China’s President Xi Jinping flew in to Hong Kong today to spearhead the 20th anniversary celebrations of the handover of the territory from British control.
One country, two systems. Curiously and quite unusually, this is an event that feels as though it had happened a lot longer ago. With or without Chinese control, Honkers remains a pretty special place.
Meanwhile, out here, we’re looking at the results of two continents, two systems. While the Europeans are arguing about bank bail-outs and to what extent the bodies really have all been identified and counted, in the US the Fed has signed off on the stress tests on all of the banks it has listed in the systemically pertinent cohort. Now that the Fed has given the banking system a clean bill of health, the major institutions can begin to wind down the rate of reserve build-up and go back to paying proper dividends. Only Capital One, which specialises in lending to the lower end the borrower spectrum, was given a finger-wagging with respect to procedures although it was given until year-end to tidy up its operations.
On this side of the pond the talk has been about the Spanish and Italian banking systems and the wind down of Banco Popular and of the Veneto twins but we might do well not to forget that as recently as last September people were biting their fingernails as to whether Deutsche Bank, long the poster child of European banking, was about to hit the buffers. But why did Europe get it so horribly wrong?
Double standards
To be frank, I think the answer is much closer than we think. The pluralism of banking on the Continent had often been lauded for having local lenders with local knowledge lending to local businesses. That was good. What was not so good was the boards of these local banks were packed with the equally local great and good and among these were more than a fair share of politicians. There followed what was, I suppose, a sort of pork-barrel lending policy. Loans were waved through not on their merits as a credit transaction but based on what impact they might have on local jobs and prosperity and, in consequence, on local voting patterns. Corruption within the system did not come in the form of brown envelopes but ballot papers.
In the event, when things began to go wrong, the facts were obfuscated to save the blushes of local dignitaries. Hence the slowness of the car crash and my belief that we have still not seen the true state of the loan books of many banks around the Continent. Please don’t get me wrong; I’m not trying to suggest that all of Europe’s banks are vested with corrupt boards but the second and third-tier local banks, those with nothing to do capital market fat cats in three-piece suits with Porsches and Ferraris, are the ones that worry me.
In the heydays, the link between local business and local lenders was held up as the way to go. That I would not dispute but what belongs in the regulation is a ban on anybody who is elected to public office or who has been in the past 10 years from sitting on the board of a bank or from drawing fees as a consultant. I have no problem with bankers going into politics but I’d love to see an end to politicians going into banking. The thought of Tony Blair as a “senior adviser” to JP Morgan is one of the cases in point. The link between politics and banking becomes even more toxic when local authorities are either owners or shareholders in the banks. Some of the lending policies of the German Landesbanks, a sector of which I have first-hand experience, were verging on kindergarten banking as the dividend stream had become a main-stay of local government budgets and boards deceived themselves into believing that the payout could be maintained in a falling interest rate environment but without an increase in credit risk. This explains in a single line the voracious appetite by such banks for any kind of toxic US sub-prime structures as long as they could come with a Triple A rating attached.
So 10 years after things began to go wrong the US, Europe is still struggling to work out which side is up while American banks are back on the straight and narrow. The prospect of enhanced dividends drove the US banks’ stock prices higher. More to the point, despite warnings that some of the consumer lending isn’t as safe as the banks are trying to convince themselves, the Fed has tacitly given the green light to the Trump administration’s thoughts on loosening some of the tight regulatory girdle. The Volker rule remains one of the biggest thorns in the side of the banks – Deutsche, who else, is currently in the spotlight for having breached proprietary exposure rules in the inflation swap space – and hopes are rising again for a resumption of good old risk taking. The Fed has expressed its satisfaction that capital buffers are now sufficiently strong to protect taxpayers from having to intervene again in the event of a credit crisis.
Say what I like and like what I say
The FT makes a point today about the confusion that is being spread by both the Bank of England under the guidance of Mark “The Magician” Carney and the ECB as led by St Mario. Both of them have within a week assured markets that current monetary policy will be held, only to contradict themselves within a couple of days by indicating that monetary tightening is in the offing. I don’t know who originally said that if he remains silent people might think he’s stupid but if he speaks they will know he is but perhaps the time has come for both of them to tread a bit more carefully. Coming out and declaring that they had been misunderstood might work for the winner of Celebrity Desert Island Talent Dancing or even for the incumbent occupant of the White House but it doesn’t work for the head of a central bank.
Two-year Gilts and two-year Schatz yields seem to indicate the sooner-rather-than-later side of the argument. Gilt yields rose above the bank rate of 25bp and as at the time of writing are still headed north, trading at 0.33%, a 12-month high. Schatz yields are in a similar time frame and have leapt to an eye-watering yield of -56bp. To remind, the yield on the Schatz has been negative since December 2014 and it reached its low towards the end of February of this year at -0.946%. If one had locked in the benchmark Schatz, the BKO 0 12/2018, in February, one would now not only be running a negative yield of around 10% but one would also be nursing capital losses of around 1%. Not bad for the putatively most defensive security available to eurozone investors. And then people wonder why all the money is headed into equities.
Oil is trading higher again as it continues to behave slightly like Doctor Dolittle’s pushmi-pullyu. Technical analysts will be looking for it to out-trade the falling trend line, which as of today would be at around US$49/bbl for WTI. At this point in time this is less pertinent but the down channel is strong and some very strong price action will be required to break out to the upside.