Credit deflation and the reflation cycle to come (part 3)

[CannonFodder]

I agree there will be some properties where the banks lose money but in aggregate the majority of properties will cover their loan or pay the rates. People will lose houses as bank profits increase.

The riskier mortgages will be the most recent as Ltv high without time to pay off. Banks will try to limit these as things get going naturally. Refuse remortgage or sell to vulture

GOV wont like this, question is whether we see a freddie fannie NAMA in the UK

[Democorruptcy]

9 hours ago, CannonFodder said:

With respect, i disagree.

Basel 3 gives a leverage ratio of 3 % so 33 times lend out.

Then take into account that this is current mortgages on the bank.s book. So create 33 mortgages sell on, etc. Create another 33.

That considers all financial institutions are signed up to it.

I do agree that banks are in a bad way atm but that is cos interest rates are so low. Higher rates will heal them.

They were fine in the 70s.

I DONT like the banks but the higher rates go, the more money people pay to banks.

More money coming in is good for banks.

They create their own money supply so interest rates flow heavily to margin.

Bank shares on BoE days recently prove your point. In November when they were expected to raise bit didn't bank shares had a bad day. On the day they did raise bank shares went up.

 

[DurhamBorn]

10 hours ago, Lightscribe said:

As I’ve said before on here. The BK will bankrupt the majority of the population through stocks/pensions/houses/debt/cost of living.

Too big to bail out so planned controlled economic demolition and asset forfeiture. Very few (like us on here) will be able to economically survive the decade. We won’t be left alone either, all assets will be fair game and taxable for the benefit of the many rather than the few.

That then paves inroads for UBI, social credit scores and CBDCs.

My roadmap is still showing that inflation (and fiscal drag) will do most of the damage.The government has over 50% scrounging from the others now so they wont roll back the state yet.However we will now enter the stage where parts of the state take from each other and fight for the resources.Although the UK population do have pensions,a lot is still in DB.Most of the general population have wealth in housing,so given how far the band is stretched housing will take a lot of the wealth destruction (inflation adjusted).I still think those 60/40 type pensions will also take a lot of pain even more so with fees and in drawdown.

I think you will find more and more people living together to cut down on bills as well.

When i was growing up i knew a lot of people who owned individual shares.Now i only know people in my family.Very few have assets that create an income outside of property.Bennies and BTL.

This thread is really about the fact we were facing (and are now in) a distribution cycle.

 

 

[DurhamBorn]

1 hour ago, CannonFodder said:

I agree there will be some properties where the banks lose money but in aggregate the majority of properties will cover their loan or pay the rates. People will lose houses as bank profits increase.

The riskier mortgages will be the most recent as Ltv high without time to pay off. Banks will try to limit these as things get going naturally. Refuse remortgage or sell to vulture

GOV wont like this, question is whether we see a freddie fannie NAMA in the UK

I think this is right.Banks (and insurers) will make much higher profits from rates that should cover losses.I think one outcome will be much more social house building and more multi generation living.The banking sector had its balance sheets repaired,the bankrupt now are governments.Of course every £ less the government spends will be then a destruction of a private asset.The reason i wont own banks though is derivative risk.That could take them down,not their own loan book.

[Castlevania]

50 minutes ago, DurhamBorn said:

I think this is right.Banks (and insurers) will make much higher profits from rates that should cover losses.I think one outcome will be much more social house building and more multi generation living.The banking sector had its balance sheets repaired,the bankrupt now are governments.Of course every £ less the government spends will be then a destruction of a private asset.The reason i wont own banks though is derivative risk.That could take them down,not their own loan book.

I disagree. It’s the loan books that will hole the banks. 

[DurhamBorn]

35 minutes ago, Castlevania said:

I disagree. It’s the loan books that will hole the banks. 

Depends on the banks and where their loans sit.Residential loan books can be 60% LTV average.Rates going up make a massive difference here because at 5% the banks can swallow a lot of defaults before they go under due to profits.Main victims will be people losing their equity i think.There will be lots of dislocation ahead thats certain.Key is to keep to the de-complex areas mostly.

These Private Equity loans could be where most danger sits,so anyone lending to them will be in trouble of course.

 

[spygirl]

16 hours ago, Plan-b said:

Surely housing can never be allowed to substantially fall, if it does then the banks go with it. Perhaps the currency will be devalued instead so any property falls to the casual observer look small.

This seems to be the way of every currency in history. 

Why would you assume that?

The only way to get a stable, strong economy is to follow the Swiss - hard currency, high productivity, low debt, run current account surplus.

Doing what the UK has done for 20y, allowing currency to fall and borrowing loads to let fat Shazza sit on her arse will blow up sooner or later.

With energy costs rising and Fed raising, we are now at later.

 

 

[BurntBread]

29 minutes ago, DurhamBorn said:

Depends on the banks and where their loans sit.Residential loan books can be 60% LTV average.Rates going up make a massive difference here because at 5% the banks can swallow a lot of defaults before they go under due to profits.Main victims will be people losing their equity i think.There will be lots of dislocation ahead thats certain.Key is to keep to the de-complex areas mostly.

These Private Equity loans could be where most danger sits,so anyone lending to them will be in trouble of course.

 

DB, are you staying out of investing in banks for the whole cycle, or are there indicators you are looking for which will tell you that the derivative risk is mostly gone, and that banking stocks might then have a place in a diversified portfolio?

[spygirl]

12 hours ago, CannonFodder said:

With respect, i disagree.

Basel 3 gives a leverage ratio of 3 % so 33 times lend out.

Then take into account that this is current mortgages on the bank.s book. So create 33 mortgages sell on, etc. Create another 33.

That considers all financial institutions are signed up to it.

I do agree that banks are in a bad way atm but that is cos interest rates are so low. Higher rates will heal them.

They were fine in the 70s.

I DONT like the banks but the higher rates go, the more money people pay to banks.

More money coming in is good for banks.

They create their own money supply so interest rates flow heavily to margin.

https://www.bis.org/bcbs/publ/d424_hlsummary.pdf

I dont think UK has a mortgage security market anymore.

Going forward, banks will have to hold 20% capital against mortgages.

20% deposit, 20% from bonds rest drawn down from BoE.

 

[ThoughtCriminal]

25-40% rises for IKEA crap

[DurhamBorn]

1 hour ago, BurntBread said:

DB, are you staying out of investing in banks for the whole cycle, or are there indicators you are looking for which will tell you that the derivative risk is mostly gone, and that banking stocks might then have a place in a diversified portfolio?

Whole cycle.I see no need to own them given risks.I do hold some financials though,M+G ,Abrdn because i think there will be a big wealth transfer ahead between generations coming out of housing and gilts into investments.I also hold DirectLine,very recent addition.Inflation and tax are the biggest risks to wealth this decade for me.

[spygirl]

2 hours ago, BurntBread said:

DB, are you staying out of investing in banks for the whole cycle, or are there indicators you are looking for which will tell you that the derivative risk is mostly gone, and that banking stocks might then have a place in a diversified portfolio?

I can understand why people would want to work for bank - retail or investment.

I cant understand anyone wanting an equity investment.

 

[M S E Refugee]

These two are on live at 4.15pm.

[Roger]

15 hours ago, CannonFodder said:

Perhaps think of it that a bank borrows a £1 and then lends it out again 25, 40 or 75 times, the same £1 i mean.

At 1% interest, it costs 1p to borrow and 75p in income so 74p profit

At 10%, it cost 10p to borrow and 750p income so profit is £7.40 on every £1 they borrow from central banks.

High interest rates are not bad for banks.

This is very oversimplified.

Is this not far too simplified?

This bank has £1 of capital. It has £75 of lending on the asset side of its balance sheet. So it still has to find £74 of funding from the markets. In the absence of any crazy central bank schemes, it'll have to pay a market interest rate on that.

[stoobs]

Banks create money at the point of issuing a loan.

That money is then destroyed when the loan is repaid.

The bank does not need to obtain that money from anywhere else as it didn't exist before the loan was issued.

[JMD]

16 hours ago, Majorpain said:

https://www.theguardian.com/business/2021/dec/27/fears-of-higher-uk-home-prices-as-habito-launches-7x-mortgage

7 times income but over 40 years.  Northern Rock 2.0?

Massive two fingers up at BOE.

I think long term/lifetime fixes are precisely what the BOE want to see far more of. Habito are offering 60% LTV at approx. 3% for 25 years - this is if you accept erc and 10% max overpayments, which maybe suggests they want long term customers? Is the Habito approach the lending model that government wants to see, so they can raise rates with impunity?      ...Not a panacea of course but government won't get the blame if homeowners suffer nasty consequences, which is of course the idea, and government can even become the heroes of the story if decide to back the failing lenders with government bonds, in return for big share of the nation's housing equity. And perhaps this is the way governments make themselves appear solvent for the next twenty years?!

[spygirl]

50 minutes ago, stoobs said:

Banks create money at the point of issuing a loan.

That money is then destroyed when the loan is repaid.

The bank does not need to obtain that money from anywhere else as it didn't exist before the loan was issued.

CB create the money  at the banks request.

Moneys is destroyed by IR and paying back the debt.

The big booms in UKHPI were both down to gormless fuckwittery which inflated banks liabilities with no repayment -

Endowment mortgages 1985-1995ish.

IO mortgages 2002-2008.

 

Heres a nice chart, which puts the changes in an easy to see chart

https://ourworldindata.org/grapher/leverage-ratio-of-banks-in-the-uk-and-us-19602018

Bank leverage has gone back to where it was pre 1984.

 

[spygirl]

5 minutes ago, JMD said:

I think long term/lifetime fixes are precisely what the BOE want to see far more of. Habito are offering 60% LTV at approx. 3% for 25 years - this is if you accept erc and 10% max overpayments, which maybe suggests they want long term customers? Is the Habito approach the lending model that government wants to see, so they can raise rates with impunity?      ...Not a panacea of course but government won't get the blame if homeowners suffer nasty consequences, which is of course the idea, and government can even become the heroes of the story if decide to back the failing lenders with government bonds, in return for big share of the nation's housing equity. And perhaps this is the way governments make themselves appear solvent for the next twenty years?!

Again, habito is made up bollocks.

What the BoE wants is a large deposit, a lot of bank capital and a chunk of bonds with a 5y fix.

BoE wants its capital at the end of a long list of other creditors.

40%+ deposit and a 5y+ fix and you can get a pass the affordability checks n hoop jumping.

 

[Castlevania]

4 hours ago, DurhamBorn said:

Depends on the banks and where their loans sit.Residential loan books can be 60% LTV average.Rates going up make a massive difference here because at 5% the banks can swallow a lot of defaults before they go under due to profits.Main victims will be people losing their equity i think.There will be lots of dislocation ahead thats certain.Key is to keep to the de-complex areas mostly.

These Private Equity loans could be where most danger sits,so anyone lending to them will be in trouble of course.

 

The problem is the credit markets. The Central Banks are totally scared of price discovery, and markets doing their thing because a number of companies would default and cause the entire lending market to seize up. The rounds of QE have been to save the credit markets.

A related problem is that banking book accounting is subjective and backward looking - you invariably only take provisions and write downs when things are already very bad. The derivative books by contrast are all marked to market on a daily basis, there’s no hiding. The focus since the financial crisis has been on the derivative side - nowadays a large amount of trades are routed through CCP’s such as LCH and Euronext; banks actively price in the counterparty risk of their clients and have trading desks that simply price and actively hedge this risk; and most derivatives are collateralised. 

I’m very wary of some of the lending books on banks balance sheets.

[stoobs]

11 minutes ago, spygirl said:

CB create the money  at the banks request.

Moneys is destroyed by IR and paying back the debt.

The big booms in UKHPI were both down to gormless fuckwittery which inflated banks liabilities with no repayment -

Endowment mortgages 1985-1995ish.

IO mortgages 2002-2008.

 

Heres a nice chart, which puts the changes in an easy to see chart

https://ourworldindata.org/grapher/leverage-ratio-of-banks-in-the-uk-and-us-19602018

Bank leverage has gone back to where it was pre 1984.

 

BoE explainer from 2014:

Money creation in the modern economy

Quote

Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money — the so-called ‘money multiplier’ approach. In that view, central banks implement monetary policy by choosing a quantity of reserves. And, because there is assumed to be a constant ratio of broad money to base money, these reserves are then ‘multiplied up’ to a much greater change in bank loans and deposits. For the theory to hold, the amount of reserves must be a binding constraint on lending, and the central bank must directly determine the amount of reserves. While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality. Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves — that is, interest rates.

Quote

Of the two types of broad money, bank deposits make up the vast majority — 97% of the amount currently in circulation.(6) And in the modern economy, those bank deposits are mostly created by commercial banks themselves.

Commercial banks create money, in the form of bank deposits, by making new loans.

 

[Castlevania]

To add, I prefer the U.K. banks to the European ones. Not that I’d buy any of them. I still haven’t worked out whether the Northern European banks are hedging the interest rate risk on the 30 year fixed term mortgages at fuck all interest that they’ve been writing. I have a feeling that it’s a no.

[JMD]

6 hours ago, DurhamBorn said:

My roadmap is still showing that inflation (and fiscal drag) will do most of the damage.The government has over 50% scrounging from the others now so they wont roll back the state yet.However we will now enter the stage where parts of the state take from each other and fight for the resources.Although the UK population do have pensions,a lot is still in DB.Most of the general population have wealth in housing,so given how far the band is stretched housing will take a lot of the wealth destruction (inflation adjusted).I still think those 60/40 type pensions will also take a lot of pain even more so with fees and in drawdown.

I think you will find more and more people living together to cut down on bills as well.

When i was growing up i knew a lot of people who owned individual shares.Now i only know people in my family.Very few have assets that create an income outside of property.Bennies and BTL.

This thread is really about the fact we were facing (and are now in) a distribution cycle.

 

 

Yes I think(hope?) your model is correct DB, in terms of inflation doing the most damage. After all it makes sense to me that governments, amongst the looming incoming financial chaos, and the fighting for resources that you mention will happen - won't simply be looking to rob everyone blind, instead government will also be (trying to be clever and) seeking to provide some 'getouts' for some in society - firstly their long term friends of course, but also those types of people with the foresight to take advantage. That imho is the true value of this thread, to highlight such areas of foresight/discussion, and to provide inspiration and ideas for some of those potential 'getouts', such as buying inflation loving shares, PM's, etc.                                                                                                                                                           ...Of course that's the good news(!?), however it's my understanding that the above preparation may only be the prologue for what may happen come the end of the decade. But personally I'm fairly happy that I have most of phase-one covered, and as DB reminds us phase-two/monetary collapse may not happen, depends on government policies this decade.

[Majorpain]

32 minutes ago, spygirl said:

CB create the money  at the banks request.

Not true, the money created for mortgage/financing is simply magicked up out of thin air as long as the bank remain within its capital constraints.

This creates a problem that as the bank is not a central bank and cannot create currency, so technically its not "legal" money its creating....

[moneyscam]

2 hours ago, Castlevania said:

The problem is the credit markets. The Central Banks are totally scared of price discovery, and markets doing their thing because a number of companies would default and cause the entire lending market to seize up. The rounds of QE have been to save the credit markets.

A related problem is that banking book accounting is subjective and backward looking - you invariably only take provisions and write downs when things are already very bad. The derivative books by contrast are all marked to market on a daily basis, there’s no hiding. The focus since the financial crisis has been on the derivative side - nowadays a large amount of trades are routed through CCP’s such as LCH and Euronext; banks actively price in the counterparty risk of their clients and have trading desks that simply price and actively hedge this risk; and most derivatives are collateralised. 

I’m very wary of some of the lending books on banks balance sheets.

Every entity that uses OTC derivatives is required to clear in Europe under MIFIR. However not every entity will qualify or meet the membership criteria of a CCP. In practice membership of the CCP remains the preserve of the large dealer banks as they can meet the steep capital and net equity requirements that CCP membership requires. This is mitigated by the non qualifying entities being allowed to clear their trades through an existing CCP member or what is known as client clearing via a clearing member. The client's trade with the bank becomes the clearing members trade with the CCP.

So the clearing member bank has to manage this risk by applying the same initial margin / variation margin and collateral requirements that the CCP will apply to the clearing member. In essence, the bank faces the same counterparty risk with clients regardless of whether the trade is cleared through a CCP or not. The CCP's effectively only silo and mitigate the counterparty risk between dealer banks ie between clearing member to clearing member at the CCP.

Last time I looked circa 65% of OTC trades are dealer (bank) to client, the rest being dealer to dealer (bank to bank). So  a good chunk of individual client counterparty risk still lies with the bank in reality. 

[sancho panza]

On 27/12/2021 at 12:08, Juniper said:

I saw an argument for a strong dollar this morning from Chase Taylor of Pinecone Macro:

It does make sense that energy may be a strong influence given the current prices. Currency still proves too complex for my understanding so I just thought the different perspective was interesting.

Jesse Felder talked on macrovoices last week about a ‘trifecta’ of rising energy prices, rising dollar and rising interest rates leading to an earnings recession…perhaps an option for where we’re headed? @sancho panza this is similar to your theory but I’m not sure your thoughts on the dollar?

and @CannonFodder

I msut say thought provoking commetns.Been busy with kids and moving house.Been thinking about this since I read your commetns.If I get some research time tmrw then I'll have a dig through ye olde dollar/recession/stock market drops timelines.

I've previously published my BK checklist and remain long as a result of not enough ticks on the lsit.

I saw someone put up a David Hunter psot the other day and he was talkign about a run back down in the dollar(which would happen to coincide nicely with his blow off top prediction.WHilst I wouldn't time off DH ,I don't feel comfortable surfing in the opposite direction to him,he seems to get the tidal moves quite well in a similar way to @DurhamBorn,not surprising given similar mentors.I know DB never normally shies away from a call(unlike me) but I remember him being unsure if we'd bottomed on the DXY or whether there was room for anotehr leg down.Be interesting to hear his views on the matter.

AS you say CF,all these countries raising rates and Fed staying steady does imply weaker dollar.Historically,I know 08 had a perfect weak dollar phase up and down before the smash in Oct and much as we had a weak dollar phase to the 90 level,it didn't really feel like a pre BK weak dollar phase to me.

If we get a proper run down in the dollar to 85 on the DXY then we could see oil/gold moonshoot and then I'd be ready to move sell and move short/to cash.