Moody's NOW Downgrades Banking?
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2023-03-16 07:00 by Karl Denninger
in Banking System , 572 references Ignore this thread
Moody's NOW Downgrades Banking?
[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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Comments on Moody's NOW Downgrades Banking?
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Pharmadude 232 posts, incept 2020-03-26
2023-03-16 07:51:35

The train has left the station going downhill fast with the wheels on fire because there's no lube on the hubs and the breaks are busted.

The loud boom heard after the train derails is the government blowing up the remains.

It's just that basic math is too hard to do when the focus is on diversity and inclusion.
Wayiwalk 665 posts, incept 2016-11-09
2023-03-16 07:51:42

Nice article!

The Lockdowns Will Continue Until the Morale Improves!

I keep thinking, "it can't get any worse" and then it does!
Rollformer 2k posts, incept 2013-02-13
2023-03-16 07:57:29

That this would happen is obvious to outsiders. I do not think it was obvious to the bankers. Of course the Fed would bail them out. The Fed alphabet thing is all they are going to get, and it is not much of a bailout.

The thing you have to understand, is that the people who run the banks are sales people. Not like the good ones, like the engineer who sells industrial equipment. These people, despite their fancy degrees, are on the order of car salesmen and dirt pimps. They want to make money above all, the customer be damned.

These sorts of people need to be rooted out of Wall Street, as well as every organization in this country. God willing, they will be.
Tickerguy 193k posts, incept 2007-06-26
2023-03-16 07:58:10

Given this is the same shit from 15 years ago @Rollformer I say we root 'em out of society generally, and make sure its done in a way that nobody will contemplate doing it again for a generation or more.

The difference between "kill" and "murder" is that murder, as a subset of kill, is undeserved by the deceased.
Sandor 3k posts, incept 2007-08-08
2023-03-16 08:04:11

Yep. Moved a fair amount of cash from Truist into my Schwab account and bought a treasury at 4.77% maturing at the end of June.
Erroldo 660 posts, incept 2013-09-12
2023-03-16 08:45:24

I have cash in CIT savings at 4% and Chase at 0%. Need to move to where I can buy treasuries with most of it.
Pharmadude 232 posts, incept 2020-03-26
2023-03-16 08:45:30

Banking should be highly focused on math, oh but the top bankers had to prove they weren't racist.

Because knowing math is racist.

So not only is the government saving these crony capitalists, but the government is applauding and rewarding these unbiased non-racists.

Don't expect any arrests of the cronies, just sayin.
Ronniemcghee 364 posts, incept 2012-07-28
2023-03-16 08:45:35

Do you really need to raise the debt ceiling if you are serious about cutting federal waste, fraud, abuse, and deficits?

The GOP is dedicated to these?

Or are buybacks still - a thing -
Greenacr 768 posts, incept 2016-03-15
2023-03-16 08:45:43

Clueless Janet Yellen due to stress her confidence in the US Banking System today in front of the Senate Banking Committee. Every time Biden or one of his minions opens their mouth you can expect the opposite and bad things.

Great Article
Blanca 527 posts, incept 2020-07-25
2023-03-16 08:48:41

Yesterday a friend asked me what was going on with the banks and should he pull all his money out! I told him if his money is deposited in an FDIC insured bank he has nothing to worry about as long as he has less than $250K deposited. I assume the same is true about the safety of funds at an NCUA credit union.

I'll bet most Americans don't understand deposit insurance, and don't have enough in any bank to worry about it. But they can be easily panicked (witness the COVID hysteria).
Cmoledor 1k posts, incept 2021-04-13
2023-03-16 09:19:46

Let chips fall where they may.

The whole world is one big fucking scam
Why are you giving a vulgarity warning here? Our genial host is an advocate of both skullfucking and sodomy via rusty chainsaw. Credit to Rollformer
Phils 200 posts, incept 2018-02-07
2023-03-16 09:19:51

I would have expected the bank stockholders to have caught this blunder before it reached the failure point.

Better put fresh paint on the "Stupid Benches"- the ones that the GM bond holders used after losing their financial ass in 2009.

Haven't heard a word from the banking experts that are running the Derivatives Division. This should be "more better".

Tomorrow is "Bad News Friday.
Whossane 268 posts, incept 2018-01-25
2023-03-16 09:19:59

Speaking of Janet Yellen, she just travelled to Ukraine to pledge her support for the man whose campaign was financed by the oligarch who embezzled 5 billion from Privat Bank. Hmm.
Ihsmta 878 posts, incept 2008-04-10
2023-03-16 09:23:57

That a vast majority of individuals in this country have less than $250,000 on deposit with any given "bank" is the reason this is not on their radar.

What I find disconcerting is that individuals and entities with more than $250,000 on deposit do not take the time to know the institution that they are entrusting their money to.

You were correct, Warren Buffet. I'm sitting on the beach, watching the tide go out, noting the swimmers, counting those surprised faces whose ugly naked assess are beginning to show.

"Economists are no different than the prophets of ancient Pompeii who reassured that Mt Vesuvius would never blow. After all, it never had before." Baxter Black, DVM and Cowboy Poet

"You can avoi
Cvdoc 551 posts, incept 2009-06-11
2023-03-16 09:24:10

1. The Republicans aren't serious about cutting government spending. If they were, they would not increase the debt ceiling and make serious cuts. Cut to the bone cuts. How many of these federal agencies could be shut down, e.g. Energy, Education, etc

2. We are governing by crisis. And we use "emergency" to justify unconstitutional actions.

3. These people aren't entirely stupid but they are greedy. Ukraine is a laundromat for money and bribes.

There is only one way it will play out. This will fail like Rome. And our own actions are accelerating it. If you are China or Saudi Arabia, why by US treasuries.

These people who led us here will step forward to lead us out at the other side. They need to be punished so severely that their decendents never think of careers in public policy

Few men desire liberty; most men wish only for a just master.
Rollformer 2k posts, incept 2013-02-13
2023-03-16 09:24:33

Just heard from my contact in the car business that two banks lowered vehicle interest rates today. One a moneycenter bank, the other a sizable regional. Show of strength driving into the fire?
Bodhi 5k posts, incept 2008-02-23
2023-03-16 09:32:56

What I find disconcerting is that individuals and entities with more than $250,000 on deposit do not take the time to know the institution that they are entrusting their money to.

After hearing about Credit Suisse, I went to town yesterday to pull some cash out of my credit union and fill up the gas tank. I was in and out of the CU in 5 minutes, no line at all.

I suspect the majority of people are living paycheck-to-paycheck, so basically they have no cash to pull, much less $250k or more. Besides, most millennials and younger don't dirty their hands with cash anymore.

The proper function of man is to live, not to exist. I shall not waste my days in trying to prolong them. I shall use my time. ~Jack London
Kennington 393 posts, incept 2013-09-12
2023-03-16 10:02:48

ECB raises rates would seem this will only add to the instability going on. Next weeks Fed meeting is going to potentially set of some real fireworks!
Frat 12k posts, incept 2009-07-15
2023-03-16 10:02:57

Individualizing profits while socializing losses - every bankster's wet dream.

And here we are again, just 15 little years from the last one. The only way this stops is by quite-literally chopping heads, a complete and utter economic crash, or in nuclear fireballs.

At this point, I don't know which of the three is most likely.

We're fucked. There will be no happy ending here; there is no going back to 'normal.'. There are only bad outcomes and worse outcomes. And we don't get to choose those, either.
Davinci 61 posts, incept 2021-10-12
2023-03-16 10:03:13

@Tickerguy said: "the distortions that were into the system have to come back out or the ratchet job will continue until more and more things break."

I think more and more things WILL break. Additionally, this looks like the slow nationalization of savings (if not the actual banking system); if the incentives TG describes stay in place long enough, all savings will move from banks to T-bills, making the government the bank.
Neal 289 posts, incept 2014-01-09
2023-03-16 11:15:00

There is reportedly 200 billion in FDIC funds. Now how many trillions of deposits are covered by that sum and what happens when panic really gets going and tens of millions of savers decide to withdrawal physical cash to keep at home such that the 200 billion is paid out for collapsing banks at the same time that all the banks that have not yet failed are also looking for money to assuage their own customers?
Does the government or whatever just create more money to cover both the FDIC and the still standing banks? Digital money will only cover part of the problem as many will want physical hard cash. Also how many will not want even banknotes but actual coins such as stackers and preppers. The US mints only just over a billion dollars of coins each year so it wouldnt take many to stack coins such as the nickel for there to be empty tills. When retailers cant make change then more people will notice that there are problems and Greshams Law will make all coins vanish. And yes Ive lived in a country where this happened and I keep at least half a ton of coins stashed away as my fallback money. Worst comes to happen and the coins metal content will exceed their face value plus they can always be used as shrapnel as has happened in many wars.
Boredfree 1k posts, incept 2021-09-15
2023-03-16 11:15:24

If we're facing the ultimate in financial feces hitting the fan blades does FDIC insurance mean anything?

This is a sucky time to be stuck in the finanacial middle as you're gonna be SQUEEZED! Mostly downward economically.

Poor folks and the uber rich will be ok.
I'd be shorting Starbucks if I knew anything about investing. Then again, I don't have money to invest.

Can't lose what you don't have... ;)

The problem is most people want to point a finger rather than their thumb when dealing with challenges.
Synopsis 85 posts, incept 2010-02-05
2023-03-16 11:15:33

After holding rates near zero for 15 years, its a given that anyone holding a bond which the bought in the past 15 years will be under water after the interest rates began to rise. Its not that complicated. Obviously after 15 years of ZIRP this was going to be a big problem. Instead they tell us its the bank are sound, dont take any money out and earn 0.5 percent (meanwhile inflation is raging) in your savings. Again, we should only listen to the so called sophisticated experts when it comes to the import stuff.

Oldpool 1k posts, incept 2010-06-23
2023-03-16 11:15:49

Dont forget that those same banks had long duration notes prior to ZIRP.

Liberty, Comrade!
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