Regional Banks

While many impartial observers have been lamenting the death of Abenomics now that the Nikkei - essentially the only favorable indicator resulting from the coordinated and unprecedented action by the Japanese government and its less than independent central bank - has peaked and dropped 20% from the highs, Wall Street was largely mum on its Abenomics scorecard. This changed overnight following a scathing report by Goldman which slams Abenomics, it sorry current condition, and where it is headed, warning that unless the BOJ promptly implements a set of changes to how it manipulates markets as per Goldman's recommendations, the situation will get out of control fast. To wit: "Our conclusion is that the positive market reaction initially created by the policy has been almost completely undone. At the same time, a lack of credible forward guidance for policy duration means that five-year JGB yields have risen in comparison with before the easing started, and volatility has also increased. It will not be an easy task to completely rebuild confidence in the BOJ among overseas investors after it has been undermined, and the BOJ will not be able to easily pull out of its 2% price target after committing to it."

"... equity markets were quick to shrug off the uncertainty and extended their gains as investors expected poor fundamentals to be followed by further policy easing."

It doesn't take an Econ Ph.D to realize that what Japan is trying to do: which is to recreate the US monetary experiment of the past four years, which has had rising stocks and bonds at the same time, the first due to the Fed's endless monetary injections (and pent up inflation expectations) and the second due to quality collateral mismatch and scarcity and shadow bank system funding via reserve currency "deposit-like" instruments such as TSYs, is a problem. After all, those who understand that the BOJ is merely taking hints from the Fed all along the way, have been warning about just that, and also warning that once the dam breaks, and if (or when) there is a massive rotation out of bonds into stocks, it is the Japanese banks - levered to the gills with trillions of JGBs - that will crack first. Apparently, this elementary finance 101 logic has finally trickled down to the BOJ, whose minutes over the weekend revealed that members are pointing out "contradictions" in the Kuroda-stated intent of doubling the monetary base in two years, unleashing inflation, sending the stock market soaring, all the while pressuring bondholders to not sell their bonds. As the FT reports, "According to the minutes of the April 26 policy meeting, released on Monday, a “few” board members said the BoJ’s original stance “might initially have been perceived by market participants as contradictory”, causing “fluctuations in financial markets”.

In the 1940s, the Fed adopted pegging operations to protect the financial system against rising interest rates and to ensure the smooth financing of the war effort. In effect, the Fed became part of the Treasury’s debt management team; as the budget deficit hit 25% of GDP in WW2, it capped 1Y notes at 87.5bps and 30Y bonds at 2.5%. From the massive bond holdings of its domestic banks to its exploding public debt, Japan today faces a situation very similar to the US in the 1940s. When the long-term rate climbs above 2%, the BoJ will probably adopt outright measures to underpin JGB prices to prevent turmoil in the financial system and a fiscal crisis - and just as Kyle Bass noted yesterday, they are going to need a bigger boat as direct financial repression in Japan is unavoidable.

Despite the eagerness of Abenomics and the new BOJ head Kuroda to have their cake and eat it too, in this case manifesting in soaring stock prices, plunging Yen, rising GDP and exports, and most importantly, flat or declining bond yields, so far they have succeeded in carrying out three of the four, as it is physically impossible for any central planner to completely overrule the laws of math, economics and physics indefinitely. Volatility aside the recent surge in yields higher is finally starting to take its tool on domestic bond issuers. As Bloomberg reports, already two names have pulled deals from the jittery bond market due to "soaring" borrowing costs. The first is Toyota Industries which as NHK reported, canceled the sale of JPY20 billion debt. Toyota is among Japanese firms that put off selling debt as long-term yields on government debt have risen, increasing borrowing costs, public broadcaster NHK says without citing anyone. Last week JFE Holdings announced it would delay plans to sell bonds due to market volatility. So two names down... and the 10 Year is not even north of 1%... But perhaps, more importantly, what happens to JGB holdings as the benchmark Japanese government bond continues trading with the volatility of a 1999 pennystock, and as more and more VaR stops are hit, forcing even more holders to dump the paper out of purely technical considerations: a topic we touched upon most recently last week, and which courtesy of JPM, which looks back at exactly the same event just 10 years delayed, now has a name: VaR shocks.  For those who wish to skip the punchline here it is:  A 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan's banks.

We have long discussed the problem that the Japanese government faces if interest rates in the troubled nation rise (cost of debt financing will swamp revenues in a vicious circle); but now it seems there is another - just as vicious - problem (that the BoJ is set to discuss according to Nikkei). The inability of the BoJ to 'control' Japanese interest rates (JGB rates spiking unprecedentedly day after day) has put the banking system in a lot of trouble. As we explained recently the banks appeared to initially 'hedge' their huge JGB positions but now appear to recognize that first out wins and are reducing exposure overall (YTD -3.7% according to local data). The reason - simple - as the IMF explains via the BoJ - according to BOJ estimates (footnote 4), a 100bp (parallel) rise in market yields would lead to mark-to-market (MTM) losses of 20% of Tier-1 capital for regional banks and 10% for the major banks. He who sells first wins...

What once used to be a field in which men of towering intellect tried to establish, discuss and lay down the tenets of what was widely considered an entirely new science as recently as the late 19th century, has become a field in which a great many rather mediocre intellectuals are mainly serving the interests of the State. Nassim Taleb recently too to task a number of the so-called mainstream economists - assessing and analyzing the flaws of modern policy-making and central economic planning as well as the fractionally reserved banking system. We wish him success in tackling the handmaidens of statism and their pseudo-scientific output. Anyone criticizing the producers of fig leaves for interventionism deserves our support. Of course, if an economist rejects interventionism and supports the establishment of an unhampered free market, then there is obviously no role for him as an 'economic planner' and 'adviser to policymakers' (except for advising them to stay the hell out of the economy and stop meddling with it). 

“… current policies come with a cost even as they act to magically float asset prices higher…, a bond and equity investor can choose to play with historically high risk to principal or quit the game and earn nothing."  Bill Gross, PIMCO

After showing Ireland's biggest banks failed to report borrowings/encumbrances, I give EVERYONE means to play credit analyst. Calculate Ireland needing another bailout right here (hint: this app probably shames your favorite ratings agency).

It begins here: Introduction of cold, hard evidence of bank shenanigans (with complete documentation) that A) should be prosecuted & B) cause enough concern to make you worry about your bank's integrity. 

It's not just Cyprus, and no - it's not just Canada either. I'm preparing a list of specific banks that I have 1st hand knowledge that would prevent me from keeping my money in them. Get "Cyprus'd"!!!

This in a nutshell is Europe’s financial system today: a totally insolvent sewer of garbage debt, run by corrupt career politicians who have no clue how to fix it or their economies… and which results in a big fat ZERO for those who are nuts enough to invest in it.

If it ain't broke, how do you fix it? Here are a variety of solutions from practictioners, academics and investors.

Latest from my friend David Kotok.  I think both he and Meredith Whitney are too bullish on the banks

After having less than half the total US deposits back in 2005, China has pumped enough cash into the economy using various public and private conduits to make even Ben Bernanke blush: between January 2005 and January 2013, Chinese bank deposits have soared by a whopping $11 trillion, rising from $4 trillion to $15 trillion! We have no idea what the real Chinese GDP number is but this expansion alone is anywhere between 200 and 300% of the real GDP as it stands now. And more: between January 2012 and January 2013 Chinese deposits rose by just over $2 trillion. In other words, while everyone focuses on Uncle Ben and his measly $1 trillion in base money creation in 2013 (while loan creation at commercial banks continues to decline), China will have created well more than double this amount of money in the current year alone!