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November 18, 2024  | Updated | In this issue of The Institutional Risk Analyst , we ask a basic question. Will the US bond market wait for President-elect Donald Trump to take office in January and unveil his agenda? Or will the long end of the yield curve surge even higher as the likelihood of a US debt default increases?  BTW, President Joe Biden will let the Ukrainians take the gloves off before Christmas and strike targets deep inside Russia, a little parting gift for the incoming POTUS from the Party of War. With the Russian military disintegrating and 100,000 North Korean soldiers "reportedly" headed for Kursk, according to sources favoring escalation, how long will the US and other NATO countries stay out of the Ukraine War? In fact, the Russians have training agreements with the North Koreans in the Far East. And they receive ammunition. Everything else is a lie designed by the Party of War to justify the ever increasing escalation.   Our first quarterly conference call was held last week for subscribers to the Premium Service  of The IRA . We’ll be doing another call in Q1 2025.  Watch for a placeholder for the next discussion via email. In the space of 45 days, the credit markets have gone from certainty regarding falling interest rates to increasing fear of higher interest rates. “The economy is not sending any signals that we need to be in a hurry to lower rates,” Federal Reserve Chair Jerome Powell said during a speech in Dallas.   While Chairman Powell was inclined to be helpful to President Biden, he is inclined not to be helpful to Donald Trump and will now gladly drag his feet on further rate cuts. Given that Trump does not have much room to maneuver because of the rising budget deficit and LT interest rates, this sets the stage for a very public political confrontation with the Fed in the New Year. Those of us who traded the Trump Casino bonds years ago through several bankruptcies get the joke. In the tertiary phase of debt default, non-payment becomes inevitable. If all of this were not enough, the Fed has no idea about the state of liquidity in the markets as we approach the end of the year. Bill Nelson , Chief Economist at Bank Policy Institute , notes in his latest missive that "The Fed's guide for when to end QT may be unreliable." Specifically, the FOMC's calculus regarding the adequate level of reserves is subject to considerable uncertainty. The interaction between the Fed's investment portfolio, the Treasury General Account and Reverse RPs, and bank investment decisions, Nelson relates, can change the correlation between bank reserves and interest rates from positive to negative to neutral "instantaneously."  This means that Chairman Powell and the other members of the Fed's Board of Governors really have no idea whether there is sufficient liquidity in the system as the central bank slowly shrinks its balance sheet. Truth to tell, nothing has changed since December 2018, when Powell et al almost crashed the US financial system except 1) the increasingly political stance of the Federal Reserve as a new Republican administration takes office and 2) the prospective level of uncertainty coming from the Trump White House. For mortgage lenders and the equity markets, increased interest rate volatility is going to be the challenge going forward. For Fed Chairman Jerome Powell, the big question is when to push the red button and resign. Some progressives and market watchers were heartened when Chairman Powell pushed back on the idea that the President of the United States could fire him or other Fed governors. In purely technical, legal terms, this is correct. But as a practical political matter, no Fed chairman or governor can function without the support of the White House and the US Treasury. Richard J. Whalen (1935-2023) agreed to be an advisor to former Merrill Lynch CEO and Treasury Secretary Donald Regan in Reagan I, but he laid out several conditions that we recount in the Second Edition of "Inflated: Money, Debt and the American Dream," to be released by John Wiley in 2025: "Dick, I’ve been asked to become Secretary of the Treasury,” said Regan. Whalen replied: “I know, you’re on the list.” Regan said, “What should I do?” And Whalen said, “If you want it, take it, but for Christ’s sake stay away from Nancy Reagan and do not mess around with the Fed. Those are my terms if you want my help.” Sadly such civilized rules no longer apply in the confines of Washington in 2024. There is no institutional respect for the Fed in the politicized world of Washington, in large part because the US is headed for a financial crisis. The politicians in both parties are growing desperate for a way out like rats fleeing a sinking ship. Suffice to say, it's 1861 all over again and Donald Trump stands in the shoes of Abraham Lincoln as the head of a broke government. Fed Chairman are typically picked by the incumbent president and usually have served at the Treasury, on the Council of Economic Advisors or National Economic Council. Powell lacks this pedigree. President Jimmy Carter appointed Paul Volcker as chairman of the Board of Governors of the Federal Reserve System in 1979, just before losing the 1980 election to President Ronald Reagan .   Reagan was happy to have Volcker take the heat on inflation in the 1980s, but in the current scenario Donald Trump may not have much time to be nice.  Such is the fiscal fiasco created by President Joe Biden, Treasury Secretary Janet Yellen and Congress that the US markets could see a significant market correction before Trump takes office.  The US government is running a cumulative deficit of $1.9 trillion so far in FY2024 ($302 billion more than the same period in the prior fiscal year when adjusted for timing shifts*), according to the Bipartisan Policy Center . Spending is rising faster than revenue, largely due to higher interest rates. As our astute colleague Ralph Delguidice asked last week, does Trump even have an opportunity to roll out a new program before the proverbial debt comes due in the Treasury bond markets? Corporate debt spreads are relatively tight vs risk-free yields. Private companies are taking advantage of this fact in the new issue market.  But the reason corporate spreads are tightening is rising government debt yields and deteriorating sovereign credit default swaps spreads, not better corporate credit. That is bad. The floor of government credit default spreads is rising on a sea of unpayable public debt. There is a reason why the folks at FRED no longer publish US credit default swap rates. The charts below come from David Kotok of Cumberland Advisors c/o Bloomberg & CMA, and show the widening of five year CDS spreads for the United States since 2019.  David will be talking about the market for US CDS on the Money Show in Sarasota on December 7th . Suffice to say that the probability of default for the US has risen 4x since 2008. Source: Bloomberg/CMA Source: Bloomberg/CMA What these two charts illustrate is that the cost of insuring against a debt default by the United States is rising significantly. While the ebb and flow of the markets continues, the LT trend is headed toward an eventual default. Indeed, the US seems to be on track to see debt spreads for the US rise above corporate spreads for the largest and most liquid private companies for the first time since WWI. When President-elect Trump ponders his selection for Treasury Secretary, he ought to ask who will do a better job of managing a US debt default. Elon Musk has urged followers on X to support Howard Lutnick , former CEO of Cantor Fitzgerald . Lutnick is up against Scott Bessent , the founder of capital management firm Key Square , who reportedly wants the US dollar to remain the world’s reserve currency and use tariffs as a negotiating tactic. “My view FWIW is that Bessent is a business-as-usual choice, whereas @howardlutnick will actually enact change,” Musk posted on Saturday. “Business-as-usual is driving America bankrupt, so we need change one way or another.” But do either President Trump or Elon Musk understand how little time remains for political posturing? 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 13, 2024  | Premium Service  | With the victory of President Donald Trump  on November 5th, a number of our friends and neighbors who supported Vice President Kamala Harris have gone into seclusion. A period of morning has been declared among many people who placed the blue Harris-Waltz signs on their front lawns. Placing the signage on the lawn allowed them to think, for a while, that they were somehow superior to Trump supporters. After all, it was obvious, right? But it was not to be.  The pro-Harris crowd expected to win because they felt entitled  to win. Many of our friends in the Democratic Party would tell us that conservatives should not even be allowed to hold public office . The pro-Trump folks, however, did not need signs on the lawn. They already knew the outcome of the election as we noted in The IRA . We wanted to show compassion. This Friday, when we celebrate at Trump National , we will keep those disappointed Harris-Waltz folks in our prayers.  Moving from the absurd to the merely ridiculous, we note that the list of aspirational stocks and crypto tokens that are rising at double-digit annual rates is growing.  What does it say when ETFs based loosely upon a moveable fraud called bitcoin, a notional asset that is convertible into nothing at all, rises to near $100,000 fiat legal tender dollars?  It says inflation is still the problem. Fact is, Americans have grown entitled to capital appreciation, that is inflation , in all manner of assets and tokens. Thus the question: Could President elect Donald Trump be facing a maxi market correction before Inauguration Day? We note in the new edition of “Inflated: Money, Debt & the American Dream” to be released by Wiley Global in 2025 that President Trump and the Republicans face the same dire peril as did President Grover Cleveland 120 year ago: “President Grover Cleveland led the Democrats to an electoral triumph in the fall of 1892, winning control over both houses of the Congress and the White House for the first time in more than a third of a century. The conservative Cleveland took power just as the U.S. economy was collapsing. Foreign creditors and the country’s citizens were fleeing paper assets and demanding payment in gold. Even as the Democrats savored their victory in the five-month interregnum between the election and the inauguration of the new president in March 1893, the global financial markets began to unravel.” The financial crisis of 1893 was caused by inflation. Specifically, when the Treasury made purchases of silver, which were being paid for in then convertible greenbacks, Americans promptly exchanged paper for gold. In 1893, money was gold and greenbacks were debt convertible into gold. Today the paper dollar is convertible into nothing, but at least you can pay your rent or buy groceries. Crypto currencies are speculative tokens that must be converted back into fiat paper dollars to be useful.  Does President Trump understand the difference?  Below we review the constituents of our mortgage finance surveillance group to update our readers on the GSEs and other residential mortgage issuers. Remember, Fannie Mae and Freddie Mac are no different than issuers like PennyMac (PFSI) --  except that they also insure the mortgages and mortgage-backed securities (MBS). Our first live discussion for subscribers to the Premium Service  of The Institutional Risk Analyst  will occur on Friday, November 15, 2024 at 10:00 ET. Subscribers look for further details via email! Likewise the crowd of people who expect the GSEs, Fannie Mae and Freddie Mac, to be released from captivity is also growing, but not nearly enough to make it actually happen. In fact, the top-performing mortgage stock in the US over the past year is no longer one of the GSEs, but instead Blend Labs (BLND) , up 277% as of the close yesterday.  After BLND comes Freddie Mac, then Compass Inc (COMP)  followed by Fannie Mae. How could BLND and COMP possibly bypass the GSEs in terms of 1-year total returns? The short answer is that BLND and COMP each went public in 2021 at the end of quantitative easing and both stocks got crushed thereafter.  BLND and COMP both went out above $20 per share and both stocks fell into single digits. The low for COMP, a real estate brokerage firm, was $1.815 in November 2023. The low for BLND, an unprofitable mortgage firm, was $0.55 in May of 2023. As traders who follow the GSE penny stocks and preferred know, it is east to show triple digit equity returns when the stocks start near zero. The high for Freddie Mac was $74 on 12/21/2004 and basically went to zero after the government takeover in September 2009. The low for Freddie was $0.128 in March of 2011. Following the re-election of President Trump the stock surged from $1.2 to $2.60 at the close yesterday. Does this mean that Freddie Mac is ever going to be a public company ever again? Not likely.  As we’ve said before, when irrational exuberance takes GSEs stocks “to da moon,” take the money off the table. Let a greater fool speculate on an eventual release. One of the questions we have been asked about the Trump transition and mortgage finance is what must happen before the GSEs can be released. The short answer is that we need legislation to move the mortgage guarantee business from the GSEs to Ginnie Mae. The private GSEs cannot support $8 trillion in residential and multifamily MBS.   Ideally, new housing legislation would spin Ginnie Mae out from HUD as an independent agency so that it may be properly funded and staffed. The only trouble with this scenario is that once the GSEs shed the mortgage guarantee business, there is not much left. Without a sovereign rating and the revenue from the guarantee business, the GSEs are not very attractive as mortgage issuers. After Fannie Mae in our mortgage equity group, next on the list is Finance of America (FOA) , an unprofitable reverse mortgage lender that went public in 2020 over $100 per share and hit a low of $7 this past July. With a market cap measured in the millions of dollars and a spread of 150bp in credit default swaps (CDS), FOA is hardly an industry bellwether.  Yet the stock closed just shy of $20 yesterday. Again, if your stock is left for dead, it is easy to generate triple digit returns given the right nudge.  After FOA, the next member of the mortgage equity list is Zillow (Z) , a long-time public company that peaked at $200 per share in 2021 then basically lost 90% of its value but did not touch the all time low of $15 in 2016. Z jumped following the election of President Trump, but we cannot see how Washington is going to save real estate agents from the trial lawyers. Given the huge push by consumer groups to address the issue of home affordability, we think the NAR settlement from last year is set in stone. Sellers don’t mind paying 3% instead of 6% commission on a home sale. Bottom line, we think that the mortgage finance sector illustrates a larger problem for investors and also President-elect Trump, namely that the accumulated inflation added to the system during four years of President Joe Biden is still pushing up asset prices even as the economy shows signs of slowing. In our next comment, we'll be looking at some of the payments platforms in our fintech equity group to see what the world of consumer lending tells us about the state of the US economy. 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 11, 2024  | Happy Veterans Day. Memorial Day honors America's military men and women who lost their lives in service to their country. Veterans Day is the day we thank and honor ALL those who served honorably in the military – in wartime or peacetime. On Veterans Day, we are grateful to our great, great grandsire, Richard James Whalen , who walked from Poughkeepsie to Louisiana and back with the New York 159th Volunteers during the Civil War. Dick, as he was called, was a sharp shooter who also was known for wrestling black bears…  Last week saw a relatively rare event on Wall Street when R.W. Baird analysts led by David George  said JPMorgan (JPM)  was "best-in-class," but that it is "time to take profits" in the shares. That is, Baird put a "sell" rating on Jamie Dimon . JPM is up almost 50% so far this year and common shares are changing hands at roughly 14 times forward 2026 earnings. Below we take a hard look at the House of Morgan and some of the other names in the  WGA Bank Top 10 Index . Source: WGA LLC The surge in JPM following the election win by President Donald Trump was unusual and arguably begs to be sold, but the same can be said of a number of top banks, as shown in the chart below. The entire bank group moved higher with the election, but this change in valuation may not be permanent. Source: Google Finance (11/08/24) Will the change in government in Washington be sufficiently profound to impact bank stocks so dramatically? Probably not. The end of the Biden Administration will certainly usher in a more positive environment for all types of companies. After four years of progressive madness in Washington, banks are likely to see more reasonable behavior from federal regulators. Banks will also see higher credit expenses and flat to down net-interest margins because of bond market volatility. With the 10-year Treasury note at 4.3% yield Friday, the mark-to-market losses for US banks will again rise. As of Friday’s close, JPM was trading over 2x book and 5x revenue, so it may seem a safe bet that the stock is overvalued. Readers of The IRA should recognize that a lot of equity managers have piled into JPM and other large-cap names as part of the return of allocations to big banks since the end of Q2. Of note, JPM did not really trade off in the first half of the year. As a result, it will take a considerable stumble by JPM to convince managers to move out of the $670 billion market cap stock.  When they do change their view of JPM, however, look out below for all financials. JPM is now ranked #3 in the WGA Bank Top 10 Index and has been in this exclusive group all year. The stock has a beta just above 1, which is a function of the steady, almost 50% appreciation of JPM during 2024. Short-interest on JPM is < 1% of the float and still tiny compared with other large cap names. Yet there is a growing crowd of short sellers following the leading bank stock. Short-interest on JPM increased through the summer, culminating in a sharp selloff in August on recession fears. The median level of short interest for the S&P 500 is just 1.8% vs over 3.5% in 2008. The secular inflation of equity valuations over the paste decade has naturally tended to push down broad measures of short-selling. But that said, JPM is definitely attracting more attention from shorts who see a huge stock that may be due for a correction. So is JPM expensive? Compared with other stocks in our group, no. The bank has below-peer credit losses and the best operating metrics of the largest banks. Fact is, the banking industry has segmented into a handful of above-average performers and JPM is the largest leader of these winners. These stocks are visible in the WGA Bank Top 10 Index as shown below. Subscribers to the Premium Service have access to the constituents of the index and the weightings. WGA Bank Top 10 Index Source: WGA LLC American Express (AXP) is trading near 7x book value vs 4x a year ago. Another top performer, Ameriprise (AMP) , is over 8x book vs 7x a year ago. East West Bancorp (EWBC) is just below 2x book value vs 1.1x a year ago.  With a bit of an interruption in the first half, most of the better performers in the group are fully valued or more because a number of the other large-cap names are underperforming significantly. For example, t here is a reason that Warren Buffett has been selling Bank of America (BAC) for the portfolio of Berkshire Hathaway Inc. (BRK) . BAC ranks 46th in the WGA Bank Top 50 Index, an improvement from Q3 2024. Yet BAC is still dragging because of the bank's abysmal job of balance sheet management during and after the Fed's experiment in "quantitative easing" between 2020 and 2022. BAC's yield on earning assets vs net income was just 1.92% in Q3 2024. 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 4, 2024  | The US bond market rallied for awhile on Friday morning, but the growing size of leveraged short positions in Treasury futures killed any sustained rebound. Brian Meehan of Bloomberg reports that short bets on Treasury yields have risen 50% in the past year to more than $1 trillion notional. These positions are so large that a sudden shift to net long could force the Fed to bail out the Treasury bond market again as in Q1 2020. Save the date! Our first live discussion for subscribers to the Premium Service of The Institutional Risk Analyst will occur on Friday, November 15, 2024 at 10:00 ET. Subscribers look for further details via email! Meanwhile, oblivious to the mounting risk in the bond market, global equity managers have piled back into financials with both feet. Like we said. Keep in mind that as the 10-year Treasury note rises in yield, banks become more and more insolvent, as shown in the table below. The average yield on large bank securities was just 3% in Q2 2024, according to the FFIEC. Fannie Mae 3s for delivery in November were trading ~ 86 cents on the dollar Friday. Source: FDIC/WGA LLC We rebalanced the WGA Bank Top Indices on Friday with the help of our friends at Thematic and the new group is reflected in the indices. Notice that JPMorgan (JPM)  is in the top of the group at number four behind Discover Financial (DFS) , Synchrony (SYF)  and  East West Bancorp (EWBC) . Also note that JPM and DFS, the latter of which is awaiting acquisition by CapitalOne Financial (COF) , are the only two names that have been in our top ten group all of 2024.   WGA Bank Top 10 Index Constituents Source: WGA LLC JPM's position in the index was unchanged vs Q3, but there was a lot of movement in the rest of the group. Wells Fargo (WFC) is back in the top quartile of the test group and Bank of America (BAC)  moved from the third quartile to the second, but Citigroup (C) , Truist Financial (TFC)  and Ally Financial (ALLY)  remain in the bottom quartile of our 105 bank test group.  Subscribers to the Premium Service  have access to the index constituents and the weightings for Q4 2024 . The chart below shows the entire test group by market cap, with the highest scoring banks starting on the left. Source: WGA LLC Even as hedge funds place huge bets on Treasury yields moving higher, the Fed may be finally considering sales of mortgage-backed securities. The Federal Reserve Board has been reducing the size of its Treasury holdings by $25 billion per month and up to $35 billion in MBS, but in fact the rate of prepayments on the mortgage paper is only a fraction of that amount. Prepayments on late vintage MBS surged in Q3 2024, but the sharp rebound in Treasury yields abruptly ended the September mortgage market rally.  “Speeds in the premium coupons jumped considerably last week, and have been elevated for the past four weeks,” notes Scott Buchta at Brean in a note about actual prepayments in September. “These pay-offs will primarily show up in the October prepayment report as there were a couple of collection days included in the Sept 28th-Oct 4th report…. The biggest w/w increases were in the 6.5% and higher coupons. In general, prepayment activity in the discount coupons remains very low (<=5 CPR) as turnover and cash-out refinancing activity remains muted.” “It is important to remember that these are the actual pay-offs (end of the process), vs refi applications which are at the beginning stages,” Buchta continues. “These [refi] indices are most likely near their peak, and we expect them to drop considerably as we move through November and into December as the refi indices have fallen 45% from their recent highs.” Why is this a problem for the Fed? Because the reduction of the system open market account (SOMA) at the Fed is moving asymmetrically, with relatively short duration Treasury paper running off in a very mechanical and predictable fashion. The low coupon MBS, however, is lingering as the few high coupon securities held by the Fed prepay, but the rest of the portfolio of low-coupon MBS is barely moving.  More, the effective duration of the SOMA MBS holdings is now larger than the Treasury securities owned by the Fed. Although the cap under the Fed’s “quantitative tightening” or QT is $35 billion in prepays of MBS from the SOMA each month, the actual prepayments are closer to $15 billion per month. The table below shows the relative increase in the MBS as a percentage of total SOMA securities. Keep in mind that, measured in dollars, the duration of the $2.2 trillion in nominal MBS owned by the Fed is closer to $6-7 trillion, depending on your prepayment assumptions. Source: FRED Last week, Bill Nelson at the Bank Policy Institute published an important piece about how the Fed manages (or fails to manage) reserves.  He noted, for example, that the model for liquidity used by the Board was designed decades ago (1968 in fact) by Bill Poole to measure liquidity intraday . The model was never intended to predict liquidity needs over time. Nelson: “There is a flaw at the heart of this conception of monetary policy implementation.  The Fed seems to think that when it oversupplies reserve balances, those extra balances just sit idly in each bank’s account at its Reserve Bank, ready to be redeployed easily in pursuit of higher yields.  The mistake has arisen because the Fed is drawing intuition from a decades-old model of reserve supply and the federal funds rate that was intended to describe the relationship over a day.  The mistake has caused the Fed to incorrectly judge that QE can fairly easily be reversed by QT and to misunderstand the relationship between its balance sheet and repo market resilience.” At the end of his piece, Nelson suggests that the Fed may be considering sales of MBS. Why? Because the portion of the SOMA portfolio that is in MBS is now rising as Treasury paper runs off. This is contrary to the public statements by Chairman Jerome Powell and other FOMC members that the Committee would like to return to owning primarily Treasury securities. In technical terms, moreover, it would be desirable to put away this huge block of duration with investors and invest the proceeds in higher coupon Treasury securities. A big reason for Powell to do the CMO trade is to narrow the Fed's negative net interest margin and eventually get it positive . Nelson notes that while the Fed is shrinking only by allowing securities to mature without replacement, it could also gradually sell securities. The Fed originally planned to sell securities to normalize its balance sheet as discussed in the June 2011 FOMC meeting. He concludes:  “It would be doubly useful if the Fed sold MBS as opposed to Treasuries.  The Fed’s current normalization principles state  When QT started, 32 percent of its portfolio was MBS.  Now, 34 percent is MBS.  No one is refinancing the mortgages made at ultra-low rates that are bundled into the Fed’s MBS, so the securities are maturing very slowly. In a recent speech, Lorie Logan , President of the Dallas Fed, reminded the audience that the FOMC said in May 2022 that the FOMC might sell MBS and that they haven’t rescinded that possibility. Maybe it is not a coincidence that Roberto Perli, the recently hired head of the open markets desk at the New York Fed, is an expert on mortgage markets.” In June of 2022, we asked whether it wasn’t time for the Fed to engage the  Federal Housing Finance Agency (FHFA) under Director Sandra Thompson to fix the growing duration trap facing the Fed, the GSEs, many REITs and the banking industry (“ The Fed and Housing ”). Thompson, who has extensive experience at FDIC and Resolution Trust Corp dealing with bad assets and troubled depositories, understands why time is the most precious aspect of managing risk.  And time may be against us all when it comes to LT interest rates. Obviously with residential mortgage rates near 7% again, nobody in Washington or on Wall Street wants to see the Fed making outright sales of MBS into a retreating secondary market. But the Fed can use the power of wide spreads, which have boosted issuance of collateralized mortgage obligations (CMOs) and other structured securities, to shed low-coupon MBS on the books of the Fed and also banks and other financial institutions. The goal is to normalize net interest margin for the Fed and banks within say two years. We wrote in March of 2023: “The Fed, the prudential regulators, the FHFA and the GSEs need to sit down together and fashion a comprehensive program that will allow [the Fed], banks, REITs and the GSEs themselves to repackage low-coupon loans and MBS into CMOs and sell this paper into the market. The FHFA needs to re-open the doors of the GSEs to securities and seasoned loans older than six months. Once the selling process begins, prudential regulators will need to give banks forbearance in terms of the recognition of losses and the impact on capital. ”   Given the fact that LT interest rates may, in fact, continue to rise, we need to buy time so that banks are not forced into involuntary sales.  The good news is that by using the power of the GSEs as underwriters, we can restructure the cash flows from the existing MBS and create attractive “AAA” rated income producing securities and deep-discount zero coupon securities.  Banks and other investment grade investors can buy the relatively short-duration front tranches of these CMOs, while funds and insurers will find the longer-duration paper attractive.  The Fed ought to aggressively sell the short-duration tranches of deals created with SOMA MBS by the GSEs, but retain the volatile, longer duration (and higher return) principal only (P/O) tail pieces to reduce the impact on markets (and possibly generate a nice return for the Fed and taxpayers in the future). The FOMC should authorize the FRBNY to contract with the GSEs to issue CMOs starting with the lowest coupon paper, the 2s and 1.5s that the SOMA now holds. The same dynamic that has caused the duration of COVID-era MBS to quadruple or more since 2021 also affords the Fed an opportunity to get back some of the billions of tax dollars they have spent via QE. Unlike banks and other private financial institutions, the Fed has the ability to sequester long-duration, deep discount tranches of CMOs that can be problematic for private issuers. It’s time for the Fed to get smart on managing duration risk and help itself and the banks before circumstances create another money market crisis.  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 30, 2024  | With the 10-year Treasury note now 75bp above recent lows after the Fed’s September rate cut, market participants are exhibiting confusion. The subliminal guidance from on high has suddenly stopped. No longer can equity traders discern the future direction of markets by reading the last FOMC press release. With Fannie Mae 6.5s for November at 102, mortgage rates will be above 7% by year end, at least if you are concerned about profitability. Into this intellectual vacuum, hordes of Buy Side economists and allied media are focusing their painfully conventional perspectives onto a key national issue. Will the election of Donald Trump cause higher interest rates in the US? Not necessarily. VP Kamala Harris is about business as usual, as illustrated by the fact that Treasury Secretary Janet Yellen failed to mention the budget deficit once during her remarks to the American Bankers Association yesterday . Donald Trump is a change agent, but you may not like the change. Most Americans really don't want to see the size of the federal government reduced because it implies lower living standards going forward. Our historical analog for President Trump is President Andrew Jackson (1829-1837). As we write in the upcoming Second Edition of “Inflated: Money, Debt & the American Dream” to be released by Wiley Global (WLY) in 2025: “Jackson was opposed by most of the nation’s newspapers, bankers, businessmen, and manufacturers, especially in the Northeast, but still won 56 percent of the popular vote in 1828. Comparisons between President Jackson and Donald Trump’s surprise victory over Hillary Clinton in the 2016 race and Kamala Harris in 2024 are not unreasonable. Thus began the Jacksonian Age.” If President Trump and his loyal boy wonder, Elon Musk , make progress cutting the federal deficit, then the likelihood is for interest rates to fall even as the dollar soars. The global bid for dollars and, more important, risk free Treasury collateral is so strong that a sudden reduction in new issuance by the Treasury will cause interest rates to fall sharply. The FOMC will become superfluous. Decades of deficits and related inflation will suddenly reverse and become deflationary. The chart below from SIFMA shows total securities issuance. The Treasury is the dark green line at the top of the chart and accounts for half of total issuance today . Source: SIFMA Remember, this market is used to absorbing $1.7 trillion (FY 2023) per year in new mostly short-term Treasury securities. What happens to demand for Treasury bills and also "AA+" Ginnie Mae MBS when we turn off the new issue spigot at Treasury?   The chart from FRED shows the assets of money market funds (blue line) and RRPs (red line). If Treasury reduces T-bill issuance, government-only mutual funds will need to change their investment criteria. Many executives of banks and money market funds will beg the FOMC to allow them to return to the subsidized world of reverse repurchase agreements (RRPs). But imagine if a future Treasury Secretary publicly tells the FOMC to keep RRPs inside of T-bill yields going forward. Just imagine. With economic data pointing to a robust economy, the bears are struggling to maintain their calls for immediate and deep rate cuts by the Powell FOMC. The US economy is not doing a "soft landing" but rather a "touch-and-go," a maneuver we've done more than once at La Guardia Airport in NYC. Since quality IPOs are now a very distant memory, starving equity traders have adopted an even more brazen and aggressive form of “pump and dump” strategy for extracting value from the clueless retail crowd. Source: SIFMA   Consider the case of two refugee stocks, Fannie Mae and Freddie Mae. These two captive GSEs have been pumped and dumped several times in the past year. The catalyst for this action? The distant prospect of a political decision by former President Donald Trump to release the GSEs from government conservatorship. As we've noted several times in The Institutional Risk Analyst , the GSEs were the two best performing mortgage stocks in the past year and more. Source: Google Finance We’ve explained ad nauseum  why neither of these finance companies will be released from government control in the near term, but that makes it all the easier for certain Wall Street firms and their consultants to pump up the stock. Brokers reveal fictional non-public meetings in Washington where the release of the GSEs is being discussed, right now. Firms distribute "white papers" and other email missives to retail investors, all with little or no disclosure. Think of the beauty of Fannie Mae and Freddie Mac from the perspective of some disreputable equity trader working for an equally prestigious securities firm. Since the prospective decision about releasing the GSEs is a question of politics and, thus, largely unknowable, you can tell your clients whatever crap story pops into your little head. You can tell lies and damn lies about the idea of releasing Fannie and Freddie, but the SEC and FINRA cannot and will not say a word.  It’s all about politics, after all. Fannie Mae peaked a little shy of $2 back in March 2024, then fell down to ~ $1.30 in June, but rebounded to a little over $1.60 by mid-October. Then the pump and dump crowd bailed, sending the penny stock into a swoon. One equity maven asked The IRA earlier this week: “Why is Fannie falling.” More sellers than buyers. Another mutual fund CEO asked if investing in the preferred stock of the GSEs is advisable. Only if you understand that it is just a speculative "flutter" and not an investment. And no matter how many times you may hear from this securities firm or that consultant that former FHFA Director Mark Calabria  is going to "take the GSEs out," it ain’t gonna happen without legislation from Congress and years of preparation. The odds of legislation on the GSEs and housing reform more generally are slightly worse than the prospects for crypto currencies to be declared legal tender by Congress this January. But remember, even the intelligent and righteous Mr. Calabria can come up with all kinds of fanciful statements and ideas about GSE release, but it does not matter. It’s all political. When it comes to Fannie Mae and Freddie Mac, members of FINRA can dress in clown suits, don the Mickey Mouse ears that the head of Enron once wore to investor meetings, and tell lies and lies. And it does not matter.  Meanwhile in the kingdom of fintech, the practitioners of pump and dump have been very busy indeed. Both SoFi Technologies (SOFI)  and PayPal Holdings (PYPL)  got the sudden dump treatment after reporting earnings.  The content of the earnings does not matter, but the steady runup in the stock prior to the earnings release tells the tale. At $11 billion in market cap, SOFI is a small stock, but PYPL at over $80 billion market cap was pushed around just the same, as shown in the chart below. Source: Bloomberg (10/29/2024) What these examples of excess liquidity illustrate is that there is a lot more demand – aka, inflation – than there are opportunities to earn that expected 2 & 20 return (or maybe just 1 & 10). A drop in the federal budget deficit will put sustained downward pressure on interest rates, so much so that President Trump may not even need to browbeat the Fed. Now imagine that. And a sustained drop in interest rates will make the deficit easier to finance, may improve the quality and breadth of the equity markets, and will also make the solvency issues of the US banking system fade into memory.  If LT interest rates continue to rise, on the other hand, then the US banking system is going to be in big trouble come Inauguration Day. With the 10-year Treasury note at 4.3% this AM, the US banking system is insolvent by a couple of trillion dollars, as shown in the table below from The IRA Bank Book for Q3 2024 . Source: FDIC/WGA LLC 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 21, 2024  | The Russian propaganda machine is working full time to promote Moscow’s latest scheme for a new international payments system. Russia will present the proposal to fellow BRICS nations at the group’s summit this week in Kazan, Reuters  reported, citing a document distributed by Moscow to journalists ahead of the event.  The BRICS nations – Brazil, Russia, India, China and South Africa – admitted four new members at the start of 2024: Egypt, Ethiopia, Iran and the United Arab Emirates. Although the BRICS nations desire an alternative to the dollar, none of the members states have yet to design a workable plan. Indeed, the Russian proposal to the BRICS seems like a desperate move and essentially amounts to a system for facilitating barter between the participating nations. “The dollar’s stranglehold on global finance is fraying, and Russia’s proposal could be the nail in the coffin,” declares the Russian website www.rt.com . “And here’s the kicker: the U.S. and its allies, so adept at weaponizing the dollar, now find themselves cornered. Washington loves to peddle ‘freedom’, but when it comes to global finance, it’s all about coercion and ensuring the dollar’s imperial reign continues.” The event’s theme of anti-colonialism is appropriate given the venue. The Mongols ruled Russia for 240 years during the 13th to 15th centuries. Kazan was captured from the Tartars by forces loyal to Ivan the Terrible in 1552. The region was gradually Russianized and Muslim religious activity suppressed for centuries until the fall of the Soviet Union. Located 450 miles due east of Moscow, Kazan is a symbol of the ebb and flow of geopolitical power between East and West in Eurasia.  Like many cities in Russia, Kazan became a major manufacturing center for arms during WWII. Yet today Russia remains hobbled by economic and financial weakness that stems from the country’s authoritarian government.  Despite the war in Ukraine and the loud pretensions of Vladmir Putin , Russia is declining and China is again in the ascendancy, although neither nation is really growing in economic terms. Russia first organized a meeting of the BRIC nations in 2006 but has yet to produce any tangible results. Under Putin's erratic leadership, Russia has destroyed its economic ties to Europe and has resumed its place as a vassal state to Beijing. Today, China and the US are the move-movers of global economic affairs, although the status of the former is increasingly in doubt. Meanwhile, as we discuss in the upcoming Second Edition of "Inflated: Money, Debt & the American Dream," the use of the dollar is slowly declining. Many nations choose to hold the currencies of major trading partners other than the currencies of the US, China and EU. Rather than a replacement for the dollar, the global currency system seems to be displaying accelerating entropy. “Central to that is the proposal for a new payments system based on a network of commercial banks linked to each other through the BRICS central banks,” Reuters  reports. “The system would use blockchain technology to store and transfer digital tokens backed by national currencies. This, in turn, would then allow those currencies to be easily and securely exchanged, bypassing the need for dollar transactions.” Whenever you hear the magic words "blockchain" and "digital tokens," it's a good guess that whatever follows is nonsense. China has become the leading player within the BRICS in recent years, but troubles in the Middle Kingdom caused by that nation’s incompetent communist government have hobbled economic growth. There are more empty, unused dwellings in China built at the command of paramount leader Xi Jinping than there are total homes in the US. And in keeping with the spirit of the event, no western credit cards may be used in Kazan. No word yet on who is going to safekeep the national currency backing the unnamed digital tokens that will be used to settle transactions. The BRICS payments scheme lacks a functioning financial system as a foundation. The global payments system based upon the dollar is not merely a function of a large and liquid system for exchanging value in terms of trade, but an equally important system for financing trade and other types of economic activity. Replacing the dollar is not merely a matter of creating a new means of exchange but of replacing a global market for finance and investment built over half a century following WWII. More to the point, there is no leverage in the new BRICS payments scheme. Will member nations extend credit to other nations that are in deficit? Perhaps Russia, using its large gold reserves, will propose a new IMF-style lending arrangement to finance trade and current account deficits? Not likely. So far, none of the BRICS nations have shown a willingness to inflate their currencies sufficiently to serve as a viable alternative to the dollar as a global means of exchange.  The BRICS proposal to supplant the role of the dollar is inadequate. Less than a replacement for the dollar, the BRICS system seems to be a revival of the gold standard with a veneer of technology provided by blockchains, tokens other superficial techno trappings. Despite Putin’s pretensions about cooperation with the BRICS members, you can be sure that when the Russians sell you oil or arms, they will want to be paid in kind in tangible tradable assets such a commodities, gold or, yes, even dollars. 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 17, 2024  | An astute reader of The Institutional Risk Analyst  asked a while back if Toronto-Dominion Bank (TD)  was not taking the place of Wells Fargo (WFC)  in the penalty box for big dumb banks. The short answer to that question is “Yes.” WFC is not even out of dodge yet, but TD has cut off several of the fingers of one hand in yakuza  style and is now headed for years of misery at the hands of US regulators, the Department of Justice and FinCEN.  Q: Is it time for TD to reassess its US strategy for going big in retail banking? Call us old fashioned value investors, but TD management deserve the torments of the damned for their business strategy in the US. They have risked a stable, low-beta banking and investment management business in Canada by pouring capital into a group of mediocre US retail banks over the past two decades. And they have sold their stakes in valuable investment advisory businesses. TD Bank reminds us of PepsiCo when it got into the retail restaurant business decades ago, beginning twenty years of intense value destruction. As long as PepsiCo invested in more Taco Bell restaurants, it looked great in terms of EPS growth. But ultimately the investments in retail restaurants were consuming capital and PepsiCo spun off the restaurant business in 1997 in an act of self preservation .   In fact, the TD retail bank in the US is destroying value with both hands (minus some fingers of course). And the real crime is that other banks in Canada are following TD’s bad example of buying underperforming US retail banks on the way to shareholder value hell. Click the link below to see a history of institutions acquired by TD going back in time to the successor of Penobscot Savings Bank in 1869. TD Bank US Holdings Acquisitions Because its undermanaged US retail bank was totally unprepared for a deliberate assault by organized crime organizations, TD must pay a total of $3.1 billion in penalties to resolve its latest management fiasco. This includes $1.9 billion to the Department of Justice in the single largest fine ever imposed under the Bank Secrecy Act . What was the sleepy appendage of an inoffensive Canadian bank doing with branches all over the eastern half of the US? Almost 200 branches in New Jersey alone? Getting targeted by professional criminals for a classic scam. You could write a great case study of TD about how not to manage KYC/AML risk.  In one example, TD reportedly was dupped by drug traffickers who purchased millions of dollars worth of gift cards via a branch in Southern New Jersey over a period of years. Are you shocked? All told, the bank “enabled three money laundering networks to collectively transfer more than $670 million through TD Bank between 2019 and 2023,” says the DOJ. We’ve long argued that Canadian banks as a group have utterly failed in their attempts to successfully acquire and grow retail banks in the US. There is not a single example going back fifty years where a Canadian bank made a profitable investment in a US retail bank. If we've missed one, please email: info@rcwhalen.com . Not only is the financial performance of TD’s US units below-average, but the operational risk created by the half trillion asset “retail” bank is off the scale and destroying any value to TD shareholders. TD and the other Canadian banks should stick with retail banking north of the border and global asset management.  The chart below shows the ROA of the US unit of TD vs JPMorgan, WFC and Peer Group 1. Source: FFIEC Regulators are actually compelling TD to create an entirely new unit to conduct triage and recovery for the US operation when it comes to the two acronyms from the infernal reaches of bank regulation: Know-your-customer (KYC) and anti-money laundering (AML). US authorities have imposed an asset cap on TD’s US operations, a sanction that may actually be a blessing in disguise. Rather than fighting to remove the asset cap imposed by US authorities, TD should instead take a hint from Wells Fargo and begin to downsize its US operations and shed most of the 1,200 branches and 10 million loss-leading US retail customers. Unlike WFC, which continues to report profits even after seven years in regulatory purgatory, we doubt that TD will ever generate consistent profits from the US bank unit. WFC, of note, has made a virtue of its own asset cap and dramatically downsized, exiting third-party correspondent mortgage. The chart below shows the efficiency ratio for TD Group US Holdings. Not only does the bank holding company have the highest operating costs of the group, but the variance in this metric is worrisome. Say what you want about the studied mediocrity of Bank of America (BAC) , but the results are consistent and reasonably stable. And of course JPM has the lowest cost of revenue in the industry in the low 50s. Source: FFIEC How much more capital will Canadian banks shovel into the furnace before institutional shareholders scream? TD recently sold part of its stake in Charles Schwab (SCHW) , a disastrous decision for TD shareholders who now face years of sanctions by US regulators without the benefit of the SCHW investment. The fact that TD actually sold some of its stake in SCHW to pay the US fines illustrates a certain lack of clarity on the part of CEO Bharat Masrani  and the TD Board of Directors when it comes to shareholder value. TD Bank US Holdings Source: FFIEC TD’s leaders have been talking for years about building a business in the US, but all that they seem to have done is create a vast about of reputation risk for the bank. The US unit now accounts for one quarter of TD revenue, but the operating results for the $540 billion asset TD Bank US Holdings are abysmal. We’ve said on X several times, TD ought to downsize or sell its entire US retail banking operation and throw the proceeds back into SCHW. Why?  First, doubling down on SCHW as an investment is going to be a better risk than buying also ran US retail banks. The list of dreadful crap that has been acquired by TD over the past 20 years is appalling. If we calculate the return on invested capital for TD equity only, the results are in low single-digits. If we also include the cost of the corporate debt, then the numbers get really small. TD could get better risk-adjusted returns on T-bills. How could the managers of TD ignore the published historical data for US banks showing negative risk-adjusted returns  in many years for half of the industry? Buy T-bills or Ginnie Mae pass throughs if you must, but why buy US retail banks at a premium to book value? TD Group US Holdings has $16 billion in goodwill and other intangibles out of $56 billion in total capital. Second, a significant stake in SCHW gives TD a possible option to buy the whole business, particularly if they stop wasting money on US retail banking. The retail banks that are worth buying are too expensive, but that does not mean we ought to buy crap. At present, SCHW is worth more than the larger TD Bank and has far more AUM. TD has less than $400 billion in AUM vs over $7 trillion in advisor assets for Charles Schwab. But SCHW’s total balance sheet assets are just shy of $500 billion vs $1.4 trillion for TD.   Source: Google Finance (10/16/24) TD is in for a long grind to get through the US regulatory sanctions. In the meantime, we think the Board of TD Bank needs to do some serious soul searching about the nature of shareholder value, especially adjusted for risk, based upon a US retail banking franchise. Given the huge focus on a retail consumer risk model, if TD were not being tormented for KYC/AML violations, it would be something else. Consumer risk in retail banking and mortgage lending is toxic. Investment management is lower risk and better returns. And SCHW is not the only large bank with a focus on investment advisory business in the US. 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 10, 2024  | We are in Washington, DC, this week for mortgage industry meetings, but watching events in Florida has dominated many discussions. For the housing sector in Florida, Hurricane Milton simply adds to a situation where insurance rates are either soaring or coverage is unavailable at any price. Washington is engaged on the issue of flood insurance, but the larger need is to focus on providing basic property casualty coverage for homeowners.  "This is a monster mess in Florida," says David Kotok , Chief Investment officer of Cumberland Advisors in Sarasota. "I am getting constant calls from clients about losses in Florida. This is a multi, multi billion dollar loss event. I have never seen a loss event this big in Florida. The risk and potential losses to banks and other financial institutions is massive."   Jonathan Miller  of Miller Samuel made three key points about this latest storm event in a comment yesterday: 2024 Is Shaping Up To Be The Most Expensive Year For US Disaster Clean-Up The Frequency and Intensity Of Natural Disasters Is Ramping Up The Cost and Availability Of Insurance Will Have A Profound Impact on Housing Jon's last bullet is already a big problem for residential real estate in Florida and other flood-prone states. Many homes in Florida no longer have adequate home owners insurance much less federal flood insurance. Many homes in Florida not in "flood prone areas" had no floor insurance. The State of Florida, through the Citizens Property Insurance Corp ., is the largest insurance company in Florida. Styled as an "insurer of last resort," Citizens has an 18.5% market share and appears insolvent due to hundreds of thousands of policies in the area of the state most exposed to the latest storm. “The state-backed entity is now so large that it stands in the way of a healthy and effective insurance marketplace,” notes Jonathan Levin  of Bloomberg . “It issues policies at below the actuarially appropriate rates, thus curbing private insurers’ ability to properly price risk. It also introduces moral hazard by allowing homeowners to assume too much risk, potentially putting more people in harm’s way than there otherwise would be.” As the state-owned insurer Citizens has been taking up market share at below-market rates, private carriers are fleeing the state.  The Citizens situation is a major problem for Florida Governor Ron DeSantis , who like lawmakers in Washington pondering increased fiscal support for flood insurance is unwilling to cut-off homeowners in Florida from home insurance. Meanwhile, desperate subprime and even prime insurance carriers, seeing a wall of claims and litigation in Florida, have been denying claims, even where policies should cover storm-related damage.   “Homeowners insurance is labeled as one of the hidden costs for property owners, and their escalating prices could have an impact on the secondary and capital markets, in terms of loan salability and performance,” reports Brad Finkelstein of National Mortgage News . But what happens to the value of the home on Florida if the homeowner cannot get insurance at a reasonable price? We believe that Florida Governor DeSantis will be looking for a bailout from Washington to prevent the collapse of the state home insurance carrier. Loans in conventional and government insured mortgage securities must have home owners insurance. Back in May, Fannie Mae and Freddie Mac jointly created a blog post on explaining their home insurance requirements , which call for a replacement cost value policy, rather than the alternative, for actual cash value. The requirement for replacement cost protection covers the value of the securities that finance the mortgage, securities guaranteed by the GSEs. What is fascinating about “replacement cost” is that inflation in the cost of labor and materials over the past decade has greatly increased the replacement value of homes and commercial properties. In order for lenders to meet the replacement cost value criteria of Fannie Mae and Freddie Mac, or private investors, means getting insurance coverage that may no longer exist in the Florida market. As appraised values of homes have risen due to inflation, the willingness of insurers to cover replacement value has waned because of the elevated risk of storm damage.  Commercial insurance costs for Florida condominiums, for example, have been rising faster than inflation for a decade. Many attribute the rising scale of hurricane damage to global warming. But the more immediate and obvious explanation is the vast increase in population in coastal areas of the Southeastern US. When a hurricane hits Tampa or the Carolinas or coastal New York, the number of people and households effected is far greater than a century ago. The density of coastal communities and the rising cost of homes and replacing damaged structures is a huge issue for the housing industry.  And federal flood insurance, which is eagerly supported by home builders, encourages further home building in flood prone areas.    Meanwhile, even as the impact of climate change and the increased loss severity from storms on residential housing holds the public’s attention, the impact of changing use patterns and also weather events is causing perverse and dangerous changes in insurance coverage for commercial properties. Falling property values, for example, are causing insurers to reduce coverage on buildings based upon current market value vs replacement value. And the loans that finance these buildings are often found in commercial mortgage backed securities (CMBS).  “There is a non-climate reason for insurers to reduce commercial property coverage, especially for major-city office buildings,” opines Nom de Plumber . “As office properties continue to drop in value for non-climate reasons (amid higher interest rates and operating costs, plus post-Covid tenant vacancies and lower rents), insurers are considering material reductions in coverage amounts, potentially leaving the outstanding property loans insufficiently covered for casualty loss. That itself is an initial risk.”  Falling valuations for commercial properties based upon local conditions are only the start of a frightening feedback loop of deflation, NDP worries: “We could see as a compound risk, office properties may hence become extra-exposed to climate physical losses, adversely impacting the interest-only, premium-coupon, or subordinate CMBS bond tranches which contain them, especially in Single-Borrower/Single-Asset CMBS. Insurance coverage reduction has feedback loop to valuations,” he adds. “Hard to reverse the loop direction.”   Bottom line for investors and policy makers is that severe weather events and other factors such as declining utilization of commercial properties are creating big risks for public and private investors. The federal flood insurance scheme is already insolvent and must be bailed-out by Congress.  But the bigger issue is that risks to residential and commercial property owners in states like Florida may not be commercially viable as insurance. “Floridian homeowners with property insurance claims were over than nine times more likely to sue their insurance companies than elsewhere in the country,” wrote  John Dizard in Substack last year.  “Were Florida insurance companies nine times more tight-fisted and evil than other insurance companies in the U.S.?” He continues in a prescient article: “A fair number of homeowners will have extreme difficulty finding affordable property insurance. No home-owners insurance means no access to mortgage financing supported by the US government’s housing agencies. This is a real wake-up from the Florida Dream. Reasonable people might say this set of problems was not created by Governor DeSantis, but he happens to be Governor right now, this year and next year, when the reckoning is coming due.” 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.

July 29, 2024 | Premium Service  | Last week, Mr. Cooper Group (COOP)  acquired the mortgage servicing business of Flagstar Bank, N.A., the sole bank subsidiary of New York Community Bancorp (NYCB) . The transaction disposes of Flagstar’s residential mortgage servicing business, including mortgage servicing rights and the third-party origination platform, for approximately $1.4 billion. The transaction is expected to close during the fourth quarter of 2024.  As readers of The Institutional Risk Analyst  appreciate, this sale essentially unwinds the acquisition of Flagstar Bancorp by NYCB and represents a substantial destruction of shareholder value for common stockholders. The $1.4 billion in consideration paid to NYCB by COOP represents only a slight premium to the fair value of the mortgage servicing rights (MSRs) and the roughly $4 billion in related escrow deposits. These deposits will eventually leave the bank, which seems to be in a managed windup. But the transaction is a huge windfall for COOP. COOP Chairman and CEO Jay Bray  commented, “We have the operational capacity to onboard Flagstar’s customers with a smooth and positive experience, which will be our top priority. We also look forward to welcoming Flagstar team members to the Mr. Cooper family. We have long respected Flagstar as a mortgage servicer, and we feel very closely aligned with their cultural values.” COOP funded the acquisition with available cash and credit lines, providing the leading mortgage servicer with an accretive means of deploying capital and growing earnings. Of note, Mr. Cooper will subservice loans/HELOCs remaining on Flagstar's balance sheet since the bank no longer has the capacity to perform these functions. The addition of the Flagstar MSRs and servicing book is enormously accretive to COOP and will provide future income for the group as shown in the chart below.  COOP was already headed for another strong quarter in Q2 2024, but the NYCB acquisition positions the firm nicely for the rest of the year and an eventual rate cut by the FOMC. Indeed, a number of analysts and institutional investors had been reducing exposure to COOP after a long and very positive run for the stock. Mr. Cooper | Q2 2024 The same investors and analysts who have been reducing exposure to COOP equity may now need to reconsider that calculus. COOP continues to grow operating income faster than expenses, a trend that could accelerate as the leading non-bank lender absorbs the assets and people from Flagstar. Note in the chart below the striking disparity in equity returns between the two companies. For NYCB, this transaction is the latest chapter in an unfolding disaster. The new management team of NYCB characterizes the Flagstar servicing platform as a “non-core” business, but in fact the income and liquidity generated by the mortgage servicing activities was supporting the bank. Once these assets are gone by the end of 2024, we expect that the rest of the bank will be sold or recapitalized in short order.  NYCB lost $300 million in Q2 2024 and executed a 1:3 reverse stock split in a pointless effort to window dress the ongoing value destruction under the new management team. Net interest income was down 40% YOY and 11% sequentially, reflecting asset sales and loan charge-offs. The fact that the portfolio of 1-4 family residential loans is growing is nice to hear, but this is less than 10% of the loan book vs 60% for commercial credits. We suspect that NYCB will be forced to sell those performing residential loans for cash as losses on the multifamily portfolio grow. By shrinking the bank's revenues, NYCB is making itself less valuable and less stable, but the new team seems to be powerless to change the situation. The consideration paid by COOP to NYCB is a pittance compared with the future value of Flagstar’s mortgage operations, including MSRs and subservicing contracts totaling approximately $356 billion in unpaid principal balance (UPB) and over 1 million customers. Unlike many subservicers, Flagstar controlled the escrow deposits for most of the sub-servicing assets. Flagstar was one of the last bank issuers in the government loan market. Because NYCB does not currently have an investment grade rating, the Flagstar escrow deposits will likely move to another depository when the transaction closes. NYCB states that only $3.7 billion out of $9 billion in mortgage related deposits will be lost when the transaction closes, but as and when the 1-4s are eventually sold to raise cash, the rest of the mortgage-related deposits will likely disappear.  NYCB | Q2 2024 Notice that the NYCB team characterizes the escrow deposits from residential mortgages as "high-cost and volatile," neither of which statement is true. NYCB states that the residential mortgage servicing business was “non-core,” evidence of the fantasyland atmosphere which prevails under the new team. Consider the statement of Chairman, President, and Chief Executive Officer Joseph M. Otting :  "The Flagstar mortgage servicing platform is well-respected throughout the industry, which we believe is reflected in the premium we received. While the mortgage servicing business has made significant contributions to the Bank, we also recognize the inherent financial and operational risk in a volatile interest rate environment, along with increased regulatory oversight for such businesses.” "We are focused on transforming the Bank into a leading, relationship-focused regional bank,” says the former Comptroller of the Currency Otting, reflecting the evident confusion among the bank’s new management team. “Consistent with that strategy, we will continue to provide residential mortgage products to the Bank's retail and private wealth customers.” Joe Otting does not seem to understand the value of the Flagstar mortgage servicing business. Contrary to Otting’s statements about growing the bank, NYCB seems to be winding down. The bank is closing offices and shedding assets in an effective liquidation of the business. The fact that the Flagstar sale increased the bank’s capital slightly (70 bp) is irrelevant given the scale of the bank’s remaining asset quality problems. Meanwhile, the bank’s cost of funds has risen sharply in the wake of the Q1 2024 restatement. Here is the key passage from the Q2 2024 earnings statement: “For the six months ended June 30, 2024, the net interest margin was 2.13%, down 81 basis points compared to the six months ended June 30, 2023. The year-over-year decrease was primarily the result of the impact of higher interest rates and competition on our cost of funds. The average cost of funds rose 142 basis points to 4.36% driven by a 180 basis point increase in the average cost of borrowings and a 128 basis point increase in the average cost of deposits, along with an increase in average interest-bearing liabilities.  This was partially offset by higher asset yields, which increased 40 basis points to 5.50% along with an increase in average interest-earning assets.” Fortunately the bank has been rebranded as “Flagstar,” but the legacy NYCB commercial and multifamily credit exposures are now the dominant asset. The table below from the NYCB Q2 2024 earnings presentation gives readers a sense for just how small is the consideration from the sale of the Flagstar assets to COOP relative to the bank’s asset quality problems.  NYCB | Q2 2024 The stated non-accrual loans for NYCB at the end of Q2 2024 were almost $2 billion, a figure that we suspect understates the actual delinquency in the portfolio. Given that pain in the office CRE channel is only starting to surge and defaults in the multifamily sector are already mushrooming, we view NYCB’s credit outlook as problematic. NYCB | Q2 2024 A reasonable starting haircut for the bank’s CRE and multifamily exposures would be in the neighborhood of 20-25% of par value. Obviously this would leave the bank insolvent.  Or to put it another way, you could use the $1.4 billion proceeds from the sale of the Flagstar mortgage business -- two quarters from now upon close -- to clean out the bank's delinquent loans. But we suspect you'd be putting more loan loss provisions aside immediately We view the sale of the Flagstar business as a huge and unexpected positive for Mr. Cooper, but troubling evidence that NYCB is headed for a sale or failure. The national mortgage lending, correspondent and servicing business of Flagstar was the future of NYCB, not the retail branches that Otting et al. have retained and are now slowly eliminating. We view the attempts to right the sinking ship as commendable but largely futile. Long-time readers of The Institutional Risk Analyst will recall the Fall of 2008, when Wells Fargo & Company (WFC) acquired Wachovia Corporation in a government-assisted sale to prevent the bank's collapse. An all-stock deal with WFC worth $15.1 billion was announced in October 2008, overriding a bid by Citigroup (C) to acquire Wachovia Bank from the FDIC. The Citi deal would have forced the Wachovia parent bank holding company into bankruptcy, following the parent of Washington Mutual and Lehman Brothers in its entirety earlier that year. A third financial firm filing bankruptcy in Q4 2008 might have cratered the US credit markets. Wachovia shareholders approved the merger proposal on December 23, 2008, and WFC announced the merger's close on January 1, 2009. Upon close, WFC charged off the total equity of Wachovia, creating an accounting reserve that allowed WFC to clean up the Wachovia mess over time. In our view, one way or another, NYCB will either be acquired by a larger bank that can replicate the scale of the Wachovia merger transaction, or the FDIC will take over the bank and sell the net assets at 50 cents on the dollar. Indeed, the prospective discount on the NYCB legacy CRE and multifamily books may be too large a burden for a private investor. NYCB is an example of why we have suggested in previous comments that the scale of problems in the office and multifamily sectors may be too large for the private sector to fix alone. Remember, the FDIC is still sitting on the rent-stabilized assets of Signature Bank, deeply impaired assets that NYCB refused to buy and is no longer servicing for the bank insurance fund. Stay tuned as the situation around NYCB evolves through the rest of 2024. 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 7, 2024  | Updated | The term “jump the shark” dates back to 1985 and the sitcom “Happy Days.” The character Fonzie jumps over a live shark while water-skiing. The idiom "jumping the shark" or "jump the shark,” according to Google AI , means “a creative work or entity has reached a point where something stops becoming more popular or starts to decrease in quality.” Federal Reserve Board Chairman Jerome Powell seems to have jumped the shark and hard landed, spending a lot of credibility in the process. But we keep wondering: What sudden exigency made Chairman Powell and other FOMC members ignore the mixed economic data and go “all in” on a 50 bp rate cut in September? Was the Powell FOMC playing election year politics, like all Fed chairs do, or looking at mounting economic woes and deflation overseas? Hard to say. Former Treasury Secretary Lawrence Summers  added to the holiday cheer when he said that the 50 basis point interest rate cut last month by the FOMC was “a mistake.”  Subsequent domestic jobs data supports this view, however, and suggest that Powell’s latest error may stoke inflation.  How could the Fed get things so wrong? “Every piece of Friday’s BLS report screamed that the Federal Reserve Chairman had jumped the gun yet again in suggesting in his speech on September 18 that the Federal Open Market Committee had shifted its focus from prices to jobs,” writes Komal Sri-Kumar  on Substack . " The inflation question is not resolved, and the employment picture remains strong, thank you!" It is certainly true that the bottom quartile of the US economy is living in extremis , but this is mostly the result of consumer price inflation rather than a slack economy. Housing inflation is a huge pain point for low income households, one reason why we think VP Kamala Harris will lose in November . Inflation and immigration remain the two key issues in this election. Powell’s shift in focus from prices to jobs we view as election year rhetoric, yet the slowing in the global economy seems to have also figured in Fed thinking.  Watching the signs of mounting economic distress in China’s property sector, for example, we remind readers that not only are China’s paramount leaders just as incompetent as our own, but they like to “go big” in ways that would make even the spendthrifts on the Federal Reserve Board red with envy. China is drowning in a sea of bad debt and even worse economic misallocation. In a sign of desperation, Beijing is throwing hundreds of billions in new cash at a housing economy that is caught in a 1930s style debt deflation. The scope of the value destruction is so great that Chinese consumers are fleeing paper and real estate for gold, contributing to record purchases of the metal . After a decade of economic growth directed from above, Xi Jinping's  “great leap forward" via encouraging domestic real estate development has resulted in a widening financial disaster for private companies and the government alike. Has Irving Fisher’s 1933 essay on debt deflation been translated into Mandarin? In the US, the situation involving commercial real estate is likewise dire and, as we told our readers months ago, is unlikely to be helped much by lower interest rates. This assumes, of course, that interest rates are moving lower. Blackstone (BX)  president  Jonathan Gray  said in a remarkable front-page story on Friday in the FT  that “an accelerating recovery in most of the commercial property market would not be enough to save some over-indebted owners from having to take losses, mainly on offices.”  Thank you so much Jonathan.  The fact that the US economy is racing ahead even as Europe and Asia sink into the mud of economic stagnation speaks volumes about the rules of the dollar system. Americans benefit from higher levels of nominal economic growth due to the massive excess liquidity in the system, but lose ground in terms of inflation and exploding public debt. When you hear people speak about creating “value” in such an environment, just assume it is not inflation-adjusted.  One example of a new definition for value creation comes via the Chief Executive Officer of Italian bank UniCredit (UCG) , Andrea Orcel , who quietly built up a 21% stake in moribund Commerzbank AG (CBK). He achieved this feat largely through the use of derivatives, this in order to avoid official limits on share purchases. The folks at the airline formerly known as HNA used similar tactics when they pretended to invest gobs of borrowed money into Deutsche Bank AG (DB) .  UniCredit’s Orcel says a full takeover of Commerzbank is an option, potentially creating Germany’s largest lender. Yet more than half of the staff of the German bank would likely be dismissed in a merger, a considerable shock for a country that is not growing and is not expected to grow at all in 2025.  Our bet is that DB eventually will make a bid and gain the support of the German government. If not, then the next hostile bid could be for DB itself. CBK is trading at 0.6x notional book value, yet Orcel apparently thinks that Commerzbank is good value. We wonder why UCG would pay anything at all for the crippled German bank. CBK had about half a trillion in assets at the end of June, but just $30 billion in net tangible capital, according to CapIQ. Assuming the usual skeletons in the credit closet for the average large Eurobank, CBK probably has no equity. But we can say the same about a number of US bank M&A deals. Like many US banks, UCG’s Orcel seems prepared to overpay for the target in the name of generating nominal growth of "value." The LT chart for Commerzbank below is not pretty. Notice how volume in CBK has picked up since the 2008 debacle, but the share price has barely moved. The German government has a 17% stake in CBK. Source: Bloomberg (10/04/24) CBK shares have bounced from EU12 to EU16 over the LTM, although prior to 2008 CBK traded over EU200. UCG would need approval from the German government for a full takeover. Note that members of the German business community are not even putting up a real fight at the thought of takeover by the larger Italian rival. "Unicredit has been quite good at integrating banks in Italy and CEE," notes Achim Düebel in Berlin. "German banks have made the silly mistake in the 90s to not expand to CEE (apart from Commerzbank’s ill-fated mBank engagement in Poland), and the French and Spanish markets are closed, so lack EU networks. I think a German-Italian merger focused on Mittelstand and mortgages would make more sense than, say, a German-French or a Deutsche Bank takeover." In theory, CBK is only about  10% smaller than U.S. Bancorp (USB)  at $623 billion in assets. At the end of Q2, the American bank had twice as much nominal equity and far stronger asset returns, but don’t get too excited. USB starts with minus $15 billion for the negative capital surplus, then add $75 billion in retained earnings, less $10.3 billion in accumulated other comprehensive loss for the negative mark-to-market on AFS loans and securities. That leaves just $46 billion in tangible capital, as shown below from the Form Y-9. Of note, we have not included the held-to-maturity assets in the net capital calculation for USB or CBK. U.S. Bancorp | BHCPR | 06/30/24 Source: FFIEC If interest rates are not going to fall below current levels and, more important, the rate cutting narrative at the Fed is on hold, what does this mean for the future? First and foremost, a sudden change in the “inflation is dead” narrative likely means that Fed Chairman Jerome Powell could be retiring soon. The September rate cut marks the third time that the FOMC under Powell’s leadership has made a mistake in timing. When your stock and trade is confidence, timing matters. Like the believers of the Church of Rome, investors in dollar assets trust in the leadership of the Fed as an article of faith. If the Chairman does not push the right buttons at the right time, however, then confidence -- that is, faith -- in the system suffers. Since Powell puts consensus within the FOMC first and foremost, the possibility of a split vote in November provides Powell with an opportunity to flee back to the safety of private life. Second, a lack of consensus within the FOMC will impact markets very directly and in the same degree as the market rally before the September cut. A couple of readers have asked whether residential mortgage rates will go below 6% before year-end. Given the rally in Treasury yields over the past year and the rise in yields since the Fed rate cut, we think the short-term prognosis is more likely higher Treasury yields and mortgage rates as the year ends.  As we noted to subscribers to the Premium Service last week, banks are chasing assets and yields to such a degree that returns are being forced down. Funding costs are unlikely to follow suit, thus we may see a narrowing of net interest margins in Q4 after more promising results with Q3 earnings. The sudden interruption of the rate cut narrative, as the title of this post suggests, means that the FOMC may need a new leader to carry the message going forward. Markets are not expecting a change. The collapse of the credit trade is making some banks regret asset sales made earlier in the year, but we think the real story for the end of 2024 will be higher Treasury market yields and residential mortgage rates, shrinking NIM at banks (after several better quarters) and greater uncertainty about the direction of US monetary policy.  As the FRED chart above suggests, the markets got their rate cut over the past six months and now may have to give some of that back. The 10-year Treasury note is over 4% for the first time since early August. The green line showing bank net income below may show an uptick in Q3 followed by a down quarter for the year-end 2024. Source: FDIC In our next Premium Service comment, we’ll be setting up readers for Q3 earnings for financials given the suddenly uncertain outlook for US interest rates.   The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

October 1, 2024  | As we completed the revisions to “Inflated: Money, Debt & the American Dream” last week, we had an opportunity to speak with a number of close observers of the dollar and the Treasury market about what has changed in the political-economy over the past 15 years. Answer, a lot. We asked a number of people if the dollar will still be the dominant reserve currency in 50 years for the American tricentennial. In particular, we were able to speak with our friend and fellow Lotosian   James Rickards , who is releasing his latest book “ MoneyGPT: AI and the Threat to the Global Economy .” Below are some excerpts from our wide-ranging conversation last week.  You can read more in the upcoming second edition of "Inflated," to be released in 2025 by Wiley Global . The IRA: Jim, thanks for making time and congratulations on the new book. During our research for the new edition of “Inflated,” we spent a lot of time describing the changes that have occurred in the US financial markets since 2008, particularly the explosion of public debt under President Barack Obama and the annihilation of the primary dealers. How do you view this period? Rickards: There has not been a Fed funds market since 2008. Prior to 2008, we had banks and excess reserves, but today there is no Fed funds market.  The IRA: Agreed. Are we headed back to the future of President Abraham Lincoln and Treasury Secretary Salmon Chase , who created the fiat paper dollar to finance the Civil War? That is, a bank market for Treasury debt without the non-bank dealers who supported the government debt markets for 75 years after WWII? Are we witnessing the slow-motion collapse of the Treasury market?  Almost all of the Primary Dealers are now banks. Rickards: A big part of my career was at Greenwich Capital Markets, which got its primary dealer designation by acquiring a failing primary dealer. What that meant was we were allowed to call the Fed and trade Treasury securities. Our small firm was often among the top three dealers in longer-dated Treasury debt. We arbitraged and traded Treasury bills and notes with the Fed, which we could finance overnight in the repo market. It was the ultimate example of insider trading because all of the dealers talked to one another, but that is what the Fed wanted in order to maintain an orderly market in Treasury paper. The IRA: The Fed created the dealer market in the 1950s to provide an indirect way to finance Treasury debt instead of having the banks buy it directly, as they had done through the Depression and WWII. You won't find any discussion of this on the Board of Governors web site. Americans have wandered blissfully through the 20th Century until 2008, when half the primary dealers disappeared and the other half were acquired by banks. Then in 2020, again the Treasury market collapsed and the Fed rode to the rescue. Where are we heading now? Rickards: We may find out sooner rather than later. We are in another contraction, but not in terms of the Fed. The central bank is almost irrelevant at this point. The banks are crucial today and the oxygen supply is in the repo market. Money creation comes from the banks, not the Fed. But as the Fed and the dealer community became more and more concerned with the Treasury’s needs, we did not create any new growth in the economy, no new commercial activity. Gold took a bad wrap in the 1930s for being the cause of deflation, but in fact it was because banks were unwilling to lend and we slipped into a debt deflation. The IRA: In the 1930s, holders of paper assets fled to gold, so FDR had to attack gold or the greenback franchise was out of business. Irving Fisher was right after all. Is the US economy growing or have we already fallen into a period of stagnation as the federal debt explodes?  Rickards: We have been in a depression since 2007. I use the definition of depression by Lord Keynes in the General Theory, which is a period of below trend growth with neither a tendency to collapse or grow stronger. In other words, an economic depression is depressed growth. So, if your potential growth is three and a half percent, but your actual growth is two, then you’re in a depression. By the way, from 2009 to 2019, the compounded rate of economic growth was just over two percent. The IRA: Jim, in your new book you note that Americans “no longer know what money is.” What does money mean to American society in 2024? In Chapter Three of "MoneyGPT," appropriately entitled "Moneyness," you seem to suggest that society is reverting back to a pre-written world of sound and sung narrative. You write: " We are returning to Homeric modes after 2,500 years of linear script. We are replacing money with moneyness." Will we be using large rocks in Central Park as a form of money soon? Rickards: Money is one of the foundations of civilization. Money is not the point of civilization and it’s far from the most important feature. Still, it’s part of the bedrock and performs crucial roles. Money is an advance on barter. Money is an alternative to violence. Money facilitates commerce and investment, and acts as a store of wealth. Money is among the institutions, along with law, religion, and the family, that enable civilizations to be civil and avoid a Hobbesian war of all against all. Just as money supports civilization, so money relies on civilization for its value. Money’s value springs from trust, and trust itself depends on some institution— a central bank, a rule of law, a gold hoard, an AI algorithm— to sustain it. When institutions break down, and trust is lost, the value of money is lost as well, only to await the rise of new institutions and new forms of money so the cycle begins again. The IRA: So how does this movie end? Is the dollar headed to a long-term decline? The portion of global reserves denominated in dollars has fallen to the lowest point in 30 years according to the IMF. What should a future President do to signal that the dollar is not declining?  Rickards: Humans are incredibly adaptable when it comes to money. Witness crypto as a case in point. If you are the shepherd of the dollar, you cannot take the currency for granted. People will create new currencies when the old money fails. That is why the Treasury should begin to buy gold again to demonstrate that the dollar is real. The IRA: Exchanging paper dollars for gold sounds like a good trade. But somehow we just cannot imagine a nouvelle socialist like VP Kamala Harris repudiating FDR’s 1933 currency devaluation. A future President Donald Trump could easily begin to exchange fiat paper dollars for gold. Maybe President Trump could also issue gold coins denominated by weight as a rejection of the New Deal devaluation? We'll put Judy Shelton's image on the one ounce "MAGA Eagles." And just by coincidence, Allex Pollock and Paul Kupiec of American Enterprise Institute just published an article on whether the Fed can buy gold . Rickards: The Treasury buying gold would restore confidence in the dollar and perhaps make people believe again that the currency has real value. The price of gold in dollars would clearly go up, but buying gold would be a statement to the world that we are not just going to go down the print-the-dollar rabbit hole. This does not mean that we are going back to a gold standard, but it does say that we are going to honor our obligations. But to make it to 2076, we need to think really hard about whether we have lost the thread about what money really is for America. The IRA: Buying gold would certainly be a better investment than a sovereign wealth fund or the Fed's purchase of mortgage backed securities. The Fed's accumulated losses on its interest rate mismatch now top $200 billion and climbing. Imagine if a future President Donald Trump atoned for the terrible sin of FDR for taking gold away from Americans in 1933 and the less significant act of President Richard Nixon finally closing the gold window for other nations in 1971. Thanks Jim! 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.

September 19, 2024  | In past comments in The Institutional Risk Analyst , we’ve noted that the recent propensity of the Federal Open Market Committee to err on the side of more liquidity has created significant problems for the markets. In 2020, for example, the market for Treasury debt nearly collapsed despite "big" levels of reserves. Now the Fed has gone explicitly political, pushing an excessive 50bp rate cut just ahead of a presidential election. What could go wrong? Chairman Powell panicked in 2019 and began a vast increase in liquidity that ultimately drove a huge uptick in inflation two years later. Now, Powell seems to be desperately trying to block the election of former President Donald Trump . If President Trump  wins in November, he’ll be more than justified in demanding Jerome Powell’s  immediate resignation. Trump cannot legally remove Powell as a governor without impeachment, but he can certainly appoint another Fed Chairman.  Readers of The IRA will recall that when President Harry Truman declined to reappoint Mariner Eccles as Chairman in 1948, Eccles remained on the Board to support Chairman Tom McCabe's fight for Fed independence. We note that important period in the revised edition of "Inflated: Money, Debt and the American Dream": "Though not reappointed as chairman, Eccles remained on the board and fought for the Fed’s independence during the remainder of his term as governor until he resigned in 1951. McCabe was pressured repeatedly by President Truman and Snyder to continue supporting artificially low interest rates, publicly and privately. Yet he, Eccles, Sproul, and the other members of the FOMC stood their ground and defended their responsibility for controlling inflation, which was a plausible threat from 1946 to 1950. But more important, McCabe and other Board members wanted to end the direct purchases of Treasury debt and create a dealer network to finance government needs." Kudos to Fed Governor Miki Bowman for her dissent on the FOMC’s decision. Not only is any possibility of a recession fading rapidly, but the FOMC has not really even begun to reduce the level of reserves in the system in 24 months of supposed tightening. This added liquidity in the money supply, added to the brisk rate of increase in the federal deficit, means that real liquidity in the system is growing at close to 10% annually. Q: What does the FOMC see in the “data” that would justify such reckless action?  The chart below shows reserves, the Treasury general account and reverse repurchase agreements. As we noted last week (“ Powell FOMC Folds on Inflation ”), since the US Civil War, fiat dollars (aka "greenbacks") and Treasury debt have been functionally equivalent. Menand & Younger (2023)  remind us that Alexander Hamilton  perceived that government debt had a “capacity for prompt convertibility” to currency, potentially rendering transfers “equivalent to a payment in coin.” In other words, they note, claims on the sovereign exist in a superposition of states between money and debt. This conveyed a special status on direct obligations of the federal government compared to all other financial assets, especially "at a time when money was in short supply." For financials, this latest lurch in monetary policy under the Powell FOMC suggests that our view of the macro outlook is correct. The Fed has made some subtle tweaks to the Basel III proposal that are beneficial to banks with large retained portfolios of low coupon MBS. Indeed, low coupons actually outperformed higher coupon MBS yesterday, contrary to our expectations. "Fannie Mae to-be-announced coupons of 5% and lower outpaced their Treasury hedges, with 3% coupons performing best," reports Scott Carpenter of Bloomberg . "Unlike higher coupons, lower ones are less negatively convex and may have reacted more favorably than higher coupons as the half-point reduction was larger than many expected ." We’ll be discussing these and other changes affecting financials in our next comment for subscribers to the Premium Service . But for now, Chairman Powell has set the US on a course for a liquidity driven rally in stocks and home prices over the next several years, but look for that maxi reset in home prices and financial assets on or before 2028, as we discuss in our latest book. Next week, WGA Chairman Christopher Whalen will be discussing the political and practical prospects for Fannie Mae and Freddie Mac to be released from government control. 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