Waiting for Godot or Does Anyone Really Know What Is Going on with eurozone Banks?

I have been researching eurozone banks excess reserves and repo availability for a few weeks trying to work my way through muddled commentary and sort the reality from the assumptions and found myself questioning what I know.  In doing so, I have misstated to others what I am thinking and even the data, facts, and issues about which I am concerned.  Sometimes it is best to just stand back and look for the string that pulls the material together.

I have yet to write that article which will address whether eurozone banking rules to promote solvency of banks is creating a liquidity problem, because  the eurozone banking resolution authorities seem to have so badly mismanaged the Banco Popular resolution to the point of intensifying a bank run despite monitoring bank liquidity on a daily and hourly basis.

Banco Popular was Spain's 6th largest bank having been in existence since the early 20thCentury and one of the more profitable banks until about 2016.  In February 2017, it announced it had a 3.b billion euro loss on asset writedowns and Non Performing Loan sales while maintaining it still had more than sufficient quality assets on its balance sheet.

By the end of May and first days of June reports were circulating that Banco Popular had received only 3.5 billion euro on 40 billion euro collateral rather than the 9.5 billion euro it had expected one month previously and had applied to the Bank of Spain for liquidity support receiving only 10%

Even Bloomberg Fears Financial Advisors

I recently wrote yet another article on the institutional deception of the financial advisor services in the United States which contains links to prior articles of mine on the subject as well as testimony provided to the SEC when they studied the issue a few years ago and did nothing.  That article was linked by Abnormal Returns.


Bloomberg had an article last week on how bad financial advisers are multiplying, how they deceive investors, provide advice while having conflicts of interest, how the new Fiduciary Rule is merely a

Will ETFs Have Liquidity in a Financial Crisis?

Noah Smith has a decent column today asking if it is smart to worry about ETFs.   He appears to be concerned about the liquidity of ETFs which hold bonds, derivatives, and futures.  Personally, I think the concerns also apply to equity ETFs in a Crisis market. 

One means of avoiding liquidity risk is to avoid ETNs which not only are comprised of holdings with significant liquidity risk but also can involve default.

If a individual has an account at Fidelity, Vanguard, T. Rowe Price, etc., they will find that is significantly less expensive to buy/sell an ETF (such as a Vanguard ETF at Fidelity) than a no-load mutual fund (Vanguard fund at Fidelity) with no 12(b)-1 annual expense of another company.  If it cost $75  to buy a mutual fund and only $7.95 to buy an ETF, you are being purposefully discouraged from buying the fund.

It would be imprudent to not investigate ETFs as well as mutual funds depending on where you have your investment accounts. You will look at the bid/ask spread, because the larger the spread the less liquidity. You will look at volume, because the smaller the volume the less liquidity.  You will look at expense, because you want lower expenses.  You will look at the ETF's portfolio for questionable or potentially illiquid or risky holdings.  You would look at performance over different periods of market conditions.  You would look at risk statistics.  You would look at current and historical distributions.  And that would just be the beginning of the investment decision process and choices of investment in comparison or its role within a portfolio.

Obviously, the least expense purchase is done with a Limit Order, but do not be surprised if it fails and you have to decide whether to make a Market Order.   Investing is a methodical process.  The best portfolios are holding portfolios which have elements which go up and down in different market conditions, because most people buy and sell at the wrong times when reacting to a market and lose return over time.  A knowledgeable investor will have buy/sell rules which they rigorously follow.

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Beware Financial Advisors Who Are Not Conflict of Interest Free Fiduciary Fee-Only Advisors

On June 9. 2018, the new "fiduciary" rule will take effect requiring financial advisors to "act in the best interest" of the client with respect to retirement account advice.  Unfortunately, in the United States financial advisors are allowed to say they are fiduciary if they attempt to "act in the best interests" of the client despite being financial salespeople  and/or having conflict of interest relationships with financial service companies from which they receive software, services, and incentives or compensation to use them.  A real fiduciary financial advisor is a fee-only financial advisor who works only for the client,. sells no financial products at any time in any capacity, and has no conflicts of interest.

You are going to see media recommendations that you use Broker Check, which is only going to tell you you are finding a licensed salesperson.  They may be able, under current US law, to call themselves fiduciary despite conflicts of interest, but a true fiduciary has NO conflicts of interest.  You will want to use the SEC Advisors page, which will tell you if the individual is just an investment advisor or an Investment Advisor and Broker (salesperson).  You only want an Investment Advisor who is not a Broker. 

When you first see an Investment Advisor, you will first want to see their Form ADV Part II which explains how they do business and how they are compensated.  You want a fee-only advisor who never sale financial products, because the US Securities law allows Investment Advisors to call themselves fee-only when they allow the client to decide if they want products sold to them and not just advice.  Beware.  Watch out for fee-only financial advisors who have a relationship with any person, subsidiary, company, or firm which provides financial products, including insurance, whether commissioned or not for the product placement.  A relationship is a conflict of interest.

The United States is still a predatory frontier where the regulatory authorities only debate how wolves may dress themselves as sheep dogs and profitably feast.  In a civilized society like the United Kingdom, financial advisors must be fee-only with no conflicts of interest period as I have written before and as I have submitted testimony to the SEC previously.  As I have written, the educational and designation standards in the United States are inadequate and purposefully deceptive with no existing financial designation requiring enough education which would equal a true Masters Degree in Finance (the Financial Planning degrees are totally inadequate and designed to bring university revenue not well educated professional fiduciary financial advisors). Even NAPFA is intrinsically linked to the CFP, which is a designation predominately held by, and membership dependent on, salespeople, and just another designation requiring an professionally inadequate education. (Attorneys, CPAs, and medical doctors all require rigorous professional education as well as licensing.)  I have publicly written, as you can see in the links above, that fiduciary fee-only advisors need to be regulated by am independent regulatory body which is salesperson free to avoid the continued deception of who is truly fiduciary.  Meanwhile the SEC is again asking for comment on a fiduciary standard.  They will just ask and, if under enough pressure, design a new sheep dog uniform for wolves who have all that gold in their lairs.


 Look to the ADV Form Part II and ask pointed questions.

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Understanding U.S. Private Debt Data

As I have written in the past, private debt is an important indicator of economic bubbles, but the data is not just nominal, but also historical, and  composed of trends.  While the recent U.S. private household debt report showed nominal debt levels higher than the 2008 Peak level, the debt level ratio is actually less when compared with disposable income and not deserving, when thoroughly analyzed, of scary debt level headlines.

The current report data does show continued upward trends in student loan debt and auto loan debt with a small uptick in credit card debt.  While delinquencies 90+ days are still above pre-2008 levels, the levels are actually historically low or close to historically low.  Auto loan delinquencies have been driven by subprime used car loan originators and more recently by auto manufacturers trying to move stock in a period of slowing motor vehicle sales.  The student loan problem is the result of poor governmental administration and financial aid support, rising tuition, and poor governmental oversight of private student providers who have been particularly predatory in trying to collect payments despite an established legal process.  All three private providers have similar complaints, but Navient (formerly Sallie Mae) is the largest, sued not only by the CFPB but also by two state attorney generals, and, as the largest, is currently favored by the Trump Administration to be the vendor in creating a single entry point website for student loan application and administration which would defeat the Obama Administration attempt to create a transparent, streamlined single entry point and form.  The student loan debt levels and delinquencies are a serious trend which has saddled the millennial generation with historically high student debt in a stagnant, low growth economy which has slowed marriages, home buying, and putting off having children. 

If you are going to look at household private debt, you also need to look at corporate debt and you will see the nominal levels are up, but lower when viewed as a percentage of market value and credit market debt as a percentage of net worth is also lower and close to pre-2008 levels.

There is no debt crisis.  The U.S. data is very available and current and, if you inspect the nominal, historical, and trend date, you see the student loan and auto loan trend problems which the U.S. government has failed to correct.  After all, the 1% do not have these problems, which may be why so many young adults, with respect to student loan debt, are not happy with government and the prospect they will not have the quality of life their parents have.  At some point incumbent politicians and political candidates are going to have to start listening to the current young adult generation no matter who is financing their campaigns and demanding their loyalty.


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U.S. Term Premia and U.S. Economy

An economics/financial writer recently expressed surprise that U.S. five year term premia nearly matches U.S. 5 year breakeven inflation.  To me, it seemed obvious, in this low interest, low growth economy, that the above would be true.  In 2015, Bernanke commented on how low term premia appears to be holding down  interest rates.  In the March 2017 New York Federal Reserve Bank Snapshot of the U. S. Economy, on page 14, you can see the term premia of the U.S. Treasury ten year nearly matches the 5-10 year inflation risk premia.  This is what one would expect in a period of low growth, no significantly surprising political instability in the world, and no financial instability.

I find nothing wrong in my disagreement with the writer, because he pointed to data, expressed his opinions, and ended up asking questions.  The fact that I disagreed caused me, as is my habit, to look and see if I was right or wrong.

Here is a good compilation of how the New York Federal Reserve Bank calculates term premia how it has been used and evaluated.

I have, in the past, pointed readers to the New York Federal Reserve Bank U. S. Economy in a Snapshot monthly report.  Put it in your bookmarks to review monthly. 

In New York Federal Reserve's analysis of the last 15 bond market sell offs, it immediately struck me that the last sell off in July 2013 was consistent with the Cyprus "banking" crisis.  As a country which is a member of the EMU and uses the euro as its currency, Cyprus saw its banks closed, deposits seized or taxed to fund a bailout, and monetary capital controls imposed to keep money in the country.  The bailout terms, banks resolution, and capital controls were imposed on Cyprus, a sovereign nation, by the EMU.

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China's Capital Markets, Pettis, and Balding

Here is a 93 page analysis of China's capital markets, from the Asia Securities Industry and Financial Markets Association, with three pages of recommendations with respect to equities, fixed income, FX, laws and regulation, market infrastructure, and market access. It is well worth reading. 

There are many places to look for what is going on in China and what it means for the world.  You are going to get a variety of opinions on debt, property bubbles, corruption, inequality, SMEs, currency controls, and the potential problems of deleveraging.  Bottom line, China is a very government controlled, closed society which has great power to force its will on the rich and poor.  The extent it might impact those who export to it, who have invested in China, and those who have bought its corporate stock and debt should be of concern.  It is large enough to have world-wide effect.

Michael Pettis  and Christopher Balding are good sources to follow for similar and differing views on what is going on in China and what i being done or might be done or should be done.  Both teach in China.  Pettis has a private monthly newsletter to which one can subscribe by e-mailing him at chinfinpettis@yahoo.com asking for a regular subscription as an investor or a complimentary subscription as a journalist, academic, or government official.  His blog posts are usually shorter versions of the monthly newsletter.  Balding also writes for Bloomberg View.

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Are ECB Target2 Balances Ever Risky?

Izabella Kaminska is a very talented and intelligent writer for FTAlphaville and I try to read everything she writes, because she makes you think.  I will continue to read what she writes.  When she wrote yesterday that ECB Target2 balances are a big deal, I was thrown for a loop and wondering what am I missing.  I even reached out to another financial and economic professional for a give and take discussion.

Kaminska cites the March BIS Quarterly which shows that Target2 balances have substantially increased as the result of the Asset Purchase Program but CDS spreads have remained stable.  She then concludes that the capital flight during the 2012 Greek crisis was a big deal which resulted in Target2 balances increasing and creating "financing" by Target2 credit National Central Banks, such as the Bundesbank in Germany.  She also concludes this was a failure of the transmission mechanism and cites a paper on the old Soviet Union's International Investment Bank in an attempt to draw a comparison of flows and a failure of the transmission mechanism.

I have written about Target2 twice in 2015 (here and here) and discussed it with economic and financial professional in the United states and other countries.  Additionally, as I have previously cited, Whelan published an excellent paper on Target2 and how it works in 2012.

I am going to try to keep this simple.

The stable CDS spreads with increasing Target2 balances show the Asset Purchase Program is working.  In fact Footnote 3 in the BIS March Quarterly cites the BIS November 2016 Quarterly which states, "The ensuing upward trend in TARGET balances largely reflects the settlement of these cross-border transactions by central banks and, therefore, does not signal renewed stress in financial markets."

Target2 credit balances are money created by the ECB and not by financing from the credit National Central Banks.  National Central Banks are only liable for losses at the ECB to the extent of their Capital Key ratio, which with Germany is 17.9973%.  With respect to the APP, National Central Banks are only exposed to 20% of any APP losses which would be distributed according to the NCB's Capital Key ratio. 

With respect to the study on the Soviet Union's International Investment Bank, its failure was from pricing, industrial capacity, governmental policy, access to international markets, and a weak Soviet ruble unsuitable for international trade.  It is an interesting study of a failure of the transmission mechanism.  However, the ECB and Target2 during 2012 demonstrates the success of a transmission mechanism.  While the ECB balance sheet shows spikes in 2012 and currently, they are from two different causes and both speak to the maintenance of financial stability. 

The IIB transferable ruble loans to Soviet Block countries creating foreign currency denominated debt for those countries has some similarity to every eurozone country having its debt in a foreign currency (euro), but the eurozone is a monetary union (without a fiscal transfer mechanism) with a central bank (ECB) exercising monetary policy.

When would Target2 levels constitute a risk?  Any risk to Target2 would be a risk to the eurozone itself.  This is why arguments against Target2 have been arguments against the credibility of the euro as a currency and attempts to argue the euro is on its way to a currency crisis.  While I have long maintained the euro is treading towards a currency crisis, the crisis is dependent on growing political risk fed by a defective monetary union without a fiscal transfer mechanism which uses destructive austerity to compensate and only creates negative economic growth, more unsustainable debt, and a growing eruption of political unrest which is swelling to possible political risks in Italy and France. 

People are suffering.  Greece, which is already at depression economic levels, is again facing demands for more destructive austerity from the EMU and has never recovered from the EMU enforced coup in 2012 or the monetary warfare waged by the ECB in 2015.  Spain has had a temporary government for so long it may have forgotten how a real democratic parliament functions.  Spanish and Italian banks need support.  Portugal was allowed to keep its government on condition it did what the EMU wanted.  Cyprus had its citizens bank deposits taken away from them. It is no surprise people are unhappy.  And nobody really wants to ask how strong German banks, not just the large international banks (like Deutsche Bank and Commerzbank) but the national, savings, and landes banks really are, particularly since Germany has resisted including all its banks in ECB stress tests.

How serious would the political risk have to be?  If you look at the CDS spreads of 2003 euro bonds and 2014 (which have CAC provisions) bonds, you can see the increased political risk with the spreads between the two doubling to 40 basis points.  This perceived political risk ignores the possibility of an eurozone country actually exiting the EMU, changing its countries bond laws and abrogating CAC's, and redenominating its debt from the euro to its own fiat currency.  Just using Target2 balances as a base example, it is easy to see that if Greece and Portugal both left the EMU, the EMU could easily survive with its monetary credibility tarnished.  However, if Spain and Italy left and defaulted on Target2 and redenominated euro debt, it would create a significant loss and change in remaining eurozone countries Capital Key ratio.  Even if France left, it would create a significant change in remaining countries Capital Key ratio and create damaged euro credibility.  A currency depends on its credibility to survive.

Could the eurozone survive as a monetary union without Spain and Italy if they defaulted on Target2 and redenominated their euro debt?

The political risks are growing and they are not supportive of democracy. 


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Financial Market History: Reflections on the Past for Investors Today

The CFA Institute Research Foundation and the University of Cambridge Judge Business School just published a long read study "Financial Market History: Reflections on the Past for Investors Today".

The First section "examines what we can learn about the trade-off of risk for return from an extensive analysis of historical returns on equities, bonds, and other assets" and "concludes with an extension to other financial markets."

The Second section "explores the historical evolution of how financial claims are traded."

The Third section "addresses the perception that financial markets are inherently prone to irrational exuberance and bubbles."

The Fourth section "addresses the history of financial innovation."

The Study " concludes with a contribution from Barry Eichengreen, who argues that the research frontier in financial history will be driven by current concerns motivated by the 2008–09 financial crisis. He points to a number of studies that reexamine the historical record on the basis of what we now understand about the role of banks and systemic risk. This research is now possible through low-cost and easily accessible historical data. There is the danger that access to these data may inappropriately frame research questions being asked. He concludes that looking to the past may not of itself allow us to predict what might happen in the future; however, it does allow us to understand the broader historical context and our ability to appreciate what is different about our current circumstances. This important observation helps establish why the study of financial history has such important practical significance in the current economic environment."

Understanding the market is not just for professional advisors and analysts; it is important for the investor.  It is information and factual information drives proper investing.


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Investing Requires Reliable Governmental Economic Information

As a fiduciary investment advisor, I do daily macroeconomic and financial research which is very lengthy and time consuming.  If I could not rely on unbiased (ethically professional), independent (without political interference) U.S. governmental economic statistical data, all efforts at economic and financial research would be meaningless.  Whether any current fears and concerns regarding the future of U.S government economic and scientific data are legitimate does not remove the absolute need for reliable statistically unbiased economic data which must be vigorously protected in order to have a free, democratic society.  While no statistical model is perfect, the professional ongoing debate on the construct of statistical models which are data based rather than result oriented based is fundamental to ethical professional conduct.

A lot of misunderstanding of BLS data has been repeatedly manifested, to the point where is almost a meme, by politicians who do not care if they are ignorant or lie and "financial" talking heads or wanna be talking heads who make money taking advantage of people. 

There are always professional concerns about statistical models and how they might be better, but the data has to be independent of political bias.  Brent Moulton at Political Arithmetick has written an excellent professional critic and concern for the need of independent U.S. government economic data, particularly with respect to the BLS.

Mark Thoma of  Economist's View has written at CBSmoneywatch on the political economic concerns which result if economic data is not factual data based (documentable as independent)  without political bias.  To skew the data reporting to promote a belief rather than a factual data set analytical result would make it impossible for economists to know what is going on in the economy and impossible for investors to make investment decisions within a factually known economic environment and trend.



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