Tag: liquidity

Statement of CFPB Director Rohit Chopra, Member, FDIC Board of Directors, on the Proposed Special Deposit Insurance Assessment on Large Banks

Mary Pat Campbell

Link: https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-on-the-proposed-special-deposit-insurance-assessment-on-large-banks/

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Excerpt:

First, we need to simplify our rules while strengthening them. Too many areas of regulation across our economy have become so complicated with weird formulas, dizzying methodologies, and endless loopholes and carveouts. We need simpler rules to prevent future disasters. A better alternative is to create bright line limits, with clear sanctions, including size caps and growth restrictions. Clearly observable metrics make it easier to monitor and increase consistency.

Second, we need to stop subsidizing the largest and riskiest banks by giving out free deposit insurance. When small banks fail, they rarely lead to much cost to the FDIC’s Deposit Insurance Fund, since they can be fairly easily wound down or sold. But when large banks fail, the costs to the Deposit Insurance Fund and broader economy can be steep. To make matters worse, those institutional clients with the biggest deposits feel they can get around insurance limits by going to the biggest banks. In other words, people perceive that the biggest banks get free deposit insurance over the legal limits by way of their too-big-to-fail status.

Fixing our deposit insurance pricing structure is just one small step that could help address this problem. Large, riskier banks should pay more and small, simpler banks should pay less. We should also make the framework countercyclical, so that we aren’t in the position of raising rates when banking conditions are weak.

While today’s proposed special assessment will not fall on small, local banks, the failure of First Republic Bank will be a direct hit to the Deposit Insurance Fund that is not being recouped through this special assessment. It’s a reminder that we need to fix the fund’s pricing over the long term.

Finally, as Swiss policymakers made clear regarding the recent turmoil involving Credit Suisse, more people are saying the quiet part out loud: the current resolution plans filed by the largest financial institutions in the world, which purport to show how the firms could fail without a government bailout or economic chaos, are essentially a fairy tale.5

The latest failures are another reminder that we must work to eliminate the unfair advantages bestowed upon too-big-to-fail banks. New laws and old laws alike provide a roadmap to end too-big-to-fail and the resulting risks to financial stability, fair competition, and the rule of law.6

Author(s): Rohit Chopra

Publication Date: 11 May 2023

Publication Site: Consumer Finance Protection Bureau

The Banking Sector Turmoil in Charts

Mary Pat Campbell

Link: https://www.wsj.com/articles/the-banking-sector-turmoil-in-charts-52bb6095?mod=e2twg

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It has been a wild ride for banks. Silicon Valley Bank, which catered to venture capitalists and startups, collapsed March 10 after a run on deposits that was preceded by a plunging share price and a money-losing bond sale as the bank tried to raise capital. Two days later, Signature Bank SBNY -22.87%decrease; red down pointing triangle was closed by federal regulators following a run. Then, First Republic Bank FRC 29.47%increase; green up pointing triangle, at risk of a run as its share price plummeted, was flooded with cash in an extraordinary action by some of the largest U.S. banks—but its shares resumed their plunge a day later. 

Here is how some banks ended up in the market’s crosshairs.

Author(s): Nate Rattner, Alana Pipe

Publication Date: 18 Mar 2023

Publication Site: WSJ

Bond prices mean revert after all

Mary Pat Campbell

Link: https://allisonschrager.substack.com/p/bond-prices-mean-revert-after-all?utm_campaign=post&utm_medium=web

Excerpt:

On day one of Fixed Income School, you learn that bond prices mean-revert. While a stock or a house’s price can continue to increase as the company or land becomes more valuable, yields can only go so low. Nobody will pay to lend someone else money, or at least, they won’t pay much to do that. Bond prices can only climb so high before they fall. While some evidence shows that yields trended downward slightly as the world became less risky, they still tended to revert to a mean greater than zero.

It’s easy to blame Silicon Valley Bank for being blissfully ignorant of such details. They purchased long-term bonds and mortgage-backed securities when the Fed was doing QE on steroids! Did they expect that to last forever? Well, maybe that was a reasonable assumption, based on the last 15 years, but I digress.

Many of these smaller banks, particularly Silicon Valley, are in trouble because they were particularly exposed to rate risk since their depositors’ profit model relied on low rates. So, when rates increased, they needed their money—precisely when their asset values would also plummet. It’s terrible risk management. But, to be fair, even the Fed (the FED!) did not anticipate a significant rate rise. Stress tests didn’t even consider such a scenario, even as rates were already climbing. Why would we expect bankers in California to be smarter than all-knowing bank regulators?

According to the New York Times, Central Bankers still expect rates to fall back to 2.5%. Why? Because of inequality and an aging population. But how does that work, and what’s the mechanism behind it? No good answer, or not one that squares with data before 1985, but we can hope. Sometimes we just want something to be true and for it to be true for politically convenient reasons.

Author(s): Allison Schrager

Publication Date: 20 Mar 2023

Publication Site: Known Unknowns at Substack

People Will Pay for Illiquidity

Mary Pat Campbell

Link: https://www.bloomberg.com/opinion/articles/2022-11-01/people-will-pay-for-illiquidity

Excerpt:

Adding liquidity is, conventionally, desirable. It reduces risk: If you can sell a thing easily, that makes it less risky to buy it, so you are more likely to commit capital to the thing. It increases demand: If only a few rich people can buy a thing with great difficulty, it will probably have a lower price than if everyone can buy a share of it easily. It improves transparency and makes prices more efficient. Also, financial innovation tends to be done by banks and other financial intermediaries, and their goal is pretty much to do more intermediation. More liquidity means more trading, which means more profits for banks.

Another, funnier sort of financial innovation is about subtracting liquidity. If you can buy and sell something whenever you want at a clearly observable market price, that is efficient, sure, but it can also be annoying.

….

Or we have talked about a fun post from Cliff Asness titled “ The Illiquidity Discount,” in which he argues that private equity is essentially in the business of selling illiquidity. If you are a big institution and you buy stocks in public companies, the stocks might go down, and you will be sad for various reasons. You might be tempted to sell at the wrong time. You will have to report your results to your stakeholders, and if the stocks went down those results will be bad and you will get yelled at or fired. Whereas if you put your money in a private equity fund, it will buy whole public companies and take them private, and then you won’t know what the stock price is and won’t be able to sell. The private equity fund will send you periodic reports about the values of your investments, but those values won’t necessarily move that much with public-market stock prices: The fund will base its valuations on its estimates of long-term cash flows, and those will not change from day to day. By being illiquid, the private equity fund can look less volatile. Getting similar returns with less volatility is good; getting similar returns and feeling like you have less volatility also might be good.[4] Asness writes:

If people get that PE is truly volatile but you just don’t see it, what’s all the excitement about? Well, big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns? “Ignore” in this case equals “stick with through harrowing times when you might sell if you had to face up to the full losses.” What if investors are simply smart enough to know that they can take on a lot more risk (true long-term risk) if it’s simply not shoved in their face every day (or multi-year period!)? 

One objection to this sort of financial product — illiquidity provision — is that it does not generate a lot of transactions. If you work at a bank and you think of a product that will cause customers to trade bonds or houses or diamonds more often, then it is pretty easy to figure out how to make money from that product. 

Author(s): Matt Levine

Publication Date: 1 Nov 2022

Publication Site: Bloomberg

Why Bond Liquidity May Be Headed for Trouble

Mary Pat Campbell

Link: https://www.ai-cio.com/news/why-bond-liquidity-may-be-headed-for-trouble/

Excerpt:

Reduced liquidity for bonds is getting to be a problem, according to Treasury Secretary Janet Yellen.

At a speech before the Securities Industry and Financial Markets Association annual meeting Tuesday, she reiterated an earlier observation that diminished ability to sell bonds is worrisome. Still, at SIFMA, she sought to temper her concern by adding that traders aren’t facing snags executing orders, with the biggest negative impact of lessened liquidity confined to higher transaction costs.

…..

The gauge for bond volatility, the Merrill Lynch Option Volatility Estimate, aka MOVE index, has jumped some 40% since mid-August. Other than a spike in March 2020 at the onset of the pandemic, the index (it launched in 2019) has been fairly placid—until 2022 and the beginning of big rate hikes. This all is reminiscent of the stock market’s fast-paced volatility lately.

Another related difficulty for bonds:  the imbroglio resulting from the Federal Reserve’s interest rate increases and the resulting strong dollar risk worldwide. That has promoted a rush by other central banks to match the Fed and jack up rates. To Richard Farr, chief market strategist at Merion Capital, one risk of this trend is that Treasury bonds will end up hurt.

Author(s): Larry Light

Publication Date: 26 Oct 2022

Publication Site: ai-CIO

Warning: Tossing Russian Banks From the International System Could Backfire

Mary Pat Campbell

Link: https://www.ai-cio.com/news/warning-tossing-russian-banks-from-the-international-system-could-backfire/

Excerpt:

The decision to boot Russian lenders from the global bank messaging system as punishment for its invasion of Ukraine is a very bad idea that could boomerang and hurt the West, Credit Suisse admonishes.

“Exclusions from SWIFT will lead to missed payments and giant overdrafts similar to the missed payments and giant overdrafts that we saw in March 2020,” wrote Credit Suisse strategist Zoltan Pozsar, in a research note.

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“Exclusions from SWIFT will lead to missed payments everywhere,” Pozsar wrote. Two years ago, “the virus froze the flow of goods and services that led to missed payments.” Aside from the financial panic at the outset of the pandemic, the world ran into a similar problem in 2008, when Lehman Brothers collapsed, he said. 

 Pozsar wrote: “Banks’ inability to make payments due to their exclusion from SWIFT is the same as Lehman’s inability to make payments due to its clearing bank’s unwillingness to send payments on its behalf. History does not repeat itself, but it rhymes.”

Author(s): Larry Light

Publication Date: 28 Feb 2022

Publication Site: ai-CIO

No Ordinary Panic – Bank Run in Russia

Mary Pat Campbell

Link: https://www.city-journal.org/russian-bank-run-is-no-ordinary-panic

Excerpt:

The war in Ukraine and subsequent international sanctions have triggered a bank run in Russia. But this is no ordinary run—it may become a run on the central bank itself, one that holds important lessons for introducing central bank digital currencies.

Reports show Russians lining up at ATMs to withdraw their cash. For now, the run is largely driven by fears of withdrawal limits and the anticipation that credit cards and electronic means of payments will cease to function. If that happens, cash at hand is the better alternative. For that scenario, central banks know what to do: provide solvent banks with plenty of liquidity against good collateral, as Walter Bagehot recommended.

But will that be all? As Western countries freeze the Russian central bank’s reserves and limit the ability of banks to transact internationally, the exchange rate of the ruble has collapsed, falling by more than 40 percent. Prices for ordinary goods may begin to rise, perhaps dramatically so. If that happens, then rubles would no longer be a good store of value. Russians may seek to convert them into foreign currency, but that’s hard to do with the current sanctions. Consequently, they may start to hoard goods instead, dumping their cash as they go along. The situation would no longer be a run on specific goods, but a run away from fiat money and toward goods—a run, in other words, on the central bank.

Author(s): Linda Schilling, Jesús Fernández-Villaverde, Harald Uhlig

Publication Date: 7 Mar 2022

Publication Site: City Journal

Standard Chartered fined £46.5m by Bank of England over reporting failures

Mary Pat Campbell

Link: https://www.theguardian.com/business/2021/dec/20/standard-chartered-fined-bank-of-england-pra

Excerpt:

The Bank of England has fined Standard Chartered £46.5m for repeatedly misreporting its liquidity position and for “failing to be open and cooperative” with the regulator.

The Bank’s Prudential Regulation Authority (PRA) said Standard Chartered had made five errors in reporting an important liquidity metric between March 2018 and May 2019, which meant the watchdog did not have a reliable overview of the bank’s US dollar liquidity position.

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One of the errors occurred in November 2018, as a result of a mistake in a spreadsheet entry. A positive amount was included when a zero or negative value was expected, leading to an $7.9bn (£6bn) over-reporting of the bank’s dollar liquidity position.

Author(s): Joanna Partridge

Publication Date: 20 Dec 2021

Publication Site: The Guardian

Consumers Want Liquidity: Survey

Mary Pat Campbell

Link: https://www.thinkadvisor.com/2021/03/23/consumers-want-liquidity-survey/

Excerpt:

The Million Dollar Round Table (MDRT) looks at what consumers want, and need, in a new batch of results from a survey of 2,034 U.S. adults, ages 18 and older, that was conducted in November 2020, as the third U.S. wave of the COVID-19 pandemic was beginning.

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About 68% of the MDRT survey participants had investments of some kind, according to the public results summary and the survey executive summary.

The pandemic hit the finances of many of the survey participants hard: 19% said their income rose in 2020, but 35% said their income fell.

About 82% of all of the participants said they were saving money, and many of them reported aiming more for liquidity than for a secure retirement.

Author(s): Allison Bell

Publication Date: 23 March 2021

Publication Site: Think Advisor

Public Pension Plans Are Thirsty for Liquidity

Mary Pat Campbell

Link: https://www.plansponsor.com/public-pension-plans-thirsty-liquidity/

Excerpt:

Chicago’s municipal pension plan recently redeemed $50 million from a large-cap equity fund. Seems like a non-event. Happens all the time. But the reason the pension plan did so is chilling: It was done specifically in order to make pension benefit payments. This should be a cautionary flag to underfunded pensions and to the state and municipal governments that sponsor them.

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First, when pensions are underfunded they have a tendency (or need) to take on more risk in order to try to generate higher returns.

For example, underfunded pension plans are increasing their allocations to private equity. Nothing wrong with that. But that means more of the portfolio is illiquid. It would be very unlikely that private equity positions would be sold to “make payroll,” specifically because they are so illiquid. But this leaves fewer assets that are liquid enough to be sold, and that increases the pressure on those liquid assets to be sold at a decent price. Moreover, if the plan has significant assets in liquid securities, such as large-cap equities or Treasurys, those assets can easily be sold, but then the portfolio will be out of balance and will require additional trading and rebalancing anyway.

Secondly, the pension plan must keep more cash on hand than it otherwise would. If your policy portfolio calls for a 3% allocation to cash, that is designed for diversification and dry powder. But a pension plan sponsor should be providing significant amounts of cash into the pension each year. If the sponsor is not making its contributions, then the pension plan has to carry more cash than it otherwise would.

Author(s): Charles Millard

Publication Date: 7 April 2021

Publication Site: Plansponsor