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2023-03-16 07:00 by Karl Denninger
in Banking System , 572 references
[Comments enabled]  

Oh, so-called independent ratings agencies eh?

Just like the so-called "independent and wise" regulator called the OCC?

Or the so-called "independent, unbiased" auditor KPMG that passed on SVB's books just shortly before they blew up?

I'll be fair on the latter -- their job is to verify that what was presented is true; that is, there's no indication of fraud.  That doesn't mean what they looked at doesn't smell like crap, provided the crap is disclosed accurately in the financials presented.  So far nobody has said it wasn't.

But as I've pointed out since the inflation specter reared its head and was clearly not going to be "transitory" the very thing that made banks 10x more valuable in their stock price -- that is, a portfolio written at 4% interest where the prevailing rate is now 3% and there is time remaining on the bonds so you are (difference in rate * remaining duration) to the good.

But when rates rise and you hold the lower interest bonds the exact opposite happens.

This doesn't mean the bonds are not "money good" at maturity, but it does mean this, for say, a bond of $10,000, where there is 10 years left:

  • The 2% one will pay $200 in interest per year for the ten years remaining or a total of $2,000 in interest plus the $10,000 principal, or $12,000.
  • The 4% one will pay $400 in interest per year for the ten years remaining or a total of $4,000 in interest plus the $10,000 principal, or $14,000.

If you hold the 2% one and want to sell it to me you're going to have to discount the price so that on a percentage basis I make the exact same amount as the 4% bond or I'll buy that one instead of yours.

For those who say "well, but the Fed has eliminated the forced sale with the latest action" that's true, and fair too -- but what it hasn't done, because it can't do so, is eliminate the fact that over the next ten years your bond returns $2,000 less in cash flow.

Remember the basic principle of why you always make money buying things instead of selling them: If we both have overhead of rental for our office, but mine is $8,000 a month and yours is $30,000 a month then I have a $22,000 jump on you each and every month which means I can pay for a higher-quality staff or simply more of them, I can sell cheaper than you, I can buy better-quality inputs and out-compete you on qualitypocket some of that in additional profit, or some combination of all of those.

This is why you want recessions, bankruptcies and other similar dislocation events where those who do stupid things go out of business.

Yes, if you're the dumb one that's sad.  Same for your employees; they lose their jobs.

But the economy as a whole benefits and in particular the consumer benefits wildly because they get better products and services, lower prices or both and in addition the owners of the companies that don't do stupid things make more money with which they then go into the economy and spend on that nice evening out including a $100 steak and a few $20 cocktails.

If you bail out the fools then that innovation doesn't happen.  The consumer instead is forced to eat the overpriced products and poor service because the poorly run companies do not go out of business and the well-run ones don't get to feast on their remains at a huge discount.

MCSNet feasted on such remains at several points in time with one of the most-significant being an $8/ft lease for Class "A" office space in 2 Prudential Plaza -- an opportunity that arose because Donnelly Directory did a dumb thing and walked away from that space -- and the building needed it leased to someone who could pay for it now.  We needed space at that particular time as we were out of places to put people at 1300 W Belmont and needed to hire several more warm bodies and we had cash because we were not levered up to our necks and thus didn't need anyone's approval process (e.g. for a loan at the bank) to be able to look at it, know it would meet our needs and sign the papers handing over a check for the first few months rent so the building folks knew we were both serious and could pay.

I wasn't responsible in any way for Donnelly doing the stupid things they did.  I don't even know the specifics of those stupid things; I only knew who the former tenant was but not why they were suddenly gone and the building had not just space but space they needed leased right now -- and were willing to offer at a very attractive price to make that happen.  All I know is that they had it available, we needed it, what we needed and what they had was a good fit and thus our name went on the door and there we were.

Banks are not entitled to rising stock prices; in fact banking is supposed to be a pretty boring and mildly-profitable business.  Banking is an essential thing as people need a place to keep money and an exchange mechanism to get it from one place to another with decent reliability and security.  When it stops being a boring, mildly profitable thing watch out because the odds go up a lot that someone -- or a lot of someones -- are doing something stupid.

It was screamingly obvious that anyone sitting on long-duration paper when rates started to go up had two choices: Sell it right now and accept a small loss or sit on it until it matured and accept the fact that you're going to get a lot lower return on investment until it does mature, which might take quite a while.  If you choose to do the second you had damn well better make sure you won't have to sell it early later on because you have no control over market rates but what you can certain of is that "zero" is not and cannot be permanent.  Hedging such a possibility costs money which is an even bigger kick in the nuts to go on top of your lower returns (as you have to pay for the hedge out of that return) when you just decided to take a 2% return on the paper for the next 10 years and the guy down the road is getting 4% on the newer issues!  Now your net return (ex the hedge expense) might be 1% -- or even negative.

We have regulators who, in the face of these facts, are supposed to make sure that all the banks, not just some of them, are ok under that scenario.  If someone's paying 4% interest as a bank and has a portfolio full of long-duration paper they took on in 2020-2021 its a certainty they are paying out a higher coupon than the risk-free rate (that is, either Treasuries issued during that time of reasonably short duration) or one which has proper hedging costs included and the hedges are on when one adjusts those costs for risk, interest and duration exposure.

Sheila Bair is now opining that The Fed "should hit pause" to assess the impact of the policy changes.  Sorry Sheila, nope.  The Fed knew what that impact would be because its a mathematical certainty; what happens to long-duration bonds when rates go up is known just as is what happens when they go down.  Banks profited mightily, and it is reflected in their stock prices that have in many cases risen by 10x and they've engaged in billions in buybacks on top of that over the last 15 years.  That's "profit" that they effectively siphoned off from the common person who got nothing for their deposits during the same time banks were selling assets they paid 100 for at 120 -- and pocketing the difference.  Now that its the other way around they're crying poverty and demanding protection -- that is, to steal again -- when it was their decision alone to engage in the buybacks and other spending, never mind not issuing stock into that price ramp and sitting on the money said secondaries would generate to offset the inevitable when rates went back up.

I started this blog in 2007 -- originally on Blogger (which is why you can't see any of the replies; they didn't transfer) -- because during the 2007 1Q earnings calls, which I started paying attention to in a big way after a financial dislocation in Asia a few weeks earlier, WaMu was paying dividends without having the cash income to pay them.  They were doing this by booking negative-amortization "gains" -- perfectly legal but it was wildly unsound to spend the gains as they're not cash and they will only turn into cash if the person who has the mortgage can pay yet the dividend is gone from the bank's operating checking account right now whether the mortgagee can pay down the road or not.

OCC/OTS (at the time there were two) along with The Fed -- both the DC and all the regionals -- sat on their hands and let this go on.  It wasn't a secret either as the details were disclosed in the quarterly filings which anyone could see.

18 months later, roughly, it all went to Hell.

It was 100% predictable that it would go to Hell, and thus I said it would, because it was obvious -- either the people doing that crap were going to stop doing it or it was going to blow up in their face.  Rather than stomp on it as soon as that was detected, which is the regulators jobthey sat in their offices and did God-knows-what -- everything except forcing the banks to cut that crap out.

15 years later here we are again and once again the regulators sat on their hands and doing nothing about that which is obvious and, if not stopped, is going to lead directly to ruin.

Let me be clear: So long as you shut the bank down before the bondholder capital is exhausted deposits are not at risk.  The stockholders and bondholders will get hosed but that's the price of owning said instruments issued by a company that is doing stupid things and those who buy such an instrument without paying attention to what management is doing deserve it.  While we need banks because the functions they provide are indeed crucial to our economy as I pointed out last time around the name on the door is immaterial to the function, and if the existing banks fail the real estate and other assets they own, when acquired at 10 cents on the dollar, mean the new bank is more efficient than the old one and that is a good thing from the perspective of the common person using the service.

So what should you expect as a consumer or business?

  • If you have "open lines" available expect them to get slammed down to the outstanding balance at any time.  Revolvers in the corporate world and HELOCs and credit cards in the personal arena are particularly subject to this.

  • If you need new lines in the coming months and years you are likely to find its very expensive -- if available at all.  Credit cards already are but part of bank analysis on this when offering one to you is the availability of other backstops you may have in the credit markets.  Expect the banks to consider all of those (including alleged "home equity") as zero.  On the corporate side if you're privately-held and need access to capital you may find the terms unacceptable -- if its available at all from a bank.

  • Depletion of deposits is not going to stop, and forces the first two to ratchet tighter.  Why would you sit in a bank at 2% interest (which is all they can pay since they have long-dated paper they can't sell without a crippling loss, and its paying 3%) when you can get 4% or so in direct, short-term government securities?  We're talking bills here with a 4 week duration or similar; unless you have reason to believe you might need it right now why would leave that in a bank?  Now look at this from the bank's point of view: They can't entice you with higher returns as they don't have the ability to pay them.

No, there isn't an "answer" to this either folks and as long as government deficit spending continues it will get worse, not better.  Simply put that has to stop and the distortions that were into the system have to come back out or the ratchet job will continue until more and more things break.

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Oh but so many climate-related firms are going to fail to make payroll!  - Any one of a thousand Internet scolds.

My answer: So what?

Next up - Republic, which apparently had lines out the door (if you believe the Internet) on Saturday.  Again: So what?

Folks, bubbles attract stupidity.  Stupidity is a constant in the universe; in fact it is likely the only thing that is truly infinite (with all due respect to the late Mr. Einstein.)

The so-called "Chief Risk Officer" at SVB had a masters in..... public administration.  Anyone care to bet if she passed any form of advanced mathematics -- you know, like for example Calculus or Statistics?  Do you think she understood exponents and why this graph made clear that concentration of risk and duration was stupid and likely to blow up in everyone's face -- including hers?

How about Bill Ackman and the others on the Internet screaming for a bailout?  How about the CFOs of public companies like Roku that stuck several hundred million dollars in said bank?  Was it not widespread public knowledge (and available to anyone who took 15 minutes to do research, which you'd think someone would do before putting a hundred million bucks somewhere) that this institution was chock-full of VC-funded startup companies which, historically fail 90% of the time and their debt becomes impaired or even worthless?

Where are the indictments for fiduciary malfeasance among these people?

It takes a literal five minutes with Excel to prove to yourself that if debt is rising faster than GDP no matter the interest rate eventually the interest payments on that debt will exceed all of the economy.  This of course is impossible because you cannot use over 100% of anything as its not there, but long before you reach that point you're going to have trouble putting food on the table, fuel in the vehicle and paychecks are going to bounce.  It was for this reason that one of the first sections in my book Leverage, written after the 2008 blowup which I chronicled and laid bare upon the table featured exactly this chart.

The last bit of insanity was just 15 years ago by my math.  Did we fix it?  No.  What was featured in the stupidity of 2008?  Allowing banks to run with no reserves.  Who did that?  Ben Bernanke, who got it into the TARP bill that eventually passed and which I reported on at the time.  It accelerated that which was already going to happen because Congress is full of people who think trees grow to the moon, leverage is never bad and exponents are a suggestion.

Oh by the way, your local Realtor thinks so to as does, apparently, the former SVB "risk officer" who, it is clear, didn't understand exponents -- or didn't care.

The simple reality is that it must always cost to borrow money in real terms.  This means the rate of interest must be positive in said real terms, which means across the curve rates must be higher than inflation -- again, in real terms, not in "CPI" which has intentional distortions in it such as "Owner's Equivalent Rent" when you're not renting a house, you're buying it.  Had said "CPI" actually had home prices in it then it would have shown a doubling in many markets in that section of the economy over the last three years.

In other words housing alone would have resulted in a roughly 10% per year inflation rate, plus all the other increases, which means the Fed Funds rate should have been 300bips or so beyond that all the way back to 2020 -- which would put Fed Funds at about 13% for the last three years.

It isn't of course but if it had been then all those "housing price increases" would not have happened at all.  Incidentally even today the Fed Funds rate is below inflation and thus the crazy is still on.

It's a bit less on however, and now you see what happens when even though they're still nuts being slightly "less" nuts means that these firms are no longer capable of operating without the wild-eyed crazy; even a slight reduction of the heroin dose caused them to fail.

Never mind the wild-eyed poor choices of executives (who signed off on all of this?) at SVB which the regulators all knew about and ignored.  The CEO?  A director of the San Francisco Federal Reserve.  Why don't you look up a few of the other "chief" positions and what they used to do.  Bring a barf bag.  No, really.

And what did Forbes think of all this?  Why it was good for five straight years of SVB being rated one of their BEST BANKS!

Negative real rates are never sustainable.  The insidious nature of that nonsense is that it extends duration in pre-payable debt, specifically mortgages.  Mortgages have had a roughly 7 year duration forever, despite most of them being 30 year paper nominally because people move for other than necessity reasons (e.g. "I want a bigger house", "I want to live here rather than there" and so on.)  A huge percentage of said paper was issued at 3% and now is double that or more.  Since a mortgage is not transportable (when you sell the house you extinguish the old one and take a new one) and changing that retroactively would be both wildly illegal and ruin everyone holding said paper you can't retroactively patch the issue -- which is that now nobody with a 3% mortgage is going to prepay it and move unless they have to and so the duration is extending and will continue for the next couple of decades.  This in turn means if you have a 3% mortgage bond, the new ones are 7% and there's 10 years left on the reasonable expectation of its life you're now going to have to discount the face value by the difference in interest rate times the remaining duration or I won't buy it since I can buy the new one at the higher rate!  This is not a surprise and that it would happen and accelerate was known as soon as inflation started to rise and thus force The Fed to withdraw liquidity.  The Fed cannot stop because inflation is a compound function and at the point it forces necessities to be foregone the economy collapses and, if continued beyond that point THE GOVERNMENT collapses because tax revenue wildly drops as well.  The only sound accounting move at that moment in time as a holder of said paper was to dispose of the duration or immediately discount the value of that paper to the terminal rate's presumption and adjust as required on a monthly basis.

Nobody did this yet to not do it is fraud as these are not only expected outcomes they're certain.

Where was the OCC on this that is supposed to prevent such mismatches from impairing bank capital?  How about The Fed itself, or the FDIC?  The San Francisco Fed was obviously polluted as the CEO was on their board (until he was quietly removed on Friday) but isn't it interesting that all these people who were intimately involved in firms that blew up in 2008 were concentrated in one place in executive officers with direct fiduciary responsibility?

And isn't it further quite-interesting that all the screaming you're hearing right now is about how "terrible" it will be that "climate change" related firms will be unable to make payroll and the new upcoming VC-funded startups won't because their favorite conduit has been disrupted?  What's that about -- the entire premise of these firms requires them to not only force their startups to bank in specific places with large amounts of money (since they don't earn anything they have to have access to and consume tens of millions or more a year) but cash management, you know, putting all of it other than what you need to make payroll next week in 4 week bills is too much to ask?

There's a rumor floating around (peddled by Bloomberg) that over one hundred venture and investment firms, including Sequoia, have signed a statement supporting SVB and warning of an "extinction-level event" for tech firms.  Really?  Extinction for technology or extinction for cash-furnace nonsense funded by negative real interest rates which make all manner of uneconomic things look good but require ever-expanding, exponentially-so, levels of debt issuance?

Again, that is not possible on a durable basis and once again the reason why is trivially discernable with 5 minutes and an Excel spreadsheet and graph.  It takes about an hour to do it manually using graph paper, a basic 4-function calculator or the capacity to perform basic multiplication on said paper and a pencil.

Now some basic facts on SVB specifically.

The capital structure of a bank in terms of who loses and in what order looks like this:

  • Stockholders; first to go, and go they shall.  If you owned stock in this firm you have a zero.
  • Bondholders, second to go.  Rumor on the street is that the bid on those bonds is about 40 cents on the dollar.
  • Uninsured depositors; next up, those with over $250,000 per TIN/EIN/SSN in the bank.
  • Insured depositors; those are guaranteed (if necessary) by the FDIC.

Here's reality folks irrespective of the screaming on the Internet and elsewhere in the media: The bonds still have a bid, which means those people who do this stuff for a living, and when they're wrong they lose a lot of money (they're not wrong, in other words) do not believe the bank has lost all of its bond-based capital.  They're insolvent - which just means the bond capital has been invaded.  In other words the actual loss when all is said and done for uninsured depositors is likely to be zero or close to it.  Of course this presumes we have a basic failure due to stupidity here and not fraud on top of that, which is yet to be determined with finality.  However, it may be a while before said uninsured depositors can get their money since if there was fraud then indeed some of that is gone and, if there was an interest rate being paid on it, well, it isn't anymore.  That is, the most-likely outcome for uninsured depositors is that some of their funds have been converted into a forced-time-deposit (e.g. "CD") paying zero interest until the bank can be either sold off or wound down and the assets disposed of.

If you're a company and have a huge amount of money there under these conditions obtaining a short-term line to cover that for operating purposes within days should be no big deal -- unless, of course, you are a money-losing operation and can't subordinate those deposits to secure the line because you have loan covenants that make that impossible or worse, you can't borrow or bank anywhere else without violating your other covenants such as, for example, with said venture fund that, along with SVB, loaned you the money you're operating on.  If you did that then yeah, you're screwed (and so are your employees) but that's not a function of the bank going out of business its your own fault because you were stupid and were operating an unproved, money-losing outfit funded by the leverage games that were created by said negative rate environment.  If you're in that position or employed by someone in that position what you deserve is nothing because you were stealing from the public at-large via these machinations and your bet that you could grow out of it proved false.  That this was "legal" does not change the essential character of what you were either doing or living on.  You gambled and lost so shut up.

Folks, you may personally think the "bubble" side of such things is great.  You may even have a job as a result of it.  You might be a "coder" even though you can't really code as you don't understand assembler or even how a computer actually works and thus you rely on some other piece of nonsense (like "Android Studio" or some other "abstraction" layer) to keep your software from blowing up. You might be a "Chief Risk Officer" who has a Masters in Public Administration and, it appears, never managed to pass a math class requiring the understanding of statistics or, for that matter, even exponents.  You might be one of the 90% plus who makes their living extracting funds from others in the medical system but never provides a single second of care to a single person and thus, when you get down to it, your job is to steal rather than heal.  And you might be one of those so-called property owners who thinks AirBNB is great with not a care in the world that the bartender in the local tourist establishment has nowhere to live because on that salary they can't pay $500,000 for your one or two-bedroom cabin with no closet space.

I think I want to update Einstein's observation on stupidity being infinite to include insanity, which, it appears, is in danger of exceeding stupidity in terms of prevalence.

You learned nothing from what happened 15 years ago and you demanded nothing change either.

Now there are people screaming that The Fed has "caved" and is bailing people out. Nope.  Here's their term sheet for the "Bank Term Funding Program" (Bring The Frapping Punch!). 

 

You'll note a few things.

First, the collateral has to be good.  The list of things you can pledge is found here under 201.108(b); it includes Treasuries, Fannie, Freddie, Ginnies and similar.  Note that FHA insured loans are not eligible because it is not an unconditional guarantee.  This is important.

Second, yes, they are allowing them to be pledged at "par" rather than with a haircut, but there's a price to that, which is that the lending against it is at a penalty rate and the advances are made with recourse, so if there is fraud (for example) and the collateral is not actually good the bank that does it is boned.  Second, since you must pay interest on the advance (and that ain't zero anymore!) you are digging a bigger hole and had better have a way to get out of it.

In short all this does is stop the predatory circumstance that people like Ackman were trying to incite over the weekend.  The basic problem, which is that OCC and the banking system generally, along with the ratings agencies, have sat on their hands with a known duration extending event, that is basically locking people in 3% mortgages that will not prepay as usual except under extreme duress, and on top of it with an interest rate mismatch that have a lower cash flow than current note issues of the same type and character which means their current value, if sold, is less.

But if not sold, while their face value is "good" in that they have unconditional guarantees you still get a much smaller coupon, which is what you're operating the institution on and with which you'd like to pay interest on your deposits, than you have with more-current paper issued at a higher rate.

There is no way to fix that, it was certain to happen and was not speculative thus not including that in your "models" is fraud as is ignoring it if you're a bank executive or regulator and it is for that reason that the OCC and Fed should have, six-plus months ago when it was clear inflation was not "transitory" and disappearing in a few weeks forced disgorgement and roll-down into the short end of the curve so as to prevent this from becoming an issue.  Yes, that would have hit earnings and of course the ever-sacred "buybacks" and thus stock prices in those firms would go down.

Well, guess what?  Stanching the predatory behavior of jackasses like Ackman does nothing to resolve the fundamental problem in that the monetary heroin cannot be restarted and as a direct result now, the time is for all this crap of the last fifteen years, and the entire reason this blog exists, to come back out of the system.

One of the best definitions of insanity I've ever heard is doing the same thing over and over again but expecting a different result.

Welcome to 2008, part deux.

Let me know when you're ready to force those who did it last time and now have done it again off the public policy playing field.  They won't go willingly; tyrants, thieves, brigands and other malefactors never do.

smiley

PS: Look to the right and you'll see my book, Leverage, is still there.  The inevitable result of bubble economics is still on the first set of pages and the reason its inevitable is that despite so-called "common core" 2 + 2 will always equal 4.  Here it comes.

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2023-03-11 07:00 by Karl Denninger
in Banking System , 1651 references
[Comments enabled]  

Lots of questions flying around about SVB and what it means.

There are plenty of moving parts here and lots of unknowns, most-specifically who's connected to what, where, and with what reserves?

Apparently the firm attempted to raise capital, failed, and now is looking for a buyer.  The FDIC stepped in and locked the doors -- they typically do this on a Friday after the market closes but acted early this time.

One very interesting element of this situation is that the bank, being a bank, is supposed to have reserves against this type of loss, especially startup funding which is extraordinarily risky even in the best of times.  As I've repeatedly noted one of the big concerns anyone with a brain ought to have is the wildly-distorted market picture you get from a long-term run of negative interest rates in real terms.

I can run a cash furnace, basically, that looks pretty good so long as I can keep financing it at ever-lower interest rates because I can roll over my alleged "debt" (whether I do it formally by redeeming the former debt or informally by issuing more at much lower coupons, thereby diluting the "blended" total rate) on a continual basis.

In theory these sorts of loans are supposed to be backed by assets when held by a bank.  The question of course is always what are the assets worth if you need to sell them?  The price of a used truck, for example, is very different if there are no new ones because there are no chips yet the roofers all need one to haul their stuff to jobs .vs. the converse -- the economy is in a deep recession, there are fifty new trucks on the local dealer's lot, people are putting blue tarps up instead of reroofing their house when it leaks and nobody is building new houses.

Reality is that if you hold paper at a below market rate it is always discounted to its market value.  Why?  Because if you have to sell it that's all you'll get; the buyer would be stupid to buy your 2% 10 year Treasury when he can have a new one at 3.94%.  Therefore while it is absolutely true that if you hold it for the entire 10 years you'll get your entire $10,000 (for example) back you will also get the old coupon rate until then instead of the new one.  While you can certainly make the claim that for Treasuries you can hold them to maturity that claim only holds up if they're not the backing for something else; if they are (e.g. deposits) and someone demands their money you must sell.  Therefore any logical accounting practice is that on any rise in rates you may only count them as "hold to maturity" and thus "money good" if they are not part of your collateral base for something that can be called -- such as a demand deposit.

To do otherwise -- and I don't care what the Federal Reserve, Congress or FASB claims -- is fraud.

Let's remember that Colonial claimed in an earnings report that they were fine during the crash -- and about a month later the FDIC came in, closed them, and when BB&T bought the remains they published a valuation which essentially claimed the assets had lost roughly a third of their value over a month's time.

The odds of that being real across an entire portfolio are basically zero, never mind that if you're so-poorly underwriting things that it is true you're basically running a scam outfit in the first place.  Either way there's no plausible legitimate explanation.

Now we're doing it again, and at the core of the problem was a known false premise -- rates would never rise and thus the cash furnace game was permanent.

No, it isn't.  It never was.  It never could be.

Everyone knew it too and that means representing otherwise was fraud.

So is allowing an institution to mark assets to a model when there is no guarantee that the asset will be worth the modeled price when it matures.  There is only one such asset that meets this criteria and that is a Treasury obligation of some description which does not back anything that can be called, such as a demand deposit, because if Treasury fails so does the monetary system and government -- and thus the rest is irrelevant.

This specific instance is about a bank that has a portfolio of assets with very long duration that allegedly "back" its deposits and which were issued at much lower rates than today.  If there is a demand for funds you can't sell them at par because nobody is obligated to buy and the other alternatives are trading at a higher coupon.  Its even worse in this case than usual because roughly half, from what I can see, is 5+ years out in duration!  So if that paper yields 3% but the new paper of equivalent quality yields 6% you have to discount the face to get someone to take it by the difference times the duration.

Anyone who thinks that the very same regulators that should have stomped on this six months ago didn't let other institutions do the same stupid crap has rocks in their head.  Said "regulators" were, just as back in 2008, watching Redtube instead of doing their jobs so yeah, there's more to come.

If you remember we were all told back in February of 2008 that Bear Stearns was "fine"; it then failed.  The next lie was that it was contained and not an indication of systemic fraud writ large among the banking and financial system generally -- the deliberate statement that alleged "assets" are in fact money good.  That was a lie.

Indeed the Federal Reserve knew, as did Citibank, that Lehman was insolvent weeks before it formally blew up.  How do we know this?  Because it was documented in the post-mortem; they attempted a tri-party repo with Citibank (the other party being the NY Fed), Citi rejected the collateral as not worth its claimed value and thus both unsuitable and unstable and Lehman had nothing else to put up.  The attempt failed and was deliberately concealed from the public as a whole but of course both The Fed and Citi knew it at that moment in time.

Many people were shorting Lehman at the time, which looked extraordinarily dangerous unless you knew they were bankrupt, in which case it was the trade of the century as you knew you couldn't lose.  Was it ever run to ground as to exactly who knew, who told who and that nobody shorting the stock knew -- that is, had material inside information and was trading on it, which is illegal by the way?  No.

Is this incident localized?  I have no idea.

But what I'm quite-certain of is that a lot of financial institutions have loans out at crazy leverage due to the zero reserve requirements Ben Bernanke had made available to him via the TARP bill that was eventually passed (which I reported on at the time) which, in point of fact, simply accelerated a timeline that had already been there.  In other words Congress had already planned to give the banks the ability to do this sort of thing before the 2008 blow-up despite it being ridiculously unsound and fraudulent.  Neither party has done a thing to reverse that in the 15 years since and you'll note that not one word has been spoken about it in recent years during the Fed Chair's semi-annual testimony either.  Every single one of the 535 fraudsters in Washington DC and every President since Bush has been intimately and personally responsible for same.

So is there a ticking bomb -- or three -- out there in the financial system today?  Yes.

There has been for the last 15 years and nobody has been willing to cut the burning fuse.

The fuse is now in the box and nobody knows how long it is or how big the explosive is inside.

It might be a very long fuse and a firecracker.  Whoopie de-doo-dah.

But given the incentives while the length of the fuse is not necessarily tied to incentives that the explosive is extremely large and might surround a hollow sphere with a pit in the center is in fact rather likely.

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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.

ONE DOLLAR OF CAPITAL FOR EACH DOLLAR OF UNSECURED LENDING, MARKED TO MARKET NIGHTLY.

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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