The Tipping Point: Systemic Deterioration in Finance
Artem Karida
Educator | C-suite advisor | business strategy, innovation, and marketing expert
This is?Part 3?instalment of a history of the crisis involving the banking and financial system as it is now developing, with all contents based on incoming information.
Read the first part "Falling Bank Chronicles"
Read the second part "Crisis of confidence & regionalization"
We will most likely add to the narrative.
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24.03.2023
The system's history and prospects
Any cycle of rate hikes during the last 40 years has inevitably resulted in a market shock and, as a result, an economic crisis, to which the Fed has responded by lowering rates and/or turning on the printing press.
In any case, financial conditions have improved. The causes of crises vary, as do the structural characteristics; however, the triggers were important events that frequently concealed structural distortions and imbalances in the system.
Rate hikes halted and easing began in:
There is a significant disparity between current situations. With the exception of 2020, when the system profile had comparable imbalances as presently, but there were deflationary trends, all of the previous breakdowns occurred in the absence of inflationary pressures and with a substantial margin of safety. Record inflationary pressures persist in 2023.
What exactly is a margin of safety?
The scenario is peculiar. The system is already disintegrating because the banking sector is in a state of crisis, according to a set of indicators. This can operate as a trigger in an environment where the Fed's activities are limited due to rising inflation.
In other words, the Fed cannot repeat in the 2023 crisis what it did in 2009 and 2020 by hastening the end of the monetary frenzy. What will happen to the system, which has been abandoned while becoming more dependent than ever before?
The financial system is deteriorating structurally
Another blow to the financial industry.
It hasn't even been a week since some major bank hasn't stumbled. If events continue at the same rate since March 1, only ruins will remain for six months.
A new victim was discovered - Deutsche Bank
Where the information blow to the bank (the largest decline in shares since March 2020 - minus 15% with a substantial spike in the cost of insurance against default) occurred following the intention to early redeem second-level subordinated bonds. This was expected to restore confidence in the financial system, but it turned out to be the opposite.
The story of the 2023 financial crisis demonstrates that a bank's strategic strength is unimportant (Credit Suisse had the highest liquidity coverage ratio among large banks - about half), but credibility and reputation are critical.
It is feasible to have somewhat competent reporting (if that is even fair under the current banking system settings), but the deformation of the fragile balance of trust leads to a confidence crisis (the outflow of depositors, investors and the closing of limits on the interbank market).
These actions, in turn, precipitate a new round of the liquidity crisis, exacerbating the confidence crisis.
Deutsche Bank is the backbone and largest financial structure in Germany, as well as the most important bank in Europe, and it is at the heart of the European Central Bank's monetary policy.
With the bank's strong integration financial linkages with the whole European financial system, any troubles with Deutsche Bank will undoubtedly operate as a trigger for the downfall of the entire European banking system.
The case of Deutsche Bank is notable in that any troubles with this bank act as a trigger for other European banks.
Even with SVB or crypto dumps that occurred in the United States, it was feasible to construct a hypothesis about the distinctive character of banks and their separate nature, but this one is not - this bank remains integrated.
If Deutsche Bank is shaken, it is absolutely a verdict on the whole financial system.
1.4 trillion euros in assets (three times that of Credit Suisse), a half-trillion-euro loan portfolio, 150 billion euros in securities controlled by the bank, and another 1.6 trillion euros in assets under administration. There are 265 billion euros in cash and 621 billion euros in deposits.
Investor panic attacks are related to how bank failures occur in 2023, among other things - the express mode "all-inclusive in two days."
There was a news article about a bank that went bankrupt in two days, which raises concerns about the next "help program."
It's entirely likely that hundreds of billions of dollars in credit lines will be established on Sunday as part of the equally twisted "bailout plan" executed with Credit Suisse, where the merger occurred with an unprecedented number of violations of legal conventions and common sense. But not in the case of Deutsche Bank, which is just too large and significant.
European politicians and regulators repeatedly declare the bank's stability, and the ECB promises unlimited aid on demand.
That is why you should not focus on the regulators' current actions, but rather on covert schemes. The Fed, for example, poured in two weeks 3/4 of loans from the number of asset repurchases reduced for nine months. In addition, the SNB issued 150 billion francs (14% of its own assets), including 50 billion francs in Credit Suisse lines of credit and 100 billion francs in UBS guarantees.
For the time being, Central Banks must save face in an inflationary climate, but preserving the financial system is a top concern.
Unfortunately, this does not negate the financial industry's underlying deterioration. As long as the stakes are high, there will be issues.
27.03.2023
The US regional banks
Small and medium-sized banks were dealt the most severe blow in their entire modern history (at least since the 1930s) during the week of March 8 to 15: 120 billion dollars in deposits were withdrawn per week, or 2.2% of deposit bases (H8 report from the Fed).
This is the most powerful load in absolute terms (the previous anti-record was in March 2007 - the withdrawal of 54 billion deposits), and the second most powerful blow in terms of deposits (record - 3% in March 2007).
Deposit reductions are a normal occurrence for banks and a natural fluctuation in liquidity. For example, since 2008, deposits have declined in 243 of 793 weeks, but in those weeks when the deposit base contracted, the average reduction was 0.15% of deposits, i.e. now nearly 15 times more intense.
Along with the $120 billion decrease in deposits, the debt on alternative funding channels increased dramatically (by $252 billion), with the exception of deposits and financial bonds (mainly funding through the channels of the Fed).
Almost everything was used to close cash gaps, and another $97 billion was paid in cash.
In terms of cash, the situation with small and medium-sized banks is not ideal. Deposit coverage with liquid funds (cash) fell from 17% in August 2021 to 7.3% at the beginning of March 2023 - the lowest level in at least 15 years.
As a result, when 2-3% of the deposit base is depleted in a week with a cash reserve of 7%, it hurts, which explains the gaps.
Large banks in the TOP 25 fared better; their ratio was balanced at 12-13%, and they received $67 billion in deposits over the past week, indicating that liquidity was redistributed from small to large banks as expected. SVB, by the way, was in the TOP-25 according to the classification.
As can be seen, alternative funding channels for small banks are being aggressively accelerated, and the process has been ongoing since 2022. Everything is fine for the big ones.
Liquidity is deteriorating, which will have an impact on deposit rate growth, margin reduction (interest rate risk), and credit risk realization at full capacity.
Credit risk is rising in the US banking system
Credit risk is rising in the US banking system. According to the FDIC, the cost of creating provisions for credit possible losses/write-offs increased to $ 20.7 billion in Q4 2022, the highest level in absolute terms since Q1 2011 (excluding the one-time effect of the COVID crisis). This is the period when the deferred effect of the 2009 financial crisis persisted, as did the low quality of the loan portfolio at the time.
Concerning the COVID crisis, banks created 115 billion in reserves in the first and second quarters of 2020, which is four times the norm in 2019 - in many ways, these were preventive measures based on the assumption of an economic collapse, which did not occur, and even the degradation of the loan portfolio did not happen.
Then, in 2020, the Ministry of Finance, the Fed, and the government guaranteed loans to backbone enterprises, credit holidays were implemented, and a slew of other measures was implemented to avert the crisis's acute phase. As a result, for the first time in their history, banks were dissolving reserves totalling 31 billion rubles throughout 2021.
In 2022, the cost of creating provisions for credit write-offs is increasing every quarter and has reached 11.5% in relation to interest income - a 10-year high but still within the normal range.
Actual loan write-offs for the quarter totaled 0.06% of the loan portfolio, which is half the average for 2012-2019 and 13-14 times lower than the peak of the 2008-2009 crisis. While loan quality is average.
The increase in loan provisioning costs is due to the loan portfolio's rapid growth over the last two years (plus 13%), as well as the critically low allocations to reserves from Q3 2020 to Q3 2022 (only $2.7 billion) compared to the norm of $120 billion during this time period.
The main point is that the decline in credit quality in commercial and consumer loans began against a backdrop of rising interest rates.
Because the process has only just begun (banks kept loan rates low due to a cheap funding base and excess liquidity), credit risk will manifest itself in 2023.
The cost of funding the US banking system is meager
According to calculations based on primary FDIC statistics, the cost of funding the US banking system is meager - only 0.95% per year of the weighted average cost in accordance with interest expenses on dollar deposits located in US jurisdiction (foreign offices of US banks are not taken into account).
The weighted average rate on dollar deposits was 0.51% in Q3 2022, 0.19% in Q2 2022, and 0.11% at the start of 2022.
It is critical. Deposits form 90% of the total funding resource (liabilities) of the US banking system and determine, in fact, the entire profile of banks in terms of interest expenses.
The weighted average cost of dollar liquidity, on the other hand, was 4.19% in Q4 2022, 2.8% in Q3 2022, 1.1% in Q2 2022, and 0.3% in Q1 2022.
It is a composite index based on interbank loans, funding directly from the Fed, and three-month US bills. This is a complete market rate, i.e. how much are dollars on the interbank market?
Yes, deposit rates are rising, but slowly. As a result, the gap between the market rate and the weighted average rate on deposits is 3.24 percentage points, which is the largest gap in the entire modern history of the US banking system.
This is due to surplus liquidity, which is concentrated in major banks, but this factor is steadily diminishing.
Weighted average lending rates, on the other hand, rose sharply to 5.7% from 4.3% at the start of 2022 (rebounded from the historical low) - the growth rate is significant, but much slower than the Fed rate growth, and current lending rates are in line with the period 2017-2018 when the Fed rate was 2.5%.
As a result, the spread between the market dollar rate and the credit rate shrank to 1.5 percentage points, the smallest for the whole statistical period. The typical spread is 4-4.5 p.p.
The Fed's monetary policy transmission mechanism has been destroyed, and banks are holding lending rates as best they can, but they are rising, affecting borrowers' solvency and actualizing credit risk.
Bank interest margins increased the most in ten years
Bank interest margins increased to 4.8%, the most in ten years.
In general, an increase in the interest margin with an increase in the Central Bank's key rate is unusual due to the transient nature of assets and liabilities, with deposits being mostly short-term and assets (loans) being predominantly medium-term and long-term (concerning mortgage loans).
All true, but not in the "new normal" age. Because of the excess bank liquidity generated over the last 13-15 years of monetary frenzy, large banks have been able to raise deposit rates at a slower rate than the current cost of dollar liquidity.
A market-only, pragmatic approach. There is no sense in attracting and/or retaining clients if there is extra cash. This was in 2021 and the first half of 2022, but deposits have been actively declining since mid-2022, which is naturally reflected in the money supply decline.
At the same time, deposits in the second half of 2022 decreased primarily at large banks, while deposits at small and medium-sized banks stagnated and only collapsed in March.
This is because wealthy and large clients prefer large banks, while regional banks have concentrated deposits from the proletariat.
Rich clients began to redistribute deposits in real estate (luxury real estate has better price dynamics than mass real estate), stocks, and bonds in search of higher yields.
Deposits began to be transferred to large banks again in March as a result of the failure of regional and local banks.
All of this implies that interest rate risk will rise when excess liquidity is exhausted, cash gaps widen, and deposit rates rise to attract and/or keep customers.
Furthermore, these processes will be disjointed. Megabanks may maintain high margins, while small and medium-sized banks will face challenges (liquidity depletion, depositor flight, competition for clients/investors -> deposit rate rise).
First Citizens inherits the bankrupt SVB
First Citizens inherits the bankrupt SVB, which had over 200 billion assets (173 billion deposits) at the start of the year and 167 billion assets at the time of bankruptcy (119 billion deposits).
As a result, media conjecture of a large-scale flight of savings and investors was validated by official FDIC information.
SVB lost one-third of its deposit base in a matter of months, and bankruptcy was unavoidable owing to technical reasons. To meet consumer demands, the bank sold assets, resulting in losses that surpassed capital.
First Citizens receives 52 billion in deposits and 72 billion in assets at a $16.5 billion discount, while sharing the FDIC's asset disposal losses.
Securities worth $90 billion have been surrendered to the FDIC, and the FDIC has lost approximately $20 billion in deposit insurance.
There may be an expectation that the banking crisis will pass, but the history of financial crises reveals that these processes can last for years.
Given the recent high-intensity incidents, it is evident that financial institution disruption cannot occur on a regular basis in hot headlines with online updates.
It is critical to underline that the banking crisis (which is actually a broader and more accurate phrase for a financial crisis) will not end until tight financial conditions, notably high interest rates, normalize.
Damaging activities in the financial system can act as a trigger and catalyst for a slew of bad processes affecting a diverse range of economic actors and spreading to all links in the chain.
It is critical to clearly describe the financial system's profile and potential weaknesses. The financial system's disposition will be monitored as long as the other flanks remain largely steady.
About the financial system's response to rising interest rates...
A dramatic increase in the Fed's rate results in the realization of interest rate risk in the US banking system, or, to put it another way, a sharp drop in bank interest margins. This occurs when the growth rate of interest expense on obligations begins to exceed the growth rate of interest revenue on assets.
First and foremost, due to the time structure of assets and liabilities. Loan revenue has an inertial characteristic due to the characteristics of the loan portfolio.
Many of the mortgage loans in their portfolio, for example, are long-term (15 or 30 years) and fixed-rate, and this loan portfolio was built during a 13-year era of low rates from 2009 to 2022.
Deposits, on the other hand, are largely short-term and rotate more quickly in line with current market rates.
True, there were times when banks were uninterested in recruiting a deposit base, allowing them to dramatically diverge deposit rates from money market rates, but this is no longer the case.
As a result, competition for a depositor, and investors, and an increase in rates are unavoidable (interest expenses will rise), especially in light of the banking system's fragmentation, as the deposit base is transferred from small and medium-sized banks to large ones.
Bank margins will be reduced as a result of these activities. To compensate for these processes, banks will be obliged to boost loan interest rates, which will, on the one hand, dampen demand for new loans while also reducing borrowers' stability as part of refinancing current loans under new terms.
This would result in an increase in delinquencies and write-offs (the realization of credit risk), which will dramatically raise the cost of generating provisions for loan losses at low margins (on the medium-term track), further damaging bank stability.
As a result, market and interest rate risk (losses on securities as rates rise and net interest margins fall) - > credit risk (increase in the cost of credit losses) - > bank losses - > fresh bankruptcies and cash shortfalls. It's only the beginning!
28.03.2023
Loan portfolio quality deterioration
The deterioration in loan portfolio quality has not yet fully presented itself for a mundane reason: a noticeable increase in loan rates began only in Q4 2022, and the typical impact on borrowers occurs around one year before the fall of insolvency begins.
Depending on the risk profile and loan structure, these processes are medium- to long-term in nature.
At the moment, the amount of non-performing loans in the US banking system (almost $12 trillion) is 0.72% - the portion for which delays in payment of any term are permitted.
This is owing to the considerable contribution of mortgage loans (almost half of the portfolio), where no crisis processes have yet occurred, but based on the experience of 2007-2008, these processes can linger for years.
Six years transpired between the start of difficulties and the peak of delinquent creation, i.e. in 2011-2012, when the decline of the quality of the mortgage loan portfolio was completed and stabilization began, with a strong improvement beginning in 2013 and continuing until 2022. Because of the nature and duration of the loans, there is a lot of inertia.
According to the histogram of loan delinquencies, there is a dramatic increase in delinquency on credit cards and commercial/industrial loans after more than 90 days of delinquency, with consistency over the full term of delinquency.
This is due to issues encountered during restructuring, such as banks (the problem requires a separate analysis).
Processes will develop quicker in 2023 than they did 15 years ago for numerous reasons, including increased debt burden and weaker integral sustainability. After 14 years of low-interest rates, entire sectors (zombie companies) have grown up.
In the sectoral environment, significant disparities began to emerge, with certain segments having large margins and cash reserves while others do not.
Bank lending provided a lifeline to low-performing junk bond enterprises that had failed due to a lack of demand. Lending is no longer an option.
Who saves the Treasury?
Issues in the government debt market are not new, especially now that the two primary buyers (the Fed and non-residents) have "left the stage."
The Fed has initiated an indeterminate era of balance-sheet reductions, with treasuries being drained at a rate of $60 billion per month, and demand from non-residents is exceedingly volatile.
The deterioration of US-OPEC foreign policy ties does not allow for the accumulation of extra oil and gas profits in treasuries as it did ten years ago, and the key customers in the face of China, Japan, and Europe have their own issues.
China has been at odds with the US since 2018 and has consistently reduced its investment in treasuries since then, while Europe and Japan had a foreign trade deficit due to the energy crisis, and it was the foreign trade surplus that previously served as the primary resource for investment in American securities. Non-residents' condition is stabilized by offshore corporations that are not connected to the US financial system, but more on that later.
After the 2009 financial crisis and aggressive government borrowing, non-residents and the Fed have become the primary buyers of Treasuries, increasing investment by 9.4 trillion (about the same as in Q4 2022), or 56% of all purchases - this is a lot. They are now selling, but who is going to purchase back the sales and fund the new placements?
Investment funds, brokers, dealers, and state funds preserved Treasuries in 2020-2021, and American individuals generated a net cash flow in Treasuries of more than $1 trillion in 2022, well above the previous record of $600 billion in 2010 and 2019.
This is the public's largest investment in the Treasury in history. As a result, the population and affiliated mutual funds increased their portion in the structure of the primary holders of Treasuries from 9% to 13%, while the Fed's stake decreased from 27% to 24%, and the share of investment funds, brokers, and dealers decreased from 10% to 8%.
This is most certainly not a matter of patriotism, but of protecting investments from depreciation in the face of high inflation, a stock market crash, and low deposit rates.
Bonds are purchased by Americans
In 2022, American consumers will channel an unprecedented amount of funds into bonds - more than 1.5 trillion each year - with a considerable portion (more than 1 trillion) allocated in treasuries, functioning as the primary buyer, countering the Fed's and non-residents' exodus.
In monetary terms, this is a historical high, and in terms of household income, it represents 8.3% of total annual income from all sources (salary, business, interest, dividends, social, pension and insurance payments). A stronger flow occurred at the start of 2009 when more than 10% of the proceeds were distributed into bonds.
When the general population in the United States purchases bonds, two factors come into play: the financial/economic crisis (from 2008 to 2010) and the rate disparity between bonds and deposits (2018-2019 and 2022).
Much has been written about the interest rate differential between deposits and bonds. This is the reason for the decrease in the deposit base and the national money supply, although exact figures are required.
In Q4 2022, the populace withdrew 365 billion from deposits - an absolute record, an enormous flight from monetary assets with no precedent in history. There was an influx during the inflationary crisis of the 1970s and 1980s.
The public is already withdrawing money in the second quarter (in Q3 2022 minus 42 billion). Prior to it, there was a record influx of 4.3 trillion due to government helicopter money from Q2 2020 to Q2 2022. (4 times higher than the norm for the comparable period).
The current alignment is not surprising, but the size is intriguing. Concurrently with the flight from deposits, there is a flight from stocks, where the annual flow has declined to minus 1% compared to earnings after retail clients' extraordinary interest in shares in 2020-2021 (to 6.5% of earnings). The share sale was completed in the third quarter, and there was a modest inflow at the conclusion of the year.
Hence, the US population supports the debt market's stability in the face of negative real rates and Fed sales, and the sale of shares and withdrawal of funds from deposits acts as a resource.
Bonds vs. stocks
The interest rate gap between financial instruments, combined with macroeconomic uncertainty, is the key to rising demand for bonds.
There can be no substantial demand for both stocks and bonds at the same time, which confirms the history of cash flows. Peak liquidity distribution in shares has always been connected with record outflows in bonds, and vice versa.
Hence, sustainable development in the equity market cannot be achieved until the debt market's difficulties are rectified and natural demand returns to normal - conditions in which interest rates are positive in real terms.
There are no other sufficiently capacious and liquid points for capital investment in conditions of inflation, when deposits give less than 1%, and shares in a period of uncertainty and degradation of the operating performance of businesses and banks can "zero out" at any time ", as it was "with success stories" in 2022.
In 2022, a significant event occurred: for the first time since the 1930s, cash flow to deposits and equities became negative at the same time, while the situation with deposits worsens by the quarter, while the balance point for equities was found in Q4 2022.
Deposits will continue to flow out as long as the interest rate differential between deposits and bonds remains. As a result of the uneven distribution of bank reserves and deposits, the banking system becomes unstable.
Big banks have a surplus, whereas small and medium-sized banks have a shortfall, forcing them to raise rates more quickly, realizing the interest rate first and subsequently the credit risk.
Bank excess liquidity contributed to the debt market's stability in 2022 (low deposit rates -> outflow to bonds), but it may destabilize the situation in 2023 due to liquidity distortions within the banking system and the need to raise deposit rates.
12.04.2023
The threat of a US banking catastrophe is still present.
Total failure in terms of the deposit base. By March 29, the total amount of deposits leaving the US banking system (US banks plus foreign bank branches) had reached a record $473 billion in just 4 weeks!
To appreciate the size of this. The sum of deposits that were lost from December 31, 2022, to February 28, 2023, was "just" $135 billion. The total outflow from March 1, 2022, to December 31, 2022, was $331 billion; hence, from March 1, 2022, to March 1, 2023 (exactly for a year), the total outflow was $466 billion.
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A similar sum to what was removed 11 months before the financial crisis has been taken out within the last 4 weeks!
Due to the rapid outflow of depositors, these data have been seasonally adjusted, and there is reason to suspect that the Fed has erroneously calculated seasonal coefficients. Without seasonal smoothing, the outflow for the year was $677 billion versus $940 billion, but the trends have remained consistent - March broke a historical anti-record.
This is NOT the whole money supply, but Simply deposits in American banks! Between March 1, 2020, and March 1, 2022 (a period of extreme monetary frenzy), US bank deposits climbed by $4.7 trillion, and by $5.7 trillion ten years earlier.
Currently, 20% of the deposits that had accrued during the monetary frenzy have been used (withdrawn into other assets) for the year, which is, in relative terms, the greatest flight since the Great Depression.
The usual growth rate of deposits is $700–$750 billion annually, after accounting for compounded inflation and other banking system components.
Even with such a remarkable withdrawal of deposits, there is still a $2 trillion gap from trend growth (2010-2019) that must be filled by inflation or more deposit flight in order to stabilize the money market and eliminate the "surplus," excess liquidity.
More than $300 billion worth of the deposits were sent to money market funds and similar institutions, supporting the demand for bonds and enabling the Fed to begin sales.
Bank issues still exist; everything is just getting started!
The banking crisis has been going on for more than a month now
Due to the "freezing" of the informational background, it may appear as though the worst is behind us.
US banks sold $277 billion worth of securities between February 22 and March 29, resulting in a record loss that should be recorded in the first quarter's financial accounts. In the structure of sales, MBS accounted for $169 billion, $67 billion in treasuries and $41 billion in other securities.
Throughout the history of the American financial system, no other significant sales occurred over the course of five weeks.
The last comparable event occurred during the 2008 financial crisis when $133 billion in securities were sold by November 26. According to preliminary estimates, money market funds were the biggest recipients of liquidity, intercepting $250–350 billion and distributing the ensuing liquidity to treasuries and MBS in equal distribution, keeping the debt market steady.
But, there is another factor at play here: Banks boosted their investments in securities by $2 trillion (from $3.8 to $5.8 trillion) between May 2020 and March 2022, and the total amount of these assets is currently estimated to be $5.2 trillion. The predicted change in assets from the weighted average purchase prices from May 2020 to March 2022 is minus 10% since banks purchased bonds during the period of zero interest rates (due to rising rates).
The realized loss might be between $25 and $30 billion, or up to half of the possible profit for the first quarter of 2023 for the whole banking system, given the size of the sales. However, the majority of the reset occurred in small and medium-sized banks, where losses as a percentage of total profits might be higher.
Another significant tendency is a dramatic slowdown, or perhaps a drop, in lending.
For the first time since July 2021, overall bank lending of all kinds fell by 0.3% during the previous four weeks, favouring people and legal companies.
From a high of 4% in mid-2022 and 2% in early 2023, the three-month rate dropped to 0.7% at the end of March 2023.
The credit impulse started to increase in July 2021 and culminated with all the related effects after adding $ 1.8 trillion in loans.
Now, evidently, everything is completed with all the implications.
16.03.2023
The QT program is now on hold
The Fed has paused its QT balance sheet reductions once more, bringing the gap between actual June 2022 sales of $602 billion and planned sales of $853 billion to $252 billion.
Because selling is discontinuous, one should not expect a weekly sale of securities, but it is more necessary to evaluate the medium-term trend, which demonstrates a consistent increase in the gap.
Bank deposits with the Fed increased by $440 billion after a large-scale March injection program, but declined by over $100 billion during the month - there is a significant association with the S&P 500 index.
The market is decreasing due to a liquidity squeeze and expanding due to the opposite scenario.
However, since the beginning of March, the US Treasury has "added" over $250 billion, which has been moved to dollar REPOs with the Fed, raising the repo by the same amount.
Between February 23 and April 12, bank deposits/excess reserves and REPOs surged by over $560 billion.
Apart from the local occurrence in April-May 2020, this is one of the strongest rises in banking system liquidity in history.
This was made possible by Treasury spending money and Fed loan programs.
Did everyone count and debate the "largest" balance-sheet reduction initiative, which actually totalled $600 billion in 9.5 months? And how about $560 billion in cash in seven weeks? --> This is the primary reason why the S&P 500 soared despite acknowledged difficulties.
Because of the projected budget surplus, liquidity will be reduced beginning in mid-April.
In terms of lending in the last five weeks:
Lending has fallen by $60 billion since the peak, but more instances of the banking crisis are on the way.
Deposit outflows have levelled off, but lending is beginning to fall
Consolidated figures on banks in the Fed's H8 report are consistent with bank comments - deposit outflows from the US banking system have stabilized, but lending is beginning to drop.
The date set for the cessation of lending growth is January 20, 2023. Since then, the cumulative increase in loans made to individuals and legal companies has been close to zero (within a modest margin of error).
Since March 15, 2023, there has been a tenth-of-a-percentage-point decline, which does not appear to be pronounced (or noteworthy), but there is reason to believe that March is the turning point for bank lending.
Lending reversal is a fixed feature of commercial credit at all levels, including capital-building loans (industrial facilities, commercial real estate) and other company loans. Retail lending is increasing, but the rate of increase has slowed many times.
This trend is noteworthy for various reasons:
The first reason. Bank lending increased by about $900 billion, or 9%, from March to June 2020, but this increase was virtually entirely driven by corporate loans backed by government guarantees. Furthermore, about half a trillion dollars in bank loans were repaid on a post-COVID deleveraging trajectory from June 2020 to July 2021.
There was a tipping point in July 2021, and from August 2021 to December 2022, bank lending increased by $1.7 trillion, or 16.5%, the highest growth rate ever in absolute terms and comparable to the most intense phase of bank credit growth in 2005-2007, i.e. it was a very powerful impulse.
Since January 2023, lending rates have dropped rapidly and have fallen to zero since February, and since March, the downward trend has been broken, indicating a break in the trend.
It is crucial to note that at the macro-financial level, the trend break does not occur all at once - there is a period of inertia (up to 3-6 months), but when the break occurs, the credit contraction process might last at least a year, if not several years.
It took 3.5 years in the early 1990s, over 1.5 years in the early 2000s, and nearly three years during the 2009 financial crisis.
February appears to be a trend reversal, March a confirmation of a reversal, and April will see the reality of negative loan trends.
The second reason. Bank lending in a closed capital market served as a "lifeline" during the financial crisis for vulnerable companies in the bad debt segment, which will account for 25% of all corporate debt placements in 2021.
Now that placements have dropped to zero, bank lending has begun to shrink, and cash gaps and holes in non-financial enterprises' balance sheets may widen.
Bankruptcies are unlikely to occur in a flash, although bad news may emerge between May and June.
The third reason. When helicopter money was switched off, the main resource for maintaining a high consumption rate was the depletion of savings and retail lending.
The primary savings buffer was eliminated in 2022, and retail financing is getting more expensive. As a result, we should expect a rise in negative consumer demand trends beginning in April.
What is happening today makes perfect sense. Rising interest rates beginning in Q3 2022 and tightening lending rules beginning in March 2023 as a result of the financial crisis will worsen the credit squeeze. Furthermore, loan interest rates will continue to rise as a mechanism to compensate for higher deposit expenses, and lending will suffer even more as a result.
In terms of the deposit base, deposits into the banking system totalled 61 billion seasonally adjusted and 75 billion without SA in the previous week through April 5 inclusive.
The situation is currently stabilizing slightly, although the deterioration in the banking system may be long-term due to the previously stated reasons.
22.04.2023
A warning by the head of the Bank for International Settlements
Agustin Carstens, the head of the BIS (Bank for International Settlements), an international organization that provides mutual settlements between national central banks, published an important article in which he literally says that politicians have played with testing the boundaries of what is possible in managing the economy: "Monetary and fiscal policy have tested the boundaries of what I call the "region of stability".
The crucial point is that the head of the BIS is warning that it will no longer function as it once did.
It is now widely assumed that any crack in the economy of the United States or the European Union can be repaired using the traditional method: restarting the printing press. And these are not simply opinions around the dinner table, but positions backed by hundreds of billions of dollars. In other words, the possibility of monetary pumping is priced into markets.
However, the head of the BIS, who observes events from a higher vantage point than the heads of the Fed or the ECB, advises against a return to soft monetary policy. And the existence of his paper challenges the belief that Powell or Lagarde know everything better than anyone else and that any of their pronouncements is a tried and true approach for managing expectations. Everything is extremely vague.
29.04.2023
The first details of the banking crisis emerged
The first details about the March banking panic with the primary players have emerged.
First Republic Bank reported (the bank that was under direct threat of bankruptcy in March and which depositors went through like a skating rink, withdrawing a significant portion of the deposit base, forcing the largest bankers, led by JPMorgan, to inject $30 billion in liquidity into First Republic Bank (FRC)).
The report demonstrates, in general, that banks' "Income statement" cannot be relied on when considering the potential hazards of banks. The most advantage comes from lighting a fire in your home's fireplace.
Despite the fact that the FRC was nearly destroyed, the bank reported a profit of $229 million, down from $364 million the previous year.
Non-interest revenue increased from $251 million to $286 million, but net interest income after credit write-off provisions declined from $1135 million to $907 million. The bank's overall income decreased from $1386 to $1193 million, indicating that nothing major occurred (!?).
On March 9, 2023, FRC deposits were $173.5 billion; three weeks later, the bank had lost more than $100 billion of its deposit base, or 58% of all deposits – in just three weeks!
The bank had only $34 billion in marketable assets at the time of the collapse, 90% of which were long-term securities in the HTM category with massive unrealized losses. In addition, there was around $4 billion in cash and $170 billion in loans.
Even if the FRC sold all of its securities and realized all of its funds, it would technically be unable to meet the withdrawal requirements. So, what was it?
$30 billion from large banks, about $74 billion in short-term Fed and interbank loans, and another $18 billion in long-term FHLB loans.
The problem is that the bank took on super-expensive loans at 4.8% rates, with a weighted average yield on loans of 3.73% and on securities at 3.08%, resulting in a big difference in returns between liabilities and assets, which will result in huge losses in the short run.
In other words, the bank is deserving of ultimate annihilation.
The game of elimination has only just begun
First Republic Bank is on the verge of insolvency. Another huge bank has been written off.
In the foreseeable future, the FDIC plans to place the bank under external control. Although this information is not yet official, given the specifics of how the financial sector operates on trust, such rhetoric and investor pressure is a verdict.
The events are irreversible, and First Republic Bank's insolvency is only a matter of time. When a bank was chosen following a 50-fold drop in capitalization in two months (from the highest point of fixing capitalization to the lowest at the auction on April 28), there were no precedents.
Capitalization declined about 80 times from more than 40 billion in November 2021 to 550 million.
The bank sank four times in a week, and nearly three times after the closing of trading, to $ 200 million or $ 1.3 per share, but recovered to 2.33 (the maximum was $220 per share).
They do not withstand such a setback. The fate of the $30 billion injected into the FRC by prominent Wall Street bankers led by JPMorgan Chase remains unknown. If the FRC's assets are auctioned off, and the majority of the assets are loans, it will be possible to cover, at best, the protected deposits of small depositors. Bankers will be officially left with nothing.
Don't rely on the FDIC. To save SVB and Signature Bank, the FDIC burned all available reserves.
The FDIC had $128.2 billion in reserves prior to the March financial exhibition, with about $126 billion in bonds and $2.5 billion in cash. Taking unrealized losses into account, the actual figure was less than $110 billion.
The current balance as of April 29 is unknown, but given the size of Fed loans ($170 billion) and tens of billions of dollars in US Treasury bailouts, there is actually very little free reserve available.
As a result, the FDIC's deposit guarantee is fiction based on a perpetual Call option for the scenario "We kind of guarantee deposits, but we hope that bankruptcy will never happen."
The FDIC completed its work after bailing out two banks with $208 billion in direct liabilities on deposits, and another with $70 billion in deposits is on its way.
Even if the deposit base is somehow assured and maintained by the next round of raids, First Republic Bank faces a fundamental mismatch between assets and liabilities.
Super-expensive liabilities of $40 billion at a rate closer to 5%, while assets are inexpensive, with market assets yielding 3.1% and loans yielding 3.73%, implying that the bailout plan alone costs the bank roughly $600 million per year in net losses due to the rate gap. This represents one-third of the earnings in 2022.
This does not account for asset sale losses or the anticipated increase in delinquencies and write-offs. All banks face the same issues.
If banks begin to compensate for the interest gap by raising loan rates, this will result in a decrease in demand for new loans, an increase in delinquencies, and future write-offs, which will necessitate an increase in the cost of provisions for write-offs, effectively neutralizing the entire effect of a loan rate increase.
With present Fed rates and system hazards, the processes are irreversible, and the situation for banks is dismal.
The knockout game has only barely begun!
08.05.2023
First Republic Bank has declared bankruptcy
JPMorgan acquired another bank in an attempt to rescue its $5 billion investment in March. JPMorgan's balance sheet now includes 173 billion in loans and more than 30 billion in securities assets.
JPM can purchase anyone, at any time, with about 900 billion dollars in cash. It's not surprising.
The most intriguing aspect is that JPMorgan privatizes profits while nationalizing losses. The FDIC has agreed to share the weight of losses as well as any possible loan write-offs with JPMorgan, with a potential coverage of up to $13 billion.
The FDIC is rendered ineffective because it has burned practically all of the previous two banks' potential rescue reserves and expects up to $500 million in profit each year in accordance with First Republic Bank's asset-liability structure.
According to the plan, JPM would incur $2 billion in restructuring costs over the following 1.5 years but will realize a $2.6 billion one-time gain.
JPM is returning $25 billion to other banks that bailed out the FRC in March, bringing the deposit base to $75 billion.
FRC assets are not as dangerous as the bank's troubles, which were weakening confidence and widening the gap between liabilities and assets. FRC had super-expensive capital at 5% and a 3.5% average return on assets.
A merger with JPM would allow the Fed to return funding at 5% utilizing JPM's trillion-dollar cache reserve, eliminating the bank's fundamental difficulty in the profitability gap, as well as the crisis of confidence in this particular bank.
The third reasonably significant bank in the United States arrived at the exit feet first. There are still dozens of small and medium-sized banks to save in the United States.
The Fed increased the interest rate
The Fed increased the interest rate by 0.25 percentage points to 5.25%.
This is the highest level since May 2007.
The Fed's conclusion was totally predictable, as it could not have been otherwise given the circumstances.
Powell, as usual, stated, "We don't know, we don't understand, there is too much uncertainty, we need to watch how the data accumulates and make appropriate decisions, the Fed will respond adequately and all along the same lines."
That is what Powell stands for. When the Fed sparked the greatest bubble in human history in the financial system (including the stock market), beginning an unparalleled monetary frenzy in 2020-2021, Powell stated that "there is no risk of inflation."
Furthermore, even when inflation reached 7%, the Fed continued to outperform the market by keeping rates at zero. The same is true of the banking crisis.
Powell has now produced a fresh pearl: "First Republic Bank was the last bank to fail, and a line should be drawn under the acute phase of the banking crisis." ??
When you try to analyze the mutually conflicting theses and, in some places, anger against Powell's common sense, you will notice a distinct lean towards dove rhetoric and a desire to break out from the tightening cycle.
It all started with the February meeting.
The banking crisis since March has established all of the conditions for the Fed's decision-making system to ultimately return to its prior track of "infinite softness," but the difficulty is the typical inertia of the Fed's decision-making system. With the exception of an emergency release of pressure, any rapid jerks nearly invariably cause confusion and a breach of confidence.
The banking crisis may be filled with cash, which was done, but regaining trust in the regulator is difficult if it is lost - this is a long-term damaging process with very terrible effects.
Monetary policy manoeuvres should be carried out at such a rapid pace that the market has time to embrace a new configuration of reality and generate suitable expectations.
Everything the Fed does in public, both during the meeting in Powell press conferences and between meetings through talking heads (representatives of Federal Reserve Banks), is to create a communication window/channel between the Fed and the market so that monetary policy decisions always correspond to short-term market expectations.
Disagreements between market expectations and Fed decisions are exceedingly rare and only permitted in exceptional instances and conditions, such as the COVID crisis in March 2020.
Market expectations determine the vector of change in monetary policy; in this sense, it can be recognized that expectations form the Fed's monetary policy; however, the Fed's monetary policy and the Fed's communication channel with the public are tools of monetary policy, that is, building market expectations.
But, can market expectations be autonomous and independent of the Fed's actions?
To some extent, yes, because the Fed is not an autonomous organization and is embedded in the financial system, and the financial system is primarily made up of the largest financial structures, the majority of which are primary dealers (they perform open market operations on behalf of the Fed).
It is more accurate to state the concept as follows.
Market expectations consider the interests of the financial sector, which has a direct impact on the Fed's monetary policy; yet, the Fed can modify market expectations to meet its purposes.
In general, the Fed remains a conglomeration of megabanks and investment companies.
So, when Powell declares that the Fed is committed to battling inflation by using monetary policy as an ultimatum, he is playing a confidence game. Simultaneously, a fine line is constructed between assertions and their context, establishing the narrative and tone.
The Fed may declare that it will not decrease interest rates this year while also making numerous reservations and mutually exclusive theses. The increase in disorder and entropy i.e. increased confusion and ambiguity, is sure evidence of a schism in words and intentions.
As a result, the Fed is plainly searching for wriggle room to gracefully exit. Actualization of crisis processes, as well as financial sector destabilization, will be ample reasons to put the brakes on, at the very least with toughening. Against this backdrop, the reduction of inflationary pressure will undoubtedly make room for a rate cut.
As a result, the last rate hike occurred with a high probability, and if the situation in the financial sector worsens, the first rate cut is likely in July, rather than September, as a response to the deterioration of financial conditions. The macro data will be fairly bad by this stage.
All of this is done to guarantee that readers may grasp the context of monetarist comments and Central Bank rules of the game more accurately. Denying a rate cut this year is not the same as rejecting one because the intricacies are significant.
What should be known about the Fed's decision-making process?
Because present inflation takes into account the past, there is no deciding value. It's like thinking back on last year's snow. When it comes to inflation, only inflation expectations count to the Fed.
Inflation expectations are proportional to the amount of money lost. The greater the expectations, the faster money is converted into commodities and services, alternative places of capital investment in financial markets, and money surrogates.
The pattern of family spending and company investment is directly affected by assumptions about future price dynamics.
Rising price expectations contribute to driving the money supply into commodity circulation as economic organizations strive to fix current prices through the purchase of goods and services, so "profitably" transforming savings "into material substance."
This is how boosting monetary policy is implemented during a recession, but if this process occurs under situations of limited supply for different causes, inflation will eventually accelerate due to a supply-demand imbalance.
Many other factors influence inflation expectations:
However, one important feature of inflation expectations is the projection of intent on financial markets.
When allocating liquidity among financial assets, investors are driven by anticipated inflation over the investment horizon.
Inflation expectations have a direct impact on investment horizons and priority financial instruments, influencing both demand potential and market interest rates in the debt and money markets.
That is why Central Banks control inflation expectations rather than inflation, which determines future inflation through the actions and expectations of economic entities.
TO BE UPDATED
Stay tuned.?
Regards, Negorbis.
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