
The Looming Bank Collapse - sajid
https://www.theatlantic.com/magazine/archive/2020/07/coronavirus-banks-collapse/612247/
======
solatic
It doesn't matter if the banks crash again if the Fed will just bail everybody
out again and push stock market inflation even higher than it is now. It's
clearly unsustainable, but the question is, how and why will the bubble burst?

The author posits one option, of political intervention precluding another
bailout. But the Federal Reserve is non-political precisely to shield it from
attempted short-term political machinations. Congress will complain to the
cameras and the Fed will go right back to "rescuing" the market.

No, the bottom will only well and truly drop out when there's significant
capital flight - when the dearth of real investment opportunities relative to
currency glut becomes so acute that capital leaves American borders in search
of real return. But to where? And under which circumstances?

~~~
mdorazio
Think you nailed it. The thing is, in order for capital flight to be a risk
there needs to be somewhere else of comparable size and upside opportunity to
the US that doesn't rhyme with "China" and it sure as hell isn't Europe. So
we're back to square one in which absolutely massive sums of money are chasing
returns with nowhere else to put money than the same places it already is.
It's madness on a global scale.

~~~
burlesona
This is the insanity of zero interest rate policy. It’s so hard for me to
understand why the economists and fed officials don’t see this.

~~~
QuesnayJr
It's not that we don't see it, but we don't agree. I honestly don't have the
energy to try to explain it here anymore -- the conversation always turns
unpleasant, and I need a place on the Internet where I can avoid thinking
about economics for a while.

~~~
cryptica
>> the conversation always turns unpleasant

Rationalizing the irrational tends to be unpleasant.

I think it's a complete fabrication that people are dependent on the financial
system and that we need economic stability. People enjoy drama and they are
able to recover from any economic failure. Even total failure.

Too big to fail is total BS. If a solar storm wiped out all records of bank
accounts and all records of all financial holdings, the economy would quickly
recover. The number of new opportunities that this would create would be
unprecedented.

From the perspective of most people, the best feature of capitalism is not its
ability to provide sustenance (even communism can do that), it's its ability
to provide hope for something better... Unfortunately these days our modern
version is not true capitalism, it's crony-capitalism and it doesn't yield
much hope - You are given a place in society and the only way you can get
something better is by doing something deeply unethical and then earning hush
money from your corporate masters.

We are heading towards a dystopian surveillance capitalist future. Even if the
economy crashes permanently and never recovers, that future doesn't look so
bad compared to what would happen if we stay on course with current monetary
policies.

~~~
QuesnayJr
Oh look, the conversation has turned unpleasant again. How unpredictable.

~~~
cryptica
Well I find it pleasant.

------
rufusroflpunch
We never "righted" the system after 2008 (or 2001). We just kicked the can
down the road, making the problem worse for ourselves when we eventually do
finally lose control. Our system is 100% entirely dependent upon ARTIFICIALLY
low interest rates driven by Central Banks. It's the only still keeping this
zombie of an economy moving, and it's the entire world, not just the United
States.

Central banks are doing everything in their power to keep interest rates low
because if they were to tick up even a little bit, the whole house of cards
will come toppling down. They can't do it forever and we're all just playing
chicken with hyperinflation.

~~~
itsoktocry
> _Our system is 100% entirely dependent upon ARTIFICIALLY low interest rates_

There is no such thing as "artificial" or "natural" rates of interest.

> _Central banks are doing everything in their power to keep interest rates
> low because if they were to tick up even a little bit, the whole house of
> cards will come toppling down._

Why would, or should, they "tick up"? Capital is abundant. If rates were
higher, things would be different, yes. But that is not the world we live in.

> _It 's the only still keeping this zombie of an economy moving, and it's the
> entire world_

I love the idea that the _entire_ global economy is fake, artificial and
zombie-like, because it doesn't operate the way you think it should. A
reasonable person would take a step back and question their premises and
understanding.

~~~
vsareto
>I love the idea that the entire global economy is fake, artificial and
zombie-like, because it doesn't operate the way you think it should. A
reasonable person would take a step back and question their premises and
understanding.

The new part is the _expectation_ that governments will prop up companies
during bad economies.

This is bewildering to anyone with a naive view that believes America is a
purely capitalistic economy. Surely if a company prepares enough for the
storms, it's worthy of surviving them. Running thin savings is now more risky,
but it means more profit. That's fair.

From another perspective, it's economic innovation where unpredictable
disasters don't kill huge companies or industries. This can be a good thing,
but it's not really capitalism any more.

So the person taking a step back will ask, "How far will the government go to
protect large companies? How large do you have to be to get this protection?
How does all of this work?" This is what we can't answer.

This is where people (rationally) start to believe things are fake, because
the country's leadership gets to decide what happens to companies during these
times.

Now this company knows the government is likely to bail them out, what reason
do they have to plan for the worst any more? This gets even more uncomfortable
when they get bailouts for causing the disaster themselves.

~~~
mrep
The only companies the government is propping up are the airlines and small
businesses by mainly paying for their payroll to keep people employed through
the CARES act [0]. In what way is the government protecting large companies?

[0]:
[https://en.wikipedia.org/wiki/CARES_Act](https://en.wikipedia.org/wiki/CARES_Act)

~~~
vsareto
Exactly, it's protecting large airlines from going under. This means there's
less risk here than if the government had not intervened. Any future pandemic
will likely result in a similar response, therefore, airline stocks have
reduced risk of becoming worthless.

At a basic level, if you removed all demand for airlines, you'd say "well,
airlines don't look like a great investment". But now the demand matters less
during disasters because demand isn't actually keeping the company alive as in
most businesses.

------
thephyber
I've long read about the following still being a problem (post-2009):

\- CDOs (although a new generation of them have a new name/initialism)

\- Frank/Dodd was partially rolled back

\- The definition of bank size-classes was changed to reduce the regulatory
burden over most regional banks that were previously more regulated

\- No significant adverse event happened after Standard & Poors was identified
as having significantly inaccurate ratings on CDO / mortgage bond

\- moral hazard all over the financial sector, multiplied by large QE rounds

\- shadow inventory of housing (not sure if this was sold off or if banks
still hold lots of houses off the market)

\- lots of private unicorns have opted not to try to go IPO, despite Wall
Street records over the past few years

(edit: I converted the indented list to individual paragraphs)

But given these assumptions, are the US financial markets really that healthy?
It still feels like we have a few asset bubbles, especially in the assets
which QE propped up.

~~~
yodon
As a head's up a huge fraction of HN's readers read on mobile where code
formatting like you used here makes posts unreadable.

~~~
thephyber
Yes, I've heard, but there isn't a suitable replacement format that I've seen
for a bulleted list.

The formatting doc[1] is very short and doesn't include a list.

[1]
[https://news.ycombinator.com/formatdoc](https://news.ycombinator.com/formatdoc)

------
kerkeslager
> The federal government stepped in to rescue the other big banks and
> forestall a panic. The intervention worked—though its success did not seem
> assured at the time—and the system righted itself. Of course, many Americans
> suffered as a result of the crash, losing homes, jobs, and wealth. An
> already troubling gap between America’s haves and have-nots grew wider
> still. Yet by March 2009, the economy was on the upswing, and the longest
> bull market in history had begun.

This paragraph is conceding a point that should not be conceded. The system
_did not_ right itself if many Americans lost homes, jobs, and wealth. 12
years later, not everyone has recovered from the 2008 collapse.

~~~
lazide
What criteria should someone use to judge 'righted itself'? No event can ever
be completely undone, merely compensated for. Many of the people who lost
homes should never have bought them leading up to '08 - they only were able to
because of unrealistic (and sometimes predatory) underwriting standards and
financing that NEVER would have worked out, and blew up shortly thereafter
once the people bankrolling it figured out what was going on.

The overall economy recovered, but of course it looked a bit different. It was
4-5 years later.

~~~
Klinky
Mortgages should have been heavily renegotiated, bailout given to the home
owners to pay back the mortgage in a bottom-up bailout. Let's throw in
existing homeowners as well, who had made proper payments in the mix, so they
get some benefit from the situation.

Instead lots of money handed over to banks to fix their books and toxic assets
handed over to the .gov. Lots of people losing their homes and jobs, no one in
the financial sector really seeing any jail time or penalty for their
malfeasance. Much of the financial sector actually made off quite well
during/after the crisis.

We're seeing it again with big businesses getting COVID bailouts, meanwhile
politicians are wringing their hands that unemployment insurance benefits are
"too high" and "main street" needs to get back to work. Make sure "main
street" is held accountable and/or penalized, but it seems there are a lot of
golden parachutes and soft landings for big business and the finance
industries.

------
dia80
Meh, the article doesn't mention recovery rates. If a loan defaults it's not
usual you are getting 0 back. Typically 30-40% is the assumed rate. That means
if all the loans default then the top 30% of tranches shouldn't take a loss.

So now consider, most of the underlying loans have to default and the recovery
rate has to be below battle tested assumptions before the top tiers get risky.
This is very very unlikely to happen given the Fed and the US Govt. have done
so much and are committed to do more to stave off a severe depression /
recession. It's more like people were killing it buying the safer parts at
distressed prices as over leveraged funds shed them on the back of margin
calls in March.

~~~
mycl
It says this:

> We already know that a significant majority of the loans in CLOs have weak
> covenants that offer investors only minimal legal protection; in industry
> parlance, they are “cov lite.” The holders of leveraged loans will thus be
> fortunate to get pennies on the dollar as companies default—nothing close to
> the 70 cents that has been standard in the past.

~~~
rmrfstar
Also, a lot of people make 10x levered bets on AAA instruments, which means
even a 10% loss can wipe you out.

The trick is "repo", or repurchase agreements.

(1) Buy bonds

(2) Use those bonds as collateral for a low-interest loan

(3) Use the loan money to buy bonds

(4) goto 2

See, e.g [1]

[1] [https://www.bloomberg.com/news/articles/2020-04-15/how-
repo-...](https://www.bloomberg.com/news/articles/2020-04-15/how-repo-
agreements-juiced-securitized-debt-leverage-quicktake)

~~~
dia80
The "haircut" on risky assets stops you leveraging it too much. I think it's
about 5% for US treasury bonds. So for every 100 I want to finance I need to
have 5 cash on hand. Itsuch higher for riskier assets and that keeps leverage
down. Also when things start to get edgy banks demand a bigger haircut further
reducing the available leverage forcing you to delever (e.g. March)

~~~
rmrfstar
If you step through the arithmetic, you see that a 5% haircut can take you to
20x leverage. It's a geometric series.

That means that investors' internal risk limits are the binding constraint,
not repo haircuts.

It's another way of saying that the financial sector sets its own leverage.
Historically, that has not turned out well. It's why Dodd-Frank included a
leverage rule for large banks.

~~~
whatok
> That means that investors' internal risk limits are the binding constraint,
> not repo haircuts.

While part of risk, expected return is a larger binding constraint in most
cases over risk limits. I'm probably not going to lever up 20x for an tiny
expected return. On the other hand, I may very well lever up 5-10x on
something 50x more risky than treasuries if the 10yr is yielding 0.725%.

~~~
rmrfstar
In practice most PM's have a VaR limit and a battery of dollar exposure
limits, which are all set by the risk department.

There is some credible research which suggests that large financial
institutions act as if they are optimizing mean return subject to a VaR
constraint [1].

[1] [https://www.nber.org/papers/w18943](https://www.nber.org/papers/w18943)

~~~
whatok
VaR is a fake number for way too many reasons to get into and anyone who paid
attention to VaR these past few months would have lost a ridiculous amount of
money. I only have experience working for hedge funds and how risk is managed
greatly differs from fund/strategy/assets traded. Banks no doubt manage to VaR
but banks also supposedly don't have prop trading desks anymore so they
function much differently now.

~~~
rmrfstar
The discussion seems to have shifted to argument for argument's sake.

But for the sake of argument: large bank VaR models affect hedge funds because
hedge funds get their leverage through their prime brokers which are... large
investment banks.

------
danielovichdk
From an outsider living a long way from USA, for many years now I haven't
understood how the financial instruments of USA work. It constantly looks like
the country is merely printing more money to stay afloat.

~~~
Diederich
US native here.

If I printed some $100USD bills, took them to the bank and tried to deposit
them, they would have no value. The consensus is that you aren't allowed to
print money.

The United States Government prints money all the time. This money has value
because there is a world-wide consensus that it has value.

The simple fact is that there is and has been (for many decades) no safer
place to park vast sums of money than with the United States Government.

There are limits, though it's not clear what they are. If the US Government
printed 330 billion trillion dollars, and gave a trillion to each US citizen,
then the consensus would be instantly broken.

The US Government printing 'a trillion here, a trillion there', at this moment
in history, is not materially damaging the global consensus. This confidence
is relatively easy to measure: when the US creates more debt, are there
buyers? The answer is and has been for many decades 'absolutely yes'.

I'm not trivializing this borrowing, and I'm not vilifying it. It is a unique
tool that should be used wisely.

~~~
throwaway_jobs
> The United States Government prints money all the time. This money has value
> because there is a world-wide consensus that it has value.

No the Government borrows against future taxes (consider that an accounts
receivable), the borrowed money doesn’t have value because of consensus it has
value because it is backed by future tax revenue.

If the government did as you say and borrowed a trillion per taxpayer the
system would breakdown but not because of some “consensus” but because the
account receivable (future taxes) is insufficient to payback the borrowed
money.

~~~
jfengel
It is rather astonishing that rational people continue to believe that there
is enough future tax revenue to justify this. It's entering dotcom-boom
territory, where even the most optimistic future profitability can't justify
this level of backing.

Part of it, I imagine, is that the US government is likely to benefit from
future tech booms, as it has in the past (despite tax shenanigans from the
tech companies themselves). It gets a piece of stock market profits -- a stock
market whose own levels are also currently out of keeping with rational
revenue expectation.

~~~
catsdanxe
So what would a rational person do? Stockpile guns and food? Invest in gold?

~~~
atemerev
Brace for impact. If and when the shit hits the fan, there will be no strategy
_at all_ to keep the same economic levels. Everybody will suffer.

~~~
jessaustin
The assholes keep telling us this. If they believed it, one suspects they'd
change their behavior.

------
cm2187
Idiotic article. First a CLO is essentially a portfolio of loans. You can call
that gambling, and in a way, every financial risk is gambling, but it is the
very job of a bank to take credit risk, and to lend.

Then, I don't know about Wells specifically, but it is possible that these
CLOs may not even be external transactions, that the bank securitised its own
loans so that it stands ready to post them to the central bank as collateral
to get short term funding in exchange, if a liquidity crisis hits. If it is
the case, it is actually a good thing.

The banking system is increadibly strong vs 2008, the amount of capital banks
hold is a multiple of what they held in 2008, while having reduced the size of
their balance sheets at the same time (ex Chinese banks). They hold huge
amounts of liquid assets and have limits on how much short term funding they
can rely on. In addition the introduction of bailin should protect tax payers
in the case of a bank failure.

I would be much more worried about the financial impact of money printing. The
amount of QE that the Fed has introduced is unprecedented, both in size and
velocity, and they keep printing. And we are only at the begining of this
downturn. This will massively distord the markets. And I don't believe it will
not create inflation ultimately, which is a much bigger threat to savers than
their bank credit risk.

~~~
whatok
Agree with a majority of this. US bank balance sheets are in a whole different
universe than they were during the last crisis. CLOs are not only a minuscule
portion of their holdings but they also hold a tiny percentage of outstanding
CLOs.

Japanese co-op banks on the other hand have huge CLOs holdings and would be
extremely exposed if these went sour.

------
nknealk
> I have a checking account and a home mortgage with Wells Fargo; I decided to
> see how heavily invested my bank is in CLOs. I had to dig deep into the
> footnotes of the bank’s most recent annual report, all the way to page
> 144... The total is $29.7 billion. It is a massive number. And it is inside
> the bank.

To put $29.7B that into context -- Table 4 of the most recent 10K says that
Wells has ~1.7 trillion dollars of earning assets. Tables 1 & 2 indicate they
hold around 180B of shareholder capital buffer.

~~~
thephyber
Your appraisal seems fair... of the data you are working with.

But how many other financial instruments they own are tied up in CLOs on the
books of other banks?

The whole point of The Big Short and Margin Call was that the banks aren't
resilient, independent silos. When one bank shakes or falls, it can impact the
neighboring bank which causes a domino effect. They all invest in slices of
the things that the other banks invest in, they all do it with lots of
leverage, and they all think they've hedged against the downside risk, but
that still didn't prevent the 2008 collapse.

~~~
clairity
that's literally herding behavior, which is the loss of independence among
market participants, so that risks start to align, rather than cancel each
other out.

it's disgusting that we haven't learned anything from 2008.

~~~
thephyber
To be fair, I think every financial instrument works this way (the transitive
property of assets which own assets) all the time.

Having regulations which restrict which companies are allowed to trade
specific classes of instruments/services (eg. Glass Steagall) helps mitigate
this, but doesn't even approach eliminating it.

~~~
clairity
it does work that way far too often, and that's exactly the problem.
financiers are no smarter than other kinds of market participants, and that's
what this shows.

markets _require_ relative participant independence for pricing and allocation
to function properly, otherwise we get bubbles. and now, we get constant
bailouts (of capital, not labor), so on top of that, there's no downside risk
to provide any counterbalance. it's corrupt.

------
bostik
Having just read both Liar's Poker and Barbarians at the Gates, the concept of
CLOs sounds awfully familiar.

Loaning money to high-risk companies? Bundling a whole bunch of said loans
into securities? High returns despite the risk of a significant fraction of
defaults? Sounds like the world has been here before.

If this was a B-flick, it might well be called the return (or revenge) of the
junk bond monster.

~~~
Grimm1
This sounds entirely the same and this time the industry probably thought they
were so clever because companies are likely still less risky than individual
consumers and then oops Corona!

------
nine_zeros
So what? There is only one game out there and its called printing money.

We have bad loans on the books? Oops, nothing we can do here and can't have so
many foreclosed lower valued assets. Print.

If anyone looked at billionaire net worths, they would know that
hyperinflation is rampant. The only reason it doesn't show up in the cost of
Milk is because the peasants (we the people) fight for scraps and are willing
to take smaller slice of the pie.

In other words, the Bernanke trick of inflating assets in 2008 did its job. It
inflated assets and the size of the pie increased. But 90% of the participants
still have a lower share of the pie.

------
stuntkite
How come no one is talking about the fact that a couple months ago our banks
went from fractional reserve to zero reserve? If that doesn’t scream disaster
is expected I don’t know what does. Literally anyone can form a banking org,
get fdic insurance and print. money. out. of. thin. air.

If you aren’t doing it yourself already, maybe you should. I’m gonna try and
maybe make a medium.com post about it.

------
empath75
> I ran my finger across the page to see the total for these investments,
> investments that Powell and Mnuchin have asserted are “outside the banking
> system.”

> The total is $29.7 billion. It is a massive number. And it is inside the
> bank.

What percentage of Wells Fargo's assets is that? It looks they they've 1.9
trillion in assets, so even they were worth nothing, would it have a material
impact?

~~~
tvb12
> The banks themselves may reveal that their CLO investments are larger than
> was previously understood. In fact, we’re already seeing this happen. On May
> 5, Wells Fargo disclosed $7.7 billion worth of CLOs in a different corner of
> its balance sheet than the $29.7 billion I’d found in its annual report.

There might be more?

------
Ambele
If the banks aren't paying interest on deposits anymore, does it now make
sense to withdraw some of the money and store it under a mattress somewhere?

Obviously there are theft, fire, and police confiscation risks that need to be
overcome first.

------
dustingetz
America can afford to prop it up for as long as the dollar is in demand for
international trade, and she will use her naval superiority to make sure of
that

~~~
jessaustin
OK now I'm worried. Our navy seems unequal to the task of not running into
other ships by mistake.

------
WarOnPrivacy
> "I have a checking account and a home mortgage with Wells Fargo"

Casting literally every inch of his financial judgment into doubt.

Or maybe we've just been pranked

------
gridlockd
_" There are more than $1 trillion worth of leveraged loans currently
outstanding. The majority are held in CLOs."_

To get some perspective, the FED recently added almost three trillion dollars
of "not QE" to the balance sheet, mostly because of COVID-19.

They'll be bailed out.

 _" But this time, the bailout proposal will likely face stiffer opposition,
from both parties"_

Doubtful. Everything can be blamed on the virus this time.

~~~
mrep
What part of the FEDs balance sheet [0] are you concerned about getting bailed
out because it is pretty much entirely composed of the US government's own
debt through US treasury securities and citizens homes through mortgage backed
securities?

[0]:
[https://www.federalreserve.gov/releases/h41/current/h41.htm](https://www.federalreserve.gov/releases/h41/current/h41.htm)

~~~
gridlockd
I'm saying the banks holding CLOs will get bailed out much in the same way as
those holding mortgage-backed securities. I'd be concerned if this _didn 't_
happen.

------
nojito
It doesn’t matter if CLOs collapse. The capital requirements that banks
operate under will ensure that they will withstand it.

~~~
RandomBacon
That's sarcasm right? The capital requirement has recently been dropped to
zero.

Edit for source:
[https://www.federalreserve.gov/monetarypolicy/reservereq.htm](https://www.federalreserve.gov/monetarypolicy/reservereq.htm)

~~~
whatok
Reserve requirements != capital requirements. Reserve requirements are vs
deposits, capital requirements are vs balance sheet items. Big difference
between the two.

------
apta
The current economic system is fundamentally flawed. Unless someone has the
courage to ban interest/usury, things will stay the way they are. We have
known this for thousands of years now, but unfortunately greed and
exploitation persists.

------
ed25519FUUU
Buried lede warning.

> _But there’s another threat to the economy, too. It lurks on the balance
> sheets of the big banks, and it could be cataclysmic._

(10 paragraphs later)

> _I ran my finger across the page to see the total for these investments,
> investments that Powell and Mnuchin have asserted are “outside the banking
> system.”

The total is $29.7 billion. It is a massive number. And it is inside the
bank._

