Banks & Interest Rates Archives - Page 34 of 61

September 27, 2014

Market turbulence

A Coincident Economic Activity Index above 0.2 indicates the US recovery is on track. Produced by the Philadelphia Fed, the index includes four indicators: nonfarm payroll employment, the unemployment rate, average hours worked in manufacturing, and wages and salaries. Bellwether stock Fedex also suggests rising economic activity.

Coincident Economic Activity Index

But contraction of the ECB balance sheet by € 1 Trillion over the last two years has pitched Europe back into recession.

Chart: ECB (Eurosystem) balance sheet. The target is to raise it by EUR 1 trillion – pic.twitter.com/ptoqLkNpxq

— SoberLook.com (@SoberLook) September 27, 2014

Weakness in Europe and Asia has the capacity to retard performance of US stocks despite the domestic recovery.

September 21, 2014

Amir Sufi: Who is the Economy Working For? The Impact of Rising Inequality on the American Economy

Amir Sufi, professor of Finance at the University of Chicago, testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Economic Policy. His statement titled “Who is the Economy Working For? The Impact of Rising Inequality on the American Economy” makes interesting reading.

“Only 76% of Americans aged 25 to 54 currently have jobs, compared to 80% in 2006 and 82% in 1999…..How did we get into this mess?”

The gist of his argument is:

“Richer Americans save a much higher fraction of their income, ultimately holding most of the financial assets in the economy: stocks, bonds, money-market funds, and deposits. These savings are lent by banks to middle and lower income Americans, primarily through mortgages.”

…And collapse of the housing market caused disproportionate harm to the middle and lower-income groups.

It is true is that middle and lower-income groups have a higher percentage of their wealth invested in their homes and are also far more exposed to mortgages than richer Americans. The source of funding for these mortgages, however, is not the wealthy — who are primarily invested in growth assets such as stocks — but the banks who create new credit out of thin air. The collapse of the housing market caused disproportionate hardship to middle and lower-income Americans because their wealth is concentrated in this area. The rich suffered from a collapse in stock prices, but the market has recovered to new highs while housing remains in the doldrums. That is one of the causes of rising wealth inequality.

Where I do agree with Amir is that credit growth without income growth is a recipe for disaster.

“A tempting solution to our current troubles is to encourage even more borrowing by lower and middle-income Americans. This group of Americans is likely to spend out of additional credit, which would provide a temporary boost to consumption. But unless borrowing is predicated on higher income growth, we risk falling into the same trap that led to economic catastrophe.”

The graph below compares credit growth to growth in (nominal) disposable income:

Credit and Disposable Income

The ratio of credit to disposable income rose from 2:1 during the 1960s to almost 5:1 in 2009.

Credit to Disposable Income

There is no easy path back to the stability of the 1960s. A credit contraction of that magnitude would destroy the economy. But regulators should aim to keep credit growth below the rate of income growth over the next few decades, gradually restoring the economy to a more sustainable level.

The worst possible policy would be to encourage another credit boom!

September 10, 2014

Big banks may need $41b more capital, UBS says

From Chris Joye at AFR:

UBS’s more likely scenario of a 3 per cent TBTF capital buffer combined with an increase in the average mortgage risk weight to 25 per cent gives a total capital shortfall of $41.1 billion for the majors.

Risk-weightings, especially for residential mortgages are coming under increased scrutiny. The big four banks have a major advantage in this area, employing risk-weightings as low as 15% to 20% based on their historical record of low defaults. But that history includes a credit boom lasting more than 2 decades which fueled an unprecedented rise in housing prices and is unlikely to be repeated in the future.

APRA alluded to this problem in its second FSI submission:

..APRA also highlighted the problem with the major banks’ predicting their own probabilities of defaults on home loans in the absence of a recession in 23 years and the much lower levels of housing leverage in 1991.“The Basel Committee is currently reviewing the validity and reliability of risk weights generated under the IRB approach [used by the majors] in response to studies showing that the variability … is much greater than could be explained by differences in underlying risks,” APRA said.

Only when the tide goes out do you discover who’s been swimming naked. ~ Warren Buffett

September 7, 2014

Financial reform: Call to arms | FT.com

Martin Wolf on how much capital banks should be required to hold:

The new regulatory regime is an astonishingly complex response to the failures of this model. But “keep it simple, stupid” is as good a rule in regulation as it is in life. The sensible solution seems clear: force banks to fund themselves with equity to a far greater extent than they do today.

So how much capital would do? A great deal more than the 3 per cent ratio being discussed in Basel is the answer. As Anat Admati and Martin Hellwig argue in their important book, The Bankers’ New Clothes, significantly higher capital – with true leverage certainly no greater than 10 to one and, ideally, lower still – would bring important advantages: it would limit the implicit subsidy to banks, particularly “too big to fail” ones; it would reduce the need for such intrusive and complex regulation; and it would lower the likelihood of panics.

An important feature of higher capital requirements is that these should not be based on risk-weighting. In the event, the risk weights used before the crisis proved extraordinarily fallible, indeed grossly misleading…..

There is no magic in the number of 10 times leverage (or 10% Tier 1 Capital to Total Assets) but the larger the buffer, the greater the protection against fluctuations in asset values. The Basel III minimum leverage ratio of 3% is too low to offer adequate protection, even with the highest quality assets, and while 10% is not readily attainable in the short-term, it makes a suitable long-term target.

September 7, 2014

A Prominent Financial Columnist Is Calling For Radical Reforms To The Global Economy | Business Insider

From The Economist review of Martin Wolf’s new book “The Shifts and the Shocks: What We’ve Learned–and Have Still to Learn–from the Financial Crisis”:

To make finance safer, Mr Wolf suggests replacing a fractional reserve banking system, which takes in deposits and lends most of them out in longer-term loans, with a system of “narrow banking”, where deposits must be backed by government bonds. To sustain demand without relying on dangerous asset bubbles, he proposes permanent “helicopter money”, where governments run deficits that are financed by the central bank. For a man of the mainstream, this is brave stuff.

Fractional reserve banking is inherently unstable and responsible for many of the problems in our economic system, but abandoning it completely in favor of “narrow banking”, where deposits are fully-backed by government bonds, seems unnecessary. Increasing Tier 1 capital requirements to 10 percent of total exposure, from the current 3 to 5 percent, should provide a sufficient buffer to withstand most financial shocks. Rapid expansion of credit during an asset bubble would be difficult, with high capital requirements forcing banks to be more selective in their lending. Even more so if supplemented by central bank monetary policy to counteract rapid deposit growth.

August 28, 2014

Banks hold more risk than before GFC | Chris Joye

Chris Joye explains why risk-weighted capital ratios used by Australia’s major banks are misleading and why true leverage is more than 20 times tier 1 capital.

It was only after 2008 when regulators allowed the majors to slash risk-weightings on home loans from 50 per cent to 15 per cent today that we have seen their reported and purely academic tier one capital measured against these newly “risk-weighted” loan assets which shrunk in value spike from 6.7 per cent in December 2007 to 10.5 per cent in June 2014.

By arbitrarily boosting the risk-free share of major bank home loans from 50 per cent to 85 per cent via the regulatory artifice that is a risk-weighting, one gets the fictional jump in their tier one capital that everyone believes is real.

August 22, 2014

Putin antics fail to impress markets

For all his macho posturing, Vladimir Putin has demonstrated an inability to move financial markets with his antics in Eastern Ukraine. His latest incursion towards Luhansk, with white-painted military trucks bearing aid to the rebel-held city, unchecked by the Red Cross, passed barely noticed. Instead markets are intently focused on nuances from a 68-year old Jewish mum at Jackson Hole, who also happens to chair the Federal Reserve.

I would have loved to call Janet Yellen a “grandmother”, but son Robert Akerlof — himself a PhD in Economics — does not claim any offspring on his CV. The apple doesn’t fall far from the tree. Husband, George Akerlof, is a Nobel prize-winning economist and professor emeritus at University of California, Berkeley.

The image below highlights the differences between the Fed and the ECB:

European unemployment is nearly twice the rate in the U.S.: http://t.co/ELXH1YcCcw pic.twitter.com/i5FQ1YvXBk

— Bloomberg News (@BloombergNews) August 22, 2014

The Fed’s more stimulatory approach has paid dividends in terms of economic growth and employment while inflation expectations remain muted. The inflation breakeven rate — 10-year Treasury yield minus the yield on equivalent inflation-indexed securities — continues to range between 2.0% and 2.50%.

Inflation breakeven rate

The ECB’s more austere approach, on the other hand, has caused a world of pain.

Market update

S&P 500 tests 2000.
VIX continues to indicate a bull market.
DAX hesitant rally.
China bullish.
ASX 200 faces strong resistance.

The S&P 500 hesitated after making a new high on Thursday, but there was no dramatic fall in response to news from Eastern Ukraine. Expect retracement towards 1950, followed by another test of 2000. 21-Day Twiggs Money Flow is likely to re-test the zero line, but respect would indicate strong buying pressure. Breach of support at 1900, warning of a reversal, remains unlikely.

S&P 500

* Target calculation: 1500 + ( 1500 – 750 ) = 2250

Declining CBOE Volatility Index (VIX) indicates low risk, typical of a bull market.

S&P 500 VIX

Germany’s DAX rallied above 9300 on the weekly chart, but 13-week Twiggs Money Flow warns of continued selling pressure. Reversal below support at 8900/9000 would warn of a primary down-trend.

DAX

* Target calculation: 9000 – ( 10000 – 9000 ) = 8000

Shanghai Composite Index is testing resistance at 2250. Breakout would confirm a primary up-trend, signaling an advance to 2500*. Rising 13-week Twiggs Money Flow indicates medium-term buying pressure. Respect of resistance, however, would suggest further consolidation.

Shanghai Composite Index

* Target calculation: 2250 + ( 2250 – 2000 ) = 2500

Tall wicks on ASX 200 daily candles indicate strong resistance at 5650. Respect would suggest retracement to 5550, while follow-through would be a strong bull signal, suggesting an advance to 5850*. Another 21-day Twiggs Money Flow trough above zero would indicate long-term buying pressure. Reversal below 5450 is unlikely, but would warn of a test of primary support.

ASX 200

* Target calculation: 5650 + ( 5650 – 5450 ) = 5850

August 22, 2014

Bank chiefs in last-ditch plea to David Murray on tougher rules | The Australian

From Richard Gluyas at The Australian:

THE four major-bank chief executives have each made an eleventh-hour appeal to members of the Murray financial system inquiry ahead of Tuesday’s closing date for final submissions, as concerns mount that the sector could be forced to hold even higher levels of bank capital due to the inquiry’s emphasis on resilience. The closed-door meetings with the inquiry panel members come as Steven Munchenberg, chief executive of peak lobby group the Australian Bankers’ Association, said the industry was “jittery” about the inquiry’s focus on balance-sheet resilience because more onerous capital requirements would affect the banks’ ability to lend and serve the economy.

I disagree. Banks with strong balance sheets are better able to serve the needs of the economy. Highly leveraged banks leave the economy vulnerable to a financial crisis and are more likely to contract lending during periods of economic stress.

The shrill outcry may have something to do with the impact on bankers bonuses. Incentives based on capital employed would shrink if shareholder’s capital is increased.

Bank shareholders on the other hand are likely to benefit from stronger balance sheets. Reduced default risk is likely to enhance market valuation metrics like price-earnings multiples. Reduced risk premiums will also lower cost of funding and enhance lending margins. And shareholders are also likely to benefit from enhanced growth prospects. Analysis by the Bank for International Settlements in the post crisis period shows banks with higher capital ratios experience higher asset and loan growth.

August 22, 2014

Bank Watch: US Tsy’s OFR Finds Risk Weighting Has No Clothes | MNI

Denny Gulino writes on recent research commissioned by Treasury Department’s Office of Financial Research (“OFR”) to investigate the validity of using risk-weightings to determine bank capital requirements:

On risk weighting, OFR commissioned researchers Paul Glasserman at Columbia University and Wanmo Kang of the Korea Advanced Institute of Science and Technology to examine the subject from the ground up. As much as the practice has been incorporated in regulatory parlance, they were able to find very little other research on the validity of the weighting methodology.

“Risk weights implicitly assign prices in terms of additional capital to asset categories and thus inevitably create incentives for banks to choose some assets over others,” they wrote.

“Surprisingly,” they went on, “the ideal risk weights turn out to have little to do with risk and are instead proportional to the profitability on each asset.”

August 22, 2014

Paul Krugman: Hawks Crying Wolf | NYTimes.com

According to a recent report in The Times, there is dissent at the Fed: “An increasingly vocal minority of Federal Reserve officials want the central bank to retreat more quickly” from its easy-money policies, which they warn run the risk of causing inflation…

…The Times article singles out for special mention Charles Plosser of the Philadelphia Fed, who is, indeed, warning about inflation risks. But you should know that he warned about the danger of rising inflation in 2008. He warned about it in 2009. He did the same in 2010, 2011, 2012 and 2013. He was wrong each time, but, undaunted, he’s now doing it again…