We have received many questions on what shadow banking really is. Here is one of the easiest explanations, courtesy Azizonomics.
Meet James. James bought a house. It cost him $150,000, of which $30,000 had come from his own savings, leaving him with a $120,000 30-year fixed-rate mortgage from the WTF Bank, with a final cost (after 30 years of interest) of $200,000. Now, up until the ’80s, a mortgage was just a mortgage. Banks would lend the funds and profit from interest as the mortgage is paid back.
Not so today. James’s $200,000 mortgage was packaged up with 1,000 other mortgages into a £180 million MBS, (mortgage backed security), and sold for an immediate gain by WTF Bank to Privet Asset Management, a hedge fund. Privet then placed this MBS with Sacks of Gold, an investment bank, in return for a $18 billion short-term collateralised (“hypothecated”) loan. Two days later Sacks of Gold faced a margin call, and so re-hypothecated this collateral for another short-term collateralised $18 billion loan with J.P. Morecocaine, another investment bank. Three weeks later, a huge stock market crash resulted in a liquidity panic, resulting in more margin calls, more forced selling, which left Privet Asset Management — who had already lost a lot of money betting stocks would go up — completely insolvent.
Guest post by Peter Tchir.
The one source of sellers that is missing, is the correlation desk. With that gone, you miss the leverage of some “less than smart” bank selling $100 million of mezz protection that turns into $1 billion of the sketchiest names out there, but the situation on bank hedging is interesting. Need to get through ECB this week, and some realistic quantification of LIBOR liebility, but CDS seems set to outperform stocks and bonds.
Is IG18 going to zero?
Probably not, but I think we could see an “eclipse” this week where IG18 trades lower than HY18. That has often been a sign of continued bullishness (though it failed in March) and I think IG could set new tights for the year.
I don’t particularly like U.S. equities here. I don’t like the ETF’s or liquid bonds. I like less liquid bonds as the liquidity premium is too high right now. I continue to think that High Yield High Beta CDS can be Highly Rewarding as we sent out on July 13th. But I’m becoming more convinced that IG CDS can perform extremely well here.
Before explaining my rationale, it is worth looking at this chart.
Could the Euro mess be saved by simply pushing CTRL ALT DELETE, rebooting the Economy and then cushioning the fall? Der Spiegel shares some of Wagenknecht’s left wing ideas.
If there is one thing that has seemed to characterize the euro crisis, it is the lack of alternatives. The common currency bailout fund, for example, had to be vastly enlarged to prevent financial markets from plunging the common currency zone into chaos. Spain had to be given billions in aid to prevent its banks from collapsing and making the situation even worse. The list of instances in which European leaders have made moves they’ve called mandatory is long.
Another must read piece by Grant Williams.
The change in the structure of Japan’s population over the past 50 years is starkly reflected in the country’s population pyramid which looks ever more shaky with each passing year while the forecasts for 2050 are, frankly, frightening (chart, above).
By 2050, Japan’s population is projected to fall to 90m. Incredibly, as recently as 1990, the number of working Japanese was three times that of both children AND the elderly.
In 2011, Japan’s budget for social welfare was ¥90 trillion but that was at least ¥1 trillion short of where it needed to be, precipitating further issuance of government bonds and that, on top of the increased strain caused by the Kansai tsunami has Japan’s bond market teetering on the edge of implosion—still.
A 2011 report from the National Institute of Population and Social Security Research (could that BE any more Japanese?) shed some light on just how fast things could deteriorate from here: