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Saturday, 16 December 2017

Napoleonic markets: Moved by fear, not interest

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There is always a little quote or bon mot to be found when one logs on to one’s Bloomberg in the morning and today’s was by Napoleon (…presumably the Corsican general and not George Orwell’s pig) who said that the only two ways to make men move was by interest or fear. Well, with rates as low as they are it can barely be interest so that just leaves fear…

Fooling aside and after another strong day for equities – the Dow went out last night “only” 2.2% down on the year at 11,320.71 which is 500 points above its lowest recent close – one must ask oneself what the risks are which make up the “risk on/risk off” trade seeing that the iTraxx Crossover index closed at 717/722 which is its weakest reading since the recent volatility began.

It is not rare for rates and equities to disagree on what happens next, but for credit and equities to be moving so sharply in opposite directions is unusual. Lord Wellington is supposed to have said of cavalry officers that they kept their brains between their horses’ ears and it appears now as though securities dealers are keeping theirs in the bottom drawers of their desks. The way in which Bank of America, my alma mater, is being traded in both equity and credit markets is a case in point.

There is no doubt that the bank is “beleaguered” but some of the nonsense which is being bandied about is not helpful, nor is the way in which supposedly intelligent traders and investors with MBAs, PhDs and CFAs are dealing with the situation. Henry Blodget, the banned former research analyst, has not helped with his blog and with his blue sky claim that the bank needs to raise US$200bn of new capital. In a world where investment banks need to add two page disclaimers to three line research comments and where a firm’s bankers and analysts are blocked from sending each other e-mails, it is astonishing that the likes of Blodget, banned from the securities industry in the aftermath of the dot-com research scandals, can happily knock out anything into the blogosphere that he likes; that’s the First Amendment at work for you. Not that Blodget is to blame for the mess in which BofA finds itself.

The blame is clear for all to see; Hugh McColl started the expansion of the Charlotte, NC, based North Carolina National Bank (NCNB) which was renamed NationsBank in 1991 and which made its quantum leap with the acquisition of the San Francisco based BankAmerica Corp in 1998 thus creating the Bank of America we know today. In 2001 Ken Lewis took the helm. With his permatan and his over-whitened and over-straightened teeth, Lewis smiled his way into expanding the bank until it hit the federal limit of controlling 10% of the nations deposit base. Critics cheekily suggested that Lewis knew how to squeeze costs out of mergers until they ran out of oxygen but that he never had a clue of how banking worked.

Tigers on the loose

Entering the 2007 crisis he famously stated in a conference call that he had as much fun in investment banking as he could take and then promptly acquired Merrill, Lynch, Pierce, Fenner & Smith at the first opportunity – which in the case of Merrill’s was the last. Having secured the only investment bank which he had ever really wanted to buy – he loved the idea of owning ML’s retail distribution network – but in the “buy any bank you like at a discount” period, hubris got the better of him and he readily jumped on Countrywide, the country’s largest residential mortgage provider. He now owned a bank which had blown up as the dominant producer of synthetic CDOs but also the master of the sub-prime mortgage, both areas which BofA had been very cautious in. If taking on Merrill’s was like buying a cat in a bag, then taking on Countrywide was picking up sack full of hungry tigers – and these are the ones which are now on the loose.

However, BofA has a massive and pretty stable deposit base and one which should not be underestimated. Over 9/11, while New York was in seizure, BofA took on the role as central clearer and lender of last resort. It is one mightily powerful bank and rumours such as that JP Morgan is casting a slide rule over it are for all practical purposes without merit. The risks which it is currently facing are primarily litigation risks as every Tom, Dick and Harry who lost his shirt while greedily snapping up anything with a yield during the boom times is looking to recoup from the nation’s largest bank by assets. Its risks are not entirely of the banking variety – even given the miserable mortgage book it acquired with Countrywide – but they lie with the courts in a litigious country which generically hates bankers and which would probably blame them for the Washington earthquake if it could.

Alas, there are probably banks which carry far more risk as the wave of refinancings which the market expects in the autumn looms. Money markets are already shot to pieces – a leading money market head I called yesterday posed the rhetorical question “Why would banks want to lend to banks?” – and institutional investors don’t appear too keen either.

With rates as low as they are, even privates are rethinking their investment strategies as they pile into classic cars, antiques and anything else one can take home and hope for some future performance. Markets feel oversold to me but as Keynes reminds us, markets can remain irrational for longer than we can remain solvent.

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