This time China’s property bubble really could burst
The Perils of Financial Freedom
Adair Turner, former Chairman of the United Kingdom’s Financial Services Authority, is a member of the UK’s Financial Policy Committee and the House of Lords.
It has emerged that the bank has adapted its “too big to fail” strategy to deflect any damage arising from criminal charges away from the group as a whole. A special holding company, CS International Advisors, was set up last December to house all US client accounts that fall under the investigation.
“Under this construct, the group and its parent company would be responsible for paying fines, but the new subsidiary might bear the weight of any criminal indictment,” Peter V Kunz, an expert in international corporate law at the University of Bern, told swissinfo.ch.
“This is important because the US, in all likelihood, could not tolerate any Credit Suisse subsidiaries operating in the US if the parent company has been issued with a criminal indictment.”
CS International Advisors may have been created by the bank as a sacrificial lamb for the US Department of Justice, speculated Kunz.
“In addition to issuing stiff financial penalties, the DoJ needs a symbolic scalp to show that they are being tough,” Kunz said. “Credit Suisse is dangling just such a trophy in front of them.”
In short, the holding company resembles a hastily constructed garden shed at the end of the garden designed to be obliterated by a storm while protecting the main building.
Driven on by demanding regulators, UBS and Credit Suisse have shown no lack of effort or will to shed billions of francs worth of risky assets and substantially swell loss absorbing capital reserves.
For example, after the 2011 rogue trading scandal, UBS slashed its investment banking business and vowed to halve the CHF300 billion of risky assets that were sitting on its books by 2016.
But both are still deemed too big to fail, and as such, pose too big a threat to the country’s economy.
It is easy to understand why neither institution, along with Zurich Cantonal Bank (ZKB) - the other systemically relevant institution - could be allowed to go bust.
What is too big to fail?
Such vital services include retail deposit and savings accounts, mortgage loans and lines of credit to companies – the finance that greases the wheels of business and households.
When a financial institution has captured a large share of this domestic market, its bankruptcy could cause chaos.
Governments and regulators also take into account the number of people who are employed domestically by such banks. The prospect of tens of thousands of workers losing their jobs all at once is hard to stomach.
Then there is the value that these institutions add to the domestic economy as a whole to be taken into consideration. Profits generated by services offered by banks add up to a large chunk of the gross domestic product whilst, in normal times, corporations and their employees contribute a large slice of taxes.
UBS and Credit Suisse were named as ‘too big to fail’ banks from the onset, but ZKB was added to the list by the Swiss National Bank in November, 2013.
On May 7, Finma released estimates of how much capital reserves UBS Credit Suisse will have to set aside (capital ratios) by 2019, when too big to fail laws fully come into effect, and how much of their own trading can be financed by debt (leverage ratio).
Based on the current state of the banks’ books, UBS would have a minimum capital ratio of 19.2% and a leverage ratio of 4.6% while the smaller Credit Suisse would be set a capital ratio of 16.7% and a leverage ratio of 4%.
However, Finma stressed that the estimates are likely to change as the banks continue to shed risk.
Worth to the economy
Credit Suisse has 1.8 million domestic clients spread among its retail, asset management and wealth management businesses. It also has CHF95 billion ($108 billion) share of residential mortgage loans on its books out of a total of around CHF690 billion across all Swiss banks.
ZKB claims to have cornered between 6-8% of the household loans market with almost CHF70 billion in outstanding residential mortgages. Between them, all three banks currently employ more than 50,000 people in Switzerland while supporting many other jobs indirectly.
Just before the financial crisis struck, the combined balance sheets of UBS and Credit Suisse were six times larger than Switzerland’s entire economic output. That ratio has now shrunk to two and a half times gross domestic product, but the loss of just one bank would still leave a large hole in Switzerland’s economy.
While exact details are thin on the ground, the driving force is to bundle vital Swiss services in holding companies based in Switzerland and house riskier investment banking and US wealth management businesses under different legal constructs in Britain and the US.
The theory is that each holding company could be liquidated without affecting the others in the event of a catastrophe. The banks also hope that the Swiss Financial Market Supervisory Authority (Finma), the country’s regulator, will be impressed enough to ease up on capital requirement demands.
But Finma is so far playing hard to get, only saying that each bank has to jump through yet more (unspecified) hoops to qualify for such relief.
“The fact that a bank has created a new holding structure does not automatically result in minimum capital requirements relief,” Finma spokesman Vinzenz Mathys told swissinfo.ch. “Holding structures could count as one measure that addresses resolution and recovery requirements under too big to fail regulations, but a range of other measures also need to be fulfilled.”
ZKB, the smallest of the ‘too big to fail’ banks, does not anticipate having to change its structure as it has fewer international operations. Like Credit Suisse, ZKB is under active criminal investigation in the US for alleged tax evasion offences, but the cantonal bank is keeping its legal strategy to itself.
Daniel Gros is Director of the Brussels-based Center for European Policy Studies. He has worked for the International Monetary Fund, and served as an economic adviser to the European Commission, the European Parliament, and the French prime minister and finance minister. He is the editor of Economie Internationale and International Finance.
$1.4 Quadrillion Derivatives Meltdown, Chaos & $11,000 Gold
May 10, 2014
Greyerz: “Eric, every day we get reminders that hyperinflation is on its way. The Congressional Budget Office now estimates that U.S. government debt will rise by $10 trillion to $27 trillion by 2024. This of course means that deficits will escalate and money printing likewise because with the U.S. running chronic deficits, no one will buy the Treasury debt. This means it all needs to be monetized, and thus bought by the Fed.
The consequences of this debt monetization will be horrendous. The dollar will collapse and interest rates will surge. This reminds me of what the world witnessed in the 1970s. To be older doesn’t always mean we are wiser, but it does give us a major advantage when it comes to experience....
“In 1972 I came to the U.K. from Switzerland and was CFO of the United Kingdom’s largest electronic retailer, Dixon's. I got my first options in the company at 1.30 pounds. Three years later those options were worth 11 pence. They were down from 1.30 to 11 pence. And I bought my first house in the U.K. in 1973.
A year after I bought my house I paid 21 percent interest on my mortgage. That was for a short time and then I paid about 18 percent for a long time. You ask yourself: How many people today could keep their homes if they had to pay 18 percent interest? Well, almost nobody.
Of course at that time there was a major recession worldwide, but in addition the U.K. had a coal miners strike and a three-day work week. The other two days there was no electricity. So if you take Dixon's, we had to sell electrical equipment such as televisions with candle-lights. Of course I couldn’t show the people that they were working.
That led to a shortage of candles. We had to get our candles from Switzerland. In 1972 inflation in the U.K. was 8 percent and in 1974 it was 16 percent. By 1980 it was 18 percent. We had a period of eight years with inflation in the mid-teens. So what happened to the currency?
In 1972 when I came to the U.K. one pound gave you 10 Swiss francs. By 1978 you only got three Swiss francs for one pound. So the pound had declined by two-thirds. Today you get only about 1.50. This tells you what happens to a weak currency in a badly managed economy. Luckily at the time the world wasn’t dependent on computers. Today a 3-day week would mean that the whole society would be paralyzed.
The reason why I am mentioning this very valuable experience is that the situation in the U.S. and many other countries is very similar to the 1970s. And the exponentially rising debt levels in the U.S. as well as many other countries over the next 10 years will guarantee hyperinflation. This will mean very high interest rates and collapsing currencies.
Of course this vicious circle will lead to higher interest rates with lower tax revenues. If we add to that problems in the financial system, with bad debt levels rising dramatically and the $1.4 quadrillion in derivatives blowing up, it’s not difficult to envisage massive hyperinflation.
But circling back to the 1970s, in 1972 when I came to the U.K. gold was $40. Over the next eight years gold went to $850. But it wasn’t a straight ride. In December 1974 gold was $204. In August 1976 gold plunged to $108. That was a massive 50 percent correction, and everyone thought that the bull market in gold was over. Then from August 1976 to January 1980 gold went up 8.5 times in price. So if we look at the price today at roughly $1,300, 8.5 times that would be $11,000.
But this is not the 1970s. Government debt and money printing worldwide are much, much greater. And virtually the whole world today is in trouble. In addition we have massive geopolitical risks. And it will not be like 1980-2000 when it comes to the gold correction. We are not going to see a similar correction after gold reaches a peak in the next few years.
At that time gold will either be money, because people will not trust paper money, or gold will be some other part of the monetary system. Therefore I don’t expect to get more than just a slight correction after this massive gold rally that we will see in the next few years.
But with regard to the short term, I still believe that gold and silver will rise to levels that few people can imagine. This is why people shouldn’t worry about the short-term price. People are holding gold to protect their wealth and they will need this protection in coming years.”