are

1. Still more reliant on non-deposits finding than their US counterparts; 
2. This reliance on non-deposits funding in Euro area is actually getting bigger, not smaller compared to the pre-crisis levels; and
3. This reliance is facilitated by two factors: slower deleveraging in the banking system in the Euro area, and ECB policy on funding the banks, despite the fact that Euro area banks are operating in demographic environment of older population (with higher share of deposits in their portfolios) than the US system. Note that Japanese system reflects this demographic difference in the 'correct' direction, implying older demographic consistent with lower loans/deposits ratio.

Here's the BIS chart on Banking sector loan-to-deposit and non-core liabilities ratios  showing loan-deposit ratios:

Note: 1)  Weighted average by deposits. 2)  Bank liabilities (excluding equity) minus customer deposits divided by total liabilities. 3) The United States, Japan and Europe (the euro area, the United Kingdom and Switzerland). This ratio measures the degree to which banks finance their assets using non-deposit funding sources.

Source for the chart: http://www.bis.org/statistics/gli/gli_feb15.pdf.

9/10/2013: Leveraged and Sick: Euro Area Banks - Sunday Times October 6

This is an unedited version of my Sunday Times column from October 6, 2013.


Newton’s Third Law of Motion postulates that to every action, there is always an equal and opposite reaction. Alas, as recent economic history suggests, physics laws do not apply to economics.

The events of September are case in point. In recent weeks, economic data from the euro area and Ireland have been signaling some improvement in growth conditions. Physics would suggest that the reaction should be to use this time to put forward new systems that can help us averting or mitigating the next crises and deal with the current one. Political economy, in contrast, tells us that any improvement is just a signal to policymakers to slip back into the comfort of status quo.

Meanwhile, the core problems of the Financial Crisis and the Great Recession remain unaddressed, and risks in the global financial markets, are rising, not falling.

More ominously, the Euro area, and by corollary Ireland, are now once again in the line of fire. The reason for this is that for all the talk about drastic changes in the way the financial services operate and are regulated, Europe has done virtually nothing to effectively address the lessons learned since September 2008.


Last month we marked the fifth anniversaries of the Lehman Brothers’ bankruptcy and the introduction of the Irish banking guarantee. These events define the breaking points of the global financial crisis. In the same month we also saw the restart of the Greek debt negotiations ahead of the Third Bailout, the Portuguese Government announcement that its debt will reach 128 percent of the country GDP by the end of this year, a renewed political crisis in Italy, and continued catastrophic decline in the Cypriot economy. Public debt levels across the entire euro periphery are still rising; economies continue to shrink or stagnate. Financial system remains dysfunctional and loaded with risks. Voters are growing weary of this mess. In Spain, political divisions and separatist movements gained strength, while German and Austrian elections have signaled a prospect of the governments’ paralysis.

In Ireland, the poster boy for EU policies, pressures continued to build up in the banking system. The Central Bank is barely containing its dissatisfaction with the lack of progress achieved by the banks in dealing with arrears and is forcefully pushing through new, ever more ambitious, mortgages resolutions targets. Yet it is not empowered to enforce these targets and has no capacity to steer the banks in the direction of safeguarding consumer interests. Business loans continue to meltdown hidden in the accounts.

Meanwhile, the latest set of data from the banking sector is highlighting the fact that little has changed on the ground in five years of the crisis. Domestic deposits are flat or declining – depending on which part of the system one looks at. Foreign deposits are falling. Credit supply continues to shrink.


Perhaps the greatest problem faced by the euro area and Ireland is that since the late 2008, tens of thousands of pages of new regulations have been drawn up in attempting to cover up the collapse of the banking system. Well in excess of EUR 700 billion was spent on ‘repairing’ the banks. And yet, few tangible changes on the ground have taken place. The lessons of the crisis have not been learned and its legacy continues to persist.

There are three basic problems with euro area financial systems as they stand today - the very same problems that plagued the system since the start of the crisis. These are: high leverage and systemic risks, excessive concentration of the banks by size, and wrong-headed regulatory responses to the crisis.

European banks are still leveraged far above safety levels. Lehman Brothers borrowed 31 times its own capital in mid-2008. Today, euro area banks borrow even more. No new European rules on leverage have been written, let alone implemented.

New York University’s Volatility Lab maintains a current database on systemic risks present in the global banking sector. Top 50, ranked by the degree of leverage carried on their balance sheet, euro area banks had combined exposure to USD 1.376 trillion in systemic risks at the end of last week. The banks market value was half of that at USD668 billion. Average leverage in the euro area top 50 banks is 58.5 or almost double Lehman's, when measured as a function of own equity. Two flagship Irish banks, still rated internationally, Bank of Ireland and Ptsb, are ranked 37th and 46th in terms of overall leverage risks and carry combined systemic risk of USD11.4 billion. Accounting for the banks provisions for bad loans, the two would rank in top 20 most risky banks in the advanced world.

Compare this to the US banking system. The highest level of leverage recorded for any American bank is 20.4 times (to equity). Total systemic risk of the top 50 leveraged financial institutions in the entire Americas (North and South) is around USD489 billion, set against the market value of these institutions of USD1.4 trillion.

Since September 2008, systemic risk in the US banking system has more than halved. In the case of euro area, the decline is only one-fifth.

Euro area banks positions as too-big-to-fail are becoming even stronger as the result of the crisis. In the peripheral euro states, and especially in Ireland, this effect is magnified by the deliberate policies attempting to shore up their banking systems by further concentrating market power of ‘Pillar’ banks.


Another area in which change has been scarce is the regulations concerning the funding of the banks. The crisis was driven, in part, by the short-term nature of banks funding – the main cause for the issuance of the September 2008 banking guarantee in Ireland.

In the wake of the crisis, one would naturally expect the new regulatory changes to focus on increasing the deposits share in funding and on reducing banks’ reliance on and costly (in the case of restructuring) senior bonds. None of this has happened to-date and following Cypriot haircuts on depositors one can argue that the ability of euro area banks to raise funding via deposits has now been reduced, not increased.

In addition to driving consolidation of the sector, Europe’s political leaders promised to raise the capital requirements on the banks. Actions did not match their rhetoric. Higher capital holdings are not being put in place fast enough. The EU is actively attempting to delay global efforts at introduction of new minimum standards for capital. As the result, current levels of capital buffers held by the top 50 euro area banks are below those held by Lehman Brothers at the end of 2008. Irish banks capital levels, even after massive injections of 2011, are also lower than that of Lehman’s once the expected losses are accounted for.


Even more ominously, the ideology of harmonisation as a solution to every problem still dominates the EU thinking. This ideology directly contradicts core principles of risk management. By reducing diversity of the regulatory and supervisory systems, the EU is making a bet that its approach to regulation is the best that can ever be developed. History of the entire European Monetary Union existence tells us that this is unlikely to be the case.

Moving from diverse regulatory systems and competitive banking toward harmonised regulation and more concentrated financial sector dominated by the too-big-to-fail ‘Pillar’ institutions implies the need for ever-rising levels of rescue funds and capital buffers.

Currently, there are only two proposals as to how this demand for rescue funds can be addressed. You guessed it – both are utterly unrealistic when it comes to political economy’s reality.

The first one is promising to deliver a small rescue fund for future banks rescues capitalized out of a special banks levy. The fund is not going to be operative for at least ten years from its formation and will not be able to deal with the current crisis legacy debts.

The second plan was summarized this week in the IMF policy paper. Per IMF, full fiscal harmonisation is a necessary condition for existence of the common currency. A full fiscal union, and by corollary a political union as well, is required to absorb potential shocks from the future crises. The union should cover better oversight by the EU authorities over national budgets and fiscal policies, a centralised budget, borrowing and taxing authority, and a credible and independent fund for backstopping shocks to the banking sector. In more simple terms, the IMF is outlining a federal government for Europe, minus democratic controls and elections.

Under all of these plans, there is no promise of relief for Ireland on crisis-related banking debts. In fact, the IMF proposals clearly and explicitly state that the stand-alone fund will only be available to deal with future crises. Addressing legacy costs will require separate mutualisation of the Government liabilities relating to the banking sector rescues. The IMF proposal, in the case of Ireland, means accepting tax harmonisation and surrendering some of the Irish tax revenues to the federal authorities.


At this stage, it is painfully clear to any objective observer that fundamental drivers of the Financial Crisis triggered by the events of September 2008 remain unaddressed in the case of European banking. Thus, core risks contained in the financial system in Europe and in Ireland in particular are now rising once again. Politics have been trumping logic over the last five years just as they did in the years building up to the crisis. This is not a good prescription for the future.

Box-Out: 

A study by the Bank for International Settlements researchers, Stephen Cecchetti and Enisse Kharroubi, published this week, attempted to uncover the reasons for the negative relationship between the rate of growth in financial services and the rate of growth in innovation-related productivity. In other words, the study looked at what is known in economics as total factor productivity growth – growth in productivity attributable to skills, technology, as well as other 'softer' sources, such as, for example, entrepreneurship or changes in corporate strategies, etc. The authors found that an increase in financial sector activity leads to outflow of skilled workers away from entrepreneurial ventures and toward financial sector. This, in turn, results in the financial sector growth crowding out growth in R&D-intensive firms and industries. The study used data for 15 OECD countries, including some countries with open economies and significant shares of financial sector in GDP, similar to Ireland. The findings are striking: R&D intensive sectors located in a country whose financial system is growing rapidly grow between 1.9 and 2.9% a year slower low R&D intensity sectors located in a country whose financial system is growing slowly. This huge effect implies that for the economies like Ireland, shifting economic development to R&D-intensive activity will require significant efforts to mitigate the effects of the IFSC on draining the indigenous skills pool. It also implies that Ireland should consider running an entirely separate system for attracting skilled immigrants for specific sectors.

15/9/2013: BIS Quarterly: a tale of two banking systems

Two hugely revealing charts from the BIS Quarterly Review, September 2013 (http://www.bis.org/publ/qtrpdf/r_qt1309e.pdf) show exactly the remaining adjustments yet to be undertaken by the banking sector in Europe, compared to the US.

Here they are:

 and

 
note how European banks lag US banks in assets deleveraging, and in raising capital, and are slightly lagging in terms of changes in the ratio of risk-weighted assets. In risk-weighted capital ratios, the european banks are about 1/3rd of the way shy of the US, and in terms of capital, roughly 1/2 of the adjustment to the US levels is still required.

And per operational weaknesses of the European banking system? Next we have a table:

Although different across periods, the divergences between the European and US banks are still qualitatively the same for pre-crisis and crisis periods. In particular, US banks operate at higher cost than European ones, but generate more interest income and other income.

16/12/2012: A Bucket of the Bad with a Pinch of the Ugly

I wanted to post this chart for some time now, but kept forgetting about it. The chart comes from RBS research on banks from November 2012 and is based on data through Q3 2012.

The interesting bits - beyond the overall apparent weakness of the European banks, as highlighted in the headline, is which banks are the weakest. Basically: Mediobanca leads, with Danske and Banco Popolare in second. Which brings us to the irony of Danske's latest marketing push for becoming a bank for the 'New Normal' (see here). Oh, the irony...

18/07/2011: Some thoughts on Irish stocks bubble

There is a classic defined relationship between the various stages of bubble formation and markets responses, as illustrated in the chart from (source here) below.

Of course, there is an argument to be made that ‘normal’ bubbles are driven by either information asymmetries or behavioural ‘exuberance’ or both, and are, therefore, significant but temporary departures from the steady state ‘mean’ growth trend. The return to the mean, thus implies the end of the correction phase, as also shown in the chart below.


Of course, one can make an argument that what we have experienced in the case of Ireland is more than a simple bubble, but a structural break underwritten by underlying fundamentals, such as lower permanent rate of growth.

Irish GDP grew 8.82% cumulative in the period 2003-2010 in terms of constant prices or annualized rate of growth of 1.215%. In per capita terms current prices it grew by 14.85% cumulatively and at an annualized rate of 1.998%. Taken from these rates, from 2003 on through today, the average expected value of IFIN should be around 8,898 (mid-point between 8,659 and 9,139 implied by above rates from the ‘Smart Money’ period mid-point valuation). Note that, crucially, the new mean post-bubble bursting should be at least at or above the ‘Smart Money’ end-of-period valuations.

This is certainly not the case with Irish financials as shown in figure below:
Note that three forecasts (my own calculations, so treat as indicative, rather than absolute) provided assume that the average annual growth rate of 1.998% (upper forecast from the starting point at 2003-2004 average), mean forecast (based on 1.215% annualized average growth, starting from 2003-2004 average) and lower forecast (based on 1.215% annualized growth, starting from 2000-2003 average). All three are well above the post-Despair peak.

What about other signs of a classic bubble?
In the run up to the Public Money phase, it is clear that IFIN shows a number of sell-offs and shallow bear traps, but these can be linked to higher overall volatility of the index.

For any period we can take, IFIN exhibits more volatility than either S&P or FTSE bank shares sub-indices. Historically, across indices (to assure comparable scale), IFIN standard deviation stands at 65.40 against S&P’s BIX at 36.84 and FTSE A350 Banks at 32.70. January 2003 through June 2006, IFIN standard deviation was 25.16 against that for BIX of 10.29 and FTSE A350B at 12.07. For the run up to the crisis period between June 2006 and June 2007, IFIN standard deviation was 15.66 against S&P’s BIX of 4.64 and FTSE A350B of 5.22. Lastly, during the crisis – from July 2007 through today, IFIN standard deviation was 56.40 against 28.07 for S&P BIX and 27.83 for FTSE A350B.

To see the relationship, or the lack there of between the volatilities, consider the following chart.
Even from the simple consideration of the rates of change, week on week, IFIN has the lowest correlation with the S&P Banking BIX index – with relatively low explanatory power. Things are even worse if we are to look at the downside risks. Chart below plots downside weekly movements for the three indices that correspond to market declines of 2% or more week-on-week. Again, you can see that both before and during the crisis, there is little relationship between downside risk to Irish financials and to S&P measure.
And the same story is formally confirmed by the Chart below which plots the pair-wise relationships between S&P BIX and FTSE A350 and IFIN.
So overall, IFIN data strongly suggests that we are not in a “normal” financial bubble scenario.

But what about that claim that Lehman's Bros collapse had influence on our banks shares? Recall, Lehman was in trouble since Spring 2008 and went to the wall on September 15, 2008. Also recall that the issues started with Bear Sterns troubles in March 2008 and JPMorgan Chase completed its acquisition of Bear Stearns on May 30, 2008. So let's take the data subset on extreme downward volatility for the period from May 2008 through September 2009. If Lehmans and/or Bear had much of an effect on Irish financials we should expect either one of the following two or both to hold:

1. Correlation between IFIN and S&P BIX to be large and significant
2. Correlation between IFIN and BIX to be larger in the period considered than over the history from 2003 through today.

Overall, evidence suggests that actually the opposite of both (1) and (2) above holds. In fact, based on data for weekly market declines greater than 2% (relatively significant events, but not really too dramatic by far), the period between Bear & Lehman collapse and the next 12 months, Irish financials were less impacted by the US financial shares movements than in the period of 2003-present overall. The impact of Lehmans & Bear on UK financials was stronger, although not dramatically strong, however.

Daily Economics Update 23/03/2009

I am putting this link (here) to today's WSJ interview with Gary S Becker in red, bold and at the top of this post (and on the front of my blog page) not only because he is the greatest economist alive today (which he is), and not only because he taught me microeconomics (how poor of a student I was is attested to by my self-deception of believing in being right on more occasions than being wrong), but because this interview is a must read for anyone concerned about the state of our world today.

Ireland

A new invitation is out - from Brian Cowen to the social partners - to enter talks on a new National Agreement. Yes, folks, you've heard it right. The Government that can't do anything worth talking about on the crisis is back to talking about doing something on the crisis. Dust out that Excellence in Services medal for Brian. Instead of facing down the unions in their militant stance on the economy, Brian Cowen has done another one of his 'courageous' and 'decisive' flip-flops that our official media got so accustomed to calling upon him to perform. Expect: more blame for private sector, higher taxes, more pay for public servants, rampant price inflation in state-controlled sectors and... well, just expect more of what we had in Autumn 2008.

This time around, the markets will be searching for what to hit next. Given that Brian's first round of 'dealing with the crisis' has spectacularly collapsed into issuing blanket guarantees to the banks, nationalising one bank, handing taxpayers cash to two other banks, passing no meaningful measures on stimulating economy, hammering consumers and taxpayers, slaughtering retail sector and seeing public debt soar, they will be hard pressed to find a new target still standing.

Revolting, is how I can describe this latest move at best.

Just how senile our policy making has become as of late? Think Nationwide scandal. Mr Fingleton is walking away with millions and the Government and the politicos are issuing salvos of outrage. But they can do nothing - he owns the money. How? The truth is that Fingelton gets to keep his millions only because in September 2008, the Exchequer has underwritten the Nationwide. Would they have said then: "Sorry, buddy, but there is no way Nationwide is a systemic bank and so no guarantee", the bank would have gone into a receivership and Mr Fingleton would have received what he deserves after all these years of running his own 'lille piggy bank' - zilch, nada, zero.

So don't blame the bankers - blame the politicos. And let's ask Brian^2+Mary to see that assessment of the Irish banking system that managed to recognize the likes of the Nationwide as a significant enough institution to have caused a systemic risk to the entire financial system were it allowed to fail.


US:
Forbes is now on the inflation case (here): "On a year-over-year basis, the CPI will turn negative this month and stay negative for many more months. As a result, many believe inflation is a distant memory and those who fear deflation will have data to hang their hats on for much of 2009. But, these deflation-istas will be looking in the rear-view mirror. On a month-to-month basis, inflation is already starting to claw its way back. In the first two months of 2009, consumer prices are up at a 4.1% annual rate, while producer prices are up at a 5.8% rate."

Worth a read. I have warned about this threat of inflation a week ago (here), so we are ahead of the curve...


More on the Geithner 'Trillion-dollar Rescue' Plan (GP): let's do some math

1. The Feds buy $1 trillion worth of banks assets, in partnership with private buyers (95-97% financed by the Treasury - 85% in the form of a non-recourse loans and remaining in the form of equity). Suppose that 5% comes from private investors. Taxpayers liability is $950bn.
2. Now, assume that the average price paid for assets is $0.80-0.85 on the dollar - an assumption consistent with 'clean' assets TARP financing. Banks get an effective disposal of $1tr/0.8=$1.25tr worth of assets. This is the implied value of assets on banks balance sheets. But the banks have marked these assets down already. Suppose the original markdowns were ca 10% impairment. The original, pre-writedown value of the assets that is being purchased under the GP is, therefore $1.25tr/0.9=$1.39tr.
3. Current market price for distressed assets is roughly equal to the recovery rate on such assets - ca $0.40-0.55 per dollar value, so the mark to market value of these assets is now $1.39tr*0.45=$625bn.

Recall that 95-97% is going to be financed by the Feds, and the Government share will be roughly 20% of the entire value. So under GP, taxpayers are getting $125bn in assets in exchange for $950bn in payment... Ahem, that is a rotten deal, indeed.

But what does this deal buy in the end? Combine that with the fact that

• ca 40% of all banks balance sheet assets in the US are in residential mortgages,
  
• ca 24% - in Commercial mortgages,
• of the remaining stuff, 55% is in corporate and industrial loans,
  
• of which good 1/5th is again linked to property.
  

Thus, total balance sheet exposure to property in the case of the US banks is somewhere in the region of 68%. Of these, at least 40% is toxic, so that we can assume that 25% of the entire banks' balancesheets is of reasonably nasty quality. Suppose banks sell (via GP) these assets at $0.80 on the dollar. The required post-sale writedown on the loans will be 25%(1-0.8)=5% of the entire asset base. Per latest statement (December 31, 2008) by the Bank of America, this venerable (if vulnerable) institution has tangible equity to total assets ratio of 5.0% and Tier 1 ratio of 9.2%. This is excluding the toxic stuff it inherited from Merrill Lynch. Thus, in effect, participating in GP will wipe out all of the bank's tangible equity and more than 1/2 of its Tier 1 capital, pushing it well below the 6% Tier 1 ratio required of reasonably sound banks.

So this implies that very few banks will be willing to sell at $0.80 on the dollar. A more acceptable price for banks would be $0.95 to a dollar, but at that price, the US taxpayers will fall some $833mln short on the deal.

Could someone please tell me why we are talking about GP as some sort of a market-turning deal? Unless, that is, we are buying into the plan because it is the first, and so far the only plan that a new Democratic Party White House has contrived?


US Personal Income data: "US personal income growth slowed to 3.9 percent in 2008 from 6.0 percent in 2007 with all states except Alaska sharing in the slowdown," according to the data released by the US Bureau of Economic Analysis. The U.S. growth was the slowest since 2003. Inflation, as measured by the national price index for personal consumption expenditures, rose to 3.3 percent in 2008 up from 2.6 percent in 2007. Here is a nice map of heaviest (and lightest) hit states:
Can you see the pattern? Well, here is another map:

House Prices (US): Home prices rose 1.7% in January relative to December 2008, says Federal Housing Finance Agency - the first monthly increase in 12 months. This leaves home prices down 6.3% in the past 12 months and -9.6% off from their peak in April 2006. In December, the year-on-year decline was 8.8%. One note of caution - this is the preliminary estimate subject to at least two future revisions. For example, December 2008 preliminary estimate was showing 0.1% fall in prices, but this was revised today to -0.2% decline. Overall, in January, home prices rose in 8 out of 9 regions (only Pacific states registered a decline -0.9%), with strongest gains in East North Central (+3.9%) and South Atlantic (+3.6%) regions.