Using Veritas to Construct the "Per…

29-04-2017 Hits:84585 BoomBustBlog Reggie Middleton

Using Veritas to Construct the "Perfect" Digital Investment Portfolio" & How to Value "Hard to Value" tokens, Pt 1

The golden grail of investing is to find that investable asset that provides the greatest reward with the least risk. Alas, despite how commonsensical that precept seems to be, many...

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The Veritas 2017 Token Offering Summary …

15-04-2017 Hits:79054 BoomBustBlog Reggie Middleton

The Veritas 2017 Token Offering Summary Available For Download and Sharing

The Veritas Offering Summary is now available for download, which packs all the information about Veritas in a single page. A step by step guide to purchasing Veritas can be downloaded here.

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What Happens When the Fund Fee Fight Hit…

10-04-2017 Hits:78906 BoomBustBlog Reggie Middleton

What Happens When the Fund Fee Fight Hits the Blockchain

A hedge fund recently made news by securitizing its LP units as Ethereum-based tokens and selling them as tradeable (thereby liquid) assets. This brings technology to the VC industry that...

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Veritaseum: The ICO That's Ushering in t…

07-04-2017 Hits:83386 BoomBustBlog Reggie Middleton

Veritaseum: The ICO That's Ushering in the Era of P2P Capital Markets

Veritaseum is in the process of building peer-to-peer capital markets that enable financial and value market participants to deal directly with each other on a counterparty risk-free basis in lieu...

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This Is Ground Zero for the 2017 Veritas…

03-04-2017 Hits:79953 BoomBustBlog Reggie Middleton

This Is Ground Zero for the 2017 Veritas Offering. Are You Ready to Get Your Key to the P2P Capital Markets?

This is the link to the Veritas Crowdsale landing page. Here is where you will be able to buy the Veritas ICO when it is launched in mid-April. Below, please...

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What is the Value Proposition For Verita…

01-04-2017 Hits:82263 BoomBustBlog Reggie Middleton

What is the Value Proposition For Veritas, Veritaseum's Software Token?

 A YouTube commenter asked a very good question that we will like to take some time to answer. The question was, verbatim: I've watched your video and gone through the slides. The exchange...

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This Real Estate Bubble, Like Some Relat…

28-03-2017 Hits:53240 BoomBustBlog Reggie Middleton

This Real Estate Bubble, Like Some Relationships, Is Complicated...

CNBC reports US home prices rise 5.9 percent to 31-month high in January according to S&P CoreLogic Case-Shiller. This puts the 20 city index close to an all time high, including...

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Bloomberg Chimes In With My Warnings As …

28-03-2017 Hits:81266 BoomBustBlog Reggie Middleton

Bloomberg Chimes In With My Warnings As Landlords Offer First Time Ever Concessions to Retail Renters

Over the last quarter I've been warning about the significant weakness in retailers and the retail real estate that most occupy (links supplied below). Now, Bloomberg reports: Manhattan Landlords Are Offering...

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Our Apple Analysis This Week - This Comp…

27-03-2017 Hits:81274 BoomBustBlog Reggie Middleton

Our Apple Analysis This Week - This Company Is Not What Most Think It IS

We will releasing our Apple forensic analysis and valuation this week for subscribers (click here to subscribe - lowest tier is the same as a Netflix subscription). As can be...

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The Country's First Newly Elected Lame D…

27-03-2017 Hits:81078 BoomBustBlog Reggie Middleton

The Country's First Newly Elected Lame Duck President Will Cause Massive Reversal Of Speculative Gains

Note: Subscribers should reference  the paywall material here for stocks that should give a good risk/reward scenario for bearish trades. The Trump administration's legislative outlook is effectively a political desert, with...

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Sears Finally Throws In The Towel Exactl…

22-03-2017 Hits:86928 BoomBustBlog Reggie Middleton

Sears Finally Throws In The Towel Exactly When I Predicted "has ‘substantial doubt’ about its future"

My prediction of Sears collapsing once interest rates started ticking upwards was absolutely on point.

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The Transformation of Television in Amer…

21-03-2017 Hits:84941 BoomBustBlog Reggie Middleton

The Transformation of Television in America and Worldwide

TV has changed more in the past 10 years than it has since it's inception nearly 100 years ago This change is profound, and the primary benefactors look and act...

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The following excerpt amplifies the anecdotal point that I made in my recent post on commercial bank loans . In particular, the amount of securitized loans banks have created, the increasing amount they started holding for thier own account, and the abrupt disruption of the market which pretty much forced them to keep everything. Keep this chart in mind as you read through William Dudley's speech.

The primary benefit of securitization was the virtualization of the bank's balance sheet. Through securitization, banks were able to underwrite a vast amount of risk relative to their balance sheet capacity, by selling off the risk to the open markets. Despite this, banks have steadily increased the amount of risk kept on (and off, through SPEs) their books  over the last 20 years, with a forced increase of this concentration in 2007 when the securitization market simply shut down - cutting off the liquidity spigot for these assets. Starting at about 2004 near the height of the securitization bubble , banks increased the pace of securitized asset retention.

image046.png

 

Excerpt from the New York Fed web site

May You Live in Interesting Times: The Sequel

William C. Dudley, Executive Vice President

Remarks at the Federal Reserve Bank of Chicago's 44th Annual Conference on Bank Structure and Competition, Chicago

 

Exhibits (slides) PDF

I gave a speech last October entitled “May You Live in Interesting Times.” In that speech I listed a number of events that I never, ever expected to see. These included AAA-rated mortgage backed securities selling at 85 to 90 cents on the dollar, asset-backed commercial paper backstopped by real assets and a full bank credit support yielding more than unsecured commercial paper issued by the same bank, and a Treasury bill auction that almost failed at a time that there was a flight to quality into Treasurys going on.

The list has gotten much longer since then. To mention just a few: AAA-rated collateralized debt obligations (CDOs) that may turn out to be worthless; monoline guarantors, some still with AAA ratings, but with credit default swap spreads higher than many non-investment grade companies and a major investment bank’s demise in a few short days in March.

The number of liquidity facilities developed and introduced by the Federal Reserve is another list that has gotten much longer. Policymakers have responded to the persistent pressures in funding markets by introducing several new liquidity tools.

Today, I want to focus on what we’ve been up to in terms of these liquidity-providing innovations. Before I begin in earnest let me underscore that my comments represent my own views and opinions and do not necessarily reflect the views of the Federal Reserve Bank of New York or of the Federal Reserve System.

Let me first define the underlying problem. The diagnosis is important both in influencing the design of the liquidity tools and in assessing how they are likely to influence market conditions.

As I see it, this period of market turmoil has been driven mainly by two developments. First, there has been significant reintermediation of financial flows back through the commercial banking system. The collapse of large parts of the structured finance market means that banks can no longer securitize many types of loans and other assets. Also, banks have found that off-balance-sheet exposures—such as structured investment vehicles (SIVs) or backstop lines of credit that are now being drawn upon—are adding to the demands on their balance sheets.

Second, deleveraging has occurred throughout the financial system, driven by two fundamental shifts in perception. On one side, actual risks—due to changes in the macroeconomic outlook, an increase in price volatility, and a reduction in liquidity—and perceptions about risks—due to the potential consequences of this risk for highly leveraged institutions and structures—have shifted. Many assets are now viewed as having more credit risk, price risk, and/or illiquidity risk than earlier anticipated. Leverage is being reduced in response to this increase in risk.

On the other side, the balance sheet pressures on banks have caused them to pull back in terms of their willingness to finance positions held by non-bank financial intermediaries. Thus, some of the deleveraging is forced, rather than voluntary.

In some instances, these two forces have been self-reinforcing: In March, the storm was at its fiercest. Banks and dealers were raising the haircuts they assess against the collateral they finance. The rise in haircuts, in turn, was causing forced selling, lower prices, and higher volatility. This feedback loop was reinforcing the momentum toward still higher haircuts. This dynamic culminated in the Bear Stearns illiquidity crisis.

During the past eight months, the financial sector as a whole has been trying to shed risk and to hold more liquid collateral. This is a very difficult task for the system to accomplish easily or quickly for two reasons. First, the financial sector, outside of the commercial banking system, is several times bigger than the banking system. So, with some hyperbole, you are, in essence, trying to pour an ocean through a thimble. Second, this process of deleveraging tends to push down asset prices for less liquid assets. The decline in asset prices generates losses for financial institutions. Capital is depleted, increasing the pressure on balance sheets.

One consequence of this reintermediation and deleveraging process has been persistent upward pressure on term funding rates. For example, the spreads between 1- and 3-month LIBOR and the comparable overnight index swap rates have widened sharply during this period. The overnight index swap rate is the expected effective federal funds rate over the stated maturity of the swap. As shown in the two exhibits on page two, this pressure on term funding rates has occurred in the United States, Euroland, and the United Kingdom. It is a global phenomenon.

In fact, the increase in LIBOR to overnight indexed swap (OIS) spreads may understate the degree of upward pressure on term funding rates. Note that after a Wall Street Journal article on April 16 questioned the veracity of some of the LIBOR respondents and the British Bankers Association threatened to expel any banks that they discovered had been less than fully honest—LIBOR spreads increased further.

The foreign exchange swap market indicates that the funding costs for many institutions may be even higher than suggested by the dollar LIBOR fixing. As shown in the next slide, the funding cost of borrowing dollars by swapping into dollars out of euros over a 3-month term is about 30 basis points higher than the 3-month LIBOR fixing.

So what explains this rise in funding pressures more precisely? Some have argued that the rise in term funding spreads reflects increased counterparty risk; others that the rise stems from a reduction in appetite of money market funds to provide term funding to banks. Over the past eight months, there is some validity to both of these arguments. But neither explanation provides a very satisfactory explanation.

Credit default swaps spreads for major commercial banks have narrowed considerably over the past two months. This indicates that counterparty risk assessments are improving—yet LIBOR-OIS spreads widened over this period. Thus, it is hard to pin this widening in LIBOR-OIS spreads on an increase in counterparty risk.

Similarly, the notion that money market mutual funds have lost their appetite for term bank debt has not been particularly compelling recently. The split of money market fund assets between Treasury-only versus prime money market funds has been relatively stable, the weighted average maturity of the funds has been increasing, and prime funds have increased their allocation to both foreign and domestic bank obligations. In contrast, when there was a flight to quality to Treasury-only money market funds last August, this was a more compelling explanation.

So what has been driving the recent widening in term funding spreads? In my view, the rise in funding pressures is mainly the consequence of increased balance sheet pressure on banks. This balance sheet pressure is an important consequence of the reintermediation process. Although banks have raised a lot of capital, this capital raising has only recently caught up with the offsetting mark-to-market losses and the increase in loan loss provisions. At the same time, the capital ratios that senior bank managements are targeting may have risen as the macroeconomic outlook has deteriorated and funding pressures have increased.

The argument that balance sheet pressure is the main driver behind the recent rise in term funding spreads is supported by what has been happening to the relationship between other asset prices—especially the comparison of yields for those assets that have to be held on the balance sheet versus those that can be easily sold or securitized. Consider, for example, the spread between jumbo fixed-rate mortgages and conforming fixed-rate mortgages, which is shown in the next slide. As can be seen, this spread has widened sharply in recent months, tracking the rise in the LIBOR/OIS spreads.

Why is this noteworthy? Jumbo mortgages can no longer be securitized, the market is closed. Thus, if banks originate such mortgages, they have to be willing to hold them on their balance sheets. In contrast, conforming mortgages can be sold to Fannie Mae or Freddie Mac. Because the credit risk of jumbo mortgages is likely to be comparable to the credit risk of conforming mortgages, the increase in the spread between these two assets is likely to mainly reflect an increase in the shadow price of bank balance sheet capacity.

If this is true, then the same balance sheet capacity issue is likely to be an important factor behind the widening in term funding spreads. After all, a bank has a choice. It can use its scarce balance sheet capacity to fund a jumbo mortgage or to make a 3-month term loan to another bank.

If balance sheet capacity is the main driver of the widening in spreads, this suggests that there are limits to what the Federal Reserve can accomplish in terms of narrowing such funding spreads. After all, the Fed’s actions cannot create bank capital or ease balance sheet constraints materially.

That said, the Fed can reduce bank funding risks by providing a safe harbor for financing less liquid collateral on bank and primary dealer balance sheets. Reducing this risk may prove helpful by lessening the risk that an inability to obtain funding would force the involuntary liquidation of assets. The ability to obtain funding from the Fed reduces the risk of a return to the dangerous dynamic of higher haircuts, lower prices, forced liquidations, and still higher haircuts that was evident in March.

In essence, the Federal Reserve’s willingness to provide liquidity against less liquid collateral allows the reintermediation and deleveraging process to proceed in an orderly way, which reduces the damage to weaker counterparties and funding structures. One can think of the Federal Reserve’s actions as smoothing and extending the adjustment process—not preventing it—so that the adjustment causes less damage to the financial system and less pernicious macroeconomic consequences.

The Federal Reserve has introduced three