In this issue of The Institutional Risk Analyst, a long-time reader and occasional source emerges from the shadows of corporate silence during a garden leave to opine on the West’s view of China. “D. Ricardo” is a corporate finance and risk officer who has decades of experience in New York, China and Korea. He may state the obvious for long-time students of Asia, but for many in the financial markets these views are a revelation. Could it be that narratives in the mainstream media about China are not entirely accurate? The IRA: What is one of the larger misconceptions people have of China? Ricardo: To start, contrary to common views, China is inherently weak. This doesn’t mean that China is not dangerous or aggressive, but they are not strong. Points: China is resource poor - it cannot feed its large population with its modest arable land, and must rely on importation of food-stuffs. China is energy poor – apart from poor quality high-sulfur coal, it lacks hydrocarbon deposits and radioactive fuel for reactors and must import to meet its growing energy needs. China suffers from horrible demographics – exacerbated by 40 years of ‘one child policy’. China is disliked by its neighbors – having fought armed conflicts with every one of its neighbors in the past 120 years – including skirmishes with Communist Vietnam, and the USSR. China has internal instability with minority populations in their western provinces, and among the young in the cities. China boasts fratricidal internal politics – as showcased via the Bo Xi Lai events. China is poor at basic research and the generation of new, cutting-edge intellectual property. China’s industrial policy is to steal and copy, not create. China is not an open, modern, 21st century pluralistic society that attracts talent from around the world – rather they remain closed to outsiders in almost every organizations senior ranks. China’s senior leadership knows this. Weakness drives their political decisions. And it’s critical for understanding China’s actions. The IRA: So what explains what we see and read in the news about China as a rival and economic and military threat to the United States? Ricardo: I suspect Xi Jin Ping and the Chinese Communist Party (CCP) elite are following the centuries-old tactical advice of Sun Tzu’s Art of War: “Appear weak when you are strong, and strong when you are weak.” When we look at China’s actions through this lens, the One Belt Road initiative, recent naval build-ups in the contested Spratly Islands, ‘new alliances’ granting the Chinese navy access in far flung ports in India and Africa do not suggest a strong China projecting power, but rather a weak China that is falsely projecting strength, where it cost effectively can, to mask internal weakness. The IRA: Why would China want to appear strong at all? Ricardo: This is the second key point, namely, that China’s visible (first-order) external foreign policy actions are orchestrated to address a hidden and more important (second-order) internal agenda, namely maintaining internal social stability in the face of mounting political and economic pressures. The bluster reported by western media is purposely masking the weaknesses that China does not want outsiders to see. The IRA: Policy makers do not seem to speak of a ‘China that is weak’? Ricardo: I am certain Sinologists inside the beltway are aware of China’s ‘inherently weak’ position, but I doubt few domestic Western interests, economic, political or military, etc., are served by espousing such at the present time – no, a strong China that we must actively counterbalance, is probably the preferred narrative. And again, this is not saying that China is not a rival in certain spheres, like control over advance technologies, but we need to clearly understand our opponent if we are to properly plan and respond to their actions. The IRA: So what happens next, in Hong Kong? With China’s currency? In the trade war with the Trump administration? Ricardo: In simplest terms, China will do whatever is in the immediate best interest of maintaining internal stability for the majority of its population (and by default political power for its elites in the CCP). Or, in other, more familiar words to finance professionals, similar European Central Bank Chairman Mario Draghi, China will do: ”whatever it takes.” China leaders do not want to lose the Mandate of Heaven, nor do they want to see any return of chaos. As to those specific issues – Hong Kong, renminbi and trade – each probably deserves it’s own discussion. The IRA: To be continued. Thanks Ricardo.

New York | In this issue of The Institutional Risk Analyst, we continue our discussion with a long-time reader and a corporate finance and risk officer who has decades of experience in New York, China and Korea. He goes by the Nom de Plume of D. Ricardo The IRA: When we last spoke you were explaining how China is ‘weaker’ than many in the West perceive, and that weakness in turn influences China’s actions. How does this play into what we are witnessing in the current trade war? Ricardo: China’s economy was facing challenges and had been slowing before the trade war with the US erupted, but the trade war certainly does not help. The GDP growth rate has been declining for years, but is now touching 27-year lows. China is structurally over-invested in manufacturing and real estate development capacity. Over-investment and unproductive investment leads to low and even negative productivity growth. And these ‘investments’, when uneconomically viable, lead to bad debts, which by many estimates have been increasing, separate and apart from the recent trade war impacts. China’s overall official debt levels continue to worsen. Unofficial estimates from International Institute of Finance and others place China’s debt at more than 300% of GDP. Truth is, given the government’s heavy involvement State Owned Industries and Town Village Enterprises, along with the government simultaneously owning banks, pension funds, and common corporations, and one branch of government lending to another, no one really knows China’s debt level. Worse yet, from a risk perspective, the cross-lending concentrates risk, rather than dispersing it. If the trade war was not happening, I suspect more discussions in financial circles would be focused on China’s debt problems. The IRA: The figures you cite seem to support the “China is weak narrative.” We've been fascinated by the absurd saga of heavily levered conglomerate HNA, which seemed to place unacceptable burdens on China's payments system. What action can Xi Jinping and the CCP do then in its spat with the US? Ricardo: The US just slapped billions of dollars on Chinese goods, and China retaliated with more tariffs on US goods. The impact is as would be expected, with the trade war hurting industries on both sides. But for Xi Jinping and the CCP to buckle under perceived foreign pressure would politically damaging in front of their domestic audience. Especially with the 70th anniversary of the founding of modern China approaching in October – China needs to project strength. One would hope and expect that quiet negotiations were going on behind the scenes and out of the limelight to reach an accord, but even here we face unique constraints. On the Chinese side, Xi Jinping has tightened ideological control in all aspects of life, demanding that the party line be strictly adhered to, which means information is getting filtered much more before it gets t o the top. This is partly why China misread Trump. And on the US side, Trump equally disdains expert opinions and old “China hands”, meaning back-door channels are fewer than at any other time in the last forty years. This leads to a higher risk of wrong decisions or mistakes. The IRA: That does not sound promising. Ricardo: What I am highlighting in possible “wrong decisions and mistakes” are tail risks. Most likely path involves cooler heads prevailing and a more modest path. The real question is when do US consumers, farmers and manufacturers feel the pinch and voice their concerns, such that political pressures start to sway Trump? The IRA: And Hong Kong? What are we to make of the events there? Certainly seems that the Trump trade measures have contributed to popular protests against Xi and the Chinese Communist Party. Ricardo: The protests in Hong Kong are not like the ones in Tienanmen thirty years ago, but there are important lessons to be learned. The protests in Tien-an-men thirty years ago posed an existential threat to Communist rule. There were visible fissures in the politburo leadership between Zhao Ziyang and Deng Xiao Peng; local military was not believed to be reliable towards putting down the movement, thus requiring 250,000 troops be brought in from the remote provinces; the protests were spreading to other cities; the protests were gaining legitimacy with ordinary workers outside of the student-led protests; the protests were happening in the heart of the nation’s capital - Beijing. The IRA: All true. But today social media is far more widespread, accelerating the potential for disruption inside China. Or is this a misreading of the situation? Ricardo: Fast forward to today. There are no visible fissures amongst CCP leadership; local HK forces are working to quell the disturbances; the protests are not spreading outside of HK; ordinary people in China view HK as already spoiled and coddled; and HK is far from Beijing. Basically, there is a very different situation between then and now. The (tail) risk again, however, is wrong decisions and miscalculations. Beijing will not hesitate to use force if it believes such is necessary, though they have and will try to avoid such as long as possible, with the hope that the protests dissipate similar to the Umbrella Movement of 2014. The IRA: So how does one trade this? Ricardo: In the short run, if I was running a quant shop I’d train my algos to watch internet traffic from HK. If that drops dramatically, i.e. China makes HK suddenly go dark, I’d brace for the worst. Unlikely, but a non-zero risk. Medium term, I’d look at how to play the renminbi. Given what we’ve discussed, would you want your life savings tied to their currency? The IRA: Thanks Ricardo

In this week’s edition of “The Wrap,” we feature our view of the top events in Washington and on Wall Street over the past week. Don’t forget to watch “The Wrap with Chris Whalen” on The Julia LaRoche Show  every Saturday on YouTube to catch our discussion of what’s hot and what’s not in the world of finance and investing.  April 17, 2026  | Bank earnings this week have been mostly what we expected, with income up, reported credit loss rates continuing to trend lower and most banks refusing to provide additional disclosure on private credit exposures. As the private credit mess proceeds in the weeks and months ahead, a lot of the “debt” in these deals will turn into equity – which is what it should’ve been all along. Goldman Sachs (GS) increased its Q1 2026 provision for credit losses to $315 million, a nearly 10% rise year-over-year and its highest since 2020, driven by impairments in wholesale loans and corporate lending rather than consumer debt. But it also reflects the fact that unlike Morgan Stanley (MS) and the other large advisory firms, Goldman takes a lot of credit risk on its book.  Despite strong earnings, the rise in loss provisions at Goldman and other banks reflects concerns over commercial real estate and potential inflationary risks. Even as the problematic credit card relationship with Apple (AAPL) slowly fades from memory, Goldman may see higher credit losses from its subprime commercial portfolio. Ponder the fact that Goldman’s gross yield on its loan book is ~ 10%, 2x JPMorgan (JPM) and higher than Citigroup (C) .  Source: FFIEC Speaking of commercial real estate, Bill Moreland at BankRegData reports that the three largest lenders on non-owner occupied commercial real estate, Wells Fargo (WFC) , JPMorgan & Bank of America (BAC), all saw an increase in their delinquency rate.  “While a bit early to definitively state, it's possible we're starting to see a 'second wave' of delinquencies from prior loan modifications,” Moreland notes. Every asset size category of bank below $50 billion in assets saw an increase in commercial delinquency as well. As faithful readers of The Real Deal , we can testify that many legacy commercial properties continue to trade at a discount to the last valuation, Financial markets rallied as the prospects for a negotiated deal with Iran seemed to move forward. Stocks turned higher after Trump posted on Truth Social that Israel and Lebanon reached a 10-day ceasefire agreement, lifting hopes for a break in the Middle East conflict. As of April 16, the S&P 500 and Nasdaq Composite have reached new all-time highs, surpassing previous records despite ongoing geopolitical tensions in the Middle East. The S&P 500 is up 3% over the past five trading days, while silver futures are up 4% and gold was up just 0.5%.  The Invesco KBW Bank ETF (KBWB) bank ETF was basically unchanged over the past week, as investors seem to be uncertain about what to do with financials. That said, we anticipate a strong rally in the financial markets after the weakness of the past month. In Washington, federal Judge Richard J. Leon ruled that aboveground construction on President Trump’s White House ballroom must halt until lawmakers authorize the new wing. The White House construction project, which is considerably more modest than Fed Chairman Jerome Powell’s bombastic remodel of the central bank’s HQ on Constitution Avenue, is now on hold indefinitely.   Of course, the Fed never asked the Congress for permission to spend 10x the $500 million or so that President Trump wants to spend to create yet another ballroom in Washington. Meanwhile, President Trump has threatened to “fire” Powell if the Fed Chair does not depart at the end of his term in May. Sad to say, the President does not have the power to remove Fed chairman, a task that lies entirely with the national Congress. To that point, noted researcher Peter Wallison of American Enterprise Institute writes this week in Law & Liberty : "The Supreme Court seems to have adopted a theory of the constitution that will essentially eliminate the separation of powers as the central structure of the US Constitution, in favor of an idea called the unitary executive. The case was argued in December, in a case called Trump v. Slaughter , and a decision is expected in June or July. Given its historic significance, it has not received the attention it deserves in the media. " Recent Posts John Dizard: Watch for Rationing of Oil, Gas & By-Products https://www.theinstitutionalriskanalyst.com/post/theira828 Private Credit and Large Banks https://www.theinstitutionalriskanalyst.com/post/theira834 The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

April 16, 2026  | As we noted in our discussion with Julie Hyman on Yahoo Finance this week , the big question facing banks in Q1 2026 is disclosure about private credit. The big losers in private credit are not banks, but rather institutional and retail investors who were lured into these wholly unsuitable, structurally illiquid investments by the false statements made by the sponsors.  As Goldman Sachs (GS) President John Waldron said this week: Private credit vehicles lack "clarity that this is really not a liquid product." The banks, so far, are safe so long as the equity standing in front of them in loans to nondepository financial institutions (NDFIs) remain money good. Some of these exposures are in collateralized loan obligations (CLOs), which typically feature 30-40% equity in front of the investment grade tranches. Some banks have enhanced their disclosure of private credit exposures, others have not. Below we review bank earnings so far and give some thoughts on what to expect in Q2, both in private credit and other areas.

April 13, 2026  | Updated | The US-Israeli war with Iran has created a lot of negative headwinds for the global economy, but in the US one of the bigger casualties is the residential mortgage industry. After more than a decade of subsidy by the Federal Open Market Committee via massive open market purchases of securities or "QE," the world of mortgage lending is in an extended drought. But drought may be the new normal.  Whereas in the early part of the year, mortgage lenders were looking forward to lower interest rates and higher lending volumes, the start of hostilities in Iran suddenly reversed this narrative. As we discussed this week in our podcast with Julia LaRoche , the war with Iran will likely keep inflation and interest rates elevated for months or even years to come. Refinance volumes reached a three-year high in 2025. The first two months of 2026 were also strong for mortgage lenders, but March has become a disaster for many IMBs and also some large vendors, both in terms of per-loan business volumes and hedge market results. The uptick in mortgage rates and the related drop in volumes means that the mortgage sector is facing a renewed push for consolidation and even survival. Literally dozens of vendors and professional service providers, for example, who meet the operational needs of residential lenders that have recently combined with other firms will be forced out of the industry. Some of the larger issuers in our mortgage surveillance group had been maintaining excess capacity in the hope of eventually, eventually  generating some outsized profits to catch up. This tendency to tolerate operating losses is partly a legacy of the easy money made in the COVID years and partly wishful thinking. Mortgage people are the quintessential American dreamers.  United Wholesale Mortgage Corp | 2025 10-K Exhibit A in the loss leader category is United Wholesale Mortgage (UWMC) , which just lost an important all stock acquisition to retail channel leader CrossCountry Mortgage . Buying Two Harbors (TWO)  would have added valuable assets and income to UWMC. Now the prize is going for cash to privately held CrossCountry, one of the more aggressive platforms in the industry and a rare mortgage business focused on the retail channel. Among public mortgage firms, UWMC has a lot of company when it comes to tolerating operating losses to preserve capacity in the hope of future profits. The best performing and also most volatile stock in the sector is loanDepot (LDI) , which has been reporting net losses for years. The low dollar price of LDI makes it an easy vehicle for speculating on moves in the housing sector. The table below shows the summary statement of cash flows for LDI from the 2025 10-K (Pg F-76) . Note that in 2022, coming out of COVID, LDI actually generated significant positive operating cash flows. loanDepot | 2025 10-K The fact of higher mortgage rates in March of 2026 means that volumes are likely to be quite weak in Q2 2026. This sad circumstance is going to give even more advantage to the top three to five mortgage firms that have large servicing books and have also maintained operational discipline, and thus operating profits.  Consider some of the recent M&A deals in the mortgage sector over the past year: Last year hyper-efficient  Guild Mortgage  was acquired by privately held industry leader Bayview Asset Management  (“ Bayview Acquires Guild Mortgage ”). We have written positively about Guild over the years because of the firm's intense focus on maintaining profitability. Bayview's mortgage business is financed primarily by large institutional investors. Also last year, Mortgage Cadence  was acquired by PartnerOne from Accenture . Mortgage Cadence was a prominent, award-winning financial software company, but mortgage software has no more value today than in other tech sectors. Everybody in the mortgage industry has software, but when you buy a mortgage company, only assets with cash flow matter. As already noted, Two Harbors was acquired last month by CrossCountry Mortgage, taking an important transaction away from industry volume leader UWMC.  With the Two Harbors deal, CrossCountry gets a servicer and $200 billion in additional unpaid principal balance (UPB) of servicing assets. CrossCountry has been an aggressive buyer of MSRs, according to Inside Mortgage Finance .   Seneca Mortgage Servicing  was acquired from EJF Capital by Freedom Mortgage in March, adding further heft to Freedom’s already dominant market position in government mortgages and servicing. “This deal signals Freedom’s shift toward becoming an investor-facing platform as much as a retail lender,” notes Jennifer McGuinness-Lubbert , “a move echoing what you are seeing from Pennymac and Rocket Mortgage to stay competitive in a lower-volume market.” As we've noted for some time, successful IMBs must have asset management capabilities to survive. Direct Mortgage  was  acquired by non-QM issuer Lendermac . The target was reported to be experiencing significant operational, technological, and financial distress, including a proprietary software suite. In the mortgage industry, software is an expense, period.  The PHH unit of Onity Group (ONIT)  sold its Liberty HECM portfolio to Finance of America (FOA) , an issuer that specializes is reverse mortgages. As the table below from the company’s 10-K illustrates, FOA has had an operating cash deficit for the past two years, as shown in the table below from the firm's 2025 10-K. Finance of America | 2025 10-K As we noted earlier (“ The Wrap: The Flight from AI; PennyMac + Cenlar FSB = Strike Two ”), PennyMac Financial (PFSI)  announced the purchase of Cenlar FSB earlier this year. We see the PFSI deal for Cenlar as a value destroyer in an industry that is already bleeding red ink. Why? Because we expect most of the legacy Cenlar servicing business to move to another provider.   “The acquirer's financial services company will pay $172.5 million upfront for Cenlar's portfolio and operations with a $85 million contingent consideration,” according to Bonnie Sinnock  at National Mortgage News . “Cenlar will surrender its bank charter and Pennymac will operate without one,” she adds. The fact that PennyMac did not have the vision to retain the federal thrift charter of Cenlar is very significant. After low lending volumes, the biggest pain point for mortgage lenders today is the compliance onslaught of state regulators. As a result, the most frequent inquiry from IMBs to legal counsel in Washington over the past year is about the potential of getting a national bank charter to escape state regulation. With the lobotomization of the Consumer Finance Protection Bureau by the Trump Administration, state regulators have intensified their focus on independent mortgage banks (IMBs), creating a regulatory environment what one CEO describes as “a nightmare.” But sad to say, few IMBs have the financial resources or the vision to actually navigate the process of acquiring or merging with a bank.  We have advised several IMBs on establishing or acquiring a depository in recent years, but none have come to fruition. Establishing or merging with a bank is not a trivial undertaking. Yet in the low-volume environment that confronts all IMBs, public or private, one of the most significant areas of potential cost reduction is funding. Merging a mortgage business with significant servicing assets into a bank is a strategy for long-term survival.  While the new Basel III proposal promises to reduce the regulatory capital cost of holding 1-4 family mortgages and mortgage servicing rights (MSRs), we doubt whether the change will encourage banks to re-enter mortgage lending and servicing in a serious way. After all, there are less than three dozen tiny US banks that currently are above the 10% cap on MSRs as a percentage of CET1 capital. Source: FDIC/BankRegData Can an IMB migrate to a bank business model without killing the unique entrepreneurial environment that makes mortgage firms far more efficient than banks? Maybe. Countrywide certainly did, but that story did not end well. IMBs are orders of magnitude more productive than depositories, both as lenders and servicers. But the bigger question may be whether mortgage lenders can survive without being a bank in an interest rate environment where loan coupons and also LT funding costs remain elevated. Basel III, QE & IMBs We have always believed that the interest rate and business environment after the GFC in 2008 that encouraged the growth of IMBs to acquire two-thirds market share in residential lending and servicing was an anomaly created by the Federal Open Market Committee.  During QE, when the Fed was a buyer of most new issue government and conventional MBS, loan rates were suppressed and with it the cost of debt capital for IMBs. COVID took this example to an extreme, as shown in the chart from FRED at the top of this comment. But when QE ended in 2021, IMB profitability plunged. The chart below shows the pretax profitability of IMBs since 2002 (h/t Garrett McAuley). Source: Mortgage Bankers Association When the Fed first started QE in November of 2008, it forced the profitability of mortgage lenders up dramatically. But QE also lowered mortgage rates and thus the risk-adjusted returns on 1-4 family loans to levels that were unattractive for banks to retain loans in portfolio. IMBs make and sell loans and, hopefully, retain the servicing asset. That is why the proportion of 1-4s vs total bank assets has been falling for two decades. Source: FDIC/WGA LLC As Chicago Booth Review  noted last year : “The Federal Reserve's quantitative easing (QE) programs functioned as a massive, sustained effort to lower long-term interest rates, essentially acting as a "subsidy" that reduced borrowing costs for households, businesses, and the U.S. government. By purchasing over $5.6 trillion in Treasurys between 2008 and 2023, the Fed pushed bond prices higher and yields (interest rates) lower.” Today, however, with the end of QE and now an intractable war in the Middle East, long-term interest rates have risen. The $40 trillion in public debt owed by the United States is a larger concern. Indeed, there is a growing suspicion among bond investors that long-term interest rates may remain elevated even after peace is achieved with Iran. Higher long-term interest rates are bad for mortgages, private credit and corporate issuers more generally. The strong possibility of higher mortgage interest rates is especially true if the federal debt continues to grow and a new Fed Chairman named Kevin Warsh pursues a smaller balance sheet at the central bank, effectively making the Fed a net seller of mortgages.  We wrote recently in National Mortgage News  (" What President Trump can do about mortgage rates ") about how Fannie Mae and Freddie Mac could push mortgage rates down by repurchasing COVID era securities. The same applies to Ginnie Mae, of note. But in the absence of QE, the bias in long-term interest rates must be higher.  Thus the astute mortgage banker with a decent-size servicing book must ask: How do I survive in a lower volume, higher mortgage rate environment for the foreseeable future?  The answer is to become either a non-bank depository or a full blown national bank, the latter of which gives you shelter from the partisan idiocy of state regulation via federal preemption. State-chartered, FDIC-insured banks give you some shelter from the partisan antics of state regulators. If Fed Vice Chairman Miki Bowman pushes through changes in capital requirements for whole-loans and MSRs, then the benefits of bank ownership for IMBs become compelling.  Commercial banks may not want to reenter the world of mortgage lending, especially third-part loan aggregation. And being a loan servicer is now a business that requires scale (> $500 billion in UPB). But IMBs that are able to combine with a depository while preserving the flexibility and operating efficiency of an IMB could be the long-term survivors in the world of residential lending. There is a strong argument for IMBs to migrate into a bank charter, creating a new generation of mortgage specialization institutions that have the profitability and liquidity to survive the new normal of higher interest rates. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

In this week’s edition of “The Wrap,” we feature our view of the top events in Washington and on Wall Street over the past week. Don’t forget to watch “The Wrap with Chris Whalen” on The Julia LaRoche Show  every Saturday on YouTube to catch our discussion of what’s hot and what’s not in the world of finance and investing.  April 10, 2026  | Updated | The financial markets were whipsawed again this week as the situation between Israel, the US, Iran and Lebanon dominated the headlines. Gold futures prices for June delivery have bounced off of the lows of several weeks ago, the S&P 500 is moving sideways and bitcoin remains down for the past year. Rather inexplicably, the Trump Administration agreed to a two week cease fire and “talks” with the Iranian government, but the Strait of Hormuz remains closed, as John Dizard noted in a conversation with The IRA earlier this week. The latest turn of events in Washington has left the Saudis and Israelis profoundly annoyed. The US kicked over the hornets nest in Iran, but now Washington is seeking peace even as the Iranians continue to attack the Gulf states. A few ships carrying LPG for Pakistan have been allowed through the Strait after paying Tehran the extortionate sum of $1 per barrel, payable either in Chinese yuan or bitcoin.  The US seems to be a big loser in this latest change in policy, with President Trump vacillating from threatening to destroy all evidence of Iranian civilization to total capitulation in the face of growing domestic political controversy. Pakistan has presented itself as a possible intermediary for peace talks, but Dizard suggests that the Chinese are standing behind the silk curtain in Islamabad. And long-time American clients like Saudi Arabia and Israel are furious that Washington is not destroying Tehran. Since we once represented the government of General Muhammad Zia-ul-Haq (1924–1988), the idea of a Chinese hand in Pakistan is most amusing. Pakistan as client state migrates from the British to the Americans to the Chinese in a single century? Wonderful. The Pakistani intelligence service engineered the crash of General Zia's C-130 in 1988 during the American involvement in Afghanistan. The big question facing President Trump, of course, is what happens if the Strait of Hormuz is not reopened in two weeks. If the Strait is not opened in two weeks, will the US military resume attacks? Will American forces attack civilian targets in Iran as President Trump has threatened? Meanwhile, the Chinese are the beneficiaries of Trump's bluster. Even if Iran ended any attacks on shipping today, it would take months to restore flows of energy and by-products. As Dizard reminded us, the ships needed to carry the fuel and by-products are all in the wrong places. As a result, energy prices are likely to remain elevated and will push up inflation, lowering the likelihood of a Fed interest rate cut.  Home Prices Stagnant As the very real economic impacts of the Iran war come into sharper focus (“ John Dizard: Watch for Rationing of Oil, Gas & By-Products ”), particularly the idea that the FOMC may not reduce short-term interest rates this year, one of the key questions in the minds of our readers is what is going to happen to home prices?  The answer is nada to lower. We were in Washington this week to participate in the Executive Roundtable for Mortgage Finance . The general consensus in the industry is that mortgage interest rates are going to stagnate and this will pull new loan volumes down. While some mortgage lenders were keeping excess capacity live to be ready for lower interest rates, getting the 10-year Treasury down to 4% and mortgage rates down to 6% is presently a distant dream.  Look for more industry consolidation.  10-Year US Treasury Source: dataQollab We heard several senior officials of HUD reject the notion that Ginnie Mae MBS or Treasury debt is somehow out of favor with global investors. The popular narrative currently says that China is a seller of Treasury debt, a story that is not inconsistent with the spoiler role now being played by Beijing in the Middle East. The more accurate assessment is likely that China’s state agencies have simply traded securities for cash deposits in banks.  The Chinese have lots of dollars, you understand. Yet the dollar-collapsing narrative persists: “The US’s war with Iran has put a potentially irreversible strain on the global trading system, with gold reserves having eclipsed central bank holdings of valuation-adjusted dollar assets for the first time in several decades,” writes Simon White of Bloomberg . The outlook for home prices is basically unchanged to down this year, depending on the market. Venues like Houston, TX, and Clearwater, FL, are seeing serious prices erosion. But the good news, of sorts, is that a lack of supply is likely to keep home prices stagnant in 2026. Was Q1 2026 the near-term peak for home prices? Probably, but inflation continues to push up replacement value for all homes. The misery on the 8s that our friend Stan Middleman of Freedom Mortgage predicted in our 2024 book, “ Seeing Around Corners, ” may be a prolonged period of low or no price appreciation. After years of steady home price appreciation, US home prices may be going sideways for years.  The Mortgage Bankers Association projects that U.S. home price growth will be nearly flat in 2026, with an expected increase of 0.6%. This represents a significant cooling in price appreciation, characterized by stagnation or slight declines in some markets, rather than sharp national drops. Yesterday for our discussion at the Executive Roundtable with Stan Middleman and Chris Abate , CEO of Redwood Trust (RWT) , we prepared a couple of slides. The first two slides show the declining proportion of 1-4s and MBS on the balance sheets of the US banking industry. The third slide shows all US banks sorted by MSRs/CET1 bank capital. There are a lot of smaller US banks that have chosen to go above the 25% cap on intangibles which is set in stone in US regulation. The question is why. You can download the presentation using the link below. Recent Posts Who's The Best Consumer Lender? ALLY, AXP, AX, COF, SOFI, LC, SYF https://www.theinstitutionalriskanalyst.com/post/theira831 John Dizard: Watch for Rationing of Oil, Gas & By-Products https://www.theinstitutionalriskanalyst.com/post/theira828 The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

April 1, 2026 | In this edition of The Institutional Risk Analyst , we feature a special conversation with John Dizard , a veteran financial journalist and columnist known for his in-depth analysis of global macro investing, commodities, and currency markets, most notably for his 21-year tenure at the Financial Times. When we want to know what is happening in the world of energy, John is our first call. His views on the approaching economic collapse due to the US-Israeli war against Iran are disturbing but also suggest some investment themes that we address at the end of the discussion for our Premium Service subscribers.   The IRA: John, thank you for taking the time to speak with us today. We’ll dive right into the mess created by the Israeli-US attack on Iran. Where are we now, what, week three of the war? And the world still does not even begin to appreciate the true economic consequences.   Dizard: We're only finishing up week four, and the damage is already rapidly metastasizing. This is not a war that's going to be ending quickly. For one thing, the Iranians are not in a negotiating state. They're in an extortion state. And the impacts are already bad and are getting worse.   The IRA: We noticed that Iran is already extorting payments from ships seeking safe passage through the Strait of Hormuz. The damage to production, refining and chemical capacity in the Persian Gulf is severe and growing. This seems like quite a high price to pay for keeping Israeli Prime Minister Benjamin "Bibi" Netanyahu out of prison . How bad is the physical and economic damage from the war?   Dizard:  Let's start with jet fuel and diesel. Those are the most immediate and hardest-hit product streams. But when they started this war, I think that the White House or the planning team was looking solely at oil flows. They may have looked at the U. S.'s relatively good supply balance, but they didn't look at products. They didn't look at the US requirement to import sulfur, for example. For the U. S. to produce phosphate fertilizer, it has to process its own phosphate rock with sulfuric acid.   The IRA: The Trump Administration is not strong on advanced planning, in part because the team around President Trump never knows what he is going to say or do next. The US dependence on imported sulfur for a wide range of industrial processes probably did not come up in the pre-attack discussions at the White House. After all, the primary source of market data at the Trump White House is Newsmax .   Dizard: Most, around half, of traded sulfur in the world goes through the Strait of Hormuz. It's a byproduct of refining very sulfurous, or “sour”, crude. They take out the sulfur and export it. Sulfur wasn't being considered as a pain point in the past. Now it is. You need sulfuric acid in order to produce copper, steel, nickel and many other products. Apart from fertilizer, you really need it to keep an industrial society running. The White House didn't take that into account. The US may think that they have secure sources of mineral supply from allies, like, say, Australia. The trouble is, to mine things in Australia, you need diesel. The Australians went through a period of shutting down refineries, and they do not produce enough refined products themselves. Problem. The IRA: Sounds like our friends in California. After we spoke last week, we started to ponder how this ill-advised adventure in Iran by the Trump Administration is going to hobble the global economy. But it is also going to sideline any pretentions about the environment and sustainability. Continue with your point about Australia. Dizard: Australia imports diesel from either Asian refineries or Gulf refineries. The Asian suppliers, such as Korea, have shut off exports of diesel. California also imports their fuel and refined products or oil from Asia. Now, California has the same problem as Australia. They could import some from the US Gulf Coast, though that’s complicated by California’s unique gasoline blending requirements. There's going to be a serious supply crunch in California because of their refinery closures. I don't know how they're going to deal with this. It’s expensive to get gasoline and jet fuel in California and those products, as well as diesel, are about to become even more expensive and less available. Essentially, California will have to overturn their green regulatory framework and start to re-open refineries.   The IRA: That is an amusing thought. Watching California Governor Gavin Newsom deconstruct the green project before 2028 would be fun. But Australia and the rest of Asia is a more immediate and serious problem. What does the Iran war mean for Australia?   Dizard: The Australians don't have the diesel to mine the minerals that we are hoping to buy to become free of the Chinese supply chain. You could ration jet fuel as a luxury product for distant vacations or unnecessary business meetings. But diesel is the working-class fuel. You need it to farm. You need it to mine. You need it for backup power. You need it for everything. And if there was a price to keep one's eye on, it wouldn't be so much the gasoline price as the diesel price. Which is, of course, above gasoline. And this is affecting Asia first.   The IRA: Who is most impacted by the latest colonial confrontation with Iran? The US support for the Shah of Iran was just the most recent debacle. Baku was part of various Iranian empires for centuries before being ceded to the Russian Empire in 1813 The Russians annexed vast Persian territories in the Caucasus, in a series of wars during the 19th century. But of course nobody knows the history.   Dizard: It's already affected prices in Europe. Unless there's some miracle within the next few days, we're heading towards diesel rationing in Europe, jet fuel rationing, serious shortages. And, also, lower fertilizer application this year, which means lower food production next year. But it's the fuel products, I think, that are going to cause the most immediate severe shortages.   The IRA: The thing you said to me the other day, which you've already got into quite a lot, is the fact that it is the refined product and by products coming out of the Persian Gulf that really matter.   Dizard: Right. I think there was this misconception in Mar-a-Lago that the Gulf states just have these big, giant taps that crude oil somehow comes out of, and then it gets shipped on tankers. But it's also a vast industrial complex. Very, very large fertilizer producers, for example, who serve the needs of the entire world. Saudi Arabia exports a very large amount of phosphate fertilizer. The Gulf “oil” producers also export critical fertilizer products such as urea and ammonia, which are also used to reduce pollution from diesel engines. They export a lot of other key industrial input products, such as aluminum and naphtha.   The IRA: That is an impressive list. There are certain chemicals that an industrial society needs to function.   Dizard: Not to mention helium. Helium is exported from Qatar. It's a byproduct of gas production. Without helium, you can't produce semiconductors. You can't do MRIs. There are all kinds of things you can't do. And Qatar can't bring on helium production without bringing on its LNG production trains, which have already been damaged by Iranian strikes. Let's say the war is settled later today. It'll take a minimum of four weeks to get the undamaged trains back up to speed. More likely, this is going to go on for at least a couple of months longer. I think that's a best-case scenario. The industrial production impact of this conflict is going to be severe.   The IRA: What about India and the Far East?   Dizard: Taiwan, for example, has a, about a 10-day supply of LNG on hand. Those are their working supplies. There is no strategic reserve. They depend on a continuing stream of LNG tankers coming through their ports. That produced half of their electricity. How are they going to produce semiconductors with electric power and the helium? I mean, this isn't just a matter of the crude price going up or gasoline for Memorial Day driving. It's an industrial catastrophe for key products.   The IRA: Again, it sounds like a very expensive way of keeping Bibi Netanyahu out of jail. Very, very expensive. He needed a war to stay in office and avoid prosecution. President Trump has spoken about the investigation.   Dizard: Wars start for what people think are policy reasons, but war has a momentum of its own. That's true for the Iranians, and it's true for the U.S.  I don't know how much you remember of how long we hung around Vietnam, so we wouldn't be, you know, forced into a humiliating withdrawal, which eventually we were. Or Afghanistan for the same reason with the same outcome. This is going to go on a lot longer than even the people in power think it should.   The IRA: Given the appearances versus the realities that are driving a lot of this, John, can you see the U. S. putting boots on the ground in the Strait of Hormuz just to make everybody think they're addressing the problem when they really aren't? You know, obviously, that's not going to stop the attacks. Where do you, where do you put someone on the ground?   Dizard: Let's say they put them on the ground around the export terminal in Kharg Island, which has occupied a prominent place in President Trump's mind for 40 years or more. Let's say we put our boots on the ground there. Presumably, that cuts off Iranian exports. And they're still exporting about two and a half, 2.8 million barrels a day of crude and product. If that flow goes away, the Indians will be without propane to cook their food. You'll have an even worse supply shortfall in crude. It would be a disaster even before the Iranian attacks on the US occupying force.   The IRA: Well, yeah, and that's why Trump took the sanctions off the Russians, was to rebalance that supply equation, right?   Dizard: Well, yeah, and that hasn't worked perfectly well. I mean, on the one hand, the Russians can make more money, double their money per barrel, roughly, from what they were getting before the crisis. On the other hand they're also unable to solve the oil and products supply problem because they can't export as much as they were due to Ukrainian attacks on their export terminals and refineries. However they have managed to get the U.S. to back off from sanctions, which was an enormous strategic win. I think even with the cutbacks in crude exports, the Russians have done well out of this.   The IRA: It’s interesting to see the limits of great power.   Dizard: They've also diverted supplies of defense material away from Ukraine and to the Gulf. They've won on several points. Beyond the effects on Russia’s great-power aspirations, this war has the potential, if it goes on for six months, of turning from something that will accelerate a recession that may have already been brewing into a depression. It's a disaster from the point of view of the world's economy.   The IRA: It's funny, you know, I totally agree with you. I was talking to Komal Sri-Komar , the economist, this morning, and he's anxious to hear our discussion, by the way. And I said to him, 'How do we raise rates to fight inflation?' when the damage isn't just to oil production but to chemicals, which puts the whole world into an economic depression. And you have starvation, you have a lot of other privation around the world, especially in Africa and Asia. How do you ignore that and raise interest rates in the name of fighting inflation?   Dizard: Well, there is the idea of raising interest rates to create demand destruction by reducing credit use through price increases. But while I don't think the increase in oil prices will go away quickly, there are other areas of demand that are also going to be seriously impacted. The degree of U. S. dependency on products that come directly or indirectly from the Gulf is far larger than American leaders realize. Again, we can't make phosphate fertilizer without sulfuric acid, which you can't make without sulfur. And there isn't enough sulfur. Diesel, we need to import mined products from the rest of the world in order to make stuff and deliver it to US consumers. And “demand destruction” is not a winning campaign slogan.   The IRA: So you are talking about the type of shortages we have not seen since the 1970s?   Dizard: We're already talking about physical shortages of diesel and jet fuel. That'll affect the US as well as the rest of the world. For the moment there are significant product stockpiles in, for example, Japan, Korea and Europe. The supplies in Europe are probably leaky enough so that some of it could be re-exported. Even so, demand will bid up the price of diesel, which will come back to hit American farmers. So what, $10 a gallon for diesel? The U.S is a product exporter, but the world price feeds back to the U.S.   The IRA: That is a pretty grim prognosis. Is this about supply or price?   Dizard: Sulfuric acid is not just a price thing. What about helium? Not just a price thing. I don't think that the consequences— of this or of boots on the ground action— are being discussed in these terms in the White House.   The IRA: When do you think this reality comes to the people who make the decisions. When do you think this reality starts to arrive in Washington? You think anybody's talking to them?   Dizard: Weeks. Not months, weeks. For diesel supplies there'll be serious shortages within weeks. Jet fuel, it's already a problem flying to Asia. The US exports a lot of aircraft to Asia. Can Asian customers continue to take those deliveries if they cannot fly? What about the formerly fast-expanding Gulf carriers? If you fly to a long distance, you want to be sure that you're going to be able to refuel the plane when you get there. The IRA: How about heavy oil for ships, John? Is this also impacting them?   Dizard: Well, yes, and most countries and operators subscribe to the IMO guidelines on clean maritime fuel. Now, the price of diesel also affects maritime fuel. Most shipping is done in diesel-fueled ships. So, yes, that is a problem. Heavy, high sulfur fuel it doesn't work so well with engines that are tuned, you know, to accept cleaner fuel. However, I noticed that the EPA in the U.S. is already reducing requirements for urea and ammonia additives that are used to reduce particulate emissions from diesel. I think it's because they see the shortages in ammonia and in urea. So already little things like that are happening. So there's likely to be a deterioration in air quality everywhere.   The IRA: For China, how do you see that now? You've been digesting all this for the past week.   Dizard: There’s a lot the Chinese can do to reduce the domestic impact of the Gulf war. They can reduce their LNG dependence by switching to coal-fired power plants. They're already doing that. They have substantial strategic reserves of crude and of products. So they can insulate their domestic economy for a long time. However, they also are very dependent on manufactured exports in order to keep the economy ticking over. And what they don't want is to see their customers either imploding economically or starving because they can't get enough fuel and fertilizer. I think that will motivate the Chinese to act as intermediaries to end the crisis. I don't know when that can happen. The Iranians think they're winning. And in some respects they are winning. They're having their military severely degraded and their country's a mess and people are being killed, including the leadership. But Iran has increased their apparent leverage over the world economy through their control of the Strait of Hormuz.   The IRA: The Iranians are prepared to wait. They can deny transit of the straits and they're not going to give that up because of a simple demand by the U. S. So, they're willing to live at a very low level. You know, the Revolutionary Guards, they're willing to let most citizens live at a very low level. But how do you think things look by, say, Election Day this year?   Dizard: Very bad. Very bad. I mean, let's be optimistic and say it's settled in a month. Let's say it's settled the beginning of May. At best, assuming the remaining production facilities and loading facilities and power facilities are undamaged in the region, it would take another month to get them back more or less on stream. Then it would take longer to get the ships repositioned to where they should be. And then you have at least six months to a year of restocking, because a lot of reserves and stocks of refined product and crude have been run down. They'll be restocked at a higher level. So, if we have a cease fire tomorrow, it could easily be a year before prices get down to where they were, even with the demand destruction.   The IRA: Thanks John. We should do another discussion later in the year. Trading Points

April 9, 2026  | How is the US consumer faring as the war with Iran enters the second month? President Donald Trump  has started a war in the Middle East to escape a darkening domestic scene at home. Spending remains strong, but consumer sentiment slipped to a three-month low in March due to geopolitical tensions driving up oil prices and rising inflation fears. Affordability remains the top concern of consumers as Q1 2026 comes to an end and bank earnings start next week.  The midterm elections are eight months away. Consumer loan defaults continue to trend lower after peaking a year ago in Q1 2025. We've noted for a while that delinquency in the bottom quartile of consumers has been rising, but the picture in terms of the overall portfolio of bank loans remains positive. The rising levels of defaults visible in commercial exposures captured by private credit have not yet crossed over into consumer credit exposures. Pockets of credit weakness remain, particularly in commercial real estate (CRE) and lower-income consumer credit, yet overall credit quality has proven more resilient than expected, notes S&P.  “As household debt levels grow modestly, mortgage delinquencies continue to increase,” said Wilbert van der Klaauw , Economic Research Advisor at the New York Fed  said in February. “Delinquency rates for mortgages are near historically normal levels, but the deterioration is concentrated in lower-income areas and in areas with declining home prices.” “Aggregate delinquency worsened in Q4 2025, with 4.8% of outstanding debt in some stage of delinquency,” the Fed report . “Transitions into early delinquency were mixed with mortgages and student loans increasing, while all other debt types held steady. Transitions into serious delinquency ticked up for credit card balances, mortgages, and student loans while auto loans and HELOC decreased slightly.” The Consumer Lenders: ALLY, AXP, AX, BCS, COF, LC, SOFI, SYF  As Q1 2026 earnings begin next week, let’s review the consumer lending group to update readers on performance and other developments. Although the FRBNY noted higher levels of delinquency in lower income households, overall banks are reporting lower credit losses across the entire spectrum of loans.  Losses for the eight banks in our consumer loan group reflect this trend, as shown below in the chart using data from the FFIEC . Source: FFIEC

“Across the globe, investors have one thing in mind. How far will interest rates rise and is the great bull market in bonds finally over?” Lawrence MacDonald Henry Ford's missing punch bowl February 4, 2018 | The proverbial punch bowl has been spilled all over the floor. Not surprisingly, the departure of Janet Yellen as Chair of the Board of Governors of the Federal Reserve System is bad news in many quarters. The speculative policies that helped gun assets prices around the world are now ending – at least for now. An eight year bull market in bonds is also seemingly at a conclusion. Quantitative easing or “QE” went on for years longer than necessary, thus Yellen’s successor, Chairman Jerome Powell, must clean up a particularly large mess. Cleaning up other people’s messes is, of course, the key job requirement for being Fed Chairman and, particularly, President of the Federal Reserve Bank of New York. Names like Volcker and Corrigan return to front of mind, but the past three Fed chairs have not deigned to dirty their hands with mere banking. The mess cleaning task of the Fed is similar to the role played so wonderfully by Sally Hawkins and Octavia Spencer in The Shape of Water, our vote for the Oscar this year BTW. Besides conveying dying broker dealers and insurance companies into new hands, the merger of dying zombie banks with the living, and most important, preserving the Treasury’s access to the debt markets, the Fed is now tasked with cleaning up a mess in Washington. This last responsibility is about to become particularly difficult as we rocket into the future with a Republican Congress that refuses to raise revenue out of fear of losing the next election. Before Chair Yellen actually walked out the door, the Fed’s Supervision & Regulation function announced supposed sanctions against Wells Fargo & Co (WFC). The bank engaged in widespread acts of fraud against customers, apparently for years. The sanctions are an embarrassment and amount to a single gentle slap on the backside by the Fed. For starts, by telling a $2 trillion asset zombie bank and the largest loan servicer in the industry that they cannot get bigger, you are doing the CFO a favor. After all, it's about equity returns. The Fed has the power but not the will to act. For example, replace the CSUITE of WFC and force the bank to sell 50% of its assets. Then the Fed would be doing its job, as it would do without hesitation with a smaller institution. But by slamming dying zombies into healthy banks for fear of damaging confidence, the Fed created the governance problems at WFC. And the US central bank dares not challenge the bank monstrosities it has created over the years, in part because they are all primary dealers in US government bonds. None are more surprised about the market's turn of affairs than the inhabitants of Wall Street, both the perpetrators themselves and their loyal scribes in the world of financial journalism. The idea that markets for stocks, bonds and real estate might need to correct a bit after galloping along for five years at multiples of the official inflation statistics is a revelation to many -- but certainly not all. We still have “positive fundamentals,” you understand. Most of the senior pundits in the financial press have asked the right questions at one time or another, but as former Citigroup Chairman Chuck Prince lamented, on Wall Street you dance until the music stops. Or as they used to tell teary eyed fans at the end of his concerts, “Elvis has left the building.” No, Chair Yellen will not be playing an encore. And the timing of Chair Yellen’s departure is particularly unfortunate for the overbought and overheated financial markets. Washington has just done a reprise of sorts, repeating the market movements seen after the 2016 election. The yield on the 10-year bond is rising towards a five-year high, attracting cash from absurdly over-stretched equity markets. The chart below shows the 10-year Treasury bond and the S&P 500 Index. The arrow indicates the November election and subsequent discontinuity that included a surge in interest rates and stock prices. Was the post-election uptick in stock prices supported by “good fundamentals” or the proverbial animal spirits? Our friend and The IRA reader Dick Hardy down in Atlanta worries that the ratio of the 10-year Treasury bond and the SPX are nearing a worrying divergence. “Note the head and shoulders pattern developing, and note that if one draws a trend line off the 09 low and 14 low the trend has been broken. A break below 90 (the approximate head and shoulder neckline) would be an ominous sign. Might want to put this one on your watch list,” he writes. With most markets fully correlated, we may all be staring into the eye of a perfect storm in formation. First, Congress has just passed tax reductions that promise to greatly increase Treasury funding needs in the near term. Indeed, the position taken by Secretary Stephen Mnuchin and his predecessors about the US Treasury issuing primarily short-term debt seems to be evolving with each passing day. Look for those 10s and 30s to be reopened more frequently in coming months as the reality of Argentine style fiscal policy in Washington collides square on into a receding bond market and a weak dollar. Of particular interest is the decision by the Chinese government to reduce outflows of yuan and how this political shift will impact foreign asset prices. Press reports suggest that epitomes of leveraged growth such as HNA Group seem headed for default, although we still don’t know who actually owns the company! Speaking of AML violations, let's ponder the fact that global regulators and counterparties have no idea as to the overship of HNA, the largest shareholder of Deutsche Bank AG. Reports that HNA and other Chinese investors may be forced by Communist Party leader Xi Jinping Beijing to lighten up on foreign real estate certainly provides food for thought. Will the forced assets sales by some of the more egregious examples of excessive leverage in China cause a general liquidation of the Yellen bubbles in stocks and bonds? As one New York real estate publication The Real Deal warned, "Brace yourself for a yard sale." The unwind of large bubbles does not necessarily happen quickly. The Great Crash of 1929 was actually the final crescendo of a period of financial boom and bust that began to end with the collapse of the FL real estate market in the mid-1920s. John Kenneth Galbraith, writing in his classic 1954 book “The Great Crash, 1929,” describes how parcels of land in Florida were divided into building lots and sold for a mere 10% down payment. In effect, Americans of the early 1920s were trading fractional options on FL real estate. Charles Ponzi, the great American fraudster and namesake of the financial pyramid scheme, was actively involved in selling parcels of land in Florida in the 1920s. He leveraged a steadily growing flow of investors until 1927, when the tide of new investors peaked and the FL property market began to crack. Sound familiar? Bitcoin is merely the modern day extension of the alluring logic of Charles Ponzi, albeit enabled by the Internet. The Great Crash of the stock markets in 1929 was not the final act, however, and would lead to the catastrophe of the banking crisis of 1933. As recalled in Ford Men: From Inspiration to Enterprise, a decidedly selfish Henry Ford helped to crater the US banking system by threatening to withdraw his cash from Detroit's banks. From early 1933, financial institutions from Chicago to New York closed for months and even years -- all thanks to Henry Ford’s enmity for his former business partner, Senator James Couzens, and most people generally. Scores of private banks and businesses failed in the forced deflation from early 1933 onward. When President Franklin Delano Roosevelt made his famous March 1933 inauguration day utterance about Americans having “nothing to fear but fear itself,” every bank in New York was closed. Millions of Americans were quite literally standing in the streets of major US cities. The terrible year 1933 was quite a bit worse than the crisis of 2008. Out of the experiences of the Great Depression and World War II, the Fed and Washington generally have evolved a progressive attitude towards “pump priming” consumer demand that has led us to the current juncture of zero rates and infinite duration. Most of the industrialized world, including China, is drowning in bad debt, but this fact goes unremarked. Several years ago, the big idea coming from Chair Yellen and her comrades on the Federal Open Market Committee and other global central banks was to lever up the economy with even more debt. This increase in global leverage included the purchase of trillions of dollars in stock funded with record amounts of corporate debt. Just to add some spice, the Yellen Fed purchased two trillion dollars worth of mortgage paper -- bonds that will sit on the Fed’s books for many years to come. Indeed, should we start to see mortgage agency bond issuance with 4 and even 5 percent coupons not so far down the road, the duration of the Fed’s MBS position will explode -- even as the nominal principal amount very slowly runs off. But at least holders of mortgage servicing rights (MSRs) can look forward to big positive marks in Q1 2018. The pressing question facing investors is whether interest rates will follow the pattern seen a year ago, when Treasury yields feel as the market retraced the increase in yields seen after the election of Donald Trump. The key market benchmark flirted with 2% yields in September last year. With each uptick in interest rates, the massive amounts of investor cash sitting on the sidelines returns, acting to counterbalance the market’s bearish tendencies. The difference between last year and 2018, however, is that now the Treasury is seeking to fund trillions of dollars in red ink to fund a badly advised peacetime pump priming effort. Don’t get us wrong. Structural tax reform is great. But the US badly needs to raise some revenue pronto or will run the risk of looking ridiculous to the entire world. The danger here stems not from the colorful occupant of 1600 Pennsylvania Avenue but from the fact that the larger building down the street that sits atop Capitol Hill appears to be empty -- of courage or even practical perspective. Market prognostications aside, the lack of political will among America’s leaders when it comes to matters of money is the biggest risk facing the world in 2018. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information. #Yellen #PunchBowl #HenryFord #FordMen #duration

Richard Cordray and Mick Mulvaney January 30, 2018 | It’s a strange time in the housing market. Home price increases have been running above the posted inflation rate for more than five years, yet lending volumes are expected to fall again in 2018 for the third year in a row. The end of the Progressive Inquisition at the Consumer Finance Protection Bureau is in sight, yet the housing industry continues to reel from the massive increase in the cost of regulation, which has seen productivity in the world of mortgage finance cut by two thirds since 2012. News reports suggest that thousands of jobs could be lost in mortgage finance this year due to rising interest rates and falling lending volumes. This is primarily due to slack demand for mortgage refinancing as a result of rising long-term interest rates. Chart 1 below shows the 12-month average price change from CoreLogic for all US homes going back to the 1970s. Source: CoreLogic Note the upward surge in average home prices during 2012-2014, which was due to the work-out of distressed mortgages. Closing the gap between the deeply discounted value of foreclosed homes and normal sales accounted for a lot of the price gains reported during this period. The more subdued average home price action in many coastal markets since 2014, however, is still a multiple of the official inflation statistics coming from Washington. Despite policies from the Federal Housing Administration and Federal Open Market Committee meant to boost house finance, regulation and extremely tight secondary market terms are hurting profitability and employment in the mortgage industry. Most of the credit flowing from Washington is going to consumers buying larger homes rather than first time home buyers. Meanwhile, prices for mortgage servicing rights (MSRs) are still trading at a discount to the underlying collateral, as the FT’s John Dizard reports. Mortgage industry maven Rob Chrisman wrote recently of colleagues working “in a business where many are experiencing contracting volumes and contracting margins. Bank of the Ozarks of Little Rock will stop originating home loans for resale on the secondary market, a line of business that had ‘operated at essentially break-even’… Every company is taking a hard look at the continued high cost of originating loans, regardless of channel, and evaluating profitability. Watch for plenty of changes in 2018.” With Mel Watt, head of the Federal Housing Finance Administration, leaving office in less than a year, speculation about the chances for reform of the housing enterprises, particularly Fannie Mae and Freddie Mac, has grown. So much so, in fact, that somebody decided to leak a letter from Watt to members of the Senate Banking Committee regarding his views of GSE reform. “Watt said that once they are returned to the private sector, Fannie and Freddie would be the first two ‘secondary market entities’ able to issue government-guaranteed mortgaged backed securities as a common security that has a mandated rate of return set by a regulator,” American Banker reports. If, as Watt suggests, the idea is to have two “private” utilities with a government backstop for catastrophic risks, then that is what we have today. The two enterprises have government ownership with private capital standing in front in the form of risk sharing transactions. The key flaw in both Watt’s plan and the Senate proposal for GSE reform is the role assigned for private equity capital in the “privatized” Fannie Mae and Freddie Mac. If Congress wants to privatize the GSEs, then they should go right ahead. But please note that private mortgage companies are trading well below book value at present. You see, there is no utility in providing two more independent mortgage banks to an industry with profitability issues. If true privatization is the object of GSE reform, then the last thing the mortgage sector needs right now is Fannie Mae and Freddie Mac in drag, pretending to be private finance companies. All ties between the federal government and the GSEs must be severed to make “privatization” a reality. Instead of continuing the strange pretense of the “private” GSEs, better to simply liquidate the two enterprises and focus the distribution of all government housing subsidies on the FHA and Ginnie Mae, as suggested in several alternative plans floating around the House of Representatives. The US government through FHA would offer insurance on eligible loans held by any issuer without providing a backstop for the corporation. The private bank or non-bank would then sell the mortgage backed securities to investors, with either GNMA cover, private insurance or no insurance at all. As today, higher quality mortgages such as prime jumbos would not require any government insurance cover whatsoever, but the real opportunity is to privatize the 60% of the market now served by the GSEs. If you think of the mortgage market today, 25% of all mortgage loans are held by banks in portfolio with no cover, about 50% (mostly prime loans) are guaranteed by Fannie Mae and Freddie Mac, and the rest of the market (including below prime loans) are covered by the FHA and GNMA. Private investors could easily accept uninsured prime mortgage securities now covered by the GSEs and do so at a lower cost to consumers. Some three quarters of all loans today have FICO scores above 720, quality loans that private investors would readily accept. The pricing for Fannie Mae’s risk transfer deals calculated by Well Fargo suggests that virtually all of the default risk from GSE mortgage exposures could be underwritten by the private sector and at a cost that is a fraction of the guarantee fees charged today by the GSEs. Meanwhile, across town, acting Consumer Finance Protection Bureau director Mick Mulvaney also leaked a memo outlining how the agency will operate in future. The head of the Office of Management and Budget made clear that the bad old days of the CFPB extracting settlements from mortgage companies and banks is over. He wrote: "We are government employees. We don’t just work for the government, we work for the people. And that means everyone: those who use credit cards, and those who provide those cards; those who take loans, and those who make them; those who buy cars, and those who sell them. All of those people are part of what makes this country great. And all of them deserve to be treated fairly by their government. There is a reason that Lady Justice wears a blindfold and carries a balance, along with her sword." More significantly, Mulvaney confirmed that the CFPB will no longer regulate through enforcement actions and that fines and penalties will only by imposed when there is actual harm to consumers. This changes the inquisitorial approach of former director Richard Cordray, who extracted billions in wrongful settlements from private banks and mortgage companies during his reign of terror. Cordray is now seeking the OH governorship with a war chest filled to overflowing with contributions from the trial bar. Mulvaney stated in his memo: “So, what does all of this mean, in terms of how we will operate at the Bureau? Simply put, we will be reviewing everything that we do, from investigations to lawsuits and everything in between. When it comes to enforcement, we will be focusing on quantifiable and unavoidable harm to the consumer. If we find that it exists, you can count on us to vigorously pursue the appropriate remedies. If it doesn’t, we won’t go looking for excuses to bring lawsuits…. On regulation, it seems that the people we regulate should have the right to know what the rules are before being charged with breaking them. This means more formal rulemaking on which financial institutions can rely, and less regulation by enforcement.” Under the tyranny of Richard Cordray at the CFPB, the cost of servicing a performing mortgage rose three fold in the US, one reason why many smaller independent mortgage banks have shut their doors. Larger firms are under pressure as well, which is why half of the top ten independent mortgage banks are in bankruptcy or for sale. It is fair to say that there will be a significant number of business closures and acquisitions in the mortgage sector during 2018. Even with the welcome regulatory changes in Washington, it will take years for the mortgage finance industry to recover to something like a reasonable cost structure. In the meantime, millions of Americans could lose their businesses and their jobs in 2018 – not primarily due to rising interest rates, but because of the abuse of power in Washington by ambitious progressives seeking higher office. While the changes at the CFPB are welcome in the mortgage finance sector, the fact remains that 2018 is going to be a very tough year. The entire mortgage banking and REIT sector has been selling off since the end of December, reflecting investor concerns about rising interest rates and a flat yield curve. Regulatory changes in Washington are welcome and long overdue, but for the mortgage finance industry, it is still the depths of winter. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

“To exactly solve the problem of corruption, we must hit both flies and tigers” Xi Jinping January 15, 2018 | In December this past year, Chinese lender Citic Bancorp warned that the high-flying HNA Group was having trouble paying its considerable short-term debts. After building a $40 billion pile of investments around the world largely funded with debt, HNA seems to have reached the end of its ability to grow further, both in financial and political terms. Thus western investors and banks began 2018 wondering whether the Chinese government will come to the rescue. HNA symbolizes China’s schizophrenic approach to economic growth, an on again, off again roller coaster which reflects the changing political priorities of the country’s communist leaders. Whereas in 2016 China’s leaders allowed and even encouraged Chinese investments offshore, both by companies and individuals, since last summer the situation has changed. Paramount leader Xi Jinping is reasserting the government’s control over the economy. And perhaps the highest priority for China’s rulers is reining in the overheated financial sector symbolized by firms like HNA. Think of HNA Group as a Chinese version of Softbank, but with considerably less transparency and more debt leverage. The firm exploded onto the global financial scene several years ago, acquiring New Zealand’s largest financial services firm, and stakes in companies such as Hilton and Deutsche Bank. It ostentatiously hung its name on office buildings in major world financial centers. HNA created its own aircraft leasing company, Avolon, to compete with global banks in this lucrative financial market. Incredibly, it even acquired SkyBridge Capital from hedge fund manager Anthony Scaramucci before he briefly joined the Trump Administration last summer. The public face of HNA is Adam Tan, who is identified as chief executive officer and co-founder. The company’s ownership and corporate structure remains shrouded in mystery, however, causing investors increasing disquiet. To fuel its growth, HNA aggressively leveraged existing assets to fund the purchase of new ones, the Financial Times reported last summer, a process known in Chinese as “a snake swallowing an elephant”. Rating agency S&P has cut the company’s debt rating deep into junk territory, causing some analysts to predict that the firm will eventually default. There has been talk of asset sales to deleverage and pay down debt. But the key question is whether the founders of HNA, which started off as a regional airline, have lost the political support of China’s leaders. “There has been a lot of commentary focusing on the notion that China is deleveraging,” notes Leland Miller, CEO of China Beige Book. “China is not deleveraging right now, at least in terms of where it really counts, the corporate sector. What is happening is a crackdown on certain shadow products across the financial sector. The government is clamping down on instruments it thinks are running amok, such as wealth management products, trust products, negotiable certificates of deposits, and others.” Miller notes that he expects there to be some high profile defaults in China during the coming months. It is critical that Beijing sends the message that people can and will lose money when they invest blindly into the shadow banking system, he notes: “They have to eviscerate the idea that the Great Chinese Government Backstop continues to remain in place.” Many foreign investors and corporate managers find it convenient to believe that firms like HNA are private companies that are similar to their western counterparts, but in fact all businesses in China are ultimately subordinate to the Chinese Communist Party (CCP) and Xi Jinping. Last summer, Chinese regulators began restricting liquidity to acquisitive Chinese firms, Reuters reports, ordering a group of lenders to assess exposure to some of the more aggressive dealmakers, including HNA, the property-to-film conglomerate Dalian Wanda and Anbang Insurance Group. Foreigners also like to believe that the party will support companies such as HNA when they get into financial trouble, but in fact the decision of whether to bail out an insolvent bank or company is ultimately political. HNA’s roots are also political, as a June 2017 feature article in the Financial Times makes clear, but this could ultimately lead to the firm’s undoing. When Xi Jinping ascended to become the unquestioned leader of the CCP and co-equal with Mao last year, his coronation marked the conclusion of a “anti-corruption” campaign to systematically destroy any potential rivals in the party apparat. Insecurity drives Xi’s relentless focus on abolishing alternative sources of economic and political power. His father Xi Zhongxun was persecuted during the Cultural Revolution, and Xi was for many years shunned because he was deemed “not suitable” to be a member of the party. Now firmly in charge of both the CCP and the Chinese military and police, however, Xi now appears intent upon remaking China’s economy in his own image and deemphasizing foreign influence via increased party control over “private” companies. When Xi proposed his ‘Thought on Socialism with Chinese Characteristics for a New Era’ – the opening phrase of his report to the CCP congress last year, he was starting a process of economic and political reform that is ultimately designed to focus power into his hands indefinitely. And this new stage of the “reform” process will be focused on domestic firms such as HNA as well as foreign companies with roots in China. “The [anti-corruption] campaign was aimed at the public sector; it cleaned out a rotten bureaucracy and helped Xi to wrest power from China’s provincial barons and powerful figures in the military,” writes Qi Gua in The London Review of Books. “It looks as though the next five years will see it extend to the private sector, and the first task will be to bring the tech giants to heel.” He continues: “The government is now proposing to increase its stake in our big tech monsters, Alibaba, Tencent and Baidu. According to Bloomberg, it already has holdings in Tencent (0.8 per cent) and Alibaba (1.3), but wants to acquire another 1 per cent in each: an approach they’ll find hard to refuse, even though the objective is to penetrate the two companies and oversee every key decision they make. Mao called this steady infiltration ‘mixing the sand into the hardened soil’.” As Xi prepared to take control of the CCP, China began to tighten capital outflows in the second half of last year. This change in the official tolerance for foreign investments has slowed the hectic pace of deal-making by domestic companies looking to scoop up overseas assets. The imponderable question for foreign investors, banks and companies with exposure to HNA is whether China’s leadership views the Hainan-based conglomerate as an ally or a threat. The same analysis must be done with respect to other Chinese companies with significant foreign participation. So long as China’s banks are willing to work with HNA to restructure its debt and sell off assets, then the company is likely to survive. But any such analysis must recognize that more than ever under Xi Jinping, it is the CCP representative that ultimately validates the decision by the bank’s management. If Xi Jinping finds the continued existence of HNA to support his political objectives, particularly the renewed focus on investment in China, then it is likely that China’s state-controlled banks will continue to be constructive when it comes to unwinding HNA’s massive pile of debt. If not, then HNA may be pushed into a forced restructuring that will mark a further confirmation that China’s leadership has changed the way in which views foreign investments by corporate “tigers.” This article was previously published in The National Interest and is reproduced with permission. Further reading: Cutting Through the Fed’s Orwellian Doublethink: Will the new chairman continue to say one thing and do another? The American Conservative January 12, 2018 The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

Justice Louis D. Brandeis Time Magazine, July 7, 1930 January 2, 2018 | This week in The Institutional Risk Analyst, we feature a blog post by Christopher Whalen originally published by The National Interest that tries to explain the false narrative about lower corporate taxes resulting in the repatriation of trillions in offshore cash. Many economists have spent months waxing ecstatic about the potential investment surge that will result, but sad to say it ain't so. We'll be following up with a more technical discussion of variable interest entities (VIEs) and tax fraud in a future post for The IRA. Till then, as you enjoy this week's comment, ponder the fact that not all VIEs are used for tax avoidance, but no VIE can really ever be a "true sale" that meets the draconian test established in 1925 by the U.S. Supreme Court. As Justice Louis Brandeis wrote in Benedict v. Ratner, an incomplete sale "imputes fraud conclusively." Suffice to say that the Internal Revenue Service gets the joke. Punta del Este | When the founders of the United States framed the US Constitution, one of the concerns that guided their work was the knowledge that popular democracy would eventually become an entirely commercial proposition. This fear is clearly illustrated by the tax “reform” legislation just passed by the Republican majority in Congress. It seeks to buy votes next November with reductions in federal tax revenue that must ultimately be funded with ever larger amounts of public debt. Of course, all of us hope that the various provisions of the tax bill will in fact lead to more investment, higher productivity and increased economic growth. Yet if we examine the narrative that helped to win passage of the legislation, many of the assertions made by politicians and their allies in the world of economics make little sense. In particular, the notion that lower corporate tax rates will lead to repatriation of corporate cash stashed offshore, thereby funding increased investment and productivity, and ultimately crating more jobs in the US is, upon reflection, a complete nonsense. First and foremost, corporate investment decisions are based upon the cost of capital and the prospective equity returns that new investment can generate, not the availability of cash. In a world where corporate bond yields are at all time lows and equity market valuations are at all-time highs, the effective cost of capital for many multinational companies is arguably negative. The problem is not funding new investments, but finding new endeavors in which to deploy cheap and plentiful capital. The economists who largely control the major central banks in the industrialized nations may be able to manipulate markets and cancel excessive debt through open market operations, but they cannot manufacture attractive investments. Indeed, the low interest rate regime put in place by the Federal Reserve, European Central Bank and Bank of Japan arguably retards new productive investments by driving cash into real estate, commodities and speculative whimsies such as crypto currencies. One of the most outrageous fallacies put forward by economists over the past year is that lower US corporate tax rates will cause the repatriation of offshore cash balances. This view, which is widely endorsed by many analysts, fails to reflect the true nature of offshore tax schemes and how problematic it will be to reverse these complex transactions. In 2016, Karen C. Burke and Grayson M.P. McCouch the University of Florida published an article entitled “Sham Partnerships and Equivocal Transactions” for the American Bar Association’s journal Tax Lawyer. The understated article provides an in-depth look at how US corporations have stashed literally trillions of dollars in offshore venues since the 1990s to avoid domestic taxes. The authors state: “Corporate tax shelters proliferated during the 1990s, exploiting the flexible partnership tax rules of Subchapter K to defer or eliminate tax on hundreds of billions of dollars of corporate income. The corporate tax shelters were typically structured as a financing transaction in which a U.S. corporation leased its own assets back from a partnership, generating a stream of deductible business expenses while shifting taxable income to a tax-indifferent party such as a foreign bank. Since the transaction allowed the U.S. corporation to raise capital in a tax-advantaged manner in connection with its regular business operations, it was assumed that the transaction had economic substance. Nevertheless, in scrutinizing these shelters, courts have invoked a sham partnership doctrine, derived from the longstanding Culbertson intent test, which disregards a partnership that lacks a bona fide purpose (or, alternatively, a purported partner whose interest does not constitute a bona fide equity participation).” The Internal Revenue Service is on to these fraudulent scams for which, of note, there is no statute of limitations. Significantly, in January of 2017, the US Supreme Court declined to hear an appeal involving an adverse tax decision by the IRS against an affiliate of Dow Chemical known as Chemtech. The hundreds of corporations that have used offshore transactions to hide revenue knew that Dow’s appeal was their last hope to avoid sanctions by the IRS. General Electric is another example of a US corporation that has been forced by the IRS to reverse a bogus offshore “asset sale” transactions. The IRS process of disallowing sham offshore transactions can be catastrophic. Consider the 2012 bankruptcy of tanker operator Overseas Shipholding Group (OSG). When the IRS disallowed half a billion dollars in offshore “asset sale” transactions, the company was forced to file bankruptcy and restate years of financial statements. A torrent of litigation ensued. Violations of US tax laws can lead to both civil fines and criminal prosecution for the corporate managers and their legal counsel who designed these schemes. In the case of OSG, the company’s tax counsel was sued for negligence in the bankruptcy. OSG’s tax lawyers then sued OSG’s senior executives. The competing claims were eventually settled, but none of this has created any value for OSG’s shareholders much less any new jobs. The 2017 tax law begins a new regime for future corporate taxes, but it may also compel recognition of huge past-due tax liabilities. All previous offshore corporate tax avoidance scams will now be exposed to IRS review. Dow and General Electric were required to pay back taxes, interest and penalties (up to 60% in Dow’s case). Dow and General Electric, however, escaped the criminal prosecution other corporate managers (and their legal counsel who designed these schemes) have faced. The process of reconciling offshore revenues is going to be exceeding painful for corporate managers and investors alike. Fessing up to past acts of tax avoidance is hardly likely to result in a wave of new corporate investments that increase productivity and economic growth. Indeed, while the process of coming to Jesus in the world of offshore financial partnership may generate a lot of revenue for the US Treasury, it is unlikely to boost corporate investments or even result in the actual return of cash to the US. Some investors are already anticipating that the tax legislation will result in a bonanza of stock repurchases that will boost share prices above current levels, but in fact the opposite may be the case. With an appropriate level of enforcement by the IRS, the notion that a lower tax rate on future revenue will lead to increased levels of cash for US corporations that are compelled to come forward and confess their sins with respect to past tax returns and financial disclosure seems fanciful. Many economists will be surprised to learn that the new tax bill does not actually require repatriation of offshore cash. Treasury is instead employing "deemed repatriation," which means the IRS taxes you on your unrepatriated foreign earnings whether you bring the cash back to the US or not. Taxes will be applied over eight years in an end-weighted formula which means you make your biggest payment, roughly 25% of taxes due, in year eight. The tax rates reportedly will be 15.5% on cash balances and 8% on non-cash balances. Just imagine what a compliance nightmare this creates. What is the definition of "cash"? More astute corporate managers and legal counsel who have participated in past tax avoidance transactions may approach the IRS and try to cut a deal. We could even see a formal tax amnesty proposed by the Trump Administration, but Washington insiders give such an idea long odds in the near term. “Treasury would consider offering an amnesty only if corporations evinced a real fear that they were about to be caught up in its maw,” notes one respected tax analyst in Washington. “I’m not 100% sure we are there yet. We did this with Swiss bank accounts only when we had them dead to rights.” Treasury is already working on the implementing regulations for this “virtual repatriation.” Another veteran Washington observer says that earnings return provisions of the tax bill are the highest priority item, followed by the anti-base erosion provisions, and then the worldwide regime on Global Intangible Low Tax Income--with a great acronym, “GILTI.” In theory, Treasury is going to put in place the deemed repatriation rule to raise the roughly $200 billion over ten years they need to move to a system which excludes most foreign-sourced active business income from U.S. taxation. This is the aptly named “participation-exemption system” that the US business community has been lobbying to get for years. But of course none of this is likely to result in a wave of new investments or job creation – unless you are a tax lawyer or consultant. One way or another, Treasury is going to collect its money. Perhaps that’s how House Speaker Paul Ryan plans to cover the increased deficits intentionally implemented by the new tax legislation. And for all of you economists and hedge fund moguls who think that the new tax legislation will result in a cash repatriation bonanza that will benefit stock prices or the economy, better think again. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.