SEARCH

New York | There are a number of factors that have led to the historic gains seen in equity markets since the election of Donald Trump and the subsequent tax cuts, especially when it comes to financials. Some of these assumptions were never realized, others no longer pertain. Number one was the idea that tax cuts would drive an increase in economic growth, and thus add more borrowing volumes for banks. Overall, the promise of tax cuts has yet to arrive for the banking industry when it comes to credit volumes. JPMorgan Chase (JPM) did manage to turn in some impressive lending growth, mostly in credit cards. But the overall financial performance of JPM came due to some one-time events, benefits on the legal expense line and a big pop in principal transactions. Lending fees and loan volumes overall rose a whole 2% year-over-year (YOY). The Trump tax cuts added four hundred basis points to bank equity returns this quarter, but the top line remains constrained. With EPS of $2.38, JPM’s basic earnings per share rose 40% YOY. Return on equity rose to 15% according to the JPM IR supplement. Notable for readers of The IRA Bank Book , JPM’s interest expense rose 47% in Q1 2018 vs the same period a year before. Meanwhile, interest income increased just 18% year-over-year, resulting in a substantial reduction in net interest margin (NIM). In many parts of the financial media, you still hear happy talk from economists about expanding net interest margins for banks as the Federal Open Market Committee takes the Treasury yield curve negative. But that clearly is not the case. Economists are often wrong, especially when they wander into the world of finance. Pay attention to this relationship between interest income and expense as 2018 continues and the yield curve flattens, as shown in the FRED chart below. At Citigroup (C), which like JPM is more market sensitive in terms of liabilities than the industry norm, interest expense rose 44% YOY in Q1 2018. Interest income was up a mere 12% YOY. Other than shrinking NIM, what this suggests, at least for JPM and C – some $4 trillion in assets and the two biggest OTC derivatives shops on the planet – is less return from float going forward. Interest earnings, lest we forget, account for the lion’s share of equity returns in both cases. But we digress. Aside from the lack of a demand-pull surge from the Trump tax cuts, banks have not seen the increase in corporate investment predicted by so many economists as a result of cash repatriation. In fact, most companies have paid their tax bill w/o moving the cash concerned. As we noted in January of this year (" Tax Cuts, Offshore Cash & Jobs "), this is known as “deemed repatriation” at the Internal Revenue Service. Another, third, big factor that helped drive the maniac bull rush in financials during 2017 and into February of 2018 was the prospect of deregulation. There have been a number of meaningful changes made since 2016 under administrative rules, in particular the appointment of OMB head Mick Mulvaney to run the Consumer Financial Protection Bureau. But the Trump Administration has been slow to fill regulatory positions, like Fed governors and FDIC directors. The much awaited financial reform “reform” legislation started with the Choice Act (Versions 1&2) sponsored by House Financial Services Committee Chairman Jeb Hensarling (R-TX) but was quickly narrowed down to what could garner a majority in the Senate. The original Choice Act had a broad reform of the CFPB, which is now totally gone. Senate Banking Committee Chair Mike Crapo knew that Hensarling’s Choice Act was a non-starter in the Senate. He got together with members of both parties and focused on reform for small banks, which has bipartisan support. The regulatory reform legislation that has passed the Senate is very modest indeed. The Crapo Senate bill is not a strong, broad reform proposal, but it was supported by 16 Democrats. The result is a very narrow bill which is now pending in the House but has so far not moved from the House Financial Services Committee. The IRA hears from several well-placed sources that any attempt to modify S. 2155 will doom any chances of regulatory reform this year. For example, the legislation passed by the House to streamline the Volcker Rule is the top priority of the large banks. It may be added to S. 2155 by Chairman Hensarling, but this will likely kill the legislation. So far Hensarling is not "backing down," whatever that means. Just what constituency Hensarling is serving by taking an intransigent position on S. 2155 is debatable, but the fact is that he is one of the least productive House FSC Chairs in recent memory. Hensarling could be noble and get something done as his tenure ends, but few are betting on that outcome. There are a number of Democratic Senators who signed onto S. 2155 who took a good amount of heat from Senator Elizabeth Warren (D-MA) and other far-left Democrats. And keep in mind that this is really not a Dodd-Frank reform bill as much as relief for small banks and mortgage companies. There is very little if any lift contained in the Senate legislation to help large banks. And changes to the Volcker Rule are DOA in the Senate. Bottom line: S. 2155 must get passed as is or it will die when it comes back to the Senate with amendments. The bill would get no Democratic support. We do not expect S. 2155 to get out of committee in the House. Even if Dodd-Frank reform is dead this year, that does not mean that there is no deregulation in Washington. The tenure of Mick Mulvaney as acting director of the CFPB is perhaps the most significant. Mulvaney put a stake in the heart of regulation by enforcement, a key issue for the mortgage industry. Mulvaney says he is not going to use Section 5 of the Federal Trade Commission Act (FTC Act), 15 USC 45(a)(1) (a/k/a “UDAP”), which prohibits "unfair or deceptive acts or practices in or affecting commerce." The impending $1 billion fine against Wells Fargo (WFC) by the CFPB and the OCC is an example of how Mulvaney will use the power of the CFPB when actual harm is done to consumers. But it needs to be said that the past regime of regulation via enforcement, with no due process or public guidelines for compliance, was outrageous, even by the usually irrational standards used by most progressives. Most people in the mortgage or consumer finance business, if they make a mistake and a consumer is harmed, they will make good. They don’t need to be sued. By bringing the CFPB into alignment with the FTC and other agencies when it comes to UDAP, Mulvaney has restored some modicum of fairness and balance to an agency that was run more like the Spanish Inquisition, with Richard Cordray as Torquemada. While having Mick Mulvaney at CFPB is certainly not a bad thing for banks, it is far from the wave of deregulation that was one of the original drivers of the bull market in financials. Indeed, as time slowly runs off the legislative clock, it is increasingly clear that there may be no significant financial reform legislation passed this year. This represents yet another failed promise for financials at a time when sources of support for current market valuations are dwindling.

New York | This week The Institutional Risk Analyst is travelling to San Francisco for the Executive Roundtable, a conclave of mortgage professionals that meets twice a year to discuss issues facing the housing finance industry. We’ll be reporting to the group on the progress – or lack thereof – in adopting the technology known as “blockchain.” Some of our findings follow below. A “block-chain” is the transaction validation technology behind bitcoin and other crypto currencies. It has a very high price in terms of per unit transaction cost, but has some promising qualitative possibilities. The technology combines industrial strength encryption with a public ledger that allows market participants to validate transactions collectively. Blockchain by design is extremely inefficient in order to achieve its primary purpose, namely security, but has the advantage of a public transaction record In a survey of the mortgage industry and other domains, to date we are not able to find any commercially successful adoptions of the blockchain technology. Despite an enormous amount of hype and billions of dollars in funds invested, the combination of 1) encryption and 2) public ledgers has yet to find a viable use case – other than crypto currencies such as bitcoin. Ironically, the strong cryptography of blockchain has failed to protect the network from hacking and fraud, raising basic issues about the cost-benefit tradeoff of this type of approach. And the high cost and other operational considerations has so far thwarted efforts to drive adoption. Consider some recent developments: “Decisions by Depository Trust & Clearing Corp., BNP Paribas and SIX Group to stop working on blockchain projects reflect Wall Street's concerns about industry readiness and cost” – Rob Chrisman “Wall Street has been much more excited about the system underpinning bitcoin than the cryptocurrency itself, but the global financial industry has not yet been able to do much with the technology known as blockchain” Reuters "Basically, [blockchain has become] a solution in search of a problem" – Murray Pozmanter, MD, DTCC As initial enthusiasm for the blockchain technology ebbs, party due to the hype and chicanery surrounding the multiplying crypto currencies, some observers are starting to argue in favor of using a distributed ledger technology (DLT) without the costly encryption component of crypto currency schemes. One possible use case for the mortgage industry is the documentation of title transfers for residential mortgages, an area that is rife with fraud and inaccuracy. “Since the financial crisis of 2008, there has been a certain level of distrust with respect to residential mortgages. This distrust is rooted in the secondary mortgage market, in which thousands of residential mortgage loans were originated and then sold and assigned to successor lenders and/or trustees, sometimes multiple times,” notes Michael Reyen, writing in American Banker . But hope springs eternal. Last week, Ranieri Solutions, a financial services technology investment firm founded by Lewis S. Ranieri, father of the securitized mortgage market, announced a partnership with Symbiont , to explore opportunities to use Symbiont’s blockchain platform to improve all aspects of the mortgage industry. “The mortgage market, despite significant efforts, continues to lag behind from a technological standpoint creating inefficiencies that impact mortgage loans throughout their life cycle,” say Ranieri. “By partnering with Symbiont, a proven blockchain pioneer, Ranieri Solutions believes that together we can implement this transformative technology to bring necessary efficiencies, transparency, and security to the mortgage markets.” While improving the system for conveying and documenting ownership of residential homes is clearly a valid goal, it is far from clear that blockchain is the right technology solution for the problem. Property records are the unique province of the various states. Although there is obviously a need to improve the property sale and title recordation process, the chief obstacles to change are political and bureaucratic. Amendments to the Uniform Commercial Code and the Blue Sky laws for the securities industry provide a political roadmap for such an adoption process, but blockchain may not be the right solution for this task. Coming out of the 2008 financial crisis, the states, Congress and the mortgage industry fashioned a national standard for the foreclosure process via legislation, litigation and enforcement actions. In the case of property records, there is no immediate political catalyst to bring the states together and have them voluntarily adopt a treaty mandating a consistent recordation and disclosure system for real property transfers. And, again, it is far from evident that a DLT type approach is the best way to address the need for better property records. “The Deloitte Center for Government Insights found last March that land registration was the second most popular area of focus for public-sector experiments being conducted with blockchain, behind digital payments and currency,” reports Rob Chrisman. And Bert Ely, writing in The Hill , starts to suggest a practical roadmap to make such an enhanced property recordation system a reality: “A real-world application of DLT will occur only if it makes economic sense. An application that minimizes the potential for fraud, is highly accurate and very fast in executing transactions will not be implemented if it is more costly to operate than an alternative, less sophisticated technology. The pursuit of accuracy strongly suggests a central authority or governing body must oversee a specific application of DLT in a ‘permissioned’ environment, with pre-agreed rules and procedures to ensure the accurate entry of transaction data into the DTL ledger, the prompt correction of data-entry errors and overall data integrity.” Of course anything is possible given enough time and expenditure, but we continue to believe that the blockchain is a solution in search of a use case. The qualitative benefits of a DLT, for example, impressive as they may be, do not offset the additional cost of using this technology. In that regard, blockchain seems to violate the Three Laws of Silicon Valley – cheaper, better, faster – for the adoption of a new technology. In the case of the mortgage industry, improving the way in which property records are updated and maintained is clearly a desirable objective. But we think that before such a system is considered, the various states need to agree on a consistent national data template for property records. This all sounds great in theory. The tough part is doing the heavy lifting to make it a reality. Until then, blockchain will remain a clunky, very expensive solution looking for a relevant problem. #blockchain #chrisman #RanieriSolutions

Sarasota | Why are financials selling off as earnings season starts next week? Large cap banks such as JPMorgan (NYSE:JPM) led the markets higher earlier in the year, but have since underperformed the markets. What gives? First and foremost, when the markets are looking for a reason to sell, large cap financial names usually catch more that their share of attention. Remember that Wall Street only ever cares about the top 10-names in financials by market cap. When the thundering herd sells, banks usually get a disproportionate share of the short volume. The sector accounts for about 15% of the S&P 500. When a broad selloff is underway, look for financials to participate and then some, both in terms of cash and the highly liquid derivatives. Second, financials are overvalued – still. When JPM peaked at just shy of $120 per share on February 26th of this year, the market leader was trading just shy of 2x book value. The stock is still up 15% over the past six months vs single digits for the S&P 500. JPM has single digit equity returns and no real growth in terms of revenue. Hit the bid. Third and most important is the question of net interest margins and financial repression. In the inaugural edition of The IRA Bank Book , we discuss why the banking industry is facing a squeeze on margins thanks to the Federal Open Market Committee. Few analysts on the Street know or care about this looming threat to bank profits. At present, the US banking industry is earning about $130 billion per quarter in net interest income from loans and investments, but is paying depositors and bond holders a mere $20 billion per quarter for funding. This skew in favor of bank equity holders has been extreme since 2008, but the issue of financial repression goes back to the 1990s. Ponder the chart below. Source: FDIC In Q4 2007, when US banks grossed $180 billion from loans and other earning assets, they paid depositors and bond investors almost $100 billion. In 2015, the total cost of funds for the US banking industry was just $11 billion per quarter, but the industry booked $110 billion in net interest income. Get the joke?? Bank depositors and bond holders should be earning more like $40-50 billion per quarter. Today yields on deposits and fixed income securities are rising faster than the yields on bank loans. Just as the FOMC suppressed the cost of credit for banks after 2008, now the financial engineering of former Fed Chair Janet Yellen has created an interest rate trap for banks a la the 1980s. For those of you who missed that party, in the 1980s funding costs for S&Ls rose faster than asset earnings, gutting the capital of the entire housing finance sector. The unfortunate demise of the S&Ls also created the opportunity for banks to get into mortgage lending a decade later with similarly disastrous results. We look for the cost of bank funding to rise faster than the yield on earning assets over the next two years, a situation that is likely to put an effective cap on bank earnings and public market valuations. The kicker in the analysis is that credit costs are also likely to rise faster than either revenue or pre-tax earnings, adding an additional headwind to financials as 2018 unfolds. See you on CNBC Squawk Box tomorrow ~ 8:00 ET. Further Reading Whalen, Richard Christopher, The Financial Repression Index: U.S Banking System Since 1984 (April 3, 2018). Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3155370

In this issue of The Institutional Risk Analyst, we feature a comment from our fellow fisherman David Kotok, Chairman & Chief Investment Officer of Cumberland Advisors (www.cumber.com), which was published earlier this week. A number of people have asked about the widening spread between LIBOR and the comparable rate in the US. The short answer is that, yes, it is a structural problem and may be a warning of future contagion ahead. Questions? Join us Thursday at the University of South Florida in Sarasota when we'll be talking about the state of the US banking industry and signing copies of " Ford Men: From Inspiration to Enterprise. " Today we look at the warning that the widening spread between the LIBOR rate and the OIS rate may be sounding about what lies ahead, given a two-pronged Fed tightening policy. Whether investors realize it or not, this spread (LOIS) impacts what strategies make for successful investing. This five-minute read will bring readers up to speed. We will start with Daniel Kurt's Investopedia post, " What is the OIS LIBOR Spread and What Is It For? ," from Feb. 21 of this year ( https://www.investopedia.com/articles/active-trading/061114/what-ois-libor-spread-and-what-it.asp ): "A decade ago, most traders didn't pay much attention to the difference between two important interest rates, the London Interbank Offered Rate (LIBOR) and the Overnight Indexed Swap (OIS) rate. That's because, until 2008, the gap, or 'spread,' between the two was minimal. But when LIBOR briefly skyrocketed in relation to OIS during the financial crisis beginning in 2007, the financial sector took note. Today, the LIBOR-OIS spread is considered a key measure of credit risk within the banking sector. (For a glimpse into the possible evolution of these two rates, read 'Will OIS Replace LIBOR?')" The LIBOR-OIS spread (or LOIS) has widened by twice the amount that the Federal Reserve has hiked rates. There are reasons for that, and we will discuss them below. But the impact of the LOIS's widening is at hand today. Think of it this way. The Fed sets the OIS as it determines the short-term policy rate. If the Fed wants to tighten policy by raising the short-term rate a quarter point, it has the complete power to do so. But the Fed cannot control those market forces that react to the Fed and to other factors. So if the Fed hikes a quarter point but market forces actually translate that hike into a half point, is the impact of the Fed's quarter point magnified and, in this case, doubled? We think the answer is yes. There are structural reasons why this magnification is occurring, and they are still in play. Hence the Fed is actually tighter than it would appear to be if we look only at the fed funds target rate and, by implication, at OIS. Three-month LOIS increased over a half point in the first quarter of 2018, while the Fed's policy target rate went up only a quarter point. And US Treasury debt management added to this mix. US Treasury bill yields are at their widest levels to OIS in fifteen years. They have widened in spread by a quarter point since the beginning of the year. At the end of the first quarter, three-month LIBOR was 2.30%. A year ago it was 1.15%. Thus the private sector has seen a 1.15% increase in this key interest rate. Note that about $200 trillion in global debt and derivatives prices daily from LIBOR. FRA (forward rates) used in foreign exchange derivatives are up 1% in the same period. So are US T-bill rates. And the new money market rules exacerbate these spreads. Meanwhile, the TED spread (eurodollar vs. T-bill) is wider than it was a year ago. I could go on, but the key point here is that the system is tighter by more than the Fed has tightened. There are at least six reasons: 1. Banks are reluctant to shift their liquidity pools out of the Fed (source: Joe Abate at Barclays). 2. Congress insists on perpetrating political shenanigans with the federal debt ceiling (BCA Research opinion). 3. Repatriation flows are adjusting cash balances worldwide, and the direct impact falls on the short-term money market end of the yield curve. 4. The Fed is shrinking its balance sheet at the same time it is raising the policy-setting, short-term target rate. (We think this approach is a potential double whammy for the markets. The Fed is playing with fire by trying to do two things at once.) 5. The new "base erosion and anti-abuse tax" (BEAT) was part of the 2017 tax code changes. It is causing dislocation in funding markets and driving some firms to use commercial paper (CP) as a way around the tax problem. But the CP traditional buyer was a money market fund that is now in the non-government group and can "break the buck." Using cross-currency swaps is an alternative, but banks "that used to be sources of structural demand for dollar funding (widening the basis swap) will require less dollar funding in the future. As a result, basis swap spreads tighten" (Deutsche Bank AG/London). 6. LIBOR is being phased out by 2021. The Alternative Reference Rate Committee (ARRC) wants to replace LIBOR with a new Secured Overnight Futures Rate (trading), or SOFR. Some banks are now leaving the LIBOR-setting pool in anticipation. There will be new SOFR futures contracts launched and trading. For the average investor this is a bewildering array of technical factors. We plod through all these factors ourselves in our daily work as we do the analysis on so many moving parts. Most investors have never heard of ARRC or SOFR, yet both impact their daily lives. Our issue concerns the businessmen and women who borrow using LIBOR as a reference rate. Their costs of funds are going up fast. And they are uncertain about future commitments since they know LIBOR is going away and they don't know what the market will do to replace it. And they are the ultimate target of Fed policy, for better or worse. For us there is a different question. We are puzzled by the Fed's silence on these impacts. The dot plots don't capture it. This issue is not about a GDP forecast. We are not talking about higher inflation expectations. No, this is about structural change and its impacts are broad. We worry that the Fed is setting things up for a slowing of the economy by being too doctrinaire and neglecting to acknowledge these structural changes. We worry that QT (quantitative tightening) is a dangerous force to combine with traditional interest rate normalization. We worry that the Fed has undertaken too much and is sailing the monetary policy boat into waters where the charts are incomplete. We think this policy error could be one of the reasons that the yield curve is flattening. At Cumberland our emphasis is on the higher-grade credits, whether muni or corporate or government. We are watching the distribution of credit and note Jim Bianco's observation that about half of the investment-grade debt is now Baa-rated. Jim points out that this percentage has nearly doubled from 25% in 1989. For Cumberland, that means about half the debt aggregate is off the table for our clients. We want to be sure our clients get paid. Bottom line: LOIS is screaming a message of warning. We know that members of the Fed are looking at this, but we wish there were more observations about it in their public statements. We don't expect the Fed to change its strategy. It is on a dual course of QT and rate hiking and will probably stay that course unless and until some shock occurs. So our professional stance is to worry. And we continue to search out and focus on high-grade credits. We think investors are poorly paid for chasing lower-grade or junk. #LIBOR #OIS #FOMC #KOTOK #CumberlandAdvisors #FederalReserveBoard #GIC

First we’ve launched the first volume of The IRA Bank Book , a review of the operating and credit performance of the US banking industry written for institutional investors. US banks have the best financial disclosure in the world, down to the portfolio level, a fact that allows analysts to dig deep if they care to spend the time. They don't. We’ve done the digging for you and present a macro level view of key industry trends. And best of all, you get to pay us for our work. Watching the continuing trials of HNA Group, we are reminded that the side effect of years of central bank largess will be an arithmetic reckoning when it comes to credit. The massive liabilities accumulated by the likes of HNA, Anbang Insurance and even Softbank will eventually come back to haunt these ambitious Asian debtors. And behind them stands the world’s most indebted state, namely China, governed by the paramount leader Xi Jinping. “And so castles made of sand, fall in the sea, eventually.” So wrote Jimi Hendrix in 1967, but he was talking about love not global investing, right? Our friends at Grant’s Interest Rate Observer recently cataloged China’s debt overhang in a comment appropriately titled for the Easter season: “Xi Jinping’s poisoned chalice.” They noted with typical understatement: “The whole world lives at the end of the whip of China’s credit growth.” Ditto. Especially when that growth is driven by an authoritarian state and makes no sense in economic terms. And yes the size of China’s financial pyramid is extraordinary, as befits a system where political concerns trump all other questions. The Chinese communists have taken the progressive model of money creation from the US and doubled down several times over! Everyone expressed surprise when the Trump Administration announced the imposition of tariffs on China. But readers of The Institutional Risk Analyst know that last November Leland Miller of China Beige Book pretty much called the start of the trade war down to the day . We asked author and intelligence analyst Jim Rickards what he thought of the timing and substance of the trade actions by Washington. "Many observers are shocked by the new trade wars. They shouldn’t be,” Rickards notes. “Trump has been talking about unfair trade and lost jobs for decades; long before he launched his political career. Unfair trade was a pillar of his speech announcing his presidential candidacy in June 2015 along with immigration and 'The Wall.' “Trump continued hitting the unfair trade issue hard throughout the campaign in 2016, and during the transition after he won the presidential election on November 8, 2016. He intended to make trade his first order of business upon being sworn in as president on January 20, 2017. But then the trade agenda was put on hold. Trump refrained from imposing tariffs in 2017, his first year in office, based on the advice of his national security team including National Security Advisor General H. R. McMaster, Secretary of State Rex Tillerson, and Secretary of Defense James Mattis.” “The national security team urged President Trump not to start a trade war because the U.S. needed Chinese help to avoid a war in North Korea. However, China did not do all it could to apply pressure on North Korea. Once China’s lack of cooperation on North Korea became clear by late 2017, Trump saw no harm in confronting China on trade. Now the gloves are off.” But even with the astounding numbers on China’s bad debt pile assembled by Grant’s and the sage political judgment of Jim Rickards, we remain unsatisfied in our search for an explanation of the behavior of Chinese dictator Xi Jinping. Sure, the country’s debt (aka the entire banking system) is enormous, the biggest of any industrial nation on earth. And yes, the political stars seem aligned for a trade war with the Trump Administration. But that still does no explain the level of disarray and haste seemingly driving the consolidation of political power in China. Uncle Xi is a man in a hurry. His moves to eliminate rivals in the Chinese Communist Party have come swiftly, as have belated moves to seize insurer Anbang and extend credit to the apparently insolvent HNA. But more to the point, the CCP’s tolerance for and even encouragement of the debt fueled spending spree of the past decade is unseemly. It evidences a degree of sloppiness and financial naiveté on the part of the CCP party leadership that raises questions about their chances of survival. Viewed in this light, Xi’s moves to consolidate power may be seen as defensive and reactionary. The thing western analysts have trouble accepting is that the Chinese economy is actually far weaker that the state-approved statistics suggest. Unemployment and massive bad debts are just part of an increasingly unstable situation in some Chinese provinces. China’s "One Belt, One Road" plan, for example, is a bad copy of the New Deal that is doomed to fail in terms of generating real, sustainable growth. But it will certainly add to China's debt. A trade war with the US will only exacerbate an already bad situation, where the CCP tries to manufacture internal economic demand via subsidies for dead companies and infrastructure projects that produce little or no return. The failure of Xi and the CCP to build a stable, sustainable economic system is the root of the political fear evidenced by Xi and his cronies. James Palmer wrote in Foreign Affairs in February ’18: “[T]he most recent change signals something far deeper than the party’s primacy over the law; it spotlights the essential instability of the entire political system… During Lunar New Year this month, traditional fireworks were banned from Beijing — even down to the firecrackers thrown joyfully by small children. By itself, that could be passed off as a legitimate health and safety measure. But such was the worry about public gatherings that there were not even any organized displays of fireworks. For the first time in decades, the sky over China’s capital as spring arrived was dead, black, and silent.” Thus the trade war moves by the Trump Administration, to position for the 2018 and 2020 elections by focusing outward in the daily search for new antagonists, comes at a bad time for China and the financial markets. With Mike Pompeo at the State Department, John Bolton as National Security chief and Peter Navarro as trade czar, you have an almost Reagan era formulation that may try to use trade disputes to provoke a political crisis in China. Yes, the Trump White house may even think regime change in Beijing is possible given sufficient pressure. Ponder the effect of a 21st Century version of the Taiping Rebellion with nuclear weapons in the mix. China's version of the US Civil War lasted for some 14 years (1850–64), decimated 17 provinces, took an estimated 20 million lives. And this type of unrest is precisely what Xi and China's communist rulers fear. Financial markets need to anticipate that the tariffs announced by the White House are only the first steps in a much broader retaliation against China for decades of theft and deceptive trade practices. Again, Rickards: “What the market is missing is that all of the tariffs on steel, aluminum, solar panels and the rest are small beer compared to the mother of all trade sanctions coming soon in the form of a “Section 301” report that will land on the President’s desk any day. Section 301 of the Trade Act of 1974 is the “nuclear option” when it comes to trade wars. It does not involve tariffs and subsidies by trading partners. It involves the theft of intellectual property. The damages from Chinese theft of U.S. intellectual property will add up to trillions of dollars.” He continues: “The remedies available to President Trump are much broader than those permitted by other provisions of the trade act. Trump does not have to retaliate against a specific good or industry. He can impose penalties on any part of the Chinese economy that arguably benefited from the theft of intellectual property. When it comes to electronics, computer code, and the 'internet of things,' that can be almost anything. When the Section 301 report reaches Trump’s desk he has 90 days to make decisions on penalties on Chinese goods. But, those decisions have already been made. Trump is just waiting for the report. When he gets it, he won’t wait 90 days to respond. He’ll respond almost immediately. So, these opening salvos are just the beginning. There's a lot more trade war damage to come." As the markets react to the moves by Xi Jinping and Donald Trump, it is important to remember that there is a wonderful co-dependence between the governments in Beijing and Washington. Both leaders need a new enemy to distract their restive populations from other issues. In the case of President Donald Trump, he needs enemies to distract attention from the increasingly erratic and scandal prone nature of his government . We note, in this regard, that our colleagues at Kroll Bond Rating Agency just assigned a "AAA" rating to the United States even as we stare at $1 trillion plus annual fiscal deficits. Really? For Uncle Xi, he seeks to focus attention away from the growing tyranny and insecurity evidenced by China’s return to 1950s style authoritarianism. With growing concerns about the political stability of China, including unflattering comparisons of Xi with Romanian dictator Nicolae Ceaușescu (1918-1989), it will be increasingly difficult for corporate cheerleaders in the West to sell the China growth story. In the case of both Uncle Xi and President Trump, we should remember the words of George Orwell in his 1944 classic, “Animal Farm: A fairy story.” “Twelve voices were shouting in anger, and they were all alike. No question now, what had happened to the faces of the pigs. The creatures outside looked from pig to man, and from man to pig, and from pig to man again; but already it was impossible to say which was which.” Happy Easter. #NicolaeCeaușescu #XiJinping #DonaldTrump #JamesRickards #LelandMiller #ChinaBeigeBook #JimiHendrix

New York | Next week we launch the first paid product for The Institutional Risk Analyst , "The IRA Bank Book," which will feature our concise thoughts on the US banking industry and credit markets, along with some pretty charts to illuminate the discussion. More on this soon. This week the markets await the first press conference of Federal Reserve Board Chairman Jerome Powell, a tribal ritual that brings together the media, investors and policy makers in a shared experience of confusion, accidental misstatement and deliberate obfuscation. The question we all ask is whether the Federal Open Market Committee will raise targets for short-term interest rates a quarter of a percentage point? Or More? How soon? But the question that we ought to ask is this: How long will it take for the narcotic effect of central bank market intervention to wear off? And what happens to market volatility as the end of official suppression of rates and credit spreads slowly plays out. Will there be lumps in the proverbial gravy train on Wall Street? Yeah… "We make linear forecasts but in reality, interest rates, corporate profits and exchange rates—all crucial measures of return in their markets—are actually nonlinear series,” writes our friend John Silvia, Chief Economist of Wells Fargo & Co (NYSE:WFC). “This is an important challenge to how we think.” Indeed, the biggest challenge facing market analysts is to ignore the linear data that overwhelms our senses and focus on the random nature of markets. Consider the idea of record bank profitability, a theme repeated over and over again by the financial media. But is this true? One of the things we focus on in the inaugural issue of "The IRA Bank Book" is whether the US banking industry is really profitable given the huge disparity between the rising interest earnings of banks and the still tiny, heavily subsidized cost of funds for the industry. One of the costs for consumers of central bank intervention has been the transfer of trillions of dollars in income from savers to debtors such as banks over the past decade. In Q4 2017, the total interest expense of all US banks was just $21 billion, but banks made $150 billion on total earning assets at the end of 2017. A decade ago, the interest expense of a smaller US banking industry was $100 billion vs $180 billion in income. Today adjusted for the 33% growth in total bank assets, US banks should be paying well more than $100 billion on various sources of funding, from deposits to short-term borrowing from other banks to bond investors. With the net interest income of banks at $107 billion last quarter, how much of bank earnings disappears in a rising rate environment? (Q: Do you think investors or journalists can get their minds around the idea of shrinking NIM in a rising interest rate world?) If we simply return to the net interest income spreads of a decade ago, that implies a shrinkage of $25 billion in net interest income for US banks as rates rise. Much depends on how fast deposit rates rise. Just saying. Source: FDIC Meanwhile, away from the relatively blissful world of banks, bonds and borrowed money, the world of global equities and perceived volatility is starting to evidence increased stress. After years of a 100% correlation between stocks and bonds, rate movements are beginning to impact the direction and magnitude of stock price moves. How this process of “normalization” proceeds and at what pace are the imponderable questions. But to John Silvia’s earlier observation, neither equity markets nor bonds follow a linear pattern. Instead, global markets tend to follow a change pattern closer to entropy , where the inefficiency of market understanding and reaction in terms of asset allocation tends to make investors lag events as a matter of course. Even with massive amounts of data, the gap to understanding and then action is considerable and largely random. And this random quality is present both for policy makers and investors, raising interesting questions as to systemic risk events. “The main problem with entropy uncertainty models is that they are used to justify the notion that there’s room to push agendas to the limit line of the outer edge of the envelope that supports the policy maker’s cognitive bias,” opines Dennis Santiago, Senior Managing Director for Compliance and Analytics at Total Bank Solutions. “It’s a rubber band. It’ll snap.” Even with the sharp rise in equity market volatility in early February, many market participants are still groggy after years on maintenance medication c/o the FOMC. An important indicator of changing market perception is corporate credit spreads, which are starting to widen as uncertainty regarding interest rates and the economy grow, as shown in the chart below. The smarter money is already rolling out of equities into the safety of short duration credit, but the broad market still underestimates the possible rate of acceleration in volatility. “Active equities investors were slower to react to last week’s ‘signal’ in momentum ‘reversals’ and defensive / ‘duration-sensitive’ leadership—as such, much more ‘deer in headlights’ yesterday than rest with Long-Short Beta to Nasdaq at the 86th percentile,” writes Charlie McElliott at Nomura. Note to readers: You don’t want to be the deer in the headlights. There are some analysts who believe that Chairman Powell and his colleagues on the FOMC may try to get ahead of the curve and increase rates by more than 25 basis points when the Fed next moves. Powell is in the difficult position of having to remedy the slow pace of FOMC decision making under his predecessor. Although a rise of 50bp is certainly justified by the available employment and inflation indicators, not to mention toppy stock and real estate prices, accelerating the normalization process via Fed action may have a very unpleasant impact on investor perceptions, volatility and most important, credit spreads. Our biggest worry heading into the end of Q1 2018 is that the artificial stability engineered by the Fed is going to snap again, but on a larger scale and more lasting basis than we saw in February. In the event, credit spreads will widen, loss rates on loans and credit products will accelerate, and the US economy may slowly slip into a stall. Fed Chairmen tend to start their terms with a financial crisis and the migration back to normal may be very rough indeed. #volatility #federalreserveboard #entropy

San Diego | Reports last week that Goldman Sachs (NYSE:GS) CEO Lloyd Blankfein was planning to retire by the end of 2018 caused a bit of a fuss. We spoke about the prospect of a change on CNBC’s Closing Bell on Friday. And yes, we do hope Mr. Blankfein goes to Washington, a city where adult supervision is badly needed. As Blankfein prepares to declare victory and hand the leader’s baton to another GS banker, it is worth considering how the investment bank has changed under his tenure and its competitive prospects going forward. While Blankfein did an admirable job stewarding GS through the financial crisis, the bank’s future has never been less certain. When GS was founded by German immigrants in 1869 , the tiny non-bank made its way in a marketplace dominated by large commercial banks. Marcus Goldman built his firm by providing credit to small businesses in New York, what is today known as commercial paper. By the turn of the century, GS was venturing into the world of equity underwriting, leading offering for businesses like General Cigar and Sears Roebuck. You can divide the history of GS into two major periods: the first half, which includes the firm’s early years and the 40-year tenure of Sidney Weinberg; and the second half, which begins with the ascension of Gus Levy as senior partner in 1969. Levy grew the trading business which became the primary source of revenue for GS by the 1970s. Weinberg, who was known as “Mr. Wall Street,” focused on building the firm’s corporate finance business after the 1930s. Under his direction, GS recovered from the Great Depression and became a leader on Wall Street in such areas as real estate and mergers & acquisitions. And yet despite the success of GS, the firm still operated in the shadow of the large Wall Street commercial banks and investment houses. Sidney James Weinberg For example, when the Ford clan wanted to save their business from the Internal Revenue Service after the death of Henry Ford in 1947, the family of Edsel Ford consulted Sidney Weinberg. The result of those efforts was the novel creation of the Ford Foundation, as described in “ Ford Men: From Inspiration to Enterprise . ” But when Ford Motor Co (NYSE:F) went public in 1956, Blyth, Eastman Dillon & Co. got the mandate. GS was the number four underwriter in the deal. Even with Weinberg’s relationship with the Ford family, another firm got the underwriting business. Going back 12 years to when Blankfein took over as CEO, GS was in some respect little changed from the firm created by Gus Levy. It was a large broker dealer with no bank deposit base and a business that rested on two legs, investment banking and trading. A third leg could be added to include the internal funds managed by GS for its partners and clients, a dimension that made the bank part advisor and part private equity investor. With the 2008 financial crisis, however, GS was forced to become a bank – in name, at least – in order to gain access to liquidity and support from the Federal Reserve. While other firms such as Lehman Brothers and Bear, Stearns & Co. were annihilated during the 2008 financial crisis, GS survived, albeit in a different form. With the passage of Dodd Frank in 2010, the major banks were forced to shed their internal funds and principal activities because of the Volcker Rule, which rightly identified the principal activities of banks as a fundamental conflict of interest with the bank’s clients. So today the house build by Marcus Goldman really rests upon just two legs, leaving GS vulnerable to changes in the trading environment. By becoming a bank, GS reassured its clients and came under the regulation (and protection) of the Federal Reserve Board. But in one of the many ironies of this period, the Fed’s purchase of securities as part of “Quantitative Easing” badly diminished the trading business of GS and the other major Wall Street banks. As we described earlier (“ Banks and the Fed’s Duration Trap ”), by taking $4 trillion worth of securities out of the private marketplace, the Federal Open Market Committee not only distorted credit spreads and juiced asset prices, but also suppressed volatility and trading in the secondary markets. Today at just shy of $1 trillion in total assets, GS is one of the smallest of the global universal banks. Compared to other large US banks, GS has among the lowest asset returns and net operating income as a percentage of total assets, but boasts non-interest income as a percentage of its balance sheet that is three times that of larger peers. At year-end 2017, net loans and leases at Goldman’s single subsidiary bank were just 12% of the firm’s consolidated assets vs 70% for most large banks. These metrics illustrate how the GS business model is very different from that of JPMorgan (NYSE:JPM) and Citigroup (NYSE:C) and remains dependent upon transactional income and volatile sources of funding. Let’s compare GS with Morgan Stanley (NYSE:MS), a slightly smaller bank holding company with two subsidiary banks that generates significantly more net interest income as a percentage of its balance sheet. The MS bank units have total assets of nearly $200 billion while the Goldman Sachs Bank USA had total assets of $160 billion at year end. Net loans and leases at MS were almost one fifth of the group’s total assets at the end of 2017 vs about 15% for the GS bank unit. Significantly, Goldman’s dependence upon non-core funding is twice that of JPM and C and roughly four times that of MS. The double leverage of GS (equity investment in subs / equity capital) was 116% at year end vs 101% for larger banks and just 85% for MS. Of note, the double leverage of GS was just 102% at the end of 2014. Credit rating agencies tend to get nervous when double leverage in a bank holding company is above 115%. One of the key measures of financial strength for a universal bank in the post-Dodd Frank world is assets under management (AUM), in part because so many universal banks have de-emphasized trading and focused instead on the regular cash flows of wealth management. At MS, assets under management were $438 billion at the end of 2017 generating an average of 46bp of fee income of $2.1 billion in 2017. Total fee based client assets at MS were $1 trillion at year-end earning 76bp on average or over $13 billion in pretax income. Of the $37 billion in net revenues for MS at year end 2017, 50% came from sales and trading, 44% came from wealth management and the remainder from investment management. By comparison, GS had $32 billion in net revenues at December 31, 2017, with less than a third coming from wealth and investment management and the largest portion from traditional trading and investment banking activities. GS has $1 trillion plus in assets under supervision, plus another $300 billion in liquidity products, yet the Investment Management segment generated half the net revenues of the comparable business at MS. In the half century since Gus Levy became the leader of GS, investment bank and trading remain the two largest segments at the firm. As and when new leadership takes over GS from Lloyd Blankfein, the key issue that confronts the firm is how to grow its current business model into a more balanced and less volatile franchise. Each time that GS has stumbled in terms of earnings from trading, for example, the firm has spent a great deal of time talking about growing the Goldman Sachs Bank into consumer deposit taking and lending. But these are low return businesses that offer more risk than reward. Trading cryptocurrencies was another suggestion advanced by Mr. Blankfein after a disappointing earnings report, a decidedly bad idea whose time hopefully has come and gone. As we discussed on CNBC last week, the opportunity for GS is to go where the larger banks are not. GS, for example, went into real estate finance, M&A and risk arbitrage long before the larger bulge bracket firms. In the wake of the 2008 financial crisis, many of the larger US banks have backed away from consumer finance and instead focused on lower risk wealth management and business lending. If GS chooses to remain a commercial bank, then it might consider acquiring another depository with a real retail deposit base and an established lending operation, hopefully one focused on business lending where spreads are higher and risks considerable lower. Construction lending, for example, is a short duration asset business that many commercial banks have fled, but it can be a very lucrative and low-risk business if managed properly. It also leads to other types of lending and asset securitization opportunities in real estate that GS knows very well. But if GS is to survive and prosper in the 21st Century, it needs to rely upon its legendary ability to see and execute on new opportunities before the larger players. Trading and investment banking are the heart of GS, but trying to grow consumer banking as the third leg of the stool seems like a bad trade, even if it helps to grow the wealth management business. Also, fighting with other banks and non-banks for the honor of earning 70bp on AUM is a tough way to get to double digit equity returns. If Lloyd Blankfein and his colleagues want a real world model for an innovative way to grow his bank we respectfully suggest two examples from the world of “fintech” (both of which we own): Square (NYSE:SQ) and PayPal (NASDAQ:PYPL). These are pioneers, “disruptors” in a sense, but also represent incremental additions to the existing monopoly of big banks in the world of payments processing. In each case, SQ and PYPL saw an opportunity to extend and reprice an existing business controlled by the largest banks and did so in partnership with the banks! SQ, for example, completely disrupted the sleepy world of bank merchant processing for credit cards and thereby created a new market segment and a new revenue stream. The entry of Starbucks (NASDAQ: SBUX) into the banal world of coffee is another example of creating a new, higher margin segment atop an established marketplace. The challenge for GS is how to leverage the fact of being a commercial bank into new, emerging markets where the big banks are not yet established. The trap that GS wants to avoid is doing what the larger universal banks are doing, but on a smaller scale. This is the unfortunate pattern that ultimately led to the demise of Lehman Brothers and Bear Stearns, which lacked the size, client base and liquidity to survive when the financial tide went out. When Sidney Weinberg and Gus Levy ran GS, they had not yet achieved the wealth and public acclaim that the firm has today. GS was still a tiny non-bank brokerage firm compared to the giant behemoths of Wall Street, which financed the Goldman business and still do today. GS is too small as a bank and too large as a securities firm to be a non-bank. GS has the financial wherewithal and reputation to make a bold move that allows them to break out of the established Wall Street model, but the question is whether they have the imagination, hunger and courage to take that risk. Fortunately, Weinberg and Levy provide pretty good role models for leading change.

In this issue of The Institutional Risk Analyst, we feature a comment by John Mouseau, Executive Vice President & Director of Fixed Income at Cumberland Advisors. You can read more of Cumberland's always timely comments on the financial markets at www.cumber.com . Sarasota | The Wall Street Journal had a story on the front page of the “B” section Wednesday morning about banks getting some relief with regard to counting municipal bonds among their “liquid assets.” On Tuesday the Senate voted to formally debate a bill containing that provision, and it should have enough Democratic support to pass. The debate over this issue has been going on for some time, and we wrote about it in 2015 ( http://www.cumber.com/hqla-and-lcr/ ). We always thought it was a mistake on a number of fronts that munis were left off the list of high-quality liquid assets (HQLA). First and foremost is the importance of banks in the marketplace. Because of the tax exemption, banks have been buyers of tax-free municipal bonds for years. The level of taxation on municipal bonds clearly has an effect on banks’ decisions to own tax-free or taxable debt. So changes in the tax structure are one input into the buying decision. The banks’ book (purchase) yields are another input, and the designation of bonds as either “available for sale” or “hold to maturity” is another input. (Without getting overly complicated, the distinction is that realized gains or losses from “available for sale” bonds flow into the income statement, while bonds in the second category are generally held to maturity and recorded at cost.) However, one of the most important purchase considerations is the generally high credit quality of the overall municipal bond market. Moody’s publishes a study that is updated approximately every two years in which it compares municipal bond and corporate bond default rates by rating categories over a ten-year period. In the last report, for 2016, in the broadest category, “A”-rated municipal bonds had a cumulative default rate over ten years of .07%, while that of corporates (globally) was 2.22%. While both numbers are low, the corporate default rate is 31x that of municipals in the “A” category. If you look at the numbers cumulatively, including AAA to A, the default rate for munis is .09% in total and 3.38% for corporates. In this case the corporate default rate is 37x that of municipal debt, which implies that there is higher event risk in corporates (e.g., in high-quality bonds subject to the stress of takeovers). The fact that high-quality corporates were included in the 2014 bill as high-quality liquid assets but municipal bonds were not has always stuck in our craw. General Electric was rated AAA by Standard & Poor’s up to 2009, when it lost its gilt-edged credit status and is now rated A, yet the State of Maryland has been a AAA credit before, during, and since the financial crisis. Our point is that on a credit quality basis municipals have outshined corporates for many years and in most cases have provided better taxable-equivalent, risk-adjusted yields for banks. Why would regulators be prejudiced against the muni credit? Our thought is that lobbying by state and local governments was lacking four years ago when these regulations were first promulgated. And there tends to be inertia among banks to modify rules once regulations are in place. But make no mistake; this new bill is a winner for banks and a winner for the muni bond market. Banks may have a lower tax rate but that will not necessarily disturb higher purchase yields. And the fact that munis should be able to be counted as high-quality liquid assets will further cement their part in banks’ portfolios. Indeed, this bill will help Congress put the “quality” into the “high-quality” designation. #munis #HQLA #Congress #Mouseau #CumberlandAdvisors

New York | Count the numbers of markets and economic indicators currently at extreme valuations and positive correlations. Financial markets showed a glimmer of normality last week when stock prices fell and bonds rose. The surprise expressed by market participants is an illustration of just how long investors have been dealing with a market where all manner of assets are correlated and at multi-year highs. We talked about this last week with our friends at BNN in Toronto in a TV hit from Bloomberg TV in New York. To our readers: We are ending our weekly email notifications via our third-party listserve. If you’d like a reminder from Wix when new items are posted, please register again at www.theinstitutionalriskanalyst.com and you can manage your subscription directly. As before, new items will be posted on Twitter , Google and other social media . Apologies for any inconvenience. – The IRA Markets were abuzz last week over the prospect of a trade war, but we see President Donald Trump’s latest outburst over tarrifs as the opening salvo in the 2020 election cycle. Yet a number of observers are openly wondering if the latest upward move in interest rates is essentially finished and if the next leg for the 10-year Treasury is a bull rally back down to the low 2% range in yield. As the chart below illustrates, the 10-year popped to 2.8% yield following the November 2016 election, then re-traced back down just shy of 2% yield on September 8th of last year. Despite the latest upward move in rates, we remain in the bond bull, flattening yield curve camp for the simple reason that there is still far too much liquidity – call them dead presidents -- chasing scarce assets. Even with credit problems emerging around the world following eight years of irrational easing by the Federal Reserve and other central banks, the markets and particularly credit spreads remain remarkably calm – almost too tranquil. It’s as though that last big dose of monetary thorazine from former Fed Chair Janet Yellen still has not quite worn off. Should long-term interest rates continue to rise, however, we think it is fair to ask whether the period of low credit costs and artificially boosted economic activity in the US also is ending. It is clear that the proverbial party is over in autos, with rising credit standards and falling sales incentives more than tapping the brakes on industry volumes. The particularly nasty chart below shows monthly light vehicle sales in the US through January 2018. Default rates on prime auto loans held by banks have essentially doubled since 2015 and now stand at 1%, which is really not a big deal compared with unsecured loans. But the rate of change is notable. The Wall Street Journal reported last week that residual values for cars coming off lease are falling, one reason why dealers and the automakers have pulled back on costly sales incentives. By no coincidence, loss given default (LGD) for auto loans, which is calculated as charge-offs less recoveries divided by charge-offs, has risen 10 points over the past three years to just under 70% of the original loan amount. LGDs are essentially the inverse of asset prices in a given loan category, thus rising LGDs for auto loans is another way of saying that prices for used cars are weakening. Our pals at the Federal Deposit Insurance Corp reported last week that provisions for future credit losses for all loans and leases have increased nine quarters in a row, albeit from very low levels seen in the trough of 2015. But the key question facing investors is whether the end of the period of extraordinary ease by global central banks will now see a decline in economic activity and an increase in credit costs for US banks and bond investors. The secular increase in asset prices for stocks, bonds and particularly real estate is exhibit number one in this analysis. As we’ve noted in past issues of The Institutional Risk Analyst , the credit metrics coming from US banks in asset classes such as 1-4 family home loans and multi-family real estate are anything but normal and suggest an adjustment down the road. Will home sales and even prices follow the bearish example of autos? It is interesting to see, for example, that past-due 1-4s owned by banks actually rose to 2.7% in Q4 ’17 after falling steadily for the past five years. More thought-provoking, however, is that fact that record low LGDs for bank owned 1-4s have stabilized at just 24% of the original loan balance vs the 25-year average of 65%, as shown below. Is the next leg up? Source: FDIC Like the chart for auto sales above, the LGDs of 1-4 family loans exhibit a large degree of skew from historical norms, something you’d expect to see after years of experimentation by Chair Yellen and her colleagues on the Federal Open Market Committee. The researchers at the San Francisco Fed (hat tip to Rosie) put it very nicely in a January 8th comment: “Current valuation ratios for U.S. equities and household net worth are high relative to historical benchmarks. The cyclically adjusted price-to-earnings ratio reached its third highest level on record recently, and the ratio of household net worth to disposable income, which includes a broad set of household assets, stands at a record high. Such extreme values of these ratios have historically been followed by reversions toward their long-run averages. However, other current factors, such as low interest rates, caution against bearish forecasts.” So if Yellen and company have front loaded a decade of growth into the past five years, what does that say about prices for stocks, bonds and particularly real estate? While the price increases illustrated in the world of 1-4 family loans suggest a considerable deviation from long-term averages, the degree of skew in the world of multifamily real estate is even more pronounced and suggests a proportionately great degree of asset price distortion. The chart below show LGDs for the $400 billion in bank owned loans backed by multifamily residential properties. Like 1-4s, the default rates on this asset class are extremely low – in large part because distressed debtors are often taken out of these exposures short of a formal default. Last quarter, LGDs for bank multifamily exposures fell to minus 109%, meaning in cash terms that recoveries exceeded charge-offs 2:1. Source: FDIC This chart describing relative change in collateral valuations in the multifamily sector suggests that these assets are overvalued and must, eventually, revert to the LT mean. Also, if the weakness in autos suggests a more general slowing of economic activity, particularly among consumers, how much should banks and bond investors expect loss rates – and LGDs – to rise in coming months and years in related asset classes? The good news is that both 1-4s and multifamily assets are quite solid historically, with the 2007-2010 period of extreme losses standing out. Losses on bank owned 1-4s peaked at the end of 2009 at a whole 2.47% for $2.5 trillion in loans. Multifamily loans held by banks saw net charge-offs peak at just 1.77% at the end of 2009. The chart below shows loss and past due rates for both 1-4 family and multifamily loans. Source: FDIC Compared with unsecured consumer loans, the real estate exposures of US banks have performed quite well over the past 25 years. For example, the charge off rate on the $850 billion in credit card receivables held by all US banks at year end was 3.77%. Of course, credit cards are a much more profitable product for banks than making loans on real estate. But the unusual behavior of the credit loss experience of these asset classes today suggest that prices are very toppy indeed. Both the low loss rates and LGDs displayed by real estate portfolios illustrate the high value of the collateral behind these bank credit exposures. The key question for investors and risk mavens is when or even if these valuations actually adjust downward. When you price credit at zero and compress spreads via brute force methods like quantitative easing, it is easy to conceal a lot of sins in credit terms. For example, the dearth of assets engineered by the Fed has also led to a deterioration in credit covenants and other investor protections. Yet even today, few economists inside the Fed system have publicly stated that QE was overdone, that is distorted markets, and has perhaps created the circumstances for the next financial crunch. Fed Chairman Jerome Powell brushed aside a new paper by two Wall Street economists and two academics questioning the effectiveness of QE, but the next couple of years may reveal some significant real world costs of this ultimately speculative policy. The bad news is that the enormous skew in asset prices engineered by the FOMC may hold significant credit risk in the future. The twin shocks of rising interest rates and widening credit spreads could significantly increase loss rates across the board in US and global banks. Looking at the body language of US regulators, it is hard to avoid the conclusion that the supervisory community is bracing for a repricing of risk.

New York | None other than Warren Buffett of investment fame started off the week complaining to Becky Quick of CNBC that there’s not enough big things to buy. Railroads? Airlines? Not even Wells Fargo & Co (NYSE:WFC) suffices to satiate Mr. Buffett's hunger for assets. With over $120 billion in cash burning its way through his trouser pocket, the best that the Sage of Omaha can come up with is buying one of the most overvalued stocks of all, namely the computer cult led by Apple Computer (NASDAQ: AAPL). Sure sounds like inflation to us. Too much cash chasing too few goods or at least good opportunities? Of note, we’re scheduled on CNBC WorldWide Exchange this Tuesday at 5:50 ET with Wilfred Frost to talk about the outlook for JPMorgan (NYSE:JPM) and other financials. In a year with rising volatility and slow loan growth, valuations for large banks are back to 52-week high but with virtually no change in the outlook for earnings save from changes in corporate taxes. In 2017, the only two loan categories at JPM that grew were real estate and agriculture, including some festering CRE multifamily exposures we can see out the office window here in Midtown Manhattan. As we’ve noted previously, the gross yield on JPM’s loan book was only 4.57% through the end of Q3 ’17 vs. 6.9% for Citigroup (NYSE:C) due to the subprime consumer and credit card book. But the gross yield on Citi’s commercial loan book is half JPM’s, illustrating the extreme competition for assets in the world of large commercial bank credits. Once you net out 100bps of SG&A, getting to the Street's 6% revenue growth rate for JPM obviously depends on the trading and advisory side of the bank. Indeed, Street analysts have JPM growing revenue 6% in Q1 and ~ 4% for all of '18. Positives are rising interest rates in terms of NIM and a positive mark on the bank's MSRs. Net interest income was up mid-teens for JPM in 2017. Negatives include slowing loan growth, still modest trading/FIG volumes, and a soft residential loan market. JPM, Wells Fargo & Co (NYSE:WFC), and Bank America (NYSE:BAC) are paying up big time for jumbo mortgages in major MSAs, a large but unprofitable business for years to come. Same goes for C&I loans and CRE, which really peaked in terms of volumes in '16 and have been slowing every since. Like WFC, big negative for JPM is size. The bank's yield on earning assets is in the bottom decile of large bank peer group. The bank’s overall results are boosted by trading/asset management, which is half of the bank, but precious little vigorish is coming from the loan book. The same shortage of assets that so vexes Warren Buffett is putting enormous downward pressure on bank loan yields and even relatively inaccessible assets such as GNMA MSRs, which are changing hands around a 9% unlevered yield according to our friends at Mountain View. This is half the yield seen for GNMA MSRs back in 2012, another indication of the tightness of asset markets. So on Tuesday as former Fed Chairs Janet Yellen and Ben Bernanke are celebrated at Brookings Institution in Washington, we will no doubt hear some cautious discussion about rising risks of inflation. But in fact Chair Yellen and her colleagues on the Federal Open Market Committee have already baked double digit inflation into asset prices. This type of thinking apparently prompted Goldman Sachs (NYSE:GS) to issue a report suggesting a stock market collapse if the 10-year Treasury bond reaches 4.5% yield. We take some comfort that bond spreads have not moved significantly even as the yield on the 10-year has backed up three quarters of a point from the 2016 lows (see chart below). But the latest CBRE report on cap rates for commercial real estate shows record tight spreads in multifamily. And we keep wondering if the systemic shortage of investable assets will cause another bond rally such as followed the 2016 election. Now the slow increase in interest rates and, dare we say, volatility will eventually boost the possibility of revenue growth on the trading side of banks like JPM and C. Our former colleague Mike Mayo has triple digit growth targets for earnings from JPM and Citi over the next three years. But to hit those generous levels of earnings growth, the FOMC needs to figure a way to lighten the system portfolio and increase trading volumes on the Street. With rates rising and the “economic cycle” showing signs of maturity, it is hard to see where we can grow volumes in the large banks to fulfill those sort of bullish earnings estimates. Indeed, the biggest risk to the overheated equity markets is the Fed. If Fed Chairman Jerome Powell is true to form during his two congressional appearances this week, look for him to continue speaking forthrightly about things like inflation and deficits. Powell also may surprise everyone and scold Congress for again raiding the Fed's capital to "pay" for the most recent spending bill. The Federal Reserve Chairman is the nation’s banker. He has a duty to speak up when Congress and the Executive Branch are so badly wrong on so many issues. He can start by explaining to members of Congress why the Fed and Treasury are alter egos and why remittances from or the assets of the Fed are not valid sources of new public revenue. None of this is particularly good for the markets. Powell is the most intelligent, forthright and decisive Fed Chair we've seen in many years -- and he is not an economist. We think Chairman Powell is likely to break the golden rule of Washington, which is to never tell the truth in public. #JeromePowell #JanetYellen #JPMorganChase #WellsFargo #Citigroup #C #JPM #WFC #GS #GoldmanSachs

"Al", retired Wells Fargo stagecoach pony New York | Wall Street more than bounced last week as the secular shortage of stocks quickly snapped investors out of their collective funk. But one once stellar performer in the large cap financials, Wells Fargo & Co (NYSE:WFC), hung back from the surging crowd. In years gone by, Wells was the quiet exemplar of operating efficiency among large banks, but no more. Today WFC is the bank that everyone loves to hate. But while WFC may be the object of scorn, its operations continue pretty much as before. As we told SquawkBox a week ago, having WFC trading at a discount to JPMorgan (NYSE:JPM) is not a normal state of affairs. The former has better nominal as well as risk adjusted returns than JPM on most days, but of late WFC senior management has been slicing off figurative fingers and toes in a stunning display of reputational self-destruction. With WFC up just single digits for the year following the perfunctory sanctions from Chair Janet Yellen and the Federal Reserve Board, and its large bank peers up 3x this amount, the question many investors ask naturally is whether Warren Buffett’s favorite bank is good value compared with JPM and other peers. The short answer is “Yes” – but only if you believe that WFC, sans problemas , ought to be trading at 2x book value. With JPM at 1.7x book, WFC in normal times should be trading at a 20-25% premium to the House of Morgan. But these are hardly normal times. It seems more than ironic that at a time when financials are trading at all time highs, one of the more dependable large banks has managed to put itself into the penalty box with progressive politicians and federal regulators. Ron Lieber of The New York Times last week listed the long bill of particulars against WFC: “Any one of the sins that Wells Fargo committed against consumers would have been bad enough. There was the unnecessary auto insurance it forced auto loan borrowers to buy. And the data breach where scores of the bank’s wealthiest clients woke up to the news that a lawyer for the company had handed over their personal information to an adversary. Plus accusations of unauthorized changes to people’s mortgages. And those fake accounts — numbering in seven figures — that employees created in customers’ names.” Lieber then goes on to bemoan the fact that he cannot pull all of his business from WFC, including the operationally challenged world of loan servicing. WFC has $1.7 trillion in loans it manages as a loan servicer. In the consumer centric world of financial journalism, it may seem entirely appropriate for borrowers to have the option – nay, the right – to decide who services their mortgage. But in fact it is the investor in the mortgage note, frequently Uncle Sam, who ultimately makes that decision. For the past two decades, WFC has built a huge business originating and servicing residential and commercial mortgages. By default, when investors purchase a mortgage backed security (MBS) issued by a large universal bank such as Wells, they also select the loan servicer. WFC originates or buys the billions of dollars per year in residential mortgage loans, packages them into securities, and then issues MBS while retaining the right to service the loans, what is known as mortgage servicing rights or “MSRs.” Servicing rights such as MSRs are naturally occuring negative duration assets, the opposite in technical terms to a loan portfolio or a Treasury bond. This invaluable quality makes MSRs perform well in a rising interest rate environment as we see today. But most Sell Side analysts neither know nor care about such details when it comes to following mortgage focused banks and non-banks such as WFC. And only a few members of the mainstream financial press such as John Dizard at the FT dare to write about MSRs. The total carrying value of WFC’s residential and commercial MSRs was $14.7 billion at September 30, 2017, and $14.4 billion at December 31, 2016, or a bit less than one percent of the $1.7 trillion in total outstanding principal balance of mortgage paper that Wells services. The nation’s largest loan servicing portfolio (WFC owns about one third of all bank owned MSRs) generates significant income for the bank, but is also perhaps the most problematic business for WFC due to the consumer facing risks that arise in the mortgage world every single day. You can argue that the large financials are overvalued, as we did on CNBC's Halftime Report the other day, but don’t fight the Fed, ECB and Bank of Japan all at once. The path to “normal” as defined in the Gospel according to St Janet will take years longer than the Federal Open Market Committee admits publicly. Note, for example, that the estimated timing of prepayments on the Fed’s portfolio of RMBS is clustered in the mid-2020s, at least for now. Like Sell Side bank earnings estimates, the FOMC numbers on monthly portfolio runoff rates will change over the course of 2018. The beauty of MSRs is sadly called “extension risk.” Rates rise, bond prices fall, prepayments decrease, duration and IRR increase, and the fair value of your MSR magically grows. Kidder Peabody (1986)? Long Term Capital Management (1998)? Citigroup (2008)? All of these firms died due to extension risk on various types of pass through securities, one reason why the SEC effectively banned non-banks from issuing their own MBS in 1998. By amending Rule 2a-7, the SEC not only may have killed LTCM, but it made it impossible for nonbanks to issue their own paper. The SEC under Chairman Arthur Levitt handed the largest banks a monopoly in making and servicing home mortgages. It is hard to ignore the superior performance of WFC vs other large banks, even if you assume no balance sheet growth due to the Fed sanctions and the risk of its many consumer facing businesses. WFC has equity returns that are two points better than its assets peers and with similar risk adjusted returns on capital (RAROC). The only name in the top five banks with even close to WFCs’ equity returns is USB, which deliberately manages its size at below half a trillion in total assets. Source: TBS Bank Monitor Q3 2017 Could smaller mean higher ROEs at WFC?? An intriguing possibility. The travails of WFC are a blissful situation, however, compared to the life and death situation that confronts many non-bank mortgage firms as the first quarter of 2018 heads to a close. Indeed, market pressures are seemingly driving a renewed focus on M&A. Nationstar Mortgage (NYSE: NSM) last Tuesday announced a nearly $4 billion merger with WMIH Corp. (NASDAQ: WMIH), the successor company to mortgage originator Washington Mutual. After 2008, WFC and other large banks sold problematic mortgages to non-banks such as NSM. Firms such as Countrywide and Washington Mutual, though technically commercial banks, operated as non-banks in the secondary market for home loans and funded themselves mostly with short-term money. Let’s walk down memory lane. In September 2008, readers of The IRA will doubtless recall, JPMorgan Chase acquired the banking operations of Washington Mutual Bank in a transaction facilitated by the Federal Deposit Insurance Corporation. JPMorgan Chase acquired the assets, assumed the qualified financial contracts and made a payment of $1.9 billion to the FDIC. Claims by equity, subordinated and senior debt holders of WMIH were not acquired and ended up in bankruptcy in Delaware. "For all depositors and other customers of Washington Mutual Bank, this is simply a combination of two banks," FDIC Chairman Sheila C. Bair said that fateful day. "WaMu's balance sheet and the payment paid by JPMorgan Chase allowed a transaction in which neither the uninsured depositors nor the insurance fund absorbed any losses," Bair added significantly. Of course, when the FDIC seized the bank and sold it to JPM, it left the controlling financial investor, Texas Pacific Group, high and dry. From bankruptcy, the predecessors of WMIH commenced nearly a decade of litigation with the FDIC and other parties over disputed assets of the failed bank. When WMIH won a $2 billion judgment against FDIC, the bank insurance agency then turned around and sued the officers and directors of WaMu for the now $2 billion deficiency in the FDIC fund. God does have a sense of humor. WMIH’s merger with NSM marks a new page in the firm’s corporate history. With a decade of litigation behind it, WMIH now boasts a couple hundred million in capital and $6 billion in usable net operating loss (NOL) carryforwards. WMIH also has a new private equity sponsor, KKR, who is joined by Texas Teacher Retirement Fund and Greywolf Capital. The NSM transaction also may mark the start of a consolidation in the world of mortgage finance and servicing, where over-capacity is hurting profitability as loan volumes and servicing assets steadily fall. But don’t look for any large banks to be buyers of large non-bank mortgage firms. WFC is one of the few large banks that remain in the market for government-guaranteed FHA loans and Ginnie Mae securities. As non-bank seller servicers exit the GNMA market, banks such as WFC and Flagstar (NYSE:FBC) will be under pressure from regulators to pick up the slack or even acquire insolvent non-banks, but likely that door is closed for the largest banks. Thanks to Dodd-Frank and the CFPB, federal bank regulators consider consumer facing businesses toxic for the large banks. They have effectively told WFC et al to avoid reputation risk at all costs. Even if WFC is not allowed to grow its assets for the next several years, we expect the bank to eventually return to a slight premium to JPM. We see two possibilities. Either a) WFC is going to slowly rise to 2x book value vs JPM’s 1.7x multiple or b) JPM and the other larger banks will slowly adjust downward as the full weight of securities issuance descends upon the major banks in the post-QE world. Just for the record, we are betting on the latter scenario as Wall Street desperately seeks a reasonable explanation for current market valuations. Just remember that reaching “normal” and adjusting asset prices accordingly will take years thanks to the over-generosity of Chair Yellen and the FOMC. #WellFargo #JanetYellen #FOMC #WFC #JPM #NSM #WMIH #FBC

New York | In this issue of The Institutional Risk Analyst , we turn our attention to the auto sector. Kevin Tynan is the Senior Automotive Analyst at Bloomberg Intelligence and has been covering the industry for decades. We first met Kevin during the research for " Ford Men: From Inspiration to Enterprise " and value his insights on the automakers and the macro trends that impact this particularly American industry sector. We spoke to Kevin last week at his office in Princeton. The IRA: Ford just reported lackluster earnings, making more money per unit on lower sales. How do you assess the situation facing the US automakers? Is this a case of the industry shrinking or is there a more nuanced explanation for the competitive situation is facing the US automakers? Tynan: Those issues are really Ford specific. They are caught between this smallish product portfolio that is very dependent upon one nameplate, namely the F-series pickup truck, and the lack of other products. Lincoln only did sales of about 100,000 units last year. The market in the US is just about to touch 70 percent trucks overall and Ford is about 76%. But Fiat-Chrysler was 90 percent trucks in January or nine out of ten units sold were some form of truck. GM was about 80% trucks and SUVs in January, but they have a much broader portfolio. They have GMC which is only trucks and Silverado under the Chevrolet brand and all the trucks in Buick and even Escalade in Cadillac. The IRA: Wow. It gives us a feeling of déjà vu when you describe the industry. Nothing has really changed, has it? For much of the 20th Century Ford was only ever compared to Chevrolet because it was so much smaller that the colossus of General Motors built by Alfred Sloan. Ford never had a move-up offering for its customers from the basic Ford models and now is dependent upon a premium truck line. Tynan: Just looking at the statistics it may seem so, but under the surface it is really different. If you go back to pre-bankruptcy days for GM and Chrysler, one thing that is different is the definition of a truck. When gas was $4.50 per gallon you really saw the consumer shop on the car side of the dealership. You don’t see that today. A decade ago most SUVs were being built on a truck platform, but that is not the case at all today. These were full frame vehicles. Today there are very few SUVs that are built on the same platform as the pickups. The IRA: What we call trucks in the data are really passenger cars, is that the point? Tynan: Yes. Fuel efficiency has improved so dramatically compared with 2008 that the price of gasoline is no longer an issue for consumers. Even if there was a spike in gasoline prices, consumers would be buying smaller trucks not go back to the car side. The IRA: So is it really fair to say that the industry is 80% trucks or has the definition of a truck now become blended with a passenger car into the now ubiquitous crossover? Tynan: It is just a different type of truck. Look at the Ford Explorer, which was really the first mass produced SUV and was built on a truck chassis. Now the Explorer is built on the same platform as the Taurus. Nissan Pathfinder shares a platform with the Altima. There are a lot of crossovers out there that look like trucks but are built on passenger car platforms. They have the driving dynamics and efficiency of cars. There are a couple of automakers who are really too car heavy and they are scrambling to move to trucks. VW, BMW and Tesla are all upside down in terms of the focus on cars. Tesla is valued as a tech company, but as a car maker they are in precisely the wrong place in terms of consumer who want a higher ride and other attributes of a truck or crossover. The IRA: Don’t get us started on Tesla. It’s a toy. Tesla is a beautiful model slot car built by a guy who thinks he’s Tony Stark. Elon Musk is clearly a genius, but he should stick to building rockets. He just spent a couple of billion dollars to put a Tesla into orbit on the Falcon Heavy rocket. Maybe Tesla could build a flying car to cut the commute to JFK? Tynan: Well, Tesla could at least build a car that consumers want. The IRA: We spent a couple of weeks in Uruguay over the holiday and there were a number of brand new Maserati SUVs in Punta del Este. With the taxes that is a very expensive car, but the ladies love them. My spouse has a passion for the Porsche Cayenne – not a 911. She wants the SUV, but then again, she also thinks the new F-250 Super Duty is pretty cool. Tynan: What you are seeing with the premium brands – Jaguar, Lamborghini, Porsche and BMW – are lower, wider SUV crossovers. I was joking with somebody the other day that we may eventually see the return of wagons for people who don’t want that high, floating feeling and want to sit low but want the utility of a truck. The wave of the future may be a return to wagons in the guise of a crossover. The IRA: I drove a Lexus LX 300 for many years. That was the first round, stylish SUV that really appealed to women. It was dependable and great on gas. But most men seem to prefer sedans. Look at the Audi A-3 mini wagon, which unfortunately became a sedan. Tynan: Have a look at the Volvo V-90, absolutely gorgeous wagon. It is beautifully designed and they just came out with the Cross Country version which is a legitimate wagon you can take off road. All wheel drive, all you need. The IRA: Let’s talk about mobility. Has the panic over mobility subsided or are all of the automakers still chasing this threat/opportunity? Tynan: There is a lot of capital being wasted on mobility. It feels strange. Automakers are trying to reinvent themselves by getting into things they have never done before. The automakers are chasing relevance. There is a lot of money being spent with no ROI attached to it, but what is interesting is that this is what is driving valuations in the market right now. The IRA: Yes, it's called the Amazon model. Go out and spend as much as possible and grab market share and pretend that you are Jeff Bezos. Or look at Uber, a car service with Internet enablement that has no comparative advantage long term. Uber is burning capital to subsidize a car service for urban millennials who may never own a car. There seems to be a massive misallocation of capital in the mobility space on an almost Chinese scale. Is this too harsh? Tynan: The fascinating thing about Uber is the idea of level five self-driving. If you take the cost of the driver out of the equation, let’s say its mid-five figures, that becomes interesting. You can amortize the cost over five years for a car that runs 24x7. Can we ever get to level five? Will the government ever support the investment required? I don’t know. Robo taxis everywhere. If the current model does not make money, then you take out the most expensive part of the model which is the driver, then maybe you have a shot at profitability. The IRA: Well, we see it in the movies so it must be true. The 1973 Woody Allen film “Sleeper” is the first self-driving car we can recall. That is going to take some time. New highways with the guidance systems embedded in the pavement. But more to the point, who is going to insure the operation of these passenger vehicles? Tynan: Correct. We are legitimately at level two now and some manufacturers with large corporate parents will maybe get to level three in a few years, but nobody ever talks about the cost. It is challenging today to put $1,800 options in passenger vehicles. The cost of a driverless car is going to be enormous compared with the price of today’s vehicles. Frankly, the auto industry is not going to get to level five for consumers anytime soon. The IRA: To that point, doesn’t it make more sense for the first autonomous vehicles to be trucks or busses? Issues like safety and liability almost force the first roll-out of driverless vehicles to come in use cases other than passenger cars. Tynan: Think about congestion. There are valid applications for cars to operate autonomously and, say, drop you off at work and then carry other passengers while you are at work. But I am not sure that this really addresses congestion in urban areas. The IRA: More to the point, think about the current trends in housing. Less affluent populations are being forced out of the center cities into the suburbs. These people are going to need transportation to get to work, to school, to shop, etc. The demographics are compelling. Tynan: I’d be happy if we could fix the potholes. I have an eight mile commute on Route 206 towards Princeton in the morning and the roads are a mess. We don’t invest enough in infrastructure. The idea that we are going to wire the entire country or wireless the entire country so that autonomous vehicles can drive at 80 mph eight inches from each other seems a bit of a stretch. The IRA: Sounds like the sales pitch for Blockchain. So talk about the auto sector going forward. The auto sector went from death and destruction in 2010 to an amazing rebound through 2016. What should we expect over the next decade in terms of auto sales? Tynan: We hear a lot of analysts talking about “peak auto.” In 2016 we saw a record at 17.5 million units and then sales fell a bit in 2017. In fact, 2014 was “peak car” but on the truck side of the business demand is still increasing. Hard as it may be to believe, approaching 70% trucks for the industry as a whole is still not yet a peak. Those two categories – compact car and midsize car – really dwindled as crossovers and compact crossovers specifically surged. Compact crossover is the largest segment in the industry now. But as sales volumes for smaller car segments fell, trucks and SUVs simply could not grow fast enough to meet demand. Investors look at US auto sales and say “they’ve peaked, they’re plateauing.” But in fact car sales have fallen so fast that truck sales are struggling to keep up – but making a valiant effort at it. The IRA: So what should investors be focused on with the automakers? Tynan: The profits from truck sales are so much better than cars - automakers are actively deemphasizing their car offerings or at least the smart manufacturers are doing so. The IRA: Tastes have clearly changed. Going back to the Model T Ford, the car was essentially a wagon with a gasoline engine. Then we evolved large, enclosed passenger cars and trucks were really meant for commercial use. It took years for engineers at Ford to convince Henry Ford to make a Model T truck. And even then, you had to buy most of the parts for your Model T from the Sears catalog. But now consumers seem to embrace the crossover as the ideal design. Based on your comments, it sounds like the crossover is the design archetype for the future. Tynan: The higher ride height is clearly in favor, especially as more and more people buy SUVs. The fact that you can seat six people is also a big attraction. The utility of a truck and the ride dynamics and gas mileage of a car is a very compelling combination. There is no way back to the pre-2008 days, even if gas prices spike. On the luxury side of the business, big sedans are no longer the sweet spot for consumers. The IRA: What percentage of F-150 owners are women? Do you have any idea? Tynan: I’m not sure about that, but the percentage of people who drive a truck and never use it for work is soaring. The new pickups are very nicely appointed and can compete in terms of features and comfort with any passenger car. The mid-size trucks are nice too, Ford is getting back into smaller trucks with the new Ranger. The IRA: What in the world happened with Ford? How did they ever decide that people did not want a small truck? They left the entire mid-size segment in the US to the Japanese. Bill Ford is all twisted in a knot over mobility, but then Ford abandoned an important product segment in a category they should dominate. Tynan: They were printing money with the F-150. I’ve spoke to Ford a number of times about this decision. They’re feeling was that the smaller truck would have to be 25 percent more fuel efficient and be 25 percent cheaper to not cannibalize F-150 sales. When GM got back into the segment with Canyon and Colorado, they took market share but not from Toyota Tacoma or other manufacturers. The whole segment just grew. That small truck segment that was 300,000 units a few years ago was almost half a million units last year, but growth has also slowed. Ford and Fiat-Chrysler with the Jeep pickup missed the opportunity. I think that horse has left the barn. Today the Toyota Tacoma is half the segment, while GM is about a third. And the thing is that Ford sells Ranger all over the world. They just weren’t bringing it here. The IRA: As you said Kevin, trucks have not peaked. The Toyota Tacoma is a beautiful vehicle. Tynan: While the US automakers dominate the large truck segment, until GM got back into smaller trucks Toyota owned that segment almost entirely. So it's not about brand loyalty as much as it is about producing a product that consumer want to buy. Some people want to have a pickup that can fit into their garage. They don’t need a full size pickup. So there is roughly half a million buyers for that size vehicle. The IRA: So last question, let’s bring it back to Ford. What is your assessment of Bill Ford and the situation with “his” company in the wake of Alan Mulally and the departure of Mark Fields last year? Bill Ford periodically feels the need to demonstrate his “leadership” with new ideas, but had to retreat entirely a decade ago and was rescued by Mulally. Tynan: The message from Ford has been tough to decipher. Analysts are wondering if Ford is really about cars and trucks or is it about mobility and smart cities? They have been talking about things that have nothing to do with the basic business of making cars and trucks. The message coming from Ford is not as clear as say GM, which is all about making vehicles even while working on new technologies. Mark Fields had been with the company for 25 years, but then was let go after three years as CEO. It seemed a little bit strange to have Fields in the organization for that long and to be that wrong about his leadership ability. The IRA: Tales of Henry the Deuce. Thanks Kevin. #Ford #Tesla #GM #FiatChrysler #Nissan #ElonMusk