Heroes; Crisis, What Crisis? 

 

‘(Cash rules everything around me) take you on a natural joint 

(C.R.E.A.M. get the money) 

(Dollar dollar bill, y’all) here we, here we go, check this shit, yo’ 

Both the White House and Jamie Dimon of J P Morgan have played down fears that the collapse of three US banks in as many months spells serious trouble for the world’s biggest economy. 
 
President Biden takes the line that that the US financial system is fundamentally OK; the economy has slowed down it continues to grow. Jobs are still being created, and the unemployment rate is only 3.4%. Manufacturing firms are heading to the US to take advantage of the green subsidies contained in Biden’s Inflation Reduction Act. 

The problem is that the wall of cheap money made available by central banks post-GFC has inflated one of the biggest bubbles of the past 100-years. However, to deal with recent inflation we have seen the fastest rise in interest rates for four decades, raising bank rate from near zero to more than 5% in a little over 12-months. 
 

‘it is unlikely that the Fed can finesse a soft landing for the economy’

 
As a conclusion, it is unlikely that the Fed can finesse a soft landing for the economy. Analysts expect rates to peak in June, and to be just over 4% by the end of 2023. The question here is, are markets are getting ahead of themselves? Slowing job data is unlikely to be sufficient to convince the Fed to start cutting rates. But, more banks going bust might convince them. 

Analysis of > 4,800 U.S. banks, co-authored by Amit Seru, a professor of finance at Stanford Graduate School of Business, found that banks could be sitting on $2.2 trillion in losses. 

This is far greater than the number quoted by Federal Deposit Insurance Corporation (FDIC) Chairman Martin Gruenberg in a speech just a few days before Silicon Valley Bank failed, in which he said that the market value of U.S. banks’ long-term assets had dropped $620 billion in 2022.  

As a result of rising interest rates, the market value of the average U.S. bank’s assets is about 9% lower than its value on paper, and 10% of banks have had larger unrealized losses than Silicon Valley Bank (‘SVB’). 
 

‘banks could be sitting on $2.2 trillion in losses’

 
Reports show that were several reasons why SVB failed. 

Firstly there was interest rate risk; the value of mortgages, bonds, and other long-term assets declined when interest rates rose. These unrealised losses are not reflected on banks’ balance sheets, but they can be calculated by marking investments to their current market value. In the year to March 2023, the market value of SVB’s assets declined by C.16%, or $34 billion. 

Research shows that the average bank’s assets have lost around 10% of their value over the past year. 

In addition to its losses, C.78% of SVB’s deposit fell outside of the cover provided by the Federal Deposit Insurance Corporation, which insures deposits up to $250,000. The normal figure would be closer to 25%; SVB was in the top 1% of banks with uninsured leverage. 

This made SVB especially vulnerable to a bank run. Which is exactly what happened after the bank revealed it was taking a major loss on the sale of Treasurys and mortgage-backed securities, customers withdrew $42 billion in a single day, leaving it with a negative cash balance of nearly $1 billion. It failed a day later. 
 

‘customers withdrew $42 billion in a single day’

 
The FDIC tried to stem the impact of the Silicon Valley Bank’s failure by taking the unusual step of ‘backstopping’ its uninsured deposits.  

Source: https://www.gsb.stanford.edu/insights/many-us-banks-face-same-risks-brought-down-silicon-valley-bank 

Another area of concern is banks’ exposure to the Commercial Real Estate (‘CRE’) sector, a C. $5 trillion market. 

The rising cost of the debt financing on prime CRE is causing concern. Many bank analysts are starting to say that CRE will impact on smaller US bank lenders, and also to shadow-banking ‘Alternatives’, such as credit hedge funds. Many, are now finding out just how illiquid office blocks in empty cities can become. 
 

‘finding out just how illiquid office blocks in empty cities can become’

 
As an example, the former Bank of America building at 555 California in San Francisco has been placed on a loan servicer watch-list of real estate deals it considers likely crisis points. In just 2-years the cost of a $1.2 bn 2-year mortgage on the building taken out in 2021 has risen 38% The owner has just filed to extend the loan. US Property developer Vornado, which owns 70% of the building, wrote down its property portfolio by $600mm last month. 

The other 30% of 555 California is owned by a certain Donald J Trump! 

The problem isn’t the tenants of the SF building, it’s the rising cost of the mortgage to over $6 mm per month, and what can the landlord do to absorb crippling debt service costs as rents remain under pressure.  

San Francisco is struggling with a 28% office vacancy rate and is the ‘the most empty downtown in America’, according to CBRE. 

A recent report by JP Morgan found that over $450 bn of US CRE lending is due to mature this year. In normal conditions that would not be a problem, but these are not normal times, and refinancing will be a challenge, and at what cost. 

Many of these deals were financed during the era of 0.5%  Fred Rates, today is 5.25%. 

Signature Bank, which failed in March, was the 10th largest CRE lender in the US.  

A recent report from Bank of America highlighted it’s the smaller US banks that provide 70% of US CRE debt, while 20% comes from shadow banking alternative funders. Today, credit conditions for borrowers have got considerably tighter, lenders are less willing to lend, thus current CRE investors are stuck with property they have to refinance at punitive rates. As a result it is likely that there will be significant defaults, putting even greater pressure on CRE valuations creating a vicious circle for both borrowers and lenders. 

As in 2007 when Bear Stearns and BNP started shuttering a number of asset backed investment funds, we are seeing the same on prime US CRE funds run by Blackstone and Starwood. Other property backed deals managed by prime names have defaulted; Blackstone’s $69 bn REIT was the largest. Last year the value of US property funds fell 20%. Blackrock, CBRE and other real money funds gated UK property funds last year also, impacted by illiquidity and drawdowns. 
 

‘Rising interest rates, tighter credit conditions as CRE lenders panic, plus Covid, Working from Home and the reluctance of commuters to go back to the office has hit the office sector particularly hard’

 
Rising interest rates, tighter credit conditions as CRE lenders panic, plus Covid, Working from Home and the reluctance of commuters to go back to the office has hit the office sector particularly hard. Over 80% of office workers spend at least one day per week WFH, with knock-on effects across retail, hospitality and service sectors. Retail is being crushed by crashing consumer discretionary spending. 

And, the longer rates stay high the tougher life gets for vulnerable banks. The more robust ones will limit the flow of new credit to firms and individuals. Inflation will be squeezed out of the economy but at a heavy cost. The Fed will eventually cut interest rates aggressively but by then a hard landing would be very likely. 

As mentioned earlier central bank policy created a bubble, and, as with any bubble it ends with asset prices booming across the board including shares, residential property, bonds, cryptocurrencies, as we saw in 2021. 

However, this time there is a key difference; the four previous bubbles had all come at the peak of business cycles, when the strength of the underlying economy provided some justification for the optimism in the financial markets. This time, asset prices, lubricated by vast amounts of cheap money from the Fed, boomed but the real economy did not. 
 

‘asset prices, lubricated by vast amounts of cheap money from the Fed, boomed but the real economy did not’

 
The bubble is deflating in stages. When the Fed began to tighten policy early last year asset prices began to fall; equities and bond prices fell last year. The next stage in deflating the bubble was banks being caught-out by the unexpectedly rapid rise in interest rates, e.g., Silicon Valley Bank. The next stage, when the real economy starts to suffer, is just beginning. By the time unemployment starts rising, the recession will already be under way. Some say it already is. 

Today, the BoE increased interest rates again. When will they learn that this is a blunt instrument? 

The BoE’s governor, Andrew Bailey, tells us that the outlook for growth and unemployment has improved. Whereas 6-months ago the bank had been expecting a shallow but long recession, falling energy prices and economic activity has been stronger than expected. As a result they’re forecasting modest but positive growth and a much smaller increase in unemployment. 
 

‘for many, we have been in recession since 2008!’

 
Obviously he has missed the fact that, for many, we have been in recession since 2008! 

The governor also said that they expected inflation to fall sharply over the coming months. Like a drowning man seeing a lifeboat the government were quick to seize this as evidence of Rishi delivering on his pledge to halve inflation by year-end. One question, could the government explain what they have done to achieve this? It looks to me like nothing! 

However, they have managed to diminish the economy. As Mark Carney, a former BoE governor, pointed out, the UK economy fell from being 90% the size of Germany’s economy in 2016 to 70% in 2022, The government promptly labelled him as a bitter ‘remoaner’ and blamed Covid and the war in Ukraine, dodging the obvious fact that Germany, and all other countries, were also hit by those events. 

Rishi is a technocratic problem-solver; a numbers man who understands the economy. Yet his first big call in politics was to make the case that Brexit would deliver a high-growth, dynamic economy. He got it wrong and was an essential part of an economically catastrophic decision. 

Readers may recollect that prior to the GFC, the UK Lender Northern Rock offered a 125% mortgage. No wonder they failed. 

15-years on we are seeing the return of the 100% mortgage offered by Skipton BS. As the saying goes, ‘a Home Without Equity Is Just a Rental With Debt.’ 
 

‘a Home Without Equity Is Just a Rental With Debt.’ 

 
Skipton’s intentions are laudable as they seek to help those ‘trapped in rental cycles’ and who do not have access to ‘the bank of mum and dad,’ and so are therefore unable to save up enough for a home deposit. 

However, this just feels the wrong time for both borrower and provider to enter into something so highly leveraged.  

We finish this look at banks with a bank of a different type, but one that is becoming increasingly important; food banks. 

As Gordon Brown wrote at the weekend, food banks are increasingly ‘taking over from the welfare state‘, forcing them into a permanent role in fighting poverty. 

With food banks increasingly warning that even working people are seeking help, a new ‘multibank’ model is now emerging to help families with everything from hygiene products to furniture. However, concerns are growing that their services are becoming so widespread that they are now a crucial fixture, rather than a last resort. 
 

‘Envoyez-les à la banque alimentaire’

 
Brown warned of ‘rising deprivation among those without money or power‘. He also warns food banks are filling the growing hole in support. ‘As charities take over from the welfare state as our national safety net and the food bank, not the social security system, becomes the last line of defence against destitution, it is difficult not to fear for the future.’ 

Sir Michael Marmot, who led a pioneering work into health inequalities in 2010, said that it was a ‘grim picture‘ that food banks were now so widespread. ‘I wouldn’t close a single food bank, there is a fire raging and we do have to put it out,’ he said. ‘I’m full of admiration for the organisations and individuals who do it. But it’s not a long-term solution. In my 2010 report, I recommended that everyone should have at least the minimum income necessary for a healthy life. We’ve been retreating from that.’ 

The government said: ‘We are committed to helping the most vulnerable and that’s why we have provided an extra £1bn to the household support fund to help with essential costs including food, clothing and utilities. We are providing record levels of direct financial support to help vulnerable families with the cost of living – £1,200 last year and a further £1,350 in 2023-24 – and we have also recently uprated benefits by 10.1% and made an unprecedented increase to the national living wage.’ 

Or, in the words of the Tory’s vice-chair, they don’t know how to budget properly. Envoyez-les à la banque alimentaire (Send them to the food bank). 
 

‘Here, have a dollar 

In fact, no brotherman here, have two 

Two dollars means a snack for me 

But it means a big deal to you.’ 

 
If Tuesday’s Coronation Special came as an unexpected and welcome bonus, Philip’s latest piece comes as a double helping; it starts by considering the possibility (probablity?) of a crisis amongst the 4,800 banks in the US in light of the lethal combination of increasing interest rates and plummeting commercial real estate valuations and in his preamble – herein published in its entirety – updates many of the ongoing themes that are the bedrock of this column.

In both instances, his depth of knowledge and passion are palpable, and would not benefit one jot by further editorial comment:

‘This week I decided to almost avoid government bashing, and decided to take a look at the banks, and consider whether there is a forthcoming crisis. I think there will be, especially in more regional US banks which will likely see the US enter a recession.

However, I don’t think it will be global as was the case in 2008. Besides, lost people in the UK are already in a recession.

Anyway, now that’s over back to government bashing.

I read this week that our new King got a going over from Johnson after he spoke out against the government’s immigration plans. It would seem he will be joining the naysayers such as the judiciary on the government’s hate list, as will Justin Welby, the archbishop of Canterbury.

In a speech to the Lords he said international rules on the protection of refugees are not inconvenient obstructions to be got round by governments.

Even if the bill were to stop the boats, which he does not think likely, it will not stop climate change, or international conflict.

The UNHCR has warned this could lead to the collapse of the international system for protecting refugees. The archbishop asked, “Is that what we want?”

Welby says the UK cannot take all refugees. But it ignores the need to address the problem of refugees. He continued saying it was isolationist, morally unacceptable, and politically impractical, to let the poorest countries deal with [the refugee crisis] alone.

The government responded with Robert Jenrick, the immigration minister, saying  the archbishop was “wrong on both counts.”

Responding to the claim that the bill was “morally unacceptable and politically impractical”, Jenrick said, “there’s nothing moral about allowing the pernicious trade of people smugglers to continue … I disagree with him respectfully.”

“By bringing forward this proposal we make it clear that if you come across illegally on a small boat you will not find a route to life in the UK. That will have a serious deterrent effect.”

The Tory’s have taken a leaf out of the playbook of Hungary’s far-right autocrat Viktor Orbán, who proudly describes his country as an “illiberal democracy.” A model retains the trappings of democracy, e.g., regular elections, but it is a war on democratic culture.

An example of this are the new laws surrounding protests, which effectively give the police dictatorial powers. The Met, which has been found by an official inquiry to be institutionally racist, homophobic and misogynistic, are clearly not the right people to enjoy such powers.

Authoritarian rulers, not rowdy protesters present a far greater potential evil. Yet our right-wing populist rulers and their fawning media have succeeded in presenting demonstrators as the real menace to be feared.

You would hope that Labour would be against this Tory war on democracy but it isn’t the case. Light-blue Kier is so terrified of losing an election that he has refused to commit to repealing the Public Order Act the opposition voted against just months ago, saying he would allow it to “bed in.”

Over in La La land PM Sunak once again displayed the common touch, flying to the south coast and back by helicopter.

He was in Southampton visiting a pharmacy to announce government plans for chemists to provide prescriptions for millions of patients in England.

However, instead of getting the train from Waterloo station for the 160-mile round trip, which would have taken one hour 15 minutes each way, and cost about £30 for a return fare, he opted to travel by air. An equivalent private flight would cost in the region of £6,000 return.

The cost of the helicopter was believed to have been picked up by the taxpayer. The prime minister’s spokesperson has previously said his travel arrangements made the “most effective use of his time”. Bollocks!

Musically it’s hip-hop week. We start with the Wu Tang Clan and “C.R.E.A.M”, and play-out with Arrested Development and “Mr Wendell”. Enjoy!

  
@coldwarsteve
 

 

Philip Gilbert is a city-based corporate financier, and former investment banker.

Philip is a great believer in meritocracy, and in the belief that if you want something enough you can make it happen. These beliefs were formed in his formative years, of the late 1970s and 80s

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