Mar 26 2017

On The Edge Of An “Uncontrollable Liquidity Event”: The Definitive Guide To China’s Financial System

Re-Posted From ZERO HEDGE Mar 26, 2017 8:26 PM

While most traders over the past month have been obsessing over developments in Washington, the real action – most of it under the radar – has played out in China, where as discussed over the past few weeks, domestic liquidity has tightened notably, culminating with an unexpected bailout by the PBOC of various smaller banks who defaulted on their interbank loans as interested rates particularly on Certificates of Deposit (CD) – which have become a preferred funding conduit for many Chinese banks – soared. Ironically, these mini PBOC bailouts took place only after the PBOC itself decided to tighten conditions sufficient to choke off much of the shadow debt funding China’s traditional banks.

As a result, the interbank CD rate rallied strongly, leaving a narrower or negative spread for some smaller banks, whose legacy carry trades (see below for details) suddenly became unprofitable. Also, as reported last Tuesday, several small banks failed to meet overnight repo obligations. This liquidity tightness has been mainly due to escalating financial deleveraging, as the PBOC has lifted market rates and rolled out stricter macroprudential policy rules.

But all those events in isolation seem as merely noise against what otherwise appears to be a relatively benign, even boring, backdrop: after all, neither China’s stock, nor bond markets, has seen even remote volatility in recent months, and certainly nothing compared to what was experienced one year ago, when the Chinese turmoil nearly led to a bear market across developed markets. Then again, maybe the markets are simply once again behind the curve due to all the inherent complexity of China’s unprecedented, financialized and extremely complex pre-Minsky moment ponzi scheme.

Last last week, Deutsche Bank analysts led by Hans Fan released what is the definitive research report summarizing all the latest troubling trends facing China, which judging by capital markets, nobody is paying any attention to. They should, because as Deutsche Bank puts it, if taken too far, they threaten an “uncontrollable liquidity event“, i.e., the financial cataclysm that Kyle Bass and other perma-china-bears have been waiting for.

And, as usual, it all started with rising interest rates, which in turn is leading to increasing funding pressure, which if left unchecked, could lead to dire consequences for China’s underfunded banking system.

Here is a fantastic explanation of everything that has happened in China in recent weeks, and more importantly, what may happen next, courtesy of Deutsche Bank. We urge readers to familiarize themselves with the content as we will refer back to this article in future posts.

* * *

Only in early stage of financial deleveraging

China’s monetary policy has been shifting gradually towards a tightening stance since 2H16. Targeting the liabilities side of the banking sector, the PBOC hiked rates of monetary tools, such as MLF, SLF and OMO (Figure 1), and withdrew liquidity on a net basis after the Chinese New Year (Figure 2). At the same time, it targeted the asset side of the banking sector when it rolled out stricter MPA rules by including off-BS WMP credit in broader credit assessment and imposing stricter-than-expected penalties on banks that fail to comply.

As a result, the key indicators in the money market, including repo and CD rates, all suggest stretched domestic liquidity. For example, the 7-day repo rate, which is the most representative liquidity indicator, has exceeded the interest rate corridor ceiling of 3.45% several times this year (Figure 3). Moreover, the interbank CD rate spiked to 4.6% on 20 Mar 2017, up c.180bps from last year’s low (Figure 4).

We summarize in the below diagram recent financial deleveraging efforts by regulators.

Why push forward financial deleveraging?

We believe the PBOC aims mainly to contain the fast-growing leverage in China’s financial sector. In our view, the country’s financial leverage basically relates to speculators borrowing excessive wholesale funding to grow assets and chase yield, rather than relying on vanilla deposits. To measure this, we believe one of the good indicators of financial leverage is the credit-to-deposit ratio, calculated as total banking credit as a percentage of total deposits. The higher the ratio, the more fragile the financial sector, and the more likely the banking system will run into difficulties to finance unexpected funding requirements. Traditionally the loan-to-deposit ratio was widely used to measure system liquidity risk, but has become increasingly irrelevant in China, as banks are growing their bond investments and shadow banking books to extend credit.

As shown in Figure 6, the credit-to-deposit ratio in China’s banking system has risen sharply by 27ppts since 2011 to reach 116% as of February 2017. We see the rising credit-to-deposit ratio basically is a function of increasing reliance on wholesale funding to support strong credit growth. As of end 2016, borrowing from banks and NBFIs accounted for 17% of total liabilities, against 8% 10 years ago (Figure 7).

Which banks are more leveraged? Joint-stock banks and city/rural banks

As we have long argued, the risks are not evenly distributed in China’s banking system; there are notable differences in the balance sheet structures of different types of banks. As shown in Figure 8, medium-sized banks, which mainly include joint-stock banks, recorded the highest credit-to-deposit ratios and hence are most reliant on wholesale funding. At the same time, small banks, which mainly include city/rural commercial banks, also delivered notable increases in credit-to-deposit ratios, despite a lower absolute level. The credit-to-deposit ratio for small banks has increased by 30ppts since 2010, vs. 14ppts for the big-four banks in the same period.

On the liabilities side, medium-sized and small banks mainly rely on wholesale funding, i.e. borrowing from banks and NBFIs. As of 1H16, wholesale funding made up 31% and 23% for medium-sized and small banks, respectively, against only 13% for big-four banks, as shown in Figure 9.

A closer look into interbank CDs – funding pressure ahead

Wholesale funding for smaller banks has been obtained mainly by issuing CDs in the interbank market. Interbank CDs have supported 20% of smaller banks’ assets expansion over the past 12 months. Since the introduction of interbank CDs in 2014, CD issuance recorded strong growth and the balance jumped 89% yoy to Rmb7.3tr in Feb 2017 (Figure 10), or 3.4% of total banking liabilities.

Joint-stock and city/rural banks account for 99% of issuance (Figure 12). In the coming months these banks have ambitious CD pipelines. More than 400 banks announced plans to issue CDs worth Rmb14.6tr in 2017. This represents 60% yoy growth from the issuance plan in 2016. Investor-wise, WMPs, various asset management plans and commercial banks themselves are the major buyers, which combined make up 79% of the total balance (Figure 13).

However, we view banks that are more reliant on CDs as more vulnerable to rising rates and tighter regulations.

Reflecting tighter liquidity, the interbank CD rate has rallied strongly, with the 6-month CD pricing at 4.6% on average. Some CDs issued by smaller rural commercial banks have been priced close to 5% recently. This would have pushed up the funding cost and notably for smaller banks. If banks invest in low-risk assets such as mortgages, discounted bills and treasury bonds, this would lead to a negative spread. Alternatively, banks can lengthen asset duration, increase the risk appetite, add leverage or slow down asset growth. Among these alternatives, we believe a slowdown in asset growth is the most likely.

Caixin previously reported CDs are likely to be reclassified as interbank liabilities, capped at 33% of total liabilities. This potential regulation could add funding pressure for banks with a heavy reliance on interbank liabilities. With Rmb4tr interbank CDs to mature during Mar- Jun 2017 (Figure 16) and interbank liabilities exposure approaching the limit (Figure 17), joint-stock and city/rural banks are subject to notable funding pressure.

We show the listed banks’ issuances in the chart below. INDB, SPDB and PAB are among the most exposed to interbank CDs.

* * *

What are the implications?

Are we close to a “tipping point”?

For now, probably not, especially in a year of leadership transition. In our view, the risk of an uncontrollable liquidity event is low, as the PBOC will do whatever it takes to inject liquidity if needed. In the domestic liquidity market, the PBOC exerts strong influence in both the volume and pricing of liquidity. With 90%+ of financial institutions directly or indirectly controlled by the government, PBOC will likely continue to give liquidity support. In 2H15, the central bank established an interest rate corridor to contain interbank rates within a narrow range and pledged to inject unlimited liquidity to support banks with funding needs.

However, continuing liquidity injections do not come without a cost. A bigger asset bubble, persistent capital outflow pressure and a lower yield curve over the longer term are side effects that China will have to bear. At the same time, the execution risk of PBOC itself is rising.

Implications on system credit growth

We expect system credit growth to moderate from 16.4% yoy in 2016 (16.1% in Feb’17) to approximately 14-15% yoy in 2017 (Figure 23). As a result, the credit impulse is likely to trend lower from the current high level (Figure 24). The slower credit growth is mainly attributable to several factors: 1) a tighter liquidity stance to push up the funding cost of smaller banks and to force them to slow down asset growth; 2) further curbs on shadow banking; 3) a higher bond yield to defer bond issuance; and 4) slower mortgage loan growth.

Appendix A – Liquidity flows in China’s interbank market

New deposits supported 55% of asset growth in China’s banking system in 2016. The remaining 45% of new assets were mainly funded by borrowing from PBOC (19%) and borrowing from each other (19%, including bond issuance). While borrowing from NBFIs remained flat for the entire system, it was the main funding source for medium-sized and small banks. We summarize the liquidity flows in China’s interbank market in Appendix A.

Liquidity injection from PBOC. Over the past 12 months, to offset the liquidity drain from falling FX reserves, the PBOC has injected a huge amount of liquidity worth Rmb5.8tr into the banking system, which is equivalent to 400bps of RRR cuts (Figure 29). Of this injection, 30% and 24% have been made to support joint-stock banks and policy banks, respectively (Figure 30). For details, please see our report, PBOC liquidity facilities: Doing whatever it takes, 23 January 2017.

Borrowing from interbank market. Policy banks and big-four banks are net interbank lenders, while joint-stock and city/rural commercial banks are net borrowers. Joint-stock and city/rural banks not only borrow from policy/big banks, but also from each other. This could potentially lead to stronger contagion effects if some of them run into liquidity stress.

Lending/borrowing between banks and NBFIs. There has been a sharp rise in net claims to NBFIs from banks (Figure 33). We believe this is due to rising shadow banking transactions and also arbitrage activities with funds self-circulating within the financial sector. Clearly as shown in Figure 34, small banks are key lenders to NBFIs

Appendix B – What is driving the financial leverage?

From the accounting perspective, we believe the rising credit-to-deposit ratio is mainly due to bank credit circulating back into the banking system as non-deposit liabilities. In normal cases, when a bank makes a $100 corporate loan or purchases a $100 corporate bond, the bank books the credit to a corporate on the asset side while it also books a deposit on the liability side. We show a normal case in Figure 35. However, if a bank’s money circulates back into the banking system, just like in the two cases we illustrate in the diagram below, the $100 deposit is removed but interbank borrowing or borrowing from NBFIs would increase by $100. While there are likely to be many variants of bank credit circulation, we elaborate on two cases in detail.

Case #1: Bank credit circling via NBFIs

It is well known that NBFIs have been serving as SPVs to channel shadow banking credit from banks to corporates in past years. What is insufficiently addressed though is that NBFIs also have been acting as channels for bank credit circling. Let us show a simple example below:

First, Bank A invests in an asset management plan packaged by an NBFI. This is booked as a receivable investment on Bank A’s balance sheet.
Second, the NBFI invests further in a CD issued by Bank B. Bank B books the CD under interbank borrowing. The money circulates back into the banking system and no deposit is generated.
In some cases, if the yield of the CD does not cover the cost of issuing the asset management plan, the NBFI will leverage up in the bond market by pledging the CD through repo transactions. The leverage could be built up by two transactions: 1) entrusted bond investment (“Daichi” in Chinese); or 2) entrusted investment (“Weiwai” in Chinese), which we discuss in detail in our 2017 outlook report.
In this case we use the investment in a bank’s CD as an example. In reality it applies to investment in interbank CDs, interbank negotiated deposits and financial bonds issued by banks, which are all circulating money back into the banking system.

The bank credit circling through NBFIs is growing rapidly. This is evidenced by strong growth in banks’ receivable investments, which reached Rmb21tr as of end-2016 to account for 10% of commercial banking assets, as shown in Figure 36. This represents 80% CAGR in balance since 2013. The majority of these investments was made by medium-sized and small banks. Note that not all receivable investments are credit circling, but we believe it should make up a notable portion. We summarize the structure of banks’ receivable investments in Figure 38.

The NBFI here could be any trust company, broker, fund subsidiary or insurance company. We believe brokers and fund subsidiaries should be the key players, as their bond trading leverage in the interbank bond market is much higher than other participants (Figure 37).

Case #2: Bank credit circling via corporates

Corporate loans may circle back into the banking system as well. This is because many corporates use borrowed but idle cash to buy bank WMPs. Below is a simple example:

Firstly, Bank A makes a loan to a corporate.
Secondly, the corporate uses the loan proceeds to buy a wealth management product issued by Bank A.
Thirdly, Bank A invests the WMP fund in a financial bond issued by Bank B. This corporate deposit would circle back to the banking system as a non-core liability.
To make this process economic, in many cases it would require leverage. The corporate borrowing cost may be at 4%, but the financial bond issued by Bank B may only yield 3.5%. To compensate the yield shortage, Bank A has to entrust the WMP fund to a third party and to leverage up by pledging the bonds through repo transactions. This process is called entrusted investment (“Weiwai” in Chinese, or entrusting to an external party).

This type of transaction is not an individual case. As shown in Figure 39, corporates purchased Rmb7.7tr WMPs in 1H16. This accounted for 7% of total corporate debt in China, or 29% of total WMP AUM in the system. SOEs, large private corporate and listed companies enjoy ample bank lending resources with low interest cost. However, the lack of attractive investment projects in their own business prompts them to invest in the financial market (i.e. bank WMPs).

Mar 26 2017

Is Bankruptcy For Illinois The Answer?

by Tyler Durden

Re-Posted From ZERO HEDGE Mar 26, 2017 8:30 PM

Authored by Mark Glennon via WirePoints.com,

Could a formal bankruptcy proceeding for the State of Illinois be the answer to it’s fiscal crisis? If you think that’s out of the question, as many do, you’re wrong. On the contrary, though Congress isn’t working on it now, the option is quite viable, though subject to obstacles and open issues. The question is certain to gain growing national attention as a number of states sink further into insolvency, so it’s time to get up to speed. I have yet to see a single Illinois politician or reporter raise the question, but plenty of others outside the state are talking about it for Illinois. More on that later.

This article summarizes the basic issues.

First, why? Why would Illinois or any other state consider bankruptcy? Just as for insolvent corporations and municipalities that reorganize, a successful state bankruptcy would provide a fresh start by putting a state on a sustainable path that frees up funding for needed services — funding that’s getting crowded out by legacy debts. It would do that in three primary ways:

Debt that cannot be repaid gets cancelled. In the case of governments, that includes unfunded pension liabilities insofar as there’s no realistic hope of paying them. For Illinois, that means part of its $130 billion pension debt could be erased notwithstanding the state constitutional pension protection clause. Unsecured bonds and other debts could also be cut. Illinois will never have a truly balanced budget or be restored to competitiveness unless those cuts are made, as we’ve written so often before.
Unfavorable contracts and leases can be cancelled in bankruptcy, which include employment contracts and collective bargaining agreements.
Bankruptcy provides an orderly, rational process to sort out who gets what. Without it, a free-for-all eventually sets in for any entity that can’t meet its obligations. Creditors start suing and racing to courts to get the first judgement liens. Bankruptcy halts that tsunami of litigation and foreclosures.

There are constitutional objections to expanding bankruptcy to states. Bankruptcy for governments is a matter of Federal legislation — Chapter 9 the United States Bankruptcy Code. Today, it covers only cities, towns and other municipalities, but not states.

Expert legal opinions differ on whether Chapter 9 could simply be expanded by Congress to states, but my sense is that the weight of opinion is that Congress could, and eventually will, do so.

Congress unquestionably has the power to make bankruptcy laws — it’s expressly granted in the Constitution. Further, its power to apply bankruptcy to municipalities was upheld by courts over seventy years ago. Skeptics think putting state finances under control of a Federal bankruptcy court would upset the notion that states, unlike municipalities, are “sovereigns.” They cite the 10th Amendment, which reserves to states powers not granted to the Federal government, and the 11th Amendment, which prohibits lawsuits in Federal courts against a state by citizens of another state. For those interested in the details, see the article linked here by Michael McConnell, a Stanford Law School professor.

A leading expert on the other side is David Skeel, a law professor at the University of Pennsylvania. He wrote outright that, “The constitutionality of bankruptcy-for-states is beyond serious dispute.” The key, as he sees it, is that bankruptcy would be entirely voluntary, which should eliminate any concerns about Federal intrusion on state sovereignty.

A professorial legal analysis, however, probably wouldn’t matter in the end. Courts often bend the rules or make new ones when major emergencies or humanitarian issues arise. Even Professor McConnell, who doesn’t like the idea of state bankruptcy, agrees with that:

If we were facing a genuine fiscal meltdown, which could be solved only through bankruptcy or some equivalent process, and if the use of that process enjoyed the support of Congress, the President, and the affected states, it is not hard to imagine the Court swallowing its theoretical objections.

Beyond the legal issues, some fear that merely authorizing the option of bankruptcy would drive up state borrowing cost because potential bond buyers would face the added risk of having debt cancelled. That’s probably true for states in or near insolvency, but wouldn’t it also instill the needed borrowing discipline never to get to that point? Bankruptcy would only be available upon insolvency — that’s already required under the Code — which means inability to pay what’s owed. If you can’t pay you won’t pay, bankruptcy or no bankruptcy, so it might not make a difference in the long run. In any event, higher borrowing costs would only result during the period from when it was authorized to when a state filed.

Remember that most objections to bankruptcy come from the municipal bond industry, so take them with a huge grain of salt. That industry primarily just wants to protect against losses on bonds already issued. The state shouldn’t be concerned about those; only future borrowing costs should matter. Future borrowing costs are lowered, not raised, if a successful bankruptcy reduces legacy debt.

And remember that the muni bond industry is already well aware that Congress could extend bankruptcy to the states. Rest assured they know all that’s being written here, and much more. They are way ahead of the curve. To some extent, they’ve already built bankruptcy risk into what they will pay for state bonds. And their efforts to shore up their position to assure they come ahead of taxpayers and other creditor are underway, discussed in our earlier article.

Public employee unions and their supporters also don’t like bankruptcy because of the threat it poses to pension obligations. That’s perhaps rational, if you assume states will in fact eventually find some way to pay scheduled obligations. Not Illinois, in my opinion. All sides need to get on the same page about the plain math. And a bankruptcy court should not be expected to cut pensions if it’s indeed feasible to pay them in full. Unions would be wise to recognize that bankruptcy courts so far have typically favored public pensioners over unsecured bondholders. However, time is not on the pensioners’ side: The muni bond industry is hard at work doing all it can to get first liens and other mechanisms to attain priority over pensions.

Unions also worry that collective bargaining agreements could be cancelled. Well, maybe. This highlights the most important general question about how state bankruptcy would work. And the issue applies to municipal bankruptcies as well: Who controls the bankruptcy proceeding?

The key here is that, on the face of Chapter 9, the bankrupt government — basically, the incumbent politicians — have exclusive power to submit the plan of reorganization. But it’s essential, if a bankruptcy is to be successful, that the same politicians and special interests responsible for bankrupting a government not control the bankruptcy, too. Otherwise, that government is doomed forever and a day.

That problem can be overcome in a number of ways that could be written spacifically into legislation expanding Chapter 9 to states. That is, Chapter 9 would not be extended ‘as is’ to states; appropriate changes for states certainly would be made.

Puerto Rico offers a particularly interesting way to address the problem. For Puerto Rico, Congress last year passed legislation similar to bankruptcy, known as PROMESA, that included appointment of a qualified ,seven-member oversight board. That board effectively has control over most major financial issues and will have to sign off on any reorganization plan that cuts debts. Opponents of bankruptcy for states are terrified that PROMESA may have set some sort of precedent. A national television ad campaign opposed PROMESA while Congress was considering it for just that reason. We’ll be writing separately about PROMESA and whether parts of it could work for Illinois.

The problem of who controls the bankruptcy can also be overcome at the state level. Detroit handled the problem in its bankruptcy by having the state appoint an emergency manager empowered to negotiate its reorganization plan. The same concept could work for appointment of a financially competent control board similar to New York City’s during its crisis in the 1970s.

Various “bankruptcy-light” proposals have also been floated. They would have Congress use its bankruptcy power to allow states cut pension debt through a proceeding short of a full bankruptcy. One, proposed by the Manhattan Institute, was the subject of a Chicago Tribune guest article last year.

But that’s about all you’ll find from the Illinois press about bankruptcy for states. Outside, however, the discussion has proceeded for some time. In 2011 the New York Times reported that policymakers were working behind the scenes to come up with a way to let states declare bankruptcy. They did their work “on tiptoe,” according to the Times, to avoid alarming the municipal bond community. Supporters included Jeb Bush and Newt Gingrich.

Legislation never materialized but the discussion continues. Bloomberg-Business Week wrote last year under the headline, “The Case for Allowing U.S. States to Declare Bankruptcy.” Significantly, William Isaac also wrote last year that both Illinois and Chicago should already be in bankruptcy. He’s the former Chairman of the FDIC and a nationally recognized insolvency expert.

I’m not quite to the point of saying bankruptcy for Illinois is unavoidable, but it’s getting mighty close.

* * *

For those who dismiss the possible need for bankruptcy, I’ll let two points suffice here:

The only legal ways to cut the state’s $130 billion unfunded pension debt, thanks to the Illinois Supreme Court’s interpretation of the Illinois Constitution, are 1) amendment of the state’s constitution, or 2) bankruptcy. However, the constitutional amendment might not work because serious objections would remain under the United States Constitution. Further, amending the state constitution then cutting pensions would would raise the question, “Why only pensions?” Shouldn’t other debts, especially unsecured bonds, be cut equally? That would be an entirely fair objection, and the only way to fairly cut those other debts along with pensions is bankruptcy. Nobody has ever proposed a solution for Illinois that truly balances the budget and pays its debt. Pensions already consume about 25% of the state’s budget even though they remain badly underfunded, which keeps the pension debt growing rapidly.

The reason why Illinois can’t get a budget solution in place is there’s not any real one to be had. The true budget deficit is two to three times the official one that lawmakers can’t balance. See the numbers linked here. Spending has already been slashed, and tax increases attempting to stabilize the state would be suicide — they would backfire by accelerating the flight of our tax base, ultimately lowering revenue. Illinois will continue to sink rapidly into further debt unless existing obligations, especially pension debt, get cut.

Mar 26 2017

Watch These Geopolitical Flashpoints Carefully

One thing for sure is the Obama left us in a mess!

Mar 26 2017

KOMMONSENTSJANE – DID RACHEL MADDOW GET PUNK’D BY HER OWN COHORTS? DID THE CHICKEN EVER CROSS THE ROAD?

Maddow makes a fool of herself more often than naught.

kommonsentsjane

~ Conservative Zone
Trump’s Tax Return Wasn’t the Scoop Rachel Maddow Hoped It Would Be

For nearly two years now, MSNBC’s Rachel Maddow has been itching to tar and feather Donald Trump with damaging information or expository gossip that would embarrass our country’s new president or at least make him unpalatable to the nation’s voters. On Tuesday, March 14, Maddow appeared to have just such a scoop, as she teased on Twitter to draw in ratings.
The only problem? The story was less of a scoop and more simply a piece of virtual non-news because the big piece of information she had — two leaked pages of Trump’s 2005 tax return — contained no “smoking gun” bombshells.
In fact, for all practical purposes, it made Trump look like a law-abiding citizen compared to other high-profile personalities such as ex-President Obama, Democratic candidate Bernie Sanders and wealthy investor Warren Buffett, who…

View original post 842 more words

Mar 26 2017

“Don’t Say You Haven’t Been Warned”

by Tyler Durden

Authored by Jeffrey Miller via Miller’s Market Musings,

So after a long period of basically no volatility, we finally got some – in a hurry. In case you were out, the S&P 500 (SPX) finally had a down day of more than 1%. But that’s not the real story. Look in bankland, where we have been cautious ever since the rip higher on the Trump Trade (lower taxes, higher rates, lower regulations). The KRX (KBW Regional Bank Index) fell over 5% on Tuesday – yes, the bank index took a dive of 5% in one day. And it didn’t bounce. The SPY was up a bit on Wednesday, but marginally, while the dollar continued to weaken versus the Yen and Euro. The big questions being asked all revolve around whether the dip in the 10-year bond yield to under 2.40% is reflecting a weaker outlook for the Trump Trade, or, if it’s just an unwind of a massive 10-year bond short after the Fed hike last week was perceived as dovish.

All Calvin and Hobbes comics courtesy of Bill Watterson and Go Comics.

The mini-rally in the 10-year bond could be the proximate cause of the banks selling off, but that is a little too old school – that implies that what is driving these stocks right now is a focus on fundamentals. But as long-time readers know, fundamentals only matter in the very long term – in the short term, positioning, especially among the CTA/trend following/risk parity crowd, can become very important at inflection points. These funds all tend to been leaning in the same direction at the same time, in size, and are designed to pull down risk and then flip the other way quickly on a steep decline. In short, they are the embodiment of feedback loops that drove the big sell off in August 2015 and in early 2016. But…this time I think we could be in for a bigger shock. Just because the market didn’t follow through to the downside after Tuesday doesn’t mean we’re done. Instead, this may be a preview of coming attractions, as the KRX falling 5% in a day is a warning sign, not an all clear sign. Because these funds can be easily spooked – especially on a hike.

The issue isn’t that there are funds that trend-surf. The issue is that there are now a lot of them, and there has been a recent push into using these funds to “hedge” risk. The idea is that any downturn will evolve slowly enough for these funds to sell into it – which has happened in the past. But that was when the group was a lot smaller. A recent Financial Times article detailed how pervasive this has become. According to the article, clients of Pension Consulting Alliance (PCA) typically allocate 10-20% of their assets to a “CRO program.” What is a CRO program? “Crisis Risk Offset.” PCA apparently coined the term. Now, full disclosure: I know a few people who work at PCA and they are all great folks (and neighbors). This isn’t about them. It’s about allocating to momentum strategies in a size that may be too big to execute properly. Portfolio insurance anyone? If you recall, that didn’t work out well (see October 19th, 1987). Will that (down over 20% in a single day) happen again? Unlikely. But we could easily get a situation where a garden-variety 5% pullback in the SPX quickly morphs into a fast 10-15% decline, as funds de-lever their equity longs or flip short. See these charts of where we are in terms of equity exposure in various trend-following systems, and the size of these funds today.

The problem with everyone leaning in one direction is that they scare easily. When realized volatility has been near all-time lows, as it has been in recent months, the simpler versions of these strategies view assets as less risky, so they lever them up. What the models fail to capture is the speed with which volatility can return. If volatility slowly creeps back up, then the models work fine. But if it suddenly spikes higher, the models fall apart, other investors quickly de-risk, and everyone is up all night looking for ghosts. Don’t say you haven’t been warned.

This was one of the weirder weeks I’ve seen in awhile. Various proxies for U.S. interest rates were bouncing around based on each tweet and missive from D.C. about whether or not the new healthcare bill would pass. When the bill was first pulled on Thursday, U.S. stocks fell, and rate proxies reacted as if all of the Trump agenda was in trouble (Trump policies are viewed as inflationary, so rates move up when he’s doing well and down when he’s not). Look at the Yen this week – every time the Trump agenda looked vulnerable, it rallied. And then that relationship quickly fell apart at the end of the day on Friday. When the healthcare bill got pulled for good Friday, it took about 5 minutes for the narrative to shift from Trump failed to now tax cuts can happen sooner rather than later, and so the Yen fell sharply. This is the world we live in today – traders are making up new and different reasons to scare themselves daily. Should we care? I’d say no, except we’re in unstable times (see the 5% selloff in the KRX on Tuesday for proof), and with lots of money in passive funds, ETFs and trend-following strategies, it won’t take a lot to get the markets heading down fast.

So what will be the catalyst to cause more than a 1% sell-off in the SPX? While everyone is fixated with the non-bill in D.C., I think they are missing the big risk in the market, which is only getting bigger by the day. Long-time readers can guess where this is going. That’s right – China. While we’ve been distracted in the U.S., China has been raising its equivalent of the Fed Funds rate and trying to stem a credit bubble there from ballooning out of control, while at the same time trying to make sure that if they do succeed in popping the bubble, it deflates slowly. Good luck with that. I’m not saying they won’t be able to do it. I’m just saying that no country has ever pulled it off before. The borrowing rates for their non-bank financial institutions (NBFIs) are rocketing higher (see the chart below) as they scramble for funds. Evidently, the popular thing for these NBFIs to do is lend very long-term into risky ventures in order to generate higher yields, but borrow very short-term (under a year) because the funding is cheaper. If this sounds just like our S&L crisis, version 2.0, you’d be correct. I would have thought there are some things the Chinese may have wanted to avoid copying from the U.S., but apparently they’ll have to learn that lesson for themselves.

Take a look at the charts below. You’re actually seeing defaults in China occur, and at an increasing rate (albeit from zero, as extend and pretend is the national motto in China, where everything is always awesome – it is always awesome, right?). Remember, you’re also seeing short-term repo rates spiking. A sign of renewed growth and inflation fears? Ah, no. It’s a sign of stress in the funding markets and increasing counterparty risks. Put another way, credit is starting to fray in China right after the biggest increase in debt in the history of the world.

How will it end? I think Calvin has it pretty well figured out in the below comic strip.

?So to recap: the question investors need to ask themselves is what will happen if China’s issues start to manifest themselves in global markets (remember August 2015? Me too. We’re all in this together). The combination of large risk-parity funds and CTAs being quite long equities at the exact moment that China’s credit bubble is starting to show signs of stress could end quite badly. The pension funds that have hired CTAs to sell into the next selloff will exacerbate what would have in the past been a normal correction. And when retail investors who have been relentlessly told to invest their money in long-only index funds or ETFs wake up to a market that is down 10%, 15%, or 20% fast, are they going to hold on, or even buy more, or are they going to realize that their ship is just a plank, and decide to swim for shore while they can? If history is a guide, we’re going to see lots of investors making a swim for it.

Mar 26 2017

Why Middle Class Whites Are Dying Faster (In 6 Painful Charts)

by Tyler Durden

Re-Posted From ZERO HEDGE Mar 26, 2017 7:20 PM

Authored by Julia Belluz via Vox.com,

In 2015, a blockbuster study came to a surprising conclusion: Middle-aged white Americans are dying younger for the first time in decades, despite positive life expectancy trends in other wealthy countries and other segments of the US population.

The research, by Princeton University’s Anne Case and Angus Deaton, highlighted the links between economic struggles, suicides, and alcohol and drug overdoses.

Since then, Case and Deaton have been working to more fully explain their findings.

They’ve now come to a compelling conclusion: It’s complicated. There’s no single reason for this disturbing increase in the mortality rate, but a toxic cocktail of factors.

In a new 60-page paper, “Mortality and morbidity in the 21st Century,” out in draft form in the Brookings Papers on Economic Activity Thursday, the researchers weave a narrative of “cumulative disadvantage” over a lifetime for white people ages 45 through 54, particularly those with low levels of education.

Along with worsening job prospects over the past several decades, this group has seen their chances of a stable marriage and family decline, along with their overall health. To manage their despair about the gap between their hopes and what’s come of their lives, they’ve often turned to drugs, alcohol, and suicide.

Meanwhile, gains in fighting heart disease have stalled, and rates of obesity and diabetes have ploddingly climbed.

So the rise in mortality for white mid-life people in America since the late 1990s is actually the final stage of a decades-long process. “It’s about the collapse of white middle class,” said Case. Here are the five big takeaways from the researchers’ new opus.

1) Suicides, alcohol, and drug overdose deaths have gone up across the entire country. (Read: It’s not just a rural problem.)

Brookings

“Deaths of despair” — or suicide, alcoholism, and drug overdoses, particularly from opioid painkillers — are a growing problem for midlife white people.

As you can see on the left-hand map, the epidemic started in the Southwest. Now it’s “country-wide,” the study authors write, and the increase can be “seen at every level of residential urbanization in the US.” So it’s not just a rural problem or an urban problem — it’s both.

The crisis is particularly acute among middle-aged whites. “The deaths of despair come from a long-standing process of cumulative disadvantage for those with less than a college degree,” Case and Deaton write. “The story is rooted in the labor market, but involves many aspects of life, including health in childhood, marriage, child rearing, and religion.”

Brookings

In an interview, Deaton explained, “The cohort that entered the labor market in the ’70s on down, their jobs earnings and prospects are worse. That affected their marriage prospects. Marriages got screwed up. They had children out of wedlock. Their pain levels [are] going up.” All that contributes to the deaths of despair.

The study authors don’t see the opioid supply as the fundamental factor here, but “prescription of opioids for chronic pain added fuel to the flames, making the epidemic much worse than it otherwise would have been,” they wrote.

The impact of rising deaths of despair on overall mortality was masked until the late 1990s by the decline of heart disease deaths. But recently that has changed too.

2) Deaths from chronic diseases such as diabetes have been rising

County-level mortality from diabetes, urogenital, blood, and endocrine diseases between 1980 and 2014. You can see these trending up all over the country. JAMA

Progress against mortality from heart disease has slowed and stopped, and deaths from cancer, which had been on a steady decline, are also stagnating in this group.

Meanwhile, other chronic diseases have continued to rise in the whole population, particularly among middle-aged white people. Diabetes’ prevalence has exploded in the US over the past 20 years. Nearly 30 million Americans live with the disease today — more than three times the number in the early 1990s. And this may be a major, underappreciated driver of the mortality trend.

3) The least-educated Americans are suffering the most

Brookings

The rise in mortality among middle-aged whites is largely being driven by those with a high school degree or less. The researchers find that the gap in mortality between more and less educated is increasing, while mortality is also rising for those without a college degree and falling for those with a college degree.

“It looks like there are two Americas,” Case said. “One for people who went to college and one that didn’t.”

The middle-aged whites with less than a bachelor’s degree saw “progress stop in mortality from heart disease and cancer, and saw increases in chronic lower respiratory disease and deaths from drugs, alcohol, and suicide,” the researchers write.

Why education is such an important health indicator is difficult to untangle, Case added. “But when you think about what happens when industries pull out of towns, the tax base implodes, schools [are] not well funded, and the death spiral continues.”

In the past, people with low levels of education could get a job in a factory and work their way up the chain of command. “You could graduate high school, work at Bethlehem Steel, get more money every year as you get more experienced,” Deaton said, “and turn yourself into one of the famed blue-collar aristocrats of the 1970s.” Now, he added, “There’s a feeling that life has gone, and remainders of that life are getting less and less for each generation.”

To be clear, the study authors don’t buy the idea that one’s income relative to what one expected is influencing mortality. Rather, “It’s the life you expected to have relative to your father or grandfather — it’s just not there anymore,” Deaton said.

4) Other nonwhite racial groups aren’t experiencing the same mortality uptick — so it’s not just about income

Brookings

As you can see here, mortality for middle-aged black people converged with mortality for middle-aged white people with low levels of education in the late 2000s (though the white population overall is still doing better than African Americans). Meanwhile, mortality rates among Hispanics continued to fall.

These other racial groups aren’t necessarily doing any better economically than their white counterparts, which is part of the reason Case and Deaton don’t accept a simple income explanation for the death uptick.

“It is possible that it is not the last 20 years that matters, but rather that the long-run stagnation in wages and in incomes has bred a sense of hopelessness,” they write. “But … even if we go back to the late 1960s, the ethnic and racial patterns of median family incomes are similar for whites, blacks, and Hispanics, and so can provide no basis for their sharply different mortality outcomes after 1998.”

Instead, the researchers think the fact that the overall life prospects for white middle-aged people without a BA have declined over time — they are doing worse than their parents on both a personal and professional level, and probably worse than they expected — is nudging mortality downward. This regression is different from the story of progress in the African American community, for example. Here’s Case and Deaton again.

The historian Carol Anderson argued in an interview in Politico (2016) that for whites “if you’ve always been privileged, equality begins to look like oppression,” and contrasts the pessimism among whites with the “sense of hopefulness, that sense of what America could be, that has been driving black folks for centuries.” That hopefulness is consistent with the much lower suicide rates among blacks, but beyond that, while suggestive, it is hard to confront such accounts with the data.

5) This story is unique to the US

Brookings

The US, particularly middle-aged white Americans, is an outlier in the developed world when it comes to this mid-life mortality uptick.

“Mortality rates in comparable rich countries have continued their pre-millennial fall at the rates that used to characterize the US,” Case and Deaton write. “In contrast to the US, mortality rates in Europe are falling for those with low levels of educational attainment, and are doing so more rapidly than mortality rates for those with higher levels of education.”

If American wants to turn the trend around, then it has to become a little more like other countries with more generous safety nets and more accessible health care, the researchers said. Introducing a single-payer health system, for example, or value-added or goods and services taxes that support a stronger safety net would be top of their policy wish list. (America right now is, of course, moving in the opposite direction under Trump, and shredding the safety net.)

They also admit, though, that it’s taken decades to reverse the mortality progress in America, and it won’t be turned around quickly or easily. But there is one “no-brainer” change that could help, Case added. “The easy thing would be close the tap on prescription opioids for chronic pain.”

Unlike health care and increasing taxes, opioids are actually a public health issue with bipartisan support. Deaton, for his part, was hopeful. Paraphrasing Milton Friedman, he said, “All policy seems impossible until it suddenly becomes inevitable.”

Mar 26 2017

Your Pension Will Be At The Center Of America’s Next Financial Crisis

by Tyler Durden

Re-Posted From ZERO HEDGE Mar 26, 2017 5:20 PM

Authored by Jeff Reeves via The Hill

I’m not a fan of the “greed is good” mentality of Wall Street investment firms. But the next financial crisis that rocks America won’t be driven by bankers behaving badly. It will in fact be driven by pension funds that cannot pay out what they promised to retirees. According to one pension advocacy organization, nearly 1 million working and retired Americans are covered by pension plans at the risk of collapse.

The looming pension crisis is not limited by geography or economic focus. These including former public employees, such as members of South Carolina’s government pension plan, which covers roughly 550,000 people — one out of nine state residents — and is a staggering $24.1 billion in the red. These include former blue collar workers such as roughly 100,000 coal miners who face serious cuts in pension payments and health coverage thanks to a nearly $6 billion shortfall in the plan for the United Mine Workers of America. And when the bill comes due, we will all be in very big trouble.

It’s bad enough to consider the philosophical fallout here, with reneging on the promise of a pension and thus causing even more distrust of bankers and retirement planners. But I’m speaking about a cold, numbers-based perspective that causes a drag on many parts of the American economy. Consider the following.

Pensioners have no flexibility

According to a Bureau of Labor Statistics report from 2015, the average household income of someone older than age 75 is $34,097 and their average expenses exceed that slightly, at $34,382. It is not an exaggeration, then, to say that even a modest reduction in retirement income makes the typical budget of a 75-year-old unsustainable — even when the average budget is far from luxurious at current levels. This inflexibility is a hard financial reality of someone who is no longer able to work and is reliant on means other than labor to make ends meet.

Social Security is in a tight spot

So who will step up to support these former pensioners? Perhaps the government, via Social Security, except that program itself is in crisis and will see its trust fund go to zero just 17 years from now, in 2034, based on the current structure of the program. If millions of pensions go bust and retirees have no other savings to fall back on, it will be nigh impossible to cut benefits or reduce the drag on this program. But won’t a pension collapse mean we desperately need Social Security, even in an imperfect form, well beyond 2034?

Pensions

The guaranty is no solution

There is an organization, the Pension Benefit Guaranty Corporation (PBGC), which is meant to insure pensions against failure. However, it was created in 1974 as part of a host of financial reforms and is far from a perfect solution, primarily because it is funded by premiums from defined-benefit plan sponsors and assets seized from former plan sponsors that have entered bankruptcy.

What happens when a handful of troubled pension funds turns into dozens or hundreds? Remember, the PBGC guarantees a certain amount that is decidedly lower than your full pension — as members of the Road Carriers 707 pension fund learned when the group “protected” their pensions by helping to pay benefits, which had been reduced from $1,313 per month to $570. That’s better than zero, but hardly encouraging.

This is not about helping Baby Boomers fund an annual cruise to the Caribbean. Older, low-income pensioners are not saving their money. Instead, they’re spending it on necessities such as food, housing, healthcare and transportation. That means every penny you reduce from their budget means a penny in spending that is removed from the U.S. economy.

Anyone who has taken Econ 101 knows about the “multiplier effect” where $1 in extra spending can produce a much larger amount of economic activity as that dollar circulates around businesses, consumers and banks … or in this case, how $1 less in spending causes a an equally powerful cascade of negative consequences.

By helping ward against a pension crisis, America will be protecting its economy for everyone — plain and simple. But that requires some tough decisions on all sides. For instance, the U.S. Treasury denied a cut to New York Teamsters’ pension plan that was proposed last year. But now the fund is on the brink of collapse, and its recipients are facing benefits that are in some cases one-third what they were 15 years ago.

Like Social Security, current workers can’t contribute enough to offset the big obligations owed to retirees. And as with the flagship entitlement program, it’s up to regulators and legislators to step in — even when it may not be easy — in order to keep the system from collapsing. Let’s hope they make both pension reform and Social Security reform a priority in the near futu

Mar 26 2017

KOMMONSENTSJANE – THIS MAN I WOULD BELIEVE.

If anyone would know he would!

kommonsentsjane

This alone should tell us how Democrats and Obama (the dark state) were working during his time in office and/now continuing with all of this Russian BS the Democrats are putting out every day to keep the President from doing his job.

We should listen and understand what this man is telling the -American people to inform us. It is not the Russians but was our own government under Obama and the democrats. Rep. Schiff a democrat is still trying to pull the wool over American people’s eyes with his/Russian stories who is really the CIA.

john