Nearly four years after the 2008 banking crash, and more than $11 trillion in liquidity injections in the US and Eurozone-UK-Japan, the global banking system is again showing clear signs of growing unstable. Notwithstanding several rounds of bank ‘stress tests’ on both sides of the Atlantic since 2009, what has been improperly identified as a sovereign debt crisis in Europe is revealing itself with each passing week, as a more fundamental banking crisis as well.
This past week registered a series of reports and events that strongly suggest below the surface the global banking system is not in particularly good shape, and is getting worse.
The most recent indication was yesterday’s, June 21, announcement by the rating agency, Moody’s Inc., downgrading 15 banks across the globe. Included were the two big US banks, Bank of America and Citigroup, which have been in effect technically insolvent since the 2008 bank crash but which have been kept afloat by various measures supported by the US Federal Reserve. Under pressure by the US government, both have been selling off their best assets at near-firesale prices in order to raise capital. Not much better has been the US investment bank, Morgan Stanley, which recently hosted the bungled Facebook initial public offering. French and UK banks fared no better, however. HSBC, Royal Bank of Scotland, Societe General, and even the Swiss, Credit Suisse were all downgraded. This kind of widespread, global downgrading does not occur randomly. It is reflective of something systemically at work.
The Federal Reserve Signals QE3
A day before the Moody bank downgrades, the U.S. Federal Reserve announced a further $267 billion liquidity injection into the US system, in an extension of its ‘Quantitative Easing 2.5’ program called ‘Operation Twist’ announced last fall. That $267 billion was in addition to the original ‘Twist’ QE 2.5 of $400 billion, which followed a prior QE 2 of $600 billion in 2010 and a QE1 of $1.75 trillion in 2009. The ‘markets’ in the US—which means banks, various financial institutions, and very high net worth individual investors—responded to the Fed’s latest extension of QE 2.5 announcement with a thud. Stock markets in the US the following day had their worst decline in months. Expect more of the same soon to come. Investors expected on Wednesday that the Fed would introduce a bona fide QE3. Translated that means expectations of hundreds of billions more of Fed direct liquidity injection into the markets, buying up not only US treasuries but mortgages and other bonds and securities. After all, QE 2.5 was coming to an end this month, and the Fed for the past four years has always followed the concluding of a QE program with still another QE liquidity injection. Indeed, a good argument can be made that the ‘markets’ in the US are becoming increasingly dependent upon—even addicted to—continuing massive Fed liquidity injections.
The correlation between announcements and anticipations of new QE programs and the take off of stock markets, and the declining of stock market indices as QE reach the end of their course, has been very high.
Dow-Jones Industrials Average & QE Correlation
QE Program Dow Low & Date QE Intro Date QE Conclusion Date Dow High & Date
QE 1 7,062 March 3, 2009 April 4, 2010 11,204
(February 27, 2009) (April 23, 2010)
QE2 9,686 November 4, 2010 June 30, 2011 12,657
(July 2, 2010) (July 8, 2011)
QE 2.5 10,992
(September 9, 2011) September 21, 2011 June 30, 2012 12,837
(June 19, 2012)
Source: Dow-Jones Industrial Average (DJIA) History, online at nyse/tv/dow-jones-industrial-average-history-djia.htm.
While QEs have been a boon to stocks and other speculators, QEs to date as a group have accomplished very little in terms of helping generate a sustained economic recovery in the U.S. In that respect they have done no more than the additional trillions of dollars in liquidity injections by the Fed in the form of near zero interest rates for almost four years now. Like QEs, near zero interest rates were supposed to provide virtually ‘free money’ to financial institutions that were, in turn, supposed to lend to stimulate investment and jobs. But that didn’t happen. Following QE1 and zero rates, after the official end of the recession in June 2009 bank lending fell for 15 consecutive months. To whatever extent bank lending rose in 2010 it went mostly to hedge funds and the largest corporations. Small and medium sized companies continued to starve for bank loans. And now, in recent months, lending is in retreat once again. So if anything is proven by the past four years, it is that monetary and Fed policies (QE, zero rates, etc) have had little to no effect on the real economy and economic recovery in the U.S. What they have achieved is a return to speculative lending practices by banks (called euphemistically ‘trading’)—i.e. banks lending to hedge funds and other institutional investors that then speculate in foreign currencies, commodities, oil futures, stocks, junk bonds, and, of course, derivatives of various sorts including CDS on Greek sovereign bond debt.
ECB Follows the Fed’s Lead
What the US Federal Reserve has been doing since 2008 the ECB has begun to mimic increasingly as well. For the EU banks, the ECB since late 2010 has been the only game in town when it comes to EU banks’ bailout. The two Euro-wide bail out funds, the European Financial Stability Facility (EFSF) and the more recent European Stability Mechanism (ESM) are targeted mainly for bailing out sovereign debt, from Greece to Spain and beyond. And the International Monetary Fund’s smaller cash hoard is being held in reserve, uncommitted, as the IMF tries desperately to line up China and other emerging economies’ contributions to its fund. But now the Euro banks are in deepening crisis, not just the governments, confirming what this writer has been saying and publishing for more than a year—namely, what’s developing in the EU is not simply a sovereign debt crisis and contagion but, more fundamentally, a growing banking crisis and contagion. It is a dual debt crisis growing in scope and intensity, and the two poles of the crisis—sovereign and banking system—are exacerbating each other.
Following the lead of the US central bank, the Federal Reserve, since 2010 the European Central Bank, ECB, has injected the equivalent of trillions of dollars into the Euro banks, including hundreds of billions of dollars in late 2011 plus another $125 billion earlier this month in what is only an initial tranche required to bail out Spanish banks. An eventual full bailout of Spain’s banks will cost, per this writer’s estimate, at least $300 billion. (And that doesn’t include future bailouts of more hundreds of billions of dollars to rescue Spain’s regional and central governments that the EFSF and/or ESM bail out funds will have to address.)
The Eurozone banking crisis is so severe that in recent months cross-border bank to bank lending in the Eurozone has been drying up. As ECB chairman, Mario Draghi, reportedly said just last week, the inter-bank lending system is ‘dysfunctional’ and ‘simply not working’. And as inter-bank lending has begun to dry up, so too as lending to EU nonbank businesses. Together the two developments signal a sure sign of a general banking crisis in early stages of development.
Much of the growing EU bank crisis can be laid at the feet of the general solution to the sovereign debt crises that EU governments, banks, and investors have been attempting to implement for two years now: Austerity. Austerity solutions imposed in Greece, Spain and now the U.K. result in less government revenue generation and further rising government debt. Repeated and prolonged recessions result in revenue falling off faster than cuts in deficit spending (austerity) can make up for the revenue losses. Budgets consequently continue to fall deeper into the red and government bond yields escalate further. Speculators in credit default swaps on government debt then accelerate the process, making it worse. Government debt then has to be restructured, often at a greater cost. Austerity solutions also have a simultaneous negative impact on the private sector as well: The deficit cutting at the heart of austerity solutions results in less consumption by households and subsequently less business spending in turn as household income drops. Banks thus generate less income from loans to businesses and households, while they simultaneously have to put aside more capital in anticipation of sovereign debt losses. Bank lending freezes up, as is now increasingly the case in the Eurozone, just as it has been in the U.S.
The Bank of England
Like the US Federal Reserve and the ECB, the Bank of England ((BoE) has also implemented a near zero interest rate policy and successive QEs. To date nearly $500 billion has been committed to QE bond and securities buying by the BoE. But that hasn’t prevented the UK from falling into a double dip recession recently, as the government simultaneously embarked on a major austerity, deficit cutting policy. QE by the central bank may have temporarily kept the UK banking system afloat, but not so the economy now in a bona fide double dip.
A week ago the BoE’s monetary policy committee met to discuss increasing the amount of liquidity into the banks in yet another QE round. It postponed that decision, however, until early July, waiting on events in the Eurozone later this month, and further ECB and US Federal Reserve actions. Another $120 billion QE by the BoE therefore will likely soon occur.
Bank of Japan
The Bank of Japan also launched its own QE in a surprise move this past February-March 2012. It is projected to further that injection of liquidity later sometime later this year
Global Central Bank Crisis Coordination
What appears in development is an attempt on a global scale to coordinate central bank interventions in the form of QE liquidity injections, not only in the Eurozone but elsewhere as well. This appears to be in response at least in part to the big private banks globally demanding such coordinated action. In other words, they expect another banking crunch soon and are demanding another bailout in anticipation and before it happens.
The Eurozone debt crisis in Spain, Greece, and soon Italy is only one of the main drivers of this, however. The sovereign debt crisis represents a squeeze on banks’ income as a result of borrowers inability to repay principal and interest on past debt. Austerity is about getting someone else, the taxpayer and populace, to pay the bill. QE, zero interest rates, and monetary policy represents the equivalent of a massive, short term ‘bridge’ loan (often free of charge) to the banks via printing money or government subsidized bonds. But all that’s ‘past’ payment revenue. The deepening recession represents the inability of banks to earn ‘future’ revenue.
And recession and future revenue shortfalls are the even greater, imminent threat to banks’ solvency. Not only is the Eurozone rapidly descending, country by country, into recession across the continent, but the UK is already there. Meanwhile, the US economy is now clearly on a track in recent months to its third ‘relapse’ this summer. Economic indicators across the board are flashing red, from jobs to housing to business spending to manufacturing activity to consumer and business sentiment. And should US policymakers decide in November 2012 immediately after the elections to cut spending by an additional $2-$4 trillion, on top of the $2.2 trillion to start taking effect in January 2013—as this writer has repeatedly predicted will be the case—then a US double dip recession is etched in stone. At the same time it is becoming abundantly clear, as this writer also predicted last year, that China and the other BRICS economies are destined for a ‘hard landing’ in 2012-13. All that said, a global double dip possibility is rising significantly.
The banks know this and are demanding pre-emptive action by their respective central banks in order to buffer their cash and liquidity up front. A coordinated global QE action may buy global banks some additional time, but it won’t solve the bigger problem of a global economy slouching toward a synchronized double dip. Bankers may indeed get their pre-emptive bailout. But the rest of the economy will likely be left to fend for itself in 2013-14, just as it was in 2009-11. Only this time, this ‘second dip’ may be worse, much worse, than the first.
Dr. Jack Rasmus