#globalfinancialcrisis

Credit card delinquency in America – nothing to see here?

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Waltzing through the treasure trove of data at the St Louis Fed, this chart intrigued. It shows delinquency rates on credit cards among the smaller banks. Presumably the smaller banks have to chase less credit worthy customers because they lack the ultimate battleship marketing cannons of the bigger financial instititutions. We’re back at times worse than the highest levels seen during GFC. Among all banks, we are still away off the $40bn of delinqient credit card debts we’re back at levels higher than those before Lehman’s brought financial markets to a grinding halt.

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Add to that the step up in interest rates as well to levels we saw before the whole edifice of cards came crumbling down.

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Then why worry when the number of financial institutions looking to tighten standards on consumer lending languishes at close to zero, the types of levels we saw ahead of the market collapse? Nothing to see here?

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Meanwhile American household savings languish at 3%. Similar levels as just before GFC  melt down. Not much in the rainy day funds. So when Trump’s new economic policy advisor Larry Kudlow starts telling us to back a strong dollar and weak gold, you know exactly what to do.

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Moral hazard was supposed to be contained at the private sector level. Looks as though this time around the government is joining the party.

Truly sickening US Public Pensions data

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Following on from the earlier post and our 2016 report on the black hole in US state public pension unfunded liabilities, we have updated the figures to 2016. It is hard to know where to start without chills. The current state of US public pension funds represents the love child of Kathy Bates in Misery and Freddie Krueger. Actuarial accounting allows for pension funds to appear far prettier than they are in reality. For instance the actuarial deficit in public pension funds is a ‘mere’ $1.47 trillion. However using realistic returns data (marking-to-market(M-2-M)) that explodes to $6.74 trillion, 4.6-fold higher.  This is a traffic accident waiting to happen. US Pension Tracker illustrates the changes in the charts presented.

Before we get stuck in, we note that the gross pension deficits do not arrive at once. Naturally it is a balance of contributions from existing employees and achieving long term growth rates that can fund retirees while sustaining future obligations. CM notes that the problems could well get worse with such huge unfunded liabilities coinciding with bubbles in most asset classes. Unlike private sector pension funds, the states have an unwritten obligation to step up and fill the gap. However as we will soon see, M-2-M unfunded liabilities outstrip state government expenditures by huge amounts.

From a layman’s perspective, either taxes go up, public services get culled or pensioners are asked politely to take a substantial haircut to their retirement. Apart from the drastic changes that would be required in lifestyles, the economic slowdown that would ensue would have knock on effects with state revenue collection further exacerbating a terrible situation.

CM will use California as the benchmark. Our studies compare 2016 with 2008.

The chart above shows the M-2-M 2016 unfunded liability per household. In California’s case, the 2016 figure is $122,121. In 2008 this figure was only $36,159. In 8 years the gap has ballooned 3.38x. Every single state in America with the exception of Arizona has seen a deterioration.

The following chart shows the growth rate in M-2-M pension liabilities to total state expenditure. In California’s case that equates to 3.2x in those 8 years.

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Sadly it gets worse when we look at the impact on current total state expenditures these deficits comprise. For California the gap is c.6x what the state spends on constituents.

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Then taking it further,  in the last 8 years California has seen a 2.62-fold jump in the gap between liabilities and state total expenditures.

1 MKT PER HH DEBT TAX EXP 2016 VS 2008

This is a ticking time bomb. Moreover it is only the pensions for the public sector. We have already seen raids on particular state pension funds with some looking to retire early merely to cash out before there is nothing left. Take this example in Illinois.

Sadly the Illinois Police Pension is rapidly approaching the point of being unable to service its pension members and a taxpayer bailout looks unlikely given the State of Illinois’ mulling bankruptcy. Local Government Information Services (LGIS) writes, At the end of 2020, LGIS estimates that the Policemen’s Annuity and Benefit Fund of Chicago will have less than $150 million in assets to pay $928 million promised to 14,133 retirees the following yearFund assets will fall from $3.2 billion at the end of 2015 to $1.4 billion at the end of 2018, $751 million at the end of 2019, and $143 million at the end of 2020, according to LGIS…LGIS analyzed 12 years of the fund’s mandated financial filings with the Illinois Department of Insurance (DOI), which regulates public pension funds. It found that– without taxpayer subsidies and the ability to use active employee contributions to pay current retirees, a practice that is illegal in the private sector– the fund would have already run completely dry, in 2015…The Chicago police pension fund held $3.2 billion in assets in 2003. It shelled out $3.8 billion more in benefits to retired police officers than it generated in investment returns between 2003 and 2015…Over that span, the fund paid out $6.9 billion and earned $3.0 billion, paying an additional $134 million in fees to investment managers.”

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To highlight the pressure such states/cities could face, this is a frightening example of how the tax base can evaporate before one’s eyes putting even more pressure on bail outs.

This problem is going to get catastrophically worse with the state of bloated asset markets with puny returns. Looking at how it has been handled in the past Detroit, Michigan gives some flavor. It declared bankruptcy around this time three years ago. Its pension and healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half of those occupying the city’s 305,000 properties didn’t pay tax. Almost 80,000 were unoccupied meaning no revenue in the door. Over the three years post the GFC Detroit’s population plunged from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.

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A reminder of credit ratings and ability to pay – both awful

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An astute market’s person sent me an interesting chart (above) from the IMF highlighting that US companies have added $7.8t in debt & other liabilities since 2010. The ability to cover interest payments is now at the weakest level since 2008 crisis. When looking at credit ratings for US companies over the last decade, the deterioration has been marked. For all of the turbo charged low interest rate environment set by central banks, the ‘real’ state of corporate financial health on aggregate continues to worsen despite near full employment, record level equity markets and every other word of encouragement from our politicians. However if this is the state of the corporate sector at arguably the sweet spot of the economic cycle I shudder to think the state of potential bankruptcies that will come when the cycle takes a turn for the worse. This is a very bad sign.

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Oh lord won’t you buy me a Mercedes-Benz my friends all have Porsches & I must make amends

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It really helps an economy to have a robust car market. In the US car companies employ around 9% of the workforce which includes the businesses that feed off suppliers. The amount of people employed in a factory means those people need to buy groceries, get the dry-cleaning done and send the kids to daycare. Car factories are mini-cities. States fork out $100 millions in tax breaks for auto companies to set up facilities because of all the benefits that accrue  and the likelihood that after the plant has been built the economics means they’re stuck for decades.

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US auto inventories on the way up

Even with borrowing rates at ridiculously low levels, inventories are back to the 1.2mn unit level  just shy of the peak we saw at the same trough of GFC. Although inventories are at 2.82x sales right now (peaked at 4.7x during GFC) it is heading back up.

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The big weakness in car sales is more an issue with companies than consumers. In order to shift metal deals got better and better. However many car makers fell into the trap of offering residual value guarantees on cars after 3 years. So as they were sweetening deals today, cars of three years ago were coming back onto their books but the car maker was losing money on 90% of the returns with average losses of $3,000 per car. All of this was bringing forward consumption.

Now we have a predicament of auto companies having to reevaluate who they finance. We’ve seen default rates from sub-prime borrowers jump 20% or more in recent months. When I was in Sydney a last month BMW was raked over the coals for offering a mother of 10 kids a car loan.

BMW Australia Finance was found to have loaned $27,000 to a single mother of 10 children even though she was in casual employment and had negative disposable income. It gave $23,300 to a refugee aged 21 who had been employed for just one month and whose income was overstated. And it loaned nearly $50,000 to a 76-year-old man based on earning projections rather than real income. The loan was almost twice the value of the car. I call that desperation and coming from a luxury maker speaks volumes how bad it must be among volume makers.

Car makers are desperate. Even my old man got a brand spanking new 7-series for $50,000 off list price that when he told me I thought he’d bought the outgoing model. It is not healthy in the auto space. Perhaps they’re singing Janis Joplin tunes in the hope that profitability is miracle restored. Forget it. We’ve already seen how heavily Class-8 highway truck orders have plunged for the last year. Now expect to see mass firings, plant line closures and losses moun in passenger cars.

This will be another blow to the gullible masses who think Central banks have steered us down the path to prosperity. They haven’t and once again the end of Obama’s presidency will earmark the state in which he left the economy. In a horrid state.

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Japan’s moral hazard plan would be harakiri

I’ve said it before and I’ll say it again. Central banks are in such dire straits. ECB President Draghi admitted that he is merely doing what every other central bank is doing. Group think. Perhaps more telling is  Alan Greenspan has started to put himself into the public again saying we are in trouble. You know we are in really big trouble because he’s always ‘behind the curve’. My bigger concern is how the Central Banks cannot play moral hazard like the private sector has. If central banks decide to magically make debt disappear through a debt jubilee the financial devastation would be 100x worse than 1929.

The Japanese have been toying with a plan to wipe out the US$10 trillion of public debt by converting the JGBs they’ll buy with printed money into zero coupon perpetual bonds.The value of a zero coupon perpetual is mathematically zero. So in a heart beat the Japanese government debt gets written down to zero. The Bank of Japan has a $10 trillion asset which is now worth nothing. 200% of GDP gone in an instant. Mauldin also made this assertion that monetising all debt at once by all countries would be unthinkable but the only way you could do it.

Let’s entertain the premise if Japan did this. What would happen? Global markets run on confidence. Nothing more. Nothing less. Without confidence markets will fret. People forget that the Japanese government STILL needs to fund Y40-50 trillion every year to plug the hole in the deficit. Tax take is less than Y56 trillion. Expenditures, thanks to an ageing society are rising above Y100tn. That gap won’t close easily. Sure the BoJ could print that gap every year but honestly, how could Japan’s yen be worth anything if they printed $400-500bn per annum? That’s right Japan would press start on the printing presses and produce the GDP of Thailand or Austria or Sweden or Belgium or Taiwan. Does this pass any sniff test?

Japan imports 60% of its food. It imports most of its energy sources like coal or LNG. It imports iron ore and coking coal to make steel. They must pay these foreigners in their currency. What supplier would want to accept a currency where the central bank just prints it. No country would accept yen pricing. Yes, hyper inflation would be the result. 

The debt service costs of the Japanese banks would become extreme. The low interest fixed mortgages which drives bank income are funded by predominantly depositors. However to avoid the Japanese banks witnessing capital flight they would need to raise deposit rates to dizzying levels and even then as Mrs Watanabe realises the Japanese yen is becoming like the Zimbabwean dollar she’ll convert into another currency exacerbating the downward pressure. Japanese banks would quickly become insolvent. Then corporations would start collapsing causing widespread unemployment.

The Global Financial Crisis (GFC) of 2008 taught us about moral hazard. People just walked away from their interest only mortgages and left the taxpayer to clean up the mess. Moral hazard is not good under any circumstances but if central banks and governments start playing moral hazard by ‘walking away from debt’ then effectively you permanently ruin trust and financial markets are destroyed. Think about. If people think that the end game will always result in a bail out then moral hazard becomes the default. It is permanent helicopter money. There is absolutely zero incentive to act prudently. Everyone should have a $50mn home, a Rolls-Royce and not have to work for it. Simple economics means that this solution is completely untenable. In a sense paper money would be worthless, we would have full unemployment and society would cease to function.

Now before we start reeling off the resumes of the incredibly intelligent people who can mathematically prove theories like this, note that was exactly the same type of argument hurled at me back in 2001 when I heavily criticised Greenspan predicting he would lead the world off a cliff in 5 years. I was right and they were wrong. Central banks have no idea. Their policies are group think. They don’t live in markets. They don’t breath markets 24-7. The only thing Greenspan was right on was to say “The gut feel of the 55-year old trader is more important than the mathematical elegance of the 25-year old genius.” Ask any of your experienced financial sector friends and get them to give you their gut feeling in private (publically they’e always bullish) and their answer to an almost 100% degree will be funereal.

If Japan makes the move to make $10 trillion dollars disappear (i.e. the GDP of China, home to 1.2 billion people) it will be the biggest mass suicide the world has ever seen in financial markets. You can take that to the BANK.

1/3rd of China’s GDP is now spent on debt servicing

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John Mauldin has an interesting piece out that pretty much is inline with my thoughts on how the global economy is heading for the tank. This GFC will be worse than the first although different in its form.

We are drowning in more debt than we were at the time of GFC. It is chronically bad. Mauldin mentioned.

“So, China has problems. Their debt has just ballooned. Depending on whom you want to listen to, 40% to 80% of the last $6 trillion the Chinese borrowed went to pay interest on the debt they already had. In less polite circles we would call that a Ponzi scheme….Now, they do have a lot of money. Yes. Can they print more? Yes. Do they want to have a New Silk Road? Do they want to be the world’s reserve currency? Do they want to be the most powerful country in the world? Of course they do…The Chinese see themselves rebuilding their own ancient empire. You don’t do that on the back of a weak currency – but then we come to the problem of a strong Chinese currency. Oh, by the way, their debt service is up to 30% of GDP, but that’s a detail that is mostly overlooked.”

Emerging markets is a massive elephant in the room and we will see their currencies get sold off heavily.

“Emerging markets are the fourth weak link. How do they dig out? They borrowed $10 trillion in dollars that they have to pay back from income earned in their local currencies. Dollar valuation can create serious problems for their debt. And it happens at the worst possible time, during a crisis or global recession when the US dollar is the cleanest dirty shirt in the closet. The value of the dollar will rise at precisely the time when the profits and tax revenues of the emerging-market corporations and countries will fall.”

The US is heading toward $30 trillion of debt and you can bet the Fed has to move to negative rates too.

The folly of negative rates is simple. The retiring population are now finding it harder to get stable income products without going further up the risk chain both in term and product. Obviously the longer the term of the bond, the worse it will be for duration. People talk of debt monetisation and writing it all off but the confidence of the financial system cannot stay alive if those that hold the debt get wiped out. It may still happen but anyone thinking it would be a good thing invite moral hazard of the worst kind.

I completely agree that savers are being buried. Any inflation has been in asset markets and this comment backs up what  I have been saying about the person on the street is still being crushed. 47% of Americans, according to the Fed, can’t raise $400 in emergency cash without selling something. I believe Brexit was also a function of the sharp rise in poverty.  The rise of Trump is also a function of the anti-establishment movement.

“I am afraid that the one thing we can count on is that whatever policy the Fed chooses will be the wrong policy. They believe they can set the price of money and thereby balance demand and supply. Can anybody name me one instance where fixed prices worked in the real world, creating a paradise where supply and demand were balanced? They have manipulated [I keep making this claim] the system and set the wrong price of money. They have created a world where savers are penalized, companies are paid to buy their competition rather than compete, and only the participants on Wall Street are rewarded with appreciation of their assets. My Austrian and monetarist economics school friends, who predicted inflation from all the QE that we saw, have actually seen inflation it has just been in asset prices that benefited Wall Street and not Main Street…And it’s not just a US problem. It’s Europe and Japan and anywhere in the world where interest rates and savers have been repressed.”

Several EU banks headed for insolvency?

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Looks as though several European banks are headed for the dustbin. In the prelude to GFC1 we had words like NINJA loans (no income, no job or assets) which entered financial lexicon. Now the latest word for equity markets is TINA (there is no alternative).

ZeroHedge wrote on the folding of a Belgian bank

Belgium-based Optima Bank has been shut down by both the National Bank of Belgium (which also acts as the Belgian regulating body) as well as the ECB. According to the national supervisor, the bank would have been unable to meet its commitments to its clients and was forced to cease all banking activities after some potentially fraudulent transaction were unveiled.

It’s surprising to see the main media have tried to keep this silent as even the website of the National Bank of Belgium didn’t bother to issue the press release in English (whereas all other press releases on the home page can be read in English). There’s no statement from the ECB either, nor has this news been translated on the English version of website of the state-owned national television station.

The situation is so bad the regulator has already immediately tasked the special fund organizing the Deposit Guarantee Scheme to start paying out the clients of the bank, even though Optima Bank hasn’t filed a bankruptcy procedure just yet. The urgency of the need to pay the clients does indicate the situation is extremely bad and even though it’s a very small one (it had closed the savings accounts division last year), there are two more important things you need to keep in mind.