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Friday
Dec062013

The Fed’s Employment-Taper Myth, Big Six Bank Stocks, and Downgrades

There is a prevailing, politically expedient myth that the Fed’s bond purchase programs are somehow akin to job fairs; as if there’s an economic umbilical cord stretching from a mortgage-backed security lying on the Fed’s books to a decent job becoming available in the heart of America. Yet, since the Fed began its unprecedented zero-interest rate and multi-trillion dollar bond-buying policies - the real beneficiaries have been the Big Six banks (that hold more than $500 billion of assets): JPM Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.

The Big Six banks’ stock prices have outperformed the Dow’s rise by more than double, since early 2009. Moreover, low to zero percent interest rates on citizens’ savings accounts have catalyzed depositors, pensions, and mutual funds to buy more stocks to make up for low returns on bonds and money market instruments, further buoying the stock market.

Quantitative Easing ‘QE’ entails buying bonds, not creating jobs

No matter how many articles and politicians claim the Fed is buying Treasury and mortgage-backed securities (MBS) to help the a) economy or b)  unemployed, it isn’t true.

According to the Economic Policy Institute “the unemployment rate is vastly understating weakness in today’s labor market.” True, the official unemployment rate  (called ‘U-3’ on the Bureau of Labor Statistics reports) has inched downward from a high of 10% in early 2009 to 7%. But, that’s because people have dropped out of the hunt for jobs. The number of these ‘ workers’ as EPI calls them, has risen with the stock market’s rise; that’s not a sign of a healthier employment situation.

If those workers were still ‘participating’ in the employment-seeking crowd, the adjusted U-3 unemployment rate would have hovered between 10 and 11.8% since early 2009. It is currently at 10.3%. In other words, it’s still pretty damn high.

And that’s a more conservative estimate of unemployment than places like John Williams’ Shadowstats computes, which pegs the unemployment rate at Great Depression levels of just below 23%.

(The BLS’s estimate of the U-6 unemployment rate, which includes people who have briefly stopped looking (short-term discouraged or marginally attached workers) or found part-time rather than full time jobs, is at 13.2%. It has declined along with the official U-3 estimate, but does not account for the “missing” 5.7 million workers, either. Plus, the BLS long-term jobless figures have remained steady around 4 million people.)

Happy Hundredth Birthday Fed! (Bank to the bankers, not the people)

As I explore in greater detail in my upcoming book, All the Presidents’ Bankers, the Fed wasn’t created in the wake of the Panic of 1907 to help people find jobs. It was created to provide bankers a backstop to the pitfalls of risky bets gone wrong, and propel the US to a financial superpower position competitive with major European banks via supporting the US dollar.

As per its official summary in the Federal Reserve Act of 1913 (approaching its century anniversary on December 23, 2013), the Federal Reserve was formed to “provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.”

Besides, if the Fed really wanted to make a dent in unemployment today, it could have spent the nearly $1.4 trillion it used to buy MBS to create 14 million jobs paying $100K or 28 million jobs paying $50k, or funded the small businesses that the big banks are not. Equating QE with employment illogically equates offering the biggest banks a  dumping ground for their securities with middle and lower class prosperity.

QE is ongoing because the Big Six still hold crappy mortgages and like trading

According to the latest New York Fed's quarterly trends report; the Big Six banks’ annualized trading income, as a percentage of trading assets, is higher than pre-crisis levels, whereas non-trading non-interest income as a percentage of total assets is lower. That means banks are making more money out of trading post-crisis than pre-crisis relative to other businesses.

In addition, total non-performing loans, as a percent of total loans, is 4.75% (from a 2009 high of 7.25%) for the Big Six. This figure remains more than double pre-crisis levels, and more than double that of the rest of the industry (i.e. the smaller banks).

Nearly 10% of the residential mortgage loans of the Big Six banks are non-performing. This is not very different from the 11% highs in 2009 (compared to smaller banks whose ratios are 3.5% vs. 6% in 2009). In other words, the Big Six banks still hold near record high levels of bad mortgages, and in higher concentrations than smaller banks. That’s why the Fed isn’t tapering, not because it’s waiting for a magic unemployment rate.

QE Propels Big Six Bank Stock Prices

Since the financial crisis, the Fed has amassed a $3.88 trillion book of securities, or quintupled the size of its pre-crisis book. As of December 2013, the Fed owns $1.44 trillion MBS, many purchased from its largest member banks, the ones engaged in settlements and litigations over the integrity of similar securities and loans within them.

Since the Fed announced QE3, a $40 billion extension asset purchases per month (over the then-prevailing limit of $45 billion) on September 13, 2012,

the Dow has jumped 19%. BUT meanwhile - the Big Six bank stocks are up on average 53.5% (JPM Chase is up 43%, Bank of America 74%, Goldman 42%, Citigroup 57%, Morgan Stanley 77% and Wells Fargo 27%.)

Since its March 2009 lows, the Dow is up 142%. BUT - the Big Six bank stocks are up on average 324% or more than twice the level of the Dow. (JPM Chase is up 258%, BofA 396%, Goldman 122%, Citigroup 499% (accounting for its 10 to 1 reverse stock split in March 2011 - it was trading close to a buck on March 6, 2009) Morgan Stanley 80%, and Wells 408%.) Yes, they were near death, but you can’t argue the Fed’s policy helped the broad economy as opposed to mega-disproportionally helping the banks. These numbers don’t lie. And help from the Fed won’t stop with a new Chair.

Yellen to the (bank) rescue?

In her statement to Obama on October 9, 2013, Janet Yellen said “thank you for giving me this opportunity to continue serving the Federal Reserve and carrying out its important work on behalf of the American people.”

A month later, she told the Senate Banking Committee, “It could be costly to fail to provide accommodation [to the market],” underscoring her support for quantitative easing and zero-interest rate monetary policy (and Big Six bank stock prices).

In its latest FOMC meeting release, the Fed reiterated, “the Committee decided to await more evidence that progress [in the economy] will be sustained before adjusting the pace of its purchases.” It says the same thing every month, with slightly different wording. Every time the market wobbles on ‘taper’ fears, it jumps back, because professionals know the Fed will keep on buying bonds, because that’s what the Big Six banks need it to do. To analyze taper-time, look at the banks’ mortgage book, not the unemployment rate.

Resolution Plans and Downgrading for the Wrong Reasons

On November 14, Moody’s downgraded 3 of the Big Six banks - Goldman, JPM Chase, and Morgan Stanley - and also Bank of New York a notch each because “there’s less likelihood in the future that these banks will be helped by the government” in a financial emergency. Moody’s has the downgrade right, but for the wrong reasons.

The big banks had to present ‘living wills” as the media calls them, or Dodd-Frank Title II required resolution strategies. They amount to the big banks selling whatever crap they own in an emergency and dumping whatever remains of their firms on the FDIC. 

I examined the plans submitted to the Fed on October 30.  They aren’t long. The ones for JPM Chase and Goldman Sachs, for instance, tally 31 pages each, of which 30 pages discuss their businesses and just one page - resolution strategy.

The FDIC basically would get the toxic stuff unsellable by the ‘troubled’ bank and place it in a newly established ‘bridge bank’ before the ‘troubled’ bank finds another buyer or declares bankruptcy. Which is exactly what happened with IndyMac and other banks that were ‘taken over’ by the FDIC and then resold to private equity and other firms.

If all else fails, each firm would undergo bankruptcy proceedings, in an “orderly” manner and “with minimum systemic disruption” and “without losses to taxpayers.”  Or so the process is characterized by JPM Chase and the others.

Goldman Sachs also waited until page 31 of 31 to present its main resolution idea, consisting of  “recapitalizing our two major broker-dealers, one in the U.S. and one in the U.K., and several other material entities, through the forgiveness of intercompany indebtedness...” This amounts to massaging inter-company numbers if things go haywire.

But banks oozing eloquences like “orderly market” or ‘minimum-disruption” bankruptcy and the reality being so, are two different things. Lehman Brothers tried most of these methods and still catalyzed a widespread economic meltdown. Bear Stearns didn’t declare bankruptcy, but the Fed and Treasury still conspired to guarantee its assets in a sale to JPM Chase. Technically, politicians and bankers argued no taxpayer money was used in that scenario because the guarantee wasn’t part of the TARP funds, but it was a government guarantee all the same so the distinctions amounts to splitting political hairs.

There is simply NOTHING NEW in these plans, no safety shield for the world. The problem remains that the FDIC can’t handle a systemic banking collapse, which is a threat that the Big Six banks, in all their insured-deposit-holding-glory still pose.

If all of the banks implode on the back of still existing co-dependent chains of derivatives or toxic assets or whatever the next calamity delivers, even if the Treasury Department doesn’t get Congress to pony up funds to purchase preferred shares in the big banks, and even if the FDIC creates bridge banks to take over trillions of dollars of bad assets - which it can’t afford to do, the Fed would simply enter QE-Turbo Mode.

It doesn’t matter if bankers and politicians don’t consider this a ‘taxpayer-backed’ bailout as per the lofty aspirations of a tepid Dodd-Frank Act. Because whatever subsidies are offered in that case, we will all still be screwed, and we will all pay in some manner. The Fed’s balance sheet and Treasury debt would bloat further. The cycle would continue.

 

Reader Comments (15)

Another succinct description by Ms Prins. Funny how this is not well understood. Well, perhaps Reality will be more apparent as the crisis continues.

December 6, 2013 | Unregistered CommenterDan Friedman

Good article, Nomi. Thanks.

"It is to be regretted that the rich and powerful too often bend the acts of government to their own selfish purposes." - Andrew Jackson

Were he able to comment on today's monetary system he'd say, 'Nothing’s changed'.

December 6, 2013 | Unregistered Commenterjp111

Yes, Andrew Jackson's words are certainly timeless, though I think beyond the bending of the government, is the fact that too often, they are also entrenched in the government.

December 6, 2013 | Registered CommenterNomi Prins

You raise many Interesting points in this article Nomi.
The point about the "non-performing/bad mortgage loans" can be taken further. In pure nominal sense the 10% is in itself alarming. Take leverage into account together with the derivative side line bets on top, you have exponential issues where the Banks' capital is practically depleted when the clock strikes 12.
If you ask me, they are all insolvent without the FED.
By extrapolation therefore the FED is keeping the banking / monetary system functioning and averting chaos and anarchy(and more importantly for them, loss of power and control). Whilst it seems on face value that the FED is favouring the Big 6 (which it is), it also is more focussed on mitigating the risk of disaster and crisis. The unfortunate side of this equation is that we don't really know what occurs if the FED stops its support. Do we really want to find out ?
I would rather a lengthy period of stagnation than go through a Greater Depression.
Double, Double, Toil and Trouble.

December 9, 2013 | Unregistered CommenterLiquid Motion

Yes, the leverage connected to the non-performing loans makes the overall position of these banks' books that much more precarious, just as the leverage within and around the $14 trillion of mortgage-related assets created before the 'crisis' (I used the number $140 trillion of leveraged risk in It takes a Pillage) belies a far greater danger. The whole system would implode without the Fed and the general subsidies that created the appearance of stability in 2009 / 2010, but which were really means to pile liquidity into the banks. The problem with the changing-deck-chairs-on-the-Titanic approach, is that it doesn't allow for an actual strengthening and reforming of the system, which is sorely needed.

December 9, 2013 | Registered CommenterNomi Prins

Reforming of the system is only one part of the solution.

How do you go about eliminating the existing $220TLN Federal/Corporate/Private Debt (including unfunded liabilities) without default. At some stage the Debt has to be settled. I know there is limited scope for that to occur under normal market/economic conditions. Without being cute we face an insurmountable problem here. I think you know ( as I do) that we are caught in a vicious downward spiral from which there is no escape velocity. Greater debt brings less growth but more consequences.
Stopping the debt issuance only creates an immediate crash and further hardship for all and sundry.

Am afraid that any actions taken now ( by way of reform or ceasing QE) will be too little too late, The FED can only hold things together while there is confidence in the system. You understand how banking works. Without confidence in the system everything collapses. That is when the FED loses control. That day is coming...if you are honest you will admit that it cannot be avoided.

December 10, 2013 | Unregistered CommenterLiquid Motion

I think we're saying the same thing - without the Fed, the system collapses, and with what the Fed has done by rolling this ball further up the hill, it has made things worse, because it has not allowed for anything like a true and orderly unwinding of debt, leverage (within and between securities) and interlocked derivatives positions, nor have any legislation or regulations required any such thing . While fabricating temporary confidence, which is why it keeps buying debt, the Fed is trying to run out the maturity clock (the average maturity of debt it holds is 5-10 years, which is an awfully long time to keep all this going.) As I wrote - the FDIC can't handle a systemic collapse, even if Dodd-Frank supporters seem to think it can, it can only try to handle a collapse with increased Fed help, hence the vicious circle. I agree totally this won't end well, nor is it over.

December 10, 2013 | Registered CommenterNomi Prins

Appreciate your response Nomi.

One final question for you : - In your honest opinion how long do they (FED) have.
Exclude other Black Swans (War in ME, Currency crash as triggers for e.g.) from the equation and exclude reform.....pure and simple ...unadulterated opinion.....how long before the fabrication of confidence is eroded. What is the outside time frame for holding this together.
I have my school of thought but would sincerely be interested in hearing yours given your understanding of the mechanics of the Fed and of the Big 6 and of financial markets. Debt maturities notwithstanding, debt is still debt and not solved with more debt. Twisting of the treasuries is almost done. MBS buying is swapping paper debt for worthless assets. I am sure you would agree that not only are the Big 6 carrying negative equity but so too is the FED.
What will be the warning signal for you that things will unravel very quickly ....interest rates +100bps ?

December 11, 2013 | Unregistered CommenterLiquid Motion

It's hard to say exactly when a more acute crisis will occur (as opposed to the slow economic burn in which we find ourselves anyway) due to the complexity and interdependence of the Big Banks and their books, I can't isolate just one specific element as the main catalyst. One issue is that the Fed's MBS book is over-valued and these securities are the ones, or like the ones, at the center of all the banks' settlements and ongoing litigations and inflation of their own numbers, plus as I mentioned in the piece, the big six banks' nonperforming real-estate loans, especially the single family ones - have remained at pre-crisis levels despite the Fed's purchasing of the securities comprised of these loans. So, a combination of these non-performance (i.e. defaulting) levels remaining high or getting higher, the banks' beginning to take charge offs on losses they are deferring which are masking the problems in said loans, degradation of the related derivatives, including those derivative chains that connect the banks to each other, an implosion of all the developer stocks and loans that have increased well-beyond their crisis levels (and that portended the original crisis in early 2007), corporate credit spreads widening increasing corporate debt loads and our discovery that banks are involved in masking debt again, and one big round of announced losses from a key player - which could be a corporate player that's a favorite client of the banks (remember Enron), or any of the banks themselves.....all these could happen and will have worse repercussions if they happen simultaneously.

I could throw out a timeframe for the hell of it, but another major crisis is predicated on a combination of these kinds of likely events, any one of which could catalyze the others, and then everything crumbles quickly. The Fed actually ceasing to purchase securities would also be a catalyst, because it leaves banks in the position of reduced liquidity and demand for their worst performing assets, which would lead to a greater credit crunch - also a catalyst for a broader meltdown.

December 12, 2013 | Registered CommenterNomi Prins

Citibank did a 1:10 split in 2011. It is up 5x from the absolute bottom in March 2009, not 5000%.
Unbelievable numbers in this article make it less persuasive.

December 13, 2013 | Unregistered CommenterRichard A Date

Richard,

Thank you very much - that is a most excellent catch and I have corrected the relevant numbers in the piece to account for Citigroup's reverse stock split in 2011 and indicate its rise as up about 500%, not 5000%. You are right, accuracy is key to persuasiveness - and fixing errors is a humbling and important endeavor.

Nomi

December 13, 2013 | Registered CommenterNomi Prins

Greg Hunter's USAWatchdog.com still has the incorrect numbers up.
Its gone viral! :O

December 14, 2013 | Unregistered CommenterRichard A Date

I am having trouble with math also.

Bank of America is up from 6 to 15. That is 150% gain
not 250% and not 396% as appears in the article, Please correct me if I misspeak.

December 14, 2013 | Unregistered CommenterRIchard A Date

Thank you for the question, Richard. But, that math is correct:
Bank of America closed at 3.14 on March 6, 2009:
http://finance.yahoo.com/q/hp?s=BAC&a=02&b=2&c=2009&d=02&e=10&f=2009&g=d
As of the day I wrote the piece, it closed at 15.57. So, (15.57-3.14)/3.14 = 3.958 or rounding one decimal point 3.96 or 396%.

December 15, 2013 | Registered CommenterNomi Prins

so what are common people to do to protect themselves from this banking insanity? How does one get through to folks that they are at risk, their banked assets are at risk? Is there an amount in checking, savings, brokerage accounts that TPTB will not try to touch, is there an amount they will not try to confiscate? How do 'the people' fight back against this financial insanity or is it just too ingrained and we have to wait for complete implosion which hurts everyone? Sorry for all the questions, just seems trying to position ones meager (compared to Wallstreet) assets to minimize loss from banking or political policies is like playing a game of wack a mole.

December 18, 2013 | Unregistered CommenterRoxie

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