Evolving Financial Institutions

Posted on November 20, 2012

So much of the world is in transition, why do people want the commercial banking industry to be what it was many years ago? This is just not going to happen.

As I have written many, many times, finance is information! We have seen, over the past fifty years or so how the advancements in information technology have contributed, for better or worse, to the innovations that have taken place in financial institutions and financial instruments.

Given the continuing advancements in the information technology field how can we not expect the financial field to continue to evolve? Check out all that is being done in mobile banking these days. At least in my area of the world I am seeing more and more advertisements about mobile banking and what it does for the customer.

And, this is just the ground level. More and more people you talk with and read about claim that they have only gone into a bank office once or twice in the past two or three years. And, the only reason they went into the bank was to complain about not receiving notifications from the bank that their interest rates were being dropped. If this is not enough, read David Wolman’s book, “The End of Money” (Da Capo Press, 2012).

But, who is going to even keep their money in a typical commercial bank? I don’t. I work with an institution that satisfies my banking needs and ties all my financial relationships together so that I can move seamlessly from one asset class to another almost instantaneously.

How about my mortgage? (Yes, I have one!) The commercial bank I know set me up with their affiliated mortgage that immediately sold the mortgage to Wells Fargo (WFC), which now just services the loan because it is owned by Fannie … read the rest

August 2012 – The Future of Small Business Financing

Posted on August 23, 2012

Everyone loves small business.

At least that’s what the politicians want you to believe.

The reality is different. Small business is under attack from every quarter. Government policies favor large banks and large multinational businesses. Credit is tight and the banks favor the larger borrowers. Increased regulations stifle innovation and protect large incumbents that can afford teams of lawyers and lobbyists.

What’s the little guy to do? Waiting for the politicians to change the system is wishful thinking. Smart business people find ways to prosper in every environment.


And the current environment is not great for small firms. The Federal Reserve Senior Loan Officer survey has recently confirmed what we have suspected for some time: banks have been more generous in easing underwriting requirements for larger companies than they have been for smaller companies. Paynet, which maintains data on 17 million small business loans, reports that lending conditions for small firms have deteriorated in recent months after two years of bounce back from the 2009 bottom.  For additional details go to the full article on Capital Matters.


Financial Market Risk
And there’s a risk that things could get a lot worse for businesses that don’t tie down their financing soon.  We just published an article on Seeking Alpha that has received a great deal of attention with more than 14,400 page views so far. Our thesis is that the Fed’s zero interest rate policy has led to a situation where longer term treasury bonds are trading at yield levels that provide a spread to inflation far below the historical norms. Markets eventually return to their mean and often overshoot it so there is growing risk in the longer term debt market. Our concern is two-fold. First, that individual investors need to be aware of the potential impact of this return to the mean … read the rest

A Swan Blacker Than The Darkest Night

Posted on August 18, 2012

Interest Rates Rise at 2652% Annualized Rate! That’s probably a headline you will not see in the Wall Street Journal and it’s certainly a bit over the top, but those are the facts. From July 18 to August 17, the interest rate on the two-year Treasury jumped from .22% to .29%. That’s a 32% one month increase and works out to an annual jump of 2652% if you compound the increase monthly. Just to be fair the ten-year rate “only” rose from 1.52% to 1.81% or about 19% over the same period. With the magic of compound interest that generates a far more benign 713% annualized rate rise.

If you haven’t already done the math, those growth rates would take you to a 43.8% annual interest rate on the two year a year from now and a 12.9% interest rate on the ten year at that point. Of course that is not going to happen. Most likely we’ve just seen a random fluctuation in an overbought market. The Fed has promised to keep interest rates low for an extended period after all.

We’ve been saying for some time that the seeds have been planted for a move into a period of stagflation comparable to what we saw from the mid-1960’s and the 1970’s. That move, which transformed the benign inflation of the 1950’s to a raging inferno by the end of the period, eventually took Treasury rates for the 10 year to unheard of levels of 15% by the end of the 1970’s. This resulted in a collapse of the bond market and the eventual failure of entire savings and loan industry in the United States in the 1980s.

The United States and most of the developed world have benefited tremendously over the past 30 years from a steady drop in long-term bond rates.… read the rest

QE Anyone?

Posted on August 10, 2012

If anyone doubts we are moving to more monetary accommodation, take a look at the excerpt below from last night’s U.S. Financial Data release from the St. Louis Fed. The lower right hand corner reflects the most recent trends.

In June, we posted an article indicating a seeming correlation between the trend in direction and magnitude of U.S. M2 growth and U.S. economic activity. The decline in the M2 growth rate has now turned, and is headed up again, as you can see below, but the turn is not as dramatic as the growth in the Monetary Base.

We’ve previously stated our concern that the U.S. could be heading into a period of rapidly increasing inflation, similar to that experienced in the early 1970s that led to many years of stagflation, only ending with Mr. Volcker’s monetary castor oil. We’ve got all the ingredients, including this summer’s rapid runup in commodity prices. The past twelve month the GDP price deflator has dropped from 2.4% to 1.9% on an annual basis, averaging a bit above the Fed’s 2% target. 2-3% is in the range where the 1970’s inflation began to take off. Yet, we’re in a period where many, if not most, observers have been talking recession and increased likelihood of deflation. Real inflation will come as a black swan for many, with significant implications for both fixed income and equity markets.

Could the current round of easing be the spark that finally ignites the inflationary flame? There are lots of reasons to suspect that’s possible. Calculated Risk just supported a growing belief that housing may finally be bottoming. Declining home prices have been a primary force that’s kept inflation in check for the past few years. Add to that a renewed commodity spiral, annual wage inflation in China hitting 13-15% and evidence that the read the rest

Are Derivatives Accounting Rules Helping the Big Banks Overstate Their Earnings?

Posted on November 21, 2011

Profits do not mean the same thing for the major banks as they do for ordinary businesses.  If you manufacture or distribute widgets, calculating your profit on a sale is pretty straightforward.  What did it cost to acquire or make the widget? What did you sell it for?  The difference is profit.  For a broker/dealer it works pretty much the same way.  What did the bond cost me?  What commissions did I pay?  The difference is profit.

Now consider the case of the major money center banks.  Thanks to the repeal of Glass Steagall they are in the position to act not only as a broker dealer, but also as a principal, holding the financial instruments they create in their long-term investment book.  During the heyday of the mortgage securitization boom, this permitted the banks to package bundles of mortgages into mortgage-backed securities (MBS), booking a hefty spread in the process.  The MBSs could then be repackaged as collateralized debt obligations (CDO) and the CDOs could then be re-repackaged an infinite number of times as synthetic CDOs thanks to the magic of credit default swaps.

At each step of the process the bank earned a hefty origination spread, the investment bankers, brokers, lawyers and a myriad of consultants and rating agencies made their commissions and fees and everyone was happy, at least as long as the securities could be pawned off to some Norwegian village north of the Artic Circle.  At some point the music stopped and the Norwegians went back to hunting reindeer, but not so the bankers.

Thanks to the repeal of Glass Steagall the banks were able to find new customers for the convoluted structures their well-oiled machines were churning out by the hundreds: they held them on their own books.  By booking the securities at “retail” this process enabled the … read the rest