December 4, 2017 | We think 2017 will be remembered as the Year of the Bubbles. Everywhere you look, whether its stocks or real estate or even overt acts of fraud like bitcoin, the value of fiat paper dollars measured in prices for other “assets” is falling. Crypto currencies, to be clear, are more a class of felony than investable assets, but the crypto games provide supply for demand in an age of scarcity engineered by the central banks. During a visit to the Atlanta Fed last week, we had a fascinating dinner with a group of institutional investors. Like many metros around the US, Atlanta real estate is booming after years of post-crisis lethargy and ample amounts of monetary gasoline from the FOMC. Our friend Dick Hardy organized the dinner. He noted, going back to crypto, that bitcoin is really about a shrinking float of available tokens, an ingenious aspect of the bitcoin scheme. But in the world of bank credit, scarcity and abundance exist simultaneously. Bank earnings in 2018 are likely to continue to rise with asset returns, and expenses are likely to fall as regulatory changes ripple through the world of banks and non-banks alike. The big wild cards are an inverted yield curve in the US and an economic slowdown in China, as we discussed in our interview with Lee Miller of China Beige Book. But in terms of valuations for financials, current equity and asset returns for US banks remain significantly below pre-crisis levels. Chart 1 below shows asset and equity returns for all US banks. Source: FDIC For the past five years, there has been a bull market in residential and commercial real estate, albeit for properties that are decidedly up-market. With the increased cost of regulation, the minimum threshold for a residential mortgage that somebody actually wants to service has risen proportionately. If the mortgage has a unpaid principal balance of say $300k or less, it is just marginally profitable for many servicers – especially those located in CA. We note in this regard that Walter Investment Corp (WAC) just filed for bankruptcy court protection. Other non-bank players in the residential mortgage space are struggling. During our discussion last week in Atlanta, MBA chief economist Mike Fratantoni reported that non-bank lenders managed to get profit margins back up to about 40bp in Q3 ‘17 from single digits in the first half of the year, but depositories fared far worse in the MBA survey. A decade ago, residential lending returns were over 2%. Consider high-touch First Republic Bank (FRC), the San Francisco based lender that focuses on managing assets for high-income clientele and making jumbo mortgages for same. As of Q3 ’17, the gross spread on all of the bank’s real estate loans – which is 80% of FRC’s loan book – was just over 3%. The overall 3.1% yield for FRC’s entire loan book is half a standard deviation below its peers, according to the TBS bank Monitor. Chart 2 below shows FRC’s gross loan spread vs its asset peers. Source: FDIC/TBS Bank Monitor FRC has never particularly focused on smaller mortgages, preferring the well-bid world of jumbo loans, which the bank sells into securitizations managed by the likes of Redwood Trust (RWT) with servicing retained. Most other banks large and small have fled the low end of the residential mortgage market and focus primarily on tri-coastal jumbos over $1 million. Chase, Wells Fargo (WFC) and Bank America (BAC) are super competitive on jumbos over $1 million in urban markets. The larger institutions win business by offering APRs and other terms that are well-below that of conforming loans half that size – and barely make money. They typically keep prime jumbo loans in portfolio. Having escaped the below-prime world of FHA mortgages, overall bank loan credit in 1-4 family mortgages is pristine. The net charge-off rate in Q3 ’17 was just 0.04%, largely because home prices are rising so fast thanks to the Yellen Inflation that banks are having a hard time losing money when that rare mortgage default event occurs. In Chart 3 below, note that past due 1-4 family loans remain stubbornly high at 2.6% in Q3 ’17, this due to the backlog of foreclosures that remain in the judicial states of the Northeast. The glacial pace of foreclosures in judicial states, which often exceeds 1,000 days from default to resolution, is just one aspect of the cost of “consumer protection” for MBS investors. Source: FDIC The positive impact of rising home prices on bank credit is shown in Chart 4. In Q3 ’17, loss-given default (LGD) in 1-4s reach a new low of just 24%, the lowest observation for this metric since at least 1990. The 30-year average LGD for 1-4s is 66%, a fact that will perhaps be of note to our friends at the Board of Governors in Washington. The plummeting LGD for residential mortgages owned by banks illustrate very graphically how the actions of the Fed have boosted home prices and greatly advantaged home sellers. Source: FDIC Since banks avoid the bottom third of the US mortgage market in terms of credit quality, the credit outlook for banks is quite positive – but we still expect to see defaults slowly rise from the current low levels. Seeing a 24% LGD is a skew, an outlier. Because of the sharp supply shortage of 1-4 family homes as well as affordable apartments in many markets, we do not expect to see prices decline appreciably as the Fed ends QE. But as we told the audience in Atlanta on Friday, we don’t expect to see mortgage interest rates rising because of the dearth of duration in the bond market. Last week in The Institutional Risk Analyst, we talked about how the fact of the Fed’s ownership of $4 trillion in Treasury paper and MBS has taken away upward pressure on bond yields. Since none of the global central banks that collectively own $20 trillion plus in debt and equity hedge their positions, there is no selling pressure to push bond prices lower and yields higher. Banks and other fixed income investors are trapped in the world of “lower for longer” so long as the central banks retain their bloated securities holdings. Indeed, as we predicted during the discussion at the FRB Atlanta, we expect to see an inverted yield curve in Q1 ’18. Last week, Peter Cecchini, chief market strategist at Cantor Fitzgerald, called the flattening yield curve “the most important thing to have a clear idea about now.” This is especially true for banks and other financials, which have surged past the S&P 500 and other equity market benchmarks in the collective madness surrounding stocks in the runup to the tax cutting legislation. Sure, net-interest margins have been rising for banks, however we believe that the prospect of a flat or inverted yield curve will give investors and FOMC members reason for pause. Chart 5 illustrates the recent upturn in bank interest income even as interest expenses have risen far more slowly. So far, banks seem to have managed to keep hungry depositors at bay as yields have risen from 2015 lows, but the Fed is still effectively transferring $80 billion per quarter from depositors to banks. Note how wide the net interest margin grew in 2009 when the Fed slashed rates but yields on earning assets were still relatively high compared with today. Source: FDIC As we’ve noted in previous missives, bank returns on the $16 trillion or so in earning assets are still quite subdued at just shy of 80bps. And the market for new bank loans in sectors such as C&I and commercial real estate remain extremely competitive for larger banks, putting an effective cap on loan yields. So unless bond spreads expand and loan yields actually rise from current levels – something we think is unlikely – the bullish improvement in bank interest earnings may slow. More, if as we suspect the yield curve inverts next year, the FOMC may need to rethink its schedule for benchmark rate increases. Bank credit metrics look quite good at present – too good really. Negative net loss rates for multifamily loans and construction & development exposures remind us that the FOMC has greatly skewed the world of credit – in some cases by several ratings notches. This anomaly will eventually be reversed, revealing tens of billions worth of mispriced exposures on the books of US banks. As Chart 6 below suggests, the cost of credit for construction and development loans in the US remains badly skewed and has been negative since 2015. The degree of downward deviation from the 30-year average LGD of 60% suggests that the adjustment could be far more severe than the 2007 financial crisis – if and when a more general deflation of asset prices occurs. But it remains to be seen whether asset prices can adjust in the near term. Source: FDIC So the good news is that bank earnings likely will to continue to improve with relatively low credit costs, but a flat Treasury yield curve may change that trend. Asset and equity returns for US banks remain 1/3 below pre-2008 levels. Loan growth will probably continue to decelerate from the torrid levels of 2015 and 2016. Whether or not anyone on the FOMC gets the joke in the near term and starts to sell MBS and long-dated Treasury bonds is perhaps the most important question facing bank investors as 2017 comes to a close. 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.

"Gold is money. Everything else is credit" J.P. Morgan 1912 March 10, 2026  | In this   Premium Service  edition of The Institutional Risk Analyst , we update our readers on the   WGA Precious Metals Top 25  in the wake of the war with Iran and various other developments in the world of risk. The good news is that the US bond market has largely run in place and most major sectors outside of credit and energy are stable. Could it be that the world is eventually going to shrug off the US-Israeli military onslaught against Iran?   When we saw the vicious backwardation in oil prices this week, and the equally steep slope down in the price of oil going into the out months, we were struck by this dichotomy.  Likewise the relative stability in the US Treasury market, with the ten-year note still confined to that 4.10-4.20% range that has prevailed all year and long-before the new conflict with Iran, suggests that the current kerfuffle in the media is overdone. Equity markets closed up yesterday, oil prices were down 24% and the key 10-year Treasury note fell in yield. Source: dataCollab That said, the price of oil has basically doubled in a few weeks and is likely to remain elevated for weeks or months more unless and until the US Navy and the militaries of other nations can re-open the Strait of Hormuz. Higher oil prices may be a fact of life for months ahead, a result that is unlikely to be helpful to the Trump Administration in the approaching midterm elections. Shanaka Anslem Perera   wrote in an excellent post on Substack :  “At midnight Greenwich Mean Time on 5 March 2026, seven of the twelve International Group Protection and Indemnity clubs that collectively insure roughly 90% of the world’s ocean-going tonnage executed identical cancellation notices for war-risk coverage across the Persian Gulf, the Gulf of Oman, and Iranian territorial waters… This is not a geopolitical risk overlay. This is the first live demonstration of Actuarial Warfare: a paradigm in which private reinsurance desks, operating under regulatory capital constraints, exercise de facto sovereignty over the planet’s most critical maritime chokepoint more durably than navies, missiles, or executive orders.” In simple terms, the global insurance coverage for oil shipments must be restored before energy and chemicals will move and oil prices will come down. But so far the forward oil market is suggesting that prices will fall in a matter of weeks or months. In comments to CBS News  Monday afternoon, President Donald Trump said the war in Iran is "very complete, pretty much," and that the US is "very far" ahead of the timelines the military had projected. Notice that like banks, Perera notes, the global risk insurers are also laboring under regulatory capital constraints that change their behavior in the markets. Watch oil prices for delivery later this year for a good measure of how that process of re-opening Hormuz is proceeding. In the meantime, will the oil price spike and/or the collapse of private credit take down the rest of the global financial market? We think not. Symbolizing the pervasive Street pessimism, Wall Street icon Ed Yardeni  raised the probability of a market meltdown to 35% for the rest of the year, up from 20% previously,   Yahoo Finance reports . “At the same time, he slashed the odds of a meltup — a rally driven more by investor enthusiasm than underlying fundamentals — to just 5% from 20%,” Yahoo Finance  opined. But looking at the broad market including banks and large financials, the picture is placid. Meltup is pretty much been the characteristic of the US markets for the past several years. That said, the difference in performance between the leading banks represented by JPMorgan (JPM) , BlackRock (BLK)  and private credit giant ARES Management (ARES)  is striking. JPM is still up double digits over the past year, BLK is barely down and ARES is down double digits. But these particular performance trends were already established  before the Iran conflict began as shown in the chart below. Are the gyrations of the major credit shops a systemic risk to the markets? In our view, no. The non-depository financial institutions that we track in our finance group are tiny. Indeed, outside of insurance, most nonbank finance companies in all industry sectors are tiny. This is not to suggest that they don’t matter to the markets or the economy, but the typical nonbank like Apollo or Areas is not nearly systemic. Indeed, the entire private credit sector could collapse tomorrow and the major result would be losses to credulous investors and a great deal of litigation.   Meanwhile, the patterns impacting the metals markets also remain strong. We have warned previously that metals will be volatile because they are the ultimate macro assets. Gold and silver combine the long-term attraction of a monetary asset with the industrial demand of technology, two reasons why we follow the physical markets in metals as well as oil to figure out what is really happening. Premium Service subscribers to The IRA may login to review the latest results for   The WGA Precious Metals Top 25 and also download the entire 36-name test group. Some thoughts on the performance of the Precious Metals Top 25 group follow below.

This week, “The Wrap” features our view of the key events in Washington and on Wall Street over the past week. We also include a special review of market opportunities for our Premium Service subscribers. On Monday we’ll be updating the WGA Precious Metals Top 25  rankings. Don’t forget to watch “The Wrap” 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.  Private Credit: Repricing Lazy Leverage March 6, 2026 | This week is one of those classic risk-off periods that financial professionals will painfully remember for many years. Through much of last year, the accumulation of leverage behind all manner of assets, good and bad, seemed to have no cost, but this was never true. QE drove asset prices up and apparent credit expense and market risk down, but only for awhile. As we noted in 2017 in one of our first comments for The Institutional Risk Analyst  (“ Trump and the Age of Magical Thinking ”):  “Anyone taken as an individual is tolerably sensible and reasonable – as a member of a crowd, he at once becomes a blockhead.” Friedreich von Schiller Quoted by Bernard Baruch  The year 2025 was another year of magical thinking ℅ Donald Trump , a man whose mere presence in the room causes everyone else to descend to their most base level. Trump came to Washington as a president who spurned convention and embraced crypto currencies. He rejected New Deal regulation and shamelessly encouraging greed and self-interest in a way not seen since the years following WWI. The impact on financial markets is profound and may continue for some time.  The credit shops are getting shellacked in the equity markets, as we predicted months ago, but that is the price of 1) being public and 2) selling credit crapola to retail investors. The Iran conflict serves nicely as an accelerant for contagion, both for shorting the stock of credit managers and the affiliated funds. Risk arb traders dream of days like the past week. But as discussed below, market contagion ℅ President Donald Trump also creates opportunities. When Apollo (APO)  CEO Marc Rowan  said that this past week is "a shake out," we hope he is not talking about himself. APO unit Atlas SP got rolled in the MFS default in the UK, where the bankrupt firm doubled pledged collateral a la First Brands.  The successor to the storied real estate finance group of Credit Suisse , Atlas seemingly committed a total failure of risk management with respect to this UK mortgage issuer. Yet MFS is just the latest omission in a lengthening list of financial disasters in the post COVID years. APO is down 20% in the past 90 days. Is it a buy?  BlackRock TCP Capital Corp (TCPC) , a public business development company (BDC) managed by BlackRock (BLK) , reported a nearly 20% decline in net asset value in January 2026. The stock price of TCPC has been cut in half in 2026, hitting record lows. BDCs have relatively low leverage, but they are vulnerable to credit losses. The entire BDC universe is trading at a 30-40 point discount to par today. The drop in TCPC was largely attributed to a few bad investments, including exposure to e-commerce aggregators and the bankrupt Renovo Home Partners.  BLK is down only single digits over the past 90 days, but new revelations about losses in its credit portfolio may force the stock lower.  How can anyone believe a word from BLK officials when these revelations keep trickling out? Like many private equity schemes, Revco suddenly f iled for Chapter 7 bankruptcy liquidation in Delaware on November 3, 2025. This move followed an abrupt cessation of operations in October, 2025, which left thousands of customers with unfinished projects and employees without notice or pay. BLK has no offered to make the creditors of Revco whole. BlackRock’s Scott Kapnick , who leads the firm’s private credit business, said at a Bloomberg event that the biggest players will capitalize on the current industry turmoil while some of its smaller lenders may get left behind. “Most of the big managers are very good at managing risk, and the scaled players are going to continue to benefit from this period,” Kapnick opined.  Only days later, BLK was forced to declare another loan valued at 100 cents on the dollar in December, a $25 million advance to Infinite Commerce Holdings, as having zero value today. The investment was a second-lien loan. The company reportedly had been using a payment-in-kind (PIK) mechanism, allowing them to defer interest payments on debt. We hear that some BDC’s, asset managers, insurers, or hedge funds have pressed banks to expand non-recourse financing transactions for private credit loans which they own---but cannot sell or monetize. Fund sponsors lack sale liquidity and portfolio cashflows to meet rising investor redemption demands, as loans increasingly are moving to payment-in-kind (PIK) and Principal Onto Original Principal (“ POOP”) , which accretes in lieu of defaulted interest/principal cashflows . (H/T Victor Hong) As we noted in The IRA Bank Book Q1 2026 , major banks are already well above their eyeballs with private credit non-recourse financing transactions and regulators are watching.  Just as private credit managers had to see a run on funds when retail investors became involved, non-recourse bank loans to busted private equity companies must end up in total loss.  The selloff in the financial markets was accelerated by the widening war between Iran and the US and Israel. A number of pundits have asked about the “endgame” in the US decision to launch attacks on Iran, but the truth is that there is nobody to negotiate with in Iran as long as the revolutionary leadership remains in place. The US and Israel are simply degrading Iran’s military capabilities with brute force.  There is no endgame. In Washington, another Republican legislator has announced retirement. “Sen. Steve Daines  (R-Mont.), the 63-year-old former NRSC chair, announced late Wednesday that he won’t seek a third term in the Senate,” Punchbowl News reports . “Daines withdrew from the November ballot just minutes before the 5 p.m. filing deadline. That was around the same time that Kurt Alme — the U.S. attorney for Montana — filed to run for the seat.” As of early March 2026, 32 Republican representatives have announced they will retire from the House after this year, according to a report in The Washington Post . A dozen members of the Senate have announced their retirement, mostly Republicans. Including both House and Senate, this represents a historically high rate of turnover by members of both parties. Trumpian Analogs   It is worth reminding our readers that the Teapot Dome scandal (1921–1924), which involved the secret leasing of federal oil reserves to private companies by Interior Secretary Albert Fall , was one of the precursors to the Great Crash of 1929. Like Donald Trump, President Warren Harding (1921-1923) promised a “return to normalcy” after years of inflation and economic recession following WWI.  Trump ran against "the endless wars" of Joe Biden, but now has made common cause with Israeli leader Benjamin Netanyahu in attacking Iran .

“I'd say on Sarbanes ... [it's] probably been the best thing that's happened to our business [as a private-equity firm] and one of the worst things that's happened to America.... I find corporate managers more or less quite defeated by Sarbanes. I think it's taken a lot of the entrepreneurial zeal out of a lot of corporate managers, and as a result of that, when we talk to them about going private, they're really quite excited about it.” Stephen Schwarzman Chairman, CEO, and Co-founder The Blackstone Group LP to Charlie Rose, May 2006 March 9, 2026  | When people ask us how the world of private equity and credit grew into the trillions of dollars, the short answer is the Sarbanes-Oxley legislation of a quarter century ago. Combined with the equally prescriptive Basel Accord a decade later, the Sarbanes-Oxley Act of 2002 attempted to legislatively prohibit securities fraud. When you squeeze the proverbial investment sausage via excessive regulation, the piquant filling simply squirts out elsewhere. As we all know, fraud is only possible in a free society.    SOX, as the Sarbanes-Oxley law is known, drove the world of finance out of the light of public ownership and markets, creating a dank private cesspool of conflict and chicanery that has done enormous damage to the US economy. Combined with later acts of legislative hubris such as the 2010 Dodd-Frank law, SOX forced the investment bankers to take refuge behind opaque private markets and non-disclosure agreements in order to earn their expected 20% annual fees. Whole firms arose to pursue the noble goal of adding value in private schemes that were always inferior to public investments.  Today the world of private equity and credit is a rancid pool of conflicts and illegality that cannot possibly be seen as superior to public markets. Private equity executives even enjoy special tax provisions from Congress for "carried interest" to reward them for their efforts in soaking investors. Advocates of private schemes like crypto tokens, which are explicitly not considered securities, buy and sell Members of Congress like chattel. While PE firms are subject to SEC oversight, including the Investment Advisers Act of 1940, they are exempt from many of the disclosure and compliance requirements that protect public market investors. Our friend Victor Hong describes the hideous mess created for investors in a post last week on LinkedIn :  “Institutions which are diversified across many Private Equity funds AND Private Credit funds now find that portfolio companies in the former often are identical to (or affiliated with) borrowers in the latter.  So, as Fund LP’s, they own entirely BOTH the equity and debt of the same distressed company.  In that case, why are the Private Equity and Private Credit fund managers charging any base or performance fees to the LP’s, and for what value-added services (like a chauffeur charging for my bus ride)?  Worse yet, in cases where the portfolio company has defaulted on its debt, the Private Equity and Private Credit fund managers have hired their own SEPARATE legal teams to battle out OPPOSING restructuring/bankruptcy plans.  Peter fighting Paul is senseless when Peter IS Paul.  This amounts to a Zero-Sum Game for the LP’s which own both its debt and equity.  Peter cannot beat Paul; or vice versa. After ensuing (intended pun) extraordinary fees paid to both the Private Equity and Private Credit fund managers plus their respective lawyers, the LP’s are contractually forced to play a Negative-Sum Game. Cutting a pizza into seventeen even slices, rather than eight, leaves only less for eating but more crumbs for COCKROACHES.” Chuck Bowsher & Sarbanes Oxley One of the key fathers of the Sarbanes-Oxley legislation was our old friend Charles A. Bowsher , the former partner of Arthur Andersen who became a giant figure in the world of accounting and public policy in the 1980s. Bowsher was a close friend and contemporary of Richard J. Whalen , who at the time was the sous chef  in the Reagan kitchen cabinet. Appointed in 1981 by President Ronald Reagan to a fifteen-year term as Comptroller General of the United States, Bowsher aggressively pursued the mandate of the GAO and increased the visibility and effectiveness for the agency.  And he would later use the Enron crisis as a vehicle for imposing tough new restrictions on public companies and markets. The catalyst for SOX was the collapse of Arthur Andersen in 2002 following the firm’s conviction for obstruction of justice regarding the destruction of documents related to the Enron scandal . The firm was found guilty on June 15, 2002 , and subsequently surrendered its licenses to practice as a CPA firm, effectively ceasing operations by August 2002.  In January of that fateful year, Bowsher and four other members of the Public Oversight Board (POB) had resigned in protest of an SEC proposal by Chairman Harvey Pitt  to create a new oversight body for accounting firms in the wake of the massive Enron and WorldCom frauds. Bowsher stated that the SEC proposal sponsored by Pitt was a "sham" designed to give the auditing industry more power to discipline itself, rather than submitting to true independent scrutiny. Pitt himself left the SEC in November 2002. By publicly resigning from the POB, Bowsher made the existing self-regulatory system untenable, forcing Congress to adopt stricter, independent oversight mechanisms. The initial sponsors of the Sarbanes-Oxley Act of 2002 were Senator Paul Sarbanes (D-MD)  and Representative Michael G. Oxley (R-OH) . Title I of the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board or “PCAOB.” Of course, the securities industry continued under a self-regulation model.  Bowsher used the painful experience of Enron and the collapse of Arthur Andersen to force Congress to adopt tough new rules for public companies .  He provided crucial expert testimony to the Senate Banking, Housing and Urban Affairs Committee regarding the need for independent oversight of the accounting profession  in the wake of the Enron (2001) and WorldCom (2002) debacles.  The collapse of Enron and WorldCom cost investors billions of dollars and revealed widespread, systemic corruption and inadequate auditing. The examination function of the PCAOB was initially headed by a former Marine helicopter pilot and SEC veteran, George Henry Diacont , who worked to instill a “regulatory attitude” in the former auditors who became PCAOB inspectors. The new PCAOB imposed a high level of scrutiny on public accounting firms and public companies that, over the intervening 24 years, encouraged the expansion of the private equity and credit markets.  When the US economy cratered in 2008, half of the residential mortgage market was private and the bid for private loans quickly fell to zero. Bowsher resigned as chairman of the Federal Home Loan Bank system's Office of Finance in 2009  because he was uncomfortable with the way banks were valuing their mortgage securities, according to the Wall Street Journal . Bowsher said, "I decided I didn't have confidence in the financial statements," confirming remarks he made previously to Bloomberg News . In the intervening years, banks have left the residential mortgage market due to punitive Basel III risk weights on residential housing assets adopted in 2012 . Most housing loans today are fully documented and carry agency or government guarantees. Nonbank firms now dominate much of the world of secured housing finance, but a growing share of equity finance is also controlled by nonbanks and is now deliberately based upon private rather than public markets. And in these ersatz private "markets," investors have no rights. Private Markets Predominate The private equity market has expanded dramatically since 2008, with global Assets Under Management (AUM) growing from approximately $2 trillion in 2008 to over $13.7 trillion by 2023, reports S&P Global. Private equity increased nearly 600%, driven by massive capital inflows into private markets, which now often exceed public market fundraising. But the private markets of today are little different than the rigged equity markets which prevailed prior to the Great Depression. Over the past century, markets have come full circle back to the opaque and deceptive financial offerings that proliferated prior to the 1929 crash and the passage of financial reform legislation in the 1930s. Examples of financial fraud in the 1920s included Ponzi schemes, stock market manipulation, investment trusts, fictitious oil company investments, sales of fractional shares of real estate in FL, and fraudulent public utility holding companies.  In the late 1920s, Goldman Sachs (GS) publicly launched several entirely opaque closed-end investment trusts, most notably the Goldman Sachs Trading Corporation launched in December 1928 under Goldman partner Waddill Catchings . Goldman also listed the Shenandoah Corporation and the Blue Ridge Corporation in 1929, two highly leveraged closed-end vehicles that failed spectacularly following the great market crash. In his 1955 book The Great Crash, 1929 , economist John Kenneth Galbraith  famously used the Goldman Sachs Trading Corporation as the ultimate example of the speculative madness and "financial insanity" that defined the period leading up to the 1929 market crash. Catchings' aggressive actions nearly caused the failure of Goldman Sachs and he was eventually forced to leave the firm in disgrace. Echoing the claims today made about the superiority of private markets, Galbraith highlighted Catchings as a prominent businessman and author (co-author of Profits and Business Without a Buyer ) who argued that the economy had entered a "new era" where traditional economic rules did not apply. If this sounds like the public statements of Marc Rowan , CEO of Apollo (APO) , you are right. Galbraith portrayed Catchings as a leading example of the dangerous overconfidence and flawed economic thinking that fueled the 1929 stock market bubble. The same sort of dangerous thinking is visible in the leaders of major private equity and credit sponsors such as Apollo, Black Rock (BLK) and Ares Management (ARES) . Back to the Future The private equity and credit markets of the 2020s are much the same thing as the financial markets a century ago, but are protected by private contracts and non-disclosure agreements. Investors in the 1920s were targeted by scams promising high returns, often fueled by illegal "boiler room" tactics and mail fraud. Today private sponsors openly offer private credit strategies to retail investors with no fear of legal or regulatory sanction. Purveyors of private credit investments and crypto token schemes play the same role as the bad actors of the 1920s, but with no interference from the SEC and other agencies. Private investment schemes are often deceptive, especially in performance reporting, and they don't consistently beat simple index funds after fees, liquidity and other risks are considered. Not only are the private markets now big enough to threaten the stability of public markets, but the messy action of the past week in private credit suggests that a major correction is inevitable. The fact that Black Rock had to suspend redemptions on a fund takes us back to June 2007, when Bear Stearns allowed two unlisted funds invested in private-label mortgage securities to fail. The resulting contagion eventually led to the sale of Bear Stearns to JPMorgan (JPM) in March 2008 at a 90% discount to the firm’s price the day earlier. By raising the cost of public ownership, SOX made "going private" a more attractive option, driving a surge in takeovers by private equity firms,” wrote Robert P. Bartlett (2009) of the University of Georgia , and noted that the cost of SOX disproportionately burdened smaller firms. Bartlett predicted correctly “that going-private transactions should migrate away from high-yield debt financing after 2002 given the costs of SOX compliance and the abundance of other forms of "SOX-free" debt financing.” Needless to say, we have told readers of our Premium Service that we are not taking on new exposures in banks or other financials at the present time. Like the sage of Omaha, Warren Buffett  at Berkshire Hathaway (BRK) , we’ve been raising cash and also allocating more assets to income producing assets, and gold and silver exposures. No crypto please. As we told our friend Daniela Cambone last week , the collapse of private equity and credit could be one of the biggest busts we've ever seen on Wall Street. Why? Because the world of private equity and credit is entirely illiquid, something that retail and even institutional investors cannot tolerate in times of market stress. Apollo or Ares or Blackrock can suspend redemptions on a fund, but you cannot stop a run on reputation. In our next issue of The Institutional Risk Analyst, we'll update our WGA Precious Metals Top 25 rankings. 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.

November 30, 2017 | Is a conundrum worse than a dilemma? One of the more important and least discussed factors affecting the financial markets is how the policies of the Federal Open Market Committee have affected the dynamic between interest rates and asset prices. The Yellen Put, as we discussed in our last post for The Institutional Risk Analyst, has distorted asset prices in many different markets, but it has also changed how markets are behaving even as the FOMC attempts to normalize policy. One of the largest asset classes impacted by “quantitative easing” is the world of housing finance. Both the $10 trillion of residential mortgages and the “too be announced” or TBA market for hedging future interest rate risk rank among the largest asset classes in the world after US Treasury debt. Normally, when interest rates start to rise, investors and lenders hedge their rate exposure to mortgages and mortgage-backed securities (MBS) by selling Treasury paper and fixed rate swaps, thereby pushing bond yields higher. An essay on this very subject was published by Malz, Schaumburg et al in a blog post for the Federal Reserve Bank of New York in March 2014 (“Convexity Event Risks in a Rising Interest Rate Environment”). Since then, the size of the Fed’s portfolio has grown a bit, and volatility has dropped steadily. The key characteristic to note is that the Fed owns most of the recent vintage, lower coupon MBS that would normally be hedged by private investors and banks. For those of you who follow our work, this argument tracks that of our colleague Alan Boyce, who has long warned about the hidden duration risk in the bond market since the start of QE. The FRBNY post summarizes the situation nicely: “When interest rates increase, the price of an MBS tends to fall at an increasing rate and much faster than a comparable Treasury security due to duration extension, a feature known as the negative convexity of MBS. Managing the interest rate risk exposure of MBS relative to Treasury securities requires dynamic hedging to maintain a desired exposure of the position to movements in yields, as the duration of the MBS changes with changes in the yield curve. This practice is known as duration hedging. The amount and required frequency of hedging depends on the degree of convexity of the MBS, the volatility of rates, and investors’ objectives and risk tolerances.” Since the Fed and other sovereign holders of MBS do not hedge their positions against duration risk, the selling pressure that would normally push up yields on mortgage paper and longer-dated Treasury bonds has been muted. Thus the Treasury yield curve is flattening as the FOMC pushes short-term rates higher because longer-dated Treasury paper, interest rate swaps or TBA contracts are not being sold, either in terms of cash sales by the FOMC or hedging activity. Chart 1 shows 2s to 10s in the Treasury bond market from FRED. Source: FRED More, the volatility normally associated with a rising interest rate environment has also been constrained because the Fed’s $4 trillion plus portfolio of Treasuries and MBS is entirely passive. As the FOMC ends purchases of Treasuries and MBS, and indeed begin to sell down the portfolio, presumably the need to hedge by private investors and financial institutions will push long-term rates up and with it volatility. As Malz notes, “the biggest change [between 2005 and 2013] is the increase in Federal Reserve holdings, partly offset by a large reduction in the actively hedged GSE portfolio.” Yet since the modest selloff in 2013, volatility in the Treasury market has continued to fall. While it is clear that some smart people at the FRBNY understand the duration dilemma, it is not clear that the Fed staff in Washington and particularly the members of the Board of Governors get the joke. Unless you believe that the FOMC is intentionally pursuing a flat yield curve as a matter of policy, it seems reasonable to assume that the folks in Washington do not understand that reducing the size of the System portfolio is a necessary condition for normalizing the price of credit. George Selgin at Cato Institute wrote an important post this week talking about Chair Janet Yellen’s defense of paying interest on excess reserves (IOER) held by banks at the Fed (“Yellen's Defense of Interest on Reserves”). Selgin’s analysis raises a couple of important issues. The fact that Yellen and the FOMC will not manage IOER at or below the market rate for Fed Funds is quite telling, particularly since doing so would address many of the key criticisms of the policy. This suggests two things, first that there really is no "free" trading in Fed Funds anyway and the Fed is the market. Second that the FOMC somehow thinks that it must push higher the bottom of the band -- this despite the huge net short duration position of the street and the $4 trillion passive Fed portfolio. The more urgent question is Yellen's view of a trade off between QE/open market operations and IOER that Selgin illustrates very nicely. The FOMC seems to think that merely not growing the portfolio or slowly selling is an option while they raise benchmark rates like IOER and Fed Funds. In fact, reducing the portfolio always was the first task, before changing benchmark rates. Especially if one is cognizant of current market conditions. Unless the FOMC changes its approach to managing its $4 trillion securities portfolio, either through outright sales or active hedging, it seems likely that the Treasury yield curve will invert by Q1 ’18. The Fed could sell the entire system portfolio and the street would probably still be short duration due to low rates and continued QE purchases by ECB, BOJ, etc. And to repeat once again, the agency mortgage securities market is down 30% on issuance YOY. Again, the FOMC does not seem to appreciate that the yield curve must invert, unless the bond trading desk at the FRBNY is actively selling and/or hedging all of the MBS and even longer dated Treasury paper. Some analysts such as Ed Hyman (Barron’s, “A Smooth Exit Seen for Mortgage Securities,” 11/20/17) believe that banks will increase purchases of agency paper as the Fed unwinds QE. We beg to differ. Bank holdings of MBS as a percentage of total assets has barely moved in years. But more to the point, one has to wonder if Yellen and other members of the FOMC appreciate the trap that has been created for holders of late vintage MBS. The Fed has suppressed both interest rates and volatility via QE, as shown in Chart 2 below: Source: Bloomberg As and when the balance between buyers and sellers in the MBS market slips into net supply, volatility will explode on the upside and the considerable duration extension risk hidden inside current coupon Fannie, Freddie and Ginnie Mae MBS could prove problematic for the banking industry. “The duration extension risk goes turbo if we see rates up, volatility up and a curve steepening,” notes Boyce. Or as Malz noted succinctly in 2014: “When interest rates increase, the price of an MBS tends to fall at an increasing rate and much faster than a comparable Treasury security due to duration extension, a feature known as the negative convexity of MBS. Managing the interest rate risk exposure of MBS relative to Treasury securities requires dynamic hedging to maintain a desired exposure of the position to movements in yields, as the duration of the MBS changes with changes in the yield curve. This practice is known as duration hedging. The amount and required frequency of hedging depends on the degree of convexity of the MBS, the volatility of rates, and investors’ objectives and risk tolerances.” 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.

November 26, 2017 | The term “Greenspan Put” was coined after the stock market crash of 1987 and the subsequent bailout of Long Term Capital Management in 1998. The Fed under Chairman Alan Greenspan lowered interest rates following the fabled event of default and life continued. The idea of the Greenspan Put was that lower interest rates would cure the market’s woes. Unfortunately, the FOMC has since fallen into a pattern whereby longer periods of low or even zero interest rates are used to address yesterday’s errors, but this action also leads us into tomorrow’s financial excess. As one observer on Twitter noted in an exchange with Minneapolis Fed President Neel Kashkari: “Central Bankers are much like the US Forest Service of old. Always trying to manage 'nature' and put out the little brush fires of the capitalist system, while they seem incapable of recognizing they are the root cause of major conflagrations as a result.” When the Federal Open Market Committee briefly allowed interest rates to rise above 6% in 2000, the US financial system nearly seized up. Long-time readers of The Institutional Risk Analyst recall that Citigroup (C) reported an anomalous spike in loan defaults that sent regulators scrambling for cover. The FOMC dropped interest rates at the start of 2001 – nine months before the 911 terrorist attacks – and kept the proverbial pedal to the metal until June of 2004. Interest rates rose to 5.25% by 2006, but missed the previous highs of 2006 by a full point, a long-term trend reflected in lower earnings for banks and other credit market investors. Chart 1 below shows the return on earning assets for all US banks. The good news is that returns for US banks are rising after hitting a 40-year low at 0.75%. The bad news is that the peak return on assets will probably peak at 0.9%, a full 5bp below the levels of 2008 10bp below the 2000 peak of 1%. Source: FDIC Now 5bp may not seem like a big number, but when you are talking about $15.6 trillion in earning assets held by US banks, that number represents almost $8 billion missing from the industry's quarterly net income of $45 billion. The unfortunate dynamic of the “Greenspan Put” has been to slowly erode the earning power of banks, pensions and other savers in our economy by driving interest rates ever downward. But following the 2008 financial crisis, Chairman Ben Bernanke and later Janet Yellen doubled down. Call if the “Yellen Put.” Not content with merely driving short-term rates down to near zero, the committee embarked on a fantastic speculative adventure of market manipulation. The FOMC supposed that open market purchases of trillions of dollars in securities would somehow help the economy and get the heavily qualified measures of inflation like the Consumer Price Index to rise to a 2% target. Since then, statistical measures of inflation have barely moved, but asset prices for stocks, housing and commodities have galloped along at double digits. The true goal of the FOMC was not to restore full employment much less price stability, as required by law. Instead the US central bank was and is still today fixated on preventing a general debt deflation. Thus pumping up asset prices seemed the logical idea, even if it did not fit into the Fed's policy narrative. The fact that overall debt levels have surged thanks to the Fed’s use of low interest rates obviously begs the question: what was really accomplished? It also proves the wisdom that the monthly payment is all that matters, both to consumers and to heavily indebted governments. The global reality for the Fed, Bank of Japan and European Central Bank is the relentless increase in public debt. The Yellen Put has increased the debt load in the US and globally, but left the financial markets even more fragile than in 2007. A key measure of this danger was illustrated recently in Grant’s Interest Rate Observer, quoting Asset Allocation Insights, which notes that since 2008 the duration of the Bloomberg Barclays US Aggregate Bond Index has increased 62% to 6.2 years. Simple translation: Via manipulation of the credit markets, the FOMC has temporarily suppressed growing bond market volatility measured by duration. The Yellen Put means that bond prices will likely move at a brisk pace as and when volatility returns, a pace that will stun complacent investors. But meanwhile, the weight of the Fed’s $4 trillion bond portfolio first is going to result in an inverted yield curve. As the spread on 2s vs 10s in the US Treasury market relentlessly closes in on zero, the FOMC is grudgingly being forced to admit that open market purchases of securities may not actually impact the CPI or job creation. And remember, as Grant’s notes with understandable pleasure, that the bond market is now dominated by long-dated Treasury paper and corporate debt with minuscule coupons. And there is also a hidden duration extension risk event buried inside the $10 trillion market for mortgage backed securities, which will fall much faster in price than corporate debt. Again, the relevant terms here are volatility and option-adjusted duration. Not only has Chair Yellen and her colleagues created a time bomb of volatility in the US bond sector when it comes to market risk, but the extended period of low interest rates has also created a hidden wave of future loan and bond defaults. By suppressing credit spreads and thus the cost of credit, the FOMC afforded interior corporate and individual borrowers access to credit at premium, investment grade prices. Now the defaults are starting to accelerate. "For the first time since January 2017, the default rate for autos, bank cards and mortgages all rose together," said David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices. The net charge-off rate for bank owned credit card receivables was 3.4% vs the near-term low of 2.8% in 2015, when banking industry credit loss rates troughed. Meanwhile, loss given default for bank owned 1-4 family mortgages reached a half century low at 24% in Q3 ’17, a measure of just how far the FOMC has gunned home prices in this credit cycle. Big question: when and how much will US home prices correct downward – if at all? Is the home price inflation caused by the Yellen Put permanent? As we noted in a post on Zero Hedge this past Black Friday, “Bitcoin & Fiat Paper Dollars,” the currency system created by Congress in 1862 was a product of the “exigencies of war,” to paraphrase the late Senator Robert Byrd. He was speaking about the Civil War era legal tender laws that force you to accept paper money in payment. By equating money backed with gold with paper money, Congress created a coercive system that allows the US Treasury to expand the currency without practical limit – so long as public confidence in the system is maintained. A profligate Congress is eroding confidence in Abraham Lincoln’s precursor to bitcoin – the greenback. The magnitude and length of the Fed’s latest rescue for the US economy dwarfs the modest credit support provided to markets after the failure of LTCM. With the advent of bitcoin and other crypto currencies, the more independent minded members of society are voting with their feet and fleeing the post-WWII currency system created by Washington at Bretton Woods. Given that the price tag of the Yellen Put stretches into the trillions of dollars, how big will the next Fed intervention need to be? For example, will the FOMC stand by and watch the US equity markets correct as China slows in 2018, destroying trillions of dollars in paper wealth? After all, the chief priority of the FOMC arguably is not full employment or price stability, but rather preserving the Treasury’s access to the bond markets. So here’s the question: Does the Yellen Put imply an open-ended commitment to support the equity and bond markets, and purchase more Treasury debt in the systemic event? Answer is most definitely “Yes.” And this fact allows our national Congress to ponder tax cuts in the face of the largest spending deficits in the nation’s history, in peace time or war. ________________ On Friday December 1, 2017, Chris Whalen will participate in a Real Estate Industry Forum event hosted by the Center for Real Estate Analytics at the Federal Reserve Bank of Atlanta. 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.

Trump Pavilion from the Van Wyck Expressway November 20, 2017 | Q: Besides stocks, what asset class has benefitted the most from the radical monetary policies of the Federal Open Market Committee? A: Multifamily real estate. And what asset class most worries federal bank regulators today? Same answer. By means of introduction, multifamily real estate in major urban areas has been one of the most popular and solid asset classes for US banks historically going back to WWII. Family fortunes, including that behind Donald Trump and many other New Yorkers, started in the 1950s with multifamily housing in Manhattan, Queens and the other boroughs of New York City. Net loss rates on these assets, measured over years and decades have been among the lowest of any bank loan category, but short-term changes in valuation in the 1990s and 2008 were severe. Since the passage of the 2010 Dodd-Frank legislation, regulators have made some draconian changes to limits on bank loan types and loan-to-value (LTV) ratios that, some say, are stifling responsible lending and make little sense from a credit perspective. Most recently, federal regulators have proposed regulations that replace the high volatility commercial real estate (HVCRE) regulations with a new and much simpler High Volatility Acquisition, Development and Construction (HVADC) exposure, a measure that incorporates more risk from construction and development loans. Is all of this concern warranted? Yes. Thanks to the folks who sit on the FOMC, prices for multifamily real estate have risen so rapidly since Dodd-Frank that today net default rates are actually negative. As we’ve noted in previous missives, loss-given default (LGD) for the $400 billion in multifamily loans held by US banks is negative in four of the past six quarters. In plain terms, banks are profiting from defaults on multifamily loans because collateral prices have risen so rapidly, as shown in Chart 1 below. Source: FDIC In the world of analytics, a negative net default rate is a “red flag” because it indicates that markets have reached an outlier position that cannot be sustained. The negative loss rates post-default seen today contrast with the 100% LGDs that applied during the 2008 financial crisis. Even going back to the economic slowdown of the late 1990s, LGDs on bank multifamily exposures were relatively high. Yet as an asset class, multifamily bank loans have been among the most stable credits on the books of US depositories, especially community banks in major urban metro areas. More, while bank portfolios for multifamily loans have been stable, the overall flow of funds into multifamily assets via the asset-backed security market has surged during the period of low rates and “quantitative easing,” as shown in Chart 2 from FRED. Source: FRED Often times the most powerful limits placed on banks are not contained in statutory provisions, but in the guidance institutions receive from regulators. For the past couple of years, the Office of the Comptroller of the Currency has been giving cautionary guidance to banks and thrifts about lending on multifamily real estate in major urban areas, especially multifamily rental properties. We are talking here about Washington DC, New York, Los Angeles and Dallas, among the major urban metros. The guidance for smaller banks was that such exposures should generally not exceed 300% of tier one equity capital. Ironically, the concern of prudential regulators in multifamily housing is driven by the actions of another set of regulators acting on the FOMC. Multifamily real estate as an asset class has been among the most effected by the FOMC's manipulation of credit spreads and asset prices of the past decade. Prices for high end real estate in major metros such as Denver, Seattle and Austin have soared in recent years, fueled by low interest rates and ready supplies of private equity capital sitting on the sidelines. Ed Pinto at AEI sent us Chart 3 below, which compares the growth rate of total debt with multifamily rental units. While loan-to-value ratios for urban multifamily properties have actually fallen since the crisis, dollar exposures to banks have risen with valuations. In response, regulators and particularly the OCC have been restraining community banks from exceeding the 300% guidance in terms of total exposures. Indeed, it has been made very clear to national banks who lend on small, rental and owner-occupied commercial properties that they cannot exceed the guidance. The 300% guideline on in-town multifamily assets is in fact a cap. As the OCC noted in 2015: “Although the underwriting for loans that finance these smaller properties is similar in many respects to the underwriting for loans that finance larger properties, there are important differences that are useful to consider. The biggest difference is often the borrower. These borrowers often have less experience and fewer resources than investors in larger properties.” Since that time, however, the OCC’s views have apparently hardened, bankers tell The IRA, especially in the past year. The vehicle for delivering the message to banks is the examiner in charge of inspecting that institution. This “informal” guidance has significant weight, however, and illustrates some of the subtle issues that Republicans are hoping to address in Washington as they take control of agencies such as the OCC as well as through regulatory reform. Because of the OCC’s conservative stance, state chartered banks that focus on commercial lending have a big advantage over national banks. When state regulators and the Federal Deposit Insurance Corporation work with state-chartered institutions, they typically allow a bank to exceed regulatory guidelines if that bank shows the ability to manage credit risk. A good example of such an institution is state-chartered Bank of the Ozarks (NASDAQ:OZRK), a national lender that leads its peer group in terms of credit performance. The bank is shedding its bank holding company, meaning FDIC is the sole federal regulator for this commercial lender. This gives the state-chartered OZRK a decided advantage over national banks its size or larger. It needs to be stated that the OCC’s caution regarding commercial real estate is well-considered given the froth in all types of real estate. Increased asset prices for commercial real estate have caused a commensurate increase in the dollar amount of loan exposures even as LTV ratios have fallen since the 2008 crisis. Whenever prices for real estate are rising at a rate far higher than the underlying economic growth rate, caution is advisable. That said, multifamily and related commercial loan exposures at all US banks are performing extremely well. The $400 billion in bank loans secured by multifamily real estate held by US banks showed a tiny 0.15% non-current rate at the end of Q2 ’17 and charge-offs were essentially zero. Looking back to the 1990s, multifamily loans have gone through periods when non-current rates have risen sharply as shown in Chart 4 below. Source: FDIC But net losses after default have been extremely low, both in the 1990s and more recently. This was largely because these properties are so widely sought after by local investors. With LTV ratios for multifamily assets in the 50 percent range and falling, it also needs to be said that the intensity of the OCC’s focus on risk from multifamily loans in large markets such as New York seems overdone. Not only did multifamily loans perform better than most other real estate asset types during the 2008 financial crisis, but the equity behind these loans has basically not gone down in half a century. This point is especially powerful when you consider that the agency is at times recommending that national banks substitute unsecured commercial loans for fully secured loans on multifamily real estate. We hear that it has even been suggested to some banks by OCC personnel that commercial real estate lending on beachfront property is preferable to loans on multi-family rental properties located in cities such as Seattle and Miami. Really? In order to accept as true the OCC’s apparent position that multifamily loans pose a threat to the safety and soundness of US banks, you’d need to expect that valuations for these liquid and popular real estate assets are about to be cut in half. In fact, the default and recovery statistics for multifamily real estate loans held by banks and in ABS suggest just the opposite, that there is a strong market for assets that do default and that prudently run credit exposures in these assets have considerable protection against loss given those rare default events. While there is certainly reason to be concerned about the sharp upward move in prices for all manner of real estate given the FOMC’s extraordinary policy actions, residential real estate in major urban centers is decidedly not a source of risk for banks and thrifts. Leveraged loans? Unsecured commercial credits? Sure. The real issue illustrated by frothy real estate markets is not the safety and soundness of banks, but rather asset price inflation caused by the low interest rate policies of the FOMC. 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.

November 12, 2017 | President Donald Trump just completed a relatively upbeat swing through Asia, but made some ominous references to future trade action in his speeches, policy changes that could be focused primarily on China. This week in The Institutional Risk Analyst, we feature a discussion with Leland Miller, CEO of China Beige Book International and one of the best observers of China in the West. He’s also a Non-Resident Senior Fellow for the Asia Security Initiative, Brent Scowcroft Center on International Security, at the Atlantic Council. We spoke to Lee in New York. The IRA: Lee, let’s pick up where we left off more than a year ago, talking about the progressive accumulation of political power under Xi Jinping. How do you assess his success and did he exceed your expectations in terms of the ease with which he has consolidated his grip on power? Miller: He’s fulfilled all of them and probably more. Everyone was pretty much of the mindset over the past year that this consolidation of power by Xi was a done deal. The question was to what degree and how was he going to memorialize this power? How would the systems change to reflect that power? He went just about as far as anyone thought he would go and actually had his thought elevated to the same level as Mao Zedong. The IRA: What does that mean? Is Xi now a demigod in the communist pantheon? Miller: The Chinese Communist Party adopted Xi’s thought as part of the Party Constitution. As long as Xi Jinping is alive, he calls the shots – period. Being part of the constitution puts him on a level that only Mao Zedong himself has achieved, and ensures that his views alone provide the intellectual foundation for all of the Party’s actions. From here on out he is “the man,” whether he holds the title of President or Party Secretary. This is his show going forward. The IRA: Describe how this evolution from collective leadership to cult of personality occurred? Is this just another example of the model of one man rule in China? We are reminded of George Orwell’s classic “Animal Farm,” where the character of the pig Napoleon gradually murders all of his rivals. Miller: Well, it has not happened in a long-time, at least since Deng Xiaoping. There has been a default towards consensus leadership for decades. The people in authority had balancing needs. There were various personalities and factions who jockeyed for position within the Party in a compromise process. This time around, however, it was not a consensus process. Xi has been working for the past five years to take down potential rivals in the Communist Youth League, as well as Bo Xilai and his cabal in Chongqing, who were purged after building up a rival power base. Xi’s ally Wang Qishan went after all the other rival power bases via the anti-corruption campaign, taking them down one by one. Xi is now in control of all of the organs of power in China and that is virtually certain to be the case going forward. The IRA: Well, that’s fascinating, especially with the coincidence of the dynastic purge underway in Saudi Arabia. Is there a power base behind Xi or is he now moving solely by the sheer supremacy of his personality? Xi Zhongxun Miller: Xi was once part of a group that included a number of prominent princelings. His father, Xi Zhongxun, was a famous revolutionary. Then for years he was closely associated with has been called the Zheijiang faction, which refers to the group of people around Xi who served in trusted positions when he was Party Secretary of Zheijiang province. These people now make up a good chunk of the people in Xi’s inner orbit. But even so, there is no real challenge to his power anywhere in the party or the government. He even purged the military and replaced the top officials with younger officers more beholden to him for their positions and influence. The IRA: And created many enemies in the process. Miller: There was enormous turnover in the military, unprecedented changes. There were changes not just in the Central Military Commission, but in the top ranks of the military itself. As I said, this leaves Xi a virtually unchallenged leader and it means that if China is going to do any large-scale restructuring of its system, it is much better positioned to do it now. That doesn’t mean he will opt to do that, it just means that this is a better situation for making such changes if that ends up being what Xi decides to do. The IRA: So how does this change the equation for the US? Or the Russians? Miller: I don’t think it has much effect on Big Power relations. The only real change is that other powers now understand that they are dealing with a core decision maker and that consensus leadership is a thing of the past. The IRA: There are more and more analysts in the West seemingly willing to believe that China will not grow at 7% annually forever. Does the rise of Xi have any impact on the Chinese economy, either immediately or the longer term? Miller: It’s funny, two years ago the people who had been proclaiming that China could grow at 7% forever completely re-wrote their forecasts and started calling for a dramatic economic slowdown or crash. Now, with things looking much sunnier of late, most of those folks have gone back to their old thinking—predicting that China can keep up relatively high growth indefinitely. But they misunderstand the broader context, what was given up to get China this 2017 burst of growth. Analysts have become so ebullient about China that they miss the forest for the trees. The IRA: How so? What is wrong with the never ending China bull case? Miller: They had a great 2017 performance. A year and a half ago we were in the midst of a global contagion that resulted from a crisis in China over currency worries and capital outflows. This type of weakness was obviously unacceptable entering into a year of political leadership change, so they stepped up their interventions and made sure the economy recovered—and then some. So no question, there was an unmistakable on-year recovery in the Chinese economy virtually across the board. The IRA: Where is the catch? Miller: Everyone is on the same page right now in terms of seeing a strong 2017 economy, but the mistake analysts make is seeing this as the “new normal” for China. The Party decided that it would pull all of the stimulus levers over the past year and that’s what made 2017 such a great year for the economy. But this was done at a considerable cost—no deleveraging, an outright reversal of rebalancing, huge stimulus on both the fiscal and monetary sides—so naturally the economy will slow in the coming year as the anxiety cools down. And that’s assuming all else stays the same, which is extremely unlikely. The IRA: We had talked a few months ago about Xi wanting no surprises in 2017 and that seems to be the case. Why is it that the foreign analyst community fails to appreciate the political dimension in China? Miller: We called it the Party Congress put. Every person in China knew that the economy would be kept on track this year because the leadership couldn’t afford any problems in the run-up to the Congress in October. But you’re potentially looking at a much different 2018. They were able to hit this level of economic performance in 2017 because there were no internal or, surprisingly, external shocks. There was no aggressive tightening by global central banks, no strong dollar. In fact you had a very weak dollar through most of 2017. There were no major geopolitical tensions, nothing percolating negatively for them in the South China Sea. And most importantly, there were no Trump trade tensions, none. But we think most of these factors will reverse in 2018. The IRA: Isn’t it remarkable that the US media saves most if not all of its vitriol for Vladimir Putin, while with Uncle Xi in China the honeymoon continues. President Trump’s talk on trade has been remarkably tame with China compared with his campaign rhetoric. His trip to Asia has also been mostly free of aggressive rhetoric. Are we seeing a new Donald Trump? Miller: We think that the good times will be ending soon enough, maybe as soon as early 2018. New problems are clearly brewing for China next year and they are all pointing in one direction. We could even see the Trump Administration take trade action against China in the early months of next year. You have a president who promised tough action against many trade partners and especially China, but nothing so far. This will change. The IRA: So what about it is going to change? Trump likes to have leverage in all of his relationships, perhaps this is how he gets leverage politically and, in his own mind at least, with China. Miller: Everything politically is pushing us towards a trade conflict with China in 2018. Donald Trump wants tariffs. He promised tariffs during the campaign. Trump wants to fix the economic imbalance with China through tariff actions. He talks about this constantly behind closed doors, but so far there have been forces in the White House that have kept him from taking these steps. As the mid-terms elections approach, however, Trump must turn up the heat on trade to be able to reclaim these issues. The ability of moderates in his circle to prevent Trump from imposing tariffs on China has been impressive so far, but his desire to do something big on trade will likely be too powerful to stop in the coming year. The IRA: The global financial markets are really not prepared for such a turn of events. We could easily see the US equity markets trade off by double digits if China-US tensions flare up significantly. Does that possibility figure into the Trump calculations? How does trade action by the US impact the Chinese economy? Miller: The key issue is perception in the West. People have gotten so over-confident on China recently. One of the leading China watchers just got up at a conference last month and declared that China has already had its hard landing and that the next two years are going to be wonderful. People have gotten very cocky about China’s performance, so any volatility will shake foreign investors and markets because expectations are so high. When the US initiates the first trade action against China, perhaps as early as early 2018, it is going to take a lot of people by surprise. How China reacts will be key, both for global markets and for its own economy, but have no doubt that the first move will be made by Trump. He wants a trade war with China. Politically, he needs a trade war with China. How Xi reacts will determine the amount of collateral damage that follows. The IRA: Thanks Lee. 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.

November 6, 2017 | Writing this week in Barron’s, Harvard economist Martin Feldstein nails the proverbial issue of excessive debt square on when he notes that European Central Bank chief Mario Draghi has run out of runway when it comes to policy prescriptions. He writes: “One of the goals of large-scale bond purchases—so-called quantitative easing— was to drive down long-term interest rates in order to stimulate business investment and housing construction. But with long-term interest rates now close to zero, bond purchases would not be able to lower them any further.” But Professor Feldstein then concludes that when the inevitable economic slowdown comes in Europe, “an appropriate response to this dilemma may be a policy of coordinated fiscal expansion.” The fact that the world from Beijing to Brussels is literally choking on debt – thus Draghi’s infatuation with zero or even negative interest rates – does not dissuade Feldstein and other economists from recommending ever more debt-funded fiscal expansion. Of course, if you ask ECB chief Mario Draghi, the ECB still has plenty of room to maneuver. All central bankers suffer from the deadly sin of hubris. Last week, we posted our thoughts on the tactical situation facing the new Federal Reserve Chairman-designate Jerome Powell on Zero Hedge. We asked: "How do you think, Governor Powell, equity markets will react if Chair Yellen inverts the yield curve on her way out the door?" Might ask Governor Draghi the same question. As US interest rates rise and the policy gap between Washington and Brussels widens, our friends in Europe are going to be faced with some profound challenges. Chief among them is how to prevent Italy and other EU member states from defaulting on their debts. And the longer Draghi waits to “normalize” monetary policy, the more investors and markets will question the solidity of the European economic rebound. Wolfgang Munchau writes in the FT: “Even after a decade-long recovery, the ECB may never be able to halt asset purchases.” Ditto. His comment implies that Europe is slipping into a Japan-like state of permanent debt repudiation via QE to manage the fiscal crisis for its weaker members. But insolvent countries are just the beginning of the world's debt problem. Another important read in Barron’s this week features JPMorgan industrial analyst Stephen Tunsa talking about General Electric (NYSE:GE). Tunsa thinks that the dividend on the common shares -- now changing hands around $22 -- is going to be cut to better align with actual cash flow. He also sees the once high-flying GE, formerly a blue chip equity name, soon trading in the teens. Tunsa opines: “I think most active managers expect a [dividend} cut, but a smaller one, to the 60- to 70-cent range. Certainly if it’s below 50 cents, the stock should go down. I don’t think this stock deserves a market yield, which is around 2%, so a 3% dividend yield on 50 cents or below gets you to a share price in the teens.” Of interest, Barron’s reminds us that the financial-industrial conglomerate assembled by Jack Welch remains among the more complex financial services companies in the US even after shedding its status as a regulated financial holding company. Not only does GE Capital still finance much of the receivables of the industrial business, but the company also keeps many of these assets on its own balance sheet under complex leasing arrangements. GE notes in its most recent 10-K that its non-US activities “are no longer subject to consolidated supervision by the U.K.’s Prudential Regulation Authority (PRA). This completes GE Capital’s global exit from consolidated supervision, having had its designation as a Systemically Important Financial Institution (SIFI) removed in June 2016.” But past financial machinations still represent big a negative for GE shareholders. The company’s insurance unit, for example, remains a source of future potential financial risk due to poorly priced long-term care insurance contracts. In its latest public disclosure, which Barron’s notes is shrinking in terms of quality and quantity of its content, GE demurred on whether GE Capital will have to take additional reserves for its insurance unit. “A charge related to a probable [reserve] deficiency is not reasonably estimable at September 30, 2017,” GE notes in its last 10-Q. “Until the above described review has been completed we have deferred the decision whether GE Capital will pay additional dividends to GE.” Really? Could GE shareholders expect an unwelcome Christmas present from the new CEO John Flannery? Tunsa concludes: “If these issues are as bad as they seem from a cash-flow perspective, there’s a systemic problem that won’t be quickly fixed with cost cuts and portfolio tweaks.” The problem with GE, or course, is that they are migrating back towards righteousness after years and years of high-risk financial engineering under Neutron Jack and his hyperactive management progeny. By aspiring to profitability and stability, the story has become entirely boring and subject to the laws of financial physics. Flannery would do better to emulate Amazon (NASDAQ:AMZN) and especially Telsa (NASDAQ:TSLA) when engaged in corporate renovation. TSLA trades on a price-to-loss ratio, a unique measure that allows for unlimited growth. Unfortunately, Tesla shares closed down last week, in part because the Trump tax cutting proposal would scrap the $7,500 federal tax credit for electric cars. Much like AMZN, TSLA is about selling the future rather than present day profits. With the setbacks recently reported by TSLA in terms of actually making cars, Elon Musk and his minions dare not even speculate about eventual profitability at this stage of the game. When confronted by the most recent failures to meet manufacturing goals, Musk pivoted on a dime and announced the construction of a new factory in China. By comparison, GE sports a $175 billion market cap vs $51 billion for TSLA, which is still near its all-time high but is unprofitable and has $10 billion in high-yield debt. Cutting tax rates is great for the profitable, but of limited value to those like TSLA who have yet to report taxable income and can’t seem to hit operational goals. But investors love TSLA and hate GE, and perhaps with good reason. Mark Twain said it is easier to fool people than to convince them they’ve been fooled, a statement tailor made for the TSLA phenomenon. Perhaps that’s why TSLA continues to raise new money to feed its growing burn rate, this even as GE sinks. Meanwhile, the major automakers show signs of ganging up on the new era car maker TSLA. Short-seller Jim Chanos said last year, after the $2.6 billion merger with SolarCity Corp, that Tesla Motors is a "walking insolvency." Agreed. TSLA certainly has negative cash flow, but unlike GE, it has a positive narrative. Henry Ford said that you cannot build a reputation on what you are going to do, the polar opposite of the approach by TSLA founder Elon Musk. Ford Motor Co returned its seed investors’ capital in full after the first year of operations, but investors in TSLA may never seen dollar one. Of course, a century ago cars were the new thing, while today electric cars are a strange novelty meant to make wealthy people feel responsibly green – even if lithium batteries are a dirty and expensive way to store and deliver energy. In his effort to change the world, Musk is fighting the tides of history as well as the relentless logic of accrued interest. Musk's love child is also in a technological race with firms that want to put a sustainable propulsion source inside electric cars. The Economist reports that Mercedes-Benz is planning to introduce a plug-in hybrid SUV that combines a battery pack with a fuel-cell generator. This design is meant to replace internal-combustion engines when the EU plans to go entirely electric in 2040. We continue to believe that hybrids are the answer for clean transportation, even if the auto industry must kowtow to political correctness and build absurd battery powered cars. But forget the batteries and firms like TSLA that are pursuing this retrograde technology. Call us when the all electric Ford F-250 Super Duty truck with a compact gas turbine for power is ready for a test drive. And, no, we’re not buying or selling short TSLA or GE, but we are still accumulating a position in PayPal (PYPL), one of the more interesting names in fintech. BTW, hard copies of "Ford Men: From Inspiration to Enterprise" are again available in our online store. 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.

October 29, 2017 | During our travels over the past two weeks, we tried to keep up with the financial press, particularly the growing sense of unease felt by many observers with the relentless rise of valuations for equities and other asset classes engineered by the Fed and major central banks. Suffice to say the number of queries we receive about bank stocks being overvalued has soared. Last week saw some real gems from the world of crypto currencies. Bitcoin and the enabling technology known as “blockchain” are just the latest shiny objects to fascinate the less cautious members of the investing public. The folks at Grant’s Interest Rate Observer flagged this precious headline from Bloomberg News: “This Company Added the Word ‘Blockchain’ to Its Name and Saw Its Shares Surge 394%” The world of “investing” in blockchain schemes has always given us a feeling of amazement, but tempered with a tinge of chagrin for those credulous souls caught up in this web of intellectual fraud. Sure blockchain has some interesting attributes, but other than enabling the bitcoin phenomenon, it has limited uses that make commercial sense. Blockchain rather blatantly violates the Three Laws of technology investing – cheaper, better, faster – but nobody seems to care. Even more amusing than blockchain, however, is the fact that some of the sponsors of various “initial coin offerings” of nouvelle crypto currencies have taken the position that the ICO is an act of charity and that the investment received is a “non-refundable donation” rather than a distribution of a stake or equity in the issuer. While ICOs seem to be clearly at odds with the anti-fraud provisions of the Securities Act of 1934, so far the Securities and Exchange Commission and Department of Justice have been unwilling to put an end to the marketing of these schemes in the US. The SEC rightly describes crypto currencies as “tokens” that may be considered securities under US law, yet the widespread public confusion over these get rich quick schemes has overwhelmed the government’s willingness to call out this activity. One reason why so-called crypto currencies have gained such a following is that there is no real money to be found anywhere in the world. In the US, the legal tender laws of the 1860s forced members of the public to accept paper money – greenbacks – “for all debts, public and private,” this to help finance the Civil War. When Franklin Delano Roosevelt confiscated gold held by the public in the 1930s, paper money ceased to be a store of value directly convertible into gold or silver by individuals. Today what people refer to as “money” operates as a means of exchange and a unit of account, but the dollar ceased to be a store of value decades ago. An item purchased for $20 in 1913 when the Federal Reserve System was created would cost nearly $500 today, a cumulative rate of inflation of 2,400%. So much for central bank independence. At least the Treasury notes that circulated in the US prior to the Civil War paid interest. Today’s greenbacks issued by the Federal Reserve System are just memorials to dead presidents. More recently, central bankers have decided to confiscate private wealth represented by even fiat paper money via such means as negative interest rates and market intervention disguised by misleading labels like “quantitative easing.” As we’ve discussed before, negative interest rates imply the global confiscation of private financial assets for the benefit of debtors, especially public sector debtors. Of note, in his last blog post, John Taylor examines a thesis advanced by Allan Meltzer that QE was a policy of competitive devaluation. The US moved first, and others followed, as one of our colleagues noted last week. But the only thing that has resulted is a vast flow of capital back into the US economy. With almost $10 trillion in negative yielding bonds globally, dollar assets have become a refuge from global confiscation by the European Central Bank and Bank of Japan. Mark Twain alleged that “there is no distinctly native American criminal class except Congress,” but we wonder what would he say about the bureaucrats at the Federal Reserve Board, ECB or the BOJ? Indeed, when you survey the world of investing, it is hard to get annoyed with the starry-eyed followers of bitcoin. Call bitcoin virtual tulips. The crypto adherents at least have decided to reject the authoritarian world of fiat paper currencies issued by insolvent governments and instead embrace an alternative standard. Professor Larry White wrote in a blog post entitled “Blockchain + Gold”: “The Bitcoin system has the great virtue of securely sending value directly from stranger to stranger. It is open to anyone, anywhere in the world. The sender does not need to trust the recipient, nor any bank or other institution, to accurately record the transfer.” And what can you say about those individuals who lack the courage to take a flutter in bitcoin, but comfort themselves by talking about the “benefits” of the inefficient blockchain tech behind it? Bitcoin holders at least have the possibility of gain, but “investors” in blockchain are literally shoveling money into the furnace. Several years on and many billions of dollars later, we still have yet to see one example of a blockchain outside of the bitcoin instance that makes any economic sense. Meanwhile, we would be remiss if we did not note the ten-year anniversary of the shotgun wedding of Merrill Lynch and Bank of America (NYSE:BAC). We got several queries about the anniversary of this combination last week. One investment manager confessed during a private session in an office on Park Avenue that BAC was his best performing position, but then asked nervously if a 50% run up in less than a year is “cause for concern.” We referred to the excellent piece by Chris Cole of Artemis Capital, who notes that the “investment ecosystem has effectively self-organized into one giant short volatility trade like a snake eating its own tail, nourishing itself from its own destruction.” Cole goes on to note that in addition to central banks buying $20 trillion in public and private assets, public companies have repurchased almost $4 trillion in stock – this by issuing debt. “Like a snake eating its own tail, the equity market cannot rely on share buybacks indefinitely to nourish the illusion of growth,” notes Cole. Ditto. Of course big bank stocks are “overvalued” in terms of earnings or revenues, but do such measures really matter in a world without value? When you have global central banks gunning all asset prices in a desperate effort to avoid a sovereign debt default starting in Japan and then Europe, pedestrian metrics like price/earnings ratios and net-present value have little relevance. Remember, the reason that the Fed slammed Merrill Lynch into BAC a decade ago was in a desperate effort to preserve the US Treasury’s access to the bond market. In those dark days of 2008, primary dealers were collapsing left and right. Dealers operated by Washington Mutual, Bear, Stearns & Co, Countrywide and Wachovia all evaporated in a matter of days. When all's said and done, the Federal Reserve Board cares not about inflation or employment or the safety and soundness of banks and the financial system. The paramount concern of the Fed is to preserve the ability of the US Treasury to issue more debt and thereby keep the great game going awhile longer. The growing pile of public debt in the US is why price stability will never be part of the mix -- unless and until the Treasury is forced to live within its means. This is also why dollar-alternatives like bitcoin, imperfect and even fraudulent as they may be, will continue to capture the attention of those seeking to escape the economic tyranny of fiat paper money. Finally, we cannot fail to mention that The IRA's Chris Whalen has been included in the list of enemies compiled by the minions of George Soros. We are in decidedly good company. David Ignatius. Ann Coulter. The editor of The Nation. The "tout US journalism." Apparently everybody who is anybody in the world of media has earned the enmity of Mr. Soros, the architect of the Ukraine disaster and one of the world's great war mongers. We bask in his scorn. 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.

Tomás de Torquemada (1420-1498) “Assassins Creed” October 22, 2017 | This week The Institutional Risk Analyst is in Rocky Mountain country for the Mortgage Bankers Association meeting. The event comes amid a mixed picture for the mortgage finance industry. On the one hand, lending volumes have improved a bit over the course of the summer, but refinance volumes are still down compared with 2016, the result of volatile interest rates and a growing shortage of homes for sale. Chart 1 below shows the most recent MBA projections for residential mortgage origination for 2017 and beyond. Source: MBA On the bright side, however, seven years of Spanish Inquisition focused on the mortgage industry by state and federal regulators seems to be slowly coming to an end. The big news came last week when HUD Secretary Ben Carson said that the government’s use of the Civil War era False Claims Act as a nuclear weapon against mortgage lenders could soon be coming to an end. He asked the obvious question, namely why the US government ever began to use this 1800s law meant to prevent war profiteering against American mortgage firms. “I’m not exactly sure why there had been such an escalation previously, but the long-term effects of that escalation is obviously providing fewer appropriate choices for consumers,” Carson said of the use of the False Claims Act’s criminal penalties to bully lenders into big settlements with the Department of Justice. Housing Wire reports that he added. “And that’s exactly the opposite of what we should be doing.” Another bit of positive news came when Anthony Alexis, the Consumer Financial Protection Bureau’s enforcement chief (aka the "Inquisitor"), announced that he is stepping down after more than two years overseeing the agency's efforts to “combat abuses by the financial industry,” in the words of National Law Journal. The publication goes on to note that the departure is “certain to fuel speculation that Director Richard Cordray will leave soon to pursue the Ohio governorship.” Like the Tribunal of the Holy Office of the Inquisition in 15th Century Spain, the CFPB has a persecutorial mentality -- but without the burden of actually proving that a crime was committed. That is, the CFPB is all about politics and punishment. Yet rather than ensuring anything like a fair and transparent market for consumers in the market for mortgage finance, the CFPB instead extracts payments from private business to feed the Progressive faithful. This includes members of the trial bar who prosecute shareholder class action lawsuits, hedge funds who engage in short-sales of companies targeted for punishment, and elected officials operating in the public sector. Under the leadership of Mr. Alexis and Director Cordray, the CFPB frequently demanded payments from mortgage companies without any actual evidence of wrongdoing. This follows the familiar pattern set by Mr. Cordray when he was attorney general of Ohio, where he unsuccessfully attempted to extort millions of dollars from several private mortgage firms we know well. Big banks, not wanting to take the headline risk of litigation, would pay the CFPB’s extortionate demands. The non-bank mortgage companies, on the other hand, lacking the excess cash of a government sponsored bank, chose to fight in court rather than accede to the CFPB’s blackmail. But the larger point is that the CFPB has taken government regulation of consumer finance to a new height of capricious arrogance. Consumers ultimately pay the cost for this exercise in Progressive punishment. Sadly for Mr Alexis and his remaining colleagues at the CFPB, the bull market in former regulators has ebbed since the election of Donald Trump to the White House. Prior to November 2016, former employees of the CFPB could demand a hefty price in the private sector world of lobbying and regulatory relations for their inestimable talents. When you have a regulator as brutal and arbitrary as the CFPB, an assortment of fixers are advisable. But no more. With the impending lobotomy of the CFPB now at hand, the street value of former CFPB regulators has fallen to a discount, says one well-placed Washington lawyer. In addition to Director Cordray, Senator Kamala Harris (D-CA) is another example of a state level politician who achieved national status because of the emergence of “consumer protection” as a key part of identity politics. Some observers hope that Democrats will abandon identity politics and help liberalism become once more a unifying force for the "common good," but we see no evidence that the likes of Cordray, Senator Elizabeth Warren (D-MA) or Harris have gotten that memo. Some observers have speculated that the states will pick up the ball when it comes to the regulatory Inquisition in the world of consumer finance. But sad to say, the CFPB was the point of the spear for militant Progressives seeking to make the world safe for trial lawyers. Their political allies such as Mr. Cordray, Ms Harris and their fellow traveler, Senator Warren, will be profoundly frustrated once the CFPB is forced to assess the actual harm to consumers before issuing a demand for payment with an enforcement notice. Aaron Klein of Brookings Institution notes in an exchange on Twitter that “Unfair, abusive and deceptive practices (UDAP) has been illegal under FTC Act since 1938. Somehow capitalism has survived & thrived.” Survive is an apt description, but just barely. Capitalism died with the Robber Barons and the New Deal, but we digress. Fact is, regarding states picking up enforcement, they will have some difficulty because state laws are general tighter and with more precedent allowing less discretion to investigators. When CFPB was created, long-standing proposals from state law were brought into federal, but with a clean slate for interpretation. The CFPB represents a dangerous evolution of the UDAP principle as enforced by the Federal Trade Commission, one that lacks any notion of due process or fairness. As conceived by Dodd-Frank, the CFPB’s mission is to attempt to condemn, a priori, millions of Americans who work in the world of housing finance, from realtors to appraisers to loan underwriters to mortgage servicers to investors. No one who believes in fairness and the rule of law should support the behavior of the CFPB over the past six years. The departure of Mr. Cordray for his next adventure cannot come soon enough for many in the housing market. To see the actual economic cost of the CFPB’s reign of terror, consider one of the larger and better known names in the world of mortgage finance, New Residential Investment Corp (NYSE:NRZ). While the stock for this large real estate investment trust (REIT) is trading near its 52-week high at around $17, the $2 dividend gives it a yield over 11%. NRZ specializes in holding residential mortgage servicing rights or MSRs. When you do the math, the overall cost of capital including debt for this large, $5 billion market cap buyer of residential MSRs is well into the teens. Compare this to a government-sponsored bank such as Wells Fargo (NYSE:WFC) with an equity dividend yield under 3% and you begin to understand the enormous disadvantage of non-bank firms operating in the world of mortgage finance, especially compared with GSEs. Table 1 below comes care of our friends at Kroll Bond Ratings and shows dividend yields NRZ and other mortgage REITS. The cheapest capital for REITs generally comes from common equity and preferred shares, not debt. Note that there are a couple of outliers on the list with yields in mid-double digits, which pull up the average to 12% for these three dozen names. The 9% median for the group illustrates the skew. Keep in mind that NRZ and its affiliates in the constellation created by Fortress Investment Group (NYSE:FIG) have experienced relatively few regulatory issues and little headline risk, yet the stock trades at a deep yield discount to banks (and a 6 price/earnings ratio vs double digits for banks) with significant mortgage exposure like WFC or even other mortgage REITs. When investors look at NRZ or other players in the world of residential mortgage finance and MSRs, they generally see enormous regulatory danger and price the capital accordingly. But notice that Redwood Trust (NYSE:RWT), a REIT which specializes in acquiring and securitizing prime jumbo mortgages, has one of the lowest dividend yields in the group at just 6.7%. Going into 2018, the mortgage industry is looking forward to a more balanced and productive relationship with both regulators and policy makers. In the past year, CFPB officials have rather bombastically demanded increased investments in technology by mortgage companies. We frequently ask our friends in the regulatory community just how they expect such investments to be financed when a large part of the industry is under water in terms of profitability, this due to increased regulatory costs. As 2017 draws to a close, equity returns in the mortgage industry have never been lower. Achieving a more reasonable balance between protecting consumers from actual harm and helping the mortgage finance sector restore profitability (and sustainability) should be an important goal for the Trump Administration and the state and federal regulators responsible for enforcement. More than a few large non-bank servicers are for sale, though perhaps not the names that first come to mind. And banks continue to migrate away from the government guaranteed loan market and Ginnie Mae. A key goal for HUD Secretary Carson and his colleagues at the Federal Housing Administration ought to be restoring fairness to the relationship between private mortgage firms and the federal government. A big part of the problem starts with the use of the False Claims Act by the Department of Justice, an absurd policy that is hurting consumers by driving some of the largest players out of the FHA market. But the DOJ’s use of Civil War era law to intimidate mortgage firms is not the only reason why banks have fled the FHA. The sad fact is that residential mortgages have the lowest return on capital, both nominally and in risk-adjusted terms, of any asset that an insured depository institution can originate. Selling a residential mortgage loan creates additional incremental risk, one reason many banks are reducing loan sales and retaining the mortgages that they are willing to underwrite. So while changing the policies of the DOJ regarding FHA claims will be a big improvement, it will not be sufficient to bring commercial banks back into the FHA market. Changes must be made in the way that the CFPB regulates banks as well as non-bank companies before the returns available in residential mortgage lending will begin to approximate the risks. 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.

October 16, 2017 | Almost as soon as it started, the excitement surrounding earnings for financials in Q3 2017 dissipated like air leaving a balloon. Results for the largest banks – including JPMorgan (NYSE:JPM), Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC) – all universally disappointed, even based upon the admittedly modest expectations of the Sell Side analyst cohort. Bank of America (NYSE:BAC), the best performing stock in the large cap group (up 60% in the past year), disappointed with a $100 million charge for legacy mortgage issues. Despite strong loan growth, year-over-year BAC's net revenue is up about 5% but actually fell in the most recent period compared with Q2 '17. As with many other sectors, in large-cap financials there was little excitement, no alpha -- just slightly higher loss rates on loan portfolios that are growing high single-digits YOY. Yet equity valuations are up mid-double digits over the same period. The explanation for this remarkable divergence between stock prices and the underlying performance of public companies lies with the Federal Open Market Committee. Low interest rates and the extraordinary expansion of the Fed's balance sheet have driven asset prices up by several orders of magnitude above the level of economic growth, as shown in Chart 1 below. Meanwhile across the largely vacant floor of the New York Stock Exchange, traders puzzled over the latest management changes at General Electric Co (NYSE:GE), the once iconic symbol of American industrial prowess. Over the past year, GE's stock price has slumped by more than 20% even with the Fed's aggressive asset purchases and low rate policies. Just imagine where GE would be trading without Janet Yellen. To be fair, though, much of GE’s reputation in the second half of the 20th Century came about because of financial machinations more than the rewards of industry. A well-placed reader of The IRA summarizes the rise and fall of the company built by Thomas Edison: “For years under Welch, GE made its money from GE Capital and kept the industrial business looking good by moving costs outside the US via all kinds of financial engineering. Immelt kept on keeping on. That didn't change until it had to with the financial crisis. No matter what, untangling that kind of financial engineering spaghetti is for sure and has been a decade long process. No manager survives presiding over that. Jeffrey Immelt is gone.” Those transactions intended to move costs overseas also sought to move tax liability as well, one reason that claims in Washington about “overtaxed” US corporations are so absurd. Readers will recall our earlier discussion of the decision by the US Supreme Court in January not to hear an appeal by Dow Chemical over a fraudulent offshore tax transaction. The IRS also caught GE playing the same game. Indeed, US corporations have avoided literally tens of trillions of dollars in taxes over the past few decades using deceptive offshore financial transactions. Of note, the Supreme Court’s decision not to hear the appeal by Dow Chemical leaves offending US corporations no defense against future IRS tax claims. Like other examples of American industrial might such as IBM (NYSE:IBM), GE under its new leader John Flannery seems intent upon turning the company into a provider of software. Another reader posits that “they’re going to spend a decade selling the family silver to maintain a dividend and never make the conversion they would like and never get the multiple they want. GE is dead money at a 4% yield, which given some investors objectives – retirees and the like -- might not be such a bad thing.” The question raised by several observers is whether the departure of Immelt signals an even more aggressive “value creation” effort at GE that could lead to the eventual break-up of the company. Like General Motors (NYSE:GM), GE has been undergoing a decades long process of rationalizing its operations to fit into a post-war (that is, WWII) economy where global competition is the standard and the US government cannot guarantee profits or market share or employment for US workers. GE's decision this past June to sell the Edison-era lighting segment illustrates the gradual process of liquidation of the old industrial business. Henry Ford observed that Edison was America’s greatest inventor and worst businessman, an observation confirmed by the fact that Edison’s personal business fortunes declined after selling GE. In fact, the great inventor died a pauper. And of the dozen or so firms that were first included in the Dow Jones Industrial Average over a century ago, GE is the only name from that group that remains today. But the pressure on corporate executives to repurchase shares or sell business lines to satisfy the inflated return expectations of institutional investors is not just about good business management. The expectations of investors also reflect relative returns and asset prices, which are a function of the decisions made in Washington by the FOMC. Fed Chair Janet Yellen may think that the US economy is doing just fine, but in fact the financial sector has never been so grotesquely distorted as it is today. Let’s wind the clock back two decades to December 1996. The Labor Department had just reported a “blowout” jobs report. Then-Federal Reserve chairman Alan Greenspan had just completed a decade in office. He made a now famous speech at American Enterprise Institute wherein Greenspan asked if "irrational exuberance" had begun to play a role in the increase of certain asset prices. He said: “Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.” In the wake of the 2008 financial crisis, the FOMC abandoned its focus on the productive sector and essentially substituted exuberant monetary policy for the irrational behavior of investors in the roaring 2000s. In place of banks and other intermediaries pushing up assets prices, we instead have seen almost a decade of “quantitative easing” by the FOMC doing much the same thing. And all of this in the name of boosting the real economy? The Federal Reserve System, joined by the Bank of Japan and the European Central Bank, artificially increased assets prices in a coordinated effort not to promote growth, but avoid debt deflation. Unfortunately, without an increase in income to match the artificial rise in assets prices, the logical and unavoidable result of the end of QE is that asset prices must fall and excessive debt must be reduced. Stocks, commercial real estate and many other asset classes have been vastly inflated by the actions of global central banks. Assuming that these central bankers actually understand the implications of their actions, which are nicely summarized by Greenspan’s remarks some 20 years ago, then the obvious conclusion is that there is no way to “normalize” monetary policy without seeing a significant, secular decline in asset prices. The image below illustrates the most recent meeting of the FOMC. The lesson for investors is that much of the picture presented today in prices for various assets classes is an illusion foisted upon us all by reckless central bankers. Yellen and her colleagues seem to think that they can spin straw into gold by manipulating markets and asset prices. As Chairman Greenspan noted, however, “evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.” While you may think less of Chairman Greenspan for his role in causing the 2008 financial crisis, the fact remains that he understands markets far better than the current cast of characters on the FOMC. Yellen and her colleagues pray to different gods in the pantheon of monetary mechanics. As investors ponder the future given the actions of the FOMC under Yellen, the expectation should be that normalization, if and when it occurs, implies lower returns and higher volatility in equal proportion to the extraordinary returns and record low volatility of the recent past. 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. 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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.