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February 16, 2022 | When Facebook (FB) CEO Mark Zuckerberg sold his infant coin business Diem to Silvergate Capital Corp (SI) , he accepted a lesson that Walmart (WMT) , Alphabet (GOOG) and Apple (AAPL) have all learned over the years: banks have a federal monopoly on creating deposits and making payments. If you want to take deposits or have a hard IP address on the national payments system, namely a master account at a Federal Reserve Bank, then you got to be a bank. That is, a federally insured depository institution . Just ask Sarah Bloom Raskin. But who is Silvergate and why is this small bank from La Jolla, CA, buying FB’s stable coin business Diem? The simple answer to that question is that SI’s management team are smart and are taking advantage of the narrative in Washington, which is that stable coins will be a bank only product . We see SI as an audacious gamble on the interface between all crypto and fiat cash money, not simply stable coin tokens. At the same time, however, SI is not a very impressive model of a bank and has risks that most community banks do not face. Source: FFIEC This $16 billion asset bank, which had just $2 billion in assets at the start of 2019, trades at “only” 2.4x book today. It was trading just shy of 12x book in March of 2021, at the peak of the COVID market pump by the Federal Reserve. And why not? In the world of financials, Silvergate may be among the biggest meme stocks yet in the era of quantitative easing or QE. SI is not your typical bank over $10 billion in total assets. In fact, SI and its state-chartered bank unit, Silvergate Bank , grew so fast over the past year that the bank is not yet officially a member of Peer Group 1. SI is going to be dropping form Y-9C with the Fed shortly and providing other detailed reporting not available today. The growth in the bank’s assets has been matched by an equally torrid growth on the public market value of SI, as shown in the chart below. Very briefly, this crypto-focused bank was among the most highly valued banks in the US. But over the past year, SI has lost two thirds of its market value. Source: Yahoo Finance Founded in August 1988 as Silvergate Thrift & Loan Company, today the bank has $16 billion in total assets funded with $14 billion in certificates of deposit, most of which mature in one year or less. At December 31, 2021, Silvergate Bank had $1.7 billion in loans, $7 billion in Treasury securities, MBS and munis, and another $5 billion in deposits with other banks. The muni market has backed up about 60bp in yield since the start of 2022, of note. Because of the atypical asset structure of the bank, profitability is poor. Silvergate Bank ranked in the bottom decile of Peer Group 2 at the end of 2021, with net-income to average assets of just 72bp vs an average of 1.29% for Peer Group 2, which includes 115 banks from $10 billion to $100 billion in assets. The relatively weak fundamentals of SI and its subsidiary bank, however, have not prevented the stock from going “to the moon,” to borrow the language of Reddit, as shown in the chart below. Source: Google Notice that meme stocks such as SI and Tesla (TSLA) exploded when the FOMC began to make massive purchases of securities via QE in Q1 of 2020. In relative terms, the 90% up move in the S&P 500 over the past year barely moves the needle compared to SI (800%) and TSLA (+1,600%). And both of these MEME stocks have been correlated to moves in bitcoin and the VIX over the same period. SI has positioned itself as an enabler for crypto transactions, on the one hand, and a lender against crypto assets, providing greater “capital efficiency” (aka "leverage") for institutional investors. In January 2020, SI began offering a new lending product called SEN Leverage, which allows Silvergate customers to obtain U.S. dollar loans collateralized by bitcoin held at select digital currency exchanges and other custodians. For the three and nine months ended September 30, 2021, there were $162.0 billion and $568.1 billion, respectively, of U.S. dollar transfers that occurred on the SEN, compared to $36.7 billion and $76.5 billion, respectively, during the three and nine months ended September 30, 2020. The outstanding balance of SEN Leverage loans was $254.5 million and $77.2 million at September 30, 2021 and December 31, 2020, respectively. Think of it as warehouse lines collateralized with nothing and funded by FDIC-insured deposits. Most of the jumbo CD deposits we referenced earlier bear zero interest, providing what SI describes “mid-single digit spreads” in an investor presentation. The Silvergate exchange network or “SEN” allows 24/7 real time transfers of dollars and now euros, into and out of crypto assets. These flows totaled $35 million of transaction revenue, but also create risk for the bank, including facing a number of nonbank counterparties that are lightly capitalized and even less subject to prudential regulation. Robust AML and KYC compliance are perhaps the biggest challenges for this bank because of the essentially offshore nature of crypto trading. Source: SI Investor Presentation (February 2022) A growing area of business for the bank is lines of credit and letters of credit for crypto trading, which SI books as off-balance sheet liabilities. While the amounts are small relative to the bank's capital, the amounts are growing steadily. Total off-balance sheet items were $119 million at the end of 2021 vs $57 million at December 31, 2020. These items were assigned 100% risk weights by regulators and equaled roughly 10% of Tier 1 capital at year-end 2021. Shareholders’ equity increased $777.8 million to $1.1 billion at September 30, 2021, compared to $294.3 million at December 31, 2020. The increase in shareholders’ equity was primarily due to two common equity offerings. The bank will need to continue to grow capital to support a larger asset and deposit base, but so far core profitability is not providing sufficient support for capital growth. Our bottom line on SI and Silvergate Bank is that the bank part of the business is mediocre and unlikely to deserve a valuation multiple much above its asset peers, which means a book value multiple of equity closer to 1 than to 12. The operating efficiency of the bank at 43% is good, but expenses are rising faster than non-interest income, which seems to be the point of the business model. Income from assets is modest and does not leave the bank’s management much room for error in terms of either interest rates or credit. If you believe that crypto is a long-term investment asset, then SI seems to have stolen the march on some if its larger competition. The volumes moving through the SEN network are impressive, but it is less than clear how the bank benefits from these flows besides making loans against crypto assets as "collateral." The funding structure of the bank is unusual and, in extremis, volatile since a large portion of the deposits reprice within one year. We also wonder if higher levels of market volatility are not going to hurt the already modest returns that the bank earns on assets. As interest rates rise, the attractiveness of the bank's zero interest rate deposits may decline. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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.

And now, Master, I myself invite you To drain this vessel In which smokes and bubbles No longer Death, no longer poison, but life! MÉPHISTOPHÉLÈS ( Faust Libretto ) February 14, 2022 | A big Happy Valentine’s Day to all of the readers of The Institutional Risk Analyst . We all just spent the past week watching the slow destruction of the remaining credibility of the Federal Open Market Committee, a big problem for global equity markets that trust in the judgment of central bankers. The messy situation at the Fed begs the question: Is it time for Congress to repeal the Humphrey-Hawkins law? Part of the challenge to understanding Fed policy is that the central bank has very publicly lost its way. In an attempt to parse the “FedSpeak,” as he so aptly calls it, Steve Liesmann at CNBC has begun to rely on the language of the schoolyard to explain Fed behavior – or lack of it. But alas, there are no “take backs” or “do overs” in global finance. In fact, as Liesmann and others have noted, the Fed has still not changed policy since the start of the year. What's the fuss? The FRBNY is still buying billions of new MBS each week, even as the mortgage industry is reeling from a decidedly weak fourth quarter. A quick look at the Bloomberg terminal reveals that bond issuance in many markets is slowing as 2022 begins. Source: SIFMA Long-term interest rates are already headed higher, a fact that is having a big impact on less efficient home lenders. New age mortgage firm Better.com , for example, just revealed a $111 million loss in the first nine months of 2021, driven by – wait for it -- $1 billion in “corporate expenses,” Inside Mortgage Finance reveals. Does this include that trip to Pebble Beach for dozens of industry operators and biz dev moguls? Better.com is just one of dozens of new age enterprises that are happily destroying shareholder value c/o the FOMC. And the FOMC continues to ease policy even as February draws to a close. Notice that the aggregate mortgage related issuance in November and December was the lowest monthly rates in years. More important, notice the sharp decline in Treasury and also corporate issuance in Q4 2021 after the Treasury rebuilt its cash reserves. In January, the Treasury actually ran a surplus. During this period, the Fed did not adjust its purchases for the system open market account (SOMA), helping to force real interest rates ever more negative. If you consider QE “stimulus” inflationary, then Fed policy actually accelerated inflation in the November-January period. The big deficit at the FOMC, of course is nerve. Having allowed themselves to climb down into the mosh pit of partisan politics during COVID, the central bank is now faced with a clear rebuke from markets and consumers in terms of inflation. Rising prices are a political problem for the White House and Congress, but the Fed has already traded that coin. Getting “ahead of the curve,” as Fed staffers now claim to want, is unlikely with the Fed’s toolbox so badly depleted. Note, though, that the FOMC continues to drag its feet on changing policy. It’s almost as though Powell & Co expect to awake from a bad dream and find that inflation is no longer a problem. Reserve Bank Presidents such as James Bullard and Ester George are publicly calling for a radical change in monetary policy. Sadly, the hawks on the FOMC have no choice but to speak publicly when the FOMC has gone so badly off the rails. The lack of clarity on the Fed’s legal mandate contributes to an atmosphere of confusion in the markets. Governors and Reserve Bank presidents conduct media interviews as and when they so choose. In the days of Chairmen like Paul Volcker and even Alan Greenspan , the chairman spoke publicly and presented the consensus position of the Committee. Other FOMC members were silent unless and until they were asked to carry the consensus message. Legendary staff chief Ted Truman would have it no other way. Today, by comparison, we have policy chaos at the Fed, with FOMC members scored via dot plots and competing with one another for media attention. Whatever consensus exists among FOMC members as to the dual mandate of Humphrey Hawkins is unclear. Meanwhile, the FOMC is clearly not fully in command of the little operational details like how to end QE. Since 2008 and the term of Chairman Benjamin Bernanke , the Fed has lost its way, both in terms of policy implementation and as an organization. As the Fed’s public credibility ebbs, the markets sense the lack of direction and certainty of purpose, resulting in even greater uncertainty and market volatility. Notice that market volatility measured by the VIX has increased during the period of extraordinary asset purchases via QE. Likewise the volatility of the Treasury market has also increased as the SOMA portfolio has grown. Keep in mind that the assumption by the FOMC in approving "going big" via QE was that a surfeit of liquidity would eliminate the need to "fine tune" the market. Yet the opposite seems to be the case. Part of the problem, of course, is that most investors and media are focused on the equity markets. The Fed’s manipulation of the bond market via QE, on the other hand, is an abstraction. We’ve started counting the number of times that media and investment professionals opine that the Fed is going to start selling securities . In fact, nothing like that is in the cards. The fact that smart investors and media don’t understand this nuance is telling. When the Fed does finally, belatedly react to the change in inflation indicators over the past six months, it will need to “go big” in terms of target rates simply to regain some degree of credibility. Just as the Fed went “big” with QE in 2020 in the face of the uncertainty of COVID, now the central bank must claw back some modicum of authority by going the other way. But, again, the most daring policy likely to come from the FOMC is merely ending new purchases and allowing the Fed’s $8 trillion portfolio to slowly run off. Fed Chairman Arthur Burns noted in August of 1971 that he had failed to stop the closing of the gold window, reckoned as one of the more significant events in the history of the dollar in the post-WWII era. Yet the decision to end gold convertibility of dollar was relatively passive. “The gold window may have to be closed tomorrow because we now have a government that seems incapable, not only of constructive leadership, but of any action at all,” Burns wrote in August 21, 1971. “What a tragedy for mankind!” Half a century ago, the inflationary pressures that caused the US to stop redeeming dollars for gold at $35 per ounce were growing, with seven dollars outside the country for every dollar’s worth of gold at Fort Knox. Today the 147.3 million troy ounces of gold in Fort Knox is worth about $270 billion, but offshore dollar assets are measured in double digit trillions of dollars. In 1971, people inside and outside the US government still believed that it was possible to create real economic outcomes via government fiat, all the while maintaining low inflation. Burns talked of an “incomes policy,” trading higher wages for productivity gains even as President Richard Nixon embraced wage and price controls to offset the inflationary impact of the Vietnam War. In 1978, when Congress passed the Humphrey Hawkins law, the mandate for full employment and price stability was enshrined within the Federal Reserve Act. This political compromise juxtaposed jobs vs inflation, a conflicted relationship that cannot be managed either practically or politically. When the Fed could no longer deliver the goods after 2008 by just lowering interest rates, buying government debt became the policy tool of choice. As we noted in American Conservative (“ When The Fed Became A Socialist Job Creator’ ), the Fed is a progressive, New Deal institution. And Humphrey-Hawkins was an explicitly socialist law imposed by a Democratic majority in Congress that must inevitably lead to inflation. When Fed Chairman Bernanke tried to differentiate between credit easing and QE in a 2009 speech in London , the world witnessed the last gasps of the dual mandate. Since 2009, QE has delivered monumental inflation, this justified in the name of short-term expedience that make a mockery of the “price stability” portion of Humphrey Hawkins. The FOMC during the terms of Chairman Bernanke, Chair Janet Yellen and now Jerome Powell document the consensus view at the Fed over the past decade or more that “inflation is too low.” The first impact of QE was asset price inflation, a sea of institutional liquidity that enabled ridiculous behavior in the world of asset creation and allocation. Ponder the shift in investor perception that made investments such as better.com seem like a good idea. And there are literally hundreds of other companies that share this quality – or lack thereof. We’ll be writing about some of these names in coming weeks. But in the meantime, enjoy the ride in the financial markets over the rest of 2022 as the Fed seeks to reclaim virtue when it comes to fighting inflation. The markets will shoulder the burden, this even though few bankers or equity managers yet perceive the adjustment that lies ahead. One wealthy business owner told The IRA last week: “If the Fed does the right thing now, I will loose 25% of my net worth due to the obvious and necessary reset in stocks, but that’s OK. I’m still up a lot. But if Powell doesn’t take strong action now to control inflation, then we are all in big trouble.”

February 10, 2022 | In this issue of The Institutional Risk Analyst , we look at NexBank Capital, Inc. and its subsidiary bank, NexBank . With total assets of just below $10 billion, NexBank is the fourth largest commercial bank in Dallas and consistently ranks among the top banks in Peer Group 2 for equity returns and capital growth, operating efficiency, and asset quality. NexBank has two banking offices in Dallas, TX, and is institutionally focused, leveraging a very efficient operating model. It has three divisions—Institutional Banking, Commercial Banking, and Mortgage Banking. The following data and analysis are as of September 30, 2021, using data from the FFIEC and S&P Global, unless otherwise noted. Source: FFIEC NexBank’s earliest predecessor institution, Terrell Building and Loan Association , was chartered in 1922. Today NexBank is a state chartered, FDIC-insured subsidiary of NexBank Capital, Inc., a single bank holding company that was organized by a group of private investors in 2004 and today includes a single depository and a broker-dealer. The company’s growth has primarily been organic. In terms of recent M&A transactions, NexBank acquired College Savings Bank , a state savings bank based in NJ, in December of 2015. We wrote about NexBank back in 2017 (“ Which Are the Best Performing US Banks? ”) when we looked at some of the top-performing banks, large and small, in the US. Since that time, the total assets of the US banking system have risen dramatically due to the inflationary policies of the Federal Reserve Board. This fact puts growing pressure on NexBank and the larger members of the 144 depository institutions in Peer Group 2, which includes banks between $1 billion and $10 billion, to take the decision to go above $10 billion in total assets. NBC is focused on providing financial and banking services to institutional clients, financial institutions and corporations. Its primary subsidiary, NexBank, a commercial bank, core offerings consist of the following: Institutional Banking offers a suite of specialized lending and depository services to institutional clients and financial institutions. Commercial Banking offers a range of traditional banking products with a focus on real estate lending and commercial and industrial financing, as well as deposit and cash management services. Mortgage Banking provides conforming, government, non-conforming jumbo, and non-QM through wholesale and correspondent channels as well as traditional warehouse lines of credit. The group also offers MSR and EBO Financing. NexBank’s diversified $5.6 billion gross loan portfolio has concentrations in residential mortgage loans and commercial real estate loans. The 1-4 family residential loans are originated through both the wholesale and correspondent channels as well as through warehouse facilities for large mortgage bankers. Commercial lending largely consists of commercial real estate lending with focus on multifamily, followed by commercial and industrial loans. NBC is not structured and managed like a typical large community bank, thus peer comparisons must be made carefully. The business includes a strong focus on mortgage specialization in terms of acquiring and managing a portfolio of housing assets and related revenue lines. Among the ten largest mortgage specialization banks, NexBank had among the best equity returns in Q3 2021. Note in the table below that the lead bank of Charles Schwab Corp (SCHW) is the largest mortgage specialization bank in the US. Source: FFIEC Assets in $000s. For the full year 2021, NexBank had a return on average equity of 17.68%, according to S&P Global . Most of the economic capital risk in NexBank, as a result, comes from the securities portfolio rather than lending. Note in the chart below that the gross spread on NexBank’s portfolio of largely purchased loans and leases exhibits far less volatility than some of its higher-risk asset peers. As discussed below, the bank’s superior operating efficiency means that NBC is able to manage a lower risk franchise. Source: FFIEC Using nominal measures looking at average assets NexBank underperforms some of its more complex asset peers such as Cross River Bank and Beal Bank , yet in Q3 2021 the bank delivered a 6% Risk Adjusted Return on Economic Capital (RAROC), according to Total Bank Solutions . Look at average assets vs operating income, for example, and NBC is in the bottom third of Peer Group 1. But look at equity returns and capital growth rates, on the other hand, and NBC is in the top 5% of the 150 institutions in Peer Group 2. In Q3 2021, for example, NBC earned a 21.4% equity return on its investments in NexBank and the broker-dealer unit. Among mortgage specialization institutions below $100 billion, NexBank is one of the best performers. In Q3 2021, NexBank delivered a 18.25% ROE and a 1.3% return on assets (ROA), according to data from the FDIC. One reason for the strong equity returns of NBC is the bank’s stellar credit performance, in some quarters with zero net loan losses. With the exception of 2020, when NexBank saw losses rise above the Peer Group 2 average due to one charge-off on a large syndicated credit with COVID exposure, the bank has tracked well-below its peers in terms of credit performance. Likewise, Loss Given Default was negative or near zero historically, but rose to near 100% in 2020 due to credit expenses arising from the response to COVID. Source: FFIEC The strong historical performance of NexBank enables it to operate with lower allowance for loan & lease losses (ALLL) and lower levels of capital compared with the Peer Group 2 average. For example, in terms of exposure at default (EAD), NexBank carries unused credit commitments equal to just 10% of loans and leases compared with 100% or more for larger banks. More, with risk weighted assets (RWA) of just $6.2 billion (or 64% of total assets) at September 30, 2021, NexBank had Tier 1 capital to RWA of almost 14%. Operating efficiency is another notable area where NBC and its bank unit excel, both compared to its asset peers and larger banks. NBC has tracked below the average level of efficiency in Peer Groups 1 and 2 for many years. Source: FFIEC Due to the strong efficiency and high levels of equity returns, NBC has been able to build the capital of NexBank to a far greater degree and in less time than its asset peers. The level of debt at NBC is above peer due to the high levels of double leverage used to downstream equity capital to NexBank. An important sub-component of bank operating efficiency is non-interest or overhead expense, another area where NBC excels compared with its peers and industry leaders such as FBC. NBC’s ratio of overhead expenses vs average assets is the lowest in Peer Group 1 or 2 at 0.8% vs the Peer Group 2 average of 2.32%. In operating as well as credit terms, the bank’s superior operating efficiency means that NBC is able to manage to a lower risk business profile than its peers. Source: FFIEC At the end of Q3 2021, NBC had 131% double leverage vs 105% on average for Peer Group 1, but NBC retained over $400 million in earnings during that period. Total capital inclusive of $240 million in Tier 2 capital was $950 million for NBC. Going back to the creation of NexBank in 2004, the goal was always building shareholder equity on a conservative business foundation. As a result of declaring modest dividends at the parent level, NexBank has seen 150% growth in retained earnings over the past five years. Total holding company equity capital was $580 million at the end of Q3 2021. NexBank reported over $700 million in Tier 1 capital at the end of Q3 2021. NexBank maintains a highly liquid balance sheet and employs a sophisticated strategy to manage interest rate risk. Net loans and leases as a percentage of total deposits are below the average for Peer Group 2, reflecting the bank’s focus on investing in mortgage loans and related securities and assets, such as mortgage servicing rights. In stark comparison to more aggressive asset peers such as Cross River and Beal Bank, NexBank has steadily decreased its reliance upon noncore funding as its capital base has expanded. Roughly half of Beal Bank’s $8.1 billion balance sheet, for example, is funded with volatile sources of funds. Cross River Bank, likewise, has half of its $11.5 billion in assets funded with volatile funding sources. NexBank’s core deposits equaled 99.4% of total deposits and volatile funding sources equaled less than 5% of total funding at Q3 2021. The IRA Bank Profile is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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 IRA Bank Profile. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The IRA Bank Profile are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The IRA Bank Profile represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The IRA Bank Profile is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The IRA Bank Profile 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 IRA Bank Profile. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

A note to readers of The Institutional Risk Analyst , we have published a new paper entitled " Improving Liquidity for Ginnie Mae Servicing Assets" which is available on SSRN . The paper has been well received in the regulatory community. We hope that it will better inform the debate over "risk" from nonbanks in the mortgage sector. We make the point that the biggest risk to Ginnie Mae and the taxpayer is that unnecessary regulation and bank centric thinking will drive the remaining participants out of the government loan program entirely. We provide an overview of secured finance in the post-WWII era. The paper then asks two basic questions: 1) why do Government National Mortgage Association (GNMA) servicing assets trade at a discount to conventional and even private label mortgage servicing rights (MSRs) and 2) why do lenders offer inferior terms when lending on GNMA MSRs? To answer these questions, we examine the evolution of GNMA as part of the U.S Department of Housing and Urban Development (HUD). Particular emphasis is placed on the relationship between GNMA and private market participants in providing insured credit to support affordable home ownership. We conclude with some suggestions for reform that will improve liquidity in the GNMA market for MSRs. Here's an excerpt: When Ginnie Mae was created in 1968 and the issuance of government-insured mortgage backed securities (MBS) began in 1970, nonbank finance did not exist in the United States. In a 1925 decision, Supreme Court Justice Louis Brandeis applied New York State law to secured finance in a bankruptcy case, Benedict v Ratner 268 U.S. 353 (1925) . The decision brought secured finance to a halt and created the six tests for legal isolation that describe a “true sale.” It took lawyers, bankers, the states and Congress nearly half a century, including several revisions to the Uniform Commercial Code and numerous pieces of federal legislation, before nonbank finance was even possible in the US. Collateralized lending in the US was essentially impossible outside of banks from 1925 through the mid-1970s, and even then, banks felt constrained in terms of obtaining a clear lien on collateral. The market for secured finance that existed in 1970 was a bank market comprised of state-chartered banks and thrifts, a legacy of the Great Depression, WWII and the subsequent years of Cold War. In the post-WWII period, national banks held mostly commercial, government and state obligations and were not even allowed to lend generally on real property until the mid-1950s. When Congress created GNMA, the assumption was that the agency would operate in a securities market dominated by large commercial banks and broker dealers. The rules and regulations adopted by Congress half a century ago were influenced by the experience of the Great Depression and Benedict, and were tailored for a market operated and funded by large depositories. Significantly, GNMA would blaze a path for the GSEs and later private issuers in terms of secured financing via the issuance of MBS. Consumer finance receivables and mortgages on real property were eventually packaged into private securities, all to be financed in the engine of American prosperity known as the bond market.

February 7, 2022 | Last week saw the start of the reporting season for publicly listed mortgage companies, with loanDepot (LDI) and PennyMac Financial Services (PFSI) issuing earnings results for Q4 and the full year. “Economic forecasts for 2022 total originations average $3.1 trillion,” PFSI observed. “While a large market by historical standards, it reflects a substantial decline from a record 2021 ‒ Excess industry capacity established in recent years will need to be right-sized” -- all comments familiar to readers of the Premium Service of The Institutional Risk Analyst . Source: PFSI Among the larger issuers, PFSI, which is the external manager of PennyMac Investment Trust (PMT) REIT, has some of the better reporting. In addition to informing investors about forward volumes, PFSI also illustrates that primary/secondary spreads have fallen back toward 1% after widening last summer. As we never tire of reminding our readers, profits for financial companies are directly tied to spreads. Wider is better. The fact that $2 trillion or so in the estimated 2022 volume is likely to be purchase mortgages provides little reason for great joy. Purchase is the most costly type of mortgage origination. The fact that PFSI is focused on consumer direct, which is a lower cost execution channel, is a positive. Rising servicing income and falling prepayments on mortgage servicing rights is another positive. But production pretax income for PFSI in 2021 was half of 2020 and that downward progression will continue in 2022, led by falling correspondent volumes. Correspondent was down 50% YOY, from almost $60 billion in Q4 2020 to $33 billion in Q4 2021. Source: PFSI As we see the FOMC raising interest rates and ending both new purchases and even reinvestment of principal returns for the system open market account (SOMA), the importance of servicing portfolios grows. Both as a source of new loans and because of monthly cash flows, the yield on the MSR is a big part of future earnings. At a little over $500 billion, PennyMac Loan Services ranks sixth among primary servicers, according to Inside Mortgage Finance . LDI, on the other hand, is not a very large servicer and ranks 16th in terms of owned servicing, again according to IMF. At $162 billion in unpaid principal balance of the loans, the LDI MSR is valued at 122bp. Between the end of 2020 and 2021, the value of the LDI MSR rose to just below $2 billion from $1.1 billion at the end of 2020. Some observers remarked on the fact that LDI wrote down the MSR $118 million in Q4 2021. Our question is why didn’t LDI write down more. Sure, 5x cash flow is where the bulk market is for conventional MSRs. But 122bp does not strike us as a particularly conservative mark given that LDI wrote down $445 million in MSR in 2021. Call it a “rainy day” mark, something that is easier when you do your MSR valuation work in-house. PFSI, by comparison, took down the value of its predominantly GNMA MSR portfolio by just $44.2 million for a period end multiple of just 4.1x the cash flow from the $278 billion in UPB. But more telling is the fact that production expenses, net of LO compensation, went from 24% of net revenues in Q4 2020 to 69% in Q4 2021 (Pg 10 of LDI Presentation), suggesting that cost cutting will be a priority in 2022. PFSI has one of the longest and most stable operating profiles in the industry, even during the roller coaster years of QE and COVID. During 2020, PFSI delivered a return on equity north of 60%. The following year 2021 was half that rate., reflecting the decline in lending volumes and gain-on-sale (GOS) margins. Like the rest of the industry, PFSI believes in the virtuous cycle of lending and servicing, a proven formula unless and until delinquency becomes significant. Notice in the chart below for LDI that operating expenses in 2021 rose above 2020 levels even as revenue fell in 2021 below the previous year. PFSI also saw production expenses rise through 2021 even as revenue and volumes softened. This is the traditional operating profile of the mortgage finance business, rushing to catch an opportunity c/o the FOMC in 2020-21, followed by a painful retrenching in terms of operating expenses in 2022. LDI’s GOS margin was 4.41% in 2020 and 2.9% in 2021, a trend that may continue into 2022. Source: LDI LDI’s total expenses were up $800 million in 2021, a fact that will need to be addressed before the end of Q1 in terms of variable expenses. But then again, the entire industry is going to be dealing with layoffs and other efforts to rein in costs after a record year in 2020 and part of 2021. In that sense, the layoffs announced by Better Mortgage before the end of last year may have been prescient. Cost cutting is the name of the game in residential mortgages in 2022. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

November 18, 2021 | In this Premium Service edition of The Institutional Risk Analyst , we look at a small but highly profitable bank holding company (BHC), Raymond James Financial (RJF) , the 47th largest banking group in the US and a comp for larger specialty BHCs such as Charles Schwab (SCHW) . RJF is one of those quiet high-performer banks in the investment world that few understand but many own in LT portfolio, resulting in a 2.6x multiple to book value. The FL-based RJF just announced the purchase of Pittsburgh, Pennsylvania-based TriState Capital Holdings, Inc. (TSC) , a $12 billion asset banking group with an asset management business. Upon the close, the TriState combination will make RJF a $70 billion institution with more than $2 trillion in client assets and 8,500 financial advisors. Of note, TSC will keep its name and continue to operate as an independently chartered bank subsidiary of RJF. Source: Google Finance The fact that RJF has out-performed larger institutions in the equity markets is no surprise. The BHC’s financial performance is quite strong, due largely to the non-interest income generated by the investment business and its large broker-dealer unit, Raymond James Associates. If we compare the performance of RJF with larger institutions and Peer Group 1, the firm’s performance immediately stands out. Of note, RJF saw a significant increase in loan losses at the end of 2020 due to the adoption of CECL and the write-down of criticized loans held inside the bank. The explosion of COVID at the start of 2020 pushed down valuations for RJF and other financials, but the CECL adoption nine months later did not really affect stock prices for RJF or the Peer 1 large bank group. RJF had the capital and income to increase loss provisions as required by CECL, write down more than $100 million of doubtful loans and keep on going, and reported record revenues in that quarter. Source: FFIEC After credit losses, the next question to ask is how does RJF do in terms of pricing on the loans that they originate? Half of RJF’s consolidated balance sheet is actually loans, evenly divided between real estate, C&I and consumer facing exposures. The BHC’s loan pricing is competitive with SCHW and Morgan Stanley (MS) . Source: FFIEC Note that while RJF is not able to compete with the likes of JPMorgan (JPM) in terms of loan pricing, it compares well with the other bank specialty investment shops such as SCHW and MS. And again, while lending is important to RJF based upon assets, the total income of the BHC is weighted 16:1 in favor of non-interest revenue vs net interest income. Even though the RJF business is primarily focused toward investment products, net loans and leases are almost half of total assets of the BHC. RJF's bank unit has $30 billion in core deposits and a cost of funds that compares with the largest banks in Peer Group 1, as shown below. Source: FFIEC As we’ve noted previously, SCHW with nearly $500 billion in core deposits has among the lowest cost of funds in the industry, but dollar for dollar of assets in the bank, RJF has more investment assets than its larger rival. In fact, the investment business at RJF is so large as a percentage of the total that the FFIEC puts the firm in Peer Group 9, which is designated for “atypical” BHCs. This is also why RJF has a fiscal year ending in September, whereas most banks run on the calendar year by regulation. We’ve used Peer Group 1 for financial comparisons. Only when you look at RJF in terms of consolidated income vs average assets do you begin to appreciate the earnings power of the investment business and how this could support the growth of the bank. At present, RJF only retains half of the $66 billion of sweep deposits generated by its investment business and places the other $25 billion with other depositories. There is potential for RJF to grow the asset side of the bank and thereby increase the internal earnings of the group. As RJF grows the bank, it should be able to push its efficiency ratio down from the nosebleed 80% today to something close to the 60% reported by SCHW. Source: FFIEC In the quarter ended September 30, 2021, RJF reported $2.7 billion in net revenues and took $429 million down to the bottom line. This was a 72% growth rate year-over-year in terms of the bottom line, one reason why RJF trades in the same company as SCHW and First Republic Bank (FRC) , which trades over 3x book value. Like most financials, RJF is fully priced but has excellent potential for growth in the future, both on the investment side and the bank. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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.

Q: Are the annual stress tests good for bank stocks? See discussion on Yahoo Finance by clicking here (Interview starts at 12:30). Early in 2009, when the Federal Reserve Board began the annual exercise of “stress tests” for banks, confidence in the US financial institutions was nonexistent. The year before, Treasury Secretary Hank Paulson almost single handedly cratered the US economy by embracing the creation of a “Super SIV” to buy bad assets from the largest banks. Paulson’s ill-considered comment told investors that US banks like Citigroup (NYSE:C) were insolvent. At the time, JPMorgan (NYSE:JPM) was trading below $30 per share and other large banks were similarly discounted. As part of a broader effort to restore confidence in banks, the Supervisory Capital Assessment Program or SCAP was designed to measure whether the 19 largest banks with more than $100 billion in assets had sufficient capital. The key objective of the SCAP was not to actually measure capital per se, but instead to restore investor confidence in holding bank debt. In that sense, at least, the SCAP was successful. Kudos to Messrs Bernanke & Geithner. Yet the necessary decision to report the results of the SCAP publicly had significant future implications for banks and also for investors. In 2009, investors were concerned about a growing federal role in the banking system. And that is precisely what has occurred. The SCAP evolved into the Comprehensive Capital Analysis and Review (CCAR), which is the key part of the stress test duet that determines if banks can increase cash returns to investors. The Fed noted in May 2009: “The unprecedented nature of the SCAP, together with the extraordinary economic and financial conditions that precipitated it, has led supervisors to take the unusual step of publicly reporting the findings of this supervisory exercise. The decision to depart from the standard practice of keeping examination information confidential stemmed from the belief that greater clarity around the SCAP process and findings will make the exercise more effective at reducing uncertainty and restoring confidence in our financial institutions.” When the Dodd-Frank law was passed a year later in 2010, Congress included an expanded legal mandate to conduct annual stress tests and for hundreds of banks. In October 2012, the various federal regulatory agencies issued final rules implementing stress testing requirements for hundreds of public and private companies with over $10 billion in total assets. Most of these smaller institutions outside of the original 19 banks had no part in the 2008 financial crisis and were in fact victims. The bank stress tests continue the fine American tradition of punishing the victims. Since 2012, the stress tests have devolved, from a modestly useful annual process focused on the top institutions to a monumental waste of time and money. This effort is focused on most of the US banking industry as measured by assets. The chief architect of this regulatory effort was former Fed Governor Daniel Tarullo, who was responsible for bank supervision and resigned earlier this year. Governor Tarullo turned the stress test process into a nearly continuous form of supervisory torment involving bank management, directors and legions of consultants and lawyers. JPM CEO Jamie Dimon remarked frequently about the cost of stress tests, living wills and the various other requirements of Dodd-Frank. On top of required levels of capital, the Fed under Tarullo’s leadership proposed capital buffers and capital surcharges partly based upon the subjective stress test performance of each bank. The stated point of this exercise is supposedly ensuring the safety and soundness of US banks, but the reality is far different because the process has shifted from a short-term focus on restoring confidence in bank debt to an annual media event that impacts bank equity. So intense is Wall Street's interest in how stress tests could affect bank earnings that even Fed Chair Janet Yellen has become involved in the media frenzy. And the stress tests contain no information that would be material to investors. Violating the traditional confidence of the supervisory process to release stress test results serves no useful purpose, especially given that the tests are different for each bank. There is no comparability one bank to the next. How are analysts much less investors supposed to use this chopped salad? First and foremost, the bank stress tests do not measure the ability of a bank to weather the types of market stress seen in 2008. As regulators have known for decades, income is the key determinant of a bank’s ability to offset credit losses. Income, net of provisions for future losses, is also a key factor when it comes to predicting a bank’s probability of failure and thus maintaining investor confidence. When a bank starts to show (or event hint at) red ink due to climbing credit costs, investors start to flee and liquidity evaporates. The amount of capital the bank may or may not possess is immaterial, as illustrated by the events of 2007 and 2008. The added uncertainty caused by off-balance sheet finance (using the very same SIVs made famous by Secretary Paulson) led to the failure of many large firms from 2008 onward. Yet the only time that a bank actually consumes capital is when the institution fails and its net assets are being sold. As shown by the situation facing Citi in 2008, the GSEs, and in Italy last week, by the time that we actually start talking about a bank’s capital, that institution is already dead. Second, because of the public nature of the stress tests, the Fed and other regulators have become the very public arbiters of bank dividends and stock repurchases. The annual process of conducting the Dodd Frank Act Stress Test (DFAST) and CCAR has become a dual yardstick for whether a given banking organization can increase dividends and/or share repurchases to meet Wall Street’s expectations. The fact of the Fed conducting the stress test initial process publicly in 2009 made this evolution to the public stress test process inevitable. But any benefit in terms of bank safety and soundness has been lost as the stress test exercise mutated into a media circus that each year precedes second quarter earnings by a week or so. From an equity market perspective, the Fed’s timing could not possibly be worse. Ryan Tracy at The Wall Street Journal notes: “The tests will continue to matter to investors. The Fed will still use them to audit banks’ plans to boost dividends and buybacks for shareholders, and the numerical part of the exams will still be crucial to determining those payouts.” So are stress tests good for bank stocks? No. The stress test process is part of the expanded regulation of the US economy by the Fed since the 2008 financial crisis. Dodd Frank has reduced the opportunities for banks to earn profits, while limiting their ability to provide new credit to support economic activity. Payouts to investors are now held hostage to the opaque annual stress test process conducted by the Fed and other regulators. American banks have been neutered as sources of alpha for investors. Through the prohibition of principal trading activities and any type of risk lending, banks have become low risk, no alpha platforms. The stress test process has transformed the capital finance dimension of banks into a regime similar to the rate setting process applicable to heavily regulated electric utilities. This is not a problem of bank management, but of our public officials in Washington. While the evidence continues to mount that over-regulation of banks is constraining economic growth and job creation, there are still voices in Washington that seek additional regulatory constraints on banking. Elizabeth Warren (D-MA) told The Wall Street Journal last week that President Donald Trump does not have a mandate to lessen regulation of banks. She said: “You do polls across this country, and I’m talking about polls of everybody—Democrats, Republicans, Independents, Libertarians, vegetarians, everybody. Somewhere in the neighborhood of 80% and upward believe that the largest financial institutions in this country need more regulation, not less regulation.” Senator Warren’s comment is right but only mimics what Teddy Roosevelt proved a century ago, that most people hate big banks. But is her prescription for more regulation a good idea in terms of public policy? Absolutely not. Warren’s comment suggests that politics, not substance, is her true motivation when it comes to yowling about bank regulation. But at least she is asking questions. Looking at the patchwork of regulations, punitive capital rules and meaningless stress tests that have been embraced by Congress since 2008, there is little that either protects the taxpayer or promotes a healthy banking system. The only thing that the current regime for U.S. banks ensures is that financials will have little upside in terms of equity valuations unless and until the regulatory situation changes. That was the whole point of the rally in banks stocks following the November 2016 election. At about 1x book value, today most bank stocks are fairly valued given the current regulatory regime and their business opportunities. Some of the better performers among larger cap names such as US Bancorp (NYSE:USB), Bank of the Ozarks (NASDAQ:OZRK) and Wells Fargo (NYSE:WFC) command higher valuations due to strong financial performance, but most banks simply do not deserve higher book value or earnings multiples in the current regulatory regime. The financial crisis is over. The DFAST/CCAR process needs to be ended as a public exercise. Future capital adequacy analysis by regulators should be performed privately as it was prior to 2009. The regulatory burden on banks needs to be reviewed with an eye to removing regulations that fail either to make banks safer or support economic growth. And remember that bad banks never die from lack of capital, they just run out of cash.

November 3, 2021 | New Residential Investment (NRZ) reported Q3 2021 earnings yesterday , providing an important window into developments in the mortgage industry. Unlike Mr. Cooper (COOP) , NRZ reported higher gain on sale margins in Q3 2021. Revenue almost doubled from Q2 2021, but expenses also increased and, of note, servicing revenue was flat sequentially despite the close of the acquisition of Caliber Home Loans in August. Source: NRZ Q3 2021 When NRZ closed the acquisition of Caliber, this added significantly to the firm’s top line as well as increased its mortgage servicing rights (MSR) portfolio. That said, the brisk rate of loan prepayments still visible in the industry took $421 million off the value of the NRZ MSR portfolio in the first nine months of 2021. These servicing assets as well as loans and MBS simply vanished in a cloud of prepayments, like magic. And no surprise, NRZ is still trading at book value. Source: NRZ Q3 2021 A big question facing NRZ and other mortgage lenders and investors is the rate of prepayments going forward. Since 2020, prepayments on NRZ assets soared to over 30% annual rates on average spread across the firm’s portfolio. NRZ claims that originations exceeded MSR run off in Q3 2021, something the firm shares with COOP and other market leaders, but only due to great efforts in terms of recapturing refinance opportunities. Source: NRZ Q3 2021 “During Q3’21, average portfolio speeds slowed for the third consecutive quarter but remain well above historical averages and have room for continued improvement as refinance burn-out continues,” NRZ states. “Newly created MSRs that are being added to our portfolio have a lower WAC and higher lifetime value than those paying off.” Well, maybe. If the Fed lowers rates again, those loans will prepay too. We have observed previously that NRZ and other hybrid REITs do not have the luxury of being picky when it comes to asset purchases. When your book is running off at 25% per annum, buying or creating new assets is your one and only task. And you must replace assets that prepay before you can log any incremental growth, one of the unfortunate effects of the radical asset purchase policies of the US central bank. Thanks to Jerome Powell and the rest of the FOMC, we have asset price inflation, but zero or even negative duration in markets, sending asset returns falling towards the zero bound. “Of course, it was not so long ago that lenders had primary-secondary spreads around 50 bps and lenders made more from the MSR’s monthly cash flows than they did on originating and selling a loan,” says Mike Carnes , Managing Director, Capital Markets MSR Valuation Group, at Mortgage Industry Advisory Corporation (MIAC) . “Now we are making more from origination than from the MSR. This has created incentives for buyers to pay premiums for MSRs in the hope of recapturing some of the refinancing from a pool of loans.” The folks at NRZ claim to have recapture rates in the ~ 70 percent range, but they are doing the calculation incorrectly – a common enough problem in the mortgage industry. For the record, the mortgage industry standard for calculating a recapture rate for an MSR portfolio is defined as: Recapture rate = recapture fundings / all payoffs Nothing is excluded. A good recapture rate across the industry is 20-25%. Some of the larger nonbank shops in the government sector get into the high 30s or better. Thus the restrictions on streamline refis of VA loans, for example, imposed by Ginnie Mae in a desperate but ultimately futile effort to slow prepayments on MBS. Folks like NRZ, however, apparently look at payoffs where they can match a new loan to the same borrower on the same property, i.e, a refinance. In the adjusted recapture rate, the denominator is ONLY REFI’s vs all payoffs. IOHO, that’s cheating. But we digress. While some observers believe that prepayment rates are likely to fall back down to 2020 levels, we remain skeptical of such statements. The simple reason is that the FOMC is unlikely to change the target rate for Fed funds until at least 2023, if ever. NRZ points to estimates of the 10-year Treasury reaching 2.5% yield by 2023. We politely disagree and note that dollar swap spreads are inside Treasury yields from five years on out. Do you think there is brisk demand for dollar assets? Hmm? Source: Bloomberg We’d be very surprised to see the 10-year Treasury breaking 2% or even maintaining current levels given the strong bid for risk-free dollar collateral. Also, any slowdown in the US economy will force a choice between supporting employment or fighting inflation. The former, politically speaking, is the only part of the Humphrey-Hawkins mandate that matters at the end of the day. Of course, if President Joe Biden continues to stumble politically and fails to reappoint Fed Chairman Jerome Powell for an additional term, then the interest rate calculous changes dramatically. With MD socialist and former bank regulator Lael Brainard as Chair designate, the 10-year Treasury yield would be at 3% before you can say “Goodnight Irene.” The NRZ earning release has some points of interest. For example: “U.S. house prices have been growing at a 21% annualized growth rate over the last three months as a result of competition among buyers for a dwindling national housing supply.” Does this fact and the purchases of a non-QM originator by NRZ suggest a peak in asset prices? To that point, the acquisition of Genesis Capital LLC from Goldman Sachs (GS) is another point of interest for investors. The market for non-QM loans, business purposes loans and fix and flip financing is a fringe market that exists in times of low interest rates and rising asset prices. As and when asset prices start to soften, however, the market for these loans likewise will start to evaporate as it did in April of 2020. In our view, if Genesis was such a great business, GS would not be a seller. We think that the GS folks are too smart for that and realize that the fringe market in mortgage assets is a transient phenomenon. Once again, NRZ is buying at the top of the market in order to increase assets and drive nominal earnings. They have no choice. Stay big or go home. In addition, while Caliber and Newrez Mortgage are being combined, there is still no hint of a spinoff of the lender from NRZ to finally separate the businesses from Fortress Investment Group and its parent company, Softbank . As we’ve noted before, the creation of an independent seller/servicer called Newrez a la PennyMac Financial Services (PFSI) to pair with the NRZ REIT a la PennyMac Mortgage Trust (PMT) , would greatly enhance NRZ CEO Mike Nierenberg’s efforts. A spinoff could unlock shareholder value and hasten the rebuild of NRZ after the 2020 meltdown and subsequent prepayment blizzard c/o the Federal Open Market Committee. Creating a good comp for the NRZ empire created by Michael Nierenberg and his team is just one reason for doing a Newrez spinoff, and sooner rather than later. The notorious Japanese investment firm that owns Fortress (and indirectly controls NRZ as the external manager of the REIT) has been involved in a number of dubious investment schemes , including Wirecard and WeWork , to name the short list. Softbank is now reported to be considering the sale of Fortress, which it acquired in 2017. That is great news for NRZ shareholders. The Softbank purchase of Fortress never made sense to us. Of note, Bloomberg News reports that the Committee for Foreign Investment in the US (CFIUS) placed limits on Softbank’s corporate control of Fortress . Bloomberg reported: “To win approval from the Committee on Foreign Investment in the U.S., SoftBank agreed to cede any control of day-to-day operations of Fortress. Since the transaction closed in December 2017, Fortress has been run independently.” We think it speaks volumes as to the perception of Softbank by the US government that CFIUS would put such extraordinary limits on CEO Masayoshi Son’s control of a financial firm. CFIUS limits on direct foreign investments in the US usually are driven by national security concerns. Fortress founder Wes Eden is a leader in the world of finance, of course, but the CFIUS restriction on Softbank’s investment in Fortress is remarkable nonetheless. SoftBank shares have tumbled about 21% this year in Tokyo trading, compared with the 8% gain by the Nikkei 225 Index, Bloomberg reports. The good news is that NRZ is growing and making strides in terms of asset creation and, especially, asset retention. The days when lenders could retain servicing for years and years are gone thanks to the FOMC. Duration is now zero. A blizzard of prepayments in both residential and small business loans has driven most of the hybrid REITS into the fringe markets of non-QM loans and fix & flip financing. NRZ today is the fourth largest originator in the US, but the asset mix is changing rapidly for all originators as they chase both yield and hopefully duration outside the world of agency loans. Disclosures: NLY, CVX, NVDA, WMB, BACPRA, USBPRM, WFCPRZ, WFCPRQ, CPRN, WPLCF, UWMC (s), RKT (s) The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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.

January 31, 2022 | In this issue of The Institutional Risk Analyst, Chris Abate , CEO of Redwood Trust (RWT) , discusses the world of non-agency mortgages after two years of COVID pandemic and related responses from the Federal Open Market Committee, Federal Housing Finance Agency and other state and federal organizations. Prior to 2008, half of all mortgages written in the US were private. Now almost 15 years on, some lenders are addicted to government subsidies for borrowers who don't need them, Abate writes, but regulators are rediscovering a trusted partner in the private mortgage sector. In January of this year, the FHFA revised the GSE Enterprise Pricing Framework by increasing upfront fees (also known as loan-level pricing adjustments, or LLPAs) for certain high balance loans and loans on second homes. These changes are in keeping with the GSEs’ core mission of supporting sustainable homeownership and affordable rental housing. The changes will concentrate support to borrowers most in need of the valuable, and subsidized, liquidity that the GSE loan programs provide. As a partner to the GSEs and a leading voice for quality and innovation in the housing finance sector, Redwood Trust applauds this move by the FHFA. Not surprisingly, however, not everyone is supportive. There remain a number of lenders and their K Street lobbyists who prefer cheap credit regardless of the cost to taxpayers. They promote nonfactual scare tactics or alarmist arguments in hopes of maintaining status-quo subsidies – and easy profits – for loans to higher income borrowers. The recent LLPA increases put forth by FHFA Acting Director Sandra Thompson were a bold move. They are the clearest acknowledgment yet that government subsidization of certain parts of the mortgage market is unnecessary when the private market continues to serve them efficiently. By focusing GSE capital and resources where they are needed most, the FHFA is achieving a few very important objectives: greater support for the GSEs’ mission-driven activities, increased safety and soundness, and the continued “crowding in” of private capital in areas where specialized underwriting and loan administration expertise can more effectively serve homebuyers. We all know the dynamics in today’s housing market are unprecedented. Record high home prices and an elevated demand for homes, with extremely low levels of inventory, characterize markets in many parts of the country. Without a rationalization of mortgage subsidies, the GSEs could assume unnecessary risk on mortgages to homebuyers with incomes well in excess of the median in their own neighborhoods. In fact, household income of two times the area median is often required to support debt payments on higher balance loans, assuming a reasonable debt-to-income ratio of 40%. These can hardly be described as “mission serving” borrowers, and the considerations in extending them credit are anything but homogenous. The upward trend of GSE purchases toward larger loans is already well established. High balance loans represented approximately 11% of GSE purchases in 2021, up from 8.2% in 2018. In addition, since 2018, the average size of a high balance loan purchased by the GSEs has increased 21%. (1) Source: 1010 Data, Falcon Capital Advisors Importantly, the GSE regulator also seems to recognize this trend and is taking action. Along with the LLPA increases on high balance loans, the FHFA recently rejected as insufficient the GSEs’ “Duty to Serve” plans, which among other things, outline efforts to provide liquidity for affordable housing in underserved markets. Today’s Private Mortgage Sector The role of the private mortgage sector, in a competitive sense, has always been to serve markets that federally subsidized loan programs don’t reach. And the fact is, Redwood and others have already demonstrated the ability to seamlessly fill gaps whenever the GSE footprint has been reduced, and to do so with no discernible impact on borrower’s interest rates or process efficiency. Just last year, the private sector collectively executed a 400% increase in securitization volume of Agency-eligible loans – responding immediately and effectively to regulatory shifts impacting the GSE financing of mortgages on non-owner occupied homes. And as the private sector expanded, it continued to offer rates to homebuyers that were near or better than those offered through the GSEs, underscoring the maturity of the private market. The chart below illustrates the relationship between conforming (GSE) and private sector consumer mortgage rates over the past several years, along with annual volumes. Borrowers continue to benefit from the strong presence of the private mortgage sector. It is now estimated that a typical borrower could see a marginal rate benefit of between 0.125% to 0.25% for high balance loans and 0.25% to 1% for second homes. Along with added purchasing power, consumers benefit from private sector sponsors with deep experience in the risk-based underwriting and pricing of their home loans. At Redwood, we help make quality housing accessible to all American households. We work in support of the safety and soundness principles emphasized by the FHFA to help ensure a strong and stable housing finance market. Since 2010, Redwood alone has purchased over $50 billion of loans from our origination partners and distributed them through a combination of private-label securitizations that we sponsor, and whole loan portfolio sales to leading depositories, insurance companies, and other quality institutional investors. Our emphasis on speed to closing and reliable execution has helped to institutionalize private sector workflows in tandem with traditional GSE workstreams. We’re also leading the charge to innovate in an industry that has long been characterized by archaic systems and processes. Some recent examples include our Rapid Funding program and our use of Blockchain technology in securitization, reflecting our commitment to ensuring a powerful liquidity alternative for home owners as regulators determine the future priorities of the GSEs. We see a bright future ahead for the private label loan market and, again, applaud the FHFA for having the courage to let the markets work best for those borrowers who clearly need no assistance from the taxpayer.

January 27, 2022 | In this Premium Service issue of The Institutional Risk Analyst , we return to Citigroup (C) , one of the top three banks in the US and among the highest risk franchises in the US financial services industry. Founded in 1811, Citigroup was a banking pioneer in the early 20th Century, establishing outposts in retail banking markets from Europe to Africa and the Middle East, to China and Japan, and later Mexico and the Americas. Now the offshore empire of Citi is being dismantled under CEO Jane Fraser , including the retail banking business in Mexico just south of the US border. The model going forward apparently is international capital markets, private banking and subprime consumer lending in the US. When the rationalization of Citigroup is complete, will the Citi that Never Sleeps still have a reason to exist? Source: Google In Q4 2021, Citi reported down revenue in single digits, but a 33% drop in earnings due to rising operating expenses and the cost of disposals. Even a significant release of loan loss reserves could not put a good face on a messy quarter that included a $1.2 billion charge for winding down the Korean retail business. Citi has announced agreement with UOB Group (UOB) on the sale of Citi’s consumer banking franchises in Indonesia, Malaysia, Thailand and Vietnam. E ven if we are mindful of the costs involved in the disposal of these businesses, and the fact that Citi and other banks are often light in Q4, the performance at Citi was especially disappointing but not surprising. Over the past five years, Citi has underperformed the top-five banks in terms of both operational factors and equity market valuations. With the exception of Wells Fargo (WFC) , which continues to suffer from the dysfunction within the CSUITE, Citi has trailed the group. JPMorgan (JPM) and Bank of America (BAC) have been the best performers in terms of stock price, but we’d argue that the value destruction at BAC under CEO Brian Moynihan has been far worse than the studied mediocrity of Citi. For reasons apparent only to behavioral psychologists, Buy Side managers cannot help but buy BAC for their clients’ portfolios, one reason this name is consistently among the most actively traded large bank stocks. Citi's business mix is high-risk and highly variable, as illustrated by the fact that Q4 2021 earnings were less than half of Q1 2021. Even with the higher spread on its consumer loan book, Citi's costly funding mix and operating expenses leave shareholders short compared with JPM or USB. Over the past month, of interest, the performance of the top-five banks has inverted, with WFC outperforming the group, followed by U.S. Bancorp (USB) . Notice that JPM, which missed badly in Q4 2021 earnings, is now the laggard with BAC #4 in the group. As banks retreat from some of the lofty equity valuations seen in 2021, the group is going to start to more heavily reflect fundament performance and less the hopes and dreams of Buy Side Managers, who mostly have no idea about bank operations. The degree to which quantitative easing or “QE” by the Federal Open Market Committee has boosted bank valuations – this even as fundamentals have declined rather precipitously – will no doubt be a subject of interest for researchers in years hence. Source: FDIC/WGA LLC One CIO asked us this week about why Citi has been engaged in a “fire sale” of assets. The simple answer is that many of these business have such poor operating performance and therefore elevated efficiency ratios that Fraser had no choice but to cut and run. The chart below shows efficiency ratios for the top-five BHCs plus Goldman Sachs (GS) and Peer Group 1. Notice that C, BAC and WFC all have efficiency ratios above the Peer average, while JPM and USB are below. Source: FFIEC For large banks today, an efficiency ratio starting with a “5” is the goal, but Citi and other large banks have been losing ground in terms of profitability since 2019 under the constant pressure of the Fed’s QE. In addition, much like the General Electric (GE) of old, Citi in many ways is a legacy conglomerate. It is comprised of business lines that did not necessarily make sense, either as standalone units or as part of a larger whole. Many of the offshore retail businesses that have been sold were simply too small. The poor operating performance historically also is attributable to another aspect of Citi, namely a small core deposit base in the US. Only half of Citi’s business is supported with deposits and only half of that is in the US. The chart below shows the top five BHCs and Peer Group 1. Notice that Citi is the weakest performer in the group besides WFC, which has suffered badly due to regulatory sanctions. Source: FFIEC Notice that the unweighted average of net income to average assets for the 132 large banks in Peer Group 1 is less volatile than the results for the largest banks. Where Citi has an advantage over other banks is the gross spread on its consumer loan book, a portfolio that is relatively sub-prime compared with the other top-five banks and Peer Group 1. Notice that Citi’s gross spread on loans and leases is hundreds of basis points higher than the rest of the group. Source: FFIEC The strong cash flow from the consumer lending business has been an important part of the Citi revenue model for many years, to some degree offsetting the poor operating metrics of the offshore retail banking businesses. The loss rate on Citi’s portfolio, however, is also elevated compared with the other four banks in the top five. In many respects, monoline credit card lender CapitalOneFinancial (COF) is a better comparable for Citi’s consumer business than is JPM or BAC. Source: FFIEC The final piece of the puzzle that helps us to understand the mediocre operating performance of Citi is the cost of funds for the group. As the chart below illustrates, the cost of funds for C is considerably elevated compared to its asset peers and the unweighted average of the 132 banks in Peer Group 1. This relatively expensive funding is a major structural disadvantage for Citi, especially in a period of high credit losses. Source: FFIEC The current strategy of Fraser to finally, after years of delay and obfuscation, sell the underperforming offshore retail business leaves Citi with a two-legged strategy in a four legged banking market. The bank has no retail banking business outside of a few MSAs in the US and no asset management strategy, with the sale of Smith Barney to Morgan Stanley (MS) . Citi’s capital markets unit is limited, although as we noted in our last comment, C has the second largest derivatives exposure after JP Morgan and Goldman Sachs. In past years, we have joked about merging Citi with Deutsche Bank (DB) , another global banking institution with a limited core deposit base and a weak middle market banking presence in any market. A combination would at least consolidate two second-tier investment banks, but leaves unanswered the basic question we ask again and again: Why does this bank exist? What market does it serve and how will it grow in the future? The exchange between analyst Mike Mayo and Jane Fraser during the Q4 2021 earnings call illustrates the point . During the Cold War, Citi was an outpost serving American interests in all the right places around the developing world. The irony of Citi selling the retail business in Mexico while keeping the problematic private banking business will amuse long-time students of the bank's operational troubles when it comes to money laundering. Today, like DB, this $2.3 asset bank has lost its reason to exist. Ultimately, the history of Wall Street’s institutional money center banks has been one of atrophy and eventual consolidation. The weak have bought the strong. The only problem is that today, in 2022, there is no obvious suitor for Citi. The IRA Bank Profile is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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 IRA Bank Profile. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The IRA Bank Profile are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The IRA Bank Profile represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The IRA Bank Profile is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The IRA Bank Profile 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 IRA Bank Profile. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 25, 2022 | This week The Institutional Risk Analyst is in Nashville for the MBA’s Independent Mortgage Banker (IMB) conference. The good news is that the latest wave of COVID seems to be receding even as home prices continue to climb. The bad news is that this week the FOMC is “continuing discussions” about reducing the size of the Fed’s $8 trillion securities portfolio. But recall, the Fed is still buying bonds and has yet to hike short-term rates. How will this uncertain environment impact banks and nonbank lenders? Investors are struggling with price inflation in many goods markets even as the financial sector deflates. Telltale indicators of asset price inflation, Bitcoin tokens and Tesla (TSLA) chief among them, are both sagging as the week begins, but let’s not lose perspective – yet. Spreads have a long way to go before we return to the crisis levels of Q1 2020. And we are not nearly ready to go shopping. Just as equity investors are having a tough time making decisions about risk, on or off, the bond market is relatively tranquil, in large part because the FOMC has done an above-average job of telegraphing change. Think of it as a social learning process. As in 2018 and 2019, the FOMC is going to raise interest rates and deflate its portfolio at the same time . You'd think that Powell & Co have learned by now that tightening target rates while draining liquidity is a bad strategy, but apparently not. In 2020-2021, the Treasury was the big market mover and the FOMC was forced to accommodate massive spending plans and the aftereffect of those fiscal actions. In 2022, however, the FOMC is the big mover, even as the predicted fiscal wave from Washington is subsiding into the more familiar pattern of inaction. James Lucier of CapitalAlpha Partners wrote last week: “It’s now officially Build Back Smaller,” this after the Biden Administration abandoned most of its legislative agenda. The FOMC continues to buy MBS. The buy on Friday was $3.7b, compared to $3.3b in the previous session. As the FOMC struggles with the monstrous pile of assets that has been accumulated over the past 18 months, investors will come to understand how the shrinkage of bank reserves and the coincident decline in Treasury and MBS issuance is going to impact US interest rates. That is, collateral is becoming scarce. Assuming that the Fed does stop new purchases in March, net supply of MBS this year could reach $600 billion, but there is no shortage of buyers. Robert W. Baird writes: "GSEs purchased $595.1 billion of newly originated loans in 3Q, a 16.1% decline from the previous period. That represented 71.8% of conventional-conforming origination during the period, the lowest securitization rate since 2019.” Source: FDIC This is not about the yield on the 10-year Treasury note understand, but instead about a tectonic shift in the distribution of risk-free assets and how this change impacts spreads for MBS and other debt instruments. Changes in credit spreads, though uninteresting to equity markets, ultimately drive stocks, especially when the Fed has been manipulating the markets for years. Increased credit spreads mean lower economic growth. “We saw a 20 bp rise of HY-Ts on Friday and 1 bp rise of BBB-AA,” notes Fred Feldkamp . “By my index, that's a 61 bp decrease in US marginal efficiency of capital. At roughly $5 billion per bp per year, Friday alone ate up capital growth at the rate of $305 B per annum ($3 T over 10 years). If it was not clear that over leveraged firms will soon be forced to report reductions of earnings due to expectations of higher rates, it certainly is clear now.” Despite all of the bloodshed in MEME stocks and crypto, the damage to more pedestrian sectors of the stock market is limited. As the screenshot below illustrates, the banking world is relatively unaffected albeit somewhat cheaper than at year-end. To Feldkamp’s point, notice that JPMorgan (JPM) and Goldman Sachs (GS) , two firms with outsized global market exposures, are underperforming the group. Source: Bloomberg Both JPM and GS, of note, have derivatives exposures that could wipe out the capital of both banks several times over, but most other US banks avoid such risks. At the end of September 2021, total derivatives exposure at JPM and GS were 1,345% and 2,800% of total assets, respectively. Citigroup, by comparison, was only 1,818% of total assets at the same date. The average for all large US banks in Peer Group 1 is 28%. With American Express (AXP) trading north of 5x book and U.S. Bancorp (USB) near 1.8x or now a premium above JPM, the world is not yet ready to end. But the fun in the world of MEME stocks and pretend assets is clearly at an end. JPM strategist Peng Cheng noted yesterday that small investors are heading for the door, selling $1.4 billion in stock before noon Monday. The key question for risk managers is to differentiate between stocks that have been grossly inflated by the FOMC’s action and general market exuberance, and to what degree. If you look at valuations for banks back in Q1 2020, for example, the whole industry has essentially gone sideways for two years. If we look at names such as TSLA, NVIDIA (NVDA) and Rocket Companies (RKT) , on the other hand, the story is very different. The moral of the story is that volatility is now a permanent fixture in many markets, especially those assets where FOMC policy has inflated prices excessively. Securities markets can reprice in minutes or hours. Less efficient markets like residential real estate could overshoot for the next several years. But there are large sectors of the US equity markets that are relatively unaffected by the gyrations so far. The world is not ending just yet. In the meantime, do watch those credit spreads in coming weeks.

I used ta do a little but a little wouldn't do So the little got more and more I just keep tryin' ta get a little better Said a little better than before I used ta do a little but a little wouldn't do So the little got more and more I just keep tryin' ta get a little better Said a little better than before " Mr. Brownstone " Guns & Roses (1987) January 21, 2022 | As we enter the last week in January, it is becoming pretty clear that the FOMC has lost all credibility when it comes to financial markets or managing inflation. Market stability, lest we forget, has been a managed concept since 2009, thus when the FOMC decided to explicitly lean in the direction of "liquidity" (aka inflation) and forget the rest of the Humphrey Hawkins mandate regarding price stability, the cost was paid in credibility. Of course there is a 1:1 correlation between the Fed's credibility and its loss of independence from the US Treasury, the primary beneficiary of QE. Bill Nelson at Bank Policy Institute published an important article on January 11, 2022: “ The Fed is Stuck on the Floor: Here’s How It Can Get Up .” Nelson describes how the FOMC under Jerome Powell deliberately chose inflation of the Fed’s balance sheet as a means of managing the liquidity stress that almost cratered the US money markets that year and in December 2018. He wrote: “The Fed announced that it would conduct monetary policy by over-supplying liquidity to the financial system, driving short-term interest rates down to the rate that the Fed pays to sop the liquidity back up. Previously, the Fed had kept reserve balances (bank deposits at the Fed) just scarce enough that the overnight interest rate was determined by transactions between financial institutions; those transactions consisted of banks with extra liquidity lending to those that needed it. Now the rate is determined by transactions between banks and the Fed. Moreover, the Fed has committed to providing so much extra liquidity that it would not need to adjust the quantity of reserve balances it is supplying in response to transitory shocks to liquidity supply and demand.” Now it goes without saying that the Humphrey-Hawkins mandate is impossibly conflicted, as we wrote in American Conservative . You cannot have price stability and full employment at the same time. But when people like Chairman Powell and his predecessors, including Treasury Secretary Janet Yellen and former Fed Chairman Ben Bernanke , decide to play g-o-d with the global financial markets, bad things happen. The inflationist chorus of economists who decided that deflation was a “problem” essentially convinced the FOMC that a little inflation was a good thing. Our friend Fred Hickey , publisher of The High Tech Strategist , reminds us of the words of Ludwig von Mises , who predicted the age of inflation in the US fifty years after the passage of Humphrey Hawkins: “The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation…. What generates the evil is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the ultimate boom has caused.” Hickey adds that the fact that global central bankers, led by celebrity politicians like ECB chief Christine Lagarde , figured out that if they all printed money at the same time, they could inflate their slumping economies without the nasty penalty of currency devaluation. “The end result of their collusion was that the boom lasted much longer than it would have normally,” Hickey wrote, “and now we’ll have to deal with more severe consequences.” The great inflation of 2020-21 will be reckoned as one of the blackest periods in the history of the Federal Reserve System, but the intellectual and institutional rot goes back more than a decade to 2008, when many senior officials of the US central bank lost their nerve after watching the US financial system nearly melt down. The central banker rule book written by the likes of Martin, McCabe and Volcker was tossed out the window of 33 Liberty Street, leaving only a culture of accommodation and endless liquidity that was cheered by liberal politicians. The start of QE in 2009 under then- Fed Chairman Bernanke was the beginning of the end of the Fed’s credibility. Bernanke laid out the rationale for providing endless liquidity support in a 2009 speech at the Bank of England : “The abrupt end of the credit boom has had widespread financial and economic ramifications. Financial institutions have seen their capital depleted by losses and writedowns and their balance sheets clogged by complex credit products and other illiquid assets of uncertain value. Rising credit risks and intense risk aversion have pushed credit spreads to unprecedented levels, and markets for securitized assets, except for mortgage securities with government guarantees, have shut down. Heightened systemic risks, falling asset values, and tightening credit have in turn taken a heavy toll on business and consumer confidence and precipitated a sharp slowing in global economic activity. The damage, in terms of lost output, lost jobs, and lost wealth, is already substantial.” Rather than allow the private markets to reset after the mortgage bubble of the 2000s, Bernanke and his colleagues on the FOMC embraced inflation. Readers of The Institutional Risk Analyst know that the problem with QE and the other liquidity measures put in place by the FOMC is that they cannot be stopped without severe deflationary consequences. If the Fed stops buying securities for the system open market account (SOMA), then reserves start to fall and with it the aggregate level of bank deposits. As reserves fall and banks are forced to buy Treasury debt and GNMA MBS for their reserves, interest rates fall and collateral becomes scarce. Imagine what happens to short-term interest rates, for example, if the $1.6 trillion in reverse repurchase transactions moves back into Treasury and agency securities. The chart below shows the S&P 500 and the Fed's portfolio. Nelson notes that any program by the FOMC to now shrink its balance sheet must be accompanied by more robust open-market operations to deal with any “transitory” liquidity pressures. But now that the global equity markets have grown accustomed to trillions of dollars in excess liquidity, going back to the pre-2019 system of fine tuning is likely to be a rough ride. Nelson concludes: “The Fed is on track to stop expanding its holdings of securities by March 2022, and it is currently making plans for whether and how to reinvest payments of principal. If the Fed allows principal to be repaid without reinvestment, its securities portfolio will decline, reducing reserve balances and the ON RRP. Most likely, the Fed will reinvest payments of principal for a while before beginning to shrink. If it were to reinvest in Treasury bills rather than longer-term securities, it would be able to shrink more quickly once it decides to do so. Consequently, now is a critical time for the Fed to receive input from policymakers outside the Fed and from the public about how it should conduct monetary policy and its role in society.” Chairman Powell is already receiving a lot of “input” about the future course of US monetary policy. As the FOMC desperately attempts to regain lost credibility, the US financial markets could be in for an extended period of volatility and confusion. As the central bank redefines what is meant by price stability, asset classes from MEME stocks to crypto tokens to Treasury securities will all come under selling pressure. And appointed officials like Yellen, Bernanke and Powell may not survive the adjustment process, at least in political terms. There is, after all, nothing new in this world when it comes to inflation.