Bigger Isn’t Better

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What caused the overnight lending market to unexpectedly seize up in September? There’s a good reason to believe JPMorgan Chase (JPMC) may have been at the heart of it.

JPMorgan Chase is the largest bank in the U. S., and has about $1.49 trillion in deposits. It’s one of the big banks that provide much of the loans in the overnight money markets.

But it seems the mega-bank had gone on a stock buyback spree from January through September of this year.

Buybacks, which are designed to boost stock prices, have been enabled for years by the Fed’s artificially low-interest rates. Corporations, in fact, have been the largest purchasers of stocks, which is heavily responsible for the bull market that’s now over a decade old.

According to the SEC, JPMC has spent about $77 billion on buybacks since 2013. But the money JPMorgan Chase used for buybacks on its most recent buyback binge was, therefore, unavailable to be loaned out in the repo market.

This information is from the bank’s annual SEC filing (hat tip to the Wall Street on Parade blog):

In 2019, cash provided resulted from higher deposits and securities loaned or sold under repurchase agreements, partially offset by net payments on long-term borrowing… cash was used for repurchases of common stock and cash dividends on common and preferred stock.

That diversion of money likely contributed to the liquidity crunch, which forced the Fed had to intervene in order to make up the difference.

Here’s how Wall Street on Parade sums it up:

Had JPMorgan Chase not spent $77 billion propping up its share price with stock buybacks, it would have $77 billion more in cash to loan to businesses and consumers — the actual job of its commercial bank. Add in the tens of billions of dollars that other mega banks on Wall Street have used to buy back their own stock and it’s clear why there is a liquidity crisis on Wall Street that is forcing the Federal Reserve to hurl hundreds of billions of dollars a week at the problem.

But altogether, JPMorgan has actually withdrawn $158 billion of its liquid reserves from the Fed in the first half of this year. That’s an extraordinarily large amount of money to withdraw in such a short amount of time, as my friends at Wall Street on Parade point out. That’s bound to have an effect on the market.

And that’s what we’ve seen.

Of course, JPM is one of those Wall Street banks that are “too big to fail.” It’s the largest commercial bank in the nation, with $1.6 trillion in deposits.

But it’s not just JPM.

It’s just one part of a system rigged in favor of Wall Street that has been deemed too big to fail. It’s a corrupt and incestuous system filled with perverse incentives and conflicts of interest. Here’s an example…

82% of bank analysts on Wall Street recently gave Citigroup stock a “buy” rating. What you didn’t hear reported on CNBC or Fox Business News is that the major banks they work for — like JPM, Goldman Sachs, Morgan Stanley, Deutsche Bank, UBS and Bank of America — have strong incentive to recommend Citigroup.

That’s because all the major banks are interconnected through derivatives. And weakness in one bank could spill over into the others. So it’s not a level playing field at all. It’s tilted in favor of the big banks.

But as one observer asks, “Why should any Wall Street bank be allowed to make research recommendations on stocks and then trade in those very same stocks?”

It’s a corrupt system designed by insiders for insiders. I should know because I used to be one of them.

I worked at four of the world’s major banks for a decade and a half until I finally had enough and walked away. Two of the four banks I worked for, Bear Stearns and Lehman Bros., were destined to implode.

That’s because they overleveraged themselves, taking on too much debt to bet on risky credit instruments. These credit instruments included subprime loans, credit derivatives and Wall Street’s version of a debt buffet called CDOs, or collateralized debt obligations.

It’s now been over a decade since the world’s major central banks reacted to the financial crisis with record-low interest rates and quantitative easing.

Today the big banks are bigger than ever and the amount of debt in the system is larger than ever. There’s been no substantial reform since the financial crisis, just some cosmetic moves that have been passed off as major reform. The big banks are always ahead of the regulators.

My research for my book Collusion: How Central Bankers Rigged the World revealed how central bankers and massive financial institutions have worked together to manipulate global markets for the past decade.

Major central banks gave themselves a blank check with which to resurrect problematic banks; purchase government, mortgage and corporate bonds; and in some cases — as in Japan and Switzerland — buy stocks, too.

They have not had to explain to the public where those funds are going or why. Instead, their policies have inflated asset bubbles while coddling private banks and corporations under the guise of helping the real economy.

The zero-interest rate and bond-buying central bank policies that prevailed in the U.S., Europe and Japan were part of a coordinated effort that has plastered over potential financial instability in the largest countries and in private banks.

It has, in turn, created asset bubbles that could explode into an even greater crisis the next time around.

The world’s debt pile sits near a record $246.5 trillion. That’s three times the size of global GDP. It means that for every dollar of growth, the world is borrowing three dollars.

Of course, this huge debt pile has done very little to support the real economy. Even the IMF now admits that global central bank policies to lower interest rates in order to stave off immediate economic risks have made the situation worse.

Their actions have led to “worrisome” levels of poor credit-quality debt as well as increased financial instability.

The IMF noted that 40% of all corporate debt in major economies could be “at risk” in the event of another global economic downturn, with debt levels greater than those of the 2008–09 financial crisis.

That huge pile of debt is basically the kindling for the next financial fire. We’re just waiting for the match to light it.

So today we stand near — how near we don’t yet know — the edge of a dangerous financial conflagration. The risks posed by the largest institutions still exist, only now they’re even bigger than they were in 2007–08 because of the extra debt.

It’s not sustainable. But that doesn’t mean the central banks won’t try to keep it going with monetary easing policies in place.

It could work for a while, until it doesn’t.

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Three Concerns Hanging Over the Davos Elite

This post Three Concerns Hanging Over the Davos Elite appeared first on Daily Reckoning.

This week, the global elite descended private jets to their version of winter ski-camp – the lifestyles of the rich and powerful version.  The World Economic Forum’s (WEF) five-day annual networking extravaganza kicked off in the upscale ski resort town of Davos, Switzerland.

Every year, the powers-that-be join the WEF, select a theme, uniting some 3000 participants ranging from public office holders to private company executives to the few organizations that truly do help fix the world that they mess up.  This year’s theme is “Globalization 4.0”, or the digital revolution. The idea being, the potential tech take-over of jobs, and what wealthier countries are doing to lesser developed ones in the process.

While the topic might be focused on the future, the present is just as troubling, if not more so, than the future.   Such is the disconnect between real people and corporations.  That’s what the estimated 600,000 Swiss Franc membership to be a part of the WEF constellation gets you as a CEO at the Davos table.

Government leaders like German Chancellor Angela Merkel, Brazil’s president, Jair Bolsonaro and Chinese Vice President, Wang Qishan are in attendance this week. Business leaders like Microsoft co-founder Bill Gates and JPMorgan Chase CEO, Jamie Dimon will also take part in the festivities.

Yet, even though the various leaders will likely promote their achievements, what’s lurking behind the pristine snowcapped Alps, is a dark foreboding of a less secure world. Nearly every major forecast from around the world is projecting an economic slowdown. As one Bloomberg article reports, “companies are the most bearish since 2016 as economic data falls short of expectations and political risks mount amid an international trade war, U.S. government shutdown and Brexit.”

The list of non-attendees includes U.S. President Donald Trump, UK Prime Minister Theresa May and French President, Emmanuel Macron. They are too busy dealing with complex political problems in their own government institutions and domestic home fronts to make the trek.

Below is a breakdown of the three flashpoints that the Davos crowd should be watching in 2019:

Economic Growth Will Slow

Signs of slowing global economic growth are increasing. We’re seeing that in both smaller emerging market countries and larger, more complex ones. Weaker-than-anticipated data from the U.S., China, Japan and Europe are stoking worries about the worldwide outlook for 2019.

Many mainstream outlets are beginning to understand the turmoil ahead. Goldman Sachs, my old firm, is predicting an economic slowdown in the U.S. And the International Monetary Fund (IMF) has revised downward its 2019 U.S. growth prediction to 2.5% from 2.7% from 2018. It believes that the U.S. will be negatively impacted by the economic slowdowns of American trade partners and that the 2020 slowdown could be even “sharper” as a result.

The IMF also points to pressure from ongoing trade tensions between the U.S. and China and growing dysfunction between the U.S. and other major trading partners, such as Europe.

Because the world’s economies have become increasingly interdependent, problems in one economy can have widespread consequences. We learned this once before: the collapse of U.S.-based investment bank, Lehman Brothers, triggered a greater international banking crisis in 2008. That sort of connectivity has only grown. The reality is that we may now face even greater threats than forecast so far, which could lead to another financial or credit crisis.

It is likely that China could be ground zero for a global economic slowdown. Recent data out of China indicates that much global GDP and trade activity that should normally be in the first quarter (Q1) of 2019 was pulled forward into Q4 2018 to “beat” the tariff increase.

It’s likely that the same phenomenon could happen in the U.S. If this trend does snowball, you should expect to see rapidly deteriorating economic numbers arriving in the months ahead.

Debt Burdens Will Worsen

No matter how you slice it, public, corporate and individual debt levels around the world are at historical extremes. Household debt figures from the New York Federal Reserve noted that U.S. household debt (which includes mortgage debt, auto debt and credit card debt) was hovering at around $13.5 trillion. That debt has risen for 17 straight quarters.

What is different this time is that current levels are higher than just before the 2008 financial crisis hit.

In addition, global debt reached $247 trillion in the first quarter of 2018. By mid-year, the global debt-to-GDP ratio had exceeded 318%. That means every dollar of growth cost more than three dollars of debt to produce.

After a decade of low interest rates, courtesy of the Fed and other central banks, the total value of non-financial global debt, both public and private, rose by 60% to hit a record high of $182 trillion.

In addition, the quality of that debt has continued to deteriorate. That sets the scene for a riskier environment. Over on Wall Street they are already disguising debt by stuffing smaller riskier, or “leveraged” loans into more complex securities. It’s the same disastrous formula that was applied in the 2008 subprime crisis.

Now, landmark institutions like Moody’s Investors Service and S&P Global are finally sounding the alarm on these leveraged loans and the Collateralized Loan Obligations (CLOs) that Wall Street is creating from them.

CLO issuance in the U.S. has risen by more than 60% since 2016. Unfortunately, it should come as no surprise that Wall Street is now proposing even looser standards on these risky securities. The idea is that the biggest banks on Wall Street can actively repackage risky leveraged loans into dodgy securities while the music is still playing.

If rates do rise, or economic growth deteriorates, so will these loans and the CLOs that contain them, potentially causing a new credit crisis this year. If the music stops, (or investors no longer want to buy the CLOs that Wall Street is selling) look out below.

Corporate Earnings Will Be Lower

With earnings season now underway, we can expect a lot of gaming of results in contrast to earlier reports and projections. What I learned from my time on Wall Street is that this is a standard dance that happens between financial analysts and corporations.

What you should know is that companies will always want to maximize share prices. There are several ways to do that. One way is for companies to buy their own shares, which we saw happen in record numbers recently. This process was aided by the savings from the Trump corporate tax cuts, as well as the artificial stimulus that was provided by the Fed through its easy money strategy.

Another way is to reduce earnings expectations, or fake out the markets. That way, even if earnings do fall, they look better than forecast, which gives shares a pop in response. However, that pop can be followed by a fall because of the lower earnings.

The third way is to simply do well as a business. In a slowing economic environment, however, that becomes harder to do. Plus, it’s even more difficult in today’s environment of geopolitical uncertainty, as a multitude of key elections take place around the world in the coming months.

These three concerns were central in conversation in Davos. Expect global markets to be alert to the comments coming from the Swiss mountain town. Severe dips and further volatility could be ahead if any gloomy rhetoric streams from the Davos gathering.

How Will the Fed React?

Ready to help, is the answer. This month, yet another top Federal Reserve official noted that economic growth could be slowing down. That would mean the Fed should, as Powell indicated, switch from its prior fixed plan of “gradually” raising interest rates to a more “ad-hoc approach.”

Indeed, Federal Reserve Bank of New York President John Williams, used Chairman Powell’s new buzz phrase, “data dependence,” to indicate that the Fed would be watching the economy more. While he didn’t say it explicitly, it has become largely clear that the markets are determining Fed policy.

Based on my own analysis, along with high-level meetings in DC, I see growing reasons to believe the Fed will back off its hawkish policy stance. As we continue to sound the alarm, there are now a myriad of reasons including trade wars, slowing global economic conditions and market volatility.

Traders are now assigning only a 15% chance of another rate hike by June. Just three months ago, those odds were 45%.

Watch for even more market volatility with upward movements coming from increasingly dovish statements released by the Fed and other central banks. Expect added downward outcomes from state of the global economy along with geo-political pressures.

Regards,

Nomi Prins

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