Posts tagged ‘banks’
As market bears know all too well, one of the world’s crushing problems at present is China, and everything connected thereto. At the height of the panic which made for such an enjoyable start to 2016, one specific pointer towards China’s imminent and terminal doom was identified as her debt “binge”. Only this Wednesday, this very same binge headlined a blog post from The Economist magazine which warned:
“DEBT in China is piling up fast. Private debt, at 200% of GDP, is only slightly lower than it was in Japan at the onset of its lost decades . . . and well above the level in America on the eve of the financial crisis of 2007-08 . . . The value of non-performing loans in China rose from 1.2% of GDP in December 2014 to 1.9% a year later. . . .”
Specifics such as these betoken credibility. Yet they also invite questions. What does “private debt” mean? Which matters more: the 1.9%, or the 200%? What are the equivalent numbers for the other economies mentioned?
Let us start with the components of “debt” in China. First of all the only one which the bears seem not to want to mention: sovereign debt. This is estimated at 43% of GDP by the IMF on a gross basis for 2015. At the same time, however, China has huge sovereign reserves – about $3.2trn at the moment, again on IMF numbers, which is about 31% of 2015 GDP. With the country targeting a fiscal deficit of 3% this year and reserves trending downwards since 2014 it is true that the country’s sovereign debt position is deteriorating on a net as well as a gross basis but it should be obvious that it is nobody’s idea of a crisis. (UK sovereign debt was 88% of GDP on the same, gross basis in 2014, the eurozone’s over 90%, the USA’s over 100% and Japan’s approaching 250%.)
The “private debt” figure mentioned in the quote comprises a corporate (non bank) debt ratio of 165% and household ratio of 40%. That sounds a lot scarier than 43%. But it is not far off similar figures in other places. Only yesterday the Federal Reserve published America’s balance sheet for last year showing non-bank corporate and household debt of 74% and 82% respectively, making “private debt” of 156% altogether. Lump in sovereign and financial sector debts too and the total comes out at a cool $63.4trn, or 364% of US GDP. (The equivalent figure for China is 247%.)
The UK’s balance sheet comes out even worse than this on a broad basis due to the massively distorting impact from the financial sector. According to our own balance sheet, our total financial liabilities for 2014 came out at a nice, round £30trn, or about sixteen and a half times our GDP that year. Use net figures for the financial sector, however, and this plunges down to a much less startling 487% of output, of which a mere 349% is that “private debt”.
These sorts of numbers are esoteric territory, and not usually visited by relevant parties such as ratings companies. There are reasons for this. Vast swathes of the figures are prone to uncertainty and conceptual artificiality, for instance. We can look at government budgets, and bond yields, and arrive at a view on the sustainability of a country’s debt position. But what is the household sector surplus, or deficit?
Let us draw a line under these “private” or “total” debt to GDP arguments now and move on to non-performing loans. The banking system NPL ratio did rise from 1.5% to 1.6% in 2014 and will have risen further last year. The government is working on new measures to convert NPLs into equity stakes in struggling companies and one can read this bearishly. Whatever the final announcement and accompanying figures on this front, however, we do know that the required reserve ratio for major banks stands at 17% despite recent monetary loosening, up from 7.5% a decade ago. We must, as always, wait and see. The time bomb expected from Chinese trust investments two years ago failed to detonate, but bond defaults have been making headlines. Perhaps this time the country’s banking system, strongly capitalised as it is, will blow up in the face of an NPL crisis the government is already taking measures to manage.
The Chinese economy, like all economies, has its problems. And like the problems of other countries, some of these are local in nature. But in talking up a catastrophic debt burden where none really exists the bear case overreaches itself. There is enough out there to worry us in the real world – we do not have to look for phantoms.
This week’s Budget was, of course, highly political. The Chancellor’s £250,000 reduction in the lifetime allowance for private pensions deprived his Labour opponents of a funding source nominated for one of their policies; his single announcement on inheritance tax was nothing more than an opportunity to poke fun at the Leader of the Opposition for his tax avoidance twenty years previously; and he devoted much of his speech to refuting high-profile opposition criticism of the government’s record and intentions.
There are, however, areas of economic policy over which the Labour and Conservative parties are in total agreement. They compete to paint themselves as the true pursuers of tax avoidance, especially by maleficent multinationals. And they unite in their commitment to bashing Britain’s banks.
As is well known, a coterie of lavishly-rewarded financiers were single-handedly responsible for the credit crunch and ensuing Great Recession (forcing those Northern Rock borrowers to take out 125% mortgages, for example, and then compelling investors to purchase these assets at hideously mispriced levels from the originating banks). So the special tax on bank assets which has been running since 2010 is a great moral enterprise as well as a revenue generator, and we should all applaud the Chancellor for increasing it to bring in another £900m per year.
On the other hand, some of the Budget’s fiscal arithmetic depends on raising capital from sales of the government’s stake in Lloyds Banking Group plc. Indeed, quite a lot of the UK’s employment and economic output arises from the financial services industry. It may be some time before the next knighthood is bestowed for services to banking, but despite its present position in public esteem banking does perform a service to the country.
Unfortunately the British government’s record in rescuing financial institutions compares poorly to that of the USA, for example, where the subprime mortgage market kicked things off back in 2007. In another piece of news earlier this month we saw Mr Osborne raise £500m from selling the latest slice of the UK’s stake in Lloyds. The total raised from such sales to date now amounts to £8.5bn, which may seem impressive. But the size of the Lloyds bailout was £20bn. The government still owns 23% of the bank, a stake worth about £13.2bn at the time of writing. Over the Atlantic, the US Treasury had got out of its $45bn bailout of Citigroup entirely by mid-2011, making a $13bn profit on the original amount and further gains on charging for a default protection facility which was never used. Similarly, while the US government still owns mortgage securitization behemoths Fannie Mae and Freddie Mac, which received a combined bailout of over $187bn in 2008 and still face problems, it has received back more than this amount in dividends from both companies. The UK government still owns 62% of RBS, has not sold any shares and has not received a penny back from its £46bn bailout.
RBS, of course, was not assisted by its various financial and managerial idiosyncrasies in the years preceding the crisis. But policies such as the bank levy have not helped. The great purchase protection insurance compensation bonanza – which has seen RBS alone pay out billions over the last four years – has not helped either. And the crisis-period support afforded by the Bank of England lacked the breadth and scale of the several emergency lending programmes of the Federal Reserve and slew of measures taken by the US Treasury under its Troubled Asset Relief Program.
Predictably, all this has reflected poorly on the very balance sheets whose tax rate the Chancellor has just raised. While the Big Four US banks have seen their provisions for losses on loans fall steadily since mid-2010 to about a third of their peak level, combined loss reserves at Barclays, Lloyds and RBS only started to fall a year later and are still at almost 60% of their peak.
The share of the UK’s economic activity accounted for by financial services remains relatively high, at 8%. But it has been falling slightly over the past five years. It is unfortunate, to say the least, that public policy has contributed to this effect.
There is of course an election looming. But it looks as though whatever government takes charge the banking sector can expect more of the same. That is bad for the UK economy. And even in the aftermath of the crash bank shares still make up 12.6% of the value of the FTSE 100. The American approach certainly had its flaws but it has indisputably produced a better outcome and outlook for the financial sector and for US taxpayers than our own.
It is now seven years since the first signs of strain and balance sheet writedowns signalled trouble in the US subprime mortgage market. A few months later – in June 2007 – the first credit rating downgrades of securities backed by pools of these mortgages occurred. The collateralization and ownership restrictions placed on institutional investors in the vast “asset backed” market were superglued to these ratings. On the back of the downgrades, Bear Stearns put up $3.2bn of lending to prop up one of its two subprime hedge funds. Amid collateral calls the entire subprime mortgage market collapsed. In July Bear announced that both its funds were worthless, and for the next few months an explosion in downgrades (and underlying mortgage defaults) began to focus the financial world’s attention.
So it may seem surprising to say that we are only really at the end of the beginning of this crisis. Seven years is a long time. And yet …
Last week saw the release of Q4 mortgage delinquency data for the US. The headline number showed that delinquencies – loans at various stages of falling behind with payments up to and including foreclosure – as a proportion of the whole mortgage market fell again, to 6.4%, as they have done steadily since peaking at 10.1% in March 2010. But dig deeper and we find that the subprime delinquency rate ticked up. In fact it has been stuck in a 20-22% range for the last two calendar years, not far shy of its 27% peak in ’10. The overall improvement in delinquencies has been entirely due to improvements in the prime mortgage market over that period. Subprime foreclosures are running at over 10% of loans, still materially higher than at the peak of the previous default cycle in 2000. For that reason, there are still plenty of ratings downgrades on mortgage-backed securities working their way through the system.
At the same time it is right that the US mortgage market has lost its power to terrify. Overall, as we know, the real estate market has been picking up again (with a recent setback driven by the execrable weather). And bank balance sheets have improved steadily and considerably in line with the mortgage market overall. Reserves for losses on loans across the Big Four US banks – JP Morgan, Bank of America, Citigroup and Wells Fargo – peaked at $158.8bn in Q1 2010. The current reporting season showed that had fallen by almost 60% to $67.8bn in the quarter just gone. That’s some way north of the $42.2bn reported at the end of 2007, but still pretty impressive.
Perhaps this partly explains why it looks too cautious from a US perspective to say we are only at the end of the beginning of the credit crunch. From a more global perspective, however, the description fits more clearly.
Here in the UK our banks have not recovered so well. At Barclays, loan loss reserves only trickled slightly lower last year and are roughly 41% below their reported peak. For Lloyds the figure is 38% and at RBS of course reserves hit a new high of £25.2bn for Q4 – 39% higher than the amount provisioned for at the end of 2010.
Turning to Europe, where banks are at least as far adrift, we have another aspect of the crunch to contend with. In some cases (most notoriously perhaps in that of Iceland), bank distress led directly to a sovereign debt crisis. In most countries it played a significant role – as did the crunch’s recessionary effects on the wider economy, of course. And we should remember that the Cypriot banking system went down less than a year ago, all part of the same protracted drama of downgrade, writedown, bailout and default.
Symptoms of the sovereign crisis remain. The yield on ten year Greek government debt fell below 7% only today for instance, the first time since the country’s ignominious junking by S&P in April 2010.
Which brings us on to the next stage. Greek government debt to GDP for 2013 is forecast by the IMF to reach 175.7% – more than 5% above the peak reached prior to the debt restructuring of 2012. It is still not certain whether another restructuring of one kind or another will be needed to make this manageable on a 5-10 year view. Much will depend on how the economy performs this year. And it is still less certain when Greece will be able to consider re-entering the bond market, as some less severely crippled bailout economies have already done.
Once we know that the Greek debt position is settled it could be the beginning of the end of the credit crunch, and not before. Then Greece – as others, including the rest of the eurozone, UK and the US – will be set on the path of managing its economic affairs with a huge burden of borrowing round its neck that will mark fiscal planning with servicing costs for many years to come. That is the lasting legacy of the insane credit markets of the mid-2000s. Only when that borrowing, weighing down across most of the developed world, has been firmly established on a reducing path for some time – only then will we be able to say that the credit crunch is over.
In terms of what all this means for markets let me make one observation.
Risk markets became absurdly optimistic in a short period of time during the end of the Great Recession in 2009, not at all seeming to understand the scale or possible longevity of the problem. Then came the sovereign debt crisis and a period of complete panic in 2011, and then, pretty steadily since the most successful example of Open Mouth Operations in history (by the ECB in mid-2012), risk has come back into favour.
The key point is this: by backing fundamentals, and so being sceptical of risk in late 2009 and more constructive thereafter (and especially in the autumn of 2011), investors would have done pretty well.
The gargantuan upheaval of the credit crunch and the hysteria which followed have left their mark in different ways at different times. There are still plenty of anomalies out there both between and within asset classes. As and when (and if) the ripples from that giant explosion seven years ago continue to fade, there is every reason to continue to expect that backing the fundamentals will remain a profitable thing to do.
The release of minutes from the July meeting of the Federal Open Market Committee generated headlines this week. Fears of the effects of “tapering” – the reduction by the Fed of the amounts of fixed income security purchases it makes under its “QE3” programme of quantitative easing – have continued to unsettle markets.
There was no clear steer from the minutes as to when this will eventually begin. But according to research released by the San Francisco Fed earlier this month it doesn’t matter much anyway. The Fed economists who wrote the study estimate that a QE2-sized programme ($600bn of US Treasuries purchased over two years) without accompanying dovish guidance on interest rates would have added only 0.04% to GDP growth and 0.02% to inflation. Even with this guidance they assessed the impact at a meagre +0.13% on GDP and +0.03% on inflation. As they conclude:
Asset purchase programs like QE2 appear to have, at best, moderate effects on economic growth and inflation … those effects are weaker and more uncertain than conventional interest rate policy. This suggests that communication about the beginning of federal funds rate increases will have stronger effects than guidance about the end of asset purchases.
Moreover, one of their key model assumptions was that QE would lead holders of longer-dated Treasuries to reallocate capital to other asset classes or the wider economy (they assume no impact on holders who are indifferent to bond maturities):
If long-term yields fall, these investors have less incentive to save and may allocate more money to consumption or investment in nonfinancial assets. This boosts aggregate demand and puts upward pressure on inflation.
This analysis will be familiar to readers who remember the numbers involved in our own programme of QE here in the UK. As this blog observed some time ago, however, with the government issuing at least as much debt into the bond market as the Bank of England is taking out, this “helicopter drop” monetary model simply doesn’t fly:
Imagine that you were in the crowd underneath the helicopter and had managed to scramble successfully for £50. Then, as the helicopter flies away and you are about to put the money into your wallet, you feel a tap on your shoulder. You turn to see a man standing in front of you with a knife, who mugs you for it. Would you feel like the beneficiary of a windfall and embark on an inflationary spending bonanza, or would you put your wallet away in bewilderment, feeling as if the whole exercise had been an elaborate distraction?
Unsurprisingly for an economy which has seen the level of public debt to GDP rise from a little over 60% at the start of the Great Recession to over 100% today, the same logic applies over the Atlantic. Since the Fed started QE it has bought $2,196bn of Treasuries. Over the same period, BoA Merrill Lynch data on the Treasury and TIPS markets shows that the face value of the US government bond market has increased by $5,251bn – almost two and a half times as much.
So the numbers suggest US QE has been a monetary sideshow, as does a study made by the Fed’s own specialists. The same is also true if we look at other possible transmission mechanisms which the study ignores, such as the weekly Fed data on loans and leases made by US commercial banks for example, which after a prolonged decline only exceeded their previous (2008) peak towards the middle of last month.
This is not to denigrate the Fed’s whole programme of unconventional policy measures. The purchase of mortgage-backed securities alongside government bonds for instance might well have helped repair bank balance sheets – as well as contribute to lower mortgage rates, and alongside the effect of initial emergency measures such as the Troubled Asset Relief Programme, the Federal takeover and capitalisation of Fannie Mae and Freddie Mac, etc. In fact the speed of the banking sector recovery in the US – as opposed to in Europe (including the UK) – has been one of the great relative strengths of the American economy. The Fed’s activities during the subprime crisis and its devastating aftermath are not to be sniffed at.
Nonetheless, some participants are betting that ending, or merely reducing, a programme whose actual monetary effects are likely to have been trivial will destabilise economic recovery in the US and across the globe.
This appears to betoken an unreasonably heightened level of concern.
The market’s focus of late has been on the Fed, US growth and China. There has been news out on all three in recent days – but there has also been some news out on Europe.
This week saw further agreement on an EU-wide framework for banks (specifically as regards the topical subject of bailouts). It accompanies ongoing work on arrangements for federal – sorry, supranational – oversight of national budgets.
News on European affairs passes with little comment these days. This would have been unthinkable a short time ago. When budgetary oversight was agreed about 18 months ago it was headline news across the world. And the catalyst for the whole sequence of emergency summits, the insolvency and bailout of Greece just over three years ago, was of course seismic: during the week after the bailout announcement itself, the Euro Stoxx 50 index fell by over 11%. Then, after the attention-grabbing trillion dollar support package for the whole eurozone was announced the following Sunday, it rallied by over 10% in a day.
Now there is no such excitement. Like the banking system and budgetary oversight measures, the emergency EFSF and ESM programmes have come along quietly – from zero to just shy of €200bn in funds raised in three years. Once upon a time – when eurozone bond markets went haywire in 2011 – the then ten-year EFSF bond, backed by guarantees from all eurozone sovereign states, traded briefly at 2% over the yield on its German government benchmark. Now that spread stands at 0.6%, and despite all the volatility has dribbled along in a range of 0.4% – 0.7% all year.
This is quite a turnaround. From star of the show (albeit as anti-hero), Europe hardly seems to appear on stage any more. Which begs the question: are we being complacent? Do arguments over 0.5% vs 0.3% on US incomes and 7.0% vs 7.5% growth in China miss the bigger point? Has the European crisis become the elephant in the room?
As a bear case it is a tempting proposition. Just when we have all started ignoring Europe, a new bailout or political upset will come along and upset the apple cart again. If only those headstrong Eurozoneans would adopt an expansive approach to fiscal policy and improve their competitiveness via currency devaluation, etc., they might enjoy the kind of economic success which characterised Britain in the 1970s (this blog has never fully understood the logic of this confidently-touted advice).
There is an alternative, of course. A slew of indicators in recent weeks, from activity gauges to measures of confidence, have shown that the beaten-up Continental economy might at last be turning the corner and emerging from its painful though shallow slump into the anguished and shallow upturn its central bank expects.
Still, the pace of recovery in Europe doesn’t matter so long as it finally occurs. No one thinks of Europe as the engine of world growth. But it is obvious that the benefits of entrenchment in activity there would extend to those countries who are seen that way (China, for instance).
Without wishing to extend the list of animals too far: if Europe turns out to be the elephant in the room the bears will undoubtedly have their day. Otherwise – at some point – it will be the turn of the bulls again.
“Nice banking system you got there. Be a shame if something … happened to it.”
Obviously this paraphrases the lengthy talks which took place earlier this month between the Cypriot government and the Troika – the biggest, most powerful and most ruthless gang of organised cross-border lenders in the world. But it is the case that the Troika’s three bosses (the European Commission, ECB and IMF) have their desperate borrower firmly by its heart and mind. Impertinent Cyprus initially tried to stop the Troika taking a cut of its bank deposits, voting it down in its little parliament on Tuesday. So Cyprus was given the chance to vote again (and get it right this time, or else). We shall see, probably tonight, whether Cypriot lawmakers give up some of their bank deposits in return for being allowed to keep the system as a whole propped up by Troika lending.
The idea of a government-sponsored bank raid might have seemed outlandish a few years ago. What is truly fascinating about the events of recent days, however, is the equanimity which has met them. Like the reaction to the elections in Italy we wrote about last week this surely has something to tell us about the current level of market confidence.
After all, we have been somewhere very similar before. Almost two years ago, scary demands from lenders were emerging about something called “private sector involvement” (PSI) – the idea that holders of Greek bonds should share the pain of bailing the country out with European taxpayers. Initially a German idea, it was approved by Merkozy (remember them?) and in due course officially adopted as part of the restructuring arrangements for Greek sovereign debt last year.
At the time, PSI caused chaos. As this blog observed on 8 July 2011, for example:
… Markets were blindsided on Tuesday by the decision of Moody’s, the credit rating company, to junk Portugal. Confidence was creeping back in after Athens took its austerity medicine, securing the release of emergency funds – and then, wham! – a cent off the euro, a down day for equities and a two point jump in Portugal’s 10 year yield.
From Moody’s full statement it is clear that their main concern is the possibility that private sector creditors may be expected to incur losses in a hypothetical future renegotiation of Portugal’s bailout. This concern arises from the possibility that such private sector losses will form part of the renegotiation of the bailout of Greece.
It really was pandemonium: no one knew what was going to happen, and almost everyone was panicking.
This time the background is the same. Deposit-holders have taken the place of bondholders; a dangerous precedent is being set; there is the risk of cross-border contagion in the eurozone and elsewhere; the whole plan was an unexpected surprise. But this time the panic is missing. Peripheral eurozone bond yields have not shot higher, equity markets are not materially weaker and the euro is about where it was a week ago.
Part of the explanation may lie in practicalities. Punishing Greek bondholders was a larger-scale and more arbitrary exercise than going after Cypriot banks. Cyprus is a country half the size of Wales with a population of 1.1m. It has GDP of about €18bn, and less than $1bn in gold and foreign exchange reserves. And yet it has €68bn of bank deposits, about a third of which are estimated to be of Russian origin.
This latter estimate is necessarily imprecise. The attraction of Cyprus as a banking centre lay in a combination of many things: low tax rates, an accommodating approach to offshore investment, a common law heritage which recognises the validity of trusts – and strict rules on banking secrecy. Suspicions of money laundering improprieties were raised months ago and led to an investigation of money laundering controls as a precondition of the Troika’s bailout.
Nonetheless, whatever one thinks of the properness of Cypriot banking, the sanguine response to the confiscation of bank deposits in a eurozone country is noteworthy, and especially so in the context of PSI and the reactions to it at the time.
Among the burdens weighing on markets this month has been renewed concern over the prospect of a slowdown in China. In particular, the country’s growth target was revised down to 7.5%, data on exports and foreign investment were weaker than expected, and activity surveys have been a mixed bag. And there are many who await a catastrophic collapse of the property market following years of eye-watering growth.
Some of these concerns are more valid than others. Take the official growth target, for instance. This has been running at 8% for the past 8 years, during which time the pace of expansion actually averaged over 10%.
The property market is scarier. There have been signs of a slowdown in the official data for some time, which anecdote suggests could be far worse. (The reliability of Chinese statistics is a constant cause for concern.) But even here, the slowdown comes as a result of government action – action which at the level of monetary policy took the form of aggressive increases to the reserves required to be held against lending by the country’s banks. The credit crunch was so devastating in its effects partly because it took western policymakers by surprise. The same cannot be said of China.
Furthermore, an important side effect of hiking the required level of capital reserves in the banking system (currently 20.5%) is that it ought to prove more resilient in the face of write downs, limiting the impact of any property bubble on the wider economy. And taking a step further back, even if any banks do need bailing out this won’t be a problem for a nation with no government debt to speak of and over $3,200bn in reserves.
It is the foreign investment and export data, however, that reminds us just how remarkable the Chinese experience has been in recent years. While FDI last month was 0.9% lower than a year earlier, it contracted at rates of over 36% at the nadir of the credit crunch. At the same time, exports – rising at a “disappointing” 18% at present – fell by over a quarter. And amidst the wholesale collapse of its foreign markets, real growth in China’s GDP bottomed at +6.2%.
This was nothing short of incredible. It proved that China’s expansion had organic momentum, something which had disastrously eluded the “Asian Tigers” a decade earlier for example. And while China is the world’s second largest economy in terms of dollar output, if we divide that output by the country’s huge population we find that it remains quite poor in per capita terms – about 90th in the world rather than second, alongside the poorer parts of eastern Europe or the Caribbean. Growth in domestic demand should have a lot further to run.
This “year of the dragon” has got off to a rocky start. The bear case on China – and Chinese real estate in particular – has some merit. But the risks are known and are playing out against a constructive background. If the country could weather the international events of 2007-9 in the way that it did, markets may well be underestimating its resilience to a home-grown shock.