“I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it,’” Bank of Japan Gov. Haruhiko Kuroda said at a conference hosted by the BOJ on Thursday. –Kuroda 2015
April 7 – Bloomberg (Alexandre Tanzi): “US bank lending contracted by the most on record in the last two weeks of March, indicating a substantial tightening of credit conditions in the wake of several high-profile bank collapses… Commercial bank lending dropped nearly $105 billion in the two weeks ended March 29, the most in Federal Reserve data back to 1973. The more than $45 billion decrease in the latest week was primarily due to a drop in loans by small banks… Friday’s report also showed commercial bank deposits dropped $64.7 billion in the latest week, marking the 10th-straight decrease that mainly reflected a decline at large firms… The Fed’s report showed that by bank size, lending decreased $23.5 billion at the 25 largest domestically chartered banks in the latest two weeks, and plunged $73.6 billion at smaller commercial banks over the same period.”
The U.S. economy is slowing. It’s likely the long-delayed start of a major down-cycle. There’s always an ebb and flow to economic activity. Repeatedly, the U.S. economy proved resilient. The prevailing dynamic has been one of a bond market reacting forcefully to nascent signs of waning economic momentum, with sinking market yields spurring “risk on” and resulting looser market conditions. And any loosening of conditions then poured fuel on a historic bank lending boom feasting on powerful inflationary biases (i.e. surging demand; rising consumer, producer and asset prices; inflating profits, incomes and investment…)
So, today’s key question: Is the U.S. bank lending boom still intact, or has that Bubble been pierced? This touches on a fundamental Bubble dynamic: A Bubble maintaining an inflationary bias will demonstrate a powerful response to stimulus. Importantly, however, as this same bubble deflates, it will develop increasing resistance to stimulus measures.
The “tech” Bubble demonstrated powerful inflationary biases during the late nineties, exemplified by the doubling of Nasdaq the year following 1998 post-Russia/LTCM stimulus measures. Tech then turned largely immune to aggressive Fed stimulus measures in the post-Bubble 2001/2002 backdrop. Later, housing markets for years proved impervious to extreme post-Bubble reflationary monetary stimulus.
April 6 – Bloomberg (Jonnelle Marte): “Federal Reserve Bank of St. Louis President James Bullard said steps taken to ease financial strains were working and the central bank should keep raising interest rates to fight high inflation. ‘Financial stress seems to be abated, at least for now,’ Bullard told reporters… ‘And so it’s a good moment to continue to fight inflation and try to get on that disinflationary path.’ The St. Louis Fed chief said he doesn’t think tighter credit conditions stemming from the recent banking turmoil will be substantial enough to tip the US economy into recession, noting that demand for loans is still strong.”
James Bullard might be right. And I’m the first to proclaim “Bubbles go to unimaginable extremes – then double” and “call the end of a Bubble at your own peril.” They tend to show extraordinary resilience – until they suddenly don’t. And there remain strong inflationary biases throughout the economy that will work to sustain loan demand.
But I don’t believe Bullard, the Fed or any of us should dismiss ramifications of a significant tightening of bank lending standards following years of lending and Credit excess. We witnessed not that many years ago how a tightening of lending for subprime mortgages marked the beginning of the end to the great mortgage finance Bubble. At the time, subprime was dismissed by the Fed, Wall Street analysts, pundits and about everyone.
April 3 – Reuters (Chibuike Oguh): “Blackstone Inc said… it had again blocked withdrawals from its $70 billion real estate income trust in March as the private equity firm faced a flurry of redemption requests. Blackstone has been exercising its right to block investor withdrawals from BREIT since November after requests exceeded a preset 5% of the net asset value of the fund. BREIT fulfilled March withdrawal requests of $666 million, representing only 15% of the $4.5 billion in total redemption requests for the month, the firm said in a letter to investors.”
When market financial conditions tightened in 2022, the pullback in corporate debt issuance was more than offset by booming bank and non-bank lending. So-called “private Credit” was expanding rapidly, a new Wall Street darling viewed as less susceptible to rising rates and market volatility. The bloom is off the rose. Investors in Blackstone’s BREIT and similar new investment vehicles understood they were making somewhat of a compromise with liquidity. But I doubt they had any idea they would be left waiting months to get their money out.
A major tightening of real estate lending is now unfolding. Tighter bank lending will be compounded by a pullback in “private Credit” and other non-bank lenders. This is particularly problematic for earnings and loan quality for small and mid-sized banks that have operated so aggressively in real estate finance over recent years. Office buildings are an obvious trouble spot, but commercial real estate in general is vulnerable. Moreover, cracks are appearing in the booming nationwide apartment marketplace, and there are indications of waning institutional interest in residential housing.
Ten-year Treasury yields declined eight bps this week (though futures yields popped on Friday’s payrolls data) to a 2023 low of 3.39%. At 5.00%, the rates market is pricing a 70% probability for a 25 bps rate hike on May 3rd. But between then and the FOMC’s December 13th meeting, markets anticipate a dovish pivot with three 25 bps rate cuts.
The stock market will do what the stock market wants to do. But I wouldn’t dismiss the warning signaled by bond and rate markets. SVB will be one of scores of “accidents.”
When I contemplate the scope of boom-time excess, serious market structure issues, financial system fragilities and economic maladjustment, I don’t see how a major crisis can be averted. But I’m mindful that this could play out differently than 2008.
During the (2005 to 2007) peak of mortgage finance Bubble excess, mortgage Credit accounted for upwards of half of total U.S. Non-Financial Debt growth. And much of this risky Credit was intermediated through Wall Street’s securitization and derivatives markets. Directly and indirectly, there were enormous amounts of mortgage-related speculative leverage. The Lehman Brothers panic and market dislocation caused an abrupt and dramatic lending shutdown and Credit collapse for the marginal source of finance fueling the U.S. Bubble economy and financial markets.
Over the past three years, mortgage Credit has accounted for about a quarter of total Non-Financial Debt. Non-mortgage bank loans over the past three years ($1.5 TN) are almost double the 2005-2007 level. Asset-backed Securities (chiefly riskier non-GSE mortgage securities) surged $1.9 TN over the three years ’05-’07. ABS increased about $300 billion over the past three years. GSE MBS expanded $1.1 TN in ’05-’07 versus $280 billion 2019-2022.
Bank Assets ballooned $5.5 TN over the past three years – versus $3.0 TN for the period ’05 to ’07. The point is that the banking system has been playing a greater role in financing this Bubble – and securitizations much less. The system would appear these days to be less acutely vulnerable compared to 2008 for an abrupt stoppage of key sources of finance for the U.S. economy.
Unlike 2008, securitization and derivatives markets might not today be the epicenter of systemic vulnerability. Instead, the banking system is sitting on much greater Credit risk than when mortgage risks were offloaded to the markets during the mortgage finance Bubble. At $25.6 TN, Banking System Assets ended 2022 almost double the 2007 level.
From Fed Z.1 data, Financial Sector debt growth jumped to a 9.66% rate last year, the strongest since 2007’s 13.50%. Most macro analysts disregard Financial Sector debt, believing that incorporating it in analysis would be “double counting” borrowings already included elsewhere (i.e. mortgage and business). Especially late in the Credit cycle, a jump in Financial Sector borrowings signals a surge in risk intermediation – fateful late-cycle intermediation that will come back to haunt the financial sector and economy when the Bubble bursts.
GSE Assets expanded an unprecedented $2.094 TN, or 29.4%, over the past three years to a record $9.224 TN. I’ve previously noted that FHLB Assets surged $524 billion, or 72%, in 2022 – with indications for Q1 growth upwards of (a stunning) $400 billion.
I highlight the GSEs because they play an instrumental role in system stability. With implicit and explicit Treasury backing, their Trillions of debt obligations provide a pillar of stability for the Credit system. Their three-decade role as quasi-central bank emergency liquidity providers has thwarted many liquidity crises, ensuring a major Bubble evolved into a historic one.
The GSEs are highly leveraged and vulnerable. That Fannie and Freddie were incapacitated (from accounting scandals) in 2008 was a major factor in how the crisis unfolded. As for today, we can think of the GSEs as a stabilizing force – until they’re not. The FHLB has been playing a pivotal role – last year prolonging the lending boom and last month stabilizing bank liquidity. But how sustainable is the ballooning of FHLB balance sheets? A slowdown in growth would have major consequences for the banking system, just as it heads into challenging times. A GSE in trouble would have immediate and far-reaching systemic ramifications.
I’m uncomfortable that the GSE’s have become such dominant borrowers in the money market. Moreover, there are alarming Bubble elements in the massive expansion of money fund assets. Money Funds have inflated $663 billion, or 33% annualized, since the end of October (to a record $5.247 TN). Since the start of the pandemic, Money Funds have expanded $1.630 TN, or 45%. My baseline analysis views the situation as an unfolding banking system crisis that will over time envelope the non-bank sectors. Instability in the money fund complex would spark something more like 2008.
So many lessons, including that amiable central bankers with infectious smiles are the most dangerous. I have a difficult time believing Haruhiko Kuroda would have been left unchecked to run his fateful experiment for a full decade if he wasn’t so likable. Such a nice guy wouldn’t ever fleece Japan’s savers and jeopardize Japanese and global stability. If only Haruhiko was an a-hole.
April 7 – Bloomberg (Toru Fujioka and Sumio Ito): “Haruhiko Kuroda spoke to reporters one last time as the Governor of the Bank of Japan on Friday, ending a decade-long term filled with surprises that shook global financial markets and transformed the image of the central bank previously known for doing too little, too late. He ended his 10 years expressing regret that his goal ultimately wasn’t achieved, but said the possibility of reaching stable price growth is higher. ‘The time for achieving the 2% stable price goal is now getting close,’ Kuroda said. ‘The norms surrounding prices are changing’… After being picked by Abe, Kuroda opened a new chapter for central banking with aggressive easing.”
April 3 – Xinhua: “The Bank of Japan (BOJ) bought a record 135,989 billion yen (1.02 trillion U.S. dollars) in Japanese government bonds in fiscal 2022, almost double the amount a year earlier, the central bank said. To counter increased bond sales in the market caused by its yield control policy, the BOJ actively bought 10-year and other government bonds in the year through March, the largest amount on record, topping the previous high of 115,800.1 billion yen marked in fiscal 2016.”
April 5 – Bloomberg (Toru Fujioka): “Within weeks of taking office a decade ago, Bank of Japan Governor Haruhiko Kuroda fired his ‘shock and awe’ stimulus targeting a return to steady 2% inflation in around two years. As his tenure ends, the original ‘time horizon’ remains largely that — something within sight but out of reach. Through 10 years of experimental policy that rewrote the rules of global central banking, Kuroda’s BOJ forked out 1.55 quadrillion yen ($11.7 trillion) on bonds, stock funds and corporate debt. Deflation was tamed though not vanquished; businesses were kept afloat and zombie companies plodded on; workers kept their jobs even as productivity flat lined; the government funded vast spending programs and the deficit deepened; and the economy eked out modest expansions, though only Italy grew slower among major economies. The staggering cost has economists asking: ‘Was it all worth it?’”
Inflationism is always such a slippery slope. History is strewn with measured and transitory bouts of money printing (monetary inflation) morphing into around-the-clock and around calendars. Was it worth it? No way.
The ratio of Bank of Japan Assets-to-GDP was about 32% when Kuroda was nominated for BOJ Governor in February 2013. It is today at a staggering 131%. BOJ Assets inflated from 160 TN yen to 735 TN – or about $5.6 TN dollars. The BOJ holds $4.4 TN of Japanese government bonds, a now dysfunctional “market” that trades with little liquidity and completely divorced from underlying fundamentals. Japanese debt has inflated to 264% of GDP. One dollar bought 93 yen in February 2013. Today it will get you 132 sharply devalued Japanese yen.
Kuroda back in 2013 unleashed the Abenomics “bazooka.” It’s now up to the disarming Kazuo Ueda to attempt to negotiate an armistice. It’s anything but clear why the markets would be willing to participate. They’ve been waiting years for the BOJ to either run out of ammo or the will to fight.
There is never a convenient time to burst a Bubble. Today is an especially inopportune juncture. Global markets are fragile and global leveraged speculation vulnerable. It’s worth reminding readers that Japan’s serious structural issues date back to its eighties Bubble period. In contrast to Beijing these days, Tokyo appreciated in 1989 that its runaway Bubble posed a grave risk to Japan’s future – economically and socially.
For the first two post-Bubble decades, patient Japanese policymakers refrained from doing anything stupid. But Bernanke and others publicly berated their stupidity for not massively inflating. And with the Fed, ECB and other central banks’ inflationary measures seemingly bearing fruit, eventually this criticism could no longer be deflected. A decade later, the Kuroda BOJ’s inflationary experiment has been a monumental failure – the scope of which will be exposed as Ueda attempts the wretched duty of repressing the printing presses.
The biggest lesson from Kuroda’s rein: No individual (or small group) should ever have such absolute power to inflate – in Tokyo, Washington, Frankfurt, Beijing or elsewhere.
Original Post 8 April 2023
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Categories: Doug Noland