The Volatility / Quantitative Easing Dance of Doom

The battle between the ‘haves’ and ‘have-nots’ of global financial policy is escalating to the point where the ‘haves’ might start to sweat – a tiny little. This phase of heightened volatility in the markets is a harbinger of the inevitable meltdown that will follow the grand plastering-over of a systemically fraudulent global financial system. It’s like a sputtering gas tank signaling an approach to ‘empty’.

Obscene amounts of central bank liquidity applauded by government leaders that have protected the political-financial establishment with failed oversight and lack of foresight, have coalesced to form one of the most unequal, unstable economic environments in modern history. The ongoing availability of cheap capital for big bank solvency, growth and leverage purposes, as well as stock and bond market propulsion has fostered a false sense of economic security that bears little resemblance to most personal realities.

We are entering the seventh year of US initiated zero-interest-rate policy. Biblically, Joseph only gathered wheat for seven years before seven years of famine. Quantitative easing, or central bank bond buying from banks and the governments that sustain them, has enjoyed its longest period of existence ever. If these policies were about fortifying economic conditions from the ground up, fostering equality as a force for future stability, they would have worked by now. We would have moved on from them sooner.

But they aren’t. Never were. Never will be. They were designed to aid big banks and capital markets, to provide cover to feeble leadership. They are policies of capital creation, dispersion and global reallocation.  The markets have acted accordingly. 

What began with the US Federal Reserve became a global phenomenon of subsidizing the financial system and its largest players.  Most real people - that don’t run hedge funds or big banks or leverage other peoples’ money in esoteric derivatives trades - have their own meager fortunes at risk. They don’t have the power of ECB head, Mario Draghi to issue the 'buy' order from atop the ECB mountain. Nor do they reap the benefits.

Retail sales are down because people have no extra money and can’t take on excess debt through credit cards forever. They aren’t governments or central banks that can print when they want to, or big private banks that can summon such assistance at will.

Federal Reserve Chair, Janet Yellen recently chastised these bankers. This, while the Fed has become their largest client and the world’s biggest hedge fund.  While she wags her finger, the Fed is paying JPM Chase to manage the $1.7 trillion portfolio of mortgage related assets that it purchased from the largest banks. In other words, somewhere along the line, the public is both paying to buy nefarious assets from the big banks at full value, thereby supporting an artificially higher price and demand for these and similar assets, and paying the nation’s largest bank for managing them on behalf of the Fed. Yellen says things like “poor values may undermine bank safety” and all of a sudden she’s on an anti-bank rampage?  What about the fact that just six banks control 97% of all trading assets in the US banking system and 95% of derivatives? Or that 30 banks control 40% of lending and 52% of assets worldwide?

Think about the twilight zone squared logic of this. Yellen’s predecessors, Alan Greenspan and Ben Bernanke, enabled the path of the US banking system to become more concentrated in the hands the Big Six banks, which have legacy connections to the Big Six banks that drove the country to disaster during the 1929 Crash, and have been at the forefront of the nexus of political-financial power policies for more than a century. Yellen had a seat at the Clinton administration banking deregulation table when Glass-Steagall was summarily dismantled thereby enabling big banks to become bigger and more complex and risky. Those commercial banks that didn’t hook up with investment banks back then, got their chance in the wake of the financial crisis of 2008. They also concocted 75% of the toxic assets that were spread globally and the associated leverage behind them in the lead up to 2008.

Rather than show meaningful initiative to engender safety in the financial system (which if she had, or wanted to, would have rendered her a non-viable candidate for her position), she reprimanded the banks while providing them cheap capital. That’s like egging people with a tendency toward excess on as they gorge on multi-course gourmet dinners, making disparaging comments about their girth, and being dubbed their coach for The Biggest Loser while serving them the next course. Political theatre is its own end.

This latest rise of market volatility, however, is foreshadowing the real end of global QE as a proxy bond investor packaged for political purposes as necessary to combat deflation, increase liquidity, or whatever the reason-du-jour providing the QE program legitimacy beyond its true function of providing cheap capital to the private banking system, is.

The reason that the artificial resuscitation of the entire global financial system has worked as long as it has is due to the collaboration of major governments, central banks, and powerful private banks behind it. These three pillars of power have been mutually reinforcing.  Since early 2009, the bond and stock market have soared on the back of external capital from the central banks supported by the elite government leaders of the countries with the largest banks.

Just this year, 23 central banks have cut rates due to ‘sluggish growth’ – as if this cheap money has helped main populations anywhere. In the process their currencies will weaken. The US may have a strong dollar on the back of having had the largest and first QE / ZIRP program which is why  (behind the banks’ need) there’s no particular reason – yet - for the Fed to raise rates. Plus, the labor situation is barely improving even if the headline unemployment figures based on low job-market participation and poorly paying jobs appears better. Also, the ‘lower demand’ for oil amidst higher production (and some big commodity trading desks slamming oil prices and blaming Saudi Arabia) has made inflation (outside of the cost of living and the stock market) look tame enough to make rates hikes unnecessary.  But the big market players think (or say, anyway) that rate hikes could happen soon. This uncertainty begets higher volatility.

Meanwhile, the Euro is tanking against the dollar because Mario Draghi's ECB is on a QE roll, buying covered bonds from the likes of Deutschebank, ING, and BNP while pummeling Greece for not wanting to further crucify its population in order to repay funds that had egregious terms to begin with. Their ‘bailout’ had nothing to do with helping Greece attain a stronger economy and everything to do with validating speculators and the banks that sold them bonds. The IMF even sort of admitted this. But the Troika has made plutocratic finance a blood sport.

All this is fodder for triple digit market swings. Somewhere in the madness, lies the notion that this particular policy of speculation subsidization for the upper banking class can’t last forever. There are only so many entities that can buy so many bonds and filter so much cheap capital into the system for so long. At some point the ECB program will run its stated course. Rates around the world will head to zero or somewhat negative. And then what?  There will be no more powder in the QE / ZIRP global keg. That’s when it gets really bad.

Meanwhile, the rising volatility we will face this year (to the downside) in the financial markets, will signal this unraveling. The best course for mere individuals is to reduce their exposure to the insanity.  “Know when to hold ‘em, know when to fold ‘em, know when to walk away” as the lyrics to the old gambling song go. Because rest assured, the big boys are going to be on the financial life rafts first…economic Titanic style. That volatility – it’s the iceberg finally looming. 

The Fed’s Employment-Taper Myth, Big Six Bank Stocks, and Downgrades

There is a prevailing, politically expedient myth that the Fed’s bond purchase programs are somehow akin to job fairs; as if there’s an economic umbilical cord stretching from a mortgage-backed security lying on the Fed’s books to a decent job becoming available in the heart of America. Yet, since the Fed began its unprecedented zero-interest rate and multi-trillion dollar bond-buying policies - the real beneficiaries have been the Big Six banks (that hold more than $500 billion of assets): JPM Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.

The Big Six banks’ stock prices have outperformed the Dow’s rise by more than double, since early 2009. Moreover, low to zero percent interest rates on citizens’ savings accounts have catalyzed depositors, pensions, and mutual funds to buy more stocks to make up for low returns on bonds and money market instruments, further buoying the stock market.

Quantitative Easing ‘QE’ entails buying bonds, not creating jobs

No matter how many articles and politicians claim the Fed is buying Treasury and mortgage-backed securities (MBS) to help the a) economy or b)  unemployed, it isn’t true.

According to the Economic Policy Institute “the unemployment rate is vastly understating weakness in today’s labor market.” True, the official unemployment rate  (called ‘U-3’ on the Bureau of Labor Statistics reports) has inched downward from a high of 10% in early 2009 to 7%. But, that’s because people have dropped out of the hunt for jobs. The number of these ‘ workers’ as EPI calls them, has risen with the stock market’s rise; that’s not a sign of a healthier employment situation.

If those workers were still ‘participating’ in the employment-seeking crowd, the adjusted U-3 unemployment rate would have hovered between 10 and 11.8% since early 2009. It is currently at 10.3%. In other words, it’s still pretty damn high.

And that’s a more conservative estimate of unemployment than places like John Williams’ Shadowstats computes, which pegs the unemployment rate at Great Depression levels of just below 23%.

(The BLS’s estimate of the U-6 unemployment rate, which includes people who have briefly stopped looking (short-term discouraged or marginally attached workers) or found part-time rather than full time jobs, is at 13.2%. It has declined along with the official U-3 estimate, but does not account for the “missing” 5.7 million workers, either. Plus, the BLS long-term jobless figures have remained steady around 4 million people.)

Happy Hundredth Birthday Fed! (Bank to the bankers, not the people)

As I explore in greater detail in my upcoming book, All the Presidents’ Bankers, the Fed wasn’t created in the wake of the Panic of 1907 to help people find jobs. It was created to provide bankers a backstop to the pitfalls of risky bets gone wrong, and propel the US to a financial superpower position competitive with major European banks via supporting the US dollar.

As per its official summary in the Federal Reserve Act of 1913 (approaching its century anniversary on December 23, 2013), the Federal Reserve was formed to “provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.”

Besides, if the Fed really wanted to make a dent in unemployment today, it could have spent the nearly $1.4 trillion it used to buy MBS to create 14 million jobs paying $100K or 28 million jobs paying $50k, or funded the small businesses that the big banks are not. Equating QE with employment illogically equates offering the biggest banks a  dumping ground for their securities with middle and lower class prosperity.

QE is ongoing because the Big Six still hold crappy mortgages and like trading

According to the latest New York Fed's quarterly trends report; the Big Six banks’ annualized trading income, as a percentage of trading assets, is higher than pre-crisis levels, whereas non-trading non-interest income as a percentage of total assets is lower. That means banks are making more money out of trading post-crisis than pre-crisis relative to other businesses.

In addition, total non-performing loans, as a percent of total loans, is 4.75% (from a 2009 high of 7.25%) for the Big Six. This figure remains more than double pre-crisis levels, and more than double that of the rest of the industry (i.e. the smaller banks).

Nearly 10% of the residential mortgage loans of the Big Six banks are non-performing. This is not very different from the 11% highs in 2009 (compared to smaller banks whose ratios are 3.5% vs. 6% in 2009). In other words, the Big Six banks still hold near record high levels of bad mortgages, and in higher concentrations than smaller banks. That’s why the Fed isn’t tapering, not because it’s waiting for a magic unemployment rate.

QE Propels Big Six Bank Stock Prices

Since the financial crisis, the Fed has amassed a $3.88 trillion book of securities, or quintupled the size of its pre-crisis book. As of December 2013, the Fed owns $1.44 trillion MBS, many purchased from its largest member banks, the ones engaged in settlements and litigations over the integrity of similar securities and loans within them.

Since the Fed announced QE3, a $40 billion extension asset purchases per month (over the then-prevailing limit of $45 billion) on September 13, 2012,

the Dow has jumped 19%. BUT meanwhile - the Big Six bank stocks are up on average 53.5% (JPM Chase is up 43%, Bank of America 74%, Goldman 42%, Citigroup 57%, Morgan Stanley 77% and Wells Fargo 27%.)

Since its March 2009 lows, the Dow is up 142%. BUT - the Big Six bank stocks are up on average 324% or more than twice the level of the Dow. (JPM Chase is up 258%, BofA 396%, Goldman 122%, Citigroup 499% (accounting for its 10 to 1 reverse stock split in March 2011 - it was trading close to a buck on March 6, 2009) Morgan Stanley 80%, and Wells 408%.) Yes, they were near death, but you can’t argue the Fed’s policy helped the broad economy as opposed to mega-disproportionally helping the banks. These numbers don’t lie. And help from the Fed won’t stop with a new Chair.

Yellen to the (bank) rescue?

In her statement to Obama on October 9, 2013, Janet Yellen said “thank you for giving me this opportunity to continue serving the Federal Reserve and carrying out its important work on behalf of the American people.”

A month later, she told the Senate Banking Committee, “It could be costly to fail to provide accommodation [to the market],” underscoring her support for quantitative easing and zero-interest rate monetary policy (and Big Six bank stock prices).

In its latest FOMC meeting release, the Fed reiterated, “the Committee decided to await more evidence that progress [in the economy] will be sustained before adjusting the pace of its purchases.” It says the same thing every month, with slightly different wording. Every time the market wobbles on ‘taper’ fears, it jumps back, because professionals know the Fed will keep on buying bonds, because that’s what the Big Six banks need it to do. To analyze taper-time, look at the banks’ mortgage book, not the unemployment rate.

Resolution Plans and Downgrading for the Wrong Reasons

On November 14, Moody’s downgraded 3 of the Big Six banks - Goldman, JPM Chase, and Morgan Stanley - and also Bank of New York a notch each because “there’s less likelihood in the future that these banks will be helped by the government” in a financial emergency. Moody’s has the downgrade right, but for the wrong reasons.

The big banks had to present ‘living wills” as the media calls them, or Dodd-Frank Title II required resolution strategies. They amount to the big banks selling whatever crap they own in an emergency and dumping whatever remains of their firms on the FDIC. 

I examined the plans submitted to the Fed on October 30.  They aren’t long. The ones for JPM Chase and Goldman Sachs, for instance, tally 31 pages each, of which 30 pages discuss their businesses and just one page - resolution strategy.

The FDIC basically would get the toxic stuff unsellable by the ‘troubled’ bank and place it in a newly established ‘bridge bank’ before the ‘troubled’ bank finds another buyer or declares bankruptcy. Which is exactly what happened with IndyMac and other banks that were ‘taken over’ by the FDIC and then resold to private equity and other firms.

If all else fails, each firm would undergo bankruptcy proceedings, in an “orderly” manner and “with minimum systemic disruption” and “without losses to taxpayers.”  Or so the process is characterized by JPM Chase and the others.

Goldman Sachs also waited until page 31 of 31 to present its main resolution idea, consisting of  “recapitalizing our two major broker-dealers, one in the U.S. and one in the U.K., and several other material entities, through the forgiveness of intercompany indebtedness...” This amounts to massaging inter-company numbers if things go haywire.

But banks oozing eloquences like “orderly market” or ‘minimum-disruption” bankruptcy and the reality being so, are two different things. Lehman Brothers tried most of these methods and still catalyzed a widespread economic meltdown. Bear Stearns didn’t declare bankruptcy, but the Fed and Treasury still conspired to guarantee its assets in a sale to JPM Chase. Technically, politicians and bankers argued no taxpayer money was used in that scenario because the guarantee wasn’t part of the TARP funds, but it was a government guarantee all the same so the distinctions amounts to splitting political hairs.

There is simply NOTHING NEW in these plans, no safety shield for the world. The problem remains that the FDIC can’t handle a systemic banking collapse, which is a threat that the Big Six banks, in all their insured-deposit-holding-glory still pose.

If all of the banks implode on the back of still existing co-dependent chains of derivatives or toxic assets or whatever the next calamity delivers, even if the Treasury Department doesn’t get Congress to pony up funds to purchase preferred shares in the big banks, and even if the FDIC creates bridge banks to take over trillions of dollars of bad assets - which it can’t afford to do, the Fed would simply enter QE-Turbo Mode.

It doesn’t matter if bankers and politicians don’t consider this a ‘taxpayer-backed’ bailout as per the lofty aspirations of a tepid Dodd-Frank Act. Because whatever subsidies are offered in that case, we will all still be screwed, and we will all pay in some manner. The Fed’s balance sheet and Treasury debt would bloat further. The cycle would continue.