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Monday's Top 10: David Chaston on banks' need for capital; Could beef & lamb be heading for a dairy-style ride? The misery index; China's re-exporting, Dilbert & more
Here's my edition of Top 10 links from around the Internet today.
We have a Monday-Wednesday-Friday schedule for Top 10. Bernard will be back with his version this Wednesday. We will have another guest posting on Friday.
As always, we welcome your additions in the comments below or via email to email@example.com.
1. All banks need more capital
Sorry to be a broken record about this (starting with my 2011 article), but many independent analysts have been banging on about the dangers of bank leverage for some time now.
Regulators seem only minorly interested and the best they can come up with is Basel III.
In 2013 the book "The Bankers New Clothes" helped underscore what is fundamentally wrong with excessive leverage.
It has taken years - decades - but just perhaps we may be making a bit of progress, at least in the US.
The co-author of that book has some spine and has followed up the treatise with some aggressive testimony before the US Congress. And lawmakers there are noticing, it seems (... or, I hope).
The nub of the argument is in this NY Times article:
The industry has benefited from, and sometimes encouraged, public confusion. Banks are often described as “holding” capital, and capital is often described as a cushion or a rainy-day fund. “Every dollar of capital is one less dollar working in the economy,” the Financial Services Roundtable, a trade association representing big banks and financial firms, said in 2011. But capital, like debt, is just a kind of funding. It does the same work as borrowed money. The special value of capital is that companies are under no obligation to repay their shareholders, whereas a company that cannot repay its creditors is out of business.
The industry’s more serious argument is that equity is more expensive than debt. If governments require banks to raise more equity, the industry warns, the results would be higher interest rates, less lending and slower economic growth.
A 2010 analysis funded by the Clearing House Association, a trade group, concluded that an increase of 10 percentage points in capital requirements would raise interest rates by 0.25 to 0.45 percentage points.
This, in the view of Ms. Admati, is a small price to pay for fewer crises. She notes that debt is cheaper than equity largely because of government subsidies - not just deposit insurance but also tax deductions for interest payments on other kinds of debt - so more equity would basically transfer costs from taxpayers to banks. Even in the short term, she says, the economic impact may well be positive. A study last year by Benjamin H. Cohen, an economist at the Bank for International Settlements, found that banks with more capital tended to make more loans.
That's right. Don't fall for the idea that bank capital is some kind of rainy-day fund for use in a crisis; it's not.
Banks regard themselves - and have convinced regulators - that they are 'special'. They may have a privileged position in the economy, but their capital-to-assets ratio should not be special. They themselves would not tolerate a client with such high leverage. If they had a safer (proper) leverage ratio they would not earn such profits. But they would be safer. We should not allow them to prioritise shareholders over depositors in such way. Yes, shareholders would pay a cost with safer leverage. But it would be a one-time cost as the industry is restructured towards safety.
Regulators need to get on with the job.
2. A warning for retail investors
You can get 5.5% (more or less) investing in a five year bank term deposit. Or you can get close to 6% investing in a bank debt security traded on the NZX debt market. In fact, more and more retail investors are choosing the higher yield of these debt securities. Actually, they are subordinate to ordinary depositors so they carry more risk, a lot more. They are called hybrid securities because they are counted as bank tier 1 or tier 2 equity.
Not only do ANZ, ASB, BNZ and Westpac all issue the stuff to retail investors, but Kiwibank has also been a big issuer. The returns are poor, driven down by hot demand. It's nuts.
Earlier in the year the Financial Markets Authority issued a warning, of sorts, over a $400 million ASB subordinated and unsecured debt issue. The FMA said the ASB notes were complex instruments that might not be suitable for many investors.
"These ASB Notes carry similar risks to shares in ASB but do not have the same opportunity for growth as shares," the FMA said.
And now British regulators have decided these bank hybrids are not suitable for retail investors. Further, the Aussies are contemplating the same ban. This follows repeated warnings about the dangers. This from ASIC's MoneySmart web pages:
Banks and insurers issue hybrids to raise money that can count as regulatory capital under the prudential standards that apply to banks and insurers.
All new hybrids issued by banks and insurers are designed to be loss absorbing, which means you, not the bank, are at risk of suffering a loss. This protects the bank's depositors, at the expense of hybrid investors.
3. Our next 'dairy' boom?
We track a vast array of things in our chart series. One we follow diligently is the IMF commodity series. The latest data shows sharply rising prices for beef. In fact, this index is at its highest level ever, and the trend has just started. Likely it is driven by the same one that drove dairy prices - a new and huge shift in Chinese tastes. Beef and lamb are about to go an a dairy-style ride, although these increases are yet to be reflected in local prices to the same extent. But the trend is there.
4. A new tension risk for China
This is how you create trouble for yourself, forcing it underground, radicalising it. In a modern country with liberal and open education systems, enquiring minds left to themselves eventually reject the man-in-the-sky mysticism. But suppressed and controlled, it generates an energy to grow underground, giving it a hook for intelligent people. China is making a big mistake that it may live to regret - until it opens itself to free expression of all religions. "Freedom to worship" combined with rising material satisfaction over a long time is the surest way to ensure the evangelicals burn out and dissipate.
China will construct a "Chinese Christian theology" suitable for the country, state media reported on Thursday, as both the number of believers and tensions with the authorities are on the rise.
China has between 23 million and 40 million Protestants, accounting for 1.7 to 2.9 per cent of the total population, the state-run China Daily said, citing figures given at a seminar in Shanghai.
About 500,000 people are baptised as Protestants every year, it added. "Over the past decades, the Protestant churches in China have developed very quickly with the implementation of the country's religious policy," the paper quoted Wang Zuoan, director of the State Administration for Religious Affairs, as saying.
"The construction of Chinese Christian theology should adapt to China's national condition and integrate with Chinese culture."
China's ruling Communist Party is officially atheistic and keeps a tight grip on religion for fear it could challenge its grip on power. It requires believers to worship in places approved by the state and under government supervision.
5. Will it last ?
The misery index is an economic indicator, created by economist Arthur Okun, and found by adding the unemployment rate to the inflation rate. It is assumed that both a higher rate of unemployment and a worsening of inflation create economic and social costs for a country. As at June 2014, the New Zealand score was its lowest since December 2007. In Australia their score was its highest since 2002. (Here is a global variant that ranks NZ among many countries.)
The advantage for New Zealand over Australia has improved sharply in the period starting in mod 2014 and is now at its highest since 2003.
Expect an increasing tide of expat Kiwis coming back home.
6. Law and the truth
It seems American judges are getting sick and tired of settlements between banks and regulators that don't admit guilt, or even establish the facts or truth of a matter. The Economist has noted one judge who was ordered to rubber stamp a deal between the SEC and Citicorp, and who did so in such a way, he has pushed the whole issue back into public debate. Go for it, judge.
The settlement ended up before Mr Rakoff who had previously expressed reservations about the SEC’s approach. In this case, he suggested the SEC had erred by agreeing to charging Citigroup with mere negligence, given evidence that suggested more serious activities. But the core of his objection was the failure of the settlement to determine guilt or innocence before coming before a judge for an endorsement.
“The court has not been provided with a proven or admitted facts upon which to exercise even a modest degree of independent judgment,” he wrote. To surrender this independence, he added, “would undermine the indispensable attribute of the federal judiciary.” His conclusion: “An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous.”
8. Easy pickings
Ah, the temptation. When government finances come under serious stress, it is not unknown for them to reach over and take private pension funds. (Here, and here, for example.) Its happened a number of times before, and it happened again this week - in Russia. Their deputy economic development minister was so ashamed of the move, he expressed his frustration on Facebook. Then he was fired. This from the Moscow Times:
“I am ashamed of the decision to extend the moratorium on investing money from the national pension funds,” Deputy Economic Development Minister Sergei Belyakov wrote on his Facebook wall on Tuesday evening, earning a rebuke from the prime minister's press secretary and, on Wednesday evening, his dismissal from the government.
The National League of Management Companies has estimated that the latest decision will deprive privately managed pension funds of about 550 billion rubles ($15.2 billion) in 2015, raising the total losses to the pension system from this year and next to between 1.2 and 1.3 trillion rubles ($33 billion to $36 billion), Vedomosti reported Wednesday.
The decision, which was confirmed by Russia's Labor Ministry on Tuesday, has been seen as a reflection of the poor state of Russia's public finances amid economic slowdown and escalating Western sanctions over Russia's backing of separatist rebels in eastern Ukraine.
And these are the people who plan to buy our cheese? Fonterra better be paid in advance.
But as Zhang Monan points out, much of that is merely re-exporting high value imports bought in from other countries - and where the real value is created. More from her in Project Syndicate:
For example, the “triangular trade” model – whereby China imports significant quantities of intermediate inputs from East Asian countries like Japan and South Korea, then exports the assembled products to the US – allows for substantial redundancy in trade records. In 2010, more than one-quarter of the world’s $19 trillion in exports was counted more than once.
China’s dependence on low value-added activities like processing and assembly is rooted in its historical lack of capacity to invest in research and development. For a long time, the country was able to overcome this deficiency by capitalizing on its abundant labor force to become a global leader in low-cost, labor-intensive manufacturing.
But China’s low-cost advantage in manufacturing is diminishing rapidly, owing to rising wages and a declining demographic dividend. And its low position in global value chains means that its actual profits on exports remain far lower than those of advanced countries like the US, which specializes in high-technology, high-value-added production.
10. Today's quote
"In theory there is no difference between theory and practice. In practice there is." - Yogi Berra