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From Too Big To Fail To Too Big To Rescue?

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by The Macro Butler
Saturday, Sep 21, 2024 - 4:15

Regardless of what Wall Street analysts and their echo chambers may claim, the main point of the September 18, 2024, FOMC meeting is not the partisan and politically driven decision to cut rates but the fact that the FOMC has decided to abandon its 2% inflation target at least until the end of 2025.

 

As the 2% inflation target has shifted from being a ceiling (as it was between 2009 and 2020) and an average (as it was between 1994 and 2008) to now being a floor, the FED's Summary of Economic Projections suggests that the PCE is expected to be around 2.5% in the foreseeable future. Given that the CPI is typically 40+ basis points above the PCE, the FED is effectively aiming for a minimum inflation level of 2.4% or higher. Based on simple math, if the FED meets this new target, the average inflation rate for the next 12 months will likely be around 2.9% at best as the base effect reverse.

US CPI YoY Change (blue line); US 10-Year Yield (red line); US Core PCE YoY Change (green line).

Since all financial assets are still priced based on a 2% CPI, the bond market is on the verge of a massive repricing due to the FED's new inflation target assumptions.

The second dire implication for the bond market is that, with massive tax and fiscal stimulus and an escalation in the war cycle, both expected in different scales regardless of who occupies the White House, the projected 3.4% FED Funds Rate by the end of 2025 seems phantasmagorical and unrealistically low. Moreover, the consensus expectation of a 2.86% FED Funds Rate by that time appears to be an unachievable dream, implying that not only will the FED be unable to cut rates, as it becomes increasingly impotent and irrelevant under ‘Kamunism’ or ‘Trumponomics 2.0.’

In layman's terms, this means Wall Street is likely to be disappointed by the pace at which interest rates declines if it declines at all after the political masks are down.

 

For bonds, the FED's confirmed actions and statements add to a 'supply-driven' bearish outlook for US Treasuries in a world where USD assets have been weaponized. In this context, the US 10-year yield hit a floor on the same day as the infamous FED pivot, with 3.5% now being the new floor and resistance expected between 5.0% and 6.0%, likely to be reached once the political circus around the White House is settled.

While last Thursday was the first time 10-year yield rose after a 50-bps cut since Lehman, some may call it a coincidence, but those who understand history know that nothing happens by chance in this world and that everything in life is governed by cycles, just as night follows day, the economy follows a business cycle. Therefore, it should come as no surprise that it was on September 18, 2007, that the FED, under Chairman Ben Bernanke, initiated the interest rate cut cycle that ultimately marked the onset of what has been historically referred to as the Global Financial Crisis.

https://www.federalreserve.gov/newsevents/pressreleases/monetary20070918a.htm

Indeed, outside the unfolding political circus surrounding the race for the next four-year tenancy of the White House, and the heated debates to become the 47th president of the 'United Socialist America,' the third quarter will likely be remembered in financial history as the period of a multi-month selling spree of Bank of America shares by one of the most seasoned investors in recent financial history, Warren Buffett. Based on the latest SEC filings, Berkshire Hathaway has sold almost 197 million shares since the start of the third quarter for a record amount of approximately $8.0 billion.

After selling more than 197 million shares, Berkshire remains the largest shareholder, with 10.8% of the bank's stock, or about 836 million shares, worth approximately $34.0 billion. This means that total proceeds from share disposals since mid-July, combined with dividends earned (excluding taxes) since 2011, have surpassed the $14.6 billion the Oracle of Omaha spent to build its stake in the second-largest US retail bank.

There are likely multiple reasons why Warren Buffett has been selling Bank of America shares over the past few weeks, including the fact that the US economy is not doing as great as those negating the reality of the inflationary bust pretend for a political reason. However, Bank of America (BAC) published its last quarterly financial earnings on July 16. During the second quarter, BAC's Agency MBS holdings decreased from $457.8 billion to $448.5 billion, while the ‘paper losses’ on these holdings increased from approximately $88.5 billion to around $90 billion. This means that losses on the principal increased from 19.33% to 20%. BAC's US Treasury holdings remained stable at approximately $121.6 billion, with around $19.6 billion of mark-to-market (MTM) losses, equivalent to about 16% losses on the principal. Comparing these two points, it becomes quite evident that the value of BAC’s Agency MBS holdings is deteriorating beyond what changes in interest rates would suggest. In this context, despite efforts to obscure its troubles, if BAC’s conditions are deteriorating so significantly from an external perspective, investors can only imagine how grim the picture must look from an insider's viewpoint, like Warren’s.

As of the end of Q2 2024, Bank of America NON-AGENCY GUARANTEED REAL ESTATE PORTFOLIO WAS WORTH MUCH MORE THAN THE ONE SECURED BY THE US GOVERNMENT.

So, while BAC is carrying a 20% Mark to Market ‘paper losses on its Agency MBS holdings (that are government-guaranteed): BAC’s Allowance for Credit Losses (ACL) for Residential Real Estate Mortgages is 0.12% against 227.5bn$ of assets and BAC’s ACL for Commercial Real Estate Mortgages is 1.82% against 71.3bn$ of assets. Would the same ‘Mark to Market’ process applied across all BAC Real Estate exposures, bearing in mind it will still be an underestimation since the government guarantee won’t apply to all we will get the following results:

  • BAC Agency MBS: ~$90 billion of ‘Paper Losses’.

  • BAC Residential Real Estate Mortgages: ~$45.5 billion of ‘Paper Losses’.

  • BAC Commercial Real Estate Mortgages: ~$14.3 billion of ‘Paper Losses’

This results in an estimated total of paper losses of $149.76 billion, compared to BAC’s total tangible common shareholders’ equity of $194.5 billion at the end of Q2 2024. While this should already scare most investors, there are other concerns that are even more troubling. First, real estate is not BAC’s biggest commercial credit exposure; Asset Managers, Hedge Funds, and Private Equities are. Additionally, BAC’s consumer lending losses are starting to accumulate, with credit card ACL already equivalent to 7.38% of the total exposure the bank carries. On top of the ~$700 billion in assets BAC has already deployed, the bank is committed to lending ~$500 billion more. As seen in March 2020, this can happen on short notice if market conditions deteriorate. How BAC can meet these commitments without turning ‘paper losses’ into ‘real losses’ by selling deep underwater assets is likely the question Warren Buffett and his team have been asking themselves, which may have triggered their decision to unload their stake in the banking giant.

 

When asked about Warren Buffett's stock sales at a Barclays conference on September 10th, Bank of America’s CEO candidly told CNBC, ‘I don’t know what exactly he’s doing because, frankly, we can’t ask him, and we wouldn’t ask him. But on the other hand, the market's absorbing the stock we’re buying a portion of, and so life will go on…’

 

It’s not only Bank of America making news among US financial institutions recently. On September 10th , Ally Financials’ CFO, speaking at a banking conference in New York, announced that delinquency in the auto loan sector has been rising even before a significant spike in the unemployment rate and further inflation-driven hardship spreads across ‘United Socialist America.’ According to Ally's CFO, borrowers are struggling not only with the high cost of living but also with rising unemployment.

 

For the record, Ally's late-stage delinquent loans rose 12 bps above the five-year average in 2Q, pointing to potential charge-offs as loans advance through delinquency stages. While delinquency is seasonal, worsening trends align with management’s warning of escalating pressure in the coming months.

 

According to Ally's CFO, borrowers are struggling with both rising living costs and increasing unemployment. This issue extends beyond Ally and highlights a systemic problem linked to the broader macro environment, which is veering away from a soft-landing narrative. It’s a wake-up call for many, including bank executives. However, the Federal Reserve Bank of New York’s Q2 household debt report already revealed rising delinquency rates, particularly in auto loans and credit cards. Delinquencies for both are now at their highest levels since Q4 2010following a similar rising pace not seen since Q2 2008, just before the Global Financial Crisis.

 

 

The other macroeconomic sensitive part of credit and lending and the burst of bubbles associated with it is the situation in the commercial real estate market which has moved out of the front of financial mass media despite that the crisis has been far from being solved and magically fixed. Indeed, banks are quietly offloading assets and loans, but challenges persist. For instance, Deutsche Bank is trying to sell up to $1 billion in US commercial property loans to alleviate capital constraints due to falling asset values. This move highlights the pressure on banks to manage balance sheet risks amid rising interest rates. Similarly, US banks have struggled to reduce their commercial real estate loans, with Federal Reserve data showing a $10 billion decrease since May.

 

It’s not just Ally or Bank of America; Citigroup recently noted that credit losses are increasing as US consumers adjust their spending. Net credit losses have also risen in its large cards business, signalling broader financial strain.

 

Even JPMorgan has suggested that the current NII estimate of $89.5 billion is unrealistic and that analysts clinging to the phantasmagorical 'soft landing' narrative will need to revise their expectations. In plain English, the largest US bank, and one of the largest globally, has issued a politically correct profit warning.

Another bank that was at the epicenter of the Global Financial Crisis and adopted the status of a consumer bank in 2008 to be bailed out by the US government, thanks to its ongoing revolving door of placing employees within the government, ‘Government Sachs,’ aka Goldman Sachs, has announced a staggering pre-tax loss of $6.0 billion since the beginning of 2020 ‘on a significant portion of its consumer-lending businesses, including its credit cards.’ Several factors contribute to Goldman’s massive losses associated with the Apple Card, including lax underwriting standards and resulting charge-off rates that are nearly double those of other credit cards. In this context, it comes as no surprise that the former master of the banking universe was highlighted in the latest FED stress test as having the second worst, subprime credit card portfolio among all US banksonly to Ally Bank, whose was also in the news again for its credit quality issues, ranks worse. ‘Government Sachs’ is therefore desperately looking to exit its partnership with Apple, which includes the Apple Card and Apple Card Savings Account. Currently, Apple Card credit balances total $17 billion. The Wall Street Journal reports that GS could face even bigger losses when it offloads the Apple partnership. Behind the scenes, Goldman has been in talks with American Express and Synchrony Financial about taking over the Apple Card business.

On the other side of the pond, while last week, the suntanned ECB president was not very talkative about the potential cross-border banking merger between Commerzbank and UniCredit, it is clear to everyone with a minimum of common sense that combining two national champions with feet of clay will only create a Euro colossus with feet of clay.

However, the real games of smoke and mirrors is happening right now around the mountains of the Swiss Alps and is being played by UBS. When the Swiss banking giant with the magical keys published its Q2 2024 results on August 14, it reported a net profit more than double what Wall Street analysts expected. This was enough to generate jubilant headlines and fuel trading algorithms, which helped the stock rise throughout the day with barely a hint of volatility.

However, what looked like ‘too good to be true’ results included around $95 million in credit loss expenses for the quarter. No, this is not a typo; UBS reported just $95 million in credit losses, while other major banks are reporting losses in the hundreds of millions, if not billions. The real question that not a single ‘braindead’ analyst asked at the time is how UBS could perform so well with negligible credit losses if it doesn’t make money from its core banking operations.

A quick look at the first two lines of UBS’s consolidated financial statement reveals something unusual to anyone with a basic knowledge of finance. In the last quarter, UBS earned approximately $9.32 billion in interest income from loans and fixed-income securities that are not marked to market, while it paid around $9.32 billion in funding costs. As a result, UBS ended up with just $2 million in net interest income on $1.5 trillion worth of assets in the relevant accounting category and $1.081 trillion in liabilities measured at amortized cost. In a nutshell:

  • UBS earned $9.32 billion out of $1.5 Trillion of assets.

  • UBS paid $9.32 billion out of $1.08 Trillion of liabilities.

Now let’s consider what’s obviously happening: UBS borrowers aren’t paying interest as they should, but the bank is trying to obscure this. When a bank categorizes an asset as non-performing, it triggers a series of consequences, ultimately leading to the need for allowances for credit losses and a direct hit to its net income. Not surprisingly, as shown in the section below, UBS has only a small fraction of assets categorized in Stage 2 and Stage 3.

 

Now, let’s have some Algebra fun.

Assuming UBS earns the same percentage of interest between its assets and liabilities of the same nature, even though logically speaking, UBS should earn a higher yield on its assets:

  • 9.32/1080 = 0.86%

  • 0.86%*1500 = $12.9 billion.

  • $12.9 billion – $9.32 billion = ~$3.58 billion.

Assuming UBS lends at the same rate it borrows, there are $3.58 billion in interest revenues missing, which is equivalent to 27.7% of the total interest income related to those assets. Let emphasize that this simple algebra is using very conservative assumptions to somewhat favour UBS.

Anyone with a basic under understand know it impossible financially impossible for UBS to report $95 million in provisions for credit losses for the quarter while $3.58 billion in revenues are missing. Indeed, it’s clear that the bank should report significantly higher provisions for credit losses given the poor performance of its investments. Anyone who dig a little deeper into UBS’s numbers, we find even more ‘Stranger Things.’

 

Having a look at the first line ‘Interest Income from loans and deposits’ where the bank reports 8.4bn$ in revenues has a small (2) note attached to it which says:

Consists of interest income from cash and balances at central banks, amounts due from banks, and cash collateral receivables on derivative instruments as well as negative interest on amounts due to banks, customer deposits and cash collateral payables on derivative instruments’

These are literally UBS's words, and from what anyone can understand, this means that the $8.4 billion amount isn’t entirely equivalent to interest earned on loans. Doesn’t this imply that UBS is earning even less on its loans? Furthermore, doesn’t it suggest that UBS is being supported by central banks and other banks to fill the growing gaps in its balance sheet? At this point, it is so obvious that the 95m$ amount earmarked for expected credit losses is simply ridiculous. However, there is even more juice if we dig a little deeper.

In the last quarter, UBS reported in its revenues ‘Other Net Income from Financial Instruments Measured at Fair Value Through Profit or Loss And Other’ equivalent to ~$3.6 billion.

Isn’t this the approximate same amount of interest ‘missing’ that a simple algebra operation revealed, and that none of the Wall Street analysts pointed out in their comments on the supposed ‘better-than-expected results’? Does UBS provide any details about the source of these revenues in the 107 pages of its Q2 2024 financial statements? Nope, zero.

In this context anyone with common sense will have a strong gut feeling that UBS used an accounting trick to fake its financial statements. Those who are old enough will remember that this accounting trick is something like the infamous Lehman REPO 105 book the bank was using to cover a ~$50 billion hole in its balance sheet during the GFC.

To conclude, the math clearly doesn’t add up. When UBS’s revenues from fees, commissions, and trading (supposedly the bank's main sources of income) aren’t enough to cover the losses in its toxic books, it’s evident the bank is using an elaborate accounting scheme to give the market the impression that ‘everything is fine’ and that the Credit Suisse merger is going smoothly. In reality, the numbers paint a picture of a bank increasingly on the verge of failure.

Moving further east, Norinchukin Bank (Nochu in short) has been making headlines since the spring as the potential epicentre of a banking collapse that could contribute to Japan’s financial doom loop. A few weeks ago, Norinchukin released its latest earnings report, revealing 1,855.5 billion JPY in unrealized losses within its investment portfolio. However, it is clear that this figure is actually much larger.

No one needs a PhD in accounting or finance to see from the latest balance sheet snapshot that Norinchukin sold approximately 1 trillion JPY worth of securities last quarter, incurring a loss of 181.3 billion JPY from these sales.

 

 

Applying some very easy math, everyone can quickly calculate that Norinchukin lost ~18% in principal in the process of unloading those assets. Logically, they sold the most liquid assets, meaning losses on the rest of the portfolio, which is more illiquid, are likely worse. Even if it is conservatively assumed an 18% loss on the remaining ~43 trillion JPY of securities, that equates to ~7.74 trillion JPY in unrealized losses. With only 5.7 trillion JPY in shareholders' equity, the bank is effectively bankrupt. Though, for the time being, insolvent Norinchukin remains operational due to liquidity. However, with 60 trillion JPY in deposits against ~18 trillion JPY in cash and ~10 trillion JPY in money held in trust, any upcoming and inevitable liquidity crisis would trigger an inevitable collapse.

In this context, it shouldn’t come as a surprise anymore that in the last quarter some wise customers pulled out 2.5 trillion JPY from Norinchukin already. If the picture wasn’t dire already, besides deposits, Norinchukin is also heavily relying on other forms of very short-term funding that can disappear quickly:

  • ~12 trillion JPY in Net payables REPO

  • ~ 2 trillion JPY in Certificate of Deposits

  • ~4 trillion JPY in Short-Term Entrusted funds

  • ~3 trillion JPY in Guarantees

Given the incredibly dire shape of Nochu’s balance sheet the main question should be why hasn’t there been a run on Norinchukin Bank? The fact is that most of its deposits are held by smaller regional banks, which are also its major shareholders. This creates a ‘prisoner’s dilemma’ where pulling deposits could bankrupt many regional banks, sparking financial chaos in Japan. How long can the BOJ (and the FED as last December, behind the curtain, Norinchukin's New York Branch was accepted as one of the only 25 banks allowed to use the New York FED Standing Repo Facility) keep rescuing everyone like in 2008? It's hard to say, but the longer it drags on, the more fragile the situation becomes.

 

https://www.newyorkfed.org/markets/standing-repo-facility-counterparties

In this context, it should come as a surprise anymore that in the past 3 months Norinchukin has been unsuccessful in raising fresh capital to stay afloat, perhaps those who received the pitch deck didn’t need much effort to see the bank stands little chance to survive and putting any more money in will be equivalent to throwing it into a bonfire. In the meantime the bank is still rated A by major rating agencies which have decided like for Lehman and other previous banking scandal to put their heads in the sands to an inevitable outcome which is a bankruptcy.

The recent failure of Credit Suisse has shown that credit agencies and regulators have been unable to anticipate or fully understand how a bank fails. Liquidity ratios monitored by these institutions barely reflect the complexity of banks, which have become ‘bookkeepers’ of Kafkaesque operations beyond what these ratios are designed to account for.

On a side note, investors will also note that Temasek, one of the best contrarian indicators alongside Jim Cramer, teamed up with Norinchukin in February this year to establish a Green Agri Fund worth an estimated $173 million. As both investors follow the 'Climate Change scam narrative' promoted by the WEF, it's no surprise that this fund aims to invest in companies focused on decarbonizing the food and agriculture industries across the Asia-Pacific region.

Beyond the known distress among major banks in the US, Europe, and Japan, the ‘known unknowns’ from the Yen Carry Trade tantrum on August 5th remain unresolved. It's hard to believe that no lender incurred significant losses from this event. Regulators have stayed silent, likely to prevent a repeat of the bank runs seen in the spring of 2023. The key question is: Who lost money in the stock market crash triggered by the Yen Carry Trade Tantrum? A critical but often overlooked aspect is the settlement process within the financial system's plumbing. When shares of stock, or other securities, are bought or sold, both buyer and seller must fulfil their obligations to complete the transaction. During the settlement period, the buyer must pay for the shares, and the seller must deliver the shares. On the last day of the settlement period, the buyer becomes the holder of record of the security. In the case of Japanese securities, the settlement period take 2 days starting from the trade date.

So, what happens if after 2 days either one of the parties isn’t in a position to deliver the cash or the securities agreed? A ‘Settlement Failure’ process is initiated. If the buyer can't finalize the transaction, in the case of the Japanese stock exchange, they face a cash penalty of ~15% interest per annum for each day of delay, increasing to ~22% after five days. If the seller fails to deliver securities within 24 hours of the settlement date, the JASDEC DVP Clearing Corporation (JDCC) initiates a ‘buy-in’ process, sourcing the securities from the market, with all costs and price differences charged to the seller. If, after postponement, a counterpart still can't meet obligations, it results in a default. The Japanese market crash started on Friday August 2nd (although like in 1987 stocks were already in a correction process well before that), which means all trades for that day were due to be settled by 2 pm JST on the 6th of August. Given this information, was it merely coincidental that the BOJ and MOF held an emergency meeting at 2 p.m. JST on August 6th, despite the Nikkei rebounding by ~12%? It’s likely they discussed potential settlement issues. The significant market drop occurred on Monday, with transactions due to settle on August 7th by 2 p.m. JST. Thus, if a credit event was triggered on Monday, we should have seen its effects in the hours following. If the situation is indeed worse than 1987, brokerages and banks could emerge as the dolphin and the whales of the Yen Carry Trade Tantrum and ultimately face defaults and closures sooner rather than later.

https://www.reuters.com/markets/asia/japan-will-continue-monitor-analyse-financial-market-moves-finmin-says-2024-08-06/

Investors should understand that 1-month T-Bills, in the current environment, are effectively better than cash in the bank. T-Bills are considered ‘pristine collateral,’ allowing anyone to borrow their full value in cash. They are segregated on the lender's balance sheet, so if the lender defaults, investor can recover your assets as long as you repay the borrowed cash. Conversely, if the borrower defaults, the lender can sell the T-Bills to recover the cash without involving the bankruptcy estate. However, T-Bills can be re-hypothecated, meaning the lender can use them as collateral to borrow from a third party. This exposes the borrower to the risk of the lender's default and the potential loss of collateral if it isn't properly segregated. While extreme scenarios exist, agreements often include clauses protecting borrowers if the collateral isn't returned to a third-party custodian. In contrast, borrowing against other forms of collateral or without collateral involves higher risks. Holding cash in another institution involves credit risk, as deposits become part of the bankruptcy estate if the institution fails, with FDIC insurance in the US covering only up to $250k.

However, the FDIC is notoriously underfunded. On September 5th, the FDIC released its Q2 banking profile report, showing a $7.3 billion (11.4%) increase in net income for FDIC-insured banks, totalling $71.5 billion. This rise was driven by a decline in noninterest expenses, higher noninterest income, and gains on the sale of securities. However, the increase was partly due to nonrecurring items: an estimated $4 billion reduction in FDIC special assessment expenses, around $10 billion in one-time gains from equity security transactions, and a $4.9 billion after-tax gain from selling an insurance division. These gains were partially offset by losses from bond portfolio sales and a $2.7 billion increase in provision expenses.

To illustrate further the fragility of the US banking system, a recent study by Florida Atlantic University found that 94 US banks face a significant risk of bank runs. These banks all have a ratio of uninsured deposits to total deposits of 50% or higher, meaning they lack the hard currency to cover withdrawals in a panic. The University's Liquidity Risk from Exposures to Uninsured Deposits index reveals that BNY Mellon and John Deere Financial have a 100% ratio of uninsured deposits. This is followed by Deutsche Bank Trust Company (97.3%); State Street Bank (92.6%), Sumitomo Mitsui Trust Bank (92.1%) Northern Trust (73.9%), Citibank (72.5%), HSBC Bank (69.8%), JP Morgan Chase (51.7%), and US Bank (50.4%).

 

https://business.fau.edu/departments/finance/banking-initiative/liquidity-risk-from-exposures-to-uninsured-deposits/

Technically, the Federal Deposit Insurance Corporation (FDIC) can shut down a bank before a run occurs, protecting insured deposits up to $250,000. Deposits exceeding this amountalong with mutual funds, annuities, life insurance, bonds, and stocks, are NOT insured. While uninsured depositors have faced only 6% in losses over the past 16 years, the FDIC relies on the Deposit Insurance Fund (DIF), which is supported by Washington. However, if multiple large banks fail and depositors withdraw their money simultaneously, the government may lack sufficient funds to cover all deposits.

 

https://www.fdic.gov/system/files/2024-09/qbp.pdf#page=1

To understand how concentrated the profits among insured FDIC financial institutions are, JPMorgan Chase Bank, N.A. alone earned $11.7 billion in net income, accounting for 18% of the total profit among all 4,568 FDIC-insured banks in the US. No other bank comes close to this percentage. Bank of America N.A. reported $6.4 billion, Wells Fargo Bank N.A. $5.36 billion, and Citibank N.A. $3.37 billion in net income. Combined, these four banks earned $26.83 billion, or 42% of the total net income of the remaining 4,564 FDIC-insured banks.

In this context, it should not be surprising that one week after the US banking system fragility was exposed to the public, the FED, through its controversial Vice Chairman for Supervision, Michael Barr, announced a reduction in the planned increase in capital requirements for the largest US banks, from an initial 19% to 9%. This new plan affects Bank of America, Citigroup, JPMorgan, and other large lenders. Banks with less than $250 billion in assets will remain mostly exempt, aside from provisions related to unrealized gains and losses. Mid-sized lenders face a 3-4% increase in capital requirements. Under the 2023 proposal, banks with over $100 billion in assets would have faced a 16% increase in capital requirements, with the largest banks seeing a 19% increase in CET1. The revised plan, however, suggests a 9% increase for the largest banks. Although specifics are still forthcoming, Barr noted changes to the rule’s provisions on operational, market, and credit risk, as well as reduced risk weightings for consumer-facing products like residential real estate.

 

While Bank of America remains solvent on paper and inflation misery is driving United Socialist America into another financial crisis, it is also understandable why Warren Buffett has been actively and methodically trimming his stake in the bank over the past few weeks. Beyond the specific issues facing Bank of America, Buffett likely anticipated that the FED would have had to surrender to the sound of the Wall Street mermaids for a pivot. As someone who has studied financial history, he knows that interest rate cuts signal an impending recession and that the financial sector typically underperforms during such times as earnings in the financial sector underperformed compared to broader indices like the S&P 500 in such an environment.

Relative 12-month Fwd EPS of S&P 500 Financials sector to 12-month Fwd EPS of S&P 500 index (blue line); FED Fund Rate (red line); Correlations and US Recessions.

The Oracle of Omaha also understands that, rather than a traditional recession, the US, like much of the Western world under WEF-influenced governments, is heading into stagflation. Given his knowledge of financial history and the looming risk of a 1970s-style inflationary bust, exacerbated by wars, civil unrest, and increased regulation, the financial sector is expected to perform poorly in this stagflationary environment, as it has in the past.

Relative Performance of S&P 500 index to S&P 500 Financials Index (blue line); US Stagflation Proxy Index (red histogram); Correlation and US Recessions.

Last but not least, the recent decline in long-dated Treasury yields may signal an impending banking crisis and the dis-inversion of the 10-Year – 3 Months spread could make the March 2023 ‘bank walk’ and the 2008 Great Financial Crisis seem like a walk in the park.

Spread between US 10-Year Yield & US 3-Month Yield (Histogram); Relative performance of the S&P 500 index to S&P 500 Financials Index (blue line); US recessions.

Finally, seasoned investors  know than rather than to be lured by Forward confusion and illusion spread by repetitive liars such as Politicians and Wall Street Banksters, numbers never lie and looking at the 60-day correlation between the US 5-year yield and the KBW Bank Index has been on the rise again, meaning that an unfolding ‘Banking Armagedon’ is upon US which will translate into a massive underperformance of banking sector versus the S&P 500. This should keep not only any investors to stay away from the banking sector in general but also to get ready to see much higher volatility in financial markets in the coming weeks.  

60-day correlation between US 5-Year Yield and KBW Bank Index (histogram, upper panel); Chicago Board Options Exchange Volatility Index (VIX Index); (blue line; lower panel).

In conclusion, anyone who has studied economics knows that recession and stagflation are detrimental to the credit cycle; it's simply a constant. The balance sheets of Bank of America, statements from Ally Financials’ CFO, and other banking actions reveal that the credit cycle has been deteriorating gradually but steadily, signalling an unfolding banking Armageddon. As we enter the early stages of the economic cycle becoming full-blown stagflation, those who have ignored warning signs in favour of a phantasmagorical ‘soft landing’ narrative are now being forced to confront reality. Meanwhile, they also hold out one last hope that the Federal Reserve will be able to save everyone when history conclusively shows the Federal Reserve, and its rate cuts NEVER save anyone at any time or anywhere…

For those who still believe the government can play the role of a superhero in the next banking crisis, they should think twice. As of the end of last June, JPMorgan held over $57 trillion in derivatives, ahead of Goldman Sachs and Citibank, which held $56 trillion and $51 trillion, respectively. A simple addition reveals that the three largest US banks collectively hold approximately $164 trillion in derivatives. To put this number in perspective, that amount is nearly 5.0 times the total US public debt. In a single sentence, the 'Too Big To Fail' have become 'Too Big To Rescue.'

 

Read more and discover how to position your portfolio here: https://themacrobutler.substack.com/p/from-too-big-to-fail-to-too-big-to

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