The Market Ticker
Commentary on The Capital Markets- Category [Banking System]

C'mon folks.

First, it's illegal for the German government to bail out Deutsche Bank.  That's one of the (few) changes made in the EU post-2008, and it has gone into effect.

However, they can be bailed in.

Now let's talk about what that means, and why in fact it's worthless in a situation like this.

A bail-in would destroy the stockholder equity (first), then bondholder equity which is converted to stock.  That sounds ok but there's a problem with it.

It works roughly like this: There are multiple "tranches" of bonds with various seniority associated with them.  This is done so the institution pays less to borrow on the "higher" (or "Senior") tranches, because the lower ones are wiped out first before the Senior bonds take any loss.

The issue that arises is that all these institutions "engineer" their tranching through various machinations (including default swaps and similar) so that most of their debt issue is "Senior" or "Super-Senior."  They do this to reduce their borrowing costs but the question becomes whether that "protection" is actually effective, and the only way it is effective is if the mathematical models used to derive that alleged risk are accurate.

This is exactly what was done with the various securitized mortgages from "subprime" lenders, incidentally -- and we know how accurate those models were, right?

It works if the losses are modest because the lower tranches are literally wiped out and the more-senior ones are protected.  The problem comes if you can't satisfy the financial requirements with those subordinate debt tranches because your modeled risk profile turns out to be dog squeeze -- then the senior tranches get hit.

If these tranches are invaded you will get an immediate run on prime brokerage and other "depository" style accounts because the buyers of those "senior" debt tranches bought them with the full expectation that they were not 50%, not 80%, not 90% but 100% safe and as soon as that belief is invalidated the brown smelly stuff will hit the airmoving device at very high speed.

Indeed a mere belief that such an invasion will happen is probably enough to set off the exodus because once you get into the senior tranches the risk rises above zero that depositors will get hit.  And finally, and most-troublesome, unlike with a traditional operating company any such exodus from a bank itself further erodes the bank's capital base and thus is additive to the pressure and the senior tranche loss risk!

Finally, remember that utterly nobody who lied about the solvency of their institutions went to prison after 2008.  Nor did any central bank personnel who lied about "subprime being contained."  For this reason you cannot believe any such statement from anyone without strict proof, and given the (intentional) opacity of risk in these institutions strict proof is impossible to come by.

So yes, it is not as simple -- or as "safe" -- as people think it is.

This situation is definitely unstable, and if anyone thinks "balance sheets" are ok I will remind you that I was not in 2008 and still cannot possibly analyze any of the European banks on any sort of consolidated basis when derivative exposure and other means of hiding contingent liabilities are included, and those liabilities must be included in the event confidence in the underlying institution -- or group of institutions -- is lost.

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C'mon folks.

Deutsche Bank is on the verge of collapse.  Let me remind you that back at the time of the financial crisis in 2007/08 I wrote specifically about them, calling the firm repeatedly DoucheBank as they had an utterly ridiculous derivative exposure compared against their capital.  In fact they made US bank exposure in this regard look like the work of pikers.

Not only has nobody done a thing about that in our markets Germany, I remind you, urged them to expand their exposure -- and they have.  In addition total credit market debt has expanded by $57 trillion since 2007, a close to 40% increase!  GDP, on the other hand, has gone up nowhere near as much.  Indeed, global government debt has roughly doubled since 2008 -- to $59 trillion.

One of the largest increases has been in college student loans, which are up a staggering 130% since 2007 in the United States alone.

The problem is that economic expansion -- that is, the common output of the economy, has not matched debt expansion.  Not even close.  This is an unsustainable practice since without output expanding at a rate that exceeds expansion of debt you must eventually stop or the economy will contract even though debt is expanding, and once that begins to occur it is a black-hole event horizon from which you cannot escape until virtually everyone who is in debt has been liquidated and those who hold that debt will take monstrous losses -- in many cases 100% losses!

When Donald Trump said in the debate that we were in a huge bubble he was exactly correct -- we are.  We are in a bubble where market prices for stocks have risen dramatically, housing has gone up to a material (and unsustainable) degree, and the embedded but not measured in inflation statistical data cost of living (e.g. medical) has risen at a ridiculous rate as well.  Trump has repeatedly charged that policy from The Fed, which is largely responsible for this bubble, is political in nature; whether that's the case or it has simply resulted from Fed hubris (which Greenspan and Bernanke both displayed in abundance and only Greenspan has admitted to) is immaterial to the outcome.

This deterioration has been reflected in labor productivity, which has now gone negative.  But that's just one small place that we can measure; the other places are not measured but have far more impact.  Nonetheless, that the impact has managed to filter into unit labor productivity and costs is especially troubling.

Remember that bank leverage in the form of derivative exposure is what made the crash in 2008 happen.  Lehman, alone, blowing up was no big deal -- companies fail all the time and Lehman, in terms of size, employee count and economic impact was a literal non-event.

It was the threat of cross-default on derivatives that took down the markets and the economy, and we now have it happening again but nobody is talking about it.

If you think Germany can bail out Deutsche Bank you're delusional.  Their total derivative exposure grossly exceeds the entire net value of everything in Germany!  Not just the government's resources, all private resources as well!  In other words even if the government wanted to bail them out, even if they'd survive bailing them out politically they can't, even if they attempted to confiscate everything of value within the nation.


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It never, ever ends, does it?

Our company, J.P. Morgan Chase, employs more than 220,000 people, serves well over 100 million customers, lends hundreds of millions of dollars each day and has operations in nearly 100 countries. And if some unforeseen circumstance should put this firm at risk of collapse, I believe we should be allowed to fail. As Treasury Secretary Timothy Geithner recently put it, "No financial system can operate efficiently if financial institutions and investors assume that government will protect them from the consequences of failure." The term "too big to fail" must be excised from our vocabulary.

But ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense. The goal should be a regulatory system that allows financial institutions to meet the needs of individual and institutional customers while ensuring that even the biggest bank can be allowed to fail in a way that does not put taxpayers or the broader economy at risk.

The solution is very simple, but you will notice that Jamie doesn't bring it up.  That's because he finds it unacceptable.

What's that solution?

Prohibit as a matter of Federal Law, and enforce it vigorously under pain of immediately dissolution, THE LENDING OF MONEY UNSECURED THAT EXCEEDS THE FIRM'S CAPITAL.

This is in fact the only way you can both end "too big to fail" and not constrain size or influence.

It is also the definition of sound lending.

It is also how lending was done prior to the banksters corrupting the government and literally usurping the sovereign credit of The United States.

As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company's failure to another and to the broader economy.

A requirement that you hold one dollar of actual capital for each dollar of unsecured obligation you have, marked to market nightly, absolutely prevents this risk.

That actual excess capital can be lost but there can be no systemic bleed-through as your capital then backs your bets in each and every instance.

While the strategy of artificial limits may sound simple, it would undermine the goals of economic stability, job creation and consumer service that lawmakers are trying to promote. Let's be clear: Banks should not be big for the sake of being big. Moreover, regardless of a company's size, it must be well managed. As we've seen in many industries, companies that grow for the sake of growth or that expand into areas outside their core business strategy often stumble. On the other hand, companies that build scale for the benefit of their customers and shareholders more often succeed over time.

Then prove it by putting your own capital at risk in each and every unsecured lending transaction.  For each loan you write where the collateral is worth less than the outstanding amount of the loan, at any point in time, hold one dollar of your own capital as security against that loan's default and the bleed-through effects on the economy.

And it's not just multinational corporations that rely on such a large scale. J.P. Morgan Chase and others supply capital to states and municipalities as well as to firms of all sizes. Smaller banks play a vital role in our nation's economy, too -- but a fragmented banking system cannot always provide the level of service, breadth of products and speed of execution that clients often need. Capping the size of American banks won't eliminate the needs of big businesses; it will force them to turn to foreign banks that won't face the same restrictions.

Yes, and JP Morgan/Chase will allegedly bribe states and municipalities (aka Jefferson County Alabama) to "obtain" that business and earn a 400% profit beyond the market rate too.  Yes, I know, you didn't admit guilt in the "settlement", but you did pay $75 million and forfeit another half-billion+ in termination fees.  Is it "usual and customary" for your company to pay nearly three quarters of a billion dollars in forfeits and fines when you did nothing wrong?  Our states and municipalities would be far better off without your firm's "services."

Global economic growth requires the services of big financial firms. It also requires that big financial firms be allowed to fail.


A one-sentence Bill that, were it to become law, would instantly end "too big to fail" and yet let you grow as large as you'd like - provided you are gambling with your own money and not the sovereign credit of The United States.

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