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David Stockman: We’ve Been Lied To, Robbed, And Misled

And we’re still at risk of it happening all over again

by Adam Taggart
Saturday, March 30, 2013, 12:42 PM

Then, when the Fed’s fire hoses started spraying an elephant soup of liquidity injections in every direction and its balance sheet grew by $1.3 trillion in just thirteen weeks compared to $850 billion during its first ninety-four years, I became convinced that the Fed was flying by the seat of its pants, making it up as it went along. It was evident that its aim was to stop the hissy fit on Wall Street and that the thread of a Great Depression 2.0 was just a cover story for a panicked spree of money printing that exceeded any other episode in recorded human history.

David Stockman, The Great Deformation

David Stockman, former director of the OMB under President Reagan, former US Representative, and veteran financier is an insider’s insider. Few people understand the ways in which both Washington DC and Wall Street work and intersect better than he does.

In his upcoming book, The Great Deformation: The Corruption of Capitalism in America, Stockman lays out how we have devolved from a free market economy into a managed one that operates for the benefit of a privileged few. And when trouble arises, these few are bailed out at the expense of the public good.

By manipulating the price of money through sustained and historically low interest rates, Greenspan and Bernanke created an era of asset mis-pricing that inevitably would need to correct.  And when market forces attempted to do so in 2008, Paulson et al hoodwinked the world into believing the repercussions would be so calamitous for all that the institutions responsible for the bad actions that instigated the problem needed to be rescued — in full — at all costs.

Of course, history shows that our markets and economy would have been better off had the system been allowed to correct. Most of the “too big to fail” institutions would have survived or been broken into smaller, more resilient, entities. For those that would have failed, smaller, more responsible banks would have stepped up to replace them – as happens as part of the natural course of a free market system:

Essentially there was a cleansing run on the wholesale funding market in the canyons of Wall Street going on. It would have worked its will, just like JP Morgan allowed it to happen in 1907 when we did not have the Fed getting in the way. Because they stopped it in its tracks after the AIG bailout and then all the alphabet soup of different lines that the Fed threw out, and then the enactment of TARP, the last two investment banks standing were rescued, Goldman and Morgan [Stanley], and they should not have been. As a result of being rescued and having the cleansing liquidation of rotten balance sheets stopped, within a few weeks and certainly months they were back to the same old games, such that Goldman Sachs got $10 billion dollars for the fiscal year that started three months later after that check went out, which was October 2008. For the fiscal 2009 year, Goldman Sachs generated what I call a $29 billion surplus – $13 billion of net income after tax, and on top of that $16 billion of salaries and bonuses, 95% of it which was bonuses.

Therefore, the idea that they were on death’s door does not stack up. Even if they had been, it would not make any difference to the health of the financial system. These firms are supposed to come and go, and if people make really bad bets, if they have a trillion dollar balance sheet with six, seven, eight hundred billion dollars worth of hot-money short-term funding, then they ought to take their just reward, because it would create lessons, it would create discipline. So all the new firms that would have been formed out of the remnants of Goldman Sachs where everybody lost their stock values – which for most of these partners is tens of millions, hundreds of millions – when they formed a new firm, I doubt whether they would have gone back to the old game. What happened was the Fed stopped everything in its tracks, kept Goldman Sachs intact, the reckless Goldman Sachs and the reckless Morgan Stanley, everyone quickly recovered their stock value and the game continues. This is one of the evils that comes from this kind of deep intervention in the capital and money markets.

Stockman’s anger at the unnecessary and unfair capital transfer from taxpayer to TBTF bank is matched only by his concern that, even with those bailouts, the banking system is still unacceptably vulnerable to a repeat of the same crime:

The banks quickly worked out their solvency issues because the Fed basically took it out of the hides of Main Street savers and depositors throughout America. When the Fed panicked, it basically destroyed the free-market interest rate – you cannot have capitalism, you cannot have healthy financial markets without an interest rate, which is the price of money, the price of capital that can freely measure and reflect risk and true economic prospects.

Well, once you basically unplug the pricing mechanism of a capital market and make it entirely an administered rate by the Fed, you are going to cause all kinds of deformations as I call them, or mal-investments as some of the Austrians used to call them, that basically pollutes and corrupts the system. Look at the deposit rate right now, it is 50 basis points, maybe 40, for six months. As a result of that, probably $400-500 billion a year is being transferred as a fiscal maneuver by the Fed from savers to the banks. They are collecting the spread, they’ve then booked the profits, they’ve rebuilt their book net worth, and they paid back the TARP basically out of what was thieved from the savers of America.

Now they go down and pound the table and whine and pout like JP Morgan and the rest of them, you have to let us do stock buy backs, you have to let us pay out dividends so we can ramp our stock and collect our stock option winnings. It is outrageous that the authorities, after the so-called “near death experience” of 2008 and this massive fiscal safety net and monetary safety net was put out there, is allowing them to pay dividends and to go into the market and buy back their stock. They should be under house arrest in a sense that every dime they are making from this artificial yield group being delivered by the Fed out of the hides of savers should be put on their balance sheet to build up retained earnings, to build up a cushion. I do not care whether it is fifteen or twenty or twenty-five percent common equity and retained earnings-to-assets or not, that is what we should be doing if we are going to protect the system from another raid by these people the next time we get a meltdown, which can happen at any time.

You can see why I talk about corruption, why crony capitalism is so bad. I mean, the Basel capital standards, they are a joke. We are just allowing the banks to go back into the same old game they were playing before. Everybody said the banks in late 2007 were the greatest thing since sliced bread. The market cap of the ten largest banks in America, including from Bear Stearns all the way to Citibank and JP Morgan and Goldman and so forth, was $1.25 trillion. That was up thirty times from where the predecessors of those institutions had been. Only in 1987, when Greenspan took over and began the era of bubble finance – slowly at first then rapidly, eventually, to have the market cap grow thirty times – and then on the eve of the great meltdown see the $1.25 trillion to market cap disappear, vanish, vaporize in panic in September 2008. Only a few months later, $1 trillion of that market cap disappeared in to the abyss and panic, and Bear Stearns is going down, and all the rest.

This tells you the system is dramatically unstable. In a healthy financial system and a free capital market, if I can put it that way, you are not going to have stuff going from nowhere to @1.2 trillion and then back to a trillion practically at the drop of a hat. That is instability; that is a case of a medicated market that is essentially very dangerous and is one of the many adverse consequences and deformations that result from the central-bank dominated, corrupt monetary system that has slowly built up ever since Nixon closed the gold window, but really as I say in my book, going back to 1933 in April when Roosevelt took all the private gold. So we are in a big dead-end trap, and they are digging deeper every time you get a new maneuver.

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Investors Prepare for Euro Collapse

The fear of a collapse is not limited to banks. Early last week, Shell startled the markets. “There’s been a shift in our willingness to take credit risk in Europe,” said CFO Simon Henry. He said that the oil giant, which has cash reserves of over 17 billion dollars, would rather invest this money in US government bonds or deposit it on US bank accounts than risk it in Europe.

Banks, companies and investors are preparing themselves for a collapse of the euro. Cross-border bank lending is falling, asset managers are shunning Europe and money is flowing into German real estate and bonds. The euro remains stable against the dollar because America has debt problems too. But unlike the euro, the dollar’s structure isn’t in doubt.

08/13/2012
By Martin Hesse

Otmar Issing is looking a bit tired. The former chief economist at the European Central Bank (ECB) is sitting on a barstool in a room adjoining the Frankfurt Stock Exchange. He resembles a father whose troubled teenager has fallen in with the wrong crowd. Issing is just about to explain again all the things that have gone wrong with the euro, and why the current, as yet unsuccessful efforts to save the European common currency are cause for grave concern.

He begins with an anecdote. “Dear Otmar, congratulations on an impossible job.” That’s what the late Nobel Prize-winning American economist Milton Friedman wrote to him when Issing became a member of the ECB Executive Board. Right from the start, Friedman didn’t believe that the new currency would survive. Issing at the time saw the euro as an “experiment” that was nevertheless worth fighting for.

Fourteen years later, Issing is still fighting long after he’s gone into retirement. But just next door on the stock exchange floor, and in other financial centers around the world, apparently a great many people believe that Friedman’s prophecy will soon be fulfilled.

Banks, investors and companies are bracing themselves for the possibility that the euro will break up — and are thus increasing the likelihood that precisely this will happen.

There is increasing anxiety, particularly because politicians have not managed to solve the problems. Despite all their efforts, the situation in Greece appears hopeless. Spain is in trouble and, to make matters worse, Germany’s Constitutional Court will decide in September whether the European Stability Mechanism (ESM) is even compatible with the German constitution.

There’s a growing sense of resentment in both lending and borrowing countries — and in the nations that could soon join their ranks. German politicians such as Bavarian Finance Minister Markus Söder of the conservative Christian Social Union (CSU) are openly calling for Greece to be thrown out of the euro zone. Meanwhile the the leader of Germany’s opposition center-left Social Democrats (SPD), Sigmar Gabriel, is urging the euro countries to share liability for the debts.

On the financial markets, the political wrangling over the right way to resolve the crisis has accomplished primarily one thing: it has fueled fears of a collapse of the euro.

Cross-Border Bank Lending Down

Banks are particularly worried. “Banks and companies are starting to finance their operations locally,” says Thomas Mayer who until recently was the chief economist at Deutsche Bank, which, along with other financial institutions, has been reducing its risks in crisis-ridden countries for months now. The flow of money across borders has dried up because the banks are afraid of suffering losses.

According to the ECB, cross-border lending among euro-zone banks is steadily declining, especially since the summer of 2011. In June, these interbank transactions reached their lowest level since the outbreak of the financial crisis in 2007.

In addition to scaling back their loans to companies and financial institutions in other European countries, banks are even severing connections to their own subsidiaries abroad. Germany’s Commerzbank and Deutsche Bank apparently prefer to see their branches in Spain and Italy tap into ECB funds, rather than finance them themselves. At the same time, these banks are parking excess capital reserves at the central bank. They are preparing themselves for the eventuality that southern European countries will reintroduce their national currencies and drastically devalue them.

“Even the watchdogs don’t like to see banks take cross-border risks, although in an absurd way this runs contrary to the concept of the monetary union,” says Mayer.

Since the height of the financial crisis in 2008, the EU Commission has been pressuring European banks to reduce their business, primarily abroad, in a bid to strengthen their capital base. Furthermore, the watchdogs have introduced strict limitations on the flow of money within financial institutions. Regulators require that banks in each country independently finance themselves. For instance, Germany’s Federal Financial Supervisory Authority (BaFin) insists that HypoVereinsbank keeps its money in Germany. When the parent bank, Unicredit in Milan, asks for an excessive amount of money to be transferred from the German subsidiary to Italy, BaFin intervenes.

Breaking Points

Unicredit is an ideal example of how banks are turning back the clocks in Europe: The bank, which always prided itself as a truly pan-European institution, now grants many liberties to its regional subsidiaries, while benefiting less from the actual advantages of a European bank. High-ranking bank managers admit that, if push came to shove, this would make it possible to quickly sell off individual parts of the financial group.

In effect, the bankers are sketching predetermined breaking points on the European map. “Since private capital is no longer flowing, the central bankers are stepping into the breach,” explains Mayer. The economist goes on to explain that the risk of a breakup has been transferred to taxpayers. “Over the long term, the monetary union can’t be maintained without private investors,” he argues, “because it would only be artificially kept alive.”

The fear of a collapse is not limited to banks. Early last week, Shell startled the markets. “There’s been a shift in our willingness to take credit risk in Europe,” said CFO Simon Henry.

He said that the oil giant, which has cash reserves of over $17 billion (€13.8 billion), would rather invest this money in US government bonds or deposit it on US bank accounts than risk it in Europe. “Many companies are now taking the route that US money market funds already took a year ago: They are no longer so willing to park their reserves in European banks,” says Uwe Burkert, head of credit analysis at the Landesbank Baden-Württemberg, a publicly-owned regional bank based in the southern German state of Baden-Württemberg.

And the anonymous mass of investors, ranging from German small investors to insurance companies and American hedge funds, is looking for ways to protect themselves from the collapse of the currency — or even to benefit from it. This is reflected in the flows of capital between southern and northern Europe, rapidly rising real estate prices in Germany and zero interest rates for German sovereign bonds.

‘Euro Experiment is Increasingly Viewed as a Failure’

One person who has long expected the euro to break up is Philipp Vorndran, 50, chief strategist at Flossbach von Storch, a company that deals in asset management. Vorndran’s signature mustache may be somewhat out of step with the times, but his views aren’t. “On the financial markets, the euro experiment is increasingly viewed as a failure,” says the investment strategist, who once studied under euro architect Issing and now shares his skepticism. For the past three years, Vorndran has been preparing his clients for major changes in the composition of the monetary union.

They are now primarily investing their money in tangible assets such as real estate. The stock market rally of the past weeks can also be explained by this flight of capital into real assets. After a long decline in the number of private investors, the German Equities Institute (DAI) has registered a significant rise in the number of shareholders in Germany.

Particularly large amounts of money have recently flowed into German sovereign bonds, although with short maturity periods they now generate no interest whatsoever. “The low interest rates for German government bonds reflect the fear that the euro will break apart,” says interest-rate expert Burkert. Investors are searching for a safe haven. “At the same time, they are speculating that these bonds would gain value if the euro were actually to break apart.”

The most radical option to protect oneself against a collapse of the euro is to completely withdraw from the monetary zone. The current trend doesn’t yet amount to a large-scale capital flight from the euro zone. In May, (the ECB does not publish more current figures) more direct investments and securities investments actually flowed into Europe than out again. Nonetheless, this fell far short of balancing out the capital outflows during the troubled winter quarters, which amounted to over €140 billion.

The exchange rate of the euro only partially reflects the concerns that investors harbor about the currency. So far, the losses have remained within limits. But the explanation for this doesn’t provide much consolation: The main alternative, the US dollar, appears relatively unappealing for major investors from Asia and other regions. “Everyone is looking for the lesser of two evils,” says a Frankfurt investment banker, as he laconically sums up the situation. Yet there’s growing skepticism about the euro, not least because, in contrast to America and Asia, Europe is headed for a recession. Mayer, the former economist at Deutsche Bank, says that he expects the exchange rates to soon fall below 1.20 dollars.

“We notice that it’s becoming increasingly difficult to sell Asians and Americans on investments in Europe,” says asset manager Vorndran, although the US, Japan and the UK have massive debt problems and “are all lying in the same hospital ward,” as he puts it. “But it’s still better to invest in a weak currency than in one whose structure is jeopardized.”

Hedge Fund Gurus Give Euro Thumbs Down

Indeed, investors are increasingly speculating directly against the euro. The amount of open financial betting against the common currency — known as short positioning — has rapidly risen over the past 12 months. When ECB President Mario Draghi said three weeks ago that there was no point in wagering against the euro, anti-euro warriors grew a bit more anxious.

One of these warriors is John Paulson. The hedge fund manager once made billions by betting on a collapse of the American real estate market. Not surprisingly, the financial world sat up and took notice when Paulson, who is now widely despised in America as a crisis profiteer, announced in the spring that he would bet on a collapse of the euro.

Paulson is not the only one. Investor legend George Soros, who no longer personally manages his Quantum Funds, said in an interview in April that — if he were still active — he would bet against the euro if Europe’s politicians failed to adopt a new course. The investor war against the common currency is particularly delicate because it’s additionally fueled by major investors from the euro zone. German insurers and managers of large family fortunes have reportedly invested with Paulson and other hedge funds. “They’re sawing at the limb that they’re sitting on,” says an insider.

So far, the wager by the hedge funds has not paid off, and Paulson recently suffered major losses.

But the deciding match still has to be played.

Translated from the German by Paul Cohen

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Insight: As banks deepen commodity deals, Volcker test likely

By David Sheppard and Alexandra Alper
NEW YORK/WASHINGTON | Tue Jul 3, 2012 1:28am EDT

(Reuters) – The subtext of JPMorgan‘s landmark deal to buy crude and sell gasoline for the largest oil refinery on the U.S. East Coast was barely disguised.

In joining private equity firm Carlyle Group to help rescue Sunoco Inc‘s Philadelphia plant from likely closure, the Wall Street titan cast its multibillion-dollar physical commodity business as an essential client service, financing inventory and trading on behalf of the new owners.

This was about helping conclude a deal that would preserve jobs and avert a potential fuel price spike during the heat of an election year summer — not another risky trading venture after the more than $2 billion ‘London Whale’ loss.

But the deal also highlights a largely overlooked clause in the Volcker rule that threatens to squeeze banks out of physical markets if applied strictly by regulators, one that JPMorgan and rivals like Morgan Stanley have been quietly fighting for months.

While it has long been known the Volcker rule will ban banks’ proprietary trading in securities, futures, and other financial tools like swaps, a draft rule released in October cast a net over commercial physical contracts known as ‘commodity forwards’, which had previously been all but exempt from financial oversight.

The banks say that physical commodity forwards are a world away from the exotic derivatives blamed for exacerbating the financial crisis. A forward contract in commodities exists somewhere in the gray area between a derivative like a swap – which involves the exchange of money but not any physical assets – and the spot market, where short-term cash deals are cut.

Banks say they are also essential to conclude the kind of deal that JPMorgan lauded on Monday.

“JPMorgan’s comprehensive solution, which leverages our physical commodities capabilities… demonstrates how financial institutions with physical capabilities can prudently, yet more effectively, meet our clients’ capital needs,” the bank said in a press release.

But regulators say they are keen to avoid leaving a loophole in their brand new rule, named after former Federal Reserve Chairman Paul Volcker, that could allow banks to shift high-stakes trades from financial to physical markets.

“We intended the Volcker Rule to prohibit a broad swath of risky bets, including bets on the prices of commodities,” said Democratic Senator Carl Levin, who helped draft the part of the 2010 Dodd-Frank financial reform law that mandates the proprietary trading ban.

“The proposed Volcker Rule should cover commodity forwards because those instruments often constitute a bet on the future prices of commodities.”

In the latest example of a refining company outsourcing its trading operations to Wall Street, JPMorgan will not only provide working capital for the joint venture between Carlyle Group and Sunoco Inc, but will also operate a ‘supply and offtake’ agreement that has the bank’s traders shipping crude oil from around the world to the plant, then marketing the gasoline and diesel it makes.

If the rule is finalized as it stands the question will turn on whether banks can convince regulators that their physical deals are only done on behalf of clients, making them eligible for an exemption from the crackdown.

BANKS GET PHYSICAL

Over the last decade Wall Street banks quietly grew from financial commodity traders into major players in the physical market of crude oil cargoes, copper stockpiles and natural gas wells, often owning and operating vast assets too.

Bankers argue that forward contracts are necessary if they are to help refineries like Philadelphia curb costs and free up capital, to help power plants to hedge prices, or to let metals producers and grain farmers finance storage.

Forwards are essentially contracts to buy or sell a certain amount of a physical commodity at an agreed price in the future. Their duration can range from a few days to a number of years.

“To pull forwards into the Volcker rule just because someone has a fear that they could, in some instances, be used to evade the swap rules is just ridiculous,” one Wall Street commodities executive said.

“We move oil all over the world. We have barrels in storage. They are real, not just things on paper. They go on ships and they go to refineries. It is basically equating forwards with intent for physical delivery as swaps – and they’re not.”

She added: “You can’t burn a swap in a power plant.”

Unlike a swap, which will be settled between counterparties on the basis of an underlying financial price, a forward will usually turn into a real asset after time. Unlike hard assets, however, the forward contract can be bought or sold months or years before the commodity is produced or stored.

Historically the physical commodity markets have remained beyond financial regulatory supervision and forwards are not mentioned specifically in the part of the 2010 Dodd-Frank law that mandates the drafting of the Volcker rule.

But the drafters of Dodd-Frank say it was always their aim to prevent banks that receive government backstops like deposit insurance from trading for their own gain. They worry that banks could quickly boost trading for their own book in forward markets rather than purely for the benefit of clients.

“The issue is the potential for evasion,” said one official at the Commodity Futures Trading Commission (CFTC) who was not authorized to speak on the matter. He said traders could easily buy and sell the same commodity forward contract, profiting on the price difference, without the goods ever changing hands.

It would be a useful tool “if you want to hide activities or evade margin requirements,” he added.

RISKY BET OR HARMLESS HEDGE?

Kurt Barrow, vice president at IHS Purvin & Gertz in Houston and lead author of a Morgan Stanley-commissioned report on the impact of the Volcker rule on banks’ commodity businesses said deals like JPMorgan’s with Carlyle and Sunoco could be in jeopardy.

“One of the problems with Volcker is the way it is written assumes that every trade the banks make is in violation of it, and then they have to go through a series of steps to prove that it’s not,” Barrow said.

“If the banks have physical obligations they need to hedge, like in supply and off-take agreements with refineries, there are already concerns that they could be seen to be in violation of the Volcker rule. The rules are geared toward equity trading and don’t take account of how commodity markets really work.”

Goldman Sachs and Morgan Stanley, which alongside JPMorgan dominate physical commodity trading on Wall Street, also take part in supply and offtake agreements with independent refiners.

Without leeway to trade forward contracts, banks would have little reason to retain the metal warehouses, power plants, pipelines, and oil storage tanks that are the crown jewels of their commodity empires.

The future of those assets is already in question as the Federal Reserve must soon decide if banks backstopped by the government will be allowed to retain those assets indefinitely.

In the years preceding the financial crisis, major banks were at times booking as much as a fifth of their total profits from their commodity trading expertise, but drew criticism they could combine their physical market knowledge with huge balance sheets to try and push prices in their favor.

That criticism has resurfaced this year.

“Americans are already paying heavily at the pump for excessive speculation in the oil markets,” Senator Jeff Merkley, who co-authored the Volcker provision with Senator Levin, told Reuters.

“The last thing they need is more of that speculation and risk-taking, especially when it would not only drive gas prices even higher but could also contribute to another 2008-style meltdown.”

NO FORWARDS, NO PHYSICAL, NO SERVICE

The inclusion of forwards in the proposed Volcker rule has created concern beyond Wall Street. Some industry groups argue banks have become so embedded in the structure of both financial and physical commodity markets that they are now key trading partners for a wide range of firms.

“We were surprised,” said Russell Wasson at the National Rural Electric Cooperative Association (NRESCA). “To us they are straightforward business contracts because they’re associated with physical delivery. They’re being treated as derivatives when they never have been before.”

The concerns are the same as with other aspects of the Dodd-Frank reforms, the biggest overhaul of financial regulation since the Great Depression: tough new limits will reduce liquidity, thereby increasing market volatility and hedging costs.

The Volcker rule does include key exemptions to allow banks to hedge risk and make markets for clients.

But some commodities experts say proving that forwards fit into these categories may be too onerous to be helpful.

University of Houston professor Craig Pirrong, an expert in finance and energy markets who has generally argued against the proposed regulation, said he was skeptical of the hedging exemption’s utility, and was sure regulators would take a tough line in the wake of JPMorgan’s recent losses.

“They will have to provide justification that these (commodity forwards) are hedges or entered into as part of their “flow” business with customers,” he said.

“In the post-Whale world, banks are on the defensive and I would not bet on them prevailing on an issue like this.”

Banking executives say they are now desperate to convince skeptical regulators that their physical arms have been transformed into purely market making and client facing businesses.

“Banks have been working to reposition their commodities business… under the assumption that physical markets would be covered by Volcker,” one senior Wall Street commodities executive said.

“Several banks shut down their proprietary trading about two years ago in anticipation of this. The argument that physical commodity markets will present some kind of Volcker loophole for banks is false.”

(Reporting By David Sheppard; Editing by Bob Burgdorfer)

Largest Central Banks Now Hold Over 15 Trillion in Fictitious Capital

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Courtesy of Russ Winter of Winter Watch at Wall Street Examiner

I could not help noticing that China’s imports from Japan fell 16.2pc in December. Imports from Taiwan fell 6.2pc.  The strong yen strikes again: Honda decides to build a high-performance hybrid Acura in Ohio – instead of its home nation of Japan. The firm’s continued shift in production to North American capacity signals a wider trend of Japan’s automakers to battle currency-related losses by moving operations.

Japan is on life support. The largest buyers of its debt are now sellers.  Japan Post Holdings holds almost 3 trillion dollars of JGB’s and GPIF, the retirement fund, holds over $1 Trillion of JGB’s. Japan Post is the largest financial institution in the world and has 75% of assets in JGB’s and now wants to diversify. The retirement fund is liquidating $80+ billion per year to pay out benefits. I just read that the banks across Japan have 25% of assets in JGB’s. If rates were to move 1% (double), what would be the impact to the capital of the banks?

One argument is that Japan’s banks are going to step in lieu of the big dwindling pensions. I merely point out that the IMF is go to stress test the banks against a modest move higher in rates. That would discourage the banks from buying debt at current levels.

The insurance companies are big holders and the people are getting old and dying. The savings rate is at 2% and headed negative (also demographics). The trade surplus has turned to deficit. The budget for this year was to have more JGB issuance than government revenue (about 50% of spending to be borrowed), then the earthquake hit. There are projections that the end total may approach two thirds of total spending that will be borrowed for the current fiscal year. There are no new large buyers to replace the ones mentioned above, and to sell bonds outside of Japan would require much higher rates. The Japanese people have trusted their financial institutions to the government and the trust has been violated.  The money is gone and the government is not fiscally responsible. This party is about to end.  John Mauldin called Japan, “A bug looking for a windshield” and Kyle Bass, “A giant ponzi scheme that is running out of time”.

Japan is just one insolvent country; there are others. In tandem, the central banks of these nations hold $15 trillion plus in inflated securities, loans and sovereign securities, in one giant Ponzi pool holding increasingly insolvent debt and “liquidity” loans to banks. As defaults and more credit downgrades gather steam (UK, US, France, Germany and others), the markdowns of these $15 trillion will accelerate. It is important to remember that the capital for central banks is provided by the participating govts. For example, this is who backs the tiny $81 billion ECB capital used to lever 2.75 trillion in “assets.”

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When central banks (CBs) expand their balance sheets, they buy securities and accept collateral of securities. As such they take risks, especially when defaults occur. And what is the quality of those securities?

These charts are actually dated. The CBs own these markets, use thin capital bases, and are going to be handed the losses on the fictitious capital they hold. Tattoo this on your forehead, CBs hold well over 15 trillion in securities and loans to banks of various and often dubious quality, an immense gamble. These are all ultimately the responsibility of the sponsoring country, and represents a monster contingent liability. That will be the end game.

Barry Ritholz has each CB chart.

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Check out Russ’s premium service, Russ Winter’s Actionable. Click here for information.

Pic credit: Banksy (See more Banksy pictures here, via Bruce Krasting)

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The Untold Story Of How Banks Took Over The Oil Market

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Cullen Roche

Real resources are always a true constraint for any economy.  This has become an increasingly important point over the last 10 years as commodity prices have surged.  But the debate over the cause of this surge and the lack and real resources is still very much up in the air.  Some say it is due to an insatiable demand from China.  Some blame the decline of the dollar due to irresponsible government action.  Others say Wall Street is cornering the commodities markets and turning it into another profit making casino.   The truth, in all likelihood, lies somewhere inbetween.

One of the more important themes I’ve discussed over the years here has been the financialization of our economy.  Financialization has seeped into many facets of our economy in order to help the big banks maximize profits.  This has led to massive deregulation, increasing reliance on the FIRE industry, a concentration of power in this industry and an economy that is increasingly volatile and dependent on this industry which produces little, but takes much.   This financialization has been nowhere more apparent than it has been in the commodities markets.

A few weeks ago I wrote a piece about the continual imbalance in the commodities markets and a veteran of the energy market happened to be reading.  Dan Dicker reached out through the comments section and offered to send me a free copy of his book, Oil’s Endless Bid (see here to buy a copy).  I had heard of Dan’s book and had been meaning to read it for some time.   Now, I get a lot of free books from financial people.  A LOT.  They all want me to promote their books on the site.  95% of the books never get mentioned on the site.  As you’ve noticed, I don’t just crank out content for the sake of cranking out content and the “payment” of a free 300 page book is not really incentive enough for me to write about a book.  So, a lot of books end up in my fireplace (I’m an energy conservationist obviously).  This one is different because I think Dan is conquering an incredibly important subject and he does so from the position of an informed insider.

His perspective is very much in-line with the positions of Michael Masters who has been one of the more vocal proponents of this financialziation of the commodities markets.  Dan Dicker is a 20+ year veteran of the oil markets and a long-time seat holder at the NYMEX.  Dan’s book is a frighteningly eye opening perspective from someone who has been in the trenches and has witnessed the massive changes in real-time.   Dan highlights the massive changes that occurred over the years as the industry has morphed from one that was dominated by big oil into an industry that is dominated by big banks (from the book):

“In the mid-1990′s, the participants and performance of oil trading slowly started to change, and by 2003, the dominating forces in oil trader were no longer with the oil companies.  The list of NYMEX seat owners again shows just how deep the change was.  Right before going public in 2006, only 22 seats remained in the hands of the oil companies that had direct involvement in the buying and selling of oil and oil products.  But a much more significant percentage of seats were owned by companies that ostensibly had nothing to do with the buying and selling of physical oil.

That’s a total of 56 seats owned by investment banks!  (And yes, I include AIG, which was an enormous booker of bets on oil too, not just in famously bad mortgage swaps.)

Of course, the most important purpose for some of these firms to own seats was to execute orders for clients, some retail, but many commercial clients who were being sold on the importance of risk management of energy costs.  And during the years from the mid-1990′s though 2005, this made for a legitimate increase in the volume of crude.  But commercial growth of risk management programs was a happy appetizer for the quick rise of the investment banks in the trade of oil.  Oil companies that tried to maintain a presence and dominance in trading began to be overshadowed by the volume and influence of trading from these banks and their clients.”

These firms aren’t dominating the trading pits at these exchanges because they want to buy and sell commodities for real economic purposes.  They are dominating the exchanges because they know there is big money in financializing the asset class of commodities.  And they’re succeeding.  They’ve sold the asset class as an investment and the investing public has eaten it up hook, line and sinker.  Dan goes into much more detail about this destructive trend and its impact on the economy and ultimately concludes that massive change is needed.  We need to get control of our economy again and wrangle it back from these big banks who are looking out for the interest of their shareholders and not the US economy.  Dan Dicker’s book is one of the most important ones I have read in a long time.  It should be required reading for the US Congress.

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