Repeal of liquidation tool would be a major unnecessary error
by: Lawrence Summers
Inevitably, Congress has more attractive uses for new funds than it has sources of new funds, so there is always is a desperate search for “pay-fors” — measures that are scored by the Congressional Budget Office as raising revenue or reducing outlays and thus can be used to finance new initiatives.

The pressure is particularly acute this year with the ambitious plans of the Trump administration.

There is also the likelihood that the use of the reconciliation procedure will preclude careful deliberation of proposed pay-fors.

I recently learnt of a particularly dangerous pay-for that may have superficial appeal — the repeal of the Orderly Liquidation Authority. This repeal if enacted will exacerbate moral hazard, impair financial stability, increase economic vulnerability and in all likelihood increase the national debt. It would be a major unforced error.

The OLA is a new bankruptcy-type provision included in Dodd-Frank that gives the Federal Deposit Insurance Corporation the authority to resolve insolvent systemic financial institutions (think future Lehman-like episodes). It allows the FDIC to borrow funds from the Treasury to support the liquidation of such firms with the proviso that in the event of any losses, fees will be levied on bank holding companies and other financial institutions to fully reimburse the Treasury. This authority is a wholly rational response to the gaping hole in our financial architecture evinced by the catastrophic Lehman failure, where policymakers’ only alternatives were uncontrolled bankruptcy or taxpayer-financed bailout. Had it been in place in 2008, much carnage could have been avoided.

So, much is wrong with eliminating OLA in order to get about $20bn in CBO-blessed revenue.First, the claim that repeal of OLA will improve the federal budget is bogus. As just noted, it ignores entirely the possible exacerbation of a future economic downturn. Moreover, it does not take proper account of the fact that the law requires that the Treasury be reimbursed in full for any losses. The apparent cost occurs only because the CBO measures budget impacts within a 10-year window and if, for example, a liquidation takes place in year nine, then the reimbursement will take place outside the 10-year window. In the economically relevant present value sense OLA by construction has no budget cost.

Second, without OLA there is much more risk of a future Lehman that will have cascading consequences for the financial system and the economy. Even now, as Natasha Sarin and I have demonstrated, bank market equity values are very low by historical standards relative to total assets, so insolvencies cannot be ruled out. This risk is magnified if, as now seems likely, many of the regulatory protections contained in Dodd-Frank are repealed. Note that if the lack of the OLA causes a future financial crisis to reduce GDP by even 0.5 per cent for one year, the loss of tax revenue will exceed the CBO’s 10-year estimate of the cost of the OLA.

Third, there is the problem of moral hazard. In the absence of a framework for handling liquidation, the pressure will be increased for adhoc guarantees or other measures in time of crisis that prevent creditors from taking losses. The Fed will be under more pressure in its use of the discount window, for example. Congress may be under pressure to authorise taxpayer-financed bailouts. Creditors will believe that if nonpayment to them will set off cascading contagion, authorities will find ways to keep them whole. This will ultimately raise risk-taking and make future crises more likely as “too-big-to-fail” is restored as a possibly self-fulfilling prophecy.

Congress should and will debate proper policy for dealing with failed financial institutions. My own sense is that we are in more danger of having too few tools than too many, for reasons Tim Geithner has recently spelled out in Foreign Affairs. But there are many considerations to be weighed and reasonable people can disagree. What would be wildly unreasonable would be to prejudge the debate and undermine financial stability. I hope that cool heads will prevail and the idea of using OLA repeal as a pay-for will be abandoned.

China’s Corporate Debt Struggles Continue

Beijing wants to solve its corporate debt problem using free market principles.

By Jacob L. Shapiro

The International Monetary Fund (IMF) released a report yesterday in which it increased its forecast for China’s GDP growth by 0.3 percentage points to 6.5 percent. However, the IMF report also warned that “slow progress in addressing corporate debt” posed a risk to the forecast. China has been attempting to dispel such fears. The chairman of the state-owned China Construction Bank said at the Asian Financial Forum in Hong Kong yesterday that China’s system is healthy and out of the woods because the rate of non-performing loans (NPLs) had already peaked. On Jan. 12, business news magazine Caixin reported that a subsidiary of the Industrial and Commercial Bank of China (ICBC), the world’s largest bank, had reached deals with seven Chinese state-owned enterprises to convert approximately 60 billion yuan ($8.7 billion) of unpaid loans into equity shares. In our view, however, the fears expressed by the IMF are warranted.

This photo taken on May 5, 2015 shows workers installing a sign above the entrance to a branch of the Industrial and Commercial Bank of China in Beijing. GREG BAKER/AFP/Getty Images

The news about debt-for-equity swaps and China’s claims to be over the worst of its corporate debt problems all sound good until one remembers that it was only in October 2016 that the Bank for International Settlements (BIS) reported that China’s corporate debt was 121 trillion yuan, roughly 169 percent of China’s GDP. The IMF in a separate report the same month noted that the problem wasn’t simply a high rate of growth in Chinese corporate debt since the 2008 global financial crisis, but the fact that corporate profits have steadily declined since 2009 while the leverage ratio has increased.

One of the obvious side effects of such unrestrained credit growth is a rise in NPLs. China currently reports NPLs at 1.7 percent of total loans, but we have always taken Chinese statistics with a grain of salt. Our own bearish estimate on China’s NPLs last March was that the true figure was somewhere between 3 and 7 percent. However, the IMF in the aforementioned report suggests that the number of loans at risk of default is much higher, estimating that non-performing and special-mention loans have risen above 5 percent, while loans potentially at risk account for 15.5 percent of all commercial bank loans to the corporate sector.

The debt-for-equity swap issue has seen its fair share of controversy in China. Last March, Chinese Premier Li Keqiang publicly floated the idea that debt-for-equity swaps could be a key tool in the government’s strategy to reduce risk in the financial system, aid Chinese companies facing “temporary difficulties,” and maintain growth targets. Last May, an article in the People’s Daily newspaper criticized many of the main planks of Li’s plans. The identity of the so-called “authoritative insider,” who was interviewed for the article and eviscerated some of Li’s policy proposals, is still unknown. But it is now generally believed that the “insider” was someone close to President Xi Jinping and that the article was part of a series of moves by Xi to undercut Li’s authority.

In the end, China decided to go forward with pushing debt-for-equity swaps, but with certain conditions attached. China’s State Council published the guidelines for debt-for-equity swaps in October, not coincidentally amid a flurry of reports (including the IMF and BIS reports) that call attention to China’s corporate debt problem. A State Council announcement said that the government-backed debt-for-equity program would be launched “under market principles.” The State Council said it was forbidding “zombie enterprises” from participating; only companies facing the “temporary difficulties” described by Li and those that could demonstrate “long-term potential” would be allowed to exchange their debt for stakes.

Furthermore, unlike the last time China engaged in debt-for-equity swaps in the late 1990s, banks would be prohibited from directly exchanging their loans for equity.

China’s State Council says market principles are governing these debt-for-equity swaps. So let’s take a closer look at the companies involved in the program. Two of the companies with which ICBC recently reached agreements are BBMG Corporation and Taiyuan Iron & Steel (TISCO). BBMG is a Chinese cement producer and property developer that saw profits in 2015 fall by 17 percent. Figures available for the first half of 2016 look much better, but only because the first half of 2016 was the height of an overheated Chinese property market, which artificially propped up demand for cement.

Now that China is taking steps to rein in property prices, BBMG’s prospects are uncertain at best.

TISCO is in a far worse position; it finished 2015 in the red, to the tune of 3.36 billion yuan.

The point is that these are not good investments, and if the market was functioning without government interference, many state-owned enterprises in China would fold because they aren’t profitable. Those investing in the debt of these unprofitable enterprises either have both an extremely high tolerance for risk and an exuberant optimism, or are counting on some other kind of political or financial benefit in exchange for their investment. The propping up of unprofitable state-owned enterprises is a catch-22, because if China lets the companies fail, the Communist Party risks its legitimacy and setting off unrest throughout the country. But not letting the companies fail means continuing to shuffle debt around until the banking system can no longer handle it. The end result will be much the same in both scenarios. Without its high growth rates, China cannot count on economic growth to solve this problem, and unlike Japan, which faced a similar challenge in the ’90s, wealth inequality in China is still extreme. Hundreds of millions of people in China’s interior regions have not enjoyed the same economic advancement as those on the coast. Eventually, some sectors will have to pay up.

There is an irony that should not be lost in this debt-for-equity swap plan that China’s State Council published and that China’s five main state-owned banks are now executing. We have concluded that Xi’s control over the state’s levers has increased markedly in the last six to eight months, which means support for these debt-for-equity swaps must be coming from the top. It also certainly means that the emphasis on “market principles” is coming directly from the top as well. Yet this is the same Chinese president who in front of a large crowd of Chinese Communist Party officials last May said, “turning our backs or abandoning Marxism means that our party would lose its soul and direction.”

Xi is trying to reinvigorate the communist ideology of the party, and yet the medicine he is prescribing for China’s corporate debt problem is based on free market principles. The disjuncture between ideology and constraints is rarely so obvious.

domingo, enero 29, 2017



Returning Gold Bulls

By: Bob Loukas
Gold Sprouts

Back in December, I noted that there was not a Gold bull to be found (See post: Not a Gold Bull in Sight) and that the Gold Cycle was on the verge of a significant Cycle turn. Fast forward a month, and 20 days of this Daily Cycle (DC), gold is up almost $100 and has again caught the attention of gold bulls.

Since the Cycle turn, this has been a rather interesting first Daily Cycle in gold. Mostly because the rally over the first twenty days has been fairly constant, with the half Cycle Low noticeably absent. Moreover, the move has not seen a surge based on a typical rush to cover short positions normally seen around the turn of any Investor Cycle.

The last point might end up being more important than we think. Looking at this week's commitment of trader's report (COT), I've noticed that speculative Long and Short positions have barely turned off their recent extremes. Meaning that this $90 first DC move really has not come off the back of a shift in speculative positions. This is precisely why you do not see any large spikes in volume or price on any of the given 20 days of the Cycle. Therefore, from what I can tell, a larger degree rally lies potentially ahead for this Investor Cycle, setting the scene for an impressive 2nd Daily Cycle to come.

When the gold Cycle first turned higher almost a month ago, I said that we could expect a $100 rally over the first 20 sessions. As it stands today, the Cycle has hit day 20 and rallied $90+ off the Cycle Low. It is at a point where we should check our short-term expectations going forward. Although never ruling out another solid performing week ahead, it would also be consistent with past bullish patterns for gold to dip over the next week to form the DCL.

Daily Gold Chart

For the dollar, a big drop a week back on Day 18 of the Cycle was our confirmation that the decline had begun. Following through from that point, we now see the dollar at new lows on Day 26 today, further pushing below the Bollinger bands into deep (short-term) oversold territory. This is pretty much well beyond the normal Cycle Low timing band.

Therefore, a turn higher is absolutely imminent, and a rally of at least 3-5 sessions is expected. Because gold is also near a natural Cycle topping point, the push higher by the dollar will only help to send gold lower at least temporarily.  From that point, I do expect the dollar's next Cycle to form Left Translated, opening up the possibility of a significant sell-off post the Trump inauguration, and a decline into the next major Weekly Cycle Low.

US Dollar Index Daily Chart

As mentioned in the introduction, Sentiment and COT reports show very little change of late, even as gold begins to complete the initial thrust in this young Investor Cycle. With gold back over the 10-week moving average, and the technicals looking fantastic, all of my indicators here are in a significantly bullish alignment. Therefore, always appreciating that bear market rallies can be deceiving, I still believe there is plenty of room above for gold to allow for a significant rally.

Weekly Gold Chart

One Big, Fat, Ugly Bubble

by Nick Giambruno

The establishment is setting up Donald Trump.

The mainstream media hates him. Hollywood hates him. The “Intellectual Yet Idiot” academia class hates him.

The CIA hates him. So does the rest of the Deep State, or the permanently entrenched “national security” bureaucracy.

They did everything possible to stop Trump from taking office. None of it worked. They fired all of their bullets, but he still wouldn’t go down.

Of course, the Deep State could still try to assassinate Trump. It’s obvious the possibility has crossed his mind. He’s taken the unusual step of supplementing his Secret Service protection with loyal private security.

The Deep State’s next move is to pin the coming stock market collapse on Trump. When people think “Greater Depression,” they’ll think “Donald Trump.”

The economy has been on life support since the 2008 financial crisis. The Fed has pumped it up with unprecedented amounts of “stimulus.” This has created enormous distortions and misallocations of capital that need to be flushed.

Think of the trillions of dollars in money printing programs—euphemistically called quantitative easing (QE) 1, 2, and 3.

Meanwhile, with zero and even negative interest rates in many countries, rates are the lowest they’ve been in 5,000 years of recorded human history.

This is not hyperbole. We’re really in uncharted territory. (Interest rates were never lower than 6% in ancient Greece, and ranged from 4% to over 12% in ancient Rome.)

The too-big-to-fail banks are even bigger than they were in 2008. They have more derivatives, and they’re much more dangerous.

If the Deep State wants to trigger a stock market collapse on par with 1929, it just has to pull the plug on the extraordinary life support measures it’s used since the last crisis.

It’s already baked in the cake. It’s just a matter of when they decide to trigger the controlled demolition.

Donald Trump is the perfect fall guy. And there are signs the Deep State is already starting to get its revenge.

The most important variable to watch is the Federal Reserve—the quintessential establishment institution.

Source: Ben Garrison

Even though most politicians, economists, and pundits in the mainstream media won’t admit it, central banks exist to help governments finance themselves, at the expense of the average man. It’s the hidden, but real, reason they exist.

The Fed accommodated Obama—effectively financing his regime’s deficits by creating new currency units. I doubt they will do Trump the same favor. And Trump will likely run up enormous deficits.

Don’t forget about the $1 trillion in stimulus spending he has planned.

If the Fed doesn’t gobble up the debt used to finance Trump’s spending, it will only work to push up interest rates.

Interest Rates

Manipulating interest rates to near 5,000-year lows is a crucial part of the life-support system. Now the Fed is set to pull the plug and leave Trump holding the bag.

In December 2015 the Fed raised interest rates for the first time in almost a decade, from 0% to a mere 0.25%.

The Fed kept rates there until last month, when it raised them to 0.50%. It also announced it would accelerate rate hikes throughout 2017—three in total.

There’s a good chance the Fed will announce these rate hikes during the eight Federal Open Market Committee (FOMC) meetings it has scheduled in 2017.

2017 FOMC Meetings

February 1          July 26
March 15            September 20
May 3                  November 1
June 14               December 13

I think some of these rate hikes will be much bigger than the 0.25% most expect. They could pull a series of 0.50% rate hikes… or go even bigger.

Anything greater than the normal 0.25% tempo would shock the market—and seem designed to hurt Trump.

The establishment will get its revenge on Trump. The Federal Reserve is its weapon of choice.

Trump seems aware of the situation. He recently said, “They’re keeping the rates down so that everything else doesn’t go down.”

He’s also said that “We have a very false economy” and the stock market is a “big, fat, ugly bubble.”

During the campaign, Trump called Fed Chair Janet Yellen “highly political.” He said the Fed should raise interest rates but won’t because of “political reasons.” (Raising rates before the election would have hurt Hillary Clinton.)

The Media

The mainstream media is another variable to watch.

Paul Krugman, a New York Times economist—or, more accurately, witch doctor economist—has come out against Trump’s $1 trillion infrastructure stimulus.

It’s bizarre because Krugman, a die-hard Keynesian, had previously never seen a “stimulus” program he didn’t like. Once, he even advocated faking a space-alien invasion to stimulate the economy. It shows that Krugman is not only a fool, but a hypocrite.

This is a clue.

I bet the rest of the mainstream financial media—CNBC, Bloomberg, The Economist, etc.—will morph from bullish cheerleaders into pessimistic doom-and-gloomers after Trump takes office.

Don’t expect them to find any “green shoots” after the market tanks on Trump’s watch.

All this is why what happens after Trump’s inauguration could change everything… in sudden, unexpected ways.