Translation from an interview by Marcel de Boer & Martin Visser with Willem Buiter, chief economist at Citgroup:
Is Europe creating zombie banks?
These already exist. Most of the banks are zombie banks. There is little new lending to businesses and households. Zombie banks will not offer credit even on good projects — that is already evident on a large scale.
Full article (in Dutch) at ‘De meeste banken zijn zombiebanken’ | Het Financieele Dagblad.
The S&P 500 managed to close at a new high, with most fund managers reporting good results for the quarter, but does this signal a new bull market or a last-gasp effort to lock in performance bonuses before the market subsides into a correction?
While markets may be rising, there is strong risk aversion.
“@bespokeinvest: Utilities P/E now up to 16.75, higher than the P/Es of Tech, Financials, Industrials, Health Care, Energy and Materials.”
— Downtown Josh Brown (@ReformedBroker) March 28, 2013
This is definitely not a classic bull market.
One also needs to be wary of September and March quarter-ends. They often represent significant turning points, with new highs (red arrows) and new lows (green arrows) frequently proving unsustainable.
* Target calculation: 1530 + ( 1530 – 1485 ) = 1575
While there is no sign of divergence on 13-week Twiggs Money Flow, which would indicate unusual selling pressure, it is important to remain vigilant over the next quarter rather than blindly follow the herd. Bearish (TMF) divergence or reversal of the S&P 500 below 1500 would warn of a correction.
Interesting discussion on Bloomberg about currency-backed deposits and equity-funded loans.
The fractional reserve banking system is the primary cause of instability and asset bubbles in the global economy, allowing banks to create money out of thin air. Credit expansion above the rate of real GDP growth has only two possible consequences: inflation or asset bubbles. Both do serious long-term damage to the economy.
Under the current system, banks create new money by making loans where they don’t have deposits. The recipient of the loan generally deposits the money back in the banking system, allowing banks to fund newly-created loans with newly-created deposits. The fractional reserve system enables banks to rapidly expand credit as demand grows, but at the risk of creating a bubble.
Requiring banks to hold 100% reserves against deposits — either government bonds and short-term bills or central bank deposits — would remove the risk of bank runs and the need for deposit insurance. It would also eliminate bank bailouts and the subsidy of too-big-to-fail banks by the taxpayer. Volcker rule restrictions on proprietary trading would become unnecessary, with banks no longer able to bet with their customers’ money.
Credit would be equity-funded rather than deposit funded. While this model may seem strange to the reader, it was successfully used by German banks to fund Germany’s industrial expansion in the early 20th century and is still employed by investment banks and private equity funds to finance major ventures today. Islamic banks follow similar principles.
It would be a fairly simple exercise to structure different tiers of equity — with commensurate returns — that participate in different levels of risk. Banks would not be restricted from issuing bonds, but the ratio of debt to equity and access to the retail market could be strictly controlled by regulators.
Fractional reserve banking is not an essential component of capitalism. All that we need is an efficient financial intermediary to channel savings into capital investment. When one considers the costs of the present system — especially the massive wealth destruction wrought by an unstable banking system — the alternative is a lot more appealing.
Felix Salmon makes this succinct observation:
If a gaffe is what happens when a politician accidentally tells the truth, what’s the word for when a politician deliberately tells the truth? Dutch finance minister Jeroen Dijsselbloem, the current head of the Eurogroup, held a formal, on-the-record joint interview with Reuters and the FT today, saying that the messy and chaotic Cyprus solution is a model for future bailouts.
Those comments are now being walked back, because it’s generally not a good idea for high-ranking policymakers to say the kind of things which could precipitate bank runs across much of the Eurozone. But that doesn’t mean Dijsselbloem’s initial comments weren’t true; indeed, it’s notable that no one’s denying them outright…..
Read more at The Dijsselbloem Principle | Felix Salmon.
Houses & Holes at Macrobusiness reports on macroprudential steps being considered by the RBNZ. Macroprudential regulation are measures aimed to mitigate the risk of the financial system as a whole, or systemic risk, as opposed to the risk to individual participants.
The [Reserve Bank of New Zealand] says it wants to increase the amount of capital the country’s big four banks must set aside to cover potential losses from high loan to valuation ratio (LVR) home loans. Such a move would, in theory at least, make such lending more expensive for the banks.
Read more at RBNZ steps closer to macroprudential | | MacroBusiness.
The S&P 500 continues to find support above 1540 on the daily chart. Breakout above 1565 would signal another advance. A higher trough on 21-day Twiggs Money Flow would indicate medium-term buying pressure. Breach of the rising trendline is unlikely at present but would warn of a correction. Target for the current advance is 1600*.
* Target calculation: 1530 + ( 1530 – 1485 ) = 1575
VIX Volatility Index remains near its 2005 lows at 0.10. This does not offer much reassurance as volatility can rapidly spike. Breakout above the quarterly high at 0.20 would be a warning sign.
Bellwether transport stock Fedex dipped below $100 after an earnings disappointment. Reversal below the rising trendline at $85 would warn that the broader economy is slowing.
The Nasdaq 100 continues to struggle with resistance at 2800. Declining relative strength against the S&P 500 illustrates how blue chips are being favored over tech stocks. Bearish divergences on both 13-week Twiggs Momentum and 13-week Twiggs Money Flow warn of another correction. Reversal below the latest rising trendline would strengthen the signal. Follow-through above 2900 is unlikely at present, but would signal an advance to 3300*. Only breach of primary support at 2500 would signal a reversal.
* Target calculation: 2900 + ( 2900 – 2500 ) = 3300
While there are structural flaws in the US economy, the market is gaining momentum and the current advance shows no signs of ending.
The Committee continues to see downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
I always enjoy Martin Wolf’s objectivity:
Many insist that any tax on deposits is theft. This is nonsense. Banks are not vaults. They are thinly capitalised asset managers that make a promise – to return depositors’ money on demand and at par – that cannot always be kept without the assistance of a solvent state. Anybody who lends to banks has to understand that. It is inconceivable that banking – a risk-taking financial business – can operate without exposure to loss of at least some classes of lenders. Otherwise, bank debt is government debt. No private business can be allowed to gamble with taxpayers’ money in this way. That is evident.
Read more at Big trouble from little Cyprus – FT.com.
Lars Christensen describes how NGDP targeting would help the global economy withstand shocks like another eurozone crisis:
Lets look at two different hypothetical US monetary policy settings. First what we could call an ‘adaptive’ monetary policy rule and second on a strict NGDP targeting rule.
‘Adaptive’ monetary policy – a recipe for disaster
By an adaptive monetary policy I mean a policy where the central bank will allow ‘outside’ factors to determine or at least greatly influence US monetary conditions and hence the Fed would not offset shocks to money velocity…..
In that sense under an ‘adaptive’ monetary policy the Fed is effective[ly] allowing external financial shocks to become a tightening of US monetary conditions. The consequence every time that this is happening is not only a negative shock to US economic activity, but also increased financial distress – as in 2008 and 2011.
NGDP targeting greatly increases global financial stability
If the Fed on the other hand pursues a strict NGDP level targeting regime the story is very different.
Lets again take the case of an European sovereign default. The shock again – initially – makes investors run for safe assets. That is causing the US dollar to strengthen, which is pushing down US money velocity (money demand is increasing relative to the money supply). However, as the Fed is operating a strict NGDP targeting regime it would ‘automatically’ offset the decrease in velocity by increasing the money base (and indirectly the money supply) to keep NGDP expectations ‘on track’. Under a futures based NGDP targeting regime this would be completely automatic and ‘market determined’.
Hence, a financial shock from an euro zone sovereign default would leave no major impact on US NGDP and therefore likely not on US prices and real economic activity…..
Read more at Fed NGDP targeting would greatly increase global financial stability | The Market Monetarist.
The outcry over Cyprus levy on depositors in defaulting banks raises the question: Why were depositors not more wary of where they deposited their funds? Not all banks are created equal. The reason is deposit insurance for deposits under €100,000 implied that the government would stand behind its banks and rescue depositors should the banks ever default. The problem is that no one considered the possibility that all the banks would suffer losses sufficient that the government would be forced to default on both its explicit and implied obligations.
Some time ago I wrote about the moral hazard of deposit insurance:
Deposit Insurance: When too much of a good idea becomes a bad idea
Deposit insurance was introduced in the 1930s and saved the US banking system from extinction. Administered by the FDIC, and funded by a levy on all banking institutions, deposit insurance, however, encourages moral hazard. Depositors need not concern themselves with the solvency of the bank where they deposit their funds so long as deposits are FDIC insured. High-risk institutions are able to compete for deposits on an equal footing with well-run, low-risk competitors. This inevitably leads to higher failure rates, as in the Savings & Loan crisis of the 1980s.
The FDIC does a good job of policing deposit-takers, but no regulator can substitute for market forces. Deposit insurance is critical during times of crisis, but should be scaled back when the crisis has passed. Either limit insured deposits to say $20,000 or only insure deposits to say 90% of value, where the depositor takes the first loss of 10%. That should be sufficient to keep depositors mindful as to where they bank. And restore the competitive advantage to well-run institutions.
Requiring depositors to take the first loss of 10 percent should be standard practice for deposit insurance. The same should hold true for bank creditors. But we need to distinguish between insolvency — where liabilities exceed assets — and a liquidity event where the central bank is only called on to provide temporary respite. If the bank is rescued from insolvency by the regulator, bond holders should be required to take an equivalent haircut — painful yet not life-threatening. No one is entitled to a free ride. And bank shareholders, if a there is a bail-out, should lose everything — similar to the Swedish approach in the 1990s.
