Spot Markets Live Transcript (21/03/23)

11:00Hi everyone, welcome back. This is my first solo flight. Hope we don’t have a crash landing.

And no, I wasn’t up at dawn today!

Speaking of crash landings….

11:02ugh I was trying to post a meme pic but it didn’t work. Anyway. Let’s kick off with the fallout from UBS/CS.

There was a bit of a rout in bank stocks yesterday, but they seem to have recovered. AT1s of course underwent a vicious repricing as investors woke up to the fact that they might actually be wiped.

The AT1 problem caused a lot of consternation which basically boiled down to “we shouldn’t have been wiped because look shareholders weren’t”.

11:05There’s been a lot of chatter on twitter about whether the terms of CS AT1s allowed them to be treated as junior to equity, and whether this was unique to CS. The answer seems to be – sort of but the terms were ambiguous. Apparently it needed a new law to permit AT1s but not shareholders to be wiped.

11:07I suspect they thought it was easier to wipe AT1s, which are designed to be zeroed (even if not under these specific circumstances), than equity which arguably shouldn’t be zeroed in a going concern situation. In the 2008 bailouts, equity often wasn’t wiped.

Anyway, wiping AT1s but not shareholders not only upset investors, it annoyed other regulators. The European regulators stuck the boot in:

And the Bank of England polished its halo – the holier-than-thou tone of their statement is quite something

So it seems AT1s elsewhere in Europe will now definitely be senior to equity in any future resolutions.

11:12Meanwhile, Axel Lehmann is trying to argue that CS’s failure was down to Twitter, because the bank run that crippled it in October was started by someone on twitter saying a GSIB was on the brink of failure.

The Brussels bureau chief of The Economist is nonplussed

11:14But there were a lot of components to CS’s failure, of which Twitter was only one. All the things that Stanley Pignal mentions, plus the SEC’s demand that it restate some of its accounts, and then the “unfortunate comments” from the Saudi National Bank, which as Izzy says, feels very set up.

11:15The final straw for me was the revelation that CS’s core Swiss bank was probably worth more as an asset than it was embedded in the CS empire. That’s an overwhelming argument for breakup and I would have thought that had there not been a potentially fatal bank run, the shareholders would have forced a breakup anyway.

11:17Twitter contributed not only to CS’s fall, but also to SVB’s. In SVB’s case there were active influencers encouraging a bank run. To what extent does Twitter’s ability to amplify bad news and create widespread panic threaten the stability of the financial system?

All banks have skeletons in their closets.

It’s like when Robert Peston accelerated the panic about Northern Rock

Btw in case of use here’s the JPM report on AT1

Danny Blanchflower, ever the outlier, is calling for the Bank of England to cut rates.

And then have to cut them when they realise that they’ve over-tightened because they didn’t take account of passive tightening by nervous banks.

We’ve played this scene before, though not for a long time.

I still recall that the day after Lehman the Fed was discussing raising rates because of inflation fears.

11:28Inevitably now there are calls for tighter regulation of banks too. Or even complete redesign of the banking system. Martin Wolf in the FT wants CBDCs and a fully automated luxury payments system that completely disintermediates banks.

11:29Meanwhile in the US, there are more wobbly banks. First Republic Bank’s stock price crashed by 47% yesterday after S&P downgraded it. It was already junk, but it’s now even more so.

It has a large proportion of uninsured deposits, which have been running like a tap since SVB failed. It borrowed $30bn it borrowed from Wall Street banks, but it seems this isn’t enough to restore confidence. I’m not convinced that lifting the FDIC limit would solve its problems either. It needs more capital – or a fast resolution by FDIC.

11:31FRB isn’t the only one. Deposits have been running from mid-size US banks into the biggest banks, which are viewed as too-big-to-fail and therefore at no risk of a deposit haircut. Hmm. As Bank of Cyprus depositors know to their cost, haircuts can be a means of preventing the bank from failing. They suffered a 47% haircut as part of the bank’s bailout in 2013.

Anyway, there are now calls for the FDIC insurance limit to be raised to stop the bleeding. A consortium of mid-size banks wants the limit lifted for two years, paid for by an increase in the deposit insurance levy.

These are the very same banks that lobbied hard not to be subjected to the intensive regulation and supervision required of banks deemed “systemically important”. The 2019 reforms to Dodd-Frank downgraded the level of supervision. Personally I would suggest a temporary lifting of the FDIC limit should be accompanied by permanently tighter regulation and more supervision. Banks that require unlimited guarantees are systemically important.

Martin Wolf thinks so too

The US Treasury is said to be studying ways of temporarily lifting the FDIC insurance limit without involving Congress.

Republicans, of course:

I do like a good battle between Congress and the US Treasury. Mind you, we have the debt limit coming up…

11:37The problem with lifting the FDIC limit every time the banking system throws a tantrum is that it destroys the credibility of the limit. Some people want the FDIC limit lifted permanently, because it isn’t high enough to protect things like working capital for businesses. And it’s not just an issue for thhe US. When SVB UK failed, lots of UK tech companies worried about being unable to make payroll.

11:38So the ECB is apparently also considering raising the insurance limit.

Cypriot depositors will be spitting blood if they raise that limit. As will Irish taxpayer.

11:41On capital regulation – yes, Bruce, tier 1 is not all it is cracked up to be. The problem is that lots of the securities banks hold are zero-weighted. Silvergate had a CET1 ratio in excess of 50% when it failed, because it was losing money hand over fist through having to crystallise losses on HTM securities that were zero risk weighted.

@bruce yes NIM is still too thin. Implies continuing financial repression for both depositors and borrowers.

And Anat Admati was right. Banks need much larger capital buffers. Also the risk weighting regime needs to be looked at again.

11:46The liquidity and capital regulation we have now was designed for the post-GFC environment. It’s not fit for purpose in a higher interest rate, tighter money environment (imho).

@Bruce, Izzy mentioned on Friday that the DMO was shortening the duration of new issue gilts.

11:48So thinking about risk weighting; Per Kurowski has argued for years (probably over a decade now) that weighting government securities at zero is mispricing risk. This was also the Eurozone crisis problem: government debt that should have been safe turned out not to be.

Once again, we have failure of safe assets – this time, falling market value on securities needed as collateral to raise cash to honour par deposit withdrawals.

@Graham no bank will hedge interest rate risk on held-to-maturity portfolios. Imho it is the qualification of held-to-maturity that needs to be looked at.

11:52In effect banks have used HTM securities as a kind of insurance for uninsured deposits. Hence the calls to lift the deposit insurance limit.

So, should the deposit insurance limit be lifted? What would the consequences of doing so be?

this was the meme pic I tried to post at the start!

the lesson from Cyprus and Ireland was that unlimited deposit insurance is eventually borne by the whole economy

in Cyprus even limited insurance was too much for the economy to bear – it went into a deep recession

11:57On the other hand, widespread losses for depositors can also crash the economy. It’s a difficult balance, I think.

The problem is, we don’t have enough productive capital to scale from left in the West

We outsourced too much of it to China. And even if reshoring brings some of that back, in a high interest rate enviroinment that’s going to come wiht a very high investment cost.

which seems paradoxical but it’s true

You can see the computer age everywhere but not in the productivity statistics

So, fundamentally we have no choice but to go full reserve. The system is organically calling out for it, as it’s the only way to restore confidence. But this will create credit contraction, and it will be a net negative wealfare effect

Btw Gold is at new highs

(I think in sterling terms)

Gold and Bitcoin both up, and for the same reasons.

They’re trying to have their cake and eat it, but really this is a sort of fall of the USSR moment. Sorry to say. Question is will the unravelling be slow or fast.

Frances is back tomor with a special guest

Thank you everyone! And thank you frances 🙂