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demography, demagoguery, and the brewing liquidity panic


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Posit: "ok boomer" are convinced that their perpetual motion machine (supporting asset prices with perpetually increasing borrowing) is unfailing magic.

So what happens when demography at the polling station (or the investors' AGM) tips towards generation debt?

Tax receipts are only as sure as the political will to collect them.

And in the private sector, bondholders only come first when nothing's left (ie: in administration).

 

To restate, succinctly: the assetless indebted reason about the world differently to model.

 

Conclusion: we're heading towards the mother of all liquidity panics.

Edited by ParticleMan
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46 minutes ago, zilly said:

What's a 'liquidity panic' when it's at home?

I guess it's where people can't meet minimum debt repayments. Lots of people. And then the bankers owed all the money have a bit of a moment.

Edited by Si1
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46 minutes ago, Si1 said:

I guess it's where people can't meet minimum debt repayments. Lots of people. And then the bankers owed all the money have a bit of a moment.

I suppose you could split liquidity into 2 groups

Liquidity for banks - either lending to each other, or borrowing from govt/central banks. Seems the CBs will keep that propped up until the 

Liquidity for customers - much more constrained by credit rules. I think back to the Northern Irish House collapse, 50 % drop in house prices and they still wouldn't let people out of their mortgages. Created a pile of negative equity/200% mortgages to sweep up that debt instead. 

I worked for an Irish Bank 10 years ago. If the same thing happens again but to the retail lending market (loans/overdrafts etc) then I suspect what will happen is this. 

A pile of customers stop paying their loans - you then have to reassess your entire loan book - say £20BN.

Initially the bank does nothing and let's the debts build slowly, when it becomes apparent its a systemic issue, they will suddenly cut the value of the loans by recognising a potential 'bad debt' of, say 75%.

So the bank makes an accounting adjustment predicting only 25% of the loans due will be paid. The banks is now in possession of £5bn of good loans, and a provision for bad debt of £15bn

They can't hold the bad debt on the balance sheet because it completely screws the capital they have to hold. The basel rules now put them under pressure to get rid of the loans instead of ride out the economic problem. 

They sell the bad debt to a business like cerebrus, maybe they get £2.5bn for £15bn of loans

So the bank has £5bn of good loans £2.5bn of cash and that leaves a 'hole' on the balance sheet of £12.5bn. The Govt/CB will be falling over themselves to lend that money, which is the 1st kind of liquidity. 

The bank is 'whole' again and a crisis is averted. 

The real losers here are the mugs with the loans. Cerebrus won't let them out of that debt and will be far more aggressive in pursuing cash, or punishing customers who can't pay. Cerebrus have paid £2.5 bn for those loans they will now be under pressure to get as much of the original £15bn back as possible. That's what makes them very, very rich. 

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27 minutes ago, regprentice said:

I suppose you could split liquidity into 2 groups

Liquidity for banks - either lending to each other, or borrowing from govt/central banks. Seems the CBs will keep that propped up until the 

Liquidity for customers - much more constrained by credit rules. I think back to the Northern Irish House collapse, 50 % drop in house prices and they still wouldn't let people out of their mortgages. Created a pile of negative equity/200% mortgages to sweep up that debt instead. 

I worked for an Irish Bank 10 years ago. If the same thing happens again but to the retail lending market (loans/overdrafts etc) then I suspect what will happen is this. 

A pile of customers stop paying their loans - you then have to reassess your entire loan book - say £20BN.

Initially the bank does nothing and let's the debts build slowly, when it becomes apparent its a systemic issue, they will suddenly cut the value of the loans by recognising a potential 'bad debt' of, say 75%.

So the bank makes an accounting adjustment predicting only 25% of the loans due will be paid. The banks is now in possession of £5bn of good loans, and a provision for bad debt of £15bn

They can't hold the bad debt on the balance sheet because it completely screws the capital they have to hold. The basel rules now put them under pressure to get rid of the loans instead of ride out the economic problem. 

They sell the bad debt to a business like cerebrus, maybe they get £2.5bn for £15bn of loans

So the bank has £5bn of good loans £2.5bn of cash and that leaves a 'hole' on the balance sheet of £12.5bn. The Govt/CB will be falling over themselves to lend that money, which is the 1st kind of liquidity. 

The bank is 'whole' again and a crisis is averted. 

The real losers here are the mugs with the loans. Cerebrus won't let them out of that debt and will be far more aggressive in pursuing cash, or punishing customers who can't pay. Cerebrus have paid £2.5 bn for those loans they will now be under pressure to get as much of the original £15bn back as possible. That's what makes them very, very rich. 

Lending money from Gov/CB to banks doesn't fix the balance sheet, their net assets stay the same,  likely negative after the loss on loans. They Govt/CB needs a collateral to lend money, if a bank sold their loans there is nothing to use as a collateral.

It is of course possible that they will change the rules and provide unsecured loans but then Govt/CB takes more risk and it is likely to transfer the bank losses on its balance sheet. I think that is the ultimate end game, CBs being a sink for all losses in the financial system. They will have huge negative net assets but they will still be liquid as CBs create the money. They could try to create an illusion CBs are not bankrupt by Govts providing capital in a form of Govt bonds. This would however increase Govt debt significantly.  

The UK situation would be dependent on how other countries are doing. If they  are in a similar situation then the system would be relatively stable. Otherwise GBP would collapse. 

At the end we will have a system in which CBs create money being backed by nothing. Those money will end up at the very top, rich would get even more obscene rich, asset prices and inequality will go over the roof. I think  at some point this would implode with a civil unrest.  

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1 hour ago, regprentice said:

They sell the bad debt to a business like cerebrus, maybe they get £2.5bn for £15bn of loans

The likes of Cerebrus are only active in the CLO market because their "stock" holders (I use the term very loosely) have confidence in the return of whatever stock has in turn been lent to Cerebrus. Imagine for a second if you were promised an assured 60% haircut on any capital advanced to Cerebrus. Would this skew your pension investment decisions in any way? What if the imagined haircut was 100%?

22 minutes ago, slawek said:

I think that is the ultimate end game, CBs being a sink for all losses in the financial system.

Why would the assetless poor vote to keep these plates spinning? The angular velocity of these specific plates is maintained through a linear growth rate in tax receipts.

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12 minutes ago, ParticleMan said:

The likes of Cerebrus are only active in the CLO market because their "stock" holders (I use the term very loosely) have confidence in the return of whatever stock has in turn been lent to Cerebrus. Imagine for a second if you were promised an assured 60% haircut on any capital advanced to Cerebrus. Would this skew your pension investment decisions in any way? What if the imagined haircut was 100%?

Why would the assetless poor vote to keep these plates spinning? The angular velocity of these specific plates is maintained through a linear growth rate in tax receipts.

Tax receipts won't be able pay all the debt even with interest rates being negative. Govts will just roll over the debt indefinitely, zero coupon perpetual debt = no debt.   

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7 minutes ago, slawek said:

Govts will just roll over the debt indefinitely, zero coupon perpetual debt = no debt.   

Here's what happens to the bid if your ask crosses the market.

Quote

The physical cash holdings of German banks rose to a record 43.4 billion euros ($48 billion) in December, according to Bundesbank data published on Friday. That’s almost triple the amount at the end of May 2014, the month before the European Central Bank started charging for deposits and raising the pressure on Germany’s already beleaguered banks.

(I agree with your first sentence, it's just that the second part isn't quite playing out how "to infinity and beyond" might've thought; my argument is actually about the supply side, in that I foresee less issuance due to politically chastened reserves, as the demagogues win elections in jurisdiction after jurisdiction) 

Edited by ParticleMan
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1 hour ago, ParticleMan said:

Here's what happens to the bid if your ask crosses the market.

(I agree with your first sentence, it's just that the second part isn't quite playing out how "to infinity and beyond" might've thought; my argument is actually about the supply side, in that I foresee less issuance due to politically chastened reserves, as the demagogues win elections in jurisdiction after jurisdiction) 

Not sure whether I understand you correctly. Are you saying that populists Govts will issue less bonds? I think it is either way around, they need more money to deliver some of their promises. The UK is an example of this, Boris is borrowing more. 

Cash and gold provide a floor for interest rates. Cash hoarding is still a small percentage of all bank reserves. I don't think it will increase much more unless CBs lower rates further. Gold is unlikely to replace the current money as a medium of exchange, it is inconvenient and lacks infrastructure.  It could be used as a store of value but it doesn't pay any interest. People holding it would need to rely for its price to increase, which is not guaranteed. Gold value will probably increase but this would be a part of the bubble of all assets. For an example right now when the market expects another QE both gold and the stock market go up.    

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1 hour ago, slawek said:

Not sure whether I understand you correctly. Are you saying that populists Govts will issue less bonds? I think it is either way around, they need more money to deliver some of their promises.

They absolutely do need to continue borrowing to deliver on promises. But remember, the promise we're talking about is the promise to backstop asset prices forever. The demagogues will appeal to the assetless poor on a platform of reduced taxation and deliver it by throwing the bondholder to the wolves.

Concisely: I think it's highly likely the electorate will vote to default on the promises instead.

Edited by ParticleMan
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8 minutes ago, ParticleMan said:

.

Concisely: I think it's highly likely the electorate will vote to default on the promises instead.

And indeed, why should they pay?

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8 minutes ago, ParticleMan said:

They absolutely do need to continue borrowing to deliver on promises. But remember, the promise we're talking about is the promise to backstop asset prices forever. The demagogues will appeal to the assetless poor on a platform of reduced taxation and deliver it by throwing the bondholder to the wolves.

Concisely: I think it's highly likely the electorate will vote to default on the promises instead.

I don't think they need to default. There is no need to do this when CBs are buying the bonds and not asking them to be repaid. 

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3 minutes ago, slawek said:

I don't think they need to default. There is no need to do this when CBs are buying the bonds and not asking them to be repaid. 

Let's agree to revisit this specific topic after a reserve with a material net long position on the bond finds itself navigating an actual, severe contraction in GDP.

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5 minutes ago, ParticleMan said:

Let's agree to revisit this specific topic after a reserve with a material net long position on the bond finds itself navigating an actual, severe contraction in GDP.

What do you expect to happen in such scenario?

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20 minutes ago, slawek said:

I don't think they need to default. There is no need to do this when CBs are buying the bonds and not asking them to be repaid. 

As a side note the reserve's flow (and to a certain extent their ability to fund new nonsense) comes from the spread between GDP and the rate offered to net long bondholders.

I feel that reserves may well have lost sight of this.

We're not minting new net long bondholders. Generation debt have no assets. Everything has its limit.

Edited by ParticleMan
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3 minutes ago, ParticleMan said:

Iceland. Optimistically.

Iceland banks relied on foreign funding. The UK/US/EU CBs will work in tandem providing each other funding with direct swaps. For the UK to follow the Iceland scenario this system would need to break up. I can't imaging at the moment a possibility that they stop working together. The more they lend each other the more their fate is linked. 

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1 minute ago, ParticleMan said:

As a side note the reserve's flow (and to a certain extend their ability to fund new nonsense) comes from the spread between GDP and the rate offered to net long bondholders.

I feel that reserves may well have lost sight of this.

We're not minting new net long bondholders. Generation debt have no assets. Everything has its limit.

The CBs don't need bonds to create new reserve. When ECB lends money in LTRO it create a liability (reserve) and asset (loan to a bank). this loan can be secured by a portfolio of mortgages or corporate bond. Something similar was happening when BOE was doing FLS.

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3 minutes ago, ParticleMan said:

This is exactly why a panic is likely. All it takes is for one participant to doubt that a repo will be honoured when due.

I think there is more likely they will continue lending to each other. Creating reserves doesn't have any cost or limits. Stopping lending will a catastrophic event, a collapse of the financial system. Having a choice doing something, which is free, or collapsing everything they will continue lending.  

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5 minutes ago, slawek said:

Creating reserves doesn't have any cost or limits.

I think the effect on yields is both a cost and a limit, however indirect (and I argue - it's quite direct).

Reserves will discover that they can't loot the pensions industry twice, if they attempt it.

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2 minutes ago, ParticleMan said:

I think the effect on yields is both a cost and a limit, however indirect (and I argue - it's quite direct).

Reserves will discover that they can't loot the pensions industry twice, if they attempt it.

I should have added " for CBs".  The economic and social impact is significant. 

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2 minutes ago, slawek said:

I should have added " for CBs".  The economic and social impact is significant. 

Ok. And that's my thesis. CB's will be chastened by exactly the social impact.

Their model has faulty inputs. It's probable that generation debt don't care about supporting the price of assets they don't own, when the stark reality is that they can have asset price support or positive expectancy for savings but not both.

Edited by ParticleMan
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  • 418 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
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      • up 5%



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