Do SIFI's (aka TBTF) Have a Future?

Thomas M. Hoenig

President and Chief Executive Officer

Federal Reserve Bank of Kansas City 

June 27, 2011 

Introduction

We are approaching the one-year anniversary of the Dodd-Frank Act. With so much of the Act’s implementation work unfinished, it is not an anniversary that we can celebrate; rather it is an opportunity to take stock. In that vein, I congratulate the organizers of this conference for bringing together such an excellent group of individuals to do just that. In particular, I want to recognize the New York University Stern School of Business and economics faculty for the outstanding research they have done on critical financial reform issues. Their collaborative efforts have produced a series of must-read books that have a combination of rigorous economic analysis and practical policy prescriptions that is rarely seen these days.

Much of the Dodd-Frank discussion revolves around the economic distortions and disruptions caused by the largest and most complex financial companies, the so-called systemically important financial institutions, or SIFIs.

As we consider the topic of SIFIs, let me ask the following questions: How can one firm of relatively small global significance merit a government bailout? How can a single investment bank on Wall Street bring the world to the brink of financial collapse? How can a single insurance company require billions of dollars of public funds to stay solvent and yet continue to operate as a private institution? How can a relatively small country such as Greece hold Europe financially hostage? These are the questions for which I have found no satisfactory answers. That’s because there are none. It is not acceptable to say that these events occurred because they involved systemically important financial institutions.

Because there are no satisfactory answers to these questions, I suggest that the problem with SIFIs is they are fundamentally inconsistent with capitalism. They are inherently destabilizing to global markets and detrimental to world growth. So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, the future of capitalism is at risk and our market economy is in peril.

To more fundamentally address this issue, we must go beyond today’s Dodd-Frank. We must confine the use of the safety net to its original intent. We must reduce the artificial complexity of existing financial structures. The rewards of success must be balanced against the credible consequences of failure. In achieving such goals, we will enhance the stability of the fundamental mechanism through which monetary policy is conducted and the economy depends.

The decline in competition and accountability in banking The U.S. economy is the most successful in the history of the world. It achieved this success because it is based on the rules of capitalism, in which private ownership dominates markets and individuals reap the rewards of their success. However, for capitalism to work, businesses, including financial firms, must be allowed, or compelled, to compete freely and openly and must be held accountable for their failures. Only under these conditions do markets objectively allocate credit to those businesses that provide the highest value. For most of our history, the United States held fast to these rules of capitalism. It maintained a relatively open banking and financial system with thousands of banks from small community banks to large global players that allocated credit under this system. As late as 1980, the U.S. banking industry was relatively unconcentrated, with 14,000 commercial banks and the assets of the five largest amounting to 29 percent of total banking organization assets and 14 percent of GDP.

Today, we have a far more concentrated and less competitive banking system. There are fewer banks operating across the country, and the five largest institutions control more than half of the industry’s assets, which is equal to almost 60 percent of GDP. The largest 20 institutions control 80 percent of the industry’s assets, which amounts to about 86 percent of GDP.

Here’s the irony: This marked increase in concentrated power, and therefore, more concentrated risk, reflects past efforts to assure greater economic stability. This might best be described as “good intentions/bad outcomes” syndrome. For example, the Federal Reserve was founded following the 1907 Banking Panic and was charged with providing liquidity support to solvent banks that were experiencing funding problems. After the Great Depression, the Federal Deposit Insurance Corp. was created to provide limited deposit insurance to protect small depositors and to further increase the resiliency of the financial system.

Then, over the past 30 years, this safety net has expanded far beyond its original intent. More recently, Glass-Steagall was repealed, giving high-risk firms almost unlimited access to funds generated through their new access to the safety net. Finally, following a series of crises during the late 1980s and 1990s, the government confirmed that because of systemic impact, some institutions were just too big to fail—the largest institutions could put money in nearly any asset regardless of risk, and their creditors would not be held accountable for the risk taken. Predictably, the industry’s risk profile increased dramatically. The SIFI was born.

Is it any wonder then that in the fall of 2008 we experienced the greatest financial crisis since the Great Depression? Financial institutions had again become irresponsible in their lending practices. They had increased their leverage ratios to unprecedented levels. They became “dry kindle” for a financial fire and, with the end of the housing boom, the match was struck.

Now, with their bailout costs amounting to billions of taxpayer dollars, SIFIs are larger than ever. Strikingly, they are arguing that they should not be held to stronger capital standards if the United States hopes to remain globally competitive. That assertion is nonsense. The remainder of my remarks today will describe how the United States can achieve a stronger, more stable financial system in order to secure its future as a global economic leader.

Proposal to reduce costs and risks to the safety net and financial system Following this financial crisis, Congress and the administration turned to the work of repair and reform. Once again, the American public got the standard remedies—more and increasingly complex regulation and supervision. The Dodd-Frank reforms have all been introduced before, but financial markets skirted them. Supervisory authority existed, but it was used lightly because of political pressure and the misperceptions that free markets, with generous public support, could self-regulate.

Dodd-Frank adds new layers of these same tools, but it fails to employ one remedy used in the past to assure a more stable financial system—simplification of our financial structure through Glass-Steagall-type boundaries. To this end, there are two principles that should guide our efforts to restore such boundaries. First, institutions that have access to the safety net should be restricted to certain core activities that the safety net was intended to protect—making loans and taking deposits—and related activities consistent with the presence of the safety net.

Second, the shadow banking system should be reformed in its use of money market funds and short-term repurchase agreements—the repo market. This step will better assure that the safety net is not ultimately called upon to bail them out in crisis.

Consistent with the first principle, banking organizations with access to the safety net should be generally confined to the following activities: commercial banking, underwriting securities and advisory services, and asset and wealth management services. Underwriting, advisory, and asset and wealth management services are mostly fee-based services that do not put much of a firm’s capital at risk. In addition, asset and wealth management services are similar to the trust services that have always been allowable for banks.

Restricting activities of banking organizations

In contrast, banking organizations should be expressly prohibited from activities that include dealing and market-making, brokerage, and proprietary trading, which expose the safety net but have little in common with core banking services.1 Within the protection of the safety net, they create expansive risks that are difficult to assess, monitor or control.

Thus, banking organizations would not be allowed to do trading, either proprietary or for customers, or make markets because such activity requires the ability to do trading. In addition, allowing customer but not proprietary trading would make it easy to game the system by “concealing” proprietary trading as part of the inventory necessary to conduct customer trading. Also, prime brokerage services not only require the ability to conduct trading activities but also essentially allow companies to finance their activities with highly unstable uninsured “deposits.” This combination of factors, as we have recently witnessed, leads to unstable markets and government bailouts.

Critics of this proposal contend that institutions grow to be large and complex because of economies of scale and scope and they need the size and related complexities to be profitable and to compete globally. They believe firms must have broad, mostly unrestricted access to all financial activities to provide one-stop shopping and compete on a global basis. Arguments also are given that large banks and securities firms are necessary to make efficient markets for securities trading essential for carrying out monetary policy.

These arguments are unconvincing and, in fact, mislead. First, yes, it would be unfortunate if restricting activities were to drive U.S. banks and jobs to other countries. However, we have 200 years of banking success in this country to refute that assertion. More recently, under Glass-Steagall, U.S. banks and investment banks were highly competitive and successful as each specialized in lending to or underwriting businesses all over the world. There is considerable evidence that under Glass-Steagall the United States was at no competitive disadvantage to Europe, with its mingled merchant banking system.

The United States led the world—because it had strong, prudently run institutions that knew how to manage money in the best interests of the client.

Second, there is no strong evidence of unlimited economies of scale and even less for wide economies of scope. Although both exist, they are captured at an asset size far less than that of SIFIs today.

Third, large corporations would have ample convenient access to commercial and traditional investment banking services inside commercial banking. They would have to go to securities dealers to purchase swaps and other derivatives for hedging purposes, something that has been done in the past without difficulty.

Finally, it also seems improbable to me that any country should be willing or able to expand its safety net or to expose its taxpayers to the undefined risks of protecting ever-larger and more complex banking organizations. Instead, what countries should be focused on now is getting back to fundamentals aimed at simplifying highly complex and unstable SIFIs. The focus should be on financial stability.

Reforming the shadow banking system

A legitimate concern of limiting the safety net is that this could worsen the risk of financial instability by pushing activities to the unregulated shadow banking system. Clearly, focusing solely on the regulated banking industry and ignoring the unregulated shadow banking system would not solve the problem and, in fact, might expand the shadow banking sector that was an integral part of the financial crisis.

Much of the instability in the shadow banking system stems from its use of short-term funding for longer-term investment. The solution to this instability problem is not to provide a safety net for the shadow banks and regulate them more but, instead, to remove exceptions in which money market instruments are treated essentially as deposits. The current exceptions encourage significant short-term

funding of longer-term assets.

First, investors in money market mutual and other investment funds that are allowed to maintain a fixed net asset value of $1 have an incentive to run if they think their fund will “break the buck.” Thus, if the fixed $1 net asset value is eliminated and the share values of such funds are required to float with their market values, shadow bank reliance on this source of short-term funding and the associated threat of disruptive runs would be greatly reduced.

Second, the potential disruptions to funding stemming from the repo financing of shadow banks should be ended. One of the sources of instability during the crisis was repo runs, particularly on repo borrowers using subprime mortgage-related assets as collateral. Essentially, these borrowers funded long-term assets of relatively low quality with very short-term liabilities.

These practices would be greatly reduced by rolling back the bankruptcy law for repo collateral to the pre-2005 rules. Prior to then, if a repo borrower defaulted, mortgage-related collateral could not be immediately taken and sold by the creditors. Returning to these rules would discourage the use of mortgage-related assets as repo collateral and reduce the potential for repo runs. Term lending through securitization would continue, probably at a smaller scale, with more closely matched term wholesale funding provided by institutional investors such as mutual funds, pension funds and life insurance companies.

These changes to the rules for money market funds and repo instruments would increase the stability of the shadow banking system because term lending outside the safety net would be less dependent on “demandable” funding and more reliant on term funding, and the pricing of risk would better reflect the actual risk incurred.

A final note: Implications for monetary policy

Finally, as a member of the Federal Open Market Committee, I realize that we must consider the potential effects of these proposals on the conduct of monetary policy. The impact could be significant because, as currently practiced, monetary policy operations are channeled through a limited number of counterparties called primary dealers. These dealers are required to participate in all auctions of U.S. government debt and represent a key element in the implementation of policy.

Currently, there are only 20 primary dealers. They are the largest financial firms operating in the United States, and most are affiliated with commercial banks. It is with this relationship that the changes I propose could affect the conduct of monetary policy. Specifically, given that primary dealers could no longer be affiliated with commercial banks, would this inhibit market-making in securities, including Treasuries, and therefore interfere with the conduct of monetary policy?

The answer is “no.” It is not necessary that primary dealers be affiliated with banks. It is only necessary that they be institutions that deal in U.S. Treasuries and participate in auctions of U.S. government debt. Prior to the 1990s merger boom among investment banks and the Gramm-Leach-Bliley Act, it was typical that half or more of the primary dealers were not affiliated with commercial banks.

Therefore, the fact that primary dealers are not commercial banks would have little effect on the Federal Reserve’s ability to conduct monetary policy. I would add that although commercial banks could not be primary dealers, they could remain a key part of the monetary policy mechanism. Recently, the Federal Reserve gained experience in using the Term Auction Facility (TAF). The TAF might very successfully be used in conjunction with primary dealer operations to conduct policy well into the future.

As you may recall, during the financial crisis, the TAF was an important component of monetary policy. For example, the TAF was introduced in December 2007 with an initial auction of $20 billion. The facility was then ramped up to almost $500 billion by March 2009—about one-fourth of the assets on the Federal Reserve’s balance sheet. The maturity of TAF loans was generally 28 days or 84 days.

By broadening the Federal Reserve’s monetary tools to include the TAF to provide term funds through the banking system in parallel with the primary dealers, we could greatly expand the number of counterparties used in the conduct of monetary policy. Thus, the TAF and primary dealers would provide deep markets for the term portion of policy; primary dealers and traditional open-market operations would continue as the means for managing day-to-day operations and for maintaining the federal funds rate close to the target. With more counterparties, we enhance competition and enable nearly all banks to play a role in the conduct of monetary policy. This would make the largest banks less “SI” and more “FI.”

Conclusion

The financial system has become far less competitive and far more volatile with the onset of systemically important institutions. Though large firms remain a critical part of our economic system in the United States, they should not become so dominant that they become unaccountable to our capitalistic system. We can make the necessary reforms to end the unique status of the SIFI and, in doing so, restore much of our global competitive vigor. Only from a position of financial strength can the United States remain the global economic leader.

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1. This categorization of financial activities is from Matthew Richardson, Roy Smith and Ingo Walter in Chapter 7 of Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance, edited by Viral V. Acharya, Thomas F. Cooley, Matthew Richardson, Ingo Walter, New York University Stern School of Business,

~~~

Pew Financial Reform Project and New York University Stern School of Business

“Dodd-Frank One Year On”

Washington, D.C.

The views expressed by the author are his own and do not necessarily reflect those of the Federal Reserve System, its governors, officers or representatives.

Will the Euro Survive?

...from John Mauldin via Business Insider and Joe Weisenthal

We had dinner on Monday night at the home of Hervig von Hove of Notz-Stucki Bank, where I was speaking the next morning. There were 16 of us at the table, and these people represented a great deal of money as managers and investors. All very well-informed. We sat outside in perfect weather in the Swiss countryside. Charles Gave sat across from me at the middle of the table, and we talked and debated as the rest asked questions and offered opinions for 3-4 hours. The wine was flowing, and it was a most interesting evening. Now, with that set-up…

I was asked if I still thought the euro was going to parity with the dollar, and I said I did, although I was not sure what the euro would look like in three years, or who would be in it. There was some pushback from people who thought the dollar would be the weaker currency. So I asked for a show of hands as to how many people thought the euro would be higher in one year’s time. There were 6 hands raised, but one gentleman said he was actually abstaining. So I asked how many thought the euro would fall, and we got 12 hands. Yes, that is 19 votes for 16 people. Clearly there were at least three economists in the group who voted both ways!

Then someone asked Charles about the issue. Now, for those who have never had the extreme pleasure of time with Charles, he is a powerful, white-haired French patrician, and one of the better economists I know. Quite a brilliant thinker and not afraid to express his mind forcefully with a voice that sounds like God talking, with about the same assurance (note to self: never again follow Charles on a speaking stage).

“The question is entirely irrelevant” – punctuating the air for added emphasis. “The euro will not exist in a year. The whole thing was dysfunctional from the beginning.”

I suggested that was a tad bearish.

“Not at all. I think it is extremely bullish. The demise of the euro and the return of national currencies will allow for proper allocation of investments and resources. It is the best thing that could happen for the markets.”

I could not get him to commit to exactly how that process of dissolution would look.

“I didn’t create the euro so it is not my responsibility to solve the problem for them.”

But I cannot help but think that any exit by anyone from the euro will be disorderly, giving rise to Bernanke’s “significant effects.” Many European banks are simply not solvent if there are major sovereign defaults. The US banks have sold some $90 billion in credit default swaps on Greek, Irish, and Portuguese debt to European banks. That is supposedly balanced with other purchases of CDS, but my sources say that much of that insurance is from German Landesbanks. Yes, the same ones I mentioned above that are basically insolvent. We are joined at the hip to Europe. A European recession would certainly be felt here. And a credit event could cause the same problem as in 2008, as banks start to refuse to lend to each other again. Ugh.

The potential for a real crisis is far too high for comfort. It would mean another recession for sure, with the US already close to stall speed and global growth slowing. I hate to sound alarmist, but I am worried. Absent a problem in Europe, the US should be fine, if slow. And maybe European leaders can stall the crisis off longer, buying time for banks to move their debt to the ECB and raise capital. We have to really keep our eyes on this.

At some point, Europe needs to realize that the problem with Greece, Portugal, et al. is not illiquidity, but that they are insolvent and have few prospects for economic growth anywhere close to what is needed to solve their problems.

Europe would be better off just taking the money they are giving to Greece and using it to recapitalize their banks. Let Greece go. Give it up. Let them enter a 12-step program or whatever it is that insolvent nations do. That is harsh, but it is also the truth.

But there are very sad things going on. It is not just banks that are losers here. Pharmaceutical companies are starting to refuse to deliver to Greek hospitals, as they are up to two years behind on their payments. It turns out that Greece owes some €6 billion to private businesses like hospitals and simply cannot pay. Those costs are rising, and much of it is to hospitals for medical care supported by the government. They are issuing bonds (shades of California) for the debt in some cases, which sell for a discount of 50%, if they can be sold. And we thought finding €12 billion was a hard thing.

This is not just a Greek problem, it is a concern in many countries that are having financial difficulties.

Ronald-Peter Stöferle Interview with James Turk - Gold Money News

...a Brief Update from Dr. John

Just a brief update this week as our annual board meetings are in progress - it's notable that despite the brief reprieve of market concerns Thursday on tentative agreement over Greek aid, we actually saw very little change in the value of Greek debt. While there is a great deal of short-term attention on day-to-day developments on this front, credit spreads effectively indicate expectations of certain default within a roughly 2-year window, but very small risk of near-term default. Until we observe a firming in market internals (which have deteriorated markedly) and in leading economic measures (which have also weakened), we expect that enthusiasm about Greece may provoke short-lived market spikes and short-squeezes, but little of durable effect for the stock market.

For our part, we continue to focus on our measures of valuation and market action, both which are unfavorable at present. An improvement in the quality of market action could allow some latitude for a constructive market exposure, but with the recent advance past both the median extent and duration of cyclical bulls within secular bears (which I continue to believe is the appropriate characterization), the risk of significant market losses should not be underestimated. Presently, we estimate the prospective 10-year total return of the S&P 500 Index at about 4.2% annually, based on our standard methodology. This is better than we observed in May, but the modest improvement since then should be some indication of the limited extent to which the recent decline has restored appropriate valuations.

Strategic Growth and Strategic International Equity remain well-hedged. In Strategic Total Return, we slightly increased our duration to a still limited 2.5 years, primarily by adding to 3-5 year maturity Treasury holdings. Our primary risk exposure at present remains in the precious metals area, where the Fund has a roughly 18% position in precious metals shares. In contrast to the fairly dismal set of market conditions we observe in the equity market, the conditions we observe relating to precious metals shares have historically been associated with fairly strong returns, on average, even in the absence of much strength in the underlying spot gold price. Still, precious metals shares are associated with significant volatility, so we view an 18% position as material (though not aggressive). Given that we already observe negative real interest rates, falling long-term yields, positive inflation trends, and a very high ratio of spot gold to the prices of gold shares, we would observe the most favorable set of conditions we monitor if the ISM Purchasing Managers Index moves below 50, but I don't expect that sort of weakness in the upcoming report. Suffice it to say that I believe our present exposure in precious metals shares appropriately reflects expected return/risk prospects here.

http://www.hussman.net/wmc/wmc110627.htm

...from Monty Guild

International Energy Association To Sell Crude Oil From Government Stockpiles

Today, the U.S. and IEA decided to sell 60 million barrels of oil over the next month, supposedly to make up for the 1.5 million barrels a day that was produced by Libya.

This is a political maneuver which will have a short term effect on oil and gasoline prices. The authorities announced that this is meant to help the consumer, but it’s obvious that they also wanted to punish the speculators.  The IEA has previously said that targeting the speculators will backfire, yet here they are doing just that. We find that hard to grasp that the consumer will get more than very temporary help. The amount to be sold represents less than 1 day’s world consumption of oil, and the 30 million barrels sold in the U.S. represents about 1 1/2 day’s U.S. consumption of oil.

The sale will decreases world energy security by decreasing emergency stockpiles. The important fact is that world energy demand is rising faster than energy supply and that problem will not be solved by these band aid programs. The entire purpose of this is political the object is to decrease gasoline prices during the 2011 summer driving season in North America and Europe.

We predict that the effect of this sale will be unnoticeable in three months. At that time oil prices will be rising and possibly will be higher than they are today. We have not changed our view that further disruptions in the Middle East will take oil higher.

Gold and gold mining shares

Gold has fallen as the U.S. dollar has rallied on today’s IEA news. We believe that this is an excellent opportunity to buy gold and gold mining stocks.

As our readers know, our approach is to sell part of your position on rallies and buy on dips. This dip in price provides an opportunity. Buy part now, and if gold falls lower investors should add more. Take a close look at gold mining stocks; they have not participated as they should have during the rise in the price of gold. It is time for them to catch up. The upcoming European QE should inspire investors to own gold for both its role as real money and as a store of value during times of financial chaos. As we have pointed out before, large nations continue to buy gold to stockpile as protection from monetary and financial crises.

We believe that bullion and coins have a place in every investment portfolio, but we also think that some gold mining stocks have declined to a level that make them very attractive.

Repeatedly, short sellers have fabricated stories about smaller- and medium-sized gold mining companies in order to drive down their stock prices. These stories often get reprinted in the press.  Even well-run companies with new gold discoveries are targeted by the manipulations of short sellers. We believe these shares will now move much higher in coming months and years. To profit from this opportunity, we suggest investors focus on the following types of companies:

1.  Those that have not borrowed money via gold loans to grow,

2.  Those with enough quality gold reserves to build a mine,

3.  Those with proven management and a record of having built companies previously.

In our opinion, gold and quality gold mining companies will move much higher in the long run and now is the time to buy when investor pessimism is high and rationality is low. Eventually, the larger, better capitalized mining companies will step in and acquire the smaller operations when the acquisitions have current and expected mineral reserves exceeding their market prices as is the case for some companies. Such acquisition cycles eventually bring an end to the gold share undervaluation.

Europe’s New Plague: Debt Contagion

A new plague infests Europe. Not bacterial like the killer epidemics of past centuries, the current pathogen is debt, and the prognosis is poor. Much like 2008, when the U.S.banking system barely survived an acute crisis, Europe is careening into a monetary abyss of its own making. The outlook is increasingly uncertain. Will debt-strapped Greece accept the tough terms laid down by the International Monetary Fund (IMF) and the European Central Bank (ECB)? And behind Greece, the gasping, deep-in-debt economies of other European countries are also desperate for transfusions of money. Will they accept austerity?

The ultimate issue here is one of contagion. Will the bad debts of Greece and other nations infect, weaken, and possibly kill the collective European banking model?  In the short term, we expect the ECB to cave in and ease the austerity demands upon Greece.  Such action may avoid a serious crisis now, but not forever.

The next question is how long will the politicians in Europe continue the masquerade and pretend that policy solves the problem. What’s about to unfold is but medicine. You apply a drug (money, in this case) that temporarily relieves a symptom but you fail to address the underlying sickness which continues to progress. Investors will sigh in relief.  The stock markets will applaud.  They’ll ignore the disease…until the next flare-up.

Look for that to happen — the next phase — when the insolvency contagion spreads to the other weakened European nations: Portugal, Spain, Ireland, and others. The banks holding large amounts of these countries’ mounting debt will be attacked. Their ratings will be lowered. Investors will begin to aggressively bet against them using derivatives. Eventually, depositors will flee. This is what happened in 2008, first in March with Bear Stearns, and then after a few months of rally, Lehman in September.  How long before a similar collapse will threaten the big banks of Europe?   

Beyond Europe

When this happens, will the contagion extend beyond Europe? In our opinion, the odds are very high that the contagion will indeed extend to banks and stocks in U.S. and Asia.

Then what?  Remember we live in the age of “quantitative easing (QE) — of money printing — where leaders kick the debt ball down the timeline for future leaders to deal with.  We fully expect Europe and Asia, and perhaps both, to resort to massive amounts of QE-type of financing to save the European banking system just like the U.S. did with TARP, QE, and other programs that effectively averted a complete U.S. banking system collapse.  

With each passing week, we hear more concern about Europe’s debt. The decibels of concern are rising. On June 11, The Economist published an article asking frankly “how much financial risk has the ECB taken on as a result of the European debt crisis?”  Recently a report by Open Europe, a think tank, described as “potentially huge” the risk to taxpayers that lies buried in the ECB books. 

On June 21, the New York Times quoted IMF managing director John Lipsky warning that the European Union must be prepared to underwrite the finances of the Greek state for the next year, a much tougher position than European officials expected, in order for the IMF to realize its portion of the aid.

At some point there will be a huge (probably over 1 trillion dollar) liquidity injection by the ECB to buy up the cancerous debt of European nations. Additionally, in recent months, China’s banking system appears to be getting overextended and we expect that this may require a QE-fix inside China as well. Over time, liquidity for others may also be forthcoming by the Chinese.

How exposed is the ECB Anyway?

The ECB has allowed banks in troubled Euro zone nations to borrow as much as they need from it even if those banks have shaky collateral. The ECB’s rationale is that it really doesn't matter as long as the IMF is available to bail the nations out. Talk about throwing banking fundamentals to the wind. What happens if the IMF decides not to play ball? What happens if the borrowing nations refuse to meet the IMF’s stringent requirements of spending cuts and tax increases as many in Greece have threatened?

How much financial risk has the ECB actually taken on as a result of the debt crisis? The ECB has already bought up low-rated bonds of Greece, Ireland, and Portugalin the market. There are hundreds of billions more of bonds that European banks may need to sell to the ECB if they are to remain solvent. The ECB is thinly capitalized at 10.7 billion Euros. It is true that more capital could be contributed by member nation central banks, but the ECB already has billions in unfulfilled capital contributions from its members. To us, this means there will be a continual drain on the healthier Northern European nations. They will have to step up and contribute more and more. Hard-working, taxpaying Europeans will have to shoulder a heavy burden to pay for the profligacy of their neighbors. How long will they put up with it?

What This Means to You

As we mentioned a moment ago, Europe will eventually deal with the problem by printing money to provide liquidity to the markets and pump up the balance sheet of the ECB. Such a program is inevitable and will, in our opinion, provide a further impetus for gold, oil, and other assets. The European strategy is to keep the continent’s banking system and the ECB from failing, but the result will be a much weaker Euro and a wave of liquidity sloshing into other markets around the world.

The Western World Held Hostage by the Banksters Exposure to OTC Derivatives (Credit Default Swaps)

...from Institutional Risk Analytics, by Dick Alford

As we told our friends on CNBC's Fast Money last week, the apparent bailout for the EU banks led by BNP, Societe General and the German landesbanks is shared equally by their US derivatives counterparts. Remember, as of the end of Q1 2011, it would take just a move of less than 10bp in the aggregate value of the OTC derivatives book of JPMorgan Chase (JPM/Q1 2011 Bank Stress Rating: "B") to wipe out the firm's capital.

So the more accurate description is that all of the major players in the world of credit default swaps were bailed out on Friday, proof again that this financial ghetto known as OTC derivatives is adding to the systemic risk problem -- and holds the entire world hostage.

The net increase in financial exposures due to the existence of the CDS market in sovereign credit risk has not made the real economy safer, but instead multiplies the dollar amount of the basis risk in all markets, real or imagined. You cannot get rid of systemic risk and "too big to fail" until you limit credit derivative products to holders of actual debt. Instead we have hedge funds and banks gambling on the end of the world.

The impending damage of a mark-to-market event with respect to Greece or Ireland is such that the craven fools who inhabit public offices from Paris to Washington are forced to socialize the losses of the banks. The free market is dead and we have all arrived at a sort of involuntary socialism, where the largest banks rape and pillage, and even hedge funds and other credulous players in the financial markets are turned into victims.

This grotesque situation reminds us of the comment made by our friend Walker Todd at AIER, who suggested that governments should simply underwrite all commercial risk exposures and by law exclude all other claims from any safety net. The remaining "speculative" financial activity in things like CDS contracts would be specifically banned from the banking sector. This eliminates the need for governments to worry about who is the dumbest guy in the room, to paraphrase author Martin Mayer on this question.

The thing people need to appreciate is that the large banks today with respect to exposure to Greece and Ireland are in precisely the same position as was American International Group in 2007. In that case, AIG had written excessive credit insurance on mortgage backed securities in order to generate fictitious income. This financial fraud eventually collapsed, forcing the Fed of New York under Timothy Geithner to come riding to the rescue of JPM, Goldman Sachs ("GS") and their derivatives counterparties in Europe because AIG could not make good on its liabilities.

In the most recent case, the major dealer banks in the EU end US have created mountains of new credit risk with respect to Greece and Ireland by selling insurance to their clients, both commercial hedgers and speculators. The latter group is far larger than the true commercial hedging needs for risk management, a side benefit of the expansionary policies of the Fed under Alan Greenspan and now Ben Bernanke. Thus the original sin of monetary accommodation by the Fed comes back to haunt us all in the form of an uncontrolled market panic fueled by cash settlement credit derivatives.

The refusal of the political class to imposes losses on large bank creditors since the collapse of Lehman Brothers and Washington Mutual in 2008 illustrates the extent to which the financialization of the western industrial economies has turned into a gradual coup d'etat by the banks and the global speculators who dominate their client base. The CDS market specifically has become so large and threatening that the politicians are even forced to renege on bets against Greece by the largest and most important bank clients.

So much of what goes on inside the typical investment bank today has nothing to do with the real economy as illustrated by the Greek situation. Much of finance today is beggar they neighbor speculation. But even the hedge funds that were betting on raging contagion are getting stiffed by the banksters and their political sponsors. Just as individual savers are being denied their due via low rate policies, the speculative class is also being stiffed by banks that cannot make good on their wagers in CDS.

By saying that the banks and their creditors cannot be made to take losses on even their speculative activities, technocrats such as Germany's Angela Merkel, France's Nicholas Sarkozy and Barack Obama have become the ambassadors for the new global ruling class. The servants of the banksters, Sarkozy, Merkel and Obama, think that they can put the entire weight of restructuring Europe and US debt on the backs of taxpayers. 

Do our leaders really think that they can restructure Greece and Ireland via austerity without requiring any pain from investors in bank debt or the managers of the banks? If so, then the decision on Friday is not a solution but instead puts the western market economies on the road to further political and financial turmoil. Just as the unfair peace after WWI led to economic depression in Europe and the rise of fascism, the decision to dispense with the pretense of free market discipline in the industrial economies puts us all on the road to serfdom and political upheaval.

Doping ring busted in Andorra

...it is not just the elite professionals, it is not even just the pros, let's go get some epo for the local gran fondo

By: 

Cycling News

Published: 

June 22, 03:08, 

Updated: 

June 22, 03:11

42 cyclists among clientele

A joint operation between the Mossos, the Civil Guard and police in Andorra has uncovered a doping ring which involves some 60 professional athletes. A new report on Cadena Sur states that 42 of the clients of an internet pharmacy in Encamp are or were professional cyclists.

Police tracked 536 sales of performance enhancing products over the past year, but investigators say the pharmacy was operating for the past six years.

Also listed amongst the clientele were professional multisport athletes, bodybuilders, a motorcycle racer and kayaker.

The report named several professional cyclists as clients: Ángel Gómez Gómez (ex-Saunier Duval/Fuji Servetto), Footon Servetto rider Enrique Mata Cabello, Adolfo Garcia Quesada, a former professional with Kelme who was banned for two years for testing positive for human chorionic gonadotropin in 2006 and Vicente Ballester Martínez, also retired. Also named are under-23 riders Javier Sánchez Cidoncha, Narcís Sallent Sanglas and Kevin Kohlvelter, and ex-pro Isidro Cerrato López,

Current riders include Spanish track cyclists Carlos Herrero Nadal and Alfredo Moreno Cano, Víctor de la Parte González and Guillermo Lana Baquedano of Caja Rural and Frenchman Guillaume Pont (SP Tableware).

Another 30 riders took the drugs to help boost their performances in amateur events such as gran fondos.

Drugs sold include the blood booster Erythropoeitin (EPO), steroids and other banned substances, but named specifically was Solcoseryl, an extract of calf blood which is said to help increase oxygen consumption in hypoxic conditions as well as help heal damaged tissues.

The chief investigator, Jordi Domènech, told Cadena Sur that they limited their surveillance of the transactions to those involving performance enhancing drugs, otherwise they would have uncovered a greater number of clients.

Athletes would order drugs on a section of the website, and then products were smuggled into nearby Spain to towns like Seu d'Urgell for shipping. There was also a distribution point in Jaca, where drugs would come directly from European laboratories.

The people running the pharmacy, a man and his wife, as well as three others who operated a store in Barcelona which sold DHEA, face sentences of 6 months to two years in prison for trafficking drugs in Spain.

Follow Cyclingnews on Twitter for the very latest coverage of events taking place in the cycling world -twitter.com/cyclingnewsfeed

http://www.cyclingnews.com/news/doping-ring-busted-in-andorra

Precious Liquid

...circa 6 AM...a very rare and clear liquid magically started falling from the sky...you would have to be as old as Joe Brazzatti to remember the last time this phenomenon occurred...

Whole Foods Parking Lot...

Hugh Hendry's "Greatest Hits"

2CELLOS - Welcome to the Jungle - enjoy!

Hugh Hendry, Marc Faber, Russell Napier, Nouriel Roubini...on the global investment outlook

Global Investment Outlook: Where is the Money & What are the Risks? from Troika Dialog on Vimeo.

Starting July 2nd...

Follow Me - Bike Parks

3 Minute Gaps

...from Dr. John

The Federal Reserve is levered up greater than the Too Big Too Fail Banks in 2007...great...If the banks were TBTF, you know the Fed is waaay TBTF - the tax payers are the safety net...the more the can is kicked down the road, the greater the future mess will be when it finally unwinds...we've printed the money, but we haven't restructured the debts...

"That's especially true because debt created at points of rapid credit growth is often of fairly low-quality, as we saw in the aftermath of the housing bubble. Lehman and Bear Stearns ran leverage ratios near 30, with disastrous results. Fannie and Freddie's leverage multiples were even higher, at about 40. You might recall that Long-Term Capital Management also ran at a leverage multiple of about 40-to-1 before it imploded. It's probably worth noting that according to the Fed's consolidated balance sheet as of June 8, Ben Bernanke has now taken the Federal Reserve's leverage ratio to 53.4. Fortunately or unfortunately, U.S. taxpayers would automatically end up subsidizing any Fed losses, so unlike commercial banks, the Fed could actually go insolvent without major consequences.

..."Meanwhile, the QE2 trade is essentially unwinding, and our impression is that the Fed's balance sheet is extended enough to make QE3 a difficult (though not impossible) sell. Further economic and market weakness might modify that possibility, but it's not clear how much latitude would be possible for a Fed that is now operating at more than 53-to-1 leverage."

..."Notably, and in contrast to the broad stock and bond markets, our measures of prospective return/risk in gold shares has surged, with falling long-term yields, negative real interest rates, weakening economic statistics and a very high gold/XAU ratio all provoking a distinct jump in our expected return/risk measures for gold stocks (see my 1999 article Going for the Goldfor a discussion of some of these factors). Accordingly, we've built Strategic Total Return's exposure to precious metals shares to nearly 18% of assets, which is significant, but far from the most aggressive 30% exposure that the Fund could hold (which would require stronger inflation pressures and a weaker ISM, combining to create severe pressure on the U.S. dollar)."

http://www.hussman.net/wmc/wmc110613.htm

...James Turk on Gold Money

James Turk's presentation on the gold price and the US dollar

High Frequency Trading

remember this?

THURSDAY, MAY 6, 2010

Whew, I need a smoke...

"The panic in the middle of the day was market makers that just disappeared, and every machine on Wall Street was trying to sell into a market that didn't exist. That was a bizarre electronic quant panic of people selling into a black hole. I don't know if somebody pressed the wrong button, but the intraday was a panic machine-led move," said Peter Bookvar, U.S. market strategist at Miller Tabak.