Credit deflation and the reflation cycle to come (part 2)

[AWW]

I have personal experience of Standard Chartered. Several years ago, one of their UK departments was run by a bullying Islamic extremist. He hired many people with similar characteristics and they made it their business to make the working lives of those of different, or no, religious persuasion, a complete misery. Got away with it for quite some time before being paid off.  To say the bank was slow to act would be a gross understatement.

Hopefully, they'll go bust soon.

[sancho panza]

After Table 8 there's a discussion on Credit Book Accounting regarding risk weighting by individual banks.As far as I'm aware the larger institutions are allowed to calibrate risk weightings based on their own data (IRB approach) from bank customers.Smaller institutions such as say the Coventry Building Scoiety,will use the 'standardized' and apply parameters drawn from the data of other big banks.

So the possibility exists of different banks risk weighting loans differently.Happy to be corrected.

 

                                                                                               Section 7. Off Balance Sheet and Other Hidden Problems

Returning to the main theme, you might say that the capital ratios we reported don’t take account of off-balance-sheet (OBS) positions and you would be right.

They don’t. The implication is that our leverage numbers paint a rosier picture of banks’ leverage than is warranted. Who knows what hidden leverage or hidden losses lurk beneath?

We can however surmise that there is quite a bit of it.

There are four sets of issues here: OBS, ‘Fair Value’ valuations, credit book valuations and the impact of IFRS 9.

Let’s consider each of these in turn.

Off-balance-sheet positions

The problems of OBS positions were nicely summarised in a perceptive analysis by Frank Partnoy and Lynn Turner:

'Abusive off-balance sheet accounting was a major cause of the financial crisis. These abuses triggered a daisy chain of dysfunctional decision-making by removing transparency from investors, markets, and regulators. Off-balance sheet accounting facilitated the spread of the bad loans, securitizations, and derivative transactions that brought the financial system to the brink of collapse. ...

Off-balance sheet problems have recurred throughout history, with a similar progression. Initially, balance sheets are relatively transparent and off-balance sheet liabilities are minimal or zero. Then, market participants argue that certain items should be excluded as off-balance sheet. Complex institutions increase their use of off-shore subsidiaries and swap transactions to avoid disclosing liabilities, as they did during both the 1920s and the 2000s. Over time, the exceptions eat away at the foundations of financial statements, and the perception of the riskiness of large institutions becomes disconnected from reality. Without transparency, investors and regulators can no longer accurately assess risk. Finally, the entire edifice collapses. This is the story of both the 1920s and today.

As in the past, the off-balance sheet complexity and exceptions have gone too far. The basic notion that the balance sheet should reflect all assets and liabilities has been eaten away, like a piece of Swiss cheese with constantly expanding holes.

What is off the balance sheet swallows up what is on the balance sheet. Off-balance sheet abuses render banks’ financial statements virtually useless and their true exposures become impenetrable.24

Insert “almost” before “impenetrable” and we would agree.

Problems with ‘Fair Value’ valuations

Then there are banks’ Level 1, Level 2 and Level 3 ‘fair value’ valuations.

Roughly speaking: Level 1 assets have readily observable prices and reliable fair market values. Level 1 assets include listed stocks, government bonds, or any assets that are regularly marked to market. Level 1 is not easy to manipulate, unless you manipulate the underlying market prices, which is more difficult, but not unknown.

Level 2 (or ‘mark to model’) assets do not have directly observed market values and are traded less frequently in thin markets, but have (one hopes) approximate fair values that can be obtained from models calibrated to observed market prices. Examples include some corporate and most municipal bonds. Level 2 valuations are at best approximate and can sometimes be gamed by selecting the model or proxy price that gives the preferred valuations.

Level 3 (or ‘mark to model’ or less politely, ‘mark to myth’) assets are highly illiquid and can only be fair-valued using models calibrated to guesstimates of key parameters. Level 3 valuations are unreliable and potentially highly gameable, because both models and calibrations can be chosen to manipulate valuations and because this gaming is difficult for outsiders to detect. Examples of Level 3 positions include asset-backed and mortgage-backed securities and many forms of CDS. The experience of the GFC showed that Level 3 positions can lose much of their value in a crisis. To paraphrase Warren Buffet, its only when the tide goes out do you discover who's been swimming naked. Therefore it would be prudent to presume that Level 3 valuations might have been manipulated and that this manipulation would be revealed in a crisis when some Level 3 valuations might, e.g., collapse.

Enron provides a good example of the potential unreliability of Level 3 valuations due to unscrupulous gaming of both valuation models and fair value accounting standards, but it is far from being the only one.25 Now suppose we are reading these valuations with an eye to how they might be affected, i.e. what might go wrong, in a stress: (a) When we read the Level 1 FV valuations, it might be prudent to presume that Level 1 valuations would go with the market, i.e., down. We should also be asking about the volatility of the market prices on which the valuations are based and be concerned not with normal market volatility, but with potential market volatility in a stress, which could be considerably higher.26 (b) When reading Level 2 valuations, we might start with the Level 1 valuations and look for adverse slippage between the Level 1 and Level 2 valuations. (c) When reading the Level 3 valuations, we might ask what would happen if those were to fall further than the Level 2 valuations, keeping in mind the possibility that those involved might have succumbed to the temptation to game the system by fiddling models or adopting an ‘aggressive’ approach to accounting valuations to produce preferred outcomes.

There are some red flags here.

Credit book accounting

A former City analyst recently told one of us, “Credit book accounting and IFRS 9 are worse than IFRS 13 level 3. Most of the valuation of a loan book is just fantasy.” By the former, he was referring to the problems arising from the use of credit risk models to value banks’ credit books.27

To explain: Credit exposures on the trading book are marked to market on the assumption that the market price reflects all information on credit risk. However, there is typically no market information on the credit risk of a bank’s loan book and banks traditionally relied on valuations based on the expertise and subjective judgments of their internal credit teams. But under Basel III’s ‘advanced ratings based’ (AIRB) approach, qualifying banks (i.e., the big ones) are allowed to produce valuations by inputting their own calibrations into a credit risk capital model approved by the regulators. There are many problems with this approach, but the one that stands out is the dependence of the resulting valuations on the input values of the default probabilities involved. Unfortunately, the default probability is both notoriously difficult to calibrate and easy to game. Therefore, loan book valuation can be highly unreliable.28

IFRS 9

Finally, there are the problems from the implementation of the accounting standard (IFRS, International Financial Reporting Standard) 9, which deals with the reporting of expected loan losses. 29 IFRS came into force on January 1st to replace the old (IAS, International Accounting Standard) 39 which stipulated an ‘incurred loss’ model, i.e., banks’ expected losses were typically not recognised.30

The main departure regarding impairment accounting is that IFRS 9 requires the recognition of (at least some) expected credit losses. IFRS 9 also introduces a three-stage model for classifying credit assets.

As soon as a financial instrument is originated or purchased, and if expected losses have not increased significantly, the instrument is categorised as Stage 1 (i.e., low-risk) with the requirement that its expected losses over the next year should be reported and provided for. If the credit risk has ‘increased significantly’ but the instrument is not considered credit-impaired, then the instrument is categorised as Stage 2 and its expected losses over its lifetime should be reported and provisioned. Reclassifying a hitherto Stage 1 loan as a Stage 2 loan then creates a ‘cliff edge’ effect, i.e., a significant increase in reported losses and associated provisions, an effect aggravated further by the banks not being able to offset the lifetime expected losses by lifetime expected income. Credit-impaired instruments are categorised as Stage 3 and full lifetime expected credit losses are to be recognised for them too.

JohannesBorgen on Twitter31 has a nice take on the way IFRS 9 works:

'Under IFRS 9, there are three types of loans: Stage 1 (all good), stage 3 (defaulted) and the tricky Stage 2, which does not depend on the credit quality of a loan but whether that credit quality has deteriorated.

You can have a Stage 1 loan rated CCC if you originated it at CC and a A-rated loan in stage 2 if you originated it at AA. I know, it is very weird, but that’s how it works.

The HUGE difference between S2 and S1, is that in S1, you book a provision for the Expected Loss (EL) over a year whereas in S2 you take EL over the loan’s *entire lifetime*. The difference can be huge for some long-dated loans, like … Mortgages!

When the macro becomes shitty, IFRS 9 has a double blade effect; 1) A-year EL increase, but that was already taken into account in bank regulations so it’s not a significant change.

2) a bunch of loans go to Stage 2 and therefore losses have to be calculated over a much longer horizon (and for a low probability for default (PD) a 5-year PD looks a lot like 5 times the 1y PD … Ouch. '

This cliff edge makes banks reluctant to reclassify Stage 1 loans that have become problematic to Stage 2 where they belong. The accounting standards also give banks considerable discretion in how they classify their loans, i.e., IFRS 9 gives banks the means, motive and opportunity to disguise problem loans by keeping them classified as Stage 1 instead of moving them to Stage 2, where higher losses would be reported which would entail higher provisions and a bigger hit to capital. We might then infer that many Stage 1 loans are misclassified and that banks are carrying higher reported losses than they are reporting.

Since banks (a) have large Stage 1 positions and (b) are strongly incentivised to keep loans classified as Stage 1, then it is reasonable to suppose that the problem would be on a considerable scale and will worsen as the economy goes into recession. As an example of this cliff edge effect, LBG has a large (£500 billion) loan book. 90% of that loan book is in Stage 1 with an impairment rate of 15 pbs.32 The expected loss on its Stage 1 loans is therefore nearly 0.0015 times £450 billion = £675 million. But if its Stage 1 loans were reclassified as Stage 2 then the expected loss and associated provisions rocket up by about £15 billion, which is 22 times as much. The capital hit is two thirds of its market cap. Furthermore, this calculation is based on the optimistic assumption of a 3.5% expected lifetime loss on a Stage 2 book. The actual loss would likely be higher than that in a severe downturn, so the capital hit would plausibly be higher still.

Table Ten shows the Stage 1/Stage 2/Stage 3 positions for the Big Five banks. Their Stage 1 loans are £2.1 trillion. Were we to apply the same impairment rates to these as we did with LBG, then the expected losses would rise from £3.3 billion if the loans remained in Stage 1 to almost £74 billion (or over 21% of market cap) if they were moved to Stage 2, and to even more if the Stage 2 loss rate were to increase as well.

In short, the classification of loans into Stage 1 vs Stage 2 under IFRS 9 provides us with another promising source of hidden losses on a large scale. To quote Jonathan Ford:

'Of course, UK regulators are not blind to these pitfalls [of IFRS 9]. Last week they urged companies to go easy on Covid-related provisioning, having already urged them to take advantage of transitional arrangements, which permit them to shield their regulatory book equity from IFRS 9-related losses, only taking them over several years.33 There are other measures designed to defer crystallising provisions, linked to sectors in receipt of relief, or government-backed loans.

But while this might be expedient to deal with the “cliff-edge” problem, the immediate recourse to forbearance is unfortunate. Not least because it defeats the rule’s whole original aim.

Remember the “bad” old days when banks used to deal with the difficulty of valuing loans through a process of obfuscation; smoothing their profits almost at will through the use of hidden reserves? Fine-grained accounting rules were devised in the hope of giving greater transparency in the accounts of financial institutions.

There are doubts about the efficacy of this switch, and the propensity of rules-based (and hence gameable) systems to drive out prudence and judgment in the boardroom. But one thing is clear with rulemaking: it can never succeed in enforcing executive accountability if each time there is a crisis, the rule is either waived or withdrawn.'34

He is correct, and in any case, such responses from the regulator do not make the underlying problem (that there could be a lot of losses coming through) go away. Instead, they only hide that problem.Such responses are akin to breaking the thermometer when it gets too hot in the kitchen: ‘fair value’ valuation is of little use if it is only implemented on a ‘fair weather’ basis.

There are further problems too. The PRA has no legal authority to interfere in how banks report their statutory balance sheets. To quote Cardale and Buckner in a recent FT letter:

'The PRA … is responsible for capital adequacy only, and has no business interfering with the reporting of the statutory balance sheet. Statutory reporting is governed by the True and Fair requirement set out in the Companies Act, and it is the responsibility of company directors and auditors, not the bank, to provide assurance the financial statements meet that requirement, and taken as a whole, are free from material misstatement.'35

In any case, the regulators’ retreating at the ‘first whiff of grapeshot’ by immediately putting further transitionals in place suggests that they have little confidence in their own capital adequacy system and subverts the whole point of having any such system in the first place.

[sancho panza]

1 hour ago, Knickerless Turgid said:

Sancho,

Hence this somewhat ballsy (though understandable, given the above) call:

https://www.bbc.co.uk/news/business-52916119

They have no choice do they?80% of their profits come from HK/China.China owns HK.

HSBC and the UK banks looks ready to be served up for brekkie tbh.Read the section I've just psoted on bank accounting and you'll see how wafer thin their capital ratios appear on the surface.I wouldn't even waste any of my time having a deeper look tbh.History shows us that the msot likely outcome is that they'll be a surprising set of impairments sometime in the next year that needs the UK taxpayer to step in and bail the 'talent' out.................again.

UK resi and commercial real etstate markets are less overblown than HK but when you've average capital ratio's of 2%, even the mildest downturn will take that out.Add in the possiblity that they've hidden loads of dodgy loans at Stage 1, a doubling of unemployment, rising taxes, shrinking demand and the British banks are fubar.

[sancho panza]

 

 

                                                                                                              Section 8:The Uselessness of Existing Capital Regulation

 

The bank regulatory capital regime Basel III imposes a bewilderingly complicated set of constraints on minimum required capital ratios, most importantly those based on the ratio of CET1 capital to Risk Weighted Assets. This point made, a significant innovation in Basel III was the introduction of a leverage constraint.

So what is the maximum permitted leverage under Basel III?

The Basel rules on this point as they apply to the UK are set out in the PRA Rulebook:

3. Minimum Leverage Ratio

3.1

03/10/2017

A firm must hold sufficient tier 1 capital to maintain, at all times, a minimum leverage ratio of 3.25%.

3.2

01/01/2016

For the purposes of complying with 3.1, at least 75% of the firm’s tier 1 capital must consist of common equity tier 1 capital.

The attentive reader will note an entertaining error here. “A firm must hold … capital …” We encounter here a good example of the ‘hold capital’ fallacy that we address below36 and in the PRA Rulebook of all places. Bank don’t ‘hold’  capital, they issue it. To say that a bank ‘holds’ capital is to treat capital as an asset to the bank (it is not!) and put it on the wrong side of the balance sheet, which is an elementary mistake. And since banks cannot ‘hold’ their own capital, this requirement is impossible for them to meet and therefore impossible to enforce. Well done PRA but let’s move on.

The Basel III leverage ratio is the ratio of Tier 1 capital to TE and, somewhat confusingly, is the inverse of the leverage, where leverage is measured as TE divided by Tier 1 capital.

Thus, Basel III imposes a maximum leverage level of 1 ÷ by 3.25% equals 30.8, where leverage means TE over Tier 1 capital.

Now Tier 1 capital = Common Equity Tier 1 (CET1) capital plus Additional Tier 1 (AT1) capital, which are capital measures set out in the regulatory rulebooks. The point to note is that AT1 capital includes ‘hybrid’ instruments known as Contingent Convertible bonds (CoCos), which ought not to be considered as capital instruments at all.37 CET1 should then be considered a more reliable measure of capital than Tier 1.

Translating into a maximum permitted leverage expressed in terms of CET1 rather than Tier 1 as the denominator, the maximum permitted leverage (=LE/CET1) becomes 48.3. The calculations are set out in Appendix Thirteen. The 48.3 number does not take account of hidden leverage either.

In English, the Basel III capital rules allow banks to maintain remarkably high leverage and still be Basel III-compliant.

You might say that a maximum permitted leverage of 48.3 plus hidden leverage is a loose leverage constraint and we would agree. But here is the punchline: since CET1 capital is a book value regulatory capital measure and Basel III does not impose any constraint on market-value leverage, the maximum permitted market-value leverage under Basel III is theoretically unbounded: Basel III does not impose any maximum constraint on market value leverage!

The single most important capital measure that Basel should have addressed is the one it left out.

[Majorpain]

Quote

The envelope for the pandemic emergency purchase programme (PEPP) will be increased by €600 billion to a total of €1,350 billion. In response to the pandemic-related downward revision to inflation over the projection horizon, the PEPP expansion will further ease the general monetary policy stance, supporting funding conditions in the real economy, especially for businesses and households. The purchases will continue to be conducted in a flexible manner over time, across asset classes and among jurisdictions.

Now were talking, ECB has a much bigger bazooka this month.  Its saying something when the ECB announces 600bn of free money and the Euro jumps on the news. 

[Loki]

26 minutes ago, Majorpain said:

Now were talking, ECB has a much bigger bazooka this month.  Its saying something when the ECB announces 600bn of free money and the Euro jumps on the news. 

 

[sancho panza]

The divergence between market Cap and Book value undermines the 2019 stress tests.Reading thsi,I wouldn't touch any UK banks.....................at all....for a very long period of time.

 

For some reason,I can't copy and paste tables/charts.Chart B3 is missing.Chart B2 as well.

 

                                                                             Section 9: The BoE Position: UK Banks are Strongly Capitalised

Great Capital Rebuild

The BoE’s position, repeated many times, is the narrative of the ‘Great Capital Rebuild’, i.e., that UK banks are now so strongly recapitalised after the trauma of the GFC that they could go through a much worse than GFC event and still emerge in good shape. 38 The following quotes are typical:

The resilience of the system during the past year in part reflects the consistent build-up of capital resources by banks since the global financial crisis. ... As a result the UK banking system is well placed to provide credit to households and businesses during periods of severe stress.

That conclusion is corroborated by the 2016 stress test ….39

This stress is a big, big hit to capital.40 (Mark Carney, 2016)

“The 2019 stress test shows the UK banking system would be resilient to an unprecedented combination of simultaneous recessions in the UK and global economies that are more severe than those during the global financial crisis, large falls in asset prices, and a separate stress of misconduct costs.

All seven major banks and building societies in the test can not only withstand these extreme shocks but also continue to meet the demands for credit from UK households and businesses.

In part, that’s because their capital ratios [DB/KD: by which he means their CET1/RWA ratios] are currently over three times higher than they were at the start of the global financial crisis. Even after stress, their capital ratios would still be more than twice their precrisis levels.41 (Mark Carney, 2016)

Consider the following table.

Table Eleven: Big Five Banks’ Capital:

December 31st 2006 vs December 31st 2019

Dec 31st 2006                           Dec 31st 2019             Increase                  % Increase

                                Book Value Shareholder Capital (£ billion)

143.2                                                   344.5                      +201.3                          + 141%

                                     Market Value (=Market Cap, £ billion)

360.9                                                   246.0                     -114.9                              -32%

As of December 31st 2006, the Big Five banks’ shareholder equity was £143.2 billion. By December 31st 2019, it was £344.5 billion, an increase of £201.3 billion and a percentage increase of 141%.

Now we could hardly not acknowledge that £344.5 billion is a lot larger than £143 billion, but these numbers are book value and for reasons explained above (and also in Appendix Two), it would be preferable to use market value numbers instead. Looking at the lower line in the Table, market cap was £360.9 billion on December 31st 2006 and fell to £246.0 billion on December 31st 2019, a fall of £114.9 billion and a percentage fall of 32%.

Book value capital rose, but market value capital fell and it’s the market value that really counts.

Let’s face it: the ‘Great Capital Rebuild’ isn’t there in the data.

CET1 ratio

What about the BoE’s capital ratios? The BoE’s favourite illustration of the banks’ capital rebuild is to present a chart showing the increase in CET1 ratios since the GFC.

Consider Chart B.3 in the Bank’s November 2016 Financial Stability Report

 

 

 

 

 

 

 

The title states that “Most capital rebuilding to date has reflected falls in riskweighted assets” – a delightful piece of duckspeak – and then gives a breakdown of this ‘rebuild’ in terms of its constituent components. The rebuild it is referring to is not quite what it might seem, however: it refers to the rebuild in the banks’ average ratio of CET1 capital to RWA relative to 2009. Now the CET1 ratio was 6.92 percent in 2009 and had risen to 12.61 percent by end-2015. That increase breaks down into 0.45 percentage points in new equity raised, 1.02 percentage points in retained earnings and 4.22 percentage points in reductions in risk-weighted assets. Therefore, only 0.45 + 1.02 = 1.47 percentage points of that increase in the capital ratio represents actual increases in capital; the rest merely reflects the decrease in the RWA denominator, which is irrelevant to the actual amount of capital.

The increase in the CET1 ratio from 6.92 percent to 12.61 percent might seem impressive at first sight – an increase of 82 percent – but the actual capital rebuild was only from 6.92 percent to 8.39 percent, an increase of only 21 percent. That, and that alone, is what the chart should have shown.

A big increase in a regulatory capital ratio is one thing, but a big increase in actual capital is quite another. The sin is to pass off the former as the latter.

These tricks are straight out of Darrell Huff’s classic How to Lie with Statistics. 42 The main trick here is known in the trade as the ‘semi-attached figure.’ To quote:

'If you can’t prove what you want to prove, demonstrate something else and pretend that they are the same thing. In the daze that follows the collision of statistics with the human mind, hardly anyone will notice the difference. … There are many forms of counting up something and then reporting it as something else. The general method is to pick two things that sound the same but are not.' (Huff, 1954, pp. 71, 81)

But going to substance as opposed to (misre)presentation, the Bank is right that the CET1 ratios have considerably increased. By December 2019, they had increased over threefold.

CET1 ratios are unreliable indicators of capital strength, however. The RWA denominator is unreliable, both because it is unsound on principle and because it is highly gameable.43 The unreliability of the CET1 ratio is confirmed empirically by the poor track record of regulatory capital ratios with RWA denominators: time and again, banks have appeared strong by such ratios and then suddenly defaulted out of the blue. There are many examples during and after the GFC, including banks from the UK and Europe, and virtually the entire Icelandic and Irish banking systems. 44

The implication is clear: regulators would be wise not to rely on such ratios.

Leverage ratio

Then there is the leverage ratio. The following chart is a reproduction of Chart B.2 from the BoE’s November 2016 Financial Stability Report:

Chart B3

 

 

 

 

 

 

This chart shows some of the BoE’s estimates of UK banks’ leverage ratios spanning 2001 to 2016. In essence the BoE uses the chart to show that the leverage ratio in 2016 was higher (in fact, about 25% higher) than it was on the eve of the GFC. Table Twelve below confirm the increase (here 47%) in the average leverage ratio interpreted as the average ratio of book value capital to total assets.

Table Twelve: Big Five Banks’ Capital Ratios: December 31st 2006 vs December 31st 2019

31 Dec 2006                    31 Dec 2019                           Increase                                      % Increase

                                      Book Value Shareholder Capital (%)

4.4%                                    6.5%                                           2.1 %                                        + 47%

                                                   Market Value  (=Market Cap, %)

11.2%                                 4.7%                                          -6.5 %                                           -58%

 

However, the Table also shows that the average ratio of market value capital to total assets ratio fell by 58% over the same period.

Capital requirements ‘10 times’ higher

Another plank in the Great Capital Rebuild fairy story is that minimum bank capital requirements are ten times higher than they were before the GFC. Mark Carney is fond of making this point.45 To give one example,

“The largest banks are required to have as much as ten times more of the highest quality capital than before the crisis … (Mark Carney, 2017, his emphasis)46

The implicit suggestion is that, since multiplying by ten times is a lot, then Basel III capital requirements should now be considered high.

Even 10 times higher, bank capital standards are still low, in the sense that they still allow high leverage. Using latest average risk weights, we calculate that under Basel II UK banks can operate at a leverage level of almost 35 and still be Basel III compliant. And that is maximum permitted leverage in book value terms, let alone in market value terms. Basel III imposes no limit on market value leverage.

The bottom line is that a large percentage increase in capital requirements does not represent a large absolute increase in capital requirements if the base is low to start with.

And why was the base so low? Because Basel II had imposed extremely low minimum capital requirements.

The technical term for the BoE’s ‘10 times’ trick is statisticulation:

“Buy your Christmas presents now and save 100 per cent,” says an advertisement. This sounds like an offer worthy of old Santa himself, but it turns out to be merely a confusion of base. The reduction is only fifty per cent. The saving is one hundred percent of the reduced or new price, it is true, but that isn’t what the offer says.47

Correctly interpreted, Carney’s ‘10 times’ narrative does not imply that banks now face high capital requirements. It is, instead, a damning indictment of the inadequacy of both Basel II and Basel III.

Martin Wolf got it right when he said that Basel III was the mouse that did not roar.48

The financial health of the UK banking system not confirmed by the Bank of England’s stress tests

The final plank in the ‘Great Capital Rebuild’ fairy story is that the strength of the UK banking system is confirmed by its stress tests. But how is this even possible? UK banks are weak now, so it is impossible for a set of weak banks to go through a stress that is at least as severe or even multiple times more severe than the GFC and still come out strong. If you weren’t smelling too good when you fell into the sewer, how could you come up smelling of roses? The only logical explanation for the UK banks’ ‘strong’ performance in the BoE’s stress tests is poor modelling and more detailed analyses confirm that that is the case.49

The many weaknesses of the BoE’s stress tests include: unreasonably demanding pass standards; insufficient numbers of adverse scenarios; reliance on unreliable and gameable metrics such as RWAs and Tier 1 capital; reliance on book value instead of market value numbers; failure to address the PtB issue; the use of loss models that implied (and by a long shot) implausibly low losses that fail basic reality checks; and more. Correct almost any one of these problems and the results of the stress tests start to look a lot different.

The credibility of the stress tests is also undermined by a conflict of objectives. On the one hand, the BoE wants to use the stress tests to investigate the financial resilience of the banking system, but on the other, the BoE has a responsibility to promote confidence in the system. So what would happen if the BoE were to carry out an intellectually defensible stress test that found (and it would) that the banking system was weak? The BoE could hardly publish the results, because doing so would undermine confidence in the banking system and in the BoE’s stewardship of it. So when the BoE publishes the results of stress tests, and leaving aside that the modelling is obviously flawed, then the results have all the hallmarks of a Communist election in which the Party always wins, i.e., the stress tests always show that the banking system is strong.

One last point about these tests. A recurrent theme in the BoE’s stress test PR is that the BoE’s main stress scenario is a lot more severe than the GFC, the point being to emphasise that the stress is very severe. Since the GFC was bad, a scenario multiple times more severe is, you might say, Doomsday.

Consider as an example the Bank’s statements about its 2016 stress tests. To quote the then Governor, the adverse stress scenario in this set of tests led to “system-wide losses of £44 billion over the first two years of the stress – five times those incurred by the same banks over the two years at the height of the financial crisis.”50

This statement misled some commentators into thinking that the stress scenario was five times more severe than the GFC, but it wasn’t.

Carney’s statement implies that the system-wide losses over the two height years of the crisis were less than £44 billion/5 = £8.8 billion. Such an inference is clearly wrong, however: the system-wide losses were vastly greater than that.51 His £44 billion loss estimate is also inconsistent with the BoE’s own estimates that HBOS alone experienced losses of £34.6 billion in 2008-2009 and losses of £52.6 billion in the period 2008-2011.52 Among the big 4, RBS experienced a loss of £40.7 billion in 2008 alone. 53 Carney’s claim about the losses banks experienced in the crisis is demonstrably wrong.

The trick here is to pass off something (reported net losses, £44 billion) that sounds similar to something else (actual GFC losses, £500 billion plus, over ten times as much). One cannot really blame the journalists. They have only hours to file their stories and are overwhelmed with stress test gobbledegook (and however well they might be prepared, there seems to be more of it every year), so they look for leads from the BoE and pick up on the ‘losses five times worse than GFC’ theme – which the BoE helpfully highlighted in its exec summary. And so the Doomsday scenario is born.

So well done BoE. It successfully co-opted the press into promoting its PR line that UK banks could withstand a stress five times more severe than the GFC and still be in good shape. If only it were true. 54

 

 

 

 

 

 

 

 

 

 

 

[sancho panza]

4 hours ago, jamtomorrow said:

Small brain here is mulling over whether to repatriate some USD held in a US brokerage account. So my question for the big brains: are coups d'etat usually accompanied by capital controls?

I'm not a big brain either but I wouldn't sell any dollars here,unless you're buying a decent commodity with it.

[leonardratso]

surprised you guys are looking at banks, i lost interest in them long ago and wouldnt even consider any of them probably ever again to be honest. They are just a vehicleto me, like an old car i dont care about that gets me from a to b, if it gets burned out then it will be replaced by another old a to b.

[Bobthebuilder]

@sancho panza, Thank you for those bank posts, i really appriciate your hard work. Once again thank you for posting, very informative.

[sancho panza]

 

 

                                                              Section  10. The Bank’s Track Record: The Global Financial Crisis Revisited

When assessing the BoE’s confident claims about the banking system being strong enough to withstand a crisis more severe than the GFC and still be in good shape, let’s not forget how badly the Bank got it wrong the last time round.

As late as July 2007, the Bank had no idea of impending trouble. There were some liquidity problems in the markets, the Court of the Bank was told, but these were not sufficiently serious to warrant any action. The crisis started the next month when hedge funds started to experience their once in a zillion years 25 sigma events. 55

On September 12th 2007 the Court was told that despite some market turmoil, the Tripartite (BoE, Financial Services Authority, Treasury) System was working well and the banking system was sound. The next day, they were called to an emergency meeting as the BBC announced that Northern Rock had applied for a rescue. The run on the Rock – the first English bank run since Overend Gurney in 1866 – occurred a day later.

Even after that, the Bank continued to downplay the nature and scale of the crisis: it confidently maintained that there was only a liquidity problem and that the banking system was more than adequately capitalised.

By as late as January 2008, the Bank was still reassuring Treasury Committee that the crisis, such as it was, was merely a liquidity one and that there was no question of the banks’ capital adequacy. As Governor King told the Committee

'I do not believe that in a year’s time people will look and say that there was any lasting damage to the British banking system. It is very well capitalised, it is very strong '…56

The next month, Northern Rock began revealing losses and went from liquidity support to full nationalisation.

However, Northern Rock was relatively minor; it represented less than 1% of the total capitalisation of the UK listed banking system in 2007.57

Then came the shock of the Lehman crisis in September 2008. That was swiftly dealt with and a month later, the Bank gave itself a well-deserved pat on the back: “there was now a real sense that a corner had been turned and the bank could be proud of its work,” the minutes reveal.58

Except that the BoE had got it wrong again.

By 2009, 30% of the UK listed banking system had failed and most of the rest were on state support.

The losses incurred by the banks from the GFC (and bear in mind that many of these losses took a long time to be revealed, and it appears that some still haven’t been) were perhaps £500 billion59 and still counting. Estimates of the banks’ GFC losses vary from at least 139% to at least 349% of their starting capital, depending mainly on how one estimates the latter. The banks’ GFC losses more than wiped out the capital of the UK banking system and arguably over three times over.

What most people failed to appreciate at the time was that a liquidity problem (the inability to obtain or renew creditor funding) is often a consequence of well-founded suspicions that the banks could be harbouring hidden losses aka a capital problem.

In June 2011, Governor King at last confirmed that the crisis was not a liquidity crisis, but was, and always had been, a capital (or solvency) crisis:

'Right through this crisis from the very beginning ... an awful lot of people wanted to believe that it was a crisis of liquidity,” Sir Mervyn said. “It wasn’t, it isn’t. And until we accept that, we will never find an answer to it. It was a crisis based on solvency ... initially financial institutions and now sovereigns.'60

As Tim Bush observed:

It is perhaps an indictment of conflicts of interest in the financial (and regulatory) system that the obvious takes four years to emerge as the true reason for something, when capital markets (equity, debt and money markets) had intuitively deduced the problem in 2007 and reacted accordingly. For a banking crisis to have been confused for four years as a “liquidity” rather than a capital crisis is not an insignificant matter, given that many policy decisions will have been made on a false diagnosis.

Because the banking crisis was in truth a capital crisis, there has to have been a systemic failure in the capital adequacy regime, making what was, in truth, capital consumption appear like capital generation.61

In short: (a) the BoE’s crystal ball completely failed to see the crisis coming, despite market signals that something was amiss; then, when the crisis did come, (b) the BoE persistently misdiagnosed the true nature of the crisis as being a liquidity crisis (which is not a big deal) rather than the capital or solvency crisis that it was (which is a real big deal), despite the fact that markets had been signalling capital problems since 2007; and (c) the scale of the losses overwhelmed the UK banking system and blew the UK’s fragile regulatory capital framework out of the water.

Two further lessons to be learned from the GFC are that we should use market cap as our metric (not the accounting or regulatory book value numbers!), because market cap numbers gave the best signals of impending trouble, and that banks then, though better capitalised than banks now, were far from being adequately capitalised going into the GFC.

Fast forward to the present, markets are again signalling major problems and the Bank of England is again insisting, against the evidence, that all is well. As Sam Woods reiterated to the Treasury Committee on Wednesday April 15th, “We go into this with a well capitalized banking sector.”

Cue Yogi Berra: “It's like déjà vu all over again.”

[sancho panza]

 

 

                                                                                   Section 11The Political Economy of Bank Capital

 

It is helpful at this point to consider the big picture, the underlying political economy of bank capital. In a laissez faire world with no central bank and no financial regulation, banks would sink or swim with no expectation of being bailed out by the state or its agencies if they get themselves into difficulties.

Enter central banks and regulators, who set up lender of last resort facilities, deposit insurance and such like, and associated expectations of bailout. The bankers respond to these incentives by increasing their leverage and taking more risks to boost their returns on equity, which are the basis of bank CEOs’ remuneration. High leverage seeks to maximise the value of the (often implicit) central bank or government guarantees by letting banks borrow at rates subsidised by society at large, thereby privatising profits on the upside and socialising losses on the downside. The bankers’ social contract is not a good one for everyone else, however. The central bank huffs and puffs that banks should not take excessive risks and threaten to let them fail, but the bankers see through these empty threats and call their bluff, knowing that in a crisis, central bankers will bail them out for fear that not doing so might collapse the financial system. Round One to the bankers.

The central bankers’ respond with capital adequacy regulation, the aim of which is to impose an upper limit on leverage. The industry responds with calls for greater ‘risk-sensitivity’ in the system. Greater risk sensitivity seems like a good idea and the regulators buy into it on ‘appliance of science’ grounds greased by plenty of revolving doors, first with the Market Risk Amendment to the original Basel Accord, now known as Basel I, in 1996, and then with the Basel II project, which took nearly a decade to complete. The hallmark of Basel II was the use of credit risk models to determine banks’ capital requirements for credit-risky positions. The bankers then use their credit risk models to obtain much lower capital requirements and boost their leverage, and so defeat the whole purpose of the Basel system. Round Two to the bankers.

Basel II is then rolled out to great fanfare, the GFC hits shortly afterwards and it became clear (admittedly, earlier to some than to others) that Basel II had allowed banks to be woefully under-capitalised.

One of the main problems of Basel II was its complexity. Complexity produces gameability and the big banks, being heavily involved in the drafting of the Basel II rulebook, had ensured that there was plenty of it. The complexity of the system was key to its ineffectiveness and you might say this complexity was not so much a flaw as a design feature, at least from the bankers’ point of view: Basel II offered almost unlimited scope for arbitrage. Basel I was 30 pages long 45 and had only 5 risk weights, Basel II was 347 pages long, an order of magnitude longer than Basel II, and a big bank operating under Basel II might easily have several million parameters to calibrate.62 Then Basel III was pushed out in an unholy rush in 2010, weighing in at 616 pages, nearly twice the length of Basel II, and experts were anticipating that the eventual rulebook might run to over 60,000 pages.63 More of the same that didn’t work before is rarely the right answer. Round Three to the bankers.

The banks promoting higher leverage means the banks promoting excessive leverage, and excessive leverage periodically crashes the financial system, leading to one disaster after another and repeated taxpayer bailouts, each bigger than the last, until eventually the public refuse to put up with it any longer.

The remuneration received by the bankers for taking the excessive risks that led to the crisis was but a small fraction of the banks’ subsequent losses which was in turn but a small fraction of the damage inflicted on the economy.64 So huge damage is being inflicted on the economy so that bankers can extract relatively small rents from it. The bankers have become the new unions.

It is, accordingly, imperative for those with the public interest at heart to appreciate the game that the banking lobby has been playing so successfully against the public, who are repeatedly called on to bail the bankers out.

If the bankers were to pursue their socially destructive high leverage agenda out in the open, where everyone could see it for what it is – that the bankers make a lot of profits for themselves in the good times, and the public bail them out in the bad – then it would be harder for them to get away with it: there would be a public outcry and politicians would be under enormous pressure to put a stop to it. The bankers therefore need some cover story to give them a fig leaf of respectability, the objective being to make high leverage seem reasonable, and even desirable.

This is where the ‘hold capital’ fallacy – the claim that banks ‘hold’ capital – comes in. This fallacy feeds into the widespread misperception, promoted both by the banking industry and by the BoE, that high capital requirements are somehow a constraint on bank lending. “Of course we know that excessive debt is a bad thing,” they say, as if excessive leverage was anything but that, “but if we have to hold more capital, then lending and unemployment will be badly affected, and no one wants that.”

The bankers’ pitch sounds right, but it isn’t.

To quote Admati:

'If capital is falsely thought of as idle cash, the discussion of capital regulation is immediately derailed by imaginary trade-offs. Nonsensical claims that increased capital requirements prevent banks from making loans and ‘keep billions out of the economy’ may resonate with media, politicians and the public just because the jargon is misunderstood. In light of this confusion and its ability to muddle the debate, it is disturbing that regulators and academics, who should know better, routinely collaborate with the industry to obscure the issues by using the misleading language and failing to challenge false statements. If, instead, the language that is used focused attention properly on funding and indebtedness, the debate would be elevated and more people would be able to understand the issues.'65 (Admati, 2016)

And again:

'This is not a silly quibble about words. The language confusion creates mental confusion about what capital does and does not do. This confusion helps bankers, because it creates the false impression that [more] capital is costly and that bankers should strive to have as little of it as regulators will allow. For society, there are in fact significant benefits and essentially no cost from much higher capital requirements.'66 (Admati and Hellwig 2013, p. 98)

It is, then, unhelpful when the regulator, who should be holding the fort on the public’s behalf, buys into the industry PR campaign with statements like this one:

The FPC was concerned that banks could respond to these developments by hoarding capital and restricting lending. (Mark Carney, 2016, our emphasis)67

When the regulator itself promotes industry PR instead of debunking it, then we should not expect the regulator to be effective. In truth, the regulator has long since been captured by the industry and the regulator’s dismal performance, while shocking, is only to be expected. The bank capital regulatory system is broken and it will take a lot more than any Basels IV, V or VI to put it right. At some point, there will need to be radical reform to reverse the ever more destructive banksterisation of the economy and re-establish a Social Contract in which the bankers serve the public and not the other way round.

[sancho panza]

 

 

                                                                                              Section 12: Conclusions

We asked earlier (p. 7) whether the UK banking system has the financial resilience it needs to withstand a major shock and still emerge in good shape.

The BoE gives a reassuring upbeat answer, essentially the ‘Great Capital Rebuild,’ the merits of which we have discussed at some length.

In his final remarks as Governor, Mark Carney reiterated much the same message:

'Some watching will recall the financial crisis a little more than a decade ago. Then, the financial system was the core of the problem. Now, it can be part of the solution.

Over the past decade, the UK financial system has been transformed. We didn’t build this strength for its own sake. This is prudence with a purpose. Resilience with a reason'.68

We hope he is right.

Our concern, however, is that the evidence points the other way.

Using the latest available figures, the Big Five UK banks have an average priceto-book ratio of 39.2%, an average market cap to total asset ratio of 2.3% and an implied leverage of 43.3. These are not healthy metrics. The PtB ratio for a healthy banking system is well over 100%. The average capital ratio is far below the minimum values recommended by many experts, and the leverage is far above any accepted reasonable safe level. And these numbers ignore the hidden leverage, hidden losses and other problems in banks’ books, and there appear to be plenty of those too.

UK banks are not only in poor shape, but they are also in considerably worse shape now than they were going into the GFC. Taking the end of December 2006 as a yardstick, their average PtB ratio then was 255% and has since fallen by 212 percentage points, their average capital ratio has nearly halved and their average leverage has close to doubled. Remember too that insufficient capital (or if you prefer, excessive leverage) was rightly blamed as a major contributor to the severity of the GFC.

By these metrics the BoE’s medicine has not only failed to restore the patient to health, but has left the patient in worse shape than before. It stands to reason that even a milder version of the earlier ailment would be enough to land the patient back in ICU.

Look at it this way. The UK banks’ capital in market value terms is now a mere £140.6 billion, but the Big Five banks’ losses from the GFC were likely over £500 billion, well over three and a half times as much as their current market cap. Therefore, a GFC repeat that inflicted similar losses on the banks would wipe out their capital more than three and a half times over. UK banks are not nearly sufficiently capitalised to withstand a shock on anything close to the same scale as they experienced then and still emerge solvent, let alone in good shape and able to operate normally. Or, to put the argument the other way round, a shock mild enough to inflict a loss of £140.6 billion on the banks would be enough to wipe out their capital. UK banks might be able to withstand a mild cold, but nothing more severe.

The projections being made suggest that the economic impact of the COVID-19 shock is much worse than the economic equivalent of a cold, however. The OBR projected a 35% fall in real GDP in the second quarter of 2020, a crash on a scale not seen in this country since the early 18th century, with an overall fall of almost 13% over the year, and that was on the optimistic assumption that the economy would quickly recover.69 Other respected figures suggest worse scenarios:

“The best-case scenario would be a downturn that is more severe than the GFC (in terms of reduced cumulative global output) but shorter-lived …” (Nouriel Roubini)70

“We anticipate the worst economic fallout since the Great Depression …” (IMF head Kristalina Georgieva)71

“Forget ‘recession’: this is a depression. Although UK data lags behind the US, the evidence is mounting coronavirus makes 2008 look trivial” (David Blanchflower and David Bell)72

Does the UK banking system have the resilience it needs to face the downturn and still be in good shape? It would appear not, but we shall soon find out.

Given the fragility of the UK banking system and the severity of the crisis now engulfing it, a new round of bank bailouts would seem inevitable. We are already seeing the early signs of that in terms of increased forbearance and plans afoot to reduce capital requirements.

Naturally, it would be unfair to criticise the BoE for failing to anticipate the COVID-19 crisis. Yes, we knew that a new pandemic was inevitable but no one could anticipate when it would strike or how severe it might be, and it is a basic proposition of financial economics, and no criticism of central banks, that they can’t see shocks coming.

To go back to the Vickers quote with which we started:

Failure to anticipate systemic fragility in the face of such shocks is an altogether different matter. … Banks’ capital adequacy is a cornerstone of our economic system.” (Our emphasis)

It is reasonable to criticise the regulator for leaving the system frail when its mandate was to ensure systemic robustness. A more serious regulatory failure is difficult to imagine, and it’s not as if we haven’t all seen this movie before. The BoE’s stewardship of the banking system has turned out to be a disaster, again.

Credible experts have been warning the BoE for years that the UK banking system was far from being adequately capitalised. But instead of taking measures to ensure banks raised actual capital levels, the BoE focussed on raising regulatory capital ratios and those are not the same thing. In effect, the BoE took the easy way out, window dressing instead of fixing the under- capitalisation problem, let alone tackling its underlying causes, that is, the multiple incentives to excessive bank risk-taking that the BoE and its overseas counterparts were largely responsible for creating in the first place.

 

[sancho panza]

50 minutes ago, Bobthebuilder said:

@sancho panza, Thank you for those bank posts, i really appriciate your hard work. Once again thank you for posting, very informative.

Thanks Bob.My pleasure,Hope it was of some use.

I do it for my own education and for my families(although I'm not sure one or two of them read it) and am happy to share/be corrected.

In all honesty-given that we aren't interested in banks at the minute-I mainly concern myself with the economic effects of credit defaltion and ignore the mechanics by which it occurs.
 

Having said that,I was truly shocked by how weak the UK banks are and by how complicit the regulators have been in allowing the leveraging up(recapitalizing by upgrading Level 3 RWA is the ultimate irony) ...........................

When a few of the big banks fail-I can't see even the mildest outcome avoiding that-then the show will really start.

[Bobthebuilder]

Back in late 2007 i could see all this banking crises start to unfold, i had been reading the old K winter thread on tos and had my tunnel vision panic moment. I didnt lose any money through that crash apart from the loss in value of sterling but learnt a few big lessons, mostly about controlling the fear, my scuba diving that i was doing at the time had helped a lot with that. Fast forward a year or so and i was visiting my Sister, her hubby was about to lose his business and i could see the same fear in his face. All i told him was to learn from the experiance (you are not rich with the big house and cars if you have only 2 months money in the bank). Anyway it turned out alright for them in the end.

I am wandering a bit, sorry, but we all need to control the fear going forward and as Harley has often said find ways to minimise our exposure.

Thanks everyone, amazing thread this.

[DurhamBorn]

When i was 17 i went for a job with Lloyds.I think the day was in Newcastle.Tests and interviews etc.Lots of very posh young people.During the interview bits you could almost feel the way they looked down on you being working class.It was a horrible experience.I had a very good understanding of finance,id been buying shares since i was 14 etc but that counted for nothing.

They will be bailed,but not the same as last time.The CBs are monetizing government debt this time,not banks.

During the mid 2000s i was seeing a woman who had a very good job.She had built up £100k of debts and just went bankrupt.Wiped away.Today she still has that very good job yet has had £100k free money.Not from bank bondholders,but from taxpayers.The whole thing stinks,but it suits the elite.

[sancho panza]

48 minutes ago, Bobthebuilder said:

Back in late 2007 i could see all this banking crises start to unfold, i had been reading the old K winter thread on tos and had my tunnel vision panic moment. I didnt lose any money through that crash apart from the loss in value of sterling but learnt a few big lessons, mostly about controlling the fear, my scuba diving that i was doing at the time had helped a lot with that. Fast forward a year or so and i was visiting my Sister, her hubby was about to lose his business and i could see the same fear in his face. All i told him was to learn from the experiance (you are not rich with the big house and cars if you have only 2 months money in the bank). Anyway it turned out alright for them in the end.

I am wandering a bit, sorry, but we all need to control the fear going forward and as Harley has often said find ways to minimise our exposure.

Thanks everyone, amazing thread this.

I agree that it's good to test yourself with stress and fear.Enables you to keep the lid on when the shtf.Paramedicing has been good for me from that perspective.There's been a few moments when I wisehd the ground would swallow me up but you coem through it.

38 minutes ago, Cattle Prod said:

That's my general view, a basic utility. They aren't actually a business, beyond that function, and should be paid accordingly. Everything else flash you see is a product of parasitism and doomed to fail. Thanks @sancho panza, hair raising stuff.

That was my view too.

4 minutes ago, Cattle Prod said:

Dollar down hard against the Euro today. After announcing another 600bn euros to print, I'd have thought it would be the other way around? How on earth could that make the Euro stronger? Is it because that somehow makes the Euro area stronger, and a better bet? The Fed will have to catch up in that case...

96 handle on DXY........gold msut be getting sprung back.

[DurhamBorn]

1 minute ago, Cattle Prod said:

Dollar down hard against the Euro today. After announcing another 600bn euros to print, I'd have thought it would be the other way around? How on earth could that make the Euro stronger? Is it because that somehow makes the Euro area stronger, and a better bet? The Fed will have to catch up in that case...

Leads and lags ,dollar should go below 90 looking at liquidity profiles.I havent put 100% effort into it as iv been more concerned on tweaking investments,but thats what i see.At this stage of a cycle (the end,or the beginning of a new one) systemic risk is at its greatest.If they dont right size things go to zero.Its why i was so interested in that 100 mark on the dollar.Fed had to go hard until it fell away from that.Above,everything was about to unwind.As soon as the Fed was rightsizing that 100 level kept and that was where risk assets rallied.Euro isnt rightsized yet ,they have just removed a lot of systemic risk.Fed has $10 trillion to go i think,maybe more.1/3 done.

[Loki]

What a great idea @Cattle Prod, mind gaming different scenarios to help understand this one better.  I'm looking forward to seeing the replies from the big brains. 

[DurhamBorn]

1 minute ago, Cattle Prod said:

So let's pretend the blasted virus never happened.

The CBs of the world would not have printed any of this money (is anyone doing a running total?) until they had an excuse to do so. Like a bog standard stock market crash in October. However they have not let the chance go a begging, the "Pandemic Emergency Purchase Programme" says it all. As you say DB, they are trying to do what they have long known what needs to be done. It's not evil per se, and I'm sure all the people on furlough would agree. My question and thinking is forward looking. If we have printed x amount (1/3, you suggest), with another 2/3 to go, are we already part way through the debt deflation, and thus reducing the impact and severity of the Big Kahuna? I mean they are monetising debt, so cutting the legs off deflation already. They are even monetising corporate debt, and looking at the tenuous reasons people are now rioting over, they are probably going to somehow monetise consumer debt too. So how bad can the Big K be?

If it's sector rotation, fine, us lot have already been through it. If the FAANGS need to hit single digit PEs before bottom, perhaps it will be a long, slow affair, just grinding down as people begin to see them as utilities (which they are, really), and get excited about the hot new sexy commodity arena (the movie Trading Places was framed around commodity futures, must have been water cooler talk then and taxi drivers advising you on pork bellies!). I can see the conversations now "Oh my God I mean, it's finite! They're not making any more of it, how could I lose?!"

I understand we are in a confusing part of this phase change, and you probably don't have clear signals yet. But I thought I'd try and stimulate debate on this, it's the one big unknown left for me.

 

The debt deflation is two sided.One side is the private sector de-leveraging and the other side is the state and CBs issuing.The interaction is the key.At the moment the CBs are just ahead of things.Lots of companies will go under,but listed companies might mostly make it,but issuing equity.I still think we will see another big drop in the equity markets,but a lot could be sector rotation.Amazon is worth 50 Telefonica's for instance.6% of Amazon would buy you Telefonica,BT,Vodafone and Telia.The fact Amazon raised $10billion in debt the other day is telling.They must be looking at targets,but people wont accept Amazon stock in payment.

My approach has been to take a few profits and slowly build up some more cash again.Im also very happy with the prices iv paid for what im holding apart from a few disasters as always.

If the governments and CBs turn off the liquidity any time soon we will collapse and they will have to engage again to infinity.I really like the idea of keeping invested in de-complex areas and keeping the eye on the longer term likely structure of the cycle.Inflation is certain,high inflation is certain.From here to there is fuzzy,and in lots of ways we simply have to live with that.The perfect scenario would be a fall on sector rotation into reflation/value/pm areas.Its always the most difficult time in an investors life.Getting the falls right and being mostly cash and the right areas then buying heavy at the first bottom,then making fantastic profits only to think is there another even bigger leg down?.There might be yet.

[Shamone]

On 02/06/2020 at 19:13, SillyBilly said:

One thing I am very interested about is how Joe Public will react if markets do completely distort relative to the pain on Main Street. It won't be a good look, at all. We had Occupy Wall Street last time out, what is to come this time around? 

You can't print an economy over night, the thrust of this thread so far as I understand it is a gradual transition and a move from disinflation to inflation. That doesn't account for the sharp effect this will have on jobs and living standards in the immediate term. I think we could see interesting headlines if twice within 15 years the "rich" are seen to escape unscathed from a major economic shock while reports of stocks surging to new highs each month under a back drop of record lay offs. It would be interesting to discuss this because how do the government control the narrative here? They can't print an arc furnace tomorrow, furloughing will have to end not least because those non-furloughed will not tolerate it. Interesting times. 

Joe pubic will do nothing, the same as they always do and the reason they will always be slaves. Possibly they will fight each other over some scraps. A touch of looting.

[Bobthebuilder]

1 hour ago, DurhamBorn said:

My approach has been to take a few profits and slowly build up some more cash again

Would that include oillies, tobacco, utilities profits? Not advice just interested.

[AWW]

5 hours ago, DurhamBorn said:

I had a very good understanding of finance,id been buying shares since i was 14 etc but that counted for nothing.

It's all about who you know, DB. I'm an IT contractor; I design and build algorithmic trading systems for a living. I've worked at probably ten different banks. The people in them are nothing special; in fact many of them are completely useless and I wouldn't employ them to clean my toilet. Come work experience fortnight, in come all the teenagers to get a Big Bank on their CV. Some of them are alright, but most are completely entitled and think they're far cleverer than they are. Then, after they've done the obligatory useless degree, they get their feet under the table in Sales or on one of the trading desks and get very well paid for doing nothing special at all. I could tell you (and the PRA) stories of incompetence and negligence that you would not believe.

I'm grossly overpaid compared to what I'd earn building platforms in any other industry.

Oh by the way, my "in" was via a software company I used to work for. And I still say "bath" rather than "barth" :-)

[nirvana]

15 minutes ago, AWW said:

I design and build algorithmic trading systems for a living

ooh that's an interesting and timely post lol

Do you just do these algos for 'in house' systems or do you go after clients 'stops'? And how do you do it?

PM me if you want, I keep secrets well 

[Majorpain]

Current Nasdaq bubble is making 2000 look like a minor event, very impressive!