I wrote my annual missive on what bothers me the most about fixing the economy and published it today on the Institutional Risk Analytics website. I'm reprinting it here because I believe it is important that policy makers and presidential hopefuls pay greater attention to these issues. Our economy is withering not because we are poor but because we have no direction. We have leadership that has not led us except to drive us deeper in to chaos when they should have been fighting not for position and advantage but for national cohesion. So here we are another year deeper into a raggedy mess of our own making that we universally deplore but are as yet unable to change for the better. This is not the United States that I want to pass on to my children. I doubt it's what you want either. And so I ask you all, elite and ordinary alike, to read on and absorb what the numbers are telling us to demand for our country. That anyone who does not have a workable plan for what to do about the next four years has no right to seek inauguration next January.
Reprinted with permission exclusively on the Huffington Post.
The Institutional Risk Analyst
Can Pent Up Supply Overcome Systemic Inaction?
Life will find a way.
Jurrasic Park
In this issue of
The Institutional Risk Analyst, IRA CEO
Dennis Santiago looks at the continuing retreat of private capital from the US economy and discusses issues facing Main Street's commercial bankers and Wall Street's capital formation specialists. Using the powerful resolution of IRA's Bank Monitor, Dennis extracts and explains his take on the numbers that continue to move our private economy -- even as policy makers seem oblivious to the inevitable.
As 2011 drew to a close I had a most interesting conversation with a very well-known investment banker. It concerned the continued
dearth of new capital formation in the financial markets. Where did the private capital go? Are
investors nervous? My glib answer was that beyond the castle keeps of the Hudson and
Potomac, people weren't so much nervous as peeved. But returning to what is a very serious situation for all Americans, it is important to look at how Main Street is acting as an independent force in the evolving process. We do this not so much by watching news
soundbytes, that's just noise about noise. No, to see the tidal forces at work that will get us all to a better tomorrow, you need to follow the money.
First let's look at evidence of the investor rejection of financial markets. You can see this most by looking at deposit accumulation
trends at U.S. banks. This is capital coming out the markets being stuffed into matresses. It's no small amount, just under $3 trillion. And remember a deposit dollar is as close to $1.00 that's worth $1.00 as you'll find these days in the world of investing. Further notice that almost all of the deposit accumulation in the past few years has gone into the over $100B TBTF banks. Deposits at the smaller entities are flat and movement there has been from time deposits to checking and savings accounts as CD's have
become less attractive. From an economic perspective, this amount of cash sitting on the sidelines represents a substantial migration of capital from Main Street investing in favor of sheltering assets in FDIC insured banks, what are now some of the most government supported businesses on the planet. That change in investor risk appetite takes a lot of accelerator effect out of corporate America and the ripple effects include withdrawals
of IPO Registrations (
Form RW)
and Exchange Delistings (
Form 25) as monitored by IRA's SEC Filings cataloging tools.
So what do banks do with the influx of cash? In the case of the big banks, they plow some of it right back into
the financial casino and not into job-creating investment on Main Street. Washington and Wall Street are only too
grateful for the risk-aversion of investors as it helps them extend the timelines for resolving legacy issues
in areas such as residential housing and thus keep kicking the proverbial can down the road. For some
skittish banks, securities have replaced lending as a vehicle for
banks to deploy liabilities in an economy where investing in Main Street is viewed as being
too risky. The question that should be asked is does this really make sense on a marginal return
basis? Or is the internal portfolio allocation at work more of a matter of old habits that die hard?
Let's look at the relative worth of differing sources of income. As you can
see, interest income on lending far surpasses the magnitude of other
forms of income generation in the banking industry. It holds true across the industry. Notice
that the super large banks make roughly the same amount of aggregate lending interest income as
the remainder of the industry, around $200B/yr. Policy makers take note. This parity of magnitude
implies both groups are equally important as far as Main Street's recovery is concerned. Also
notice that interest income from loans and leases has been declining. That's visible shrinkage in the
very core of continuing operations of the banking system. See how the other sources of income that
are captive to prevailing interest rates are running flat to slightly negative as time goes on? One
can income smooth by doing accounting shifts of reserves back from the balance sheet to the income
statement to make expected earnings but we all know that's ultimately a dead end. The solution is
to get banks operating and growing at economically sustainable margins again.
One thing to notice about securities income with respect to securities holdings is that the gap in growth
slope in securities holdings by the over $100B banks has been departing from the income stream's slope
for sometime. Some of what's driving this divergence is subjective. Fear over the value of real estate values declining
precipitously, fear over obligors defaulting strategically. These fears create greater and greater leverage inherent
in the system. We've been down that road before.
Other factors are infrastructural. Some banks have winnowed down their lending operations. As pressure to lend
anew rises, they'll have a caseload capacity problem made worse by more stringent regulatory rules that have to be
met for each new loan. Some even have internal policies to not engage in new lending and "ride out" the storm. These
decisions by bank management means that these banks are effectively running a low yield mutual fund investing
predominantly in low ROI risk free securities. Yes this does take these banks out of play for contributing actively
to Main Street's economic recovery in the present. Whether that turns out to be a prudent business strategy remains
to be seen but they are running the risk that other more aggressive banks that are working the fields now will be
significantly ahead of them when they do come up for air.
All of this adds up to a pent up supply of deposits on the liabilities side of the balance sheets available
to lend. To track presure on this supply we've broken the banking population into two groups. One group has business
operations that are dominated by commercial/retail lending and the other are banks that have significantly
elevated portions of their assets devoted to securities and trading. We set the division at 60% lending as a
percent of asset base and had IRA Bank Monitor extract the average deposit dollars per lending dollar
figures for these banks over time.
I wrote a layman's piece on the Huffington Post almost exactly a year ago lamenting
"A Deepening Dearth of Lending". The numbers say things haven't improved. Among lending emphasis banks, there's been a universal migration to higher levels of deposit surpluses. Most dramatic are the larger banks that used to run aggressive leveraged lending engines that were only partially supported by core deposits. These banks are now straddling the 1-to-1 ratio boundary between loans and deposits, an extraordinary development which illustrates the still-strong deflationary bias in the US economy. The smaller institutions have even greater idle deposit ratios, which means that the net deposits above amounts required to fund lending are going into government bonds. This tendency manifests in the marketplace with fierce competition for the lending deals that are available. The competition often involves loss leader bids by banks large and small, all seeking to book an incremental addition to their performing loan portfolio. Remember that most banks in the US today are seeing more old loans being redeemed than new loans made, meaning that net credit available to the US economy is shrinking.
The story among the non-lending emphasis banks is a mish-mash of asset strategies. They include Wall Street critical investment banking houses and brokerage funds parking lots. For the most part, these institutions are more exposed to market rate risks as well as instrument reinvestment risks on their portfolios than to credit risk. They react with more volatility to certain types of economic stress scenarios versus their lender business model peers. Their assets tend to interact only indirectly with Main Street. However some of them are critical players to the capital formation process and aren't exactly thrilled with where that line of business is heading. Which gets us back to the conversation that started this article.
[Chart removed. The HuffPost buffer wasn't big enough. Please see the original article.]
The data brings up some important questions worthy of follow up by policy makers and business operators alike.
- Have the operating deposits-to-lending ratios of our Main Street financial institutions migrated to levels that impede our economy's ability to recover? If so, what should be done to maneuver the ratios to more appropriate norms? Is the Fed's zero rate posture helping to stem the flight of capital from Main Street or making things progressively worse?
- For the non-lending emphasis elements of our economic engine, do we have appropriate guidance for them? Specifically, how to make sure that we design a system of solutions which orchestrate a "greater than the sum of the parts" outcome for the nation?
- Has the amount of money that as shifted away from capital markets and new capital formations in a flight to quality placed our economy's ability to innovate domestically and compete globally at risk? Is this risk a strategic enough concern to treat it as a national interest issue? If so, how do we ponder and organize to work on a solution?
- While it's probably easier and more productive for economic recovery to focus on the lending heavy operations first, is it still appropriate to work the problem piecemeal or is getting all parties to work together the best way to get to yes?
- And perhaps most important of all, can we design the solution that is fair, equitable, believable and explainable to the American people?
Follow Dennis Santiago on Twitter:
www.twitter.com/DennisSantiago
The pressing issue now is that everyone's priority should be how to come out of this environment with as much as their wealth intact as they can. Because of the volatility, the poor shape of the economy, and the corruption, there is no way anyone can know the outcome, except the insiders in government who have exempted themselves of insider trading and conflict of interest laws. One must diversify to preserve capital. There will be big losses in some of your asset classes. Earnings and capital appreciation should be secondary considerations.
You can bet your last dollar that if businesses thought there would be demand growth in the near future, they'd be willing to expand and banks would be willing to lend to help them. Decades of stagnant wage growth are finally biting us and the solution requires the middle class to start growing again first.
Seven to ten years in prison for Anthony Mozilo and his like at AIG, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Bank of America and Morgan Stanley -- and a 400 to 900% penalty -- will quickly eliminate rampant fraud and restore public confidence. These are results that will NEVER be realized with the current SEC approach of taxing 5-10% of ill-gotten gains -- paid by the company's shareholders.
Three years after the largest financial crime in history and there has been no punishment, no criminal investigations, no FBI inquiries, no Grand Jury subpoenas, no additional resources to plumb its depths and no appointment of an independent prosecutor.
These were NOT victimless crimes -- millions have lost jobs, homes, retirements and savings. And this country brought to its knees. Bankers and CEOs are NOT above the law. If the current administration will not enforce the law, the next government will.
Why would I want to work hard? Normally, men work hard to support and have a family. Why would I want to raise children in this cesspool of consumerism? So they can grow up to create the "next great corporate logo"?
There is no reason to continue what we are doing, or to go where we are going. More irrelevantly terrible pop "aritists" like Rihanna, Gaga, or Beiber. More consumerist crap products made in other countries. Meaningless lives of comfort in the decline of the World's Largest Empire Ever.
I'll enjoy it now, but work for it? HAHAHAHAHA. Perpetuate it by taking on the responsibility of childrearing?!? HAHAHAHAHAHA.
We need to stop taking it for granted that Humans will want to perpetuate whatever society is thrown in front of them. Japan beat us to the punch, reached the level of UltraCapitalism a decade sooner than the US...and look where it got them. An entire culture of infantile males and frustrated females.
"GovernmenÂt, banking, business and the top MBA schools are based upon lying to move forward. I remember a top human resource executive telling me right before Enron, MCI and Sarbanes Oxley that I needed to learn to be more flexible. My response was that flexibilitÂy would get me an orange jump suit. Don’t get me wrong, I have a wide grey zone, but it use to be in business they looked for people who could identify problems early and resolve them. Now days I see far more of a demand for people who can come up with PR spins to hide them."
I found it amusing to share it.
It was also to take all the Customer Service complaints and deal with them to make the customer happy. I can't even TELL you how many times I was told to lie by my bosses, hanging over my shoulder listening to the handset with me. "Tell them it was FedEx's fault" or "Don't admit it was our mistake." It disgusted me, because I saw myself as a potential customer.
Boy I can't wait til my NDA expires...
The two areas I've been keeping an eye on as potential facilitators for this are small business lending (under $1 millon) and mid-size lending ($5 to $25 million loan packages). Activation both on the industrial side and the bank side has been lackluster. Industry is hesitant to invest and continues to operate with very defensive postures. Banks are frustrated. They have money to lend but are impeded by a combination of no one wanting to take a risk and the value of guarantee collateral being another hostage to inept planning and guidance by the policy side. Can Washington make locating something that will work any more obtuse?
With outsourcing and automation, I think deregulating minimum size dwellings nationally allowing smaller homes in more walkable, bike friendly neighborhoods would help jumpstart this economy. Put some financial incentives to start a smaller community.
1: The Stupid Rich Institutions have way too much cash.
2: The Stupid Rich institutions would invest in some way even if we put Liberal rules in place. Any rules (that they could manipulate) would be better than unknown rules.
Sounds like a Democratic/Progressive Mandate to me.
It would be interesting to hear your opinion on three pertinent possibilities that you do not discuss.
(1) The 1%-ers who control all that "sidelines" cash abhor Obama and are purposely keeping the US economy in the tank in hopes that he'll be voted out of office in November.
(2) The 1%-ers who control all that "sidelines" cash have zero intention of investing it in the US. They've already invested much of their capital abroad in "emerging," virtual slave-labor nations, and plan to invest the rest of it in those countries. For the moment, they worry about "overheating" those economies, so they're biding their time.
(3) The US Congress needs to re-instate Glass-Steagall immediately.
Ben Bernanke and the Federal government has laughed every time JP Morgan or Goldman Sachs gets sued over defrauding investors, whether it's MF Global or fraudclosures.
Politicians, except for Ron Paul, thinks the bailouts were cute-n-funny and are not even interested in a return to Glass-Steagall or to get rid of the Federal Reserve for its crony capitalism.
Why would anyone take out a mortgage in once hot spots for real estate when the banksters are forcing local governments to raise your property taxes to the extreme to cover the losses in prices?
Why would anyone take out a student loan since to pay it back would require no real advantage in your standard of living or even guarantee you a career for what you are studying for?
Why would anyone take out a car loan for overpriced vehicles made in Mexico to arbitrage the lower wages as a way to stuff more profits in the pockets of Wall Street and eliminate jobs in Detroit?
Why would anyone want to participate in anyway for the US economy when it's a sham, a swindle that uses derivatives as gambling chips so Wall Street can force taxpayers to eat their losses?
Why would anyone do anything except consider another country, that may be poor, but, is doing whatever it takes to develop and become food independent and provide decent housing for everyone?
And I think you are getting the idea of average investment and Investment by the Mega Rich.