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The evolution of credit and debt in 2023

January 15, 2023

The evolution of credit and debt in 2023

The evidence strongly suggests that a combined interest rate, economic and currency crisis for the US and its western alliance will continue in 2023.

This article focuses on credit, its constraints, and why quantitative easing has already crowded out private sector activity. Adjusting M2 money supply for accumulating QE indicates the degree to which this has driven the US tax base into deep recession. And the wider effects on credit in the economy should not be ignored. 

After a brief partial recovery from the covid crisis in US government finances, they are likely to start deteriorating again due to a deepening recession of private sector activity. Funding these deficits depends on foreign inward investment flows, which are faltering. Rising interest rates and an ongoing bear market make funding from this source hard to envisage.

Meanwhile, from his public statements President Putin is fully aware of these difficulties, and a consequence of the western alliance increasing their support and involvement in Ukraine makes it almost certain that Putin will take the opportunity to push the dollar over the edge.

Credit is much more than bank deposits

Economics is about credit, and its balance sheet twin, debt. Debt is either productive, in which case it can extinguish credit in due course, or it is not, and credit must be extended or written off. Money almost never comes into it. Money is distinguished from credit by having no counterparty risk, which credit always has. The role of money is to stabilise the purchasing power of credit. And the only legal form of money is metallic; gold, silver, or copper usually rendered into coin for enhanced fungibility.

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Visualizing $65 Trillion In Hidden Dollar Debt

January 12, 2023

Visualizing $65 Trillion In Hidden Dollar Debt

The scale of hidden dollar debt around the world is huge.

As Visual Capitalist’s Dorothy Neufeld details below, no less than $65 trillion in unrecorded dollar debt circulates across the global financial system in non-U.S. banks and shadow banks. To put in perspective, global GDP sits at $104 trillion.

This dollar debt is in the form of foreign-exchange swaps, which have exploded over the last decade due to years of monetary easing and ultra-low interest rates, as investors searched for higher yields. Today, unrecorded debt from these foreign-exchange swaps is worth more than double the dollar debt officially recorded on balance sheets across these institutions.

Based on analysis from the Bank of International Settlements (BIS), the above infographic charts the rise in hidden dollar debt across non-U.S. financial institutions and examines the wider implications of its growth.

Dollar Debt: A Beginners Guide

To start, we will briefly look at the role of foreign-exchange (forex) swaps in the global economy. The forex market is the largest in the world by a long stretch, with trillions traded daily.

Some of the key players that use foreign-exchange swaps are:

  • Corporations
  • Financial institutions
  • Central banks

To understand forex swaps is to look at the role of currency risk. As we have seen in 2022, the U.S. dollar has been on a tear. When this happens, it hurts company earnings that generate revenue across borders. That’s because they earn revenue in foreign currencies (which have likely declined in value against the dollar) but end up converting earnings to U.S. dollars.

In order to reduce currency risk, market participants will buy forex swaps. Here, two parties agree to exchange one currency for another. In short, this helps protect the company from unfavorable foreign exchange rates.

What’s more, due to accounting rules, forex swaps are often unrecorded on balance sheets, and as a result are quite opaque.

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The Looming Mortgage Liquidity Crisis

March 30, 2018

THE LOOMING MORTGAGE LIQUIDITY CRISIS

Every 10 years or so there is a banking crisis. We are due. However, the furthest thing from most people’s minds with the Trump boom is a banking/financial crisis, except for a few folks at the Brookings Institution, who just released a paper entitled “Liquidity Crisis in the Mortgage Market.”

You Suk Kim, of the Federal Reserve Board; Steven M. Laufer, who also labors on the Federal Reserve Board along with Karen Pence, plus, Richard Stanton of the University of California, Berkeley, and Nancy Wallace, also of University of California, Berkeley, to give away the punchline from their paper’s abstract, write, “We describe in this paper how nonbank mortgage companies are vulnerable to liquidity pressures in both their loan origination and servicing activities, and we document that this sector in aggregate appears to have minimal resources to bring to bear in a stress scenario.”

John and Joan Q. Public believe the 2018 mortgage business is like George Bailey’s Building & Loan in “It’s a Wonderful Life.” People deposit money, bankers lend it out, keeping the mortgage on their books. Easy Peasy.

As the folks from Brookings point out, it’s not that easy in these dark days of financial engineering. George Bailey’s handshake, promise and maybe a few words on a document to be signed by the borrower which meant simply, “I’ll pay you back,” has become a financial instrument, to be traded and hypothecated by faceless financial bureaucrats, each one taking a sliver of profit off the top.

Everyone remembers the crash of 2008 and plenty explanations have been posited. What the writers for Brookings explain is,

The literature has been largely silent on the liquidity vulnerabilities of the short-term loans that funded nonbank mortgage origination in the pre-crisis period, as well as the liquidity pressures that are typical in mortgage servicing when defaults are high. These vulnerabilities in the mortgage market were also not the focus of regulatory attention in the aftermath of the crisis.

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Here’s How Regulators Are Inadvertently Laying The Groundwork For The Next Housing Crisis

February 24, 2018

Here’s How Regulators Are Inadvertently Laying The Groundwork For The Next Housing Crisis

Only a few weeks ago, we pointed out a remarkable development in the US mortgage market that has significant implications not only for mortgage borrowers, but perhaps the broader economy as a whole: Wells Fargo, formerly America’s foremost mortgage lender, had seen its share of the market eclipsed by Quicken Loans – the Detroit-based, nonbank lending behemoth that pioneered applying for mortgages on the Internet with its now-famous Rocket Mortgage (readers will remember RM’s celebrity-packed SuperBowl spot).

Many factors (aside from Wells’ own criminality, which recently drew a strong, but ultimately meaningless, rebuke from the Fed) have contributed to this shift, as Bloomberg points out.

But as it turns out, the rising dominance of nonbank lenders like Quicken could portend a massive, bad-debt fueled binge reminiscent of the circumstances that led up to the housing crisis. That is to say, a wave of bad debt could create a cascading wave of defaults with repercussions far beyond the housing market.

Considering all the restrictions that Dodd-Frank and other post-crisis regulations slapped on mortgage lenders, one might wonder how this might be possible.

Of course, as Bloomberg explains, instead of making the market safer, regulators are inadvertently enabling the rise of lenders like Quicken who aren’t bound by many of the rules that restrict banks’ mortgage-lending practices. As a result, Quicken Loans is effectively free from many of the regulations that have forced some of the biggest mortgage lenders into a period of retrenchment…

Make no mistake, regulators have done plenty to rein in the mortgage business since the 2000s. New rules require that lenders carefully assess borrowers’ ability to pay, and that mortgage servicers — which process payments and manage other relations with borrowers — give troubled customers plenty of opportunity to renegotiate their debts before resorting to foreclosure.

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The 75 Trillion Dollar Shadow Banking System Is In Danger Of Collapsing

July 1, 2015

The 75 Trillion Dollar Shadow Banking System Is In Danger Of Collapsing

Shadow Banking System - Public DomainKeep an eye on the shadow banking system – it is about to be shaken to the core.  According to the Financial Stability Board, the size of the global shadow banking system has reached an astounding 75 trillion dollars.  It has approximately tripled in size since 2002.  In the U.S. alone, the size of the shadow banking system is approximately 24 trillion dollars.  At this point, shadow banking assets in the United States are even greater than those of conventional banks.  These shadow banks are largely unregulated, but governments around the world have been extremely hesitant to crack down on them because these nonbank lenders have helped fuel economic growth.  But in the end, we will all likely pay a very great price for allowing these exceedingly reckless financial institutions to run wild.

If you are not familiar with the “shadow banking system”, the following is a pretty good definition from investing answers.com…

The shadow banking system (or shadow financial system) is a network of financial institutions comprised of non-depository banks — e.g., investment banks, structured investment vehicles (SIVs), conduits, hedge funds, non-bank financial institutions and money market funds.

How it works/Example:

Shadow banking institutions generally serve as intermediaries between investors and borrowers, providing credit and capital for investors, institutional investors, and corporations, and profiting from fees and/or from the arbitrage in interest rates.

Because shadow banking institutions don’t receive traditional deposits like a depository bank, they have escaped most regulatory limits and laws imposed on the traditional banking system. Members are able to operate without being subject to regulatory oversight for unregulated activities. An example of an unregulated activity is a credit default swap (CDS).

These institutions are extremely dangerous because they are highly leveraged and they are behaving very recklessly.  They played a major role during the financial crisis of 2008, and even the New York Fed admits that shadow banking has “increased the fragility of the entire financial system”…

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