Treasury Sets Stage for Financial Crisis Sequel

The good points in Treasury’s Dodd Frank reform priority list – in particular, acknowledging that cranking up regulatory capital requirements made the corporate bond market a LOT less liquid, and therefore prone to crisis – are overshadowed by one piece of truly head-shaking stupidity.

Treasury seems to have forgotten – or perhaps it never understood (or, more likely yet, just wants to cut its pals at the once and future wards of the state on Wall Street a break) – that it was all that super-senior synthetic CDO crap, requiring nearly no regulatory capital, that blew banks apart when the ratings firms realized their models were all wrong in 2007-08.

downloadBanks stuffed to the gills with that gilded manure – they couldn’t sell it, after all, initially because it yielded zilch and later because no one wanted to catch a falling knife – were suddenly insolvent when the three blind mice began their panicky widespread ratings downgrades and the squillions of super-senior crammed in banks’ attics suddenly started requiring – yup – lots of regulatory capital.

This proposal is doubly idiotic, since it assumes that investors will want to buy this stuff when it is declining in value, just when those investors themselves are scrambling to sell their own liquid assets to meet the true bogeyman of the crisis, the promised panacea that turned out to be the virulent contagion that spread the trouble from one basket of eggs to the next and pushing asset class correlations inexorably, painfully, toward 1 – the magic of collateral and margin calls.

From the FT:

The report seeks to soften bank capital requirements for securitised products, lowering some calculations in line with international recommendations. It also suggests the highest quality layers, or “tranches”, of debt should count towards banks’ liquid assets able to be sold in a crisis to raise cash, helping them meet another international regulatory requirement.

Oh boy.

via Five takeaways from the Treasury’s deregulation report

Holy Crap. $500 Trillion in Derivatives Notionals? After Tear-ups?

I thought tear-ups were supposed to reduce the notional monster. (At least that was the hope when I edited RISK magazine 15 years ago….) If tear-ups have been happening in the background, the rate of new contract generation has been truly obscene.

via $500 Trillion in Derivatives “Remain an Important Asset Class”: Hilariously, the New York Fed | Wolf Street

Why So Few Will “Retire” Comfortably

Serial blunders in the structure of retirement vehicles, especially Social Security, explained. A long post on Naked Capitalism, well worth reading – including the comments. From the embedded interview of Michael Hudson:

The Federal Reserve has just published statistics saying the average American family, 55 and 60 years old, only has about $14,000 worth of savings. This isn’t nearly enough to retire on. There’s also been a vast looting of pension funds, largely by Wall Street. That’s why the investment banks have had to pay tens of billions of dollars of penalties for cheating pension funds and other investors. The current risk-free rate of return is 0.1% on government bonds, so the pension funds don’t have enough money to pay pensions at the rate that their junk economics advisors forecast. The money that people thought was going to be available for their retirement, all of a sudden isn’t. The pretense is that nobody could have forecast this!

There are so many corporate pension funds that are going bankrupt that the Pension Benefit Guarantee Corporation doesn’t have enough money to bail them out. The PBGC is in deficit. If you’re going to be a corporate raider, if you’re going to be a Governor Romney or whatever and you take over a company, you do what Sam Zell did with the Chicago Tribune: You loot the pension fund, you empty it out to pay the bondholders that have lent you the money to buy out the company. You then tell the workers, “I’m sorry there is nothing there. It’s wiped out.” Half of the employee stock ownership programs go bankrupt. That was already a critique made in the 1950s and ‘60s.

via Michael Hudson: Retirement? What Social Obligation? | naked capitalism

This is Worse than Before the Last Three Crashes | Wolf Street

How long will “magical thinking” sustain the rally? No way to say. But when the gears are reversed, it could get ugly…. From Wolf Street:

“There are a million reasons why multiple compression hasn’t started yet, including the scorched-earth monetary policies by central banks around the world and the hope for miracles during the Trump administration.”

via This is Worse than Before the Last Three Crashes | Wolf Street

Dow 20,000 Obscures Eroding Technicals

Share buybacks, market meth since the financial crisis, have cratered. Wolf Richter highlights just how far corporate America has pulled in its horns:

Share buybacks in the third quarter plunged 28% year-over-year, to $115.6 billion, the biggest year-over-year dive since Q3 2009, according to FactSet. It was the second quarter in a row of declines, from the glorious Q1 this year, when buybacks had reached $168 billion, behind only Q3 2007 before it all came apart.

From that great Q1 2016 to Q3, buybacks plunged 31%, or by $52 billion.

“Only” 362 of the S&P 500 companies bought back shares in Q3, the second lowest number in three years, with Q2 having been the lowest number (blue line in the chart below).

However, the third quarter has historically produced the most buybacks as companies are feverishly trying to put some lip gloss on their annual earnings per share. But not this time.

Share buybacks can be seriously value-destructive, since companies, especially buyback titans in the tech sector like Apple and Microsoft, risk buying shares at prices that are overvalued because of technicals – specifically, shrinking floats – rather than fundamentals.

Several things could be driving this.

Companies might have simply realized that their valuations are not justified by their earnings growth, and so leveraging themselves to the gills to purchase shares has become increasingly bad policy. Since management compensation is typically tied to the earnings per share growth that buybacks goose, this seems unlikely – it would run against human (or at least C-Suite) nature.

Management may be girding for tougher times ahead, protecting their cash flows from rising rates.

Management might have one eye on Trump’s plan to provide a tax “holiday” to allow them to repatriate their overseas cash without paying the full corporate tax on it, and once that happens, they may fire up the buyback machines again.

Nonetheless, the buyback stats – especially given that they fly in the face of management incentives – should be sobering for those who see Dow 20,000 as merely another signpost on the relentless upward march of share valuations.

Even with the buybacks, the S&P 500’s earnings per share has fallen sharply since hitting its historic high of 107.61 in September 2014. It was 87.17 at mid-year 2016, a level not seen since February 2011, according to

Along with investors who could soon endure unpleasant mean reversions in their stock portfolios, the valuation boom has been bad for start-ups trying to get out of the gate. The amount raised via IPOs has fallen sharply in the last two years. Again, from Richter:

Last year, the number of US-listed IPOs had plunged 38% to 170, according to Renaissance Capital. In terms of dollars, only $28.7 billion was raised, down 48% from 2014. By that measure, according to Thomson Reuters, it was the “worst year since 2009.”

But that’s like so 2015.

In 2016, only $24 billion was raised in US-listed IPOs, according to Dealogic – the worst year since 2003. Even during the Financial Crisis, IPOs raised more money than in 2016: $30 billion in 2008 and $27 billion in 2009.

He considers that this may be due, in part, to the outsized valuations of start-ups, and the unfortunate habit that “unicorns” – start-ups with valuations over $1 billion – have of imploding.

Technicals might trump (sorry…) fundamentals for a while longer, but given the new administration’s apparent glee in creating uncertainty, it seems a bad long-term bet. If Trump pushes through a capital gains tax cut, vertiginous investors might reach for their ripcords.