I’ve Got a Feeling (Dodd-Frank)


c4uhxrqwmaido-yFrom the Let It Be album, this is one of the very last songs Lennon/McCartney worked on together and was filmed as part of their final concert on the rooftop of Apple Records.

It was made up of two half-finished songs they’d each been working on.   Paul’s was a love song to Linda – they  would soon marry.  John’s was about a hard year – recently divorced, estranged from his son, deep into heroin,  his girlfriend Yoko Ono had suffered a miscarriage and they’d both recently been arrested for possession.

The prolific legendary songwriting tandem, each in very different places in life.  The unfortunate sidebar to this rich dichotomy was that The Beatles were about to break up.

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The Fed has created “a very false economy.”  … “We are in a big, fat, ugly bubble. And we better be awfully careful.”  – campaigning Trump Sep/16

“We expect to be cutting a lot out of Dodd-Frank, because frankly I have so many people, friends of mine, that have nice businesses and they can’t borrow money…They just can’t get any money because the banks just won’t let them borrow because of the rules and regulations in Dodd-Frank. So we’ll be talking about that in terms of the banking industry.”  – President Trump Feb/17

 

I’ve got a feeling playing around with US banking regulations might be a very bad idea.  Several years after the financial crisis, these bull market years of inflated real estate and stock markets are the result of emergency level central bank policies and interest rates.   Despite America’s current sense of prosperity in carrying its’ own $20 trillion of government debt,  the current extreme of QE printing AND negative interest rates in the EU and Japan solidify that the global debt crisis never went away.

Ev’rybody had a hard year,  Ev’rybody had a good time
Ev’rybody had a wet dream,  Ev’rybody saw the sunshine

No doubt there are aspects of Dodd-Frank  that might certainly be reviewed and tweaked.    But the assertion that regulations are holding back borrowing is flat out wrong.

Global corporate bond issuance (ex financials) just had a record January of $167B, twice the previous record set in 2001.

In fact US loan books have never been higher, even relative to the economy.

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Some of the massive wave of US corporate stock buybacks has been driven by borrowed money, also not suggesting that glaring capex investment opportunities are being squeezed out by a restrictive lending environment.

McKinsey puts out a periodic review of global debt.   We know you don’t get out of a hole by digging.  So we don’t get out of a debt crisis with more debt.  Yet central bank policies have engendered just that.

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Simply put, if the growth in debt levels are compounding faster than the level of interest rates and economic growth, then the debt burden is actually getting worse, as evidenced by rising debt/GDP around the world.  (Again h/t McKinsey)

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Remember, debt used for consumption today may well be borrowing from tomorrow’s growth.    As well, $200 trillion of global debt – $2trillion per percent in interest costs – is an enormous headwind should rates need to rise.  With such increased interest rate sensitivity, is it really time to play with rules that’ll expand access to credit?

A big 30% chunk of this global debt explosion has been China, whose debt grew 4-fold to $28T during the period.  It’s well known this debt financed construction of excess housing and commercial property.  These debts hang over a now vulnerable banking system exposed to leveraged non-performing and expensive assets.  They could be harbinger of another global credit event let alone a headwind for future growth.

Euro area banks are still fragile.  Brexit, and the multiple EU country elections that loom might test the questions of whether the euro union is even sustainable.

Japan has lived long on QE.  Decades of such policy history can clearly argue interest rates and loan regulation are not what is holding them back.

The Fed has painstakingly raised rates a few times and telegraph more.  But they are doing so at a still very tenuous time for this EU/China/Japan complex.  It is challenging enough for the world to transition to diverting monetary policies between the regions.  It is any wonder what new diversion in capital requirements and lending capacities could do to foreign banking systems.

I understand that the GOP feel they’ve won their window to slash US regulations across the board.  I don’t know who President Trump’s friends are, hard done by because of loan availability, interest rates, or regulation.  But the nature of this global debt beast suggest his friends may be outliers.  For a reminder – we are here…

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Ev’rybody had a good year,
Ev’rybody let their hair down,
Ev’rybody pulled their socks up,
Ev’rybody put their foot down.

The other aspect of deregulation to be toyed with possibly will  include Wall St.’s capacity to trade for it’s own account.

As a refresh, one of the real culprits of the great crisis was Bill Clinton’s 1999 repeal of Glass Steagall, the Depression-era law put into place to protect a bank’s depositor base from its’ speculations.  He also signed the Commodity Futures Modernization Act, which among other things exempted credit-default swaps from regulation.  By 2007, these moves proved to play a big role in the untethered lending environment that ultimately led to the insanity in housing markets and Wall St’s ridiculous leverage.

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In that crisis there were tax-payer bailouts yet bonuses paid, forced mergers, yet no jail time.  Too Big To Fail became vernacular.  Over the years over $200 billion in fines were doled out for bank misbehaviour, largely paid for out of bank profits from the Federal Reserve’s free money policies.

Today we have unstable bubbly asset prices and desperately low interest rates because of the crippling systemic stupidity of that era.  Desperate monetary experiments have contributed to the very societal income-disparity pressures that gave Trump’s movement and the entire alt-Right movement, a voice.  It is ironic he now seems to be pandering to a Wall St whose speculation left much of his voter base behind.

The passing of Dodd-Frank was an attempt to ensure that this kind of crippling systemic stupidity never happens again.  Surely its not perfect.  There have already been episodes of corporate paper spreads being more volatile because of the lack of liquidity that Wall St trading desks can provide.  But the world is still in financial crisis mode, and with elevated valuations, especially vulnerable.  It would be scary to imagine there to be a political will behind a notion that regulation put in place for the safety of the system was a problem.  Sanity, lack of oversight and regulation was the problem.  The same central banking illuminati that lead us into crisis is still struggling with experiments to lead us out.  Along that thinking, there is little reason to believe greater Wall St leverage and/or speculative leeway will lead us out.

Another goal of Dodd-Frank was to get Wall St.’s derivative exposures out into the open, on a centrally cleared platform, rather than the more secretive and difficult to regulate over-the-counter market.  The extreme leverage and potential scope of these derivatives markets obviously played a major role in the crisis.  I came across this interesting blog piece from Wall St on Parade in which they dwell on the derivative exposure of Goldman Sachs.

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There is no doubt that Goldman Sachs has established itself as the go-to farm system for the world’s powerhouse cockpits of policy and oversight.  From central banks (Federal Reserve – Dudley, Kashkari, Kaplan, Bank of England – Carney,  ECB – Drahgi) to past US Treasury Secretaries (Rubin, Paulson) to Trump’s current cabinet (Mnuchin, Cohn, Bannon), Goldman Sachs is plugged in.  So it will also be fascinating to see how this discussion of deregulation addresses derivative markets.

There are a lot of offsets in the running of derivative books, so the $243 trillion of notional exposure of the top 25 holders cannot be taken at face value.  However the US economy is about $19 trillion comparatively, and global GDP is about $74T – so we are playing with big numbers.   Compared to their total asset base, Goldman Sachs seems the most exposed.  And this is exposure accumulated under Dodd-Frank.  Surely it should be worrisome to see the drapes pulled further shut.

Bottom line is this.  We’re not even close to our global financial system being restored to health and to interest rates being normalized.  Global asset valuations call for prudence, not for decreased capital requirements, easier lending standards and increased speculation.  It is already bad enough we have global central banks manipulating markets with their printed trillions of intervention, do we really want to layer on less transparency onto Wall St. trading?

Two very different songs.  The optics are that the US is in a better place, progressed further into recovery and poised for fiscal reflation.  But the global debt picture is not in a good place.  The dichotomy is that the rest of the world is vulnerable.  Therefor so is the US.  Canada and Aussie debt driven real estate excesses look dangerous.  China’s banking system is vulnerable.  UK’s Brexit process is still unclear.  The EU is in extreme monetary experimentation ahead of potentially extreme political volatility.  Japan remains in perpetual debt spiral.

Given Trump’s early actions and his leanings toward taxes and trade, he seems to want to go fast and hard, early.  America first.  Tax cuts and infrastructure spend.  Given the current nature of asset prices, and debts and global stability, I have a feeling being too aggressive on Dodd- Frank could have dangerous repercussions.

Why suddenly trust the system and its players so much more now?

 

 

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