The only thing you can BANK on is political self-interest

Tuesday, 21 March 2023 — Gold Coast

[10 min read]

Dear Reader,

The 19 December 2022 issue of The Gowdie Letter asked…

‘Are US banks the canary in the coal mine?’

To quote from the issue (emphasis added on last sentence):

‘Systemic risk is the known unknown. We know there has been so much new debt loaded into the system. What we don’t know is the degree of malinvestment and level of risk-taking that surrounds a good portion of this debt.

‘Case in point, the appalling level of contempt and total lack of care shown by Sam Bankman-Fried. How many more SBF clones have operated in cavalier fashion in recent years? Or maybe he’s just the only one? I wouldn’t bet on it.

‘When market pressure is applied — like it was in 2008 — hairline cracks turn into giant crevices...swallowing up institutions like Lehman Brothers.

‘Keep an eye on US and European banks.’

To be fair, you didn’t need a PhD in finance or economics to figure out the US and European banks were vulnerable.

Curing the 2008/09 debt crisis with (truckloads) more debt, could never end well. Risk was piled upon risk.

Until last week, the only unknown was when this shaky edifice would start crumbling.

SVB is far from an isolated case

If you think Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank are the ‘worst of the banking breed’, think again.

This month’s issue of The Gowdie Advisory alerts readers to a white paper published by Stanford Graduate School of Business on 13 March 2023:

Here’s an edited extract from the Abstract (emphasis added):

‘We analyze U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financial stability. The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity.

‘A case study of the recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower capitalization than SVB.

‘To assess the financial stability of U.S. banks, we use bank call report data capturing asset and liability composition of all US banks (over 4800 institutions) combined with market-level prices of long-duration assets.’

If US banking assets were priced on a ‘mark-to-market’ basis (like they once were), there would be a US$2 trillion shortfall between notional value and actual value.

What’s US$2 trillion between friends when the Fed offers to take assets off your hands at the notional, NOT real, value?

This may come as a surprise, but SVB was NOT the worst offender in miscalculating interest rate and duration risk.

How long is the queue of undercapitalised banks standing behind the now-collapsed SVB?

Let’s do the maths…10% of more than 4,800 institutions is near enough to 500 banks. But don’t worry, we’re assured by the same incompetent morons who created this mess, the crisis has been averted.

How so?

Another Fed entity

The Fed, together with the clueless US Treasury Secretary, Janet Yellen, have created yet another entity. This one is called the ‘Bank Term Funding Program’ (BTFP).

Rather than selling securities at market prices to meet a run of deposit withdrawal requests, banks can tap the BTFP…where the Fed will accept the ‘par’ value of the security as collateral.

This Bloomberg headline says it all…this hastily convened program was designed to avert a crisis:

And in addition to this, ALL depositors in the failed banks — not just the depositors with up to US$250k — will be made whole. What messaging on moral hazard does this send to the market?

Contrary to popular thinking (and blatant self-promotion by bullion dealers) there has been NO Bail-In.

On the other side of the Atlantic, Swiss politicians have forced UBS into an arranged marriage with the ailing Credit Suisse:

Why are the officials not letting the system sort out this mess?

With a global economic model so utterly dependent upon debt-funded consumption to remain upright, the need for public confidence is paramount.

In recent weeks, I wrote a three-part series in The Daily Reckoning Australia — 21 February 2023, 28 February 2023, and 7 March 2023, titled Anxiety Levels Quietly Rising.

Reader concern over the prospect of Bail-Ins was the motivation for writing this series.

There are lots of half-truths and mischievous interpretations of legislation being bandied around the internet.

The series was my attempt at dispelling the myths and presenting the facts.

In Part Three (published 7 March 2023 — BEFORE SVB went south) my conclusion was:

‘7 per cent of the institutions have 87% of the deposits.

‘The concentration of deposits in so few institutions, means the government — in practical terms — has no choice other than to backstop the nine larger banks.

‘Allowing one or more of these nine banks to fail is not an option. Public confidence would be shattered. People would start second guessing which major bank is next. A run on the banks would become a self-fulfilling prophecy.

‘What if one of the smaller ADIs runs into trouble?

‘After exhausting all avenues to recapitalise the bank, would they confiscate (some or all) of the deposits in excess of the $250k limit?

‘According to the letter of the legislation, yes they could.

‘But what signal would that send to deposit-holders in other banks?

‘Watch out…you could be next.

‘Imagine the frantic switching of accounts out of the banking minnows into the Big 9? The loss of deposits in smaller ADIs would almost certainly trigger further bank failures.

‘Before acting, authorities would need to seriously consider Merton’s Law of Unintended Consequences…making a bad situation worse would be a really dumb move in a time of heightened anxiety. My guess is APRA would work behind the scenes to orchestrate merger/s.

‘Should one of the Big 9 fail, authorities might start with bail-ins from shareholders and investors in hybrids.

‘Confiscating investor capital — either fully or partially — to recapitalise the ailing bank/s would be perfectly acceptable to the general public.

‘If that’s not sufficient, then prior to APRA seizing deposits greater than $250k, other options might be…

‘Facilitating mergers between the Big 9.

‘Capital controls could be invoked (to stop bank runs).

‘Or, thanks to the precedent established during the pandemic, government could roll out a “Bank Keeper” programme and have the RBA print sufficient funds to finance an expanded deposit guarantee scheme.

‘There are a variety of measures the authorities have at their disposal to (potentially) quell public anxiety and unrest.

‘With 87% of deposits held in nine banks, it’s unlikely the government would allow any of them to fail. The risk of contagion would be far too great.

‘Before taking any action, government needs to act very, very carefully…public confidence is a brittle commodity. Easily broken, but not so easily restored.

‘While, when push comes to shove, I am of the opinion bail-ins are unlikely…’

While my observation related to Australia, they’ve proven to be reasonably accurate when applied to the US and European problems.

In the US, when faced with the challenge of maintaining public confidence, the Fed blinked and rolled out its version of ‘Bank Keeper’.

And, as reported by CNBC:

‘Treasury Secretary Janet Yellen told senators that government refunds of uninsured deposits will not be extended to every bank that fails, only those that pose systemic risk to the financial system.’

What Yellen was effectively saying is…allowing one or more of [the big] banks to fail is not an option.

In Europe, the politicians and Swiss central bank worked ‘behind the scenes to orchestrate a merger’.

These international precedents may or may not be adopted in Australia.

However, when push comes to shove — like it did with the RBA printing money during the pandemic — our equally hapless central bank tends to be a follower, not a leader.

APRA might hold firm to the letter of the legislation and insist on any depositor with more than $250k takes a haircut.

While APRA might want to flex its muscles, I’m not so sure about Anthony Albanese and Jim Chalmers. They don’t look like ‘Men of Steel’ to me. Perhaps I’m just a bad judge of character.

Bottom line…be prepared for more problems in the US and European banking sectors.

And, when it comes to Bail-Ins, recent action in the US and Europe indicates there’s a great deal of flexibility in what’s been said and what’s been done.

As Wall Street starts its next, and far more brutal, descent to a much lower level, expect to hear a lot more from the clueless clowns in central bank land about proposed ‘solutions’.

The one absolute in all of this is central banks are THE problem, not the solution.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

PS: This banking catastrophe only further solidifies that hard, tangible assets are the one thing we can faithfully attribute value to. My colleague James Cooper has a way of capitalising on this truth in a more speculative manner, using his decade-long geology experience to assess the potential of a mining deposit even before first drill results are revealed. If you’re interested, read more about his trading ethos below.

Dear Reader,

It’s been a crazy time for the markets recently.

But amidst the noise…I’ve been putting some plans in place.

In the next few weeks, I’m going to start pulling the trigger on what I call ‘Phase One’ mining stock trades.

That may seem counterproductive…or at the least super-contrarian…given the recent uncertainty in the financial system.

Miners haven’t been immune to the selling, as you know. After the resounding victory of many resource stocks in 2022, the euphoria has had a definite breather in the last few months.

But stick with me.

Phase One miners did more than OK when the markets were in a similar position 20 years ago. And I think we’re seeing a similar set-up now…

What is a Phase One miner?

Put simply: Phase One miners are the true wildcat, early explorers.

The true prospectors.

As a mining company unveils the potential of a mineable deposit…more value is created for shareholders along the way.

But Phase Oners don’t even have a mineable deposit.

They have mostly nothing.

So…there IS no value.

At this earliest stage…it all rests on the geologists. They put their necks…and jobs…on the line. They back educated hunches on where metal deposits are. Yes, they use geochemical and sampling techniques to improve the confidence of the theory…

But it remains a theory.

Until they get that very first strike…

That makes them incredibly risky.

To buy them as a stockholder.

And…to work for as an explorer (I know this first-hand!).

However…

Right now, it’s my contention that those ‘first strikes’ are coming a bit more frequently than they did even one year ago.

Mining exploration is ramping up.

Despite all the ructions in the wider markets.

And some Phase One miners are starting to fizz again.

We’ll explore why that is…and which Phase Ones you might want to look at…in the coming days.

For now, I just want to quickly look at a core factor you need to monitor with these kinds of companies. And all miners in general…

‘Insider buying’

The term itself sounds dodgy and illegal. But it’s not to be confused with insider trading.

It’s actually a lot more straightforward (and legit) than you might think.

Insider buying is when people WITHIN mining explorers…management, team, board of directors, even the geos out in the field doing the exploring…start buying the company’s shares on the open market. Or get involved in a new equity financing round.

The consensus is that insiders tend to only load up if they are confident in the company’s prospects…and think the shares might be worth a fair bit more down the track.

It’s by no means a perfect science.

Especially when it comes to the really small exploration stocks.

But I’ve been tracking this activity recently, and some interesting stuff is going on…

Galan Lithium non-executive director Daniel Jimenez just bought 105,000 more shares in the company. He now holds 2,447,713 fully paid ordinary shares. And 1 million options expiring 8 October 2023.

That comes after a bunch of insiders loaded up on Evolution Mining. Including its own non-exec director picking up another $244k worth of shares.

It really pays to monitor directors’ buying and selling activity for additional confirmation that the company is in a strong position.

After all, what director would buy shares in their own company if they believed the price was about to fall?

Directors have a better understanding of their business and its future growth prospects. They also have a vested interest in its success.

By uncovering who’s buying and selling shares in their own company, investors can extend their scope of research beyond fundamental and technical analysis.

This is not a unique or ‘hidden secret’, but very few investors actually implement it as part of their selection criteria.

Develop Global [ASX:DVP] CEO Bill Beament used his Northern Star windfall to take up a massive stake in DVP.

It means he now owns more than 100 million shares, equating to around 16% of the company’s entire capital.

Beament, a successful mining insider, has a strong vested interest in the company’s future success.

You won’t always see insider activity like this, but when it happens, it’s a signal for future strength and can provide additional confirmation to your analysis.

It works on the flip side, too; when directors sell shares it CAN signal future weakness. Not all selling is bad, though.

At times, a director may sell some of their capital to fund personal expenses or reduce their exposure to just one investment.

However, if I see a pattern of multiple directors selling at once, this raises a red flag for me.

There are some conflicting signals with insider buying right now.

But…for me…it fits into a wider pattern of what I see about to happen in the whole commodities space…

…and Phase One explorers in particular…

More to come…

Regards,

James Cooper,
Editor, The Daily Reckoning Australia

Dear Reader,

‘The ship is sinking! To the lifeboats!’

‘I’m sorry, Lady. Just the first-class passengers!’

The feds are going to bail out the banks and their high-end customers. California Governor Gavin Newsom’s wineries will have a place in the lifeboats. So will billionaire Mark Cuban’s drug company. But down on the lower decks, they cross themselves, put on life-vests, and hope for the best.

Silicon Valley Bank…Signature Bank…and now…CNN Business reports: ‘Global markets mixed as Credit Suisse accepts $54 billion lifeline’.

And here comes a San Francisco bank, First Republic, racing to the public trough. From The Wall Street Journal: ‘Stocks Close Higher on Hopes for First Republic Rescue’.

The Swiss bank was rescued by the central bank of Switzerland. The American bank got US$30 billion from fellow US banks.

Banks are in trouble because they got caught up in the spirit of the Fed’s bubble. They made risky loans. They bought risky assets. And when interest rates rose…and real risk reasserted itself…the seas turned rough, and boats began to sink.

So, let’s rehearse.

Disappearing money

…the feds lowered rates to below zero, adjusted for inflation; they kept real rates negative for more than 10 years.

…people borrowed…US total debt is now more than US$90 trillion.

…consumer prices rose; inflation is now at 7% on a two-year ‘stacked’ basis.

Then, to fight inflation, the Fed raised the cost of debt. Homeowners now face mortgage payments up 30% from last year. And banks find that their collateral and reserves have fallen so much they can no longer meet withdrawals.

What happens next?

A lot of investors, speculators, banks, and businesses are in a tight spot. Many cannot pay their debts. They default…money disappears.

Silvergate was worth nearly US$6 billion in November ’21. That was US$6 billion of wealth that people thought they had. Then, 16 months later, almost all of that ‘wealth’ has vanished. Poof!

And the electric truck maker, Rivian, is down 90%...another US$100 billion — gone.

The middle-class stores much of its wealth in its houses. Solid. Bricks-and-mortar wealth…that won’t go away in a crisis.

But what’s this? The house doesn’t go away…but the equity disappears. House prices have been falling for six months in a row, according to the Case-Shiller 20-City Index. Only 20% of the homes sold last year were ‘affordable’ based on median income/home prices.

Outflanked

The middle class is getting attacked on both flanks. Its wealth falls along with house prices. And its real income falls as consumer prices rise. Adjusted for inflation, wages have fallen for 23 months in a row; for nearly two years, ordinary households have gotten poorer. From MarketWatch: ‘“Net worth of median household is basically nothing,” says Carl Icahn. “We have some major problems in our economy.”’

And now the middle class will pay for the bank bailouts too. If the feds won’t allow the correction to continue — with bank failures, defaults, bankruptcies, and market crashes — the only plausible way out of the debt burden is inflation. Ordinary households will pay for it — in the form of higher consumer prices.

In the meantime, the money supply itself is falling. Over the last year, it dropped 1.7%. That doesn’t sound like much, but it is the biggest drop ever recorded.

And our guess is that the situation is going to get a lot worse before it gets better.

What we’ve seen so far is just the beginning of the correction. Based on the traditional relationship of debt/GDP, we figure the economy should have about US$40 trillion in debt, not US$90 trillion. This means that there’s a lot of bad debt still to be reckoned with.

And despite all the blah-blah…about Republicans versus Democrats…conservative versus liberals…black versus white…there are only two groups that really matter. There are the deciders…and there’s everyone else, those who don’t decide.

In an honest, free economy, Mr Market puts the losses where they belong. You make a bad bet; you lose. And you serve as a moral lesson for everybody else. ‘We won’t do what that dumbbell did’, they say to each other.

In a dishonest, un-free economy, the deciders put the losses onto whomever they want. Who pays? Would it surprise you if they put them on the un-deciders?

And reserve the lifeboats for themselves?

Regards,

Bill Bonner,
For The Daily Reckoning Australia