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Flawed Fundamentals, Nasty Macro, Structural Industry Change: For Wall Street Banks It Really Is Different This Time

Reggie Middleton's picture




 

During the last market collapse I developed a name for myself calling banking, tech and real estate company collapse.

One of the premises of many of those calls were based upon balance sheet analysis (and common sense). Basically, after mark to market rules were suspended there was a big party since the underwater asset problem had been solved. Everyone just erased and penciled in a new value for said assets... and Voila!

fasb_mark_to_market_chart.png

If only it were that easy... You see, the smoke and mirrors worked (and worked a lot longer than most of us spreadsheet wielding realists would have ever thought - 6 years), but at the end of the day, we all knew that the banking system was rebuilt on matchsticks. Right about New Years, Stacy Herbert and Max Keiser asked me what my prognositication was for the new year. I said equities and real property go boom...

I want to expand on that today. Developed nation bank regulators have tighted rules in an attempt to proof against another market crash and mass bank run. These new rules have materially altered the behavior of big money center banks. For instance, the Wall Street Journal reports: Banks Pitch Swaps as Alternative to Buying Stock, New capital rules prompt banks to seek less-onerous ways to facilitate trades

Banks are nudging certain hedge-fund clients to use derivatives instead of actual stocks when placing some bets, an effort aimed at lessening the impact of new capital rules on the banks’ businesses.

The shift generally involves derivatives called total-return swaps that mimic the effects of owning a stock or other asset. In some instances, banks take less of a balance-sheet hit when they are hedging offsetting client positions targeting the same stock using total-return swaps than they would if the bets were made via securities.

... Banks generally benefit from the tactic when two clients are betting in opposite directions on the same stock, allowing the bank to offset the hedges it often needs to employ when facilitating such trades. In one example, if a bank has two hedge-fund clients who have opposing bets on IBM Corp., with one purchasing the stock in a bet it will rise and the other selling it short in a bet it will fall, the bank under certain circumstances may have to set aside additional capital to facilitate those trades.

But if a bank has two clients using total-return swaps to take opposing bets on the same stock, it could offset the securities it has bought and sold as hedges against those positions so they don’t tie up additional capital.

If the bank had to buy securities to hedge a single client swap, without the offset, the hedge would have gone on its balance sheet.

Units of Bank of America Corp.Goldman Sachs Group Inc., J.P. Morgan Chase & Co.,Morgan Stanley and UBS AG are among those firms asking some of their clients to shift certain trades into total-return swaps instead of the underlying securities, people familiar with the efforts said.

Well, as those of you who follow me know, I've taken time off of my investment advisory business to build digital swaps powered by the blockchain. The startupt venture, Veritaseum, is uniquely positioned to capitalize on this movement because not only is it significantly ahead of most banks efforts in automating swap trading, it eliminates counterparty risk (Veritaseum swaps are trading right now, for over 45k tickers in all asset classes from all major bourses - download the client here). Why is counterparty risk so important? Back to that WSJ article...

..The downside for hedge funds is they could, in some cases, struggle to collect payments owed on a swap if their bank or other trading partner goes belly up.

One hedge-fund executive said his multibillion-dollar firm was avoiding the derivatives and opting to own the actual securities instead in part due to that risk, which he became sensitive to during the financial crisis.

And that pretty much sums it up. Counterparty risk. The big banks are starting to weigh counterparty risk vs profits, and the results are... Cut off the little guys. Here's how that article put it...

Wall Street’s focus on swaps is the latest example of how banks’ prime-brokerage businesses, which execute and finance trades for hedge funds, are changing in light of stricter regulations designed to prevent a repeat of the 2008 financial crisis.

A new slate of rules is raising capital and liquidity requirements for the biggest financial institutions, forcing them to reassess their businesses, shed certain assets and reject some customer activities, like accepting deposits.

Some banks also have been jettisoning hedge-fund clients whose trading strategies they deem too costly to support.

Do realize that not all institutional cleints will have a chance to take advantage of these new bank engineered swaps. After all, the regualtions passed to increase safety have caused the banks to turn their collective backs on thier least profitable clients. This means Veritaseum opportunity. Reference JP Morgan Pulls Plug on "Mini Prime' Clients:

J.P. Morgan’s prime-brokerage operation is casting off many hundreds of smaller hedge funds in a move that threatens to further escalate trading and financing costs for managers.

In the past two weeks, the bank has notified the “introducing brokers” it works with that it will no longer clear trades or offer financing to their hedge fund clients. The brokers — BTIG, Concept Capital, Conifer Financial, Convergex and arms of Jefferies and Wells Fargo — have 90-120 days to find new clearing banks for clients that had been using J.P. Morgan. The move affects an estimated 800-1,200 hedge funds.

With their balance sheets pressured by new regulatory-capital requirements, several Wall Street banks have taken steps in the past few years to cull smaller, less-profitable fund shops from the ranks of their prime-brokerage clients. But the abrupt retreat of J.P. Morgan from the “mini-prime” arena marks the first time a major prime broker has stopped working with introducing brokers altogether. Those firms serve as middlemen between smaller hedge funds and banks that offer clearing and financing services.

Industry professionals said the move could have far-reaching consequences, potentially stranding the smallest managers and undermining the mini-prime business model. Some said they wouldn’t be surprised if other big banks followed suit — or if introducing brokers took steps to weed out their weaker accounts.

“Guess what — some of these people [fund operators] aren’t going to find homes,” said an executive at an introducing-brokerage firm. “We’re going to look at these accounts and decide which ones are worth keeping.”

Here's a thought. What happens if technology enables these funds to deal directly with each other and clear for themelves. This technology is available here and now.

This the first time where Wall Street is challenged with technology that may be able to bypass the protections of excessive regulation. The Internet, as wondrously transformative as it was, did very little to increase the efficiencies of Wall Street as an industry, at least from the consumers perspective.

banking prices normalized and adjusted for inflation

Notice how distributed tech mashed other industries' margins and revenues - such as media...

iTuned

Because Paradigm Shifts Wipe-out Legacy Players & Wall Street is Ripe for the Taking. It has the highest prices and the highest paid workers (on average) of all consumer facing indsustries - these prices and wages are going up! This is unsustainable.

Why is it unsustainable? Because Wall Street is structurally incapable of handling the introduction of low cost product. Look, I'll prove it to you!

veritaseum  Morgan Stanley3veritaseum  Morgan Stanley4

 

veritaseum  Morgan Stanley

Email me at reggie [at] veritaseum.com if you want to know more about what we're doing and what we're up to over at the lab.

 

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Thu, 08/27/2015 - 10:53 | 6477411 centerline
centerline's picture

It's not just the bankers compensation/business model that is ripe for pruning.  It is a paradigm shift that is upon us.

The bankers have a captured system.  There is no practical way to unwind it.  Counterparty exposure is global and underpins most modern governments.

I fully agree that the days of modern banking are coming to a close.  The question that really begs to be ask is "what is next?"  I doubt it is a transactional system.  Why?  Because faith is what is about to be lost when the system inevitably rolls over.  Relationship systems will be at the core of any new markets.

Thu, 08/27/2015 - 09:39 | 6477067 taketheredpill
taketheredpill's picture

Sure it's an advertisement but also a heads up on:

 

- Trends in banking (sales coverage for my "smallish" firm has been dropped by a few banks)

- Disruptive technology that could decimate traditional banking

- Pointing out that if you believe the 2008 correction was only postponed and will be even worse whe it hits, that dreivatives/counterparty risk is lurking

 

 

Thu, 08/27/2015 - 09:38 | 6477061 deKevelioc
deKevelioc's picture

VeAdnauseum

Thu, 08/27/2015 - 08:33 | 6476829 geno-econ
geno-econ's picture

Okay Reggie, you want an intelligent question. What will be the impact of China and Russia selling US Treasuries ?

Thu, 08/27/2015 - 09:16 | 6476976 Reggie Middleton
Reggie Middleton's picture

If they do enough of it, additional QE and Z/NIRP for the US in order to prevent rates from reverting to mean (going up). Now that China is ZIRPing, it puts pressure on India and Japan to jumb (back) in the devaluation fray. The ECB ZIRP'd because of Japan, and the more everyone else ZIRPs the less effective your ZIRP is. You see, it's all relative... The ECB has thrown its pegged, non-EMU nations under the bus for apparently naught, because once India and China get into competitive ZIRPing it will materially lessen the effect of the ECB QE program, meaning that the ECB will have to NIRP harder. See what I mean?

If all of this sounds like a poorly written nursery rhyme, reference these series of posts where I clearly anticipated this nonsense of exporting deflation to your neighbor's backyard:

It's All Out War, Pt 3: Is the Danish Krone Peg to Euro More Fragile Than Glass Beads? The Danish National Bank Infers So!
(Blog)
... t it is highly unlikely that the Swiss will be the only nation that realizes it can't run lockstep with the behemoth that is the ECB in devaluing its currency. Expect to see practically all of the nor ...
Created on 10 February 2015
As US Companies Report, Signs of Imported Unemployment/Deflation Appear: It's ALL OUT (Currency) WAR! Pt. 2.5
(Blog)
In "Despite What You Don't Hear In The Media, It's ALL OUT (Currency) WAR! Pt. 1" I detailed what happened the only other time in modern history we've had a global currency war:  ... currency ...
Created on 27 January 2015
Stab, er... I Mean... Beggar Thy Neighbor - It's ALL OUT (Currency) WAR! Pt 2
(Blog)
Here Comes The Boom! By now, everybody who cares knows about the Swiss National Bank's removal of its EUR floor, and the havoc that it caused to FX brokerages around the world (Currency Brokers Fightin ...
Created on 26 January 2015
Despite What You Don't Hear In The Media, It's ALL OUT (Currency) WAR! Pt. 1
(Blog)
... er, as excerpted from Wikipedia: Currency war, also known as competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relati ...
"Fu$k the Fundamentals!": Negative Rates In EU Will Absolutely Wreck the Very System the ECB Sought to Save
(Blog)
... t's not as if there's that much equity in the system. Once two or three counterparties "legally" default, the system comes tumbling down! Take your own high leverage positions on every soveriegn, cur ...
Thu, 08/27/2015 - 10:01 | 6477161 taketheredpill
taketheredpill's picture

 

 

Fed (and the rest) have got nothing except QE, so that's all they will do.

 

The "Rate Hike / Rising Employment" ploy may have fooled some people, but I have a hard time actually seeing it happen.  Plan may be to hike 25 bp and manage fall-out but I expect fall-out to swamp any jawboning and/or take-back of the 25 bp, so....QE4.

 

They will keep doing QE as long as they can or are allowed, until that point when matters are taken out of their hands.  

 

Need an analysis of impact of next version of QE i.e. what if they switch to IG/HY Corporate Bond ETFs, how much can they do, impact compared to QE3?? etc.

 

I know this all ends badly but in the meantime I'm expected to manage based on "fundamentals"....what a joke.

 

 

 

Thu, 08/27/2015 - 09:02 | 6476928 MSimon
MSimon's picture

Don't forget to add in the Saudis.

Thu, 08/27/2015 - 07:01 | 6476631 MSimon
MSimon's picture

What he is trying to tell you is that blockchain enabled services mean the end of GS. And you guys are complaining.

 

Fracking means the end of the Saudis et. al. I discuss that and block chain here: http://classicalvalues.com/2015/08/block-chain/

Thu, 08/27/2015 - 10:05 | 6477193 taketheredpill
taketheredpill's picture

Fracking doesn't mean the end of the Saudis, just more symptomatic of extreme efforts to squeeze oil out of any possible location (deep sea, fracking, water injection) after the easy oil is gone. It's the end of the current oil-based economy at some point which impacts EVERYONE.  True end will be when Saudis CUT supply and market susses that it not intentional policy but end game of water injection causing eventual entrapment of supply.

 

 

Thu, 08/27/2015 - 04:59 | 6476535 EurGold
EurGold's picture

1oz Silver Australian Kookaburra Coin just €17.21 @ EurGold

https://www.eurgold.eu/silver/kookaburra-1oz-silver-1-dollar-legal-tende...

Thu, 08/27/2015 - 09:35 | 6477053 PleasedToMeatYou
PleasedToMeatYou's picture

Oh, come on - knock it off!  Ron Popeil wannabe, die already would ya?

Thu, 08/27/2015 - 04:36 | 6476515 jeff montanye
jeff montanye's picture

reggie could still use a copy editor but his observation about the fat, happy and somewhat clueless financial services industry that believes it deserves the inflated pay it receives, and its vulnerability to disintermediation in this internet and moore's law ravaged world, is very apt.

Wed, 08/26/2015 - 23:23 | 6476185 kelley805
kelley805's picture

Only a financial advisor that is not retiring soon would tell you to stay in because it only took 5 years to recover the loss of the last recession.

 

Here are some more signs of a recession.

http://michaelekelley.com/2015/05/29/mergers-and-acquisitions-set-record...

http://michaelekelley.com/2015/02/20/fed-warns-of-two-bubbles/

http://michaelekelley.com/2015/02/24/would-you-pay-39-more-than-asked/

http://www.zerohedge.com/news/2015-07-27/when-will-we-ever-learn/

Here is how to respond.

http://michaelekelley.com/2014/10/16/8-things-to-do-when-recession-happens/

 

Here is how to get your mind off this stuff.

http://michaelekelley.com/category/humor/

 

Good luck!

Wed, 08/26/2015 - 23:18 | 6476175 Plunk
Plunk's picture

Ad-nauseum

Thu, 08/27/2015 - 02:27 | 6476427 CHX
CHX's picture

1+ beat me to it, excatly my thought

Wed, 08/26/2015 - 21:23 | 6475836 nah
nah's picture

Buy puts and SELL on margin

.

lots more

Wed, 08/26/2015 - 19:28 | 6475425 Loismustdie
Loismustdie's picture

I'm fairly intelligent.

This is just a fucking mess. I

Wed, 08/26/2015 - 20:24 | 6475623 New_Meat
New_Meat's picture

"This is just a fucking mess. I..."

I'm so fucking fairly intelligent that I can't finish my sentence.

Wed, 08/26/2015 - 16:14 | 6474638 geno-econ
geno-econ's picture

Reggie is awesome but needs direction----join forces with Donald Trump.  Reggie for Treasury  Secretary ! 

Wed, 08/26/2015 - 17:28 | 6474983 Reggie Middleton
Reggie Middleton's picture

The mere thought sends shivers down my spine :-)

I try not to feed the trolls, but I will respond to anyone who has anything worthwhile to say... Such as... "Hey, it looks like we may be approaching peak bank compensation according to your research". If you go back in time, you can clearly see what sustained pops in Wall Street comp presages...

Thu, 08/27/2015 - 10:31 | 6477314 Groundhog Day
Groundhog Day's picture

Hey Reggie,

 

I would love you comments on when these ivy league grads who get jobs trading bonds for GS, JPM, et al, from money out of thin air will stop getting their  million dollar bonus.  I have to admit i get a bit angry and jealous when i run into one of them, and upon speaking to them for an hour or so realize they have no clue how the economy works, fed works etc

Thu, 08/27/2015 - 09:18 | 6476982 tarsubil
tarsubil's picture

Do you expect this to be used by individual small time investors? What about those worried about a MtGox scenario?

Thu, 08/27/2015 - 09:30 | 6477019 Reggie Middleton
Reggie Middleton's picture

This is perfect for individual, small time investors. The system is totally software driven, P2P, OTC and devoid of counterparty and credit risks. Mt. Gox, despite all of the hoopla in media, was a management execution failure. It could have (and likely would have) happened to any company that was run similarly.

The beauty of our platform is that you don't have to be concerned with "trusting" anybody or anything. All funds are escrowed through the blockchain, which thus far has proven to be immutable.

Click here for more info https://docs.google.com/presentation/d/1UxB33wp1rCncBtPbuzQbkS1SZg_fjCTN...

Wed, 08/26/2015 - 17:52 | 6475088 New_Meat
New_Meat's picture

Reggie, face it, you don't want to take the pay cut and you don't have Paulson-money to be "forgiven" ;-)

- Ned

{good to see u postin' again}

Wed, 08/26/2015 - 15:38 | 6474434 teslaberry
teslaberry's picture

fuck all you haters on reggie. reggie is awesome. and if you don't like his swagger it's cause you are a total fucknard that cannot see reality. 

 

go reggie!

teslark

Thu, 08/27/2015 - 09:39 | 6477071 PleasedToMeatYou
PleasedToMeatYou's picture

"a total fucknard"

Who let the 14 year old in?  Go 'way, kid. 

Wed, 08/26/2015 - 15:31 | 6474392 zipit
zipit's picture

Did he say anything new this time?  if so, what?  Because I got lost after his 2-minute intro video.

Wed, 08/26/2015 - 15:27 | 6474366 Enceladus
Enceladus's picture

I hope he's not gay

Wed, 08/26/2015 - 17:50 | 6475079 New_Meat
New_Meat's picture

If he were, he couldn't get a gun permit in VA after this morning's atrocity and Da Punk gets on with his restrictions goin'

Wed, 08/26/2015 - 15:09 | 6474233 Motorhead
Motorhead's picture

Brush it off, Reggie.  They're just jealous that you banged Lauren Lyster.

Wed, 08/26/2015 - 16:08 | 6474587 CarpetShag
CarpetShag's picture

You mean that was shown in the 1st video? Didn't watch it.

Wed, 08/26/2015 - 14:43 | 6474053 centerline
centerline's picture

Hmmm... yeah.  What happens when the whole casino catches fire? 

 

Wed, 08/26/2015 - 14:21 | 6473920 CarpetShag
CarpetShag's picture

Shit on toast, this is high powered stuff. I feel I am in the presence of an Einstein.

Wed, 08/26/2015 - 17:47 | 6475069 New_Meat
New_Meat's picture

You kids didn't see the old Reggie ;-)

Wed, 08/26/2015 - 13:28 | 6473728 oddjob
oddjob's picture

blah blah... I developed a name for myself.... blah blah blah

 

Good god you are the most narcissistic person on earth. You typify all that went wrong and don't even realize it.

Wed, 08/26/2015 - 17:46 | 6475064 New_Meat
New_Meat's picture

"Good god you are the most narcissistic person on earth."

Nyet Tovarich, off the top of your head you can name at least two who are more, and they are Americans.  Met anyone in the Saudi Royal Family?

- Ned

Wed, 08/26/2015 - 13:11 | 6473666 Lugnut
Lugnut's picture

"Be sure to drink your Ovaltine????"

WTF Tyler, hope you got a nice check for pimping Reggie.

Reggie loves him some Reggie. Cohesive text formatting and concise writing, not so much.

1000 words of disjointed topics,  two videos (the shirtless iamge wrapped in film is a particularly nice effect), a bunch of charts later and I still dont know what hes hawking, who he's hawking it to,or why I should care. <golf clap>

 

Wed, 08/26/2015 - 14:55 | 6474136 CarpetShag
CarpetShag's picture

Succinctly put.

Wed, 08/26/2015 - 12:20 | 6473447 Baa baa
Baa baa's picture

A Goddamned advertisement! How could you???

Wed, 08/26/2015 - 17:44 | 6475052 New_Meat
New_Meat's picture

Reggie always sellin'

He b careful 2 flash nuggets, cost ya to look under the veil.

Enjoy the entertainment, costin' u nada

Wed, 08/26/2015 - 16:56 | 6474846 Fester
Fester's picture

Shitcoin to the rescue.

Thu, 08/27/2015 - 08:43 | 6476854 malusDiaz
malusDiaz's picture

AND D000000000m COMeThiCH! O Says the Reggie!

Do NOT follow this link or you will be banned from the site!