Breaking Up the Banks with Glass-Steagall 2.0

 In a last minute move today, Donald Trump inserted a call to reinstate Glass-Steagall into the Republican platform, as our partner ACG Analytics predicted in February. A rallying cry of the Bernie Sanders campaign, the proposal had only previously had marginal support among a few Republicans and had been rejected by House Chairman Hensarling who recently rolled out his own financial reform proposal. Trump’s embrace of this policy — attacking large banks and tacking to the left to defeat Clinton — is a shrewd political move. As ACGA wrote in our February note: “The Next Trump Victim: Banks?“
From the prologue of the New York Times bestseller, “A Colossal Failure of Common Sense”
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By allowing commercial banks like Citigroup and JP Morgan to merge with investment banks, over $8T of customer deposits became directly exposed to another $78T+ derivatives and other 21st century financial products (CDOs, CLOs, SIVs, CMBS and more).  Smaller investment banks without deposits were forced to lever up just to compete.  From 2000 to 2008, Lehman’s leverage soared from 8-1 to 44-1. 
“Attacking his opponent as a tool of Wall Street who supports big banks over ordinary Americans is a logical path for Trump to take.”
Calls to reinstate Glass-Steagall are now in both political parties’ platforms, as Bernie Sanders supporters succeeded in placing it in the Democratic platform over Hillary Clinton’s objections. Yet actually reinstating Glass-Steagall is politically unlikely and pragmatically impractical. However, it foreshadows a path that Trump will take in the campaign which is likely to include repeated headline risk to large financial institutions.
The signature that was the genesis for the great financial crisis:
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The Republican National Convention offers a plethora of prime-time speaking opportunities where anything can happen. Next week’s Democratic National Convention will feature a prime-time speech by Sen. Elizabeth Warren (D-MA) who has embraced reinstating Glass-Steagall and loves to attack Wall Street. Substantively, Minneapolis Federal Reserve Bank President Neel Kashkari continues to work on his own plan to end “too big to fail,” which may well include breaking up the big banks. Kashkari’s plan is expected to be released publicly in December, just in time for the next President, whether Trump or Clinton, and all of their nominees to be asked whether they support it.


Italy in Brawl with Brussels over $60bn Bad Bank Bailout Proposal

The Italian government is working on plans to set up a €50bn bad bank which would aim to clean up the country’s stricken lenders, the Sunday Telegraph reported.
Rising Cost of Credit Default Protection on Large Italian Banks
UniCredit CDS
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Bank Stocks in Flames ahead of the News
EU Banks 2
Public Funds
It is understood that €10bn of public money could be used to buy bad loans at a knock-down price, taking assets with a face value of €50bn off the banks’ hands, allowing them to start giving out more good loans instead.
The scheme, which is being put together by JP Morgan, could help clean up the banks, but also puts the country’s authorities on a collision course with the EU, which does not want taxpayers bailing out banks before private investors take a hit.
The Road Ahead
First, it will all depend on Monti dei Paschi and how much capital they need. Out of the nearly 400 billion dollars of NPL’s in Italy, Monti dei Paschi is responsible for nearly 40% of them.
Second, a showdown between Italian State and the EU commission will surely come, we believe right after the 29th of July EBA (European Banking Authority) stress test results. This will be watershed moment for how Italian Banks capital requirements need to be addressed, if the number is too large and the Italian state cannot handle it, we will see renewed tensions as the ECB or Euro finance ministers will presumably have to step in.
The third possibility is a solution outside the BRRD directive (Bank Recovery Resolution Directive, explained in detail below), a legal fix, which would not require a bail-in is needed, to get an end around the legislation. The EU court case on the 19th of July looms large, EU law vs domestic law, one outcome would be a strong case to non bail-in solution, or an unfavorable outcome that bounds Italy to bail-in and the strict interpretation of BRRD.
iTraxx Snr Fin
The Markit iTraxx Europe Senior Financial index comprises 30 equally weighted  credit default swaps on investment grade European entities.
We get from this that it is implausible that we will get any resolution before the July 29th stress tests. The market at the moment seems to be pricing in to much clarity into a situation that is anything but. Article 32 of the EBA (see below for explanation) and the BRRD makes it very difficult for Italy to save its banking system without serious compromises.
The BRRD is the key to bail-in life, and at this moment there is no reason to assume that this will be torn up. A couple weeks ago the ECB leaked a rumor with regard to the loosening of the capital key, if it became a reality, it would have positive ramifications for the Italian banking system.
The ECB will not make a decision on the key before its next meeting (we believe capital key expansion rumors are far from reality, especially one year ahead of German elections). Ultimately, some sort of skirt around the BRRD bail-in laws, which Article 44 section 3 of the EBA allows, coupled with ECB involvement will occur; BUT working this out will take much more time and political tension than the market is currently pricing in.


Core CPI vs U.S. 10 Year Yield, Something Has to Give

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Something Has to Give Here

In recent years as core CPI has trended this high, the U.S. 10 Year Treasury’s yield has ranged between 2.50% and 2.90% vs. 1.56% today.  This week’s data is pointing to higher bond yields coming at markets near you.

Fed Might Still Manage 1, 2 Hikes This Year, Lockhart Says -Rtrs

Federal Reserve Bank of Atlanta President Dennis Lockhart says in interview with Reuters that there’s no real argument about inflation, and only a modest one over the financial stability implications of continuing to leave rates so low.

  • “Committee is much tighter in its array of opinion, and the differences between points of view are more nuanced and more related to sooner versus a little later on questions of policy”

Friday, we found American consumers moved into a higher gear in the second quarter, spending at the fastest quarterly pace in two years, retail sales figures will probably show on Friday. Economists project a 0.3 percent gain in core sales for June, which would take the three-month annualized gain in the so-called retail control group to 6.6 percent barring revisions. The figure is used to calculate gross domestic product and excludes food services, auto dealers, home-improvement stores and gas stations. – Bloomberg

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CPI vs 10s

The U.S. Bureau of Labor Statistics reported that year over year Core CPI (consumer price index) for June rose to 2.3 percent versus 2.2 percent May. Year over year CPI was 1.0 percent versus 1.0 percent in May. On the month CPI in June rose 0.2 percent, the same as May.
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Turkey: Lira’s largest one-day drop against the dollar since Lehman

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Global economic expansion meets radical Islam.   An increasingly oppressive government in Turkey found itself under fire Friday evening.

For now the coup is contained but the west will not rest until new, rising risks are properly assessed.


Turkey GDP

2016: $940B

2010: $760B

2000: $190B

World Bank

We talking about $1 trillion of Global GDP is under military coup threat, something the world has never seen before.  Civil war and EU migration risks are sharply on the rise as Turkey’s ruthless Erdogan regime crushes civil liberties in their coup retaliation.  Turkey’s political climate is about to become even more oppressive and authoritarian, this increases risks as many will flee the country or stay and fight the regime.


Turkey 5Nearly $60B of total government debt, but near term maturities are on the heavy side for Turkey.



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*Turkish Bank Postpones $300 Million Bond Sale Meeting on Unrest



More than 6,000 people, including military personnel, judges and prosecutors, have been detained.
 DXY new 2
Implications:  We expect a sharp flight to quality next week with the U.S. dollar being the big winner.  G10 currencies with risk correlation will suffer, other safe heaven currencies, the yen and Swiss franc will benefit.   Next week will kick off with heightened uncertainty.  Investors will start to analyze the longer term implications.  First, Turkey’s impact on the EU.  The migrant deal was not signed that long ago.  We expect a mass exodus from Turkey as the risk of a civil war have risen sharply.  We will see foreign capital fleeing the country, political instability provides additional risks that investors don’t need.  Migration from Turkey is the last thing over leveraged European governments need right now.  Brexit removed all doubt, the people of Europe have had it with millions of people jumping over the border and straining already challenged job markets as well as stressed social programs.  By stressed we mean deficit spending in the periphery well above EU stated objectives.


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Turkey 2

Turkey’s currency posted the biggest one-day drop against the dollar since October 2008 as the country’s military said it has seized power. The lira plunged 4.6% to 3.0157 per dollar, the weakest level since late January.

When was the last time a trillion dollar economy has every gone into a military coup regime?  NEVER.

Since 1960 Turkey, a NATO member has been through the drama at least three takeovers by the secular-minded army.

Islamists based Ak Party government came to power in 2002, ever since the political influence of the military has been trimmed, until today.

As it seems now the Turkey is experiencing a full on military coup. Turkey has seen over 14 terrorist attacks in the past year alone.

Turkey’s prime minster Binali Yildrim has said the uprising is from the military ranks, but Prime Minister Yildrim maintains that he and his government is still in control. However, the military, in a email statement, said it had seized power.

Turkey 3

War planes have buzzed the capital, gunfire has been heard and tanks are blocking roads in Istanbul. These developments are ongoing as it is not clear who has control at this point in time.

Gunfire reported in Turkey capital of Ankara; military jets and helicopters heard overhead.

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Turkey CDSTurkey’s 5 Year CDS made a strange reversal this morning, then closed for the day.


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Growing Pressure to throw in the Bail-in Towel for Bailouts

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Defaults on the Rise into Lower Yields??

Moody’s Global High Yield Default Rate Takes Out it’s Long Term Average surpasses long-term average in May.

Breaking News: Deutsche Bank Economist Calls for Bailout

Cost of Deutsche Bank Credit Default Protection


There are rising public cries: The banking crisis is in such urgent need that Germany / Europe should violate the current bail-in rules inside the new Banking Directive.  Existing bail-in rules are NOT realistic Deutsche Bank maintained publicly this weekend, customer deposits would be at risk and a bank run would be likely.  Changing the rules in the middle of the game is the way to go says Deutsche Bank. 

Eight years post-Lehman this is so pathetic, when will the establishment ever learn?

(to be continued below at the bottom of this blog)

Thanks to Central Banks, Bonds are Crushing Stocks in 2016

Junk vs S&P 500


Junk Bond ETF $JNK: +6.4% (w 6.1% yield)
S&P 500 $SPY: +4.2% (w 2.1% yield)


Moody’s trailing 12-month global speculative-grade default rate closed at 4.5% in May, surpassing its long-term average of 4.2% for the first time since August 2010, according to its latest global default monitor. Moody’s expects the rate to finish 2016 at 4.9%, and thereafter for upward default rate pressure to ease off.

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As we stated last year to subscribers, we believe the speculative grade default rate to hit 7% by the end of 2016, with materials and commodity sector bankruptcies leading the way.

Pure Financial Evil

Traditionally insurance companies in Japan and Europe would buy government and investment grade bonds, but today’s $12T of negative yielding government bonds are forcing them to reach for yield in junk bonds.

This week we heard from several sell side trading desks, we’re told negative interest rate torn insurance companies in Europe and Japan now piling into U.S. high yield paper.

After you implement the change in capital standards yields are basically at record lows.  This has become an evil, or perverse incentive for insurers to chase yield at the lower end of the rating spectrum.

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Cost of Credit Default Protection


The cost of credit default protection on some European banks is certainly on the rise.  Above CDS on subordinated financials, Deutsche Bank and UniCredit are shouting, WARNING.

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Credit vs Equities, What are they Telling Us?

When you look at equity prices of Intesa Sanpaolo, Deutsche Bank and UniCredit, we’re talking lows we have not seen since 2012.

Next, contrast with the relationship of subordinated credit default swaps on these banks vs the subordinated financials credit index.

Back in 2012, subordinated cds traded 310bps wide of subordinated financials index, while today only 230ish wide.  We believe the new bailout regime is a game changer, it speaks to evaporation risk to subordinated debt.

Stock Prices of European BanksEU Banks 2
 Taking a look at a banks capital structure is even more important in today’s bail-in regime world.

Breaking News: Deutsche Bank Economist Calls for Bailout

“In Europe, the bailout does not need to be so large. A €150 billion program should be enough to help European banks recapitalize,”

“Europe is seriously ill and needs to address very quickly the existing problems, or face an accident,”

David Folkerts-Landau, Deutsche Bank Chief Economist, July 10, 2016

Banks in Europe should get the money for recapitalization following a similar bail out in the U.S., Deutsche Bank Chief Economist David Folkerts-Landau, tells Welt am Sonntag in interview.

Deutsche Bank pointed to the plunge in bank stocks is only the symptom of a larger problem, negative interest rates impact on bank’s profitability, slow growth and “dangerous” deflation.

  • U.S. helped its banks with $475 billion, and such a program needed in Europe, especially for Italian lenders
    • Est. EU40b money needed by Italian banks “conservative”
  • Bail-in using private money currently not doable, would hit people’s savings, may cause bank run
  • Decline in bank stocks symptom of weak growth, high govt debt and close to “dangerous” deflation
  • Europe “extremely sick” and must solve its problems quickly


Folkerts- Landau is very concerned about Italy and the condition of local banks, the $45B number floated about if far too “conservative.”

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Coming Clean on China

“The seventeen year river of reserve currency buildup is no longer flowing.”

Billionaire Fund Manager, David Tepper


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What used to be called a fringe selection of “perma-bears” has grown to a consensus.

Nine of 15 respondents in a Bloomberg survey at the end of June, including Standard Chartered Plc and Commonwealth Bank of Australia, predicted a China government-funded recapitalization will take place within two years.  Among those who provided estimates of the cost, a majority said it will exceed $500 billion, the smart money puts the tab well over $1T.  Hedge fund managers Kyle Bass puts the number near $10T.

If you do the math, there’s only one way out for China, a colossal currency devaluation.  As we stated to subscriber last July, a recapitalization will happen after the Chinese government comes clean with the true nonperforming loan figure.

Capital Flowing Out

In 2015, we witnessed China’s plunge in reserves of nearly $520B, in the last six months of the year the number has more than $400B, Reuters reported. Reserves fell by nearly $108 billion in December of last year, by nearly $100 billion in January and by around $28.57 billion in February of this year, before rising in March and April.

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China Forex

Survey on China Bank Bailout

% of Respondents see a State Funded Bailout within Two Years

2016: 62%
2015: 41%


In Q1, net capital outflows from China in the first quarter of 2016 were nearly $130 billion, per Goldman Sachs.  China’s four biggest banks now trade at 32% discount to book value, capital flows have even the Bulls concerned.  Over the last 6 months, Goldman’s outflow data on China is 50% greater than SAFE’s onshore FX settlement data, there’s far too much fuzzy math in China.

Goldman notes that around 70 percent of the net outflows were due to Chinese residents buying foreign assets and 40 percent due to repayment of foreign-exchange liabilities. This was offset by an increase in inflows by foreigners buying renminbi-denominated assets.

“While it is possible that some residents’ acquisition of foreign-exchange assets now is intended for repayment of foreign-exchange debt later, this does not appear to be the case for the second half of last year.  We think China has masked (understated) FX outflow data by $20B a month this year.”

Goldman Sachs


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The Fed is Holding a Smoking Gun on China’s Debt Explosion

China Debt vs Fed
The Fed’s easy money gravy train has made more than a few stops in China.  As the U.S. Federal Reserve expanded it’s balance sheet in the post Lehman era, a lot of companies in China have sucked in mountains of debt at unrealistically low interest rates.   Just before the Lehman 2008 crisis, $3 in debt to gave you $1 of growth in U.S.   Today, it takes $6.50 of debt to create $1 growth in China.  It’s a colossal failure of common sense all over again.

An analysis by the Bank for International Settlements (BIS), published in March, that suggested a big chunk of the outflows were related to unwinding a once-faddish investment: Buying yuan offshore as a play on expectations the Chinese currency would continue to appreciate against the dollar as well as the mainland’s slightly higher interest rates amid a yield-starved world, says CNBC.

Of the around $175 billion decline in cross-border loans to China in the third quarter of 2015, nearly half came from offshore depositors backing out of the yuan, the BIS said, citing data from banks reporting to it.

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China debt load and banks are so interconnected.  Wealth Management Products WMPs are worth 27% more than China’s A-share equity market, this represents half of total bank deposits, explosive toxic growth.  China’s $3 trillion corporate bond market is “freezing up” amid rising defaults and canceled debt sales.  Over 18 publicly-traded Chinese bonds have defaulted so far this year, up from six in 2015.  More than 190 companies  have cancelled or delayed debt sales since the end of March.

Another big chunk came from Chinese companies paying down their foreign debt, said the BIS, which acts as a bank to central banks. It found that Chinese firms reduced their cross-border net debt over the third quarter, with the amount denominated in currencies other than the renminbi accounting for around $34 billion of the outflows.

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Goldman highlighted that it was skeptical of the offshore debt repayment narrative.

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Chinese lenders are struggling with a growing, smelly pile of bad debt after flooding the financial system with cheap credit for years to prop up economic growth. Per Bloomberg, non-performing loans jumped by more than 40 percent in the 12 months ended March to 1.4 trillion yuan ($210 billion), or 1.75 percent of the total, according to government data. The figures are widely believed to understate the true scale of the problem, we believe NPLs were probably closer to 15 trillion yuan  ($2.5T) at the end of last year.

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