Monday, June 3, 2013

Fed keeps fueling Shadow Bank machine as Big banks ( Too Big To Fail variety ) have no fear of doubling down with ZIRP in effect ! What will be the excuse when the next financial blow ups occur ?

http://www.zerohedge.com/news/2013-06-03/guest-post-why-fed-cant-stop-fueling-shadow-bank-kiting-machine


Guest Post: Why the Fed Can't Stop Fueling The Shadow Bank Kiting Machine

Tyler Durden's picture
Submitted by Tyler Durden on 06/03/2013 17:53 -0400



Submitted by Bill Frezza via Menckenism blog,
Fractional reserve banking is unlike most other businesses. It's not just because its product is money. It's because banks can manufacture their product out of thin air. Traditional commercial banks essentially create money through a well understood and time honored pyramiding of loans. Depositors who understand that their deposits are thereby placed at risk choose their banks accordingly.
Under the bygone rules of free market capitalism, only one thing kept banks from creating an infinite amount of money, and that was fear of failure. Failure occurs when depositors come to believe that their bank has lent out too much manufactured money to too many dodgy borrowers and may not be able to cover depositors’ withdrawals. When this happens, depositors rush to reclaim their money while there is still some left, leading to the bank’s collapse.
Under free market capitalism, banks compete along a spectrum of risk and reward. Conservative banks offer a higher degree of safety by maintaining larger reserves, thereby manufacturing and lending out less money. Through word and deed they let depositors know that they lend to only the most creditworthy borrowers, who generally must post valuable collateral. These banks remain profitable because they successfully attract prudent depositors willing to accept lower rates of interest.
Banks of a more speculative bent offer a lower degree of safety, maintaining smaller reserves to create and lend out more money. Seeking higher returns, they often lend to less creditworthy borrowers who may put up poor quality collateral or none at all. These banks attract risk-taking depositors looking for a higher rate of interest. They can be very profitable during periods of economic expansion but often fall into distress during economic downturns.
Periodic bank failures remind depositors of the connection between risk and reward. When caveat emptor rules, smart depositors who pay attention make money and dumb depositors who don't lose theirs.
Because the latter outcome is intolerable in a democracy, we have government-provided deposit insurance and other taxpayer-financed backstops that shield most depositors from the risk of loss. In theory banks pay premiums to fund this insurance. In practice these premiums are not risk-based. Banks are not penalized for making riskier loans, in turn often leaving the premiums too low to finance payouts. This creates a huge moral hazard, as it frees depositors to seek the highest return without regard for safety.
Worse, it removes conservative banks’ competitive advantage. Under a government-guaranteed deposit insurance regime, conservative bankers who want to stay in business must take on more risk in order to pay the higher interest rates necessary to attract depositors. This often sets off a race to the bottom, which results in periodic banking crises.
After each of these crises, politicians promise taxpayers that it will never happen again. And each time it does, the government creates a new set of labyrinthine regulations that attempt to mimic the business judgment of conservative bankers. Minimum reserve requirements are established, which normally become the maximum as there is little advantage in exceeding them. And both depositors and the bankers themselves become complacent about the banks’ investments because it is so easy to privatize gains and socialize losses.
Banks also learn that competitive advantage can be obtained by either gaming the regulations or having cronies write them. As regulations get more intrusive and complex, politicians discover that they can be used to advance social policies, such as increasing home ownership among voters with poor credit, thereby increasing the risk on banks’ loan books.
This mixed economic system is the one that replaced free market capitalism in hopes that it would prevent bank failures. Despite, and some even say because of, a regulatory regime that discouraged conservative banking and rewarded reckless mortgage lending, the banking system crashed - again - in 2007-2008.
What is not widely appreciated is that the ensuing government bailouts allowed an underlying shadow banking system to not only survive but grow even larger. It is called the shadow banking system because it operates outside most government-regulated banking laws. This is primarily because regulations and accounting standards haven’t caught up with the practices of these banks, which are relatively new and poorly understood.
It was the seizing up of the commercial paper and repo markets that funds the shadow banking system that abruptly halted the flow of liquidity that kept the mortgage bubble propped up. This revealed the underlying insolvency of Fannie Mae, Freddie Mac, and many commercial banks stuffed with subprime mortgage securities accumulated under the mixed economic system described above.
Powered by an exclusive club of primary reserve dealers, a group that once included high flyers like Lehman Brothers, MF Global, and Countrywide Securities, these shadow banks work hand in glove with the Federal Reserve to manufacture money by pyramiding loans atop the base money deposits held in their Federal Reserve accounts.
To the frustration of Keynesians, and despite an unprecedented Quantitative Easing (QE) by the Federal Reserve, conventional commercial banks have broken with custom and have amassed almost $2 trillion in excess reserves they are reluctant to lend as they scramble to digest all the bad loans still on their books. So most of the money manufactured today is actually being created by the shadow banks. But shadow banks do not generally make commercial loans. Rather, they use the money they manufacture to fund proprietary trading operations in repos and derivatives.
Where does the pyramiding come from if shadow banks aren’t making loans that get redeposited to fuel the cycle? Securities held as collateral by counterparties in a repo contract can be rehypothecated by the lender to obtain additional loans. (So can securities held in customer accounts, unless their brokerage agreements expressly prohibit it. This was an unwelcome discovery by MF Global’s hapless clients, who saw their assets whooshed off to London where different brokerage rules allow such hypothecation.) Loans made against securities held as collateral can then be used to either buy more securities, which can be fed back into the repo market, or trade a bewildering array of complex synthetic derivatives.
If this sounds like circular check kiting that’s because it is, especially when you add in the issuance of commercial paper required to grease the wheels. The biggest difference is that an embezzler kiting checks does not have the support of a central bank providing steady injections of liquidity, beefing up balance sheets that create confidence in their debt instruments.
How much of the original high quality collateral must shadow banks hold in reserve should some of their derivatives implode, as many did during the last crisis? Zero. By repeatedly spinning the wheel, the top 25 U.S. banks have piled up over $200 trillion  in leveraged bets atop a thinning wedge of collateral, claims to which are spread across an opaque and complex chain of counterparties residing in multiple legal jurisdictions. These collateral claims are co-mingled with an estimated $400 trillion to $1.3 quadrillion in notional outstanding derivatives made by other banks around the world, altogether amounting to more than 20 times global GDP.
Due to the fact that accounting standards have not kept up with these innovative practices,banks are not required to report the gross notional value of the outstanding derivative contracts on their books, only their net asset positions. These theoretical Value at Risk positions, which would only be netted out if all the contracts were unwound in an orderly manner—as one might unwind a check kiting scheme before getting caught—can only be realized in a liquidity crisis if the counterparty chains across which these contracts are hedged hold up.
These counterparty chains froze in spectacular fashion during the last financial crisis. After the collapse of Lehman Brothers and with the insolvency of AIG looming, a chorus of politicians, bankers, and bureaucrats browbeat the government into delivering a system-wide bailout. As a result, many reckless banks and bankers that should have been driven out of the market are back doing business as usual.
The largest banks learned that they need not worry about the possibility of bankruptcy. When the next crisis hits, all they have to do is shout “systemic collapse” and another bailout will appear. Being Too Big To Fail, they can maximize profits without having to hold reserves against the risk of counterparty failure, knowing that the taxpayer will always be there to make them whole.
The solution is not more regulations, which will never keep up with the financial wizards whose lobbyists end up writing these rules anyway. In addition, trades can be made anywhere in the world, so to be effective the regulations would have to be global. As long as governments continue to prop up failing banks, regulation will always be inadequate to mitigate the moral hazard that accompanies bailouts. And, ironically, the added costs of regulatory compliance will make it harder still for smaller and more prudent banks to compete.
True to form, Congress has not solved the TBTF problem but has actually made it worse, loading ever more regulations on commercial banks through Dodd-Frank. Meanwhile, taxpayer exposure to the banking system has grown even larger.
Optimists believe that as long as everyone remains calm and keeps believing everything is fine, then everything will be. Central planning advocates hope that the kiting scheme can be unwound by extending banking regulations to cover the shadow banks while the Fed somehow weans them off of Quantitative Easing. Cynics believe that asking Washington to get the situation under control is a hopeless quest, especially since few Congressmen have a clue what is really going on.
Meanwhile uncertainty hangs over the system since bankruptcy laws, which differ from country to country, have not kept up with hyper-hypothecation. Moreover, the government’s handling of the auto bailout shows that investors cannot rely on existing bankruptcy law even when it speaks clearly on an issue. Therefore, no one really knows who will have first dibs on the collateral when the music stops. And just what are those high quality assets? Sovereign bonds and mortgage CDOs, which are themselves subject to precipitous losses.
As the debate drags on and global economic conditions worsen, the growing pyramid is being kept afloat by the easy money policies of central banks too frightened to withdraw their support lest a stock market correction trigger a cascade of margin calls that brings down the whole system—much like last time.
All this money creation has not yet generated much visible consumer price inflation. This is partly because official inflation measures are suspect but mostly because the bulk of the new money being created is flowing into financial assets and not the consumer economy. This has inflated asset bubbles to levels impossible to justify based on underlying economic conditions, in particular the stock market where investors have fled in search of yield. No one knows when the bubble will pop, but when it does a donnybrook is going to break out over that thin wedge of collateral whose ownership is spread across counterparties around the world, each looking for relief from their own judges, politicians, bureaucrats, and taxpayers.
When that happens and the clamor for regulation, nationalization, confiscation, and demonization arises there is only one thing we can be sure of. The disaster will once again be blamed on a free market capitalism that has not existed in this country for over 100 years.


http://www.zerohedge.com/news/2013-06-03/fed-hiring-hft-expert-emphasis-systemic-risk

Fed Hiring HFT Expert With Emphasis On "Systemic Risk"

Tyler Durden's picture
Submitted by Tyler Durden on 06/03/2013 12:30 -0400



Ever feel like you can't put that math PhD to good use anymore and make money scalping ahead of order flow, sub-pennying and frontrunning retail in normal and dark pool markets because volumes are just off 1929 levels? Then the Chicago Fed has an offer you just can't refuse. And since money printers can't be choosers, the Fed may also have a spot for those who tried their hand at the New Media (i.e., churning slideshows): "Develop presentations and clarify complex issues for broad audiences." Yet what is most interesting is the following requirement: "Interact with highly informed and technically skilled outside stakeholders while preserving the reputation and credibility of the Reserve Bank." We'll just let that one slide...
From the Federal Reserve System (arguably the busiest recruiter of financial talent in the past 4 years)
Financial Markets Sr Analyst
Description:
The Federal Reserve Bank of Chicago is seeking qualified professionals to fill Financial Markets Senior Analyst positions in Chicago, Illinois.
Job Description: 
Conduct research and analysis on complex topics and issues in securities and derivatives financial markets trading and technology and/or payment system issues, with a particular emphasis on systemic risk.Responsible for providing important contributions to large-scale division projects. Organize successful policy group and industry meetings. Draw on knowledge of exchanges, clearinghouses, financial institutions, trading firms, and other derivatives industry participants and payment system participants to accomplish objectives. Develop presentations and clarify complex issues for broad audiences. Interact with highly informed and technically skilled outside stakeholders while preserving the reputation and credibility of the Reserve Bank. Develop and maintain communication vehicles to key stakeholders. Develop contacts with representatives of financial markets trading and technology and/or representatives of payments industry firms that foster the flow of information between FRBC and the representatives. Monitor developments in securities and derivatives trading, with an emphasis on high-speed trading, algorithmic trading, technology, and regulatory changes that impact trading and markets and/or developments in domestic and international payment systems. Disseminate information among group and to other agencies. Develop expertise in specialized areas including counterparty credit exposures, margining, and market disruptions, payments fraud, payments strategy, and payments infrastructure. Review policy issues relating to domestic and international financial markets and maintain awareness of current developments in said areas in order to act as a resource to the Financial Markets Group and the Bank's senior management. Develop proposed topics for policy research studies, publication, etc. and participate fully in the production of industry studies, policy memoranda, and comment letters, including data acquisition, analysis, conceptualization, and drafting final documents. Deliver persuasive presentations regarding financial markets to various audiences.
Qualifications:
Education Requirement:
Bachelor’s degree in Finance, Economics, or related field, or the foreign equivalent.
Work Experience Requirement: 
5 years of relevant experience, including 2 years of experience with direct analysis of financial markets regulation and policy.
Alternate Acceptable Education and/or Work Experience Requirement:
Master's degree in Finance, Economics, or related field, or the foreign equivalent, and 2 years of experience with direct analysis of financial markets regulation and policy.
Specific Skills or Other Requirements: 
(1) experience identifying and using a wide variety of information sources to create a comprehensive research database;
(2) demonstrated network of industry contacts in derivatives trading, including practitioners, consultants, academics, and regulators;
(3) first-hand experience with algorithmic derivatives trading and technology and relevant terminology; 
(4) experience with the National Market System for equity securities in terms of regulation, exchanges, and technology;
(5) knowledge of derivatives and securities industry institutions, from a regulatory and operational perspective, including broker-dealers, futures commission merchants, exchanges, proprietary trading companies, infrastructure providers, dark pools, trade consolidators, and clearinghouses.
Experience:
Experienced




http://finance.fortune.cnn.com/2013/06/03/jpmorgan-dimon-bond-bet/

( Big derivative bet - interest rate swap bet ? ) 


Jamie Dimon's $5 billion bet against bonds

By  June 3, 2013: 5:00 AM ET

Most of the big banks say they will make money from rising rates. They can't all be right.

Jamie Dimon
Sitting pretty: Dimon says his bank will make $5 billion if rates rise
FORTUNE -- Interest rates have been rising lately. And a lot of people are nervous about what will happen when the Federal Reserve stops buying bonds in the next year or so. Warren Buffett is watching. One group of people not among the rate worrywarts: Bank CEOs. Nearly every bank executive seems to be predicting his bank will make money, in some cases a lot more and seemingly overnight, when rates rise.
"Something like 20 of the 25 biggest banks in the nation will tell you they will make money when interest rates rise," says Glenn Schorr, a top bank analyst at Nomura. "But when you listen to regulators you still hear fear."
For the time being, bank investors seem to be siding with the CEOs. Shares of the big four banks, Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), and Wells Fargo (WFC), have all been rising lately despite the recent rise in rates.
The problem is that's not the way things have played out before. Rising interest rates, particularly sharp increases, have generally been bad news for banks' bottom lines. That's what happened in 1994 when the rates jumped 3%.
But bank analysts say it could be different this time around. We are starting at a much lower point on interest rates than we did nearly two decades ago. Recently, the extreme low interest rates have been a negative for banks, pushing down their net interest margins, which is the difference between what a bank pays for funding and what it gets back in interest when it makes a loan. The analysts say rising rates will significantly improve the banks' lending profits, especially since the big banks have vastly more deposits, on which the banks pay close to nothing to savers, than they did two decades ago.
What's more, pretty much everyone has expected rates to go up for a while now. Bank CEOs have regularly said in the last year that they have moved their bond investments into debt that will come due in shorter periods of time. The shorter it is until a bond matures, the less you lose when interest rates rise.
The boldest of these predictions, perhaps not surprisingly, comes from JPMorgan's brash CEO Jamie Dimon. In April, in his annual letter to shareholders, Dimon predicted that his bank would make $5 billion over the following 12 months if interest rates were to suddenly rise 3%.
It's very hard to see how. A spokesman for JPMorgan declined to comment. The analysts I talked to said they were basically taking Dimon at his word. They hadn't done the math themselves and said it would be very hard to figure out.
One answer could be that Dimon and JPMorgan Chase have taken a very big bet that interest rates would rise. Indeed, in his letter to shareholders Dimon says the bank "is currently positioned" to make money when rates rise and that that positioning "costs us a certain amount of current income." That could mean that JPMorgan has bought a large amount of interest rate swaps, a type of derivative contract that pays out when rates rise, on which the bank could be paying a regular insurance type premium.
But a large London Whale-like trade against interest rates seems unlikely from the bank right now. What's more, according to its 10-Q, JPMorgan holds fewer interest rate derivatives than it did a year ago. And it's hard to see how JPMorgan is giving up income. The bank made $21 billion last year, far more than any of its rivals.
The other possibility is that Dimon is talking about how much more money the bank would make off its lending portfolio. Indeed, in its most recent 10-K, JPMorgan included a chart that said a 1% increase in interest rates would boost the bank's lending profits by $2.1 billion, which would more than clear Dimon's bar for a 3% increase.
But it's not clear that JPMorgan would actually get that much boost. A recent report from Nomura found that lending profits don't rise nearly as much when just long-term rates rise, and short-term borrowing rates remain low, which is what has been happening lately. That's probably because those loans take the longest to reprice. Indeed, JPMorgan says that if just long-term rates were to rise, the bank would only get a $778 million boost from a 1% increase in interest rates. Triple that and you get $2.3 billion, well short of Dimon's prediction.
And that number doesn't take into effect how much JPMorgan could lose in its bond portfolio, which is hundreds of billions of dollars. Even a 1% increase in rates could cost the bank a few billion. Clearly, Dimon included the statement in his annual letter because he is getting questioned about what would happen if interest rates rise from worried investors. If he really wants those questions to go away, he has more explaining to do.

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