Reggie middleton reviews greek banks there insolvent. What about others?

[charliebrown]

Reggie seems to be some kind of forensic account.
He gets publicly available numbers on companies and figures out if the numbers add up. If your looking for a web site for shorting ideas this is a good place to start.

http://boombustblog.com/

He gave me the idea to buy puts on GGP which worked out well for me.
There is timing issues on sorting, so be careful. The premium for buying puts,
can wipe out your gains if you get your timing wrong. You also have to worry about who the gvt will prop up.

Anyhow, Reggie makes the very cogent argument that the greek banks are stuffed with greek bonds. Both mortgage and greek government bonds. By the simple fact that interest rates have soared, the present value of the bonds has gone down, due to the fact that you can't sell a 5% bond for face value if current rates are 20%.

I guess to get the accouting of the bank's capital to work out you can mark the bonds as hold to maturity, so they can be valued at par with regards to counting
on the asset side of the balance sheet, but if there is a bank panic, and the bank
has to sell, the only institution that will redeem at par of course is the central bank.
I guess that is the ECB.

So thinking ahead a bit, the question arises what about other banks? The longer we (U.S) stay at zirp, the larger the percentage of any bank's and I'm even talking "good" bank's assets are going to move to lower and lower interest rate bonds.
If a bank's assets consist primarily of debt instruments paying 5% with a 10 yr maturity, what happens if we have a big spike in interest rates. Say rates move up to 5 or 6% on 10yr treasuries. Suddenly the bank's got a capital problem.
right?


I know, I know, it should be They're insolvent. You can't edit a title.

[mmr]

Re: Reggie middleton reviews greek banks there insolvent. What about others?

If the bonds are treated as held to maturity (i.e., the bank doesn't have to mark them to market since it won't have to sell them into the market) then there may not be an immediate capital problem.

A problem could develop over time as interest costs (i.e., the rate that the bank has to pay on deposits and borrowings) increases as the yield that it earns on securities remains constant. Obviously, as interest costs approach interest income, the bank's profitability drops, which could deplete capital over time.

A few things that mitigate the impact of rising rates for US banks:

- A large portion of banks' loan and securities portfolios are floating-rate, meaning that as certain interest rates rise, banks will earn more on these loans and securities. Most home equity loans and many business loans are structured in this way.

- Banks tend to lag in raising deposit rates: usually loan interest rates rise before banks will be forced to increase deposit rates, which means that in the early stages of a rising rate cycle, bank profitability usually goes up.

- Banks can hedge their risk through derivatives, effectively turning fixed-rate securities into floating-rate securities. (In a really, really big move in rates, the derivative counterparty that has committed to paying a floating, rising rate might have trouble meeting its commitments.)

Of course, if rates moved to 6% in a very short period of time, there would be disruption, but probably not insolvency due only to changes in bond prices. As long as the Fed is available to provide financing collateralized by Treasury securities (or, in the case of Greece, the ECB is willing to provide such financing collateralized by Greek bonds, which the private sector will not), solvency is not an immediate issue. There's no need for the banks to actually sell the bonds to obtain this sort of financing, so there's no market risk (the ECB / Fed basically assumes the market risk.)

To see what ZIRP does to banks over the course of decades, Japan provides one example.

[charliebrown]

Re: Reggie middleton reviews greek banks there insolvent. What about others?

I understand what you are saying. Can the fed, take any more paper onto its balance sheet? Of course the theoretical answer is yes, but the fed does operate in a political world too. Japan has not seen the other side of Zirp. That is when interest rates start to rise for decades.

[mmr]

Re: Reggie middleton reviews greek banks there insolvent. What about others?

Without QE3, the only way that the Fed's balance sheet would expand would be if banks needed to access the Fed for funding if no other options were available.

If a bank were to run into funding challenges, it could access the Fed's discount window and get a short-term loan as long as it had enough "high-quality" bonds to secure the loan (e.g., Treasuries). The Fed's balance sheet would expand, but the growth would show up on the Fed's balance sheet as a loan to the bank rather than a security as in QE1 / QE2.

Since this would most likely only happen in a 2008-type crisis, I suspect that complaints about growing the Fed's balance sheet would not be the most urgent concern - preserving the liquidity / solvency of the banking system would take priority.

[charliebrown]

Re: Reggie middleton reviews greek banks there insolvent. What about others?

Is it marterially different if the feds balance sheet is stuffed with teasuries, or stuffed with IOUs from insolvent bank's?

Once again we generally agree, I don't care if the first bank of Springfield gets into trouble and has to use the discount window.
The thing is again, systematic risk, what if 1000 banks all find themselves with long dated, low interest rate bonds, and needs for lots of cash?

And those CDSs and hedges on interest rates, I understand there are trillions of dollars of them. Who is the counter party, should they all break one way?