Accelerating Wall Street and Subprime Booms
Doug Nolan
For a quarter when Wall Street trumpeted the narrative of mounting economic weakness and the need for aggressive rate cuts, they sure enjoyed quite an earnings windfall.
Is it legitimate (in this day and age) to fret about a downturn and weakening labor markets with Wall Street absolutely booming?
October 16 – Bloomberg (Paige Smith):
“Morgan Stanley’s record quarter in wealth management capped a banner period for one of Wall Street’s most-profitable businesses.
Client assets at retail brokerage Charles Schwab Corp. and the wealth arms of the six largest US banks surged $5 trillion in the 12 months through September.
That represented a 23% jump as the group’s revenue from the business collectively topped $84 billion so far this year.
A surge in stock markets has pushed client balances higher and attracted new customers to firms…”
October 16 – Bloomberg (Sridhar Natarajan):
“Morgan Stanley traders and bankers joined the rest of their Wall Street rivals in posting better-than-expected revenue, fueling a 32% profit surge for the third quarter and sending the shares up the most in almost four years…
The firm’s critical wealth unit also stood out, generating record revenue of $7.27 billion, higher than analysts’ expectations, with $64 billion in net new assets…
‘It was a standout quarter in a constructive environment,’ Chief Financial Officer Sharon Yeshaya said...
‘We are only getting started and capital markets are only going to get stronger…
It’s good but it’s not the peak.’”
Morgan Stanley reported record third quarter Net Income of $3.377 billion.
Total Assets expanded $45.6 billion, or 15% annualized, to a record $1.258 TN.
It’s worth noting that Total Assets inflated $663 billion, or 111%, since the end of 2019.
While on the subject, JPMorgan Total Assets expanded $67 billion during Q3 to a record $4.210 TN, with growth since 2019 at $1.523 TN, or 57%.
October 15 – Bloomberg (Sridhar Natarajan):
“Goldman Sachs… profit soared 45% in the third quarter on a surprise increase in equity-trading revenue and a resurgent investment-banking business.
The firm’s stock traders recorded their best quarter in more than three years, on track for their best year ever, while dealmakers pocketed fees that exceeded estimates across every key business line.”
As such a dominant player in securities finance, Goldman Sachs’ Q3 data are worthy of a deeper dive.
Q3 Earnings surged to $2.78 billion, with y-t-d 2024 earnings 59% higher at $9.602 billion.
Investment Banking revenues were up 20% y-o-y (to $1.86bn), Debt Underwriting 46% higher y-o-y ($605 million), and Equity Underwriting up 25% y-o-y ($385 million).
Notably, Net Interest Income surged to $2.62 billion.
“3Q24 net interest income increased 70% YoY, reflecting an increase in interest-earning assets – 3Q24 average interest-earning assets of $1.59 trillion.”
“Global Banking & Markets Net Interest Income up 37% to $1.113bn” - and compares to Q3 ‘23’s $171 million.
With Money Market Fund Assets surging $300 billion during Q3, I’ve been eagerly waiting for data to confirm a corresponding expansion in “repo” borrowings (funding “basis trade” and other levered speculations).
Goldman’s Repo Liability surged $110 billion, or an un-annualized 46%, to a record $348 billion (awaiting Repo Asset detail).
Total Assets jumped $74.7 billion, or 18% annualized, to a record $1.728 TN – with one-year growth of $151 billion, or 9.7%.
The asset “Short-Term and Long-Term Investments” ballooned $154.6 billion during the quarter (91% annualized) to a record $784 billion, with one-year growth of $239.5 billion, or 44%.
Total Assets have inflated $993 billion, or 72%, since the end of 2019.
Goldman’s stock surged 6.7% in 10 sessions, boosting y-t-d returns to 39.6%.
Stellar Wall Street 2024 returns include JPMorgan’s 35.6%, Morgan Stanley’s 33.5%, Bank of New York Mellon’s 50.6%, and Wells Fargo’s 33.5%.
The KBW Bank Index sports a y-t-d return of 31.1%, with the Broker/Dealers returning 35.6% (ended Friday at an all-time high).
Highlighting a booming Wall Street, we don’t want to ignore the increasingly powerful non-bank players inflating Bubbles in “private Credit” and leveraged lending.
October 17 – Reuters (Echo Wang):
“Blackstone beat Wall Street's expectations on its key quarterly earnings metric…, as the world's largest alternative investment firm's assets under management (AUM) hit a record $1.1 trillion...
Blackstone said it saw $41 billion of inflows during the third quarter, while it deployed and committed $54 billion of capital - the highest in over two years - amid a revival in dealmaking activity as the U.S. Federal Reserve cut rates and the economic outlook remained sanguine.”
October 16 – Bloomberg (Laura Benitez and Jack Sidders):
“In its quest to double its size by 2029, Apollo Global Management Inc. is ramping up its ability to write jumbo checks to high-grade corporations as it delves deeper into what it calls private credit’s next frontier.
The alternative-asset manager is making its high-grade capital-solutions business a key plank in its growth strategy and is beefing up resources for the unit, Apollo Co-President Scott Kleinman said…”
Year-to-date returns include KKR’s 69.6%, Blackstone’s 34.3%, Apollo Management’s 57.5%, and Carlyle Group’s 31.7%.
Can we be done with it already?
It’s illogical to assert that the policy rate is significantly below some hypothetical “neutral rate”, with Wall Street enjoying a historic boom.
October 18 – Bloomberg (Olivia Raimonde):
“A key measure of perceived riskiness in US blue-chip company bonds has fallen to its lowest levels in two decades, as investors vie for debt that can still offer relatively high yields without too much default risk.
The average risk premium, or spread, on a US investment-grade bond compared with comparable Treasuries narrowed to 0.79 percentage point on Thursday, the tightest since 2005…”
As I highlighted in last week’s CBB, corporate spreads are today the narrowest since the 2005 Wall Street bonanza.
And why wouldn’t risk premiums be meager?
Risk-taking and speculative leverage are being so handsomely rewarded.
Wall Street CEOs are making a fortune with huge compensation packages and stock grants.
Traders, investment bankers, loan officers, asset managers, Credit analysts, and derivative players anticipate huge annual bonuses.
From CEOs on down, loose finance and powerful asset inflation ensure risk embracement is highly incentivized.
October 15 – Bloomberg (Laura Curtis):
“The rise of the private credit market may lead to less systemic risk in the US financial system despite a lack of political appetite for increasing bank capital requirements, Federal Reserve Bank of Minneapolis President Neel Kashkari said.
‘It’s scary at some level, because it’s exploded to a trillion dollar plus market fairly quickly,’ Kashkari said…
‘But as I’ve examined it, a bank in the US today — a big bank — is levered roughly 10 to one, 10 times as much assets for their equity.
These private credit vehicles are typically levered one to one, so it’s much less leverage…
‘So where does systemic risk come from?
The intersection between leverage and maturity transformation.
So on both those dimensions, these private credit vehicles look like they’re much lower risk than banks…”
Mr. Kashkari should know better.
The Federal Reserve would be well-advised to reexamine the subprime mortgage Credit fiasco.
Few businesses offer the immediate “profit” and growth opportunities available from lending to high-risk borrowers.
For one, typically facing limited options, risky borrowers provide a captive audience willing to pay up for money.
And once commenced, a “subprime” lending boom is powerfully self-reinforcing.
So long as Credit remains loose (loans readily available), non-performing loans and charge-offs will remain relatively contained.
Importantly, this inflates the accounting profitability of risky lending businesses, attracting more opportunistic lenders/speculators, aggressive lending, measly risk premiums, and looser conditions.
Moreover, the rapid growth of risky loan portfolios masks losses from earlier loans turning bad.
There’s a distinct Ponzi Finance element to “subprime” booms (think 2006-2008 Phoenix housing boom and bust).
Eventually, rapidly rising loan losses catch up to slowing portfolio growth, forcing a reassessment of the true risk profile of new loans and the profitability of lending businesses more generally.
Loan rates are adjusted higher, while Credit Availability tightens.
Losing access to borrowings, tighter conditions hammer risky borrowers that had accumulated (rolled over) excessive debts during the boom.
Whether Mr. Kashkari and his Federal Reserve colleagues recognize it or not, the U.S. economy is in the throes of a historic – and deeply systemic - “subprime” Bubble.
So-called “private Credit” is chiefly risky “subprime” corporate lending, having evolved into a primary source of finance for the ongoing proliferation of unprofitable businesses.
Ditto the more general “leveraged lending.”
On the consumer side, “subprime” auto and Credit card lending continues to boom.
And I believe we’ll look back and view the proliferation of “buy now, pay later” lending programs as principally “subprime.”
October 15 – Bloomberg (Laura Curtis):
“Klarna Bank AB struck a deal to offload buy-now, pay-later loans that it originates in the UK as it looks for ways to free up capital ahead of its public debut.
The deal with a subsidiary of the hedge fund Elliott Investment Management will give Klarna £30 billion ($39bn) of fresh firepower over the coming years as it looks to grow its business around the world…
‘By efficiently managing our assets, we can deploy shareholder equity more effectively,’ Klarna Chief Financial Officer Niclas Neglen said…
‘This is a unique deal, designed to support Klarna’s global growth’…
The transaction echoes a similar arrangement that KKR & Co. struck with PayPal Holdings Inc. last year to purchase as much as €40 billion ($43bn) of buy-now-pay-later loan receivables…”
October 15 – Financial Times (Akila Quinio, Costas Mourselas, Ivan Levingston and Robert Smith):
“Klarna is offloading most of its UK ‘buy now, pay later’ portfolio to US hedge fund Elliott for undisclosed terms…
The deal with Paul Singer’s $70bn hedge fund is expected to bolster Klarna’s capitalisation and allow the fintech to continue to pursue ambitious growth targets ahead of a highly anticipated US initial public offering.”
Kashkari is too complacent.
“Private Credit” is leverage on top of leverage.
The borrowers are highly levered, the lenders are levered, and various associated securitization structures are levered.
Singer’s Elliot hedge fund is surely not using its cash to provide Klarna with a fresh $39 billion of lending “firepower.”
October 17 – Bloomberg (Will Kubzansky):
“Goldman Sachs… and Morgan Stanley sold $11.3 billion combined in investment-grade bonds… after both banks posted earnings that surpassed analyst expectations.
Both sales came a day after rival JPMorgan… issued debt amid strong investor demand, after also reporting better-than-expected third-quarter results…
The six biggest banks on Wall Street were expected to take advantage of robust investor appetite and tight spreads to sell as much as $24 billion of bonds after posting results. JPMorgan’s sale… drew about $34 billion in orders, allowing the Wall Street giant to increase the final deal size to $8 billion…”
Fed take note: Scores of new age “subprime” lenders, “private Credit,” the leveraged speculating community, along with the big money center banks, have created a powerful nexus today fueling a powerful lending boom (extending late-cycle “terminal phase excess”).
Myriad Wall Street Bubbles risk overheating in the short-term, while creating acute financial and economic vulnerability to de-leveraging and Credit tumult.
While on the subject of “terminal phase excess”…
China’s system Credit metric, Aggregate Financing, expanded a stronger-than-expected $530 billion during September, pushing two-month growth to an un-deflationary $957 billion.
At $225 billion, Bank Loans somewhat missed forecasts.
Corporate Loans increased $209 billion, down from September 2023’s $235 billion - but still up 10.2% over the past year.
At $70 billion, Consumer (chiefly mortgage) Loans showed a pulse, though were down from September 2023’s $122 billion.
One-year growth slipped to 3.0%.
Government Bonds expanded $215 billion to $10.8 TN, with two-month growth of $444 billion.
At $1.01 TN, y-t-d growth is running 21% ahead of 2023.
Total Aggregate Financing expanded $4.493 TN over the past year, or 8.0%.
From my perspective, the most alarming aspect of the analysis is how the Chinese Bubble economy continues to deflate despite enormous ongoing Credit growth.
October 13 – Bloomberg (Sangmi Cha and Winnie Hsu):
“China’s highly anticipated Finance Ministry briefing on Saturday lacked the firepower that equity investors had hoped for, indicating that the volatility that’s gripped the market following a world-beating rally will likely extend.
While Finance Minister Lan Fo’an promised more support for the struggling property sector and hinted at greater government borrowing to shore up the economy, the briefing didn’t produce a headline dollar figure for fresh fiscal stimulus that the markets had sought.”
The Shanghai Composite jumped 2.1% Monday, sank 2.5% Tuesday, was little changed Wednesday, fell 1.0% Thursday, and then surged 2.9% Friday.
China’s situation is so dire that of course stock market speculators are nervously fixated on stimulus announcements.
While markets might not be receiving the details they would prefer, it sure seems Beijing is signaling (skip the details, it’s) “whatever it takes.”
China’s Finance Minister didn’t offer numbers, but Caixin Global Monday cited sources suggesting six Trillion renminbi ($850bn) of special treasury bond issuance for stimulus.
“China's central bank kicked off two funding schemes on Friday that will initially pump as much as 800 billion yuan ($112.38bn) into the stock market…”
China pledged “to nearly double the loan quota for unfinished residential projects to 4 trillion yuan ($562bn)…”
China’s version of “whatever it takes” is destined to be incredibly expensive.
Bolstering the collapsing apartment Bubble, including hopelessly insolvent builders and 48 million pre-sold/yet to be built apartments, seems like a couple Trillion (U.S.$) is a reasonable starting point.
A couple more will help stabilize the broke local government sector.
If Beijing plans to achieve growth targets, it seems a few Trillion more will be required for ongoing real economy stimulus.
And, at some point, the egregiously bloated Chinese banking system will require its own multi-Trillions.
A historic runaway Wall Street boom, unprecedented open-ended Chinese reflation, global central banks (this week the ECB) hellbent on cutting rates despite loose conditions and speculative Bubbles, and extreme geopolitical risks.
What could possibly go wrong?
Gold jumped another $65, or 2.4%, to a record high $2,721, boosting 2024 gains to 31.9%.
Silver’s 6.9% surge to $33.72 propelled y-t-d gains to 41.7%.
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