Browsing Category: "Banking"
Below is the long term chart of the eurodollar (ED) yield, showing the effects of a decade of money printing and bubble blowing. In the last two years this has created what I have called the central bank or Wizard of Oz bubble. This bubble and all its correlated bubbles were caused by the willingness of central bankers to purchase, lend against and then hold trillions of dollars of overvalued securities. This bill of goods was sold as ‘emergency measures,’ and investors remain convinced that the mere 33 basis point interest rate reflected in the eurodollar market will and can be supported by a continuation of the emergency.
Conventional thinking is that purchases of inflated securities and money printing that goes with it are just business-as-usual instead of a freak show. In addition, it’s assumed that trillions in kick-the-can-down-the-road private debt maturities, for sure trillions more of debt sovereign debt offerings, and maturities are on the way. Oz has a heavy burden to carry indeed.
The blowback to all this activity should be apparent to any thinking person: a bagunca (mess) of destabilizing global inflation starving returns of prudent savers down to nothing; real, defacto or implied bailouts of too-many-to-count toxic basketcases; and an incredible return of moral hazard behavior and speculation. Of course you are going to see artificial maladjusted economic activity from this, at least for a short while. It is all a trap.
The logical end of the line for horrific ‘temporary emergency’ policies will be a chain reaction of sovereign defaults, insolvencies, debt restructuring, and losses for bond holders . Although this hasn’t happened formally, bondholders who bought 10-year Treasuries in Portugal eighteen month ago now have a 24% loss on principal. These are not reflected on bank balance sheets. Simply put, the yields on PIGGS sovereign debt (and elsewhere) are not about liquidity and confidence – they are about debt trapped insolvency.
Blow ups will come when players at various points along the daisy chain take big losses that can’t be supported by the Wizard of Oz or governments. In fact Oz itself will suffer big losses once the Ponzi chain breaks. The uninitiated can start here (If Only PIGGS Could Fly) for an understanding of just some of the various candidates for sovereign defaults. Historically, because of the linkages, these will come in bunches.
Portugal
Ireland
Greece
Ever since QE2 began I have been eying a short of the ED. True, there is a carry cost to shorting them. But with the implied yield at about 33 basis points (bp), that carry is now reduced to less than .275 bp per month (about $ 275 on a million contract). It is important to understand that this is a financial future, not a currency – you are not shorting the euro.
Eurodollars are foreign dollar deposits outside the U.S. banking system in foreign banks. Despite the name, these are not just European banks, although those would constitute the majority. Some are in the Middle East in places such as Bahrain (Forces Fire on Protesters). So in essence, eurodollars are dollar deposits in non-U.S. banks.
One contract tracks the 3-month London Interbank Offer Rate (LIBOR) on million-dollar offshore deposits. LIBOR is the rate that the commercial banks charge each other for overnight lending in the international market and is considered to be a global benchmark for short term interest rates. Contract specifications are laid out here. For risk management purchases, I would collaborate about $ 2,000 as the loss per contract, which would put the ED yield at 15 BP, and cover a month’s carry.
So what would make this trade work? Traditionally it has traded as a Fed policy instrument; now it seems monopolized by it . When the Fed eases or is active, traders bid up EDs. Therefore if Oz is forced by the howls of inflation to climb off the cliff, or waffles on QE3, this market will sell off. If Oz (the Fed) actually moved to tighten, it will sell off even more so. Although I assign a higher probability of this happening than conventional wisdom, I am not counting on this element. As far as being inflation fighters, Oz has an incredible capacity to call inflation such as the MIT billion price survey ‘temporary’ or irrelevant just like their emergency measures were temporary. Regardless, once the party ends, Oz will permanently lose what little creditability it never should of had. That is another reason I don’t see any market downturn as temporary.
But I digress, as the real appeal to this trade is not Fed-watching but elsewhere. How much lower can the ED yield go? Stranger things are happening, but will deposits stay in foreign banks if yields are 25 bp, or 20 bp? Bizzarro world at this stage is a manageable risk – it is not like we are dealing with 400 bp of downside to zero. Of course the trade might just sit there for a while, like watching paint dry.
However, in the short term I would point out a two day spike in emergency borrowings from the ECB, an event which in normal times with fewer Oz-induced comatose market participants would get more attention. More importantly though, are corporate CFOs and Treasurers sitting at their terminals with hair triggers ready to blow this popsicle stand (a bank run) once the wheels come off these European or Middle Eastern banks. It could just as easily be a state or local U.S. blowup that triggers it.
Who in their right mind accepts 33 basis points - Oz-backed returns in an insolvent banking system dependent on expensive government interventions? Numb to the risk, markets are counting on more bailouts and money printing in Europe, with estimates of 400-500 billion euros for the next round. In reality a lot could hit the fan over the next month. There is an election in Ireland on Feb. 25, and likely winners aren’t bank friendly.
“We believe that Ireland may be left with no option, in the absence of a renegotiated deal, but to write down the value of the bonds in the Irish banks or face the prospect of a hugely damaging sovereign default”- Fine Gael, Irish Opposition Party, February 2, 2011
There are four German regional elections over the next month, and anti-bailout political sentiment is high. The last European meeting failed to reach consensus on a resolution mechanism. In the midst of it all a special eurozone debt crisis summit is scheduled for March 11th. And finally a boatload of debt is maturing in Europe over the next month.
Disclosure: I am short March eurodollars
Editor’s note: Investors may want to consider the following international interest-rate ETFs as a proxy for eurodollars: IGOV, ISHG, BWX, BWZ
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Regardless of how much closer Obama’s budget brings our economy into a balance of payments not seen since 2001, we will continue to run deficits for the next decade, and the national debt will keep growing every year that happens.
While most of the country’s $ 14 trillion debt is held by private banks in the U.S., the Treasury Department and the Federal Reserve Board estimate that, as of December, about $ 4.4 trillion of it was held by foreign governments that purchase our treasury securities much as an investor buys shares in a company and comes to own his or her little chunk of the organization.
Looking at the list of our top international creditors, a few overall characteristics show some interesting trends: Three of the top 10 spots are held by China and its constituent parts, and while two of our biggest creditors are fellow English-speaking democracies, a considerable share of our debt is held by oil exporters that tend to be decidedly less friendly in other areas of international relations.
Here we break down the top 10 foreign holders of U.S. debt, comparing each creditor’s holdings with the equivalent chunk of the United States they “own,” represented by the latest (2009) state gross domestic product data released by the U.S. Bureau of Economic Analysis. Obviously, these creditors won’t actually take states from us as payment on our debts, but it’s fun to imagine what states and national monuments they could assert a claim to.
 ©Radar Communication |
1. Mainland China
Amount of U.S. debt: $ 891.6 billion
Share of total foreign debt: 20.4%
Building on the holdings of its associated territories, China is the undisputed largest holder of U.S. foreign debt in the world. Accounting for 20.4% of the total, mainland China’s $ 891.6 billion in U.S. treasury securities is almost equal to the combined 2009 GDP of Illinois ($ 630.4 billion) and Indiana ($ 262.6 billion) in 2009, a shade higher at a combined $ 893 billion. As President Obama — who is from Chicago — wrangles over his proposed budget with Congress he may be wise to remember that his home city may be at stake in the deal.
2. Japan
Amount of U.S. debt: $ 883.6 billion
Share of total foreign debt: 20.2%
The runner-up on the list of our most significant international creditors goes to Japan, which accounts for over a fifth of our foreign debt holdings with $ 883.6 billion in U.S. treasury securities. That astronomical number is just shy of the combined GDP of a significant chunk of the lower 48: Minnesota ($ 260.7 billion), Wisconsin ($ 244.4 billion), Iowa ($ 142.3 billion) and Missouri ($ 239.8 billion) produced a combined output of $ 887.2 billion in 2009.
3. United Kingdom
Amount of U.S. debt: $ 541.3 billion
Share of total foreign debt: 12.4%
At number three on the list is perhaps our closest ally on the world stage, the United Kingdom (which includes the British provinces of England, Scotland, Wales and Northern Ireland, as well as the Channel Islands and the Isle of Man). The U.K. holds $ 541.3 billion in U.S. foreign debt, which is 12.4% of our total external debt. That amount is equivalent to the combined GDP of two East Coast manufacturing hubs, Delaware ($ 60.6 billion) and New Jersey ($ 483 billion) — which was named, yes, after the island of Jersey in the English Channel. The two states’ combined output in 2009 came to $ 543.6 billion.
4. Oil Exporters
Amount of U.S. debt: $ 218 billion
Share of total foreign debt: 5%
Another grouped entry, the oil exporters form another international bloc with money to burn. The group includes 15 countries as diverse as the regions they represent: Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria. As a group they hold 5% of all American foreign debt, with a combined $ 218 billion of U.S. treasury securities in their own treasuries. That’s roughly equivalent to the combined 2009 GDP of Nebraska ($ 86.4 billion) and Kansas ($ 124.9 billion), which seems to be an equal trade: The two states produce a bunch of grain for export, which many of the arid oil producers tend to trade for oil.
 ©MS Illustration/Public Domain |
5. Brazil
Amount of U.S. debt: $ 180.8 billion
Share of total foreign debt: 4.1%
Rounding out the top five is the largest economy in South America, Brazil. The country known for its beaches, Carnaval and the unbridled hedonism that goes along with both has made a big investment in the U.S., buying up $ 180.8 billion in American debt up to December. That’s almost equal to the $ 180.5 billion combined GDP of Idaho ($ 54 billion) and Nevada ($ 126.5 billion), a state that is no stranger to hedonism itself.
6. Caribbean Banking Centers
Amount of U.S. debt: $ 155.6 billion
Share of total foreign debt: 3.6%
You have to have cash on hand to buy up U.S. government debt, and offshore banking has given six countries the combined capital needed to make the Caribbean Banking Centers our sixth-largest foreign creditor. The Treasury Department counts the Bahamas, Bermuda, the Cayman Islands, the Netherlands Antilles, Panama and the British Virgin Islands in this designation, which as a group holds $ 155.6 billion in U.S. treasury securities. That’s equivalent to the GDP of landlocked Kentucky ($ 156.6 billion), whose residents may not actually mind if they were ever to become an extension of some Caribbean island paradise.
7. Hong Kong
Amount of U.S. debt: $ 138.2 billion
Share of total foreign debt: 3.2%
At No. 7 on the list of our foreign creditors is Hong Kong, a formerly British part of China that maintains a separate government and economic ties than the communist mainland. With $ 138.2 billion in U.S. treasury securities, the capitalist enclave could lay claim to Yellowstone Park and our nation’s capital: The combined GDP of Wyoming ($ 37.5 billion) and Washington D.C. ($ 99.1 billion) totaled $ 136.6 billion in 2009.
 ©MS Illustration/Public Domain |
8. Canada
Amount of U.S. debt: $ 134.6 billion
Share of total foreign debt: 3.1%
They say that a friend in need is a friend indeed, and our neighbor to the north has proven to be a kind and generous creditor in our time of financial need. Canada holds about 3.1% of our foreign debt, or $ 134.6 billion. If friend were to become enemy and Canada were looking to annex some U.S. land to cover the debt though, the country would have an easy time of it. The combined GDP of Maine ($ 51.3 billion), New Hampshire ($ 59.4 billion) and Vermont ($ 25.4 billion) comes close to Canada’s debt holdings at $ 136.1 billion.
Residents of the three states in our extreme northeast corner should start practicing their French: They might become Québécois one of these days.
9. Taiwan
Amount of U.S. debt: $ 131.9 billion
Share of total foreign debt: 3.0%
Taiwan, an island barely 100 miles off the coast of China, is claimed by the People’s Republic of China, despite having its own government and economic relations with the outside world. Part of those economic relations includes the island’s holding of $ 131.9 billion of U.S. debt, roughly equivalent to the combined GDP of West Virginia ($ 63.3 billion) and Hawaii ($ 66.4 billion), which totals $ 129.7 billion.
Unless we get our spending in check, we risk losing some of our most visually stunning territory (West Virginia, obviously) to our friendly neighbors on the other side of the Pacific Ocean.
10. Russia
Amount of U.S. debt: $ 106.2 billion
Share of total foreign debt: 2.4%
Starting off the list of our major foreign creditors is Russia, which holds about 2.4% of the U.S. debt pie that sits on the international dinner table. Its $ 106.2 billion in treasury securities is equivalent to the 2009 GDP of our sparsely populated North: The combined output of North Dakota ($ 31.9 billion), South Dakota ($ 38.3 billion) and Montana ($ 36 billion) matches up nicely with the Russian holdings, at $ 106.2 billion.
Let’s hope Russian president Dmitry Medvedev doesn’t come to collect.
China faces a 60 percent risk of a banking crisis by mid-2013 in the aftermath of record lending and surging property prices, according to a Fitch Ratings gauge.
Fitch sees the risk of “holes in bank balance sheets” should a property bubble burst, Richard Fox, a London-based senior director, said in a phone interview on March 4. The risk assessment is from a macro-prudential monitor used by the ratings company.
Chinese banks fueled record property-price gains by extending a record 17.5 trillion yuan ($ 2.7 trillion) of loans over 2009 and 2010 under the stimulus program that propelled the nation through the financial crisis. Regulators’ efforts to contain the risks for lenders have included stress tests for declines in house prices and a crackdown on lending to local- government financing vehicles.
China’s risk of a systemic crisis is based on the nation’s MPI3 classification, the highest of three risk categories, in a Fitch monitor begun in 2005. The indicator signaled crises in Iceland and Ireland and has been tested back to the 1980s, Fox said.
In contrast with Fitch’s concern, the Hang Seng Finance Index (HSF), which includes five Chinese banks traded in Hong Kong, advanced 1.5 percent as of 3:34 p.m. local time.
Depleted Capital
Fitch follows an International Monetary Fund definition of a systemic financial crisis, Fox said. Such crises exhaust “all or most of the aggregate banking system capital,” cause a “large number of defaults” and “financial institutions and corporations face great difficulties repaying contracts on time,” according to a November 2008 IMF working paper.
“We’re talking about systemic crises here, affecting most of the major banks,” Fox said. “A crisis is something which technically de-capitalizes the banking system.”
Sixty percent of emerging-market countries downgraded to MPI3 face banking crises within three years, he said. China entered that classification in June. The indicator’s failures have included not sounding an alarm about the banking system in Spain, he added.
Banking systems in emerging markets are vulnerable to systemic stress when credit growth exceeds 15 percent annually over two years with real property prices rising more than 5 percent, according to Fitch.
Wen’s Pledge
Credit growth in China averaged 18.6 percent annually over 2008 and 2009 as house prices jumped, according to the ratings company. Chinese Premier Wen Jiabao pledged more efforts to cool the property market on March 5, telling lawmakers that “exorbitant” increases in housing prices in some cities are a top public concern.
The fallout from China’s lending spree may be bad loans totaling $ 400 billion, according to Hong Kong-based advisory firm Asianomics Ltd.
China is seeking to avoid a repeat of its last banking crisis, when the government spent more than $ 650 billion over a decade to bail out banks after years of state-directed lending.
Fitch’s concern contrasts with gains in banks’ profits and capital adequacy ratios and declines in non-performing loan ratios, according to data released by the China Banking Regulatory Commission.
The industry’s “capitalization has been noticeably strengthened throughout 2010, with capital ratios of major banks being well supportive of their standalone credit profiles,” Liao Qiang, a director of financial institutions ratings for Standard and Poor’s in Beijing said today.
‘Strong Liquidity’
“With reasonable loan loss reserves at present, good pre- provisioning profitability and strong liquidity, Chinese banks are likely to gradually absorb potential spikes in credit costs caused by looming bad loans, particularly from China’s property sector and local government financing platforms,” Qiang said.
Chinese banks listed in Hong Kong will likely report “strong” 2010 earnings when they report at the end of the month, BNP Paribas SA said in a report today.
In November, Moody’s Investors Service said that it had “concerns over the intrinsic, stand-alone strength of China’s banking system.” At the same time, the largest lenders weren’t materially damaged by the global financial crisis and aren’t likely to pose any significant contingent liability risk to the government balance sheet, the ratings company said.
Absorbing Losses
“Furthermore, we expect that future credit losses — arising from the surge in lending in 2009, from exposures to the property market, from risky loans to local government financing vehicles, and from off-balance sheet operations in the ‘shadow’ banking system — will be mostly absorbed by the banks themselves, either from capital, or from future earnings,” Moody’s said in a statement.
To limit risks for banks, China has increased oversight of lending to the local-government vehicles, which surged during the nation’s two-year stimulus program. In a March 5 speech to lawmakers, Wen pledged a “comprehensive audit” of local- government debt, while the Ministry of Finance said separately that “local governments face debt risks that can’t be overlooked.”
Banks have also been told to assign a higher risk rating to local-government loans.
The country’s “systemically important” lenders may be subject to an overall capital adequacy ratio of as high as 14 percent when their credit growth is judged excessive, a person with knowledge of the matter said on Jan. 28. Other lenders would need to meet a 13 percent threshold, the person said. The minimum ratio, used to gauge banks’ ability to withstand financial stress, is currently 11.5 percent for big banks.
Lenders including China Minsheng Banking Corp. and Agricultural Bank of China Ltd. (1288) have announced plans to sell more than 80 billion yuan ($ 12 billion) of shares and 70 billion yuan of subordinated bonds this year.
By Dian L. ChuRisk analysis firm Maplecroft just released its new fiscal risk index ranking of 163 countries. Europe trumps all other regions with 11 out of twelve courtiers rated as “extreme risk.” However, quite surprisingly, only one PIIGS country–Italy which takes the top spot–is in the top 12.
The others include many big economies in Europe – Belgium (2), France (3), Sweden (4), Germany (5), Hungary (6), Denmark (7), Austria (8), United Kingdom (10), Finland (11) and Greece (12). Japan at No. 9 is the only other country not in Europe within the highest risk category (See map below).
Aging Demographics
While high national debt and public spending are two common denominators, the study finds it is the aging demographic that puts these countries at extreme fiscal risk. An aging population will place increasing pressure on public expenditure such as pension and health care, while a shrinking working-age population means less productivity and less tax revenues to support public spending and debt payments.
High Dependency Ratio
Aging population also means high dependency ratio, or the number of people 65 and older to every 100 people of traditional working ages. For example, according to Maplecroft, the dependency ratio in France is 1 to 47 (i.e. 47%), Germany at 59%, Italy with 62%, and Japan at the very top with 74%, while the ratio in UK is currently 25%, and is forecast to rise to 38% by 2050.
Low Senior Labor Participation Rate
Another problem within Europe is that it has the low labor participation rate in the 65+ age bracket. In fact, the labor market participation of age 65+ amongst the ‘extreme risk’ nations range from 1.4% in France, 7.71% in UK, to 11.7% in Sweden, vs. a 28% average across all countries ranked in the index.
Maplecroft cited pensions and discrimination as two examples that would push people away from the work force.
U.S. – High Fiscal Risk
Although the United States is not ranked among the “extreme fiscal risk,” the nation is nevertheless classified as “high risk”, along with Spain, another PIIGS country, Australia, Canada and Russia.
Let’s take a look at the two metrics mentioned here.
The dependency ratio in the U.S. is 22 in 2010, but is projected to climb rapidly to 35 in 2030, according to the U.S. Census Bureau, mainly due to baby boomers moving up into the 65+ age bracket. The ratio then will rise more slowly to 37 in 2050.
The labor participation for age 65 and over in the U.S. is at 17.5 according to data at Bureau of Labor Statistics (BLS). This is better than most of the European countries, but below the overall average of 28%.
U.S. in Wave 2
Most people typically associate a country’s fiscal risk to its government’s monetary and fiscal policies, and Lehman Brothers has taught us that banking and housing crisis could push the entire world into the Great Recession.
While these are all definite risk factors, a highly productive labor force and relatively young population makeup tend to ensure more sustainable prosperity and better odds at climbing out of a hole.
The Maplecroft study concludes:
“…in high risk countries, it is increasingly likely that the private sector will be called upon to contribute in the form of pensions and private health care…. Without significant adjustments, such as raising taxes or reducing spending, countries risk going bankrupt.”
So, while Europe is being forced to do all that amid sovereign debt crisis in the middle of widespread protests over raised pension age and austerity measures, the U.S. and other “high fiscal risk” countries seem be set up as the wave 2 of this global fiscal chain of events.
NEW YORK (AP) — Stocks suffered steep losses as oil prices surged on Tuesday, renewing worries that higher fuel prices could hobble the economic recovery.
Oil rose $ 2.66 to settle at $ 99.63 a barrel amid unrest in Iran and Libya. Iran clamped down on anti-government protesters and forces loyal to Libya’s leader Moammar Gadhafi launched counter-attacks against rebels expanding control over the country.
Prices jumped 13 percent last week with a rise in turmoil across North Africa and the Middle East. That pushed gas prices up 20 cents per gallon. As a result, Americans are now paying roughly $ 75 million more per day to fill their gas tanks than a week ago.
Federal Reserve Chairman Ben Bernanke told the Senate Banking Committee that a sustained increase in crude prices could pose a risk to the recovery. But he predicted only a temporary increase in inflation, not runaway prices. The Fed chief also said he expected the economy to grow this year, although not enough to lower the 9 percent unemployment rate.
The Commerce Department reported that builders began work on fewer homes, offices and commercial projects in January. The annual rate was near its decade low, set in August.
The Dow Jones industrial average lost 168.32 points, or 1.4 percent, to 12,058.02.
The Standard & Poor’s 500 index fell 20.89, or 1.6 percent, to 1,306.33. The Nasdaq composite fell 44.86, or 1.6 percent, to 2,737.41.
Three stocks fell for every one that rose on the New York Stock Exchange. Consolidated trading volume came to 4.8 billion shares.
Fifth Third Bancorp dropped 4.5 percent after the regional bank said that the Securities and Exchange Commission was investigating its accounting and reporting of commercial loans.
Natural gas driller Range Resources Corp. lost 7 percent after the company’s fourth-quarter revenue figures came in below analysts’ expectations. Natural gas prices have been in a slump for the past year as a result of an oversupply in the market.
AutoZone Inc. rose 2 percent after the auto-parts retailer said its second-quarter income rose 20 percent as its revenue increased.
On Monday, stable oil prices and more signs of a stronger economy helped lift. All three major stock indexes ended February higher, marking their third straight month of gains. The S&P 500 index had its best start to any year since 1998.
