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August 22, 2017 | After several weeks on the road talking to mortgage professionals and business owners, below is an update on the world of housing finance. We hope to see all of the readers of The Institutional Risk Analyst in the mortgage business at the Americatalyst event in Austin, TX , next month. The big picture on housing reflected in the mainstream media is one of caution, as illustrated in The Wall Street Journal. Borodovsky & Ramkumar ask the obvious question: Are US homes overvalued? Short answer: Yes. Send your cards and letters to Janet Yellen c/o the Federal Open Market Committee in Washington. But the operating environment in the mortgage finance sector continues to be challenging to put it mildly. As we’ve discussed in several forums over the past few years, home valuations are one of the clearest indicators of inflation in the US economy. While members of the tenured world of economics somehow rationalize understating or ignoring the fact of double digit increases in home prices along the country’s affluent periphery, sure looks like asset price inflation to us. In fact, since WWII home prices in the US have gone up four times the official inflation rate. “Houses weren't always this expensive,” notes CNBC . “In 1940, the median home value in the U.S. was just $2,938. In 1980, it was $47,200, and by 2000, it had risen to $119,600. Even adjusted for inflation, the median home price in 1940 would only have been $30,600 in 2000 dollars, according to data from the U.S. Census.” Inflation, just to review, is defined as too many dollars chasing too few goods, in this case bona fide investment opportunities. A combination of slow household formation and low levels of new home construction are seen as the proximate cause of the housing price squeeze, but higher prices also limit the level of existing home sales. Many long-time residents of high priced markets like CA and NY cannot move without leaving the community entirely. So they get a home equity line or reverse mortgage, and shelter in place, thereby reducing the stock of available homes. Two key indicators that especially worry us in the world of credit is the falling cost of defaults and the widening gap between asset pricing and cash flow. Credit metrics for bank-owned single-family and multifamily loans are showing very low default rates. More, loss-given default (LGD) remains in negative territory for the latter, suggesting a steady supply of greater fools ready to buy busted multifamily property developments above par value. We can’t wait for the FDIC quarterly data for Q2 2017 to be released later today as we expect these credit metrics to skew even further. Single-family exposures are likewise showing very low default rates and LGDs at 30-year lows, again suggesting a significant asset price bubble in 1-4 family homes. The fact that many of these properties are well under water in terms of what the property could fetch as a rental also seasons our view that we are in the midst of a Fed-induced investment mania. For every seller in high priced states that finds current prices impossible to resist, there are several ready buyers. But the crowd of buyers is thinning. Charles Kindleberger wrote in his classic book, “Manias, Panics and Crashes,” in 1978: “Financial crises are associated with the peaks of business cycles. We are not interested in the business cycle as such, the rhythm of economic expansion and contraction, but only in the financial crisis that is the culmination of a period of expansion and leads to downturn.” One of the interesting facts about the mortgage sector in 2017 is that even though average prices have more than recovered from the 2008 financial crisis, much of the housing stock away from the desirable periphery has not really bounced. This is yet another reason why existing home sales at a bit over a million properties annually have gone sideways for months. The 600,000 or so new housing starts is half of the peak levels in 2005, but today’s level may actually be sustainable. We had the opportunity to hear from our friend Marina Walsh of the Mortgage Bankers Association at the Fay Servicing round table in Chicago last week. Mortgage applications have been running ahead of last year’s levels, yet overall volumes are declining because of the sharp drop in refinancing volumes. We disagree with the MBA about the direction of benchmarks such as the 10-year Treasury bond. They see 3.5% yields by next year, but we’re still liking the bull trade. But even a yield below 2% will not breath significant life into the refi market. Though prices in the residential home market remain positively frothy in coastal markets, profitability in the mortgage finance sector continues to drag. Large banks earned a whole 15 basis points on mortgage origination in the most recent MBA data, while non-banks and smaller depositories fared much better at around 60-70bps. But few players are really making money. During our conversations over the past several weeks, we confirmed that the whole residential housing finance industry is suffering through some of the worst economic performance since the peak levels of 2012. The silent crisis in non-bank finance we described last year continues and, indeed, has intensified as origination margins have been squeezed by the market's post-election gyrations. Looking at the MBA data, if you subtract the effects of mortgage servicing rights (MSR) from pre-tax income, most of the industry is operating at a significant loss. The big driver of the industry’s woes is regulation, both as a result of the creation of the Consumer Finance Protection Bureau and the actions of the states. Regulation has pushed the dollar cost of servicing a loan up four fold since 2008. From less that $100 per loan in 2008, today the full-loaded cost of servicing is now $250, according to the MBA. The cost of servicing performing loans is $163 vs over $2,000 for non-performing loans. Source: MBA As one colleague noted at the California Mortgage Banker’s technology conference in San Diego, “every loan is a different problem.” But nobody in the regulatory community seems to be concerned by the fact that the cost of servicing loans has quadrupled over the past eight years. The elephant in the room is compliance costs, which accounts for 20% of the budget for most mortgage lending operations. Technology Driving Down Costs To some degree, technology can be used to address rising costs. But when it comes to unique events spanning the range from legitimate consumer complaints to a phone call to follow-up on a past request or spurious inquiries, none of these tasks can be automated. The obsession with the wants and needs of the consumer has led the mortgage industry to some truly strange behaviors, like Nationstar (NYSE:NSM) deciding to rename itself "Mr. Cooper." Driven by the atmosphere of terror created by the CFPB, the trend in the mortgage industry is to automate the underwriting and servicing process, and make sure that all information used is documented and easily retrieved. The better-run mortgage companies in the US use common technology platforms to ensure a compliant process, but leave the compassion and empathy to humans. By using computers to embed the rules into a business process that is compliant, big steps are being made in terms of efficiency. Trouble is, this year many mortgage lenders are seeing income levels that are half of that four and five years ago. Cost cutting can only go so far to addressing the enormous expense inflation resulting from excessive regulation and revenue compression due to volatility in the bond market. Avoiding errors and therefore the possibility of a consumer complaint (and a regulatory response) is really the top priority in the mortgage industry today. As one CEO opined: “Sometimes the best customer experience is consistency in terms of answering questions and quickly as possible and communicating in a courteous and effective fashion.” All of this costs time and money, and then more money. Our key takeaway from a number of firms The IRA spoke with over the past three weeks is that response time for meeting the needs of consumers and regulators is another paramount concern. Being able to gather information, solve problems and then document the response to prove that the event was handled correctly is now required in the mortgage industry. But as one senior executive noted: “Sometimes people are easier to change than systems.” So in addition to the FOMC, banks and mortgage companies can also thank the CFPB and aspiring governors in the various states for inflating their operating costs for mortgage lending and servicing by an order of magnitude since the financial crisis. This is all done in the name helping consumers, you understand, but at the end of the day it is consumers who pay for the inflation of living costs like housing. Investors and consumers pay the cost of regulation. Over the past decade since the financial crisis, the chief accomplishment of Congress and regulators has been to raise the cost of buying or renting a home, while decreasing the profitability of firms engaged in any part of housing finance. We continue to wonder whether certain large legacy servicing platforms -- Walter Investment Management (NYSE:WAC) comes to mind -- will make it to year-end, but then we said that last year. Like the army of the dead in the popular HBO series “Game of Thrones,” the legacy portion of the mortgage servicing industry somehow continues to limp along despite hostile regulators and unforgiving markets. Profits are failing, equity returns are negative and there is no respite in sight. Even once CFPB chief Richard Cordray picks up his carpet bag and scuttles off to Ohio for a rumored gubernatorial run, business conditions are unlikely to improve in the world of mortgage finance. Winter is here. #mortgages #CFPB #Cordray #FOMC #housingfinance #rent #affordability

March 2, 2026 | Whalen Global Advisors (“WGA”)  has released the The IRA Bank Book Q1 2026 , a quarterly review of the US banking industry that focuses on operating and credit trends. The more than 30-page report is available to Premium Service subscribers and reviews the results for the industry in 2025 and sets expectations for the year ahead. Source: FDIC/WGA LLC The year 2025 was extraordinary period for many reasons, including low credit loss rates and soaring asset values. QE teaches us that high asset prices suppress the cost of credit, until asset values fall. UBS believes defaults in private credit could reach 15% , 3x the peak delinquency rates for bank loans in 2008. The report details the rising exposure of US banks to non-depository financial institutions, including credit managers and private equity sponsors. The report includes a proprietary estimate for the continent credit exposure of US banks to NDFIs, as shown in the chart below. Source: FDIC/WGA LLC In the 1920s, many observers believed that asset values had reached a ‘permanently high plateau. Sectors like private equity and credit, and AI, all promise higher credit costs ahead. When credit costs rise, earnings decline and stocks follow. The sharp declines in bank stocks in January and February illustrate this tendency. The fastest growing bank asset category remains loans to non-depository financial institutions (NDFIs), up 7% in Q4 vs Q3 and up 35% YOY to $1.4 trillion at year-end 2025. With growing signs of credit stress among nonbank lenders, banks will eventually pull back from NDFIs. The latest default involving UK mortgage issuer Market Financial Solutions threatens a £930 million shortfall in collateral backing loans to Apollo (APO) , TPG Inc. (TPG) , other NDFIs. The IRA Bank Book Q1 2026 is available for purchase in The IRA online store  and to subscribers to The IRA Premium Service . Subscribers may login and download the full report below.

The latest edition of “The Wrap” features our view of the key events in Washington and on Wall Street over the past week. Don’t forget to watch “The Wrap” on The Julia LaRoche Show  every Saturday on YouTube to catch our discussion of what’s hot and what’s not in the world of finance and investing.  AI Market Rout Accelerates February 27, 2026 | The noise from the unwind of AI is adding to the contagion across the equity markets, which is also hurting bank, credit and BDC stocks. The FDIC just released the bank industry data for Q4 and we'll be publishing The IRA Bank Book industry quarterly on Monday. A viewer asked Julia if banks were required to back their gold holdings with cash under Basel III, but the answer is no. Under Basel III, physically allocated gold is classified as a Tier 1 asset with a 0% risk weight, placing it on par with cash and high-quality government bonds. This allows banks to hold physical gold without needing to set aside additional capital for risk under Basel III. Credit costs were down for banks in Q4 and the only noise in credit is commercial property (CRE) and, of course, private equity and credit.  The world of private credit is unraveling pretty much as we predicted some months ago. Institutional investors can and do abide by limits on redemptions for private equity and credit, at least for a while. Retail investors cannot and do not, and will run when there are clear signs of distress and illiquidity. Remember the deposit run at Silicon Valley Bank. Liquidity seems to be the issue with Blue Owl (OWL)  and some other fund sponsors. The fact that OWL and its companion BDC, Blue Owl Capital Corporation (OBDC) , are public stocks only adds to the potential for a liquidity run. Selling private credit to retail investors created the circumstances for forced liquidation. Our finance company portfolio is below sorted by the 200-day moving average. Finance Company Surveillance Group Source: Yahoo Finance (02/26/26) Despite the strong results for banks and other financials, the markets are giving back all of the gains of '25 and more. Almost every name in our nonbank finance group is down double digits. Note that legacy payments giant Fiserv (FISV)  is near the bottom of the list along with OWL, Coinbase (COIN) , Robinhood Markets (HOOD)  and Upstart (UPST) .  Of note, we've learned this week that some of the larger private credit sponsors such as Apollo (APO) are funding themselves via the Federal Home Loan Banks. APO insurance subsidiary Athene, for example, is a member of the Federal Home Loan Bank of Des Moines and, through membership, has issued funding agreements to the FHLB in exchange for cash advances. APO, KKR & Co (KKR) , Brookfield (BN) and Blackstone (BX) have acquired insurers. OWL also has a relationship with an insurer as do many other private credit sponsors and managers. You'll be hearing more about private credit shops and the FHLBs in future issues of The IRA . The selloff in technology stocks and related names continued this week, even after Nvidia (NVDA)  reported upbeat earnings. The leading chipmaker gave a first-quarter outlook that easily beat the average analyst estimate and delivered a 73% surge in fourth-quarter revenue, but no matter. As we predicted last year, the bloom now seems to be off the rose for any stock related to AI. FS KKR Capital Corp. (FSK)  announced financial results for the fourth quarter and full year ended December 31, 2025, reporting results that fell short of Wall Street expectations and included a dividend cut.  FSK reported a $114 million ($0.41 per share) loss for the quarter and a ~30% cut from the previous $0.70 common stock dividend.  United Wholesale, Rocket Report United Wholesale Mortgage (UWMC)  reported solid volumes for Q4, but then spooked the market by not taking questions from investors after releasing earnings. The change in routine by UWMC CEO Matt Ishbia , who normally loves to take questions from analysts, caught investors off guard and the stock fell sharply.  The market-volume leading company guided to slightly lower Q/Q revenue in Q1 on the heels of its material acquisition announcement of Two Harbors (TWO) . Big question: Will TWO shareholders approve the deal with UWMC, especially with the acquirer's shares falling? As of Q1 2026, TWO book value per share is ~ $11.13.  Based on exchange rate and current trading price, investors will get around $9.00 per share in UWMC stock. What a deal.  By comparison, on of our favorite portfolio holdings, Annaly Capital Management (NLY) , reported strong fourth-quarter 2025 results on January 28, 2026, exceeding analyst expectations for both earnings and revenue.  Like many stocks, NLY sold off after earnings were released, but is still trading at a 10% premium to book value vs a 20% premium at the end of 2025.  And finally, Rocket Companies (RKT) beat Street estimates for revenue and net income , ending a transformational year that included the purchase of Redfin and Mr. Cooper. The stock jumped on the positive news after the close yesterday and confirms RKT as the clear leader of the residential mortgage sector. "Rocket proved itself this quarter as a category of one," said Varun Krishna , CEO and Director of Rocket Companies. "This is the power of an integrated homeownership ecosystem - massive top of funnel, scaled origination-servicing recapture, expansive distribution for industry professionals and a technologically advanced foundation for infinite capacity - built for the AI era. We exceeded guidance in a quarter that closed out a transformational year. I'm so proud of how the Rocket, Mr. Cooper, and Redfin teams executed together." "Bottom Line: The stock is our favorite way to position for an acceleration in overall housing activity, backed by the thematic catalyst of leveraging proprietary technology..." writes Eric Hagen if BTIG . "We're especially bullish around management's guidance for the $500 million of guided synergies from the COOP merger to get realized 6-12 months ahead of schedule, which is mostly the result of effectively pruning the servicing portfolio now that it's fully integrated onto a single tech platform. The stock has pulled back 20% from the 52-week high in mid-January, though we attribute much of the correction to negative read-throughs from other lenders..." Mortgage Rates Fall Our latest column in National Mortgage News  on Federal Reserve Board Vice Chairman Miki Bowman's Basel III proposal to reduce capital requirements for bank investments in mortgage loans and servicing assets is below. https://www.nationalmortgagenews.com/opinion/basel-proposal-helps-banks-but-changes-little We appreciate the feedback we received from our colleagues in the industry. Our background note on the history of Basel III is here (" Miki Bowman Pushes Back on Basel III & Residential Mortgages "). The good news about housing finance, of course, is that the average for 30-year fixed rate mortgages dipped below 6% this week, although more aggressive lenders have been below 6% for some time. Remember, lenders set mortgage rates on loans, markets set the yield on bonds and mortgage-backed securities.  We expect short-term interest rates to move lower over the course of 2026, but mortgage rates are priced off of the 10-year Treasury and may be a good bit more volatile.  We are arranging a new 30-year mortgage for a home purchase in FL and we do not intend the price the loan until late April. Silver Market Continues to Tighten Last but not least, we note again that supply problems in the silver market are threatening the market position of both the COMEX and the London Base Metals Exchange (LBME). The tightness of the physical market for silver and the rapidly eroding confidence in the pricing of the two main western exchanges suggests that a seismic shift is underway in the global market for silver. "India's markets regulator on Thursday directed mutual funds to use domestic stock exchange spot prices to value their physical gold and silver holdings from April 1, 2026," Reuters reports . "The Securities and Exchange Board of India (SEBI) said mutual funds may now use polled spot prices from recognized stock exchanges that settle physically delivered gold and silver derivatives contracts, ensuring that valuations reflect domestic market conditions." 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.

February 23, 2026  | The equity of many banks traded off in January following Q4 2025 earnings. The earnings were not bad by any means, but some investors seemingly decided to take profits after a remarkable run in banks stocks going back to last October.  Citigroup (C) remains the best performer of the top five depositories, but there seems to be more risk than reward in large banks presently. The prospect of additional interest rate cuts were the main catalyst for the secular move higher in financials in Q4, but as we like to remind readers, relative spreads are the driver for bank profits, not interest rates. Well-managed banks should make money regardless of interest rates, but a flat yield curve with relatively small differences in rates between the long and short tenors can hurt profits. Banks fund off short-term rates and lend or invest off the longer term. Twos to Tens Back in 2023, the key Treasury market benchmark of the 10-year note minus the 2-year note was negative, shown in the chart above from Fred. This reflected the tight policy of the Federal Open Market Committee. Whereas 2s to 10s were 1.5% back in 2021 during the last part of quantitative easing, today the spread is just over half a point, reflecting a less attractive interest rates environment for banks, REITs and other financial institutions that profit from leverage.

August 14, 2017 | In this issue of The Institutional Risk Analyst, we speak to George Gleason, II, Chairman and CEO of Bank of the Ozarks (NASDAQ:OZRK). Since acquiring a controlling stake in the bank in 1979, Gleason has built the $20 billion total assets institution into a regional powerhouse with over 250 offices in 9 states and a national commercial lending business. As we noted in our discussion with John Kanas of BankUnited , short-sellers have lost a lot of money betting against Gleason and his team at OZRK. The IRA: George, you have been running OZRK for almost four decades in some of the fastest growing areas of the US. Looking back over that period, how have things changed for the bank and the regions that you serve? Gleason: At the risk of sounding like Charles Dickens, I would say that everything has changed, and nothing has changed at all. In my 38-year career, the pendulum has swung from Paul Volker pushing the fed funds target rate over 20% to Ben Bernanke pushing it to almost zero. The seemingly inexorable trend of suburbanization has given way to a massive trend of re-urbanization. Technology has evolved rapidly with a rate of acceleration that seemingly increases every day. The changes are almost unlimited, but at the outset of my first day on the job 38 years ago, I articulated to our staff the principles of pursuing excellence in everything we do, always striving to be the best we can be, improving every day, working hard and adhering to the highest standards of ethics, integrity and fair dealing. Those values and principles have not changed. Whatever success we have had is attributable to our dual abilities to rapidly evolve with the constantly changing macro environment, while relentlessly holding true to the core principles and values that define our bank. The IRA: OZRK is known for being aggressive when it comes to commercial real estate lending, but also for excellence when it comes to managing credit. Of the bank’s $15 billion or so in total loans, $12 billion is in real estate. Looking back over the past three decades, OZRK has reported loan losses that are significantly below its peers. How have you been able to manage the bank so impressively including through the financial crisis? Gleason: The word “aggressive” is often used to describe our real estate business, and I don’t think that is accurate. I view us as “very active” in the real estate space, but very conservative. Real Estate Specialties Group (RESG), our large real estate group, does business across the nation with many of the best sponsors on many of the best properties on extremely conservative terms. At June 30, 2017, assuming every loan in the group was fully advanced, our weighted average loan-to-cost would be about 49% and our weighted average loan-to-value would be about 42%. We are extremely conservative, approving a mid to low single digit percentage of the loans we see. Because of our expertise in CRE and the value we bring to our clients, we see a huge volume of business and that allows us to be very selective. The IRA: Looking at some of the bank’s credit and performance metrics, you have above-average asset returns and margins, excellent operating efficiency, and a default rate that is a half a standard deviation below your asset peers. Your loan book also has a very short duration, less than three years and again well-below peer. Finally, your level of unused credit lines is above peer. How did you come to formulate this remarkable business model? Gleason: We are fortunate to have been among the best performers in the industry year after year for many years. The explanation for that performance is not simple. It is not just the CEO or the head of this unit or that unit or a few great strategies. It is a result of hundreds of skilled and highly motivated people working hard, as a team, in a constant pursuit of doing a better job today than yesterday – always striving to get better. It also has a lot to do with our mission to be the best bank in the eyes of four competing constituencies with very different goals – our customers, shareholders, employees and regulators. Simultaneously making all four of those competing interests view our bank as the “best bank” is like putting a twin fitted sheet on a king bed. They have very different interests, but solving that complex equation of reconciling those competing interests is exactly the goal we vigorously pursue every day! The IRA: Last year seemed to be a peak in terms of bank lending, both for C&I and CRE exposures. How do you see your local markets and also the national CRE market where OZRK is one of the most prominent players? Gleason: We feel good about the current environment. After the Great Recession, there were a few years where new CRE supply did not keep pace with demand growth, and that was followed by a few years where a robust level of construction occurred due to the pent-up demand. Today in most markets, submarkets and micro-markets, supply and demand is pretty much in balance for most product types. There are of course exceptions both ways, but most markets are exhibiting reasonably healthy conditions. New construction in certain markets and product types continues to be justified by population growth, household formation, job growth, changing demographics and other such trends. You just have to do your supply/demand homework on each project and make sure that the demand is going to be there to justify the new supply. Working with intelligent and discerning sponsors helps in that regard, as it means two of us are very critically and thoughtfully looking at the supply/demand metrics. The IRA: Given the bank’s consistent financial performance, you trade at a premium valuation of almost 2x book value and have 80% institutional ownership. Yet there is a certain constituency on Wall Street that seems bound and determined to short OZRK’s stock. Do you think that these pessimistic souls actually understand the bank’s business or are they simply looking at the real estate exposure? Gleason: No, I don’t think they understand our business. My guess is that they screened for banks with a high growth rate and high levels of CRE. Their dual assumptions are probably that CRE is bad and all CRE is more or less the same. That is silly. First, we see great CRE opportunities and we see bad CRE opportunities every day. Our track record over several decades suggests we are good at knowing which is which. Second, at 49% LTC and 42% LTV our RESG CRE exposure has a massively different risk profile than some other banks’ CRE portfolios at 75% or 80% LTV. The IRA: The US economy has been through five extraordinary years of Fed monetary policy where our central bank has deliberately manipulated credit spreads. How concerned are you about the impact of the Fed’s action distorting asset prices in sectors such as commercial real estate? Gleason: It has been a fascinating time to be either a commercial banker or a central banker! You probably recall that even before the official arbiters announced that the Great Recession was in fact a recession; people were all abuzz about what shape the recovery would be. Would it be “U” shaped, or “V” shaped or whatever? When asked that question back then, I always gave this answer: “The U.S. economy has fallen from a ten story window and is battered and bruised on the sidewalk. The recovery will be the economy crawling down the sidewalk, battered and bloodied, for years to come.” As we expected, it has been a long, slow and erratic path back from the bottom. Understanding that we operate in a very complex global economic and geopolitical environment with a constantly changing array of risks, our bank has become more conservative over the last ten years than ever before. For example, the leverage in our CRE portfolio is about 25 points lower on average than it was a decade ago. That doesn’t mean we have a negative view of the future, it simply means that we want to be prepared no matter what the future holds. Maybe thinking like that, I can keep my job another 38 years! The IRA: OZRK is in the process of shedding its parent holding company to save costs and boost returns. Can you talk about what drove this decision and how the change will impact the bank going forward? Gleason: For many years we did nothing in our holding company that we could not do in the bank. Early this year, I asked myself the question, “Why do we have a holding company?” When I couldn’t answer that question, I started asking others. We began to realize that we were incurring a lot of accounting, administrative and regulatory costs and work for a holding company we weren’t using. I analogized it to paying taxes, insurance and maintenance on a beach house you never visit. We got rid of it. We don’t believe it limits or changes our business strategy at all for many years to come. The IRA: Finally, talk a little about your plans for the bank going forward. You have done a series of acquisitions over the past two decades. What should your investors and customers expect to see in the future? Gleason: Last week some of our directors and a few of our top officers joined me to ring the NASDAQ opening bell to celebrate our 20th anniversary of going public. That sort of thing is not really my cup of tea, but the people at NASDAQ were wonderful and it was a great experience. I told our directors the night before that as we were ringing the bell, I was going to be thinking 1% about the last 20 years and 99% about the next 20 years. And that’s exactly what I was thinking. Our focus is clearly on the future. The IRA: No surprise there, but will we see more acquisitions? Gleason: We expect great organic growth, and some very accretive acquisitions. We are confident that the world in which we operate will continue to rapidly change, and we believe that our unchanging principles and our great people will achieve some remarkable things. I firmly believe that our best years lie ahead! The IRA: Thanks George. 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.

"When we get piled upon one another in large cities, as in Europe, we shall become as corrupt as Europe." Thomas Jefferson August 11, 2017 | When William Clay Ford Jr ., Chairman of Ford Motor Co (F), fired CEO Mark Fields earlier this year, he in part confirmed the view expressed in our book “Ford Men: From Inspiration to Enterprise,” that figuring out which supposed techno trend to believe (and invest in) will be a challenge. After surviving the automotive equivalent of nuclear winter in 2008-2011, Ford and the rest of the auto industry rebounded nicely in terms of sales and profits, peaking last year at 18 million units sold in the US. But beyond next quarter’s financial results, every leader of every major global automaker is worried about one greatly glorified word: mobility. “If there’s one takeaway from Ford ditching Fields,” concludes Wired magazine, “it’s that in our current transportation environment, ‘mobility’ isn’t so much a strategy as it is a euphemism for ‘we have no idea what’s happening next.’” Bill Ford recently told The Wall Street Journal that his company lacks vision , but he’s going to fix it – by bringing in yet another new Ford Man, Jim Hackett. We warned in “Ford Men” that Fields was starting to sound like Jacques Nasser, a view that turned out to be prescient. But Bill Ford’s prattle about vision also sounds like some of his ill-considered comments about safety and the environment of a couple decades ago. For long-term observers of the auto industry, this leadership transition at Ford Motor Co. raises concerns, in part because of what it says about the Blue Oval in a period of technological consolidation. We worry that Ford’s board of directors clearly liked the style of leadership under former CEO Alan Mulally, but still does not fully trust Bill Ford, especially given the widespread confusion over how to deal with the challenge of “mobility.” Alan Murray wrote for Fortune in May 2017: “Mark Fields’ ouster as CEO of Ford yesterday is another example, if anyone needed one, of just how hard it is to lead a company in the midst of disruptive change. The auto industry is actually riding the waves of three separate disruptions, all at the same time: electric engines, ride sharing, and autonomous vehicles. Fields enthusiastically embraced all three, investing in a Silicon Valley research center, becoming a regular at the CES tech fest, and talking of making Ford a ‘mobility company,’ with one foot firmly in the present and one boldly in the future. But shareholders weren’t buying it.” The mainstream auto business is being distracted by a growing number of irrational players and attendant consultants. The most obvious of these is Tesla (NASDAQ:TSLA), the love child of serial entrepreneur Elon Musk, who has spent billions pursuing the dream of an electric car powered by a battery with little hope of generating a profit. TSLA is in the high yield market even now borrowing another couple of billion, funds which will cover well less than a year of the company’s prodigious capital burn rate. TSLA cars are heavily subsidized by US taxpayers and are not especially green either , especially when you consider the manifold inputs needed to make these pricey toys for wealthy car aficionados. There is no question but that DC motors powered by the appropriate generator are the best way to propel a train or a ship, but using batteries to power an automobile is a strikingly retrograde development. As we note in "Ford Men," a century ago Thomas Edison was fascinated by battery powered electric cars, but ultimately advised Henry Ford to use gasoline as a power source. But specific to the idea of mobility, there are a growing number of players outside of the auto industry that have decided to ride a wave of changing consumer preference when it comes to how people use transportation. These new entrants to the world of conveyance include global limousine network Uber, online search engine provider Alphabet (NASDAQ:GOOG) and computer giant Apple (NASDAQ:AAPL). None of these names have any competency in manufacturing cars and trucks, but all are attracted by the relevance and potential audience for mobility worldwide. The tech incursion into the auto sector marks a strategic attack by one industry against another in a contest for consumer attention. Like TSLA, AAPL, GOOG and Uber are not particularly focused on making a profit – thus providing a serious problem for F and other incumbent automakers. The culture of growth that surrounds all of these new economy interlopers does not require profit – only liquidity and, for the profitless, a steady supply of greater fools. This is the economic environment defined by a growing list of money eating global monopolies – Amazon (NASDAQ:AMZN first and foremost -- that are managed for expanding market share rather than operating income and equity returns. Part of the “collateral damage” from the Fed’s zero interest rate policies (referred to by economist Paul McCulley in a past IRA comment ) is that investors how readily accept the idea of deploying capital into big, new ventures with no expectation of income or even the immediate return of principal. GOOG and AAPL spend billions of shareholder cash annually pursuing various speculative notions, while TSLA spends both equity and the proceeds from debt raised with its “B“ junk credit rating. But investors don’t seem to mind. The fact of growth drives valuation ever higher. How does Bill Ford or any sane leader in the auto industry plan strategy when surrounded by seemingly irrational competitors such as these? One of the interesting threads driving the mobility narrative in the auto industry is the idea that everyone is moving into the revived inner cities and fleeing the suburbs. Retailing clearly is in a state of apocalypse, but in part because of a huge surfeit of retail space built with cheap money. The debt placed upon the major retailers and their commercial real estate was “crazy”, to paraphrase retail expert Howard Davidowitz, “built by the lunatic ideas for growth led by Wall Street.” The other factor in the deflationary spiral in commercial real estate for retail is AMZN, which is leading the world in online fulfillment for consumer purchases. But is it really the case that the suburbs are being abandoned? We spent some time with our friends at CoreLogic recently, specifically deputy chief economist Sam Khater, who has done a lot of work on trends in population and pricing for residential housing. No surprise, Sam confirms that house prices in the outer rings around major cities have displayed more weakness than cities. He also notes that prices in the cities and inner suburbs have skyrocketed in recent years. But do these data points necessarily suggest that we are headed for a sharing economy where we’ll never own a car or go to a suburban mall or own a single-family home or travel long distances by car? What Sam’s work does suggest is that prices in the outer rings around major metros are starting to accelerate after years of under-performance. He also identifies some interesting areas of risk for lenders, investors and loan servicers (aka “asset managers”) involved in consumer lending for things like homes, automobiles and other significant credit exposures. The weakness of home price appreciation (HPA) in the outer bands around major cities could support a couple of conclusions: High HPA in cities will intensify the relative attractiveness of the outer suburbs, causing an acceleration of the long-term shift in populations that is already underway. Households with lower incomes and with young children will continue to be attracted to the relatively lower cost and greater living space of suburban housing, but will also face the cost of commuting into the city center for work and to access services. Lower price appreciation in the suburbs means less equity accumulation for home owners and thus higher spatial income inequality compared with inner city households. CoreLogic shows that HPA in outer suburbs is half the rate of cities. Changes in home buyer behavior, such as the shift to a multi-family model in heretofore single family communities, suggests pressure on outer suburban localities in terms of zoning and taxes. Lending to lower income borrowers in urban areas has fallen dramatically since 2008, one side effect of the Dodd-Frank legislation, forcing many potential home owners into rentals. These households are not able to purchase a home, meaning that they will not even be able to participate in the increase in urban home prices. The low income share of suburban home purchases is slowly rising, but still trails the overall rate of lending to all home buyers. For lenders investors and managers, the movement of less affluent populations to the suburbs suggests that the credit profile of these geographies will decline accordingly. To paraphrase Sam: “The credit risk gradient is shifting to the suburbs.” Whether the household is in a home with a mortgage or a rental, the changing demographic of the suburban dweller will be of concern to investors in mortgages and REITs specializing in residential rental properties. And for the car industry? The future is unclear. Bill Ford apparently shot long time Ford Man Mark Fields because of F’s slumping share price vs. aspirational and irrational competitors like TSLA, GOOG and Uber. AMZN will probably get into the mobility game too at some point. But the bigger problem at Ford is that the board of directors still does not have confidence in either Bill Ford or the incumbent management culture. John Baldoni wrote in Forbes : “When a company hires from the outside it is an acknowledgement that things are not working well. What the board is really saying to senior management: “We don’t trust you guys to run the company.’ No matter how you spin it, bringing in a new CEO is a slap in the face to the people already there.” For our money, we think Bill Ford ought to focus on making cars and leave the vision thing to the markets. And Jim Hackett may turn out to be a great CEO, whether he’s got the idea on mobility or not. If Ford and the other automakers listen carefully (and ignore the consultants), their customers will inevitably tell them what type of mobility solution is required for their needs. Those families rotating out to the suburbs will all need wheels, whether powered by gasoline, hybrids or batteries, private car or public transportation. But for investors focused on housing, no matter how you cut it, the dramatic trends in HPA and demographics already suggest big changes in the years ahead. The wall of hot money created by the Fed has so inflated urban commercial real estate values from London to New York to Hong Kong that the repricing of housing is likely to drive many low income households out the cities for good , what one activist likens to “ethnic cleansing.” Mobility, at the end of the day, is a trend that favors the most affluent members of our society. #Ford #GOOG #Tesla #mobility #housing #retail #ZeroHedge #AAPL

"It is not down in any map; true places never are." Moby Dick Herman Melville August 7, 2017 | News reports that prosecutors have dropped their case against Bruno Iksil, the former JPMorgan (NYSE:JPM) trader many know as the “London Whale,” comes as no surprise to readers of The IRA . Iksil, who resurfaced earlier this year , has been living in relative seclusion in France for the past few years. In previous comments posted on Zero Hedge , we dispensed with the notion that the investment activities of Iksil and the office of the JPM Chief Investment Officer were either illegal or concealed from the bank’s senior management. The fact is that Iksil and his colleagues at JPM were doing their jobs, namely generating investment gains for the bank. The outsized bets made by the “whale” in credit derivatives contracts resulted in a loss in 2012, but the operation generated significant profits for JPM in earlier years. As veteran risk manager Nom de Plumber told us in Zero Hedge in 2012: “This JPM loss, whether $2BLN or even $5BLN, is modest in both absolute and relative terms, versus its overall profitability and capital base, and especially against the far greater losses at other institutions. In practical current terms, the hit resembles a rounding error, not a stomach punch. As either taxpayers or long-term JPM investors, we should be more grateful than sorry about the JPM CIO Ina Drew. If only other institutions could also do so ‘poorly’………” When JPM and other large banks began to implement the Volcker Rule after the passage of the 2010 Dodd-Frank law, the activities of Iksil and his colleagues in New York began to come to light. Principal trading, which is now outlawed by the Volcker Rule, creates enormous opportunities – and conflicts -- for banks that act both as traders and lenders. We wrote in ZH in 2012 : “[D]ear friends in the Big Media, it is time to get a collective clue. The real problem with CDS trading by large banks such as JPM is not the speculative positions taken by traders like Bruno Iksil, but instead the vast conflict of interest between the lending side of the house and the trading side, whether the trader is on the arb desk or, in the case of Iksil, working for the CIO trading for the bank’s treasury.” When caught in the act, the bank naturally cast Iksil’s activities as being somehow illicit and against company policy. But in fact his trading activities had been understood, blessed and even directed by the JPM’s senior management going back years. Far from being a hedge for other exposures of the bank, in fact the strategy of the CIO’s office was to generate returns as the bank’s internal hedge fund. When as early as 2010 discussions reportedly occurred about “hedging” Iksil’s illiquid credit derivative positions, presumably those involved understood that this was a risk position taken as part of a deliberate investment strategy. That Iksil apparently believed that he could not be bullied by other counterparties because of the fact of trading for JPM speaks to how he viewed his activities, which were entirely visible to other market participants. The JPM CIO’s office under Ina Drew ran an active trading strategy, making markets around positions on a continuous basis to provide live valuations and generate short-term returns. The fact that big banks no longer trade their investment books illustrates the diminution of liquidity that has occurred since the adoption of the Volcker Rule. But for the banks, the legacy of the London Whale and the larger implementation of Dodd-Frank has left a deep mark on risk managers and those concerned with maintaining internal systems and controls at large banks. But now Iksil has accused JPM's Chief Executive James Dimon of laying the ground for what was eventually a $6.2 billion loss, Reuters reports . In an account on his website , Iksil also blames senior executives at the bank for the investment strategies that led to those losses. Iksil’s account now sounds an awful lot like what we heard from his former colleagues in New York some six years ago. At the time, JPM’s counsel had already mandated the elimination of the managers and traders in the CIO’s area as part of implementing the Volcker Rule, leading to a number of redundancies in New York. We know about the Whale because of the implementation of the Volcker Rule. But the key event that broke the scandal open was the public statement by Dimon, this in response to persistent press queries from The Wall Street Journal and Bloomberg News , that the rumors of losses in the CIO’s office were “a tempest in a teapot.” But for the public statement by Dimon, which required additional clarification and disclosure, the activities of the CIO that might otherwise have been dealt with in the fine print of JPM’s earnings release. Instead, JPM was forced to not only enhance disclosure of the CIO’s trading results, but then went through a firestorm of congressional hearings, regulatory questions and litigation that continues to this day. We recall sitting in the analyst presentation at JPM’s HQ dealing with the London Whale as Ken Langone glared at the assembled audience of Sell Side analysts. In his congressional testimony, Dimon attributes the bank’s loss to a modeling error, but in fact the exposure was simply ignored. Notice that at no point has the financial media or regulators questioned the company line about what actually happened and when. Iksil’s statements seem to take us back down that road and, specifically, to suggest that senior management at JPM was actively aware of the strategies taken by the CIOs office years before the big losses occurred. Our old pal Nom de Plumber commented over the weekend: “In the end, the London Whale disaster reflected the mis-marking of generic Index CDS trades, which then-CFO Doug Braunstein ignored. The problem was not complex risk modeling or market risk measurement. The quants tried to re-jigger VaR measurement of the trades, to avoid breaching risk limits-----for CIO trades which Jamie specifically demanded of Ina Drew......regardless of preceding protests from risk managers like John Hogan and Robert Rupp.” Nom de Plumber tells The IRA that Ina Drew was essentially running a hedge fund directed by Dimon and other senior managers, a fund that was largely kept outside of the bank’s risk management and reporting procedures. Consider the bizarre situation in 2011-2012 when counterparties of Iksil facing the JPM commercial bank were unable to make margin calls, but the JPM investment bank was making margin calls on these same counterparties for positions in the very same indexed credit derivatives. Bruno Iksil has waited for the proverbial concrete to harden over the past few years before coming forward with his latest accusations. This makes it difficult or impossible for Dimon and his lieutenants to change their story now. It will be very interesting indeed to see if anyone from the financial media or even the regulatory community picks up the new trail illuminated by Iksil’s statements. The episode involving the London Whale illustrates how difficult it is to learn the truth about the inner working of large banks. Big banks profit by exploiting information and conflicts found between the world of credit and the world of securities. Indeed, the CIO's office generated big returns for JPM over the decade or so that Iksil was with the bank. But the London Whale episode also shows in graphic terms why the Volcker Rule prohibitions against banks trading for their own account need to be preserved and strengthened. There is a fundamental conflict between a bank acting as a lender and trading credit derivatives. More, if the CEO of a bank – any bank – can short circuit the internal controls of his institution in order to enhance returns with a bet at the credit derivative roulette table, then by definition that bank cannot be safe and sound. Further Reading Long and the Short of JPMorgan http://www.zerohedge.com/contributed/2012-19-11/long-and-short-jpmorgan JPMorgan: What's the Fuss? http://www.zerohedge.com/contributed/2012-20-15/jpmorgan-whats-fuss Bruno Iksil, JPMorgan and the Real Conflict with Credit Default Swaps http://www.zerohedge.com/contributed/2012-15-11/bruno-iksil-jpmorgan-and-real-conflict-credit-default-swaps 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.

“While the US and the UK have been mired in political chaos this year, the EU has enjoyed improved economic conditions and some political windfalls. The question now is whether this good news will inspire long-needed EU and eurozone reforms, or merely fuel complacency – and thus set the stage for another crisis down the road.” Philippe Legrain Project Syndicate July 31, 2017 | This week The Institutional Risk Analyst takes a look a the recent reports out of the EU regarding a proposal to “freeze” the retail accounts of failing European banks. The original story in Reuters suggests that our friends in Europe actually think that telling the public that they will not have access to their funds, even funds covered by official deposit insurance schemes, is somehow helpful to addressing Europe’s troubled banking system. Investors who think that Europe is close to adopting an effective approach to dealing with failing banks may want to think again. Judging by the reaction to the story by investors and on social media, it appears that the EU has learned nothing about managing public confidence when it comes to the banking sector. In particular, the idea that the banking public – who generally fall well-below the maximum deposit insurance limit – would ever be denied access to cash virtually ensues that deposit runs and wider contagion will occur in Europe next time a depository institution gets into trouble. “The plan, if agreed, would contrast with legislative proposals made by the European Commission in November that aimed to strengthen supervisors' powers to suspend withdrawals,” Reuters reports, “but excluded from the moratorium insured depositors, which under EU rules are those below 100,000 euros ($117,000). While some Wall Street analysts are encouraging investors to jump into EU bank stocks, the fact is that there remains nearly €1 trillion in bad loans within the European banking system. This represents 6.7% of the EU economy, according to a report and action plan considered by EU finance ministers earlier this month. That compares with non-performing loans (NPL) ratios in the US and Japan of 1.7 per cent and 1.6 per cent of gross domestic product, respectively. But the most basic point to make about the proposal for a “temporary” suspension of access to cash is that such moves never work. Moratoria are part of the banking laws in Germany and many other European nations, but they are never used because once invoked the institution is dead for all practical purposes. In Spain, for example, the government had the power to impose a temporary suspension of access to deposits in the case of Banco Popular, but did not do so because it would have killed the franchise. Jochen Sanio, the former president of the German Federal Financial Supervisory Authority (BaFin), commented about banks subject to “temporary” deposit moratoria that “they never come back.” Sanio, who guided Germany through the 2008 financial crisis and forced the clean-up of insolvent state-owned banks, was retired and gagged for the rest of his life for challenging Germany’s corrupt political status quo of covert bailouts. So again, one has to wonder, why any responsible official in Europe would support the plan reported by Reuters . As the US learned the hard way in the 1930s and with the S&L crisis in the 1980s, the lack of a robust national deposit insurance function to protect retail depositors leaves an entire society vulnerable to banks runs and debt deflation. Until the EU is prepared to do “whatever is necessary,” to paraphrase ECB chief Mario Draghi, in order to protect retail bank depositors, the EU will remain far from being a united political economy. Readers of The IRA may recall the comments of German Chancellor Angela Merkel last Fall, when she suggested that the German government would not support Deutsche Bank AG (NYSE:DB) in the event that the institution got into financial trouble. At the time, DB was trading at about $12 per share in New York. We spoke about DB and the ill-considered comments made by US and German officials from Dublin on CNBC on September 30th. At the time, we reminded investors that political officials should never talk about a depository institution while it is still open for business. This is a basic, well-recognized rule that has been followed by prudential regulators around the world for many years. Yet because of the popular political pressures on elected officials such as Merkel, the temptation to engage in absurd hyperbole with respect to big banks is irresistible. We see this latest piece of news out of Europe as further evidence that there is still no political consensus about how to deal with troubled banks. As we learned last year, Merkel could not even make positive public comments about DB for fear of committing political suicide. The more recent bank resolutions in Spain and Italy were made to look like touch measures in public terms, even as the Rome government quietly subsidized the senior creditors of two failed banks in the Veneto. We noted in an earlier comment, “Fade the Great Rotation into Europe,” that the EU pretends to play tough on bank rules while bailing out the senior creditors: “Of note, Italy is being given control over the remaining ‘bad bank’ to wind down as the assets and deposits are conveyed to Intesa SanPaolo. This permits a bailout of senior unsecured creditors. So Italy gets what it wants – continued circumvention of EU bailout rules. If a bank disappears, notes a well-placed EU observer, ‘state aid rules do not apply.’” The Europeans appear to be playing a very dangerous game. On the one hand, EU officials talk publicly about getting tough on insolvent banks and even suspending access to funds for retail depositors. On the other hand, EU governments are continuing to bail out banks and large creditors in a display of cronyism and business as usual. “Under the plan discussed by EU states, pay-outs could be suspended for five working days and the block could be extended to a maximum of 20 days in exceptional circumstances,” Reuters reports. “Existing EU rules allow a two-day suspension of some payouts by failing banks, but the moratorium does not include deposits.” Contrast the EU proposal with standard practice in the US, where the Federal Deposit Insurance Corporation (“FDIC”) begins to market troubled banks before they fail and tries to execute bank closures and sales on a Friday to avoid frightening the public. The branches of the failed bank then open on the following business day as part of a solvent institution without any interruption in customer access to funds. Importantly, all insured depositors, as well as brokered deposits and advances from the Federal Home Loan Banks, are always paid out by the FDIC when the failed bank is closed in order to avoid precipitating runs on other institutions. In Europe, on the other hand, there appear to be a significant number of officials who seriously believe that denying retail bank customers access to funds covered by deposit insurance will not result in financial contagion. If such a proposal is adopted, the sort of bank runs seen in Cyprus and Greece could intensify and spread to the major countries in Europe. Imagine that a large bank failure occurs in Italy next year and Italian officials tell retail customers that they will not have access to any funds for several weeks. As we saw in 2012 in Spain and Cyprus and 2015 in Greece, retail bank runs tend to spill over into other countries and markets, creating a situation where fear takes over from rational behavior. The trouble is, Chancellor Merkel cannot commit Germany to supporting an EU accord to support the banks in the Eurozone without ending her political career. “If capital flight from the peripheral economies gathers pace, it could trigger runs on entire banking systems,” notes the infamous “Plan B” memo prepared for Merkel in 2012. “That would put the ECB—and thus, indirectly, the Bundesbank and Germany—on the hook for deposits worth trillions of euros.” In the dark days of 2012, Merkel’s government prepared for “Plan B” and was essentially ready to allow the weaker nations on the EU’s periphery – including Spain, Greece, Italy and Ireland -- to fail and drop out of euro as Germany withdrew to a core group of nations. Just as the EU still refuses to deal with Greece’s mounting debt, likewise it cannot seem to accept that protecting the small depositors of European banks is the price to be paid for preserving social order and the EU itself. Otmar Issing, former Chief Economist and Member of the Board of the European Central Bank and the German Bundesbank, summarizes the situation: “The euro crisis is not over.” 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.

“I came of age on Wall Street when the Chairman of the Federal Reserve Board—he was William McChesney Martin—condemned even trace amounts of inflation as an economic and moral evil. In the interval of 1960-65, there was not one year in which the CPI registered a year over year rise of as much as 2%.” Grant’s Interest Rate Observer July 26, 2017 | BTW, below is my latest comment on housing finance reform in American Banker , “Fannie, Freddie are irrelevant to a government-backed mortgage system.” I'll be participating at the CoreLogic Risk Summit next week in Dana Point. Come say hello! We’ve all heard of fake news, but consider the growing possibility of fake or at least virtual assets. Investors face a deliberately orchestrated shortage of real investments c/o global central banks in markets such as stocks and real estate. Is there any wonder that the financial engineers of Wall Street have again begun to manufacture new derivatives leveraging the real world? Case in point, bitcoin. The most recognized “digital currency,” bitcoin is a form of high-tech gaming instrument that fulfills just one of the traditional roles of money, but is among the world’s fastest appreciating – and most volatile-- “asset" classes. Adherents call the limited supply of bitcoin the ultimate expression of Milton Friedman style monetarist discipline. They view the digital medium as a rational response to the fiscal and monetary chaos visible in most of the industrial nations. But despite the huge gains seen in bitcoin vs conventional currencies, Jim Rickards says he’s sticking with his preferred investments: gold, cash and silver. “I don’t own any bitcoin, but for those who have a preference for bitcoin, good luck,” he told Kitco News . Bitcoin has been blessed by a federal regulatory agency in Washington. “On Monday, a bitcoin options exchange called LedgerX won approval from the Commodity Futures Trading Commission to clear bitcoin options, making it the first U.S. federally regulated platform of its kind,” reports The Wall Street Journal . LedgerX’s chief executive Paul Chou is on the CFTC’s Technology Advisory Committee. Not surprisingly, a CFTC spokeswoman said “no committee, including the Technology Advisory Committee, plays any role in any registration decision.” OK. Regardless of whether you view bitcoin as an investment or the electronic version of tulip bulbs, the fact of a traded options contract is intriguing. It allows speculators to take a flutter on bitcoin without actually touching the ersatz currency or the varied folk who are said to traffic in this ethereal world. To be fair, drug dealers, terrorists and members of organized crime organizations in nations like China, Russia and North Korea are not ideal counterparties for a US bank or fund. But a US traded option contract may allow you to play the bitcoin game, pay your taxes, and sleep at night. A lot of managers may find that degree of separation attractive. Of note, less than 24 hours after the CFTC announcement, the Securities and Exchange Commission has declared that “tokens” such as bitcoin can be considered securities, and therefore, may be need to be registered unless a valid exemption applies,” Reuters reports. "The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets," said Stephanie Avakian, the co-director of the SEC's enforcement division. Part of the “problem” with bitcoin is that it is not easy for an individual to move in and out of the stateless, “offshore” market. It will be interesting to see which financial institutions are willing to provide the infrastructure to allow a bitcoin options contract to settle in dollars and in size large enough to satiate institutional players. But the more interesting question is how investors will deploy capital in this volatile and entirely opaque market. The idea of an option on bitcoin certainly seems to have some utility. Bitcoin may not be a store of value or a unit of account, but it serves that same purpose as the dollar in terms of acting as a means of exchange. Like the dollar, bitcoin promises to pay, well, nothing, so the two moneys have rough equivalence in that regard. Our guess is that a successful launch of the bitcoin option contract could significantly increase cash trading volumes, which will manifest in higher value vs traditional currencies. But the real issue is how to gauge the ebb and flow of demand for the bitcoin tokens. A large portion of the “float” in bitcoin cannot trade because the “owners” have lost their ID numbers, thus measuring how much supply is available to meet a given amount of demand is a challenge. Additional bitcoin cannot be issued beyond the 21 million limit of the system, although the coins can be subdivided. In the short run, the only variable that can change with demand is the spot price. Also, high and sometimes variable settlement costs add to the complexity of trading bitcoin. In many respects, a conventional option contract may be significantly more efficient than the cash market for bitcoin driven by the clunky blockchain technology. While the news of the CFTC’s approval of the bitcoin options contracts may turn out to be good news for the digital currency, please note that our dim view of the blockchain clearing technology that enables bitcoin has not changed. The Journal reports that CFTC Acting Chairman Christopher Giancarlo states publicly that he’s optimistic about blockchain technology’s future. We’d like to see him explain why, paying specific attention to operational efficiency and cost. A derivative contract on a derivative digital currency has a lot more promise that the technological dead end known as blockchain. To date, we have yet to see a single commercial application of what people call “blockchain” that has real commercial potential. The same robust and expensive encryption technology that helps the bitcoin market ward off attempts at manipulation also makes blockchain unsuitable for other business uses. As Saifedean Ammous wrote in American Banker last year : "[D]espite banks' attempts to test and use blockchain technology for their own commercial gain, it is outside the realm of possibility for the technology to serve any useful purpose for the intermediaries it was designed to replace. That is akin to burdening horses with engines in the name of technological innovation: the approach would only slow down the horse and alleviate none of its problems. Such a ridiculous notion will find no real world demand." In simple terms, blockchain is just a form of industrial grade encryption tied to a bulletin board for the public portion of the keys. When it comes to clearing options contracts, the existing centralized technology solutions are far more attractive in terms of speed and cost. Indeed, it will be interesting to see how LedgerX manages delivery of bitcoin as contracts expire or whether it will require cash settlement, as is customary with gaming instruments. So let’s keep our eyes on this bitcoin options contract. It promises to expose a far greater number of investors to this global gaming instrument. We suspect that the SEC is right when they refer to them as tokens, albeit ones that can only be settled electronically. If bitcoin are eventually determined to be securities by the SEC, however, it both validates and changes the market forever. With recognition comes regulation and reporting. What the success of bitcoin says about the world of dollars, euros and yen is unsettling at a number of levels, but then again, bitcoin is ultimately just a brilliantly designed virtual market that, initially at least, promised security and anonymity. Whether those qualities can endure as the audience grows is a very intriguing question that investors need to consider. 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 18, 2017 | Earlier this week we appeared on CNBC’s “Squawk Box” to talk about bank earnings and the Fed. The results from the top-four banks – Bank America (NYSE:BAC), JPMorgan (NYSE:JPM), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) – are really no surprise to readers of The IRA . The largest banks all beat small on revenue and earnings, but showed weakness on fixed income and the mortgage banking lines. We suspect that there will be even more pain on the mortgage banking line for WFC, JPM and BAC next quarter. As we told Andrew Ross Sorkin, bank stocks have essentially been going sideways since February and are likely to continue side-stepping because most of the large cap names are fully valued after the Trump Bump. But the biggest obstacle to rising bank stock valuations is the Federal Reserve System’s policies of low rates and open market purchases of debt. At the Fed of New York back in the 1980s, one and a quarter times book was seen as the natural limit for bank valuations. Have a look at our previous note if you have any questions on the particulars. Suffice to say that 1x book value for BAC is about right given the bank’s asset and equity returns, and the state of the credit markets. Tight credit spreads make life tough for all but the best run banks. When we suggested US Bancorp (NASDAQ:USB) to Squawk Box as our favorite large cap, that was because of the operational excellence as opposed to the stock price, which trades above 2x book value. But the more interesting question from CNBC's Andrew Sorkin had to do with the choice of the next Fed Chairman. News reports suggest that White House chief of staff Gary Cohn is the leading contender to take over from Fed Chair Janet Yellen. We would welcome Cohn’s appointment not because he is an alumnus of Goldman Sachs (NYSE:GS), but because he understands financial markets and is not a PhD economist. For too long the Fed’s internal deliberations have been dominated by academic economists who do not understand the real world impact of monetary mechanics much less the workings of the financial markets. Having Cohn and other non-economists on the Federal Open Market Committee would be a welcome change that would support economic growth by encouraging investment. During our trip last week to Jackson Hole, we had the pleasure of hearing from Paul McCulley, an American economist and former managing director at PIMCO who is now teaching at Cornell. Paul is an articulate and unabashed advocated of neo-Keynesian economics (aka “socialism”). He is noted for authoring such memorable phrases as “shadow banking” and “Minski Moments.” Like most of the members of the FOMC, Paul believes that additional deficit spending was the proper response to the financial crisis of 2008. And like Chair Yellen, he apparently thinks that the fact that Congress refused to ratchet up public spending five years ago was a sufficient excuse for the unelected central bankers to “do something” in their stead in the form of near-zero interest rates and, more important, quantitative easing or “QE.” Paul explicitly equates democracy and socialism, believing that people of modest means will always vote for the smiling bureaucrat offering a bag of free groceries or subsidized health care. He also says that the Fed has too much independence and should coordinate its actions with fiscal policy. To his credit, McCulley at least concedes that while QE was the right policy "there is collateral damage.” There are two basic problems with the pro-fiscal spending argument of liberal economists. First, it is pretty clear from the literature that deficit spending does not produce any benefit in terms of increased consumer spending or jobs. For decades, American policy makers have been pulling tomorrow’s sales into today by using cheaper credit, but the efficacy of such policies has been pretty much exhausted. Some even believe rising public deficits choke off growth. The second and more important issue is that Congress has shown itself to be completely incapable of restraining spending during good times to balance off Keynesian stimulus during slack times. Keynes was no apologist for debt and explicitly assumed that government would in good times promptly repay debt incurred to fund public spending. Today repayment of public debt is never even discussed. Davidson (2003), for example, notes that Keynes believed that government should always maintain a balanced operating budget. When considering the arguments of economists such as McCulley and others who advocate increased federal deficits, the only conclusion possible is that they implicitly are taking us down the road to eventual debt default and hyperinflation. Since they never once suggest that the debt incurred to fund deficit spending should be repaid in kind, as Keynes would have insisted, the only reasonable scenario would be for the FOMC to eventually make QE a permanent feature of the American political economy. In such a scenario where the FOMC explicitly and continuously suppresses interest rates and credit spreads, and monetizes the Federal debt with open market purchases, private sector entities such as banks, companies and pension funds soon will become superfluous. Quaint notions about private property and free enterprise would be discarded in favor of a “single payer” model for the entire US economy – namely the Fed. The free market capitalism of the US would mutate into something that looks a lot like the state-directed economy of Communist China. Fortunately there still are enough Americans who understand the fallacy of the neo-Keynesian socialist model. The path to making America “great again” has nothing to do with who is in the White House, but a great deal to do with who occupies those seven seats on the Federal Reserve Board. In particular, we need a Fed Chairman and governors who are not afraid to say “no” to the fiscal profligacy in Washington. Rather than facilitating the issuance of public and private debt as the FOMC has done under Yellen, the US central bank needs to become an advocate for savers and private investment, and a vocal critic of the dissolute fiscal policies of the Congress. The members of the FOMC need to appreciate that the polices followed by Chair Yellen and the FOMC after QE1 (which re-liquefied the US banking system) were detrimental to job growth and economic expansion. Subsidizing public and private debtors at the expense of savers is no formula for private sector economic growth and job creation. For example, the folks on the FOMC don’t seem to understand that low interest rates and artificially tight credit spreads retard private business investment and advances in productivity. Since 2012 when the Fed started QE, public companies have eschewed new investment – and instead bought back trillions of dollars worth of stock financed with debt. As Ben Hunt wrote in his blog Epsilon Theory : “In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory. That’s the real world impact I’m talking about, the world of wages and output and productivity. You know, the real world that used to be the touchstone of our markets.” We told Andrew Ross Sorkin today that we like the idea of Gary Cohn as Fed Chairman because he would normalize monetary policy. We like the idea of JPM CEO Jamie Dimon running for President in 2020 even better. Based upon on his recent public comments, Dimon seems to be interested: ““And you know at one point we all have to get our act together [so that] we will do what we’re supposed to do [for] the average Americans.” Ditto Jamie. America hungers for credible leadership that can truly foster a positive environment for the US economy to grow and create opportunities for our people. The markets were hopeful that Donald Trump would provide that leadership, but this hope has been dashed. If Cohn takes the job as Fed Chairman, that is a pretty good sign that the former GS partner has given up on Trump and is looking for his next challenge. But that could be the most bullish signal investors see coming from Washington this year. 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 13, 2017 | In this issue of The Institutional Risk Analyst , we take a prospective look at Q2 2107 earnings for the large cap banks in the financial services sector. By way of disclosure, we don’t own any banks. Our direct exposure to financials is in fintech and in just two names – Square (NYSE:SQ) and PayPal (NASDAQ:PYPL). More on these names in a future issue of The IRA. The larger US banks experienced a mini bull rush following the most recent stress tests conducted by the Fed and other prudential regulators. The good news is that the banks have too much capital. The bad news is that, well, the largest banks have too little business to support revenue and earnings, leading to the obvious conclusion that share buybacks must go up. First, looking at the best valued of the large banks, let’s consider US Bancorp (NYSE:USB). With an “A+” bank stress index rating from Total Bank Solutions, USB is among the lowest risk large banks in the US. Trading at over 2x book value, the shares of the $440 billion total asset USB are up 2x the S&P 500 over the past year. Needless to say, with a beta of 0.93, this is one large bank stock most hedge funds don’t dare sell short. The Street estimates that USB’s revenue will be up 5% for the full year and earnings up 7% in 2017. Because USB does not depend upon Wall Street investment banking and derivatives activities to make its earnings number, this bank has among the most dependable financial performance of the top five commercial banks by assets. Next we move to Wells Fargo (NYSE:WFC), which like USB is primarily a lender with relatively little (but growing) exposure to Wall Street. Like USB, the $1.7 trillion asset WFC has an “A+” bank stress index rating from Total Bank Solutions. WFC’s equity currently trades a 1.5x book value reflecting the 12% return on equity, but WFC has just a 1% risk-adjusted return on capital (RAROC). The stock has a beta of 1.0, which means that its volatility matches that of the broad market. The Street has WFC growing revenue at less than 3% for 2017 and earnings up almost 4% for the same period, suggesting that cost-cutting and capital returns will be supporting investor expectations. We tend to discount these projections, however, because of WFC’s huge role in the residential mortgage finance sector. As we never tire of reminding our readers, the US housing finance sector is running about 30% below last year’s levels in terms of mortgage loan origination volumes. This sharp drop in new loan volumes is translating into an equal drop in issuance of agency mortgage securities. The result is a vicious scramble for collateral that is driving down profitability in the 1-4 family mortgage sector. Our sources in the mortgage channel say that WFC and JPMorganChase (NYSE:JPM) have been bidding up the price of whole loans in the secondary market in order to fill the shrinking mortgage securitization pipeline. The aggressive bid from WFC and other aggregators is killing margins for everyone in the secondary market. This makes us wonder if the resi sector won’t be the cause of an earnings miss for WFC and other large banks in Q2. Coming off a record low loan origination spread of 8bp in Q1 2017, the mortgage industry faces another difficult quarter. The ten-year average spread compiled by the Mortgage Bankers Association is 51bp, thus the continued drop in profitability has ominous implications for smaller mortgage firms that purchase production from third parties. If you’re a seller of loans, on the other hand, life is pretty good. Big lending and mortgage servicers such as WFC are desperate to buy collateral from third party originators, both to prop up agency securitization volumes and also to forestall eventual shrinkage in the servicing foot print. Also of note, Fred Small at CompassPoint reckons that this quarter banks and non-banks alike could be facing a 5% downward adjustment in the value of our favorite asset, mortgage servicing rights (MSRs). Moving right along to the next most valued mega bank, we turn to JPM. Trading at 1.4x book, JPM is fully valued to put it mildly. With lower asset and equity returns than WFC, to see the House of Morgan trading at these levels suggests to us a good bit of downside risk for the shares – regardless of how many managers want to own the stock. JPM has a beta of 1.2, indicating that the equity market valuation is more volatile than the broad market or asset peers such as WFC. While USB and WFC are predominantly lenders, JPM relies on lending for only about a third of its business. Trading, derivatives and asset management fill out the rest of the bank’s business model footprint – and contribute to earnings volatility. This results in a 0% RAROC for all of the JPM businesses combined vs the nominal 10% equity returns. JPM has an “A” bank stress index rating from Total Bank Solutions. We fully expect that JPM CEO Jamie Dimon will hit the admittedly low bar set by the Street’s estimates of 2.5% revenue growth for 2017 and 7% earnings expansion, mostly due to further cost cutting. Yet these earnings and revenue figures don’t really support the current equity market valuation for JPM – especially compared with more conservative names such as WFC or USB. Look at the Y-9 performance report for JPM and notice that the bank is consistently in the middle of the large bank peer group compared to WFC and USB which tend to be in the top quartile. Moving from the sublime to the ridiculous, we come to Bank of America (NYSE:BAC), a stock that is up 81% over the past year on the draconian cost cutting by management. And yet even with this amazing upward move, BAC currently trades at just 1x book value -- albeit with a beta of 1.6 or 60% more volatile than WFC or USB. Even though the Street has BAC growing revenue about 4.5% in 2017 and 2018, and earnings up a whopping 18% this year and 21% in 2018, the stock still does not impress managers enough to earn a premium to book. Perhaps this is because the bank’s earning rebound started from such a low base. BAC currently has an “A+” bank stress index rating from Total Bank Solutions and, like WFC, derives more than half of revenue and income from traditional banking. The presence of Merrill Lynch in the mix is neutral factor for the organization from a risk perspective, but BAC as a whole does not compare that well to its large bank peers looking at the Y-9 performance report published by federal regulators. Finally we come to the least valued US large bank, Citigroup (NYSE:C), which currently trades at 0.80x book on a beta of 1.6. C has an “A” bank stress index rating from Total Bank Solutions. Like JPM, C’s business model puts equal emphasis on lending, trading and investing activities, resulting in a lower RAROC at 1% vs a nominal equity return of a bit shy of 7%. Keep in mind that C has lower asset returns and higher credit costs than other large banks, begging the question as to whether the Fed should really be allowing the bank to increase payouts to equity investors. If you look at Page 3 of C’s Y-9 performance report , you’ll see that C’s yield on loans is 2% higher than the large bank peer group, yet the bank has a spread on earning assets half a point lower than other large banks. The Street has C’s revenue down in Q2 2017 but magically up 1.5% for the full year. Earnings are also expected to be down this quarter, but then will rise an astounding 9.5% for the full year. Despite the market bump following the release of the stress test results, which will result in returning more capital to investors than C actually earns in profits, like BAC the C common still trades at a discount to book. Unlike names like JPM, C does not have a significant asset management business and also announced an exit from residential mortgage origination and servicing earlier this year. This may turn out to be a blessing in disguise. C is up 58% over the past twelve months vs 13% for the S&P 500, so like JPM we’d say that the risk is on the downside for this much maligned stock. Will C hit its revenue and earnings numbers for Q2 2017? Probably, especially now that they’ve jettisoned the mortgage business. But the larger question is why does C still exist? In the wake of the 2008 financial crisis, C has been struggling to redefine itself in a way that makes sense to investors. But having sold the asset management business to Morgan Stanley (NYSE:MS) and the mortgage business to New Residential (NYSE:NRZ) and Cenlar FSB, there is not much left besides the consumer lending book and the payments business. As we’ve noted in previous comments, C’s board ought to consider selling the payments business for a premium price, spin the proceeds to shareholders, then dispose of the other assets for whatever they can get before turning off the lights. Bottom line is that earnings for the largest banks are likely to be a relatively disappointing exercise given the poor visibility on both earnings and revenue growth. Managers clearly want to own these large cap financials, but a combination of a slowing economy and the Fed’s manipulation of the credit markets is making sustained top line growth elusive. Longer term, the issue that investors must grapple with in 2017 and beyond is quantifying how much hidden credit risk is embedded in the portfolio of all US banks as a result of the Fed’s aggressive manipulation of the credit markets over the past five years. Corporate credit spreads remain extremely tight. Lurking beneath the currently benign credit metrics, however, lies significant potential losses for both banks and bond investors as an when we revert to the mean. 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.

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing" Citigroup CEO Chuck Prince July 2007 July 9, 2017 | Watching new era car company Tesla (TSLA) getting knocked down a couple of notches last week, it occurred to us that the Fed’s program of quantitative easing or "QE" amounts to a leveraged buyout (LBO) of the US equity markets. How else can we explain TSLA, a firm whose financial performance is measured by free cash outflow , being more valuable than far larger car companies that actually earn profits? Think of it: TSLA is an LBO without any cash flow. Of course, the global equity markets are all about discounting future earnings or, in the case of TSLA, the next capital raise. With $7 billion in debt and a voracious appetite for other peoples’ money, TSLA embodies the new era notion that it is acceptable for companies to loose money until they grow large enough to be profitable -- maybe. The archetype for this style of corporate management is of course Amazon (NASDAQ:AMZN), a firm that is happily consuming whole industries as it grows into a global horizontal and vertical monopoly – and all of this without so much as a peep from the Antitrust Division at the Department of Justice . These and other questions will be considered later this week when The IRA participates in the Rocky Mountain Economic Summit in Victor, ID, just over the Teton pass from Jackson Hole. Sponsored by the Bronze Buffalo Foundation, The Hero Club and the Global Interdependence Center , the Rocky Mountain Economic Summit features speakers from all over the world considering the financial outlook from the stunning perspective of the Grand Tetons. Our discussion on Thursday in Teton Springs will focus on the financial outlook for 2017 and beyond. Given the fact that the 10-year Treasury bond has risen in yield nearly 20bp in the past week, the first order of business would seem to be the direction of interest rates. But maybe not. We should heed warnings from no less than Ray Dalio that the central banker party is over, but this does not necessarily mean that the bond markets are the first concern. Our basic view remains that this latest uptick in yields for US government debt is a pause amidst a continuing deflationary scenario. The manager of the world's largest hedge fund, Dalio says he is going to "keep dancing" with the markets even though central banks are reversing their easy money policies. Where is former Citigroup (NYSE:C) CEO Chuck Prince when we need him? Reading the pronouncements coming from the latest FOMC minutes, it looks to us like the Fed’s portfolio will not be reduced down to the $1.7 trillion target until 2024. Our friend Bob Eisenbeis, formerly director of research at the Atlanta Federal Reserve Bank now chief economist at Cumberland Advisors, notes that this fact will keep Fed policy relatively easy for the next five years. And the minutes contain no hint that the Fed regrets QE or any of its other policy moves since 2008. At present, the fact of the FOMC’s massive bond position is holding interest rates down. Ask not how long it will take for the 10-year to hit 3%, but rather the number of trading days it will take for the secular forces of deflation and growing global debt to push Treasury yields back down again towards 2% yield. Thus our fascination with Italian banks. Despite the protestations of Fed Chair Janet Yellen regarding the complexity of monetary policy, it is quite easy to borrow billions when the central bank is playing “what if” with the global financial markets. Unlike the 1930s when Irving Fisher worried about debt deflation, this time around the secular demand for investments (aka “duration”) looks to be driving yields down even as the likes of TSLA drown on debt that, today at least, clearly does not seem money good. Our friend Charley Grant gives you the basic facts in a Wall Street Journal analysis: “Yet Tesla needs to raise several billion dollars to meet its goals. Assuming a $1 billion cash balance and four quarters of similarly negative cash flow, Tesla would need to raise nearly $3 billion over the next year. At current prices, that amounts to roughly 6% of the total equity value. The more the shares slip, the greater the potential dilution of existing owners.” Dilution indeed. Examples like TSLA aside, the basic problem we have with the rising rate scenario narrative that emerged last week is that corporate credit spreads remain extremely tight. All during the Trump Bump, let’s recall, as the 10-Year Treasury popped up to a whole 2.6% yield, corporate bond and swap spreads generally tightened . The Fed-induced shortage of investment paper, combined with a shrinking market for equity offerings and a $300 billion drop in agency securities issuance in the mortgage market, are all combining to keep yield spreads tight as suggested by the chart from Fred below. Given the gyrations of the bond market, US mortgage origination volumes likely will barely reach $1.6 trillion in new issuance this year vs $2 trillion in 2016. When we start to see high yield corporate bond spreads as described by the good folks at the St Louis Federal Reserve Bank edging up towards 6%, then we’ll start to give credence to the rising rate trade. Over the past three years, how many investment managers have been annihilated betting on rising interest rates and widening bond spreads? Too many to count. But to us the more relevant concern for Yellen & Co is the equity markets and its recent correlation with bonds, an unnatural circumstance that seems about ready to end. Looking at spreads in terms of the Treasury market, the impact of the FOMC’s baby steps toward normalization is illustrated by the 10-year Treasury bond vs the 2-year T-note. Does this look like a market that is just dying to move higher in terms of yield? Compare the magnitude of last week’s modest move in the 10-year to the massive Trump Bump following the November 2016 election. Our best guess is that the next major leg in the 10-year Treasury bond will be down in yield and up in price until we test the 2% threshold. Corporate debt issuance tracked by SIFMA is $100 billion ahead of last year’s levels through May at $884 billion and, more important, roughly a quarter of this amount was used to fund share buybacks by public companies. Significantly, share repurchases for the S&P 500 in Q1 2017 were $133 billion, just 1.6% less than Q4 2016 and 17.5% less than Q1 2016. Source: SIFMA/S&P The debt issuance numbers from SIFMA and share repurchase figures from S&P dwarf the level of new equity offerings at just $57 billion in Q1 2017, but it is important to note that stock buybacks also peaked in 2016. Of note, Ed Yardeni’s latest report on the subject of stock buy backs is must reading. “The result of the buybacks is that net equity issuance has been negative for the last several years and bears a striking resemblance to the period leading up to the 2008 financial crisis,” David Ader wrote presciently in Barron’s last year. In this regard, consider the coincidence of the surge in corporate debt issuance in Q1 2017 and the performance of US stocks. In the chart above, note the way that total MBS issuance has cratered since Q4 2016 thanks to the election of President Trump. Sadly, even a 10-year Treasury yield well below 2% will not revive the flagging fortunes of the US mortgage finance sector with an uptick in refinancing volumes. So our message to the folks in Jackson Hole this week is that the end of the Fed’s reckless experiment in social engineering via QE and near-zero interest rates will end in tears. “Momentum” stocks like TSLA, to paraphrase our friend Dani Hughes on CNBC last week, will adjust and the mother of all rotations into bonds and defensive stocks will ensue. We must wonder aloud if Chair Yellen and her colleagues on the FOMC fully understand what they have done to the US equity markets. The notion that five years of market manipulation by the FOMC (and other central banks, to be fair) can end happily seems rather childish, especially when you consider that the other great accomplishment by the Fed during this period is a massive increase in public and private debt. Once the hopeful souls who’ve driven bellwethers such as TSLA and AMZN into the stratosphere realize that the debt driven game of stock repurchases really is over, then we’ll see a panic rotation back into fixed income and defensive stocks. The period from QE 1 in 2012 represents one of the most reckless episodes in the history of the US central bank, a period where the FOMC essentially encouraged a partial LBO of the US equity markets. The key question for the FOMC and investors seems to be this: How much new equity issuance can the markets support if public companies eventually need to reduce debt and rotate out of the LBO trade constructed by Yellen & Co? Corporate credit spreads are the key indicator to watch, both in terms of the economy and the financial markets. It’s a game of financial musical chairs. Ray Dalio, Janet Yellen and all of us are dancing. When does the music stop?