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Banker’s Humor - The Great Moderation

Fri, Jun 20, 2008 - 12:17pm

Bankers around the World

Banker's humour shines out with what is euphemistically referred to as "The Great Moderation". Like most of these monikers it is another spin designed to put the mindless punters at ease while the bankers shuffle the cards. "Moderation" in the context of this expression refers to the unusually extended and smooth economic cycles over the past two decades but I recently saw NZ Reserve Bank boss Alan Bollard refer to the global deleveraging currently being espoused as part of the great moderation. Undoubtedly Governor Bollard like all other central bank rulers is aware of what is going on. The current round of deleveraging being miraculously reported by bankers and investment banks is just another sleigh-of-hand trick to make those dollars fly around to parts of the globe and others balance sheets where they will appear more palatable or at least avoid scrutiny.

carpetDon't you wonder when bankers report a $55 billion deleveraging in one quarter how they were clever enough to do it? The problem with deleveraging is that both sides of the balance sheet have to be skinned. There is no known way (yet) to get rid of the liability (loans) and hold onto the asset other than something very old fashioned like reducing liabilities through retained earnings and surplus cash flows, and that my friends is not the business these turkeys are in.

Theirs is the arcane world of leverage. Thimble and pea tricks where unpaid interest on mortgages is taken to account as profit, where highly leveraged assets are parked in SIVs from which banks collect fees whilst pretending that it is an arm's length transaction for which they have no supportive funding liability. The acquiescence to this behaviour by central banks, regulators and governments is truly staggering. The almost universal acceptance now, of what I wrote four months ago-that taxpayers will finish up shouldering most of the bill for the bankers" shenanigans- is profoundly interesting to me.

In the US, Congress is preparing to pass legislation to bail out over reaching banks and borrowers; US Fed without Congressional approval has acted to forestall the inevitable consequences of the great debt boom; in relatively conservative banking communities down under (no ARMs or negative amortization mortgages), the Australian Reserve Bank has been quietly accepting impaired mortgage backed paper from not only the four pillars (major national banks), but from the next tier of slime meisters as well, since last September. In New Zealand the Reserve will start allowing mortgaged backed bonds to be used as repo collateral starting next month.

Not content with sticking their snouts into the central banking system for relief, Australian banks have gone a step further and managed to offload some of those onerous assets to a strange beast called the Australian Future Fund as reported this week by the Sydney Morning Herald on June 12:

Cash-strapped banks are tapping Australia's sovereign wealth fund to raise new finance as traditional sources of funding dry up in the ongoing global credit crisis. ANZ Bank, the country's third-biggest lender by assets, has raised about $500 million in term funding from the Future Fund, an industry source said today. The Future Fund, Australia's largest single investment fund with $60 billion in assets, was set up by the government to cover public service pension liabilities. Its assets are set to grow to about $148 billion by 2020. "My understanding is that all Australian banks have done transactions with (the Future Fund). If you want debt in your portfolio, having some bank term debt is not a bad option, particularly given that you are getting more attractive spreads,'' said one industry source, who declined to be identified.
ANZ and Westpac spokesmen declined to comment, while NAB was not immediately available for comment. "It's smart move for the Future Fund and it's a smart move for the banks,'' said Martin North, managing consulting director of Fujitsu Australia and New Zealand. He said the risks attached to putting investment capital into a mortgage business are relatively low, as such businesses are backed by secured assets.

As a piece of uncritical reporting, this is a doozy. I thank my colleague Derek J in the far West for drawing it to my attention. To my knowledge these transactions have not been reported elsewhere and have drawn no flack from the usual columnists and scribes. Why the Herald is acting as a shill for the banks is unknown but why the rest of the financial community accepted this action so uncritically must have some meaning. To explain these strange transactions requires some knowledge of the Futures Fund.

It is not a sovereign wealth fund as reported by the Herald. Its funding comes from government surpluses which will disappear quickly as the economic cycle turns. It is a triumph of bureaucratic power in a country where one in four workers are public servants. After generations of accrual of public service pensions which are light years more generous than those in the private sector, the Howard government was forced by the certainty of the law of compounding numbers to deal with the inevitable consequences of these massive unfunded liabilities, so they established this fund to meet those liabilities. Many other countries including the US face similar problems as legislators happily appropriate not only immediate funding for their pet programs but continue to ignore the legacy costs that compounding numbers always create.

The government appointed trustees of the fund are charged with its maintenance and management so no doubt the spin from Mr North that "risks of putting investment capital into a mortgage business are relatively low and such businesses are backed by secured assets," was most welcome. Indeed the only way for the trustees to have approved this arrangement was if they had also formed that view on advice.

To state the obvious that mortgage backed securities have hardly proved to be a safe, secure investment elsewhere in the world highlights the very real disconnect between the hemispheres. That the new Australian Labour government has acquiesced in this charade shows what is churning under the surface. With the Australian stock market already under pressure, the prospect of the big four banks coming clean and facing up to their losses with a public issue is obviously not a prospect that can be willingly contemplated. In the scheme of things the amounts mentioned are pin pricks but we simply don't know what these transactions have been, nor do we know the extent of Reserve bank and quasi government funding extended. In a country where sporting figures make headlines while politics and finance are largely ignored, there is no clamor for disclosure. How this all complies with the Australian Stock Exchange's rules on continuous disclosure to shareholders is a mystery to me. Australian company directors are required to sign statements that their annual accounts give a "true and fair" view of the company's position. Banks creating off balance sheet SIVs and other non reportable entities, then taking them back on their books when the SIVs are unable to fund themselves makes a mockery of the process.

Neither shareholders or regulators seem concerned so the joke goes on.

The chart below is the major Australian stock market index. It is going to 4300 if what we are seeing is just a normal market correction, and I doubt very much if that is the case. Some acknowledgement of sins by the four pillars (see previous articles in FSO archive) and an appeal to shareholders for substantial funds would undoubtedly hasten the process, but the market is going to make that trip irrespective.

I have left the Danielcode numbers on this chart so you can follow along with the banker's jolly fun. This market is still floating on a tidal wave of margin lending which apparently is virtuous and obviously beneficial to markets, whilst shorting to obtain true price discovery is not. What a strange world we live in.

SPI

Central banks globally and their supporting governments are taking a bare faced punt (bet) that credit problems and asset impairment are temporary problems and by warehousing the suspect instruments, all will be restored in the fullness of time. I actually understand why they are thinking that way. To acknowledge what has truly happened on their watch and the consequences that are flowing is simply too hard. Central banks are crisis managers. It is in their genes to believe that policy can overcome gravity.

In this regard they are buttressed by consumers who simply won't stop spending. In UK where the fiscal default cycle is running a quarter behind US and who are yet to feel any real fallout or pain from the financial world, the BBC reported on Thursday:

A record level of retail spending in May has provided a respite from gloomy economic predictions. Sales rose by 3.5% during May, the strongest monthly growth since January 1986. The Bank of England's governor, Mervyn King, said the UK was facing its "most difficult economic challenge for two decades".

These are the same people who rush to buy houses and cars they could never afford and then bellow for the government to "do something" when the party is over. As for the Bank of England governor who knows what is happening and is issuing clear alarm calls-nobody is listening!

US Markets

The disconnect between international markets forms the basis for next week's "Charting around Asia" article for Financial Sense, but the present disconnect between US markets should provide some insights for readers.

The Dow Jones index, home of the big caps and the big mutual fund investors, has given up about 82% of the previous up leg of its 2008 rally. Thursday's low was at 11978 against its closest Daniel number target at 11972, a variance of just 6 points. More downside work is coming today.

DJIA

In contrast, the Russell 2000 small cap index which last week reversed off its first Daniel number retracement target at 718 gave up only 37% of the 2008 rally at last week's low. Market generalizations are rarely helpful and most will remember the relative strength of small caps leading the 2003-2007 bull market, but another way to view these markets is to consider them as reflecting the optimism of small investors over large. As we have seen in UK there is a disconnect between Threadneedle Street and the High Street and that is likely what we are seeing here.

RUT

SPX is trying desperately to hold on into the end of the month and has mirrored last week's low to the end of Thursday's trading, but Merrill's note on Regional banks out this morning (thanks Mo) will have it seeking lower DC numbers: Reuters - U.S. large-cap regional banks' stocks now appear to be in "capitulation mode" and will likely trade below fair value in the near term as more dividend cuts and capital raises, high credit risk and an uncertain earnings outlook all weigh on their share prices, an analyst at Merrill Lynch said.

The point to remember about banks is that there are going to be two separate classes going forward. For those involved merely in reckless lending inspired by misplaced faith in the property boom this will be just a cyclical credit event which we see at the end of all expansionary cycles, damaging as that is. For those involved in the paper shuffling games of fraudulent credit ratings on mortgage backed bonds and other exotics, they have built whole structures based on equally fraudulent notional earnings. Those banks and similar businesses are not going to be able to replace those earnings with honest-to-goodness banking. For those, destruction in one form or another is inevitable!!

SPX

Gold

Gold promoters are counting on the 200 day moving average as a time honored support level to fire up Gold again. On the continuous chart the MA was at 856 last Thursday when Comex Gold made its swing low at 859.60 against its DC support number at 860.40 which forced the 5 day rally that ensued. There is much to like about Gold so long as you knew the Daniel numbers that ushered in the March highs in Gold and Silver to a few ticks. The current flattish correction indicates stabilization efforts after the initial swoop from 1034 in the April contract and there is no determined selling in the physical. Gold continues its completely rational market behaviour as it makes every swing on the daily chart at its DC numbers as it has all year.

Please note that in the DC charts published on Financial Sense, future DC levels not yet used may have been removed in deference to my subscribers.

BUT, it is still hostage to the DX which is undergoing some massive therapy behind the scenes.

GOLD

DX

Given my pessimistic macro view of markets and the still unrevealed damage being done to institutions by our banker friends, I am inclined to the view that the DX rally will be short lived but there is no evidence of that now, as like all markets it continues to turn at its DC numbers.

DX

There is no need to be guessing or hoping about market turns. Better than 85% of market turns are made at DC numbers in all markets. I cover a wide range of markets in different time frames to suit investors and traders alike. Today I updated the monthly forex charts for 17 pairs that I cover. The turns on the monthly charts are as precise as those on the dailies which we tend to focus on.

Of necessity all important market turns begin on a daily or shorter time frame chart and progress to weekly and then monthly charts. This week I have had a number of emails enquiring whether I intend to provide a commentary type newsletter on markets for those without the time or inclination to obsess over the esoteric joys of market charts.

The answer to that is that I already create about 170 individual Danielcode charts for subscribers each week. They are not machine drawn, as so far the Daniel number sequence has resisted all efforts to program it! Each chart is created by hand and backed by a large and complex spreadsheet that is the only recognition to modern technology that the Danielcode bestows.

However for those of a less urgent bent, the monthly charts are highly successful at showing trends which is what all you Gold bugs are waiting for. Given the urgency for Gold investors to reposition themselves without false signals, I am starting a specific "trend" section for Gold and Silver at the Danielcode Online on Monday. I invite you to visit my website where you can get all the DC numbers and FSO readers can catch up on the new Danielcode trend indicator for Gold from its monthly chart. Monthly charts are slow to generate specific signals but they are relatively sure (these are markets, not sealed roads) and less prone to the whiplash we see in shorter time frames.

The end of fiscal year markets are sure to be fascinating as those in line for year end bonuses fight for traction against those who understand reality. Can gravity continue to be suspended for the next 10 days?

We will soon know.

About the Author

Lawyer and Financial Consultant
jneedham [at] thedanielcode [dot] com ()