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When "Virtuous Debt" Turns Ferociously Vicious: The Mother Of All Corporate Margin Calls On Deck
Submitted by Bawerk.net
Corporate foie gras
One of the arguments put forth in the bull vs. bear debate is that the solidity of US non-financial corporations have never been stronger. The amount of cash held by non-financial corporations has risen 150 per cent since the depth of the crisis in 2009. With such a massive cushion to stave off whatever the market may throw at them, they will be able to cope, or so it is held.
In addition, we know that financial corporations are flush with cash, or excess reserves held at the Federal Reserve. Throughout the various quantitative easing (QE) programs conducted by the Federal Reserve, commercial banks have been force fed cash as ducks on a foie gras farm. This has swelled their excess reserves to the unprecedented, and what would be thought unimaginable only few years’ back, level of US$2.6 trillion.
With all this cash the system should be, again according to the perma-bulls, more than ready to withstand the shock from the ongoing global deleveraging, a stronger dollar, emerging market blow-ups and the forthcoming US recession.
We beg to differ. When it comes to excess reserves they are most likely already “spoken” as a form of collateral in shadow banking chains. While the initial effect from QE on the shadow banking system was massive deflationary shock as all the high quality securities used in re-hypothecated collateral chains were soaked up by the Federal Reserve, it is a safe bet that excess reserves has to some extent filled that void.
In the non-financial sector on the other hand cash is, well, plain old cash. With more than US$1 trillion of the stuff on their balance sheet complacency is destined to be prevalent. And it is.
Credit market instruments, i.e., debt, have also risen at a tremendous rate. Net debt, that is credit market liabilities less cash, has actually never been higher. As the chart below shows, sitting at more than US$6.6 trillion, non-financial net debt outstrips even the high from 2008.
Now, if we express the gargantuan debt load as share of market value of non-financial equities outstanding things looks not only sustainable, but outright sound. At only 30 per cent the debt to equity ratio is at multiyear lows. We need to go all the way back to the peak of the dot-com folly to find today’s equal.
And it is exactly the folly of the dot-com (and went) that best epitomizes todays manic corporate debt issuance. According to Bloomberg more than US$2.7 trillion in stock buybacks has been effectuated over the last six years. We would be amiss if we didn’t mention that this spending spree, not on capital goods or R&D that will help propel future growth mind you, but on liability massaging, coincided with ZIRP.
Investors desperate for yield have more than happy to lend US Inc. trillions of dollars, even though it is used mainly to buy back own stock. Not surprisingly this also help goose the market value of equites outstanding; also known as the denominator in the ratio presented in our chart.
So more debt begets higher market value of equites which in turn improves the debt/equity ratio which gives the incentive to issue more debt ad infinitum. Or in a slightly simpler version, debt begets more debt.
We have seen the story before. In the shaded grey areas we highlight episodes when the virtuous relationship turns ferociously vicious. Remember, markets take the escalator up, but the elevator down. And the longer the escalator the further down the elevator goes.
Source: Federal Reserve Flow of Funds (Z.1), Bawerk.net
When the US recession hits (see here for more) the massive gap between the green and red line in our chart above will close in short order and the calamity will be even worse than last time, which incidentally was far worse than the time before that.
And this Ladies and Gentlemen is aggregate demand management in practice where, for some unexplained reason, the abundance of savings does not clear the market for investable funds not even at the zero lower bound.
The fact that central bank perverts capital markets and is to a large extent responsible for the very same secular stagnation central bankers believe they must fight, seems lost on today’s intelligentsia.
* * *
Back to ZH here, in addition to Bawerk's explanation of what may be the biggest "non-financial sector" margin call ever on deck, we just wanted to underscore one of the main points made in the piece above, namely the stability - or rather lack thereof - of US Commercial banks, whose cash assets according to the most recent H.8 statement amounts to $2.8 trillion. The problem is that of this, over $2.5 trillion comes from the Fed's excess reserves which at some point will be unwound, meaning the true cash level of US banks - when one excludes excess reserves - has not budged at all since the financial crisis, and has in fact declined to a pro forma level of just over $200 billion.
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How could reserves be collateral?
So, you place $100 as collateral and receive $102 for repo?
lolololololololololololol
There is little doubt that a critical mass default will happen soon enough, and the MSM will tell us all it was unexpected.
Agreed – can't be far off now. Too many major shocks and (unreported) aftershocks behind the scenes, the amplitude and frequency of which are both increasing.
all of you beware of the next FOMC announcement. their big announcement may be MOAR QE instead of a rate increase......it would blow the markets upward but it won't hold very long this time
... in between MSM reports about WWIII that, coincidentally, started at the same moment the criminals who call themselves central governments needed a distraction proportional to the collapse they caused...
The MSM will tell us it was unexpected because it is unexpected to them. In their arrogance they think they are smarter than everyone else but they are too busy on Facebook and covering that Jenner male/female person to focus on what is going on with the world's financial system.
"There will be tanks in the streets if you don't bail them out!"
Who will be the shill ass-wipe long overdue for a rough hanging and dismemberment that stands in for that hell-bound lump of flesh Hank Paulson this time?
As long as the transaction is not structured such that there is no transfer of title or transfer of custody...why can't reserves be pledged?
You need $10 million. You got to pledge something of equal value you don't want to sell (even rehypotheticated).
How can you pledge $10 million, you are not supposed to have them?
They are excess reserves, which can be withdrawn from the FED at any time at the whim of lawful owner (bank). Why can't they be pledged, it's better collateral than stawks- money good held at the nearest FRB?
In that case they would be used, not pledged. And that is exactly my point.
Primary dealers are using excess reserves to cover derivative losses
No, transformed, not used-- pledged as collateral for a new loan which would be "used".
You place $100 in Fed excess reserves as collateral against which you purchase $100 in E-minis.
It works as long as the market keeps rising.
How about using those $100 to buy those eminis, why pledge?
A repo is a transaction, collateral vs cash, hence I buy eminis.
How could I need cash to buy eminis if I already have the cash and use it outright to buy them?
JPM simply lost excess reserves outright when their Whale game revealed, or leaked. They were using excess reserves to outright recycle stocks and still are.
That is the whole point of QE. Create excess reserves so Primary Dealers recycle them by paying derivative losses.
Because the reserves, i.e., cash, are at least on paper held at the Fed (and collect interest at the IOER). They are immobile, which is also why the velocity of reserves is zero. However, nobody says a bank can't pledge $2.7 trillion in free money (which accrues interest no less) as collateral with which to buy risk, which is precisely what has been happening, giving banks a twofer on free (record) profits.
For more, see "What Shadow Banking Can Tell Us About The Fed's "Exit-Path" Dead End"
Ah, that pledge would basically be a bond then, guaranteed by the Fed. Hence practically primary dealers were supplying promisses as good as the Fed's word, basically zero margin collateral, just like Warren Buffett.
Ok, thank you
On a second thought, I can't see how reserves at the Fed would be immobile with the proper presidential executive order and congress permission for few select oligarchs only
On a third thought, how could they pledge excess reserves if they are supposed to be immobile? Why would the other side of the bet accept as payment in case of default something that is immobile?
It makes no sense. They must be mobile, upon congress permission, for few select players. Otherwise it makes no sense
The real problem, I think, is going to be the "interest" on all that debt. Debt is a sleeping monstor, and the FED will be forced to wake it up.
When and how did the commercial banks get the right to pledge their excess reserves at the Fed as collateral?
It works as long as the market keeps rising.
That is the most important thing one has to know. The entire world economy is geared towards the assumption that prices will keep rising.
When it went into reverse, the gates of hell broke loose. There are no more firewalls. This is going to burn until it runs out of fuel. All one can do is watch it unfold with each passing day.
As a spectator sport, football, baseball, soccer etc. have nothing on this.
I think shorting is the way to go - you just have to be able to cover your position in it's entirety so that when the rules change and the fed unloads funny money into the market you dont get blown out. Its completely like the casino. With a short bet you are likely going to go away with nothing - but there is the off chance that you hit a home run and walk away - no, run away - a lot richer.
Better odds than going long or getting ripped on volume in my opinion.
Where could you short? Any market would close before you could cover and would be propped up enough on a reopen to force a loss.
Yeah - thats a risk. I am not sure, though I believe those who have loaded up on all of the equities via fed money are going to open short positions before they dump. Then it will be key to follow their behavior. Thats my strategy anyway. Whenever I enter the casino, I take nothing in I cant afford to lose - if I get swamped, I will live.
I have my popcorn.
How does a commercial bank purchase E-Minis?
Gaze long and hard upon the ugly truth displayed in that last chart.
The Banks are still basically insolvent without The FED prop.
Unwind the Excess Reserves and the TBTF will turn to vapor and drift away on the wind.
...Now, um, -about your deposits...
Or in a slightly simpler version, debt begets more debt.
Wrong.
Debt is a promise to complete a trade. Failure to deliver is a default. Defaults must be met immediately with like interest collections.
When debt is "rolled over", that is default.
A properly managed MOE process does not allow rollovers. Rather, it nips these defaults in the bud with immediate interest collections. This produces a natural and responsive negative feedback loop that guarantees stability of the process.
With a properly managed MOE process, you can't "kick the can down the road".
Just as virtuous as a whore on a street corner. Magic money goes into magic debt and what comes out the other end isn't even good for fertilizer. It will be a dark, cold Winter for the market optimists.....
Please don't dimenish the virtue of the whore who, if it is of her free will, is about all that's left of true free markets. Comparing her with the fascists, and the criminals who run the central governments they own, serves only to unmeasurably elevate the virtue of them to that of the whore.
Agree.
Don't diminish whores by equating these damned fraudsters and counterfeiters with them.
Somebody might do it for the wrong reasons or fake their enjoyment of it; but, you can't counterfeit coitus.
Speaking of whores, I was just thinking back to the first person I remember calling the inevitable collapse of the Bakken/shale, the Hedge was way up on the list but the first person I remember calling it was a stripper in the bakken! I'm not trying to say that strippers are the dumbest people on earth but they usually not exactly ivy league, that is just how obvious it was. If I remember right she was blogging about it in 2009 and today we still have tons of people who can't see the ponzi through the trees. Funny
No. Perhaps she was not Ivy League.
But many young coeds work their way through University at the Second Tier Level by removing their garments...amongst providing other services...
Besides the Stripper becoming Worldly and Street Wise, some of those services rendered by the Stripper are directed toward horny old bastards with lots of cash, who may be involved in the markets. These guys may also teach these young women while receving the services rendered.
So the Stripper becomes schooled in many different ways due to her chosen profession.
The Calculus taught at a Second Tier University, or a Community College as far as that goes, is no different than the Calculus taught in the Ivy League. The method of instruction may be a little different...But it is still the same Calculus.
I am not trying to bag on strippers, I don't believe that they are all stupid by any means and the history of these women being underestimated/espionage in cat houses etc speaks for itself. I am simply saying that this shale scam was evident very early by simple pattern recognition and common sense.
Random Corporate CEO -"On the eve of my retirement, I had no idea that borrowing at 0% to boost EPS to make my bonuses these last 7 years, could ever be a problem.....Good bye and good luck."
If I understand this correctly, even corporate savings are not immune to bail-ins. Why am I not surprised.
It looks like I'll be one of the last living human beings on the planet. Yipppppeeeeeee! We're all going to die.
"The problem is that of this, over $2.5 trillion comes from the Fed's excess reserves which at some point will be unwound, meaning the true cash level of US banks - when one excludes excess reserves - has not budged at all since the financial crisis, and has in fact declined to a pro forma level of just over $200 billion."
'Which at some point will be unwound'...
When...?
- Overnight?
- Over a period of 10 years?
- Ever?
Justice forever standing at the gate, never permitted to gain entrance...
When contingent liabilities are no longer contingent.
Kafka had it right all along..
Corporate foie gras
In the days of the Depression, a family had trapped a few ducks. As they needed some things only money could buy, the father requested his three sons take a duck each and travel around trying to sell them. They agreed and headed off on seperate ways.
The youngest of them knocked on the door of a nearby farm house and a shapely young blonde farm girl answered the door.
"S'cuse me ma'am" said the guy. "I'm wunderin' if y'd be intrested in buyin' this here duck frum me". The woman replied "I'd sure like me that plump duck to cook fur our supper, but I ain't got no money to spare". "How about a fuck for it?" she asked. The man didn't hesitate and replied "Sure!".
After they'd done the deal, the lonely farm girl said "If'n yer fuck me again - ya can have the duck back".
So he did, and afterwards headed off along the road with the duck still under his arm. Soon a large truck roared past the man which frightened the duck so much that it jumped out of his arms and right under the wheels where it was squashed.
The truck driver stopped and got out to speak with the man who explained that he was out trying to get money for his family by selling the duck. The truck driver felt remorse and offered the guy a dollar for his trouble. The man agreed and headed for home with the money in his pocket.
That evening as they all gathered around the table, the father asked them how they did.
The first son replied "I done good pa, I got me three dollars fur my duck".
The second son replied "I done better'n him pa, I got five dollars".
Then the third son leaned back in his chair showing a cheeky grin and said "I done better'n all uf yers, I got a fuck for a duck, a duck for a fuck, and a buck for a fucked up duck!".
Excerpt:
Corporate foie gras
Throughout the various quantitative easing (QE) programs conducted by the Federal Reserve, commercial banks have been force fed cash as ducks on a foie gras farm. This has swelled their excess reserves to the unprecedented, and what would be thought unimaginable only few years’ back, level of US$2.6 trillion. With all this cash the system should be, again according to the perma-bulls, more than ready to withstand the shock from the ongoing global deleveraging, a stronger dollar, emerging market blow-ups and the forthcoming US recession.
We beg to differ
When it comes to excess reserves they are most likely already “spoken” as a form of collateral in shadow banking chains. While the initial effect from QE on the shadow banking system was massive deflationary shock as all the high quality securities used in re-hypothecated collateral chains were soaked up by the Federal Reserve, it is a safe bet that excess reserves has to some extent filled that void. Credit market instruments, i.e., debt, have also risen at a tremendous rate. Net debt, that is credit market liabilities less cash, has actually never been higher. Non-financial net debt outstrips even the high from 2008, sitting at more than US$6.6 trillion!
Manic corporate debt issuance
According to Bloomberg more than US$2.7 trillion in stock buybacks has been effectuated over the last six years. We would be amiss if we didn’t mention that this spending spree, not on capital goods or R&D that will help propel future growth mind you, but on liability massaging, coincided with ZIRP. Investors desperate for yield have more than happy to lend US Inc. trillions of dollars, even though it is used mainly to buy back own stock. Not surprisingly this also help goose the market value of equites outstanding; also known as the denominator in the ratio presented in our chart. So more debt begets higher market value of equites which in turn improves the debt/equity ratio which gives the incentive to issue more debt ad infinitum. Or in a slightly simpler version, debt begets more debt.
True cash level of US banks only $200 billion!
US Commercial banks, whose cash assets according to the most recent H.8 statement amounts to $2.8 trillion. The problem is that of this, over $2.5 trillion comes from the Fed’s excess reserves which at some point will be unwound, meaning the true cash level of US banks – when one excludes excess reserves – has not budged at all since the financial crisis, and has in fact declined to a pro forma level of just over $200 billion.
And remember, markets take the escalator up, but the elevator down …
Batten the hatches, stormbringer coming! No point in running because it’s coming your waaaiaaaaaaay! https://www.youtube.com/watch?v=4C2K889u_90
Long toilet paper, it has more value than the western fait scam system.
just in case zerohedge hasn't noticed, PHK and NCV have been hammered hard.
It is clear that many ZH readers are aware of the existence and role of the excess reserves of commercial banks at the Fed. But, as far as I know, no one has offered an explanation of the mechanics of how the Fed will handle these reserves when and if it attempts to raise short term rates. The current staff and governors of the Fed will claim that this problem is completely new to them and will require experimentation and patience from the markets. But this is not entirely true. If the commentators I read are correct, the Fed faced the same problem in the mid 30's. They resolved it by increasing the level of required reserves to take up the slack. Any other ideas?
We did, two years ago. And the answer is literally a dead-end, which is one more reason the Fed will promptly unwind any rate hike it implements. Read this: What Shadow Banking Can Tell Us About The Fed's "Exit-Path" Dead End
Thanks for the link, wihich I read after the above post. Maybe we should make Trump Fed chairman. That way he can break up the big banks grip on the Fed along with a lot of other china in the shop. (sarc)
you're making this to look like a Marx brothers movie.
Who gets the Oscar and who gets the rotten tomatoes?