Overnight, Frank Partnoy and Jesse Eisinger released an epic magnum opus titled "What's Inside America's Banks [17]", in which they use over 9000 words, including spot on references to Wells Fargo, JPM, Andy Haldane, Kevin Warsh, Basel II, Basel III (whose regulatory framework is now 509 pages and includes a ridiculous 78 calculus equations [18]to suggest that banks have to delever by some $3 trillion, which is why it will never pass) to give their answer: "Nobody knows."
Of course, while this yeoman's effort may come as news to a broader cross-section of the population, is it well known by anyone who has even a passing interest in the loan-loss reserve release earnings generating black boxes formerly known as banks (which once upon a time made their money using Net Interest margin, and actually lending out money to make a profit), and now simply known as FDIC insured Bank Holding Company hedge funds. This also happens to be the second sentence in the lead paragraph of the story: "Sophisticated investors describe big banks as “black boxes” that may still be concealing enormous risks—the sort that could again take down the economy." So far so good, and again - not truly news. What however may come as news to none other than the author is that the first sentence of the lead-in: 'Some four years after the 2008 financial crisis, public trust in banks is as low as ever" is, sadly, wrong.
Why is it wrong?
Because as we showed a week ago [19], the general public's "trust" and faith in banks is not expressed through the stock price of their equities, something which these days is largely determined by the Federal Reserve and the banks themselves, who not only give each other "Conviction Strong Buy" upgrades on a frequent basis but also buy each others' stocks in the biggest circle jerk imaginable, or even through slurred anecdotes at the local pub bashing Ken this and Jamie that. Instead it is expressed by how much trust the general population - the public - has put on deposit, literally, in the form of money, in either checking or, worse, savings (because under ZIRP there is no interest income, and having a savings account merely locks up one's withdrawal options) accounts with various financial institutions, or as The Atlantic calls them black boxes.
The truth is, that as of December 18, there was a record $9.2 trillion in total bank deposits: this is not only the evil 1%-ers money, but money from mom and pops - the public - who have saved cash all their lives, the bulk of it from hard work, and instead of keeping it in cash have decided to hand it over to the banks for "safe keeping." As a reminder, deposits (even savings deposits under ZIRP) are the effectively equivalent of currency in circulation. Or physical money. Money, which in a fractional reserve system is created by the fed and by private commercial banks (sometime it is surprising how much confusion there is about the money creation process: we will address this in a later article) when they create loans.
The problem, as we noted recently is that since the Lehman failure, US commercial banks have not created one incremental dollar in loans [19], and in fact the total amount of loans outstanding has dipped by some $120 billion in the past 4 years! And yet US bank deposits keep soaring, and as noted above have just crossed $9.2 trillion for the first time ever. Thank you Federal reserve excess reserves and shadow banking system repo (and other) transformations.
[20]
In other words, so explicit is the trust in banks and stability of the Fed-backstopped banking system that a whopping $2 trillion in excess deposits over loans have been parked at US banks.
Notably, all of the above ignores the fact that as of January 1, 2013 the FDIC's Transaction Account Guarantee program expired, making millions of depositors effecitvely unsecured creditors in what are the world's most insolvent (and most central bank backstopped) banks. This consolidated unsecured claim according to the WSJ amounts to some $1.5 trillion [21].
And it gets worse, because one aspect untouched in the Atlantic piece is that it is this excess differential in deposits over loans that allows banks to all be glorified, depositor-insured hedge funds and use the excess delta to gamble with risk free, Treasyrt backed depositor capital (courtesy of the Gramm Leach Bliley act which ended Glass Steagall) in the way that the JPM CIO was nothing but a massive "hedging" hedge fund with $323 billion in AUM.
[22]
This is money that the "London Whale" and his team used to distort the fixed income market so much they effectively became the market (as the Atlantic piece touched upon).
One can only wonder what other assets the banks have invested using this excess deposit base, although we are confident that valiant mainstream media effort to truly uncover the depth of the US banking system's manipulation of the US saver will gradually become apparent and known to all.
It is precisely this "money on the sidelines" that allows the banks to bid up risk assets to such stratospheric levels that the Fed can claim victory, that the financial system can continue the theater that it is capitalized thanks to a substantial equity tranche, and that social orders can be preserved in a society in which the only thing that appears to matter is the closing trade of the Russell 2000.
Yet the paradox deepens when one considers that it is precisely this money being parked with the banks, instead of being demanded for circulating purposes that has so far avoided rampant inflation. Putting the $2 trillion in just excess deposits over loans in perspective (not the entire $9.2 trillion): there is $1.1 trillion of currency in circulation. Should all this money be pulled and enter the broader economy, one can kiss any CPI data massaging goodbye.
Which brings us to the jist of the story: on one hand, the public may be disenchanted with the US banking system, but on the other, the explicit trust has never been greater. And therein lies the rub: should this trust evaporate, and should deposits be pulled for whatever reason, not only will banks be forced to unwind a myriad in risk positions they likely still have on, but the sudden increase of what even the Fed would have to admit is M1 would result in an explosion in the prices of goods and services as suddenly three dollars are chasing what previously there was only one dollar in demand for.
So, yes, the Atlantic wrote a great story on the black box nature of the US bank system, but they missed the true punchline: America's banks and the American public are gripped in the most hated yet symbiotic "love hate" relationship in history. Should the trust truly evaporate, then the banks will have no choice but to pull the proverbial pin and send risk tumbling, and inflation soaring.
Perhaps that is the precise reason why nobody: not bank management teams, not sellside analysts, not regulators, not accountants, certainly not the Fed, not legislators, and last but not least, not the US public, is ready or even cares for a true peek inside the black boxes that make up the US banks?
Pick your poison?