All Things Financial

Who got richer and more importantly, faster? It was the rabbit, no wait; I think it was the turtle. Well who cares, at the end of the day food on the table and a credit card for the Wifey to go shopping with is more important than some race from a kid’s story book .  I found an interesting article by Matthew Heimer that was claiming the rich came out ahead as opposed to the rest of America’s family.  So basically compared the rich with their 401ks vs everyone else with their home or maybe I should call it mortgage chain. And it went something like this “Thanks in large part to that fact, the nation’s 8 million wealthiest households recovered much faster than the rest of the country from the 2008 recession…. households in the upper category saw their average net worth grow by 28%, while the wealth of the nation’s other households dropped by about 4% –increasing the wealth disparity between that top tier and the rest of the country.”

                Let us give a round of applause to everyone in the 4% category, and even for those in the 28% island. It was a horrible recession and all but come one now; who did you really expect to get of the dilemma better off than the other? Really, it had to be the ones heavily invested in the stock market. It’s a bit self-evident, home prices falling and people stuck with mortgages worth more than their homes. That sad story couldn’t only end one way, and that is the poor house.  Houses technically can help you get richer quickly because of the small down payment and leverage you get. But the little secret is, when stocks tech a tumble….the Fed is usually there to help out and when the world is coming to an end, the world puts its money in America’s stock market.  So even with the big dive, everyone should have gotten as much money they could get a hold of and bought some stocks. We would have all been richer for it.  instead of a mortgage, take that amount of money you would pay and put it in a good stock or even just an index (that would be easier….by index I mean S&P500 or DOW Jones, etc  that you commonly hear about in the news but don’t pay much attention cause it is all cryptic) and it will grow faster. And use your 401k or IRA, it helps you postpone or avoid it all together if you pay up front before investing. That’s how you get to retirement and relax. And not wondering why I worked hard and have nothing to show for it. 

 

 Counter To:

Treasuries Inflation Gauge Falls to One-Month Low by Lucy Meakin & Wes Goodman

 

“Fed purchases of $85 billion each month in Treasury and mortgage debt, aiming to spur economic growth by putting downward pressure on borrowing costs, have yet to send cost in the economy.”

 

“Inflation has taken a backseat because people aren’t as concerned.”

 

Hmmm. Treasuries are being used as an inflation gauge. Well I guess they can be a good source numbers for an economist to plug in to models and spew out projections on how healthy the economy of USA is doing. Well, then again just because you have numbers doesn’t mean you have the right information when in fact you’re using the wrong source.

            Yes, even with the tremendous purchasing of treasuries at the tune of “$85 billion each month” the inflation is at around 2%. But that doesn’t mean that people aren’t concerned about inflation. I say they are concerned but an even greater concern is real income growth and bringing about an end to this recession. Inflation hasn’t reared its head because the two parties concerned aren’t dancing the tango.

            Velocity of money (or how fast money moves from person to person over some given period) is slower than a snail. The two primary parties on the dance floor, Banks and People going after credit aren’t seeking each other out. Interest rates are just too low for banks to be motivated to lend to people. And people have yet to recover from the full brunt of the recession so they aren’t realizing the low interest cost of debt. If they were then banks wouldn’t have more than $1 trillion in excess reserves collecting dust. Treasuries are a useless gauge of inflation when central banks are manipulating the real cost of debt. 

Has anyone noticed price at the pump? Well, I know that I have. Each time I am about to go somewhere I have to ask myself, do I really have to go there? Frankly, it’s because the price by the gallon has gone up quite fast but my pay is still the same.

Ben Bernanke, Chairman of the Federal Reserve, is our appointed “Wizard of Oz”. He’s been trying to get us out of the recession by buying government debt and by default keeping interest rates to encourage both lending and spending. The result is an impressive stock market rally since 2009 but no improvement consumer income. In other words if you are still like me, you are still broke. But you’ve also noticed gas and food prices have all gone up. It’s because there is a lot more money floating around which makes prices go up.  Here is a little vocab word, Inflation. It’s simply means prices of things we want have gone up even though there aren’t more people wanting to buy them. Inflation is usually a result of extra printed money in comparison to the total amount of goods made.

Here are the wonderful things our Wizard of Oz has managed to do. One, gas is more expensive but my pay is the same so I can’t. Two, interest rates are low but my income can support a mortgage. Three, banks as a collective have more than a trillion dollars but they don’t have incentive to lend, because interest rates are so low that they won’t make much profit. Thanks but no thank you Ben. On paper you’ve done quite well but really all you’ve done hasn’t helped Main Street.

The best way to help everyone is pullback all the excess money from circulation so that the dollar increases in value. I will be able to buy more food and go places without thing about gas prices. After all, you are trying to get us out of this recession buy encouraging consumption without any real growth.

What do you see in that cartoon picture? It’s a man dancing around with his cool walking stick and throwing money in the air like it’s not a thing, maybe because there is a big bag of cash behind him.”Throwing money in the air like it’s not a thing,” i want to focus on that statement. What is money really? Well obviously it allows us to go buy things and it’s how most of us get paid after working. So why the whole big fanfare and fights over money? it  seems to me from that statement, that money is means of measurement buy its nature, much like a ruler.

So let’s all remember that money doesn’t make us rich, it only measures how rich or poor we really are. Riches are in what we posses: houses, stocks, cows, farm land, cars…and to the little people, toy cars and dolls.  And money allows us to get things and sell these things to others. We should think of it almost like a place holder to our insatiable want for scarce goods. We keep it till we see something we want, exchanging it for something and that person who knows has the money keeps it till he/she see something he wants.

The man dancing about isn’t dancing cause he’s rich, he is probably dancing to a tune or he thinks he’ll get all he ever wanted cause he can buy it with the money he now has, only then will he be rich. So let us keep dancing and go start getting what we want. 

What Is It and Its Importance

Well a currency reserve is money in a foreign currency typically held by Central Banks and other large financial institutions. Central banks and governments sometimes use it to settle debts, trade, minimize borrowing cost, and in times of extreme economic stress governments sometimes use the foreign currency reserves as a substitute to their own currency.

 

Why It will Remain Supreme

American is the only country in the world that enjoys exclusivity in it’s country’s currency being used for international trade.

The usage of the Dollar (61.8%) as a currency reserve simply dominates other countries….it takes the combined economic forces of EU (24.1%) nations, to even come close to America’s which is isn’t enough. Then next most common foreign currency reserve is the British Sterling Pound (4.1%) and Japanese Yen (4.1%). The percentage date is from 2012 Q3 found on Wikipedia.

America has the most number of Fortune 500 listed on it’s stock exchanges. By virtue of being the largest economy all goods that are made internationally have to be sold in America and for that currencies have to be exchanged for dollars.

Last but not least America’s military might also compliments it’s geopolitical influence and that further strengthens the need to keep the Dollar as top foreign currency reserve.

 

Why It might Lose It’s Supremacy

 

America showed to the economic theater that even its robust economy isn’t immune to severe economic down turns, in the 2008 financial crisis.

America’s debt financing is based on two primary parties: the Fed which can keep buying up treasuries and China is so invested in our debt that traders carefully watch China’s economic growth like an egg that shouldn’t drop because we have become codependent on each other.

The other leading advanced economies are still struggling with no clear sight of recovery to pre-financial meltdown years, while developing nations are growing at astonishing rates. Brazil for example just about sustained it’s growth with little effect from the financial meltdown.

The reasons mentioned only go to show that the world is more interconnected and so participants may at some point consider an alternative because they also now have a louder voice and have economic interests to protect.

 

All things considered I believe that America’s standing will be maintained by it’s special status internationally leaving the two next potential rivals comfortable settling for second place. Russia’s economy isn’t close enough to compete; in fact Japan has greater economy even after the stock market bubble burst that has left it virtually stagnant. Militarily it might compete but not for a sustained period. China is only concerned about growing it’s economy and not it’s military to usurp America.  Their collective behavior leaves America to lead the world and so, the Dollar will be Supreme Currency Reserve for the time being. 

Mr. Simon Kennedy recently wrote on Bloomberg article titled, ‘Central Banks Deliver 45-Minute Salvo As Growth Weakens’.  The first sentence on the article pretty much summed it all up,  “Global central banks went on the offensive against the faltering world economy, cutting interest rates and increasing bond buying as a round of international stimulus gathers pace.”

He’s main points included:

“The bank of England began today’s stimulus push announcing it would restart buying bonds two months after stopping. Governor Mervyn King and colleagues raised their asset-purchase target by 50 billion pounds ($78 billion) to 375 billion pounds….”

“The world’s largest emerging market is acting more aggressively to spur growth that may have decelerated for a sixth quarter. Officials responded after two manufacturing indexes fell in June and Ahead of a report on second-quarter gross domestic product, due on July 13.” Referring to China.

“The central banks of Australia, the Czech Republic, Kazakhstan, Vietnam and Israel also cut rates in June, while the Swiss National Bank is buying euros to defend its franc ceiling. “

Results:

“Data tomorrow is forecast to confirm the weakest quarter for U.S. employment in more than two years, evidence the world’s biggest economy has lost momentum. “

My Opinion:

Quantitative easing and stimulus has been a bust. The only beneficiaries of the stimulus were the corporations that received it directly and some investors in the stock market.  My claim is clearly evidenced by looking at Can Stocks Rally Without Fed Stimulus? on wsj.com, written by Steven Russolillo. With the each time the Fed actively executed Quantitative Easing(QE) measures, the S&P 500 index it went up and at the end of it the index began to fall again.  The economies of the world won’t be improving anytime soon and the tricks that central banks are playing only distort the appearance of the of their respective economies. Perhaps the central banks should raise rates to reward savers and just let the constituents of their respective nations regain confidence. The stock market won’t make people start spending when they have a dim view of the economy or have no money. 

Mr. Nigel Davies wrote an article yesterday on Reuters pointing out the difficulties that Spain is facing with managing the cost of debt, issuing debt, and getting help from its European counterparts.

Let’s first look at cost of debt. Mr. Davis writes “The yield pain on a 3-month bill was 2.362 percent, up from just 0.846 percent a month ago. For six-month paper, it leapt to 3.237 percent from 1.737 percent in May.” Now I’ll over simplify the situation to bring about a clearer image of the situation. But first 3 month bill is basically a 3 month loan to the government and when “six-month paper”  is mentioned, that is referring to a loan to the government lasting 6 months.  Even though it might sound like a small number, an increase from 0.846 to 2.362 is still significant because of the amount it is based on. Governments tend to take on large debts, in amounts measured in billions so I’ll arbitrarily pick $10 billion. The interest payments with the numbers given would be a jump from $84,600,000 or $84 Million roughly to $236,200,000 or a little more than $200 million. Now for the 6month loan still using $10 Billion would be $173,700,000 to $323,700,000.

Now we’ll look at Spain’s ability to issue debt.  Mr. Davis said that “The bill auction showed even domestic bank support for the country’s debt fading from a month ago. The bid-to cover ratio on the 3-month was 2.6, down from 3.9 last time, and it was 2.8, compared with 4.3 last time. “For the vocabulary, bid-to-cover ratio measures how well bond sale to corporations, institutions and general public is successful. Ideally a good sale would have a ratio of 2 or greater.  And a ratio of 2 to 1 ratio for example(once again I picked a number arbitrarily) would mean that  the government came to the market with $5billion in bonds to be sold but instead there was enough demand that $10 billion in bonds would have sold out completely.  So from the numbers it looks like demand has dropped significantly.

And finally the 3^rd but not least important part of the problem, which is getting help from other Europeans in the EU. Mr. Davis stated that “Spain has already asked its European Union partners for up to 100 billion euros in aid for its banks, but financial markets have not eased in their pressure, seeing much of the EU’s efforts as only temporary solutions.”

Conclusion & summary.

Panic has entered the market while reason and patients has left. I say panic because a majority of participants in the market are speculators who would like to think of themselves as investors when really they aren’t. There are only two reasons apparent to me as to why speculators jumped in the market so quickly and want out now. Some may have wanted higher returns because the stock market isn’t very promising with such economic slowdown around the globe so Spanish debt was a pealing due to higher returns than debt from other developed nations who aren’t in such dire situation with their finances.  And the second reason could possible knowing that the debt is just too much and they were just betting against it and even though their analysis was on point, they are trying to get out of the market as quick as possible so they aren’t left stuck with an empty bag so to say. So what is the Spanis government to do? Well they can only hope to get help from their EU counterparts  and hope for it to happen sooner than later. The longer their counterparts continue debating the worse the situation will become. The cost of debt will continue to rise while the demand for it will continue dropping which will have an adverse reaction to the stock market in Spain and around the world. But if they got money quickly then speculators will have their fears eased a little and reassure them enough to get back to the market which will decrease the amount of money that Spain and it’s counterparts will have to put on the table for the long term. 

“SNB Pledges To Defend Franc Cap As Crisis Intensifies: Economy” was the article written by Klaus Wille and published on Bloomberg.com on Jun 14, 2012 2:55AM PT.

The SNB is an acronym for Swiss National Bank, which is the equivalent to our U.S. Federal Bank or Fed. So the problem that the SNB is staunchly trying to fight against, is the rise in value of the Swiss Franc. Well even thought the Swiss Franc is the currency of a European nation, it is minted by Switzerland and is independent from the Euro much like Switzerland when it comes to political participation in European affairs or even wars. The implication of this is that when the other Euro member nations(countries in Europe that use the Euro as currency) have economic trouble or fluctuations in the value of the Euro, the Swiss are relatively immune. 

Mr Wille stated that “The Swiss National Bank (SNBN), led by President Thomas Jordan, today maintained the ceiling at 1.20 francs per euro and reiterated that it will uphold the measure “with the utmost determination.” This means that the SNB is trying to maintain a peg or a fixed exchange rate of 1.20 francs for every one Euro. The goal is to prevent the Swiss Frank from appreciating in value too much as the Euro drops. Personally i think the policy to be artificially cheapening the value of the Swiss Frank. There is great demand for the Swiss Frank because the European countries are in debt and having problem raising money. So everyone is buying the Swiss Frank because it has a tendency to be stable in value and it is separate for the Euro. 

The SNB has several options at it’s disposal to maintain the 1.20 Peg to the Euro.  One, to keep it’s prime interest rate(the main interest rate set by the SNB that affects all lending with in the country, whether it is car loans, mortgages, credit cards, personal loans etc) it lower than that set by the ECB(European Central bank). This action would make it cheaper to get loans and by that increase the amount of money circulating lowering the value of the currency.

Two, the SNB can decrease the reserve requirement for banks. The reserve requirement is basically a fixed percentage of money that is required to be kept by a bank for so much money that is lent out to customers. This action if used would go further to depreciating the currency because it increases the money supply much more drastically than option one.

Three, the SNB can by the Notes in its books. Notes, meaning anything from mortgages, corporate bonds, national bonds, and other forms of public debts. 

Fourth, the SNB could buy currencies from different central banks around the world raising its foreign currency reserves which can be used to settle trade obligations in the future.

Like i stated previously the rise of the Swiss Frank is the best problem the SNB or any central bank could have at a time when most of the leading economic powers in the globe are barely growing. Instead of looking at the situation as a problem, the SNB could let the SNB appreciate to its highest levels possible. It would be to the benefit of the Swiss because they will be able to buy more goods; which in turn would improve the Swiss economy. If the SNB does follow my suggestion, then it could take steps to acquiring assets from the rest of the troubled EU nations. It could be stakes of corporations or just acquiring commodities like gold and other precious metals. 

 

There is a new phenomenon in the sovereign debt realm. Sovereign debt is much like commercial or even personal debt of a typical by standard because they are all governed by interest rates. The cost of debt (interest rate) is usually higher when there is no collateral or the creditor perceives that there is a great chance of a potential default.  Now I won’t talk about the European crisis because it makes U.S.A’s debt issue a joke because the debt to GDP is much higher in Europe and the interest rates are as high as 30% unlike here where the 30 year is yielding less than 3 %.

In http://online.wsj.com/article/SB10001424053111904332804576538363789127084.html?mod=opinion_newsreel, Mr. Ronald McKinnon is basically saying that the bond market is behaving rather unusual to the norm when debt is high and there is little sign of the government making headway to lower or manage it. When there is a lot of debt investors usually want a greater rate of return for the risk but at the moment: the 10-Yr Note Yield (1.92), 30-Yr Note Yield (2.91); and the medium and short term notes 5-Yr Note Yield(.95),2-Yr Note Yield (.24), 1-Yr Note Yield (.10). I do agree with Mr. McKinnon’s assertion that Central Banks are kicking out the Bond Vigilantes and keeping rates so low.

            Ben Bernanke is a big player in this but not the only culprit because he bought up a lot of notes with QE 1 and 2 but rates were still higher then. Then came the reemergence of Europe’s fiscal troubles with the Pigs(Portugal, Italy, Greece, and Spain). Investors in a panic sold their holdings and started going into gold for a time which made gold almost reach $2,000 an ounce but all summer it has failed to reach that level. Then the investors came to their senses and realized that gold is only a short term insurance policy and not something long term because it is just a commodity. So the best place to go was to go to the most liquid markets in the world, U.S.A. Stocks weren’t going to do because American banks were tied to those troubled European banks so the debt market was the final destination. Everyone starts buying up U.S. notes which raises the price while lowering the yield.  This is the cause of the low yields, even though it makes no sense to buy a bond with a return less than inflation (when inflation is at say 3% and the return on a bond is say 2%….that simply means that the investor is losing 1% of their original investment each year), people have more faith and would rather invest in America than anywhere else.

            For the faceable future, Yield’s will remain dismally low and the stock market will remain relatively flat if not drop more than it already has, in my opinion. The 3 reasons most convincing reasons for that to take place are Operation twist, foreign investors, and the current yield levels at the moment.

 Operation twist….the Fed’s new magic trick which will cause more harm than the good intentions is built on; the Fed will simply sell the short term notes and buy long term notes. The result would be that short term interest rates will go up while long term should come down, well they are down so how long could they get. The problem with this is that banks usually run their business by buying short term notes and selling short term notes or issuing long term debt like mortgages, the difference makes this profitable but that will be flipped backward by operation twist. And unfortunately the Fed is content on keeping inflation at a “manageable” level than rather let interest rates go up and give consumers the purchasing power they need with a strong dollar.

Foreign investors will stay put because the U.S. stock market is performing poorly even though there is inflation which should bring up stock prices and thanks to the Fed debt financing is at its lowest cost in years. Everything and even oil is performing poorly because no one is buying because of low or low consumer confidence. So even with lots of money floating around (well that is for no main street folks) there aren’t enough investors to keep the markets up. Another reason why they will stay put is because right now emerging markets are doing well, look at Brazil with a growing economy and rates on their government bonds being at average of 12 percent in yield…that still isn’t enough to motivate investors to leave the U.S.

Current yields are the hindrance to the economy’s recovery. The one way for this country to get back to good economic health is through credit without inflation. Right now we have exhausted artificial credit from the fed and created inflation at the cost of both lower purchasing power(the ability for one dollar to buy things like gasoline, right now the dollar buys less than it did 6 months ago) and high unemployment. The best way to restore the economy and release some of the artificial credit is by the fed selling their bond holdings and removing the excess cash out of circulation which will bring back the bond vigilantes. And the increased yields will mean that even the cost of short term notes will go up and with it CD’s at the local bank will also go up. When they go up it will incentivize consumers to think about saving because of a good return and it will cause a further decrease in free floating money which will translate into a stronger dollar. 

“Stocks Nose-Dive Amid Global Fears” was today’s headline on the Wall Street Journal which should be rewritten as “Realization of Failed Stimulus”. All indices in western and Asian economic powers except China were down on an average of 3 to 4% points. Now the article by Tom Lauricella would suggest that the markets are simply on correction mode(as though the markets a collective of intelligent agents) or that fear is what lead to the equities  tumbling or even more crazy that it is due to economic slowdown. The collective efforts of Central Banks to both lower interest rates and stimulating their economies was a mistake.

                A correction would imply that there was a mistake and that the indices are overvalued just slightly but that’s not the same as a global drop of 4% in a single day. The financial crisis was due to a mortgage bubble that popped then everything dropped in value whether it was commodities, equities and even bonds, but  come the end of 09 into 2010 markets rose as high as 30 percent. In my opinion that was correction because even though the drop was greater than what occurred yesterday, the drop happened because the securities were overly valued and not sufficiently backed.  Now yesterday’s drop dropped the equities slightly above the 2010 highs, this point will be tied in further down into the conclusion.

                The drastic decline in value commodities and other securities across the board isn’t due to fear or an economic slowdown.  The debt ceiling was met before the deadline and that was because America faced the threat of not meeting its obligations and a downgrade in credit rating. The fear was that if it wasn’t met then the U.S.A. would default, no since it hasn’t defaulted then why is it that rumormongers are claiming the restriction in spending might limit growth and on the flip side the debt will be too high warranting a down grade? With the debt ceiling met then the government will run and obligations will be met. Growth of the economy will only occur if more debt is incurred, but merely increasing the debt in of itself will not collapse the economy.  Take for an example when a couple is taking up a mortgage, it is very feasible in fact common to buy it with only 5 percent down payment and the other 95% incurred in debt but still the debt is paid in full with in the 30 years max. Now the U.S.A.’s debt is at around 75 percent but that doesn’t mean it can’t meet its obligations, in fact the debt ceiling agreement allows that and also more money for it to spend. The way I see it, even if the debt to GDP is 100% there is no problem as long as that money loaned to the government is spent on things that will be profitable and conducive to economic growth much like a business owner can incur as much debt as possible if the incoming revenue exceed the interest payments resulting in a profit.  So fear isn’t a valid argument.

                There economic slowdown is not the cause of the drastic decline in markets worldwide.  The major corporations are sitting on a lot of cash and for some even more that the U.S.A. government, like Apple with more than 75 Billion Dollars. This strange decisions by executives show could mean that corporations have come to the realization that the economy is going to grow slowly and so there is no need for example or even acquisition in the time when credit is very cheap with interest rates being so low which would mean a greater likelihood of successful mergers with low default on high interest junk bonds used as a means of financing.

 And so why did the markets drop so quickly when there is even a chance for more stimulus and so many plans to either increase sovereign debt or restructuring debt? The Stimulus( be it QE 1 or 2,central banks purchasing  government bonds to keep interest rates low or some other form )and lowering of interest rates simply inflated the markets with too much money and now investors and speculators alike are removing money out of the markets. The problem isn’t liquidity anymore because there is plenty of money; instead the money is too much. If the money wasn’t added to begin with then bonds would be cheaper and their interest would be higher but that was subverted buy bond buying actions by central banks. If money wasn’t added to the economy commodity prices would have remained low allowing consumers to have more discretionary funds to spend and the consumer sentiment that was bleak would have recovered by now.  And finally the manageable inflation that Central Banks preferred over deflation is here and isn’t manageable any more instead it is lowering consumer purchasing power and further prolonging true economic recovery.

 For reference to the above mentioned article go to: 

http://online.wsj.com/article/SB10001424053111903454504576488581593391582.html?mod=WSJ_Home_largeHeadline

So what is the world turning into? Jobs aren’t there, education is expensive with no guarantee of a better future, the American dream is a pipe dream and we are all just going to hell with nothing there to stop it….oh no what will do? There I tried but I just can’t do it as good as the WSJ even Marketwatch but give me credit I am not a journalist, at least they are great at writing gossip since when they stop reporting business news.  It’s easy  to move from one rumor to the next like how EU has no future with Greek Debt but now its all mighty USA which won’t raise its debt ceiling so the world will come to a halt. Well that’s a bleak vision of things to come, I’d look at it positively because US debt will be curbed and more wealth will be built if U.S. defaults.  Ms. Sjolin of marketwatctch wrote a quote ‘“Investors prefer to wait until after the deadline when there’s more certainty to buy Treasurys.”  in http://www.marketwatch.com/story/weak-debt-auctions-highlight-investor-worries-2011-07-28. That sounds like speculators are actually taking logical steps to protect themselves from lendee who might not pay up yet its just an example of how there is a lot of hysteria which is backed up with nothing but rumors. First of all America is special because unlike Greece the problem is that some politicians don’t want to increase the debt while the other country was riddled with debt that it can’t pay. Picture  John(Greece) who has a has a lot of credit card debt and can’t pay it back and the things he owns can’t cover the debt even if it was sold. Then there is Tom(U.S.A) which can has little debt and is just refusing to get another credit card because he can’t make up his mind. Clearly the two are so far apart in their dilemma that they can’t even be compared but all newspapers are trying to compare them and speculators are equating them. The reason why America will not die off even after the financial crisis two years ago is because it has the largest economy and it is filled with very industrious citizens who can’t stop creating wealth that all Europe can’t compete with.

            Time for playing devil’s advocate. Now rumor mongers might say that if America defaults that interest rates will go up and the dollar will lose its value. And guess what that will happen to some degree and what is wrong with that. It’s not like the Fed is raising interest rates and aggressively trying to sustain the purchasing power of the dollar instead they are trying to maintain a reasonable percentage of inflation which is stealing wealth from the lowest earners. Stealing because they can’t buy the same today as they did yesterday and to make matters worse that isn’t helping the job front. Now on interest rates will go up and guess what that is the best thing that can happen right now for the few who can investors but it will heart the poor. Interest rates go up will mean that U.S.A will pay a higher interest rate which will attract investors. And this will surely happen because at the interest rates right now of less than the highest earning debt of 4 percent is so low that it is pointless to own treasuries. And it will also counter the Fed’s QE 1 and 2 actions that kept the rates artificially low for so long which will eventually raise the dollar value. Now people talk about if the debt ceiling isn’t met that there will be a default. The default might happen but there is insurance for that, credit default swaps, just like insurance for homes or cars or floods, so there is no reason why people should dump U.S. Debt. And to bring the point home for how special America is just look at Brazil with a robust economy which wasn’t touched by the financial crisis and its currency appreciating against the dollar and economy thriving and the debt is paying an astonishing 12 percent. Now why would people stick with The US debt and ignore Brazilian debt if things are so dire? They wouldn’t so things will be good once more.

            Now the picture of U.S.A if the Debt ceiling is increased is nothing different from what is going now. Well more debt will be printed and interest rates won’t go up cause things will be the same. Bill Gross the bond king who won’t touch U.S. Debt still won’t use any money from his behemoth Pimco to boy any U.S.A debt cause the returns are so much lower than what he can get from corporate debt even after taxes. And markets will go up and down like they have been for weeks and oil will still be expensive and the unemployment rate will still be high. So basically it isn’t a rosier picture. So why worry?  

Banks are there to hold the money for its customers and when the need arises to facilitate credit through loans whether it is through credit cards or mortgages or even other more complex products. But it would appear that banks are no longer able to carry out such duties to all of their customers, instead banks provide credit to big business and high net worth clients leaving out small businesses and individuals (dependent on high interest credit cards). A few weeks back Google was able to sell issue bonds valued at $3Billion dollars while it had over $35 billion dollars in cash in its books. And the main reason for Google to do this is because interest rates are at an all-time law yet when it comes to individuals, interest rates on credit cards haven’t gone down at all. In fact investment grade bonds (loans to large corporations with god credit history) fetch an interest of no more than 7 percent; somehow it’s hard to find a credit card with interest that low.  

            According to Jeffrey Sparshott’s Wall Street Journal (wsj) article from June 22, 2011, “U.S. President Barack Obama signed the Small Business Jobs Act in September 2010. The law’s centerpiece is a $30 billion small business lending fund, meant to spur more loans to smaller companies”….further down the article it states “The Small Business Jobs Act defines small business lending as loans of up to $10 million to businesses with up to $50 million in annual revenues. Lenders must have less than $10 billion in assets to participate” The new funds set aside for small businesses is a necessity for improving the current state of the economy because large businesses aren’t exactly hiring at the moment and aren’t incentivized to either, but instead are changing their management to produce goods with a leaner labor pool of employees.

            Back in June 30, 2011 Emily Maltby wrote a wsj article “Small Businesses Seeking Loans Still Come Up Empty” and more importantly there two interesting bits of date found. The first, by the Fed of Kansas City, “….big banks’ outstanding loans to small businesses dropped 14% between March 2010 and March 2011, while loans by smaller lenders fell 3%.”  Secondly, by the Pepperdine study, “ In the past six months, only 17% of loan-seeking businesses with less than $5 million in annual revenue landed bank financing, the study found.” And “about 37% of respondents from privately held companies with revenue greater than $25 million have successfully secured bank loans in the last six months…” it is clear that the same big banks which got a bailout from the Government and additional large loans in the billions (Goldman Sachs got a $15Billion dollar loan at 1.16% interest rate) with a negligible interest rate for repayment, aren’t using the money for the utility of the economy as they should.

            A better use of the $35Billion set aside for small business lending should perhaps be contracted to Peer 2 Peer lenders. Mr. Angus Loten’s wsj article, Peer-to-Peer Loans Grow, of June 17, 2011; would suggest that Peer2peer lending is filling the vacuum that banks have created by ignoring small businesses and individuals seeking loans. Mr. Loten’s article points out “Based in San Francisco, Calif., LendingClub.com’s small-business lending rose 40% in 2010 and is expected to grow an additional 80% by year’s end, according to Scott Sanborn, the site’s chief marketing officer.” And “San Francisco-based Prosper.com recently reported a 38% increase in total loan volume over the first quarter”. This new growing industry will continue to thrive because banks are just not willing to spend money in servicing such clients. Whether it be credit history or no good collateral, such arguments are frivolous because lending.com and prosper.com can’t be growing at such a high rate if delinquencies were very high.  Banks and the SBA aren’t capable to service the needs of the new growing demography and so it is time for the government to assist peer2peer lending institutions so that the economy will grow quicker out of the recession. 

After the financial crisis that happened about two years ago, the BIS(Bank of International Settlements, based in Basel, Switzerland) decided to raise the capital requirements:

1. Common equity requirement from 2% to 4.5%
2. Tier 1 Capital from 4% to 6%
3. Total Capital would remain at 8%
4. A Conservation Buffer of 2.5 % which would be added to the other three bringing the minimums plus Conservation Buffer to 7.0%, 8.5%, and 10.5%.
5. And a Counter-cyclical Buffer ranging between 0-2.5%…(this buffer would be used only in the case when credit availability to curb gross credit issuance.

The the first 3 requirements are there to make sure banks are well capitalized. Then the requirement 4, is to minimize the impact of loan losses to the balance sheet of banks whether it be the typical loan defaults by customers or times of recession and other economic hardships the economy may have to endure. 

Sufficient capitalization for a bank isn’t the same as any ordinary business because unlike other enterprises, the assets and liabilities of a bank can increase without an increase in new capital. For example when a customer deposits money in a checking or a savings account the capital does in fact increase. But when a bank uses that money to make a loan to another customer and it keeps a fraction of the deposit, the assets and liabilities of the ledger increase without any capital, that’s the minor difference that sets banks apart from other enterprises. 

All assets are given a risk weight:

1. Cash and equivalents      = 0
2. Government securities     = 0
3. Interbank loans              = 0.2
4. Mortgage loans              = 0.5
5. Ordinary loans               =  1.0
6. Standby letters of credit = 1.0

then in turn the values of each asset is multiplied by the appropriate risk weight and then all the new values are added up then multiplied by the percentages of the Common Equity, Tier 1 Capital, and Total Capital. The eventual number is the amount of capital the bank should always have. 

In my opinion all these new requirements sound well on paper but can only mean that the central banks of the G20(who mostly compose and influence the BIS) members are coming up with these new standards due to political pressure.The idea that these rules will prevent another financial crisis is very ludicrous because first of all the capital is so low and can’t be used to cover all the banks obligations if they were to all default. The only banks that did collapse from the crisis were those who had poor management. The most famous one being BearStearns then the other ones which were found wanting by the Fed after the “Stress Test” were bought by the more healthier banks.

Further more with the Fed continuing its operations through the Federal Reserve Bank Window(http://www.frbdiscountwindow.org/mechanics.cfm?hdrID=14 ), the new capital standards would only be diverting capital from lending operations to sitting in a vault. If there is a short term emergency then banks can get money from each other or even get money from the Fed through the discount window. To get a loan at the Fed Funds rate(http://www.bankrate.com/rates/interest-rates/prime-rate.aspx) would only cost .25 which is a far cry from what the typical credit card customer would pay.

And finally the the banks that weren’t healthy either collapsed or were bought by the healthy ones so why increase the capital requirements when they have enough money left over to buy the band banks and absorb their toxic assets too? The Financial crisis only shows that the Fed was too eager to loan money to banks out of political pressure and not to help the economy per say. If it was concerned with helping the economy it could have used that money to absorb the mortgages and increased the lending its credit to the SBA which makes loans to small businesses, they are the ones who create jobs which intern grows a healthy economy. So the new capital requirements imposed to the big banks are more restrictive than beneficial. 

links for further reading:

http://wfhummel.cnchost.com/capitalrequirements.html

http://online.wsj.com/public/resources/documents/ZubrowHFSC.pdf

http://www.bis.org/press/p100912.htm

http://www.bis.org/press/p100912a.pdf

http://en.wikipedia.org/wiki/Capital_requirement