Anything happening with Banks?

We discuss a number of toping relating to psychology of markets. 

• Silicon Valley Bank
• Stress Tests
• How big is this crisis and what tools remain to fight it
• Credit Suisse goes boom
• European regulators dim view of US Regulators

Richard Feynman on the Scientific Method (sometimes a refresher is helpful)
 https://www.youtube.com/watch?v=EYPapE-3FRw

 Welcome back to Off the Fence, a podcast where we look at current and general topics from an institutional and hedge fund investor point of view, with the benefits of a few decades of managing investments.
  
 Every two weeks, we’ll get together and take a look at a specific topic, try to separate the wheat from the chaff and maybe even come up with some practical, compelling conclusions. To Get Off the Fence.  We’ll keep it direct and clean, with fact-based analysis and opinions.

Transcript

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hello, good morning, good afternoon, and good evening, and welcome to the Transatlantic Podcast, off the Fence, where three transatlantic guys get together and talk about current events, the future, the past, and everything in between. The topic this week is the spectacular blowups that we've had in the last few we, the last 10 days in Silicon Valley Bank's Signature Credit Suis. And it's a slow train wreck of a at the end here it seems. And the what we can expect from this, what we think of how it was handled, how it was managed, and what else might be down, coming down the road. Why don't you start, Alex, tell us what you make of it, where you see it going. I I was gonna wonder if we had anything to talk about this week. It's been wildly entertaining seeing how many experts there are in in, in fractional reserve banking and gap risk on social media. I guess everybody knows the situation. I don't think we need to go into the details. A couple of things I thought were interesting. And Luis correct me if I'm wrong, I understand that the stress test numbers for 2021 obviously exist, but the 2022 have not been published yet. And I guess when they were doing the ones for 2021, they were stressing balance sheets at the time, perhaps correctly up to a level of 2% of a move in the single in, under. Under 1% to 2% in the, in, in stress testing the banks. But you gotta believe that at the end of 2022, when they were doing their news stress test, they were doing something more in line with where rates have been. So I can't imagine, I dunno that I don't know that bank of Silicon Valley, because of the size of the balance sheet, was a participant in the stress tests because I think maybe it was below the radar for that it would've been released from stress tests, but not from not from reviews and evaluations. Yeah. That is correct, but I don't think that, that there are several advantages in US banks of be in being smaller and, there's less capital requirement. There's there's. Reasons why it, it is a good thing to be smaller in the us Yeah. Yeah. So some of these were li were lifted. I, I, my point was not on silicon specifically, but in general, my sense last time I looked, I think somewhere like 45% of the book value of bank of America equated to the lost on the holder maturity portfolio, right on the long-term securities that do not need to be marked to market. So the argument I have is that this is not exactly something that either based on public information or that the regulator didn't know about weeks ago, months ago, while back that raised from negligible interest rates up to four to 5% in the book would not have created massive craters into the banks balance sheet. What I find surprising is this idea that it's a new concept that regional banks or specialized banks are not subject to a run. If the confidence is not I, in the business, I have not read yet anything, and I am, I'm open to be corrected that the core business model of s v b forget silicon forget the signature and but for the ones that I know a little bit better, which is Silicon Valley and First Republic, that they did not have a sound. Lending business or, main Street business that it, that clearly they had forgotten the rules of 1930s banking in terms of matching liability maturity to, to assets. Yet they did. Yeah, exactly. It's, I'm not excusing, I'm not excusing it, but what I find fascinating of course, is that the very facility that was put in place after Silicon Valley blew up would've been exactly the one that they would've gone to when they were unwinding their available for sale portfolio. And yeah. And looking at their uh, a health maturity portfolio. Exactly. If you were gonna do it Monday, why didn't you do it Friday? Yeah. I think you d up the situation very well, and I first of all on the maturity gaps. The business of a bank in 2023 is precisely to take that risk. Now there's ways you can mitigate that risk, but that's what most banks do around the world is that they lend longer term that they fund. Second thing I would say is that normally banks have government securities for two reasons. One reason is to be, to have liquidity ready for, as part of your, requirements from the regulator to have liquidity buffer, it's called. Okay? Yep. And the second reason that they may have government securities, of course, they could do it in swaps too, is to hedge interest rate risk. Now in 2020, banks around the world sold most of their government securities. Longer dated government securities because as long as 10 year yields in the Euro zone, for instance, were approaching zero or negative there was, it wasn't hedging any risk to, to hold the bonds anymore. So most banks realized the gains in those portfolios in Europe, for instance. And they are only rebuilding the, what is called the Alco portfolio, which is the bonds that you hold in order to mitigate the risk that rates go down because you have large floating rate mortgage lending books and that's how you're trying to mitigate the risk that interest rates go down by own, by holding bonds. So that's one thing that this bank didn't do it for that reason. The re because they don't have a very big mortgage book relative to the positions they had in government securities. I think they're lending business sound as it may be. And I'm not this, and there doesn't seem to be, any reason to believe that it isn't? And all provisioning in the US is forward looking and they don't seem to be at least I guess it's the same management that was taking in the punting, but why did they hold longer? Dated securities is probably a function of trying to have better earnings because you got initially better yields and then you found yourself in a situation where you didn't anymore and the curve inverted and you were screwed. But what I think is going to be something that needs to be explained by their advisors is why did they think that liquidating the available for sale portfolio and a, and announcing that they were going to raise money without having a full, a fully underwritten capital raise was the solution to the problem. I think their advisors in this particular situation were not, probably well advised in, in, you why didn't this bank go to the fed discount window? Then we'll, I guess we'll have the answer soon enough. Yeah. You mentioned Bank of, you mentioned that Bank of America has 45% of its work equity in unrealized losses in their health material account. Yep. They may very well have that. They also have probably a large percentage of their book value in unrealized gains on the securities that they issued to fund their book. Because both can be, you can do both at fair value and you probably don't find that such a big misma. Now, is that something that you should go to bed and say it's great that they're, that they have also unrealized gains if they bought back their own debt and Yeah. At the end of the day, banking is a game where confidence is very important in Japan. and in countries where most of the depositors are retail are not very well-informed, there's generally you don't see backgrounds. I Backgrounds in Italy during the crisis. The only people who took their money out of Italian banks were corporates. Retail investors kept their money even though most of the banks were gone or close to gone for Spain or Portugal. You had the corporate depositors leave and retail depositors stay in Japan. You had banks that reported negative equity and have no liquidity issued. What I don't understand is why did the, but I do understand, I think why the supervisors and the regulators in the United States didn't move early. And I think it is because the philosophy of the previous crisis was that we were not going to use taxpayers money again to protect certain. Risks that were clearly not protected. And then I guess they realized that taking 20 cents of haircuts or on deposits, which was the more or less the consensus estimate of the haircut that un, that uninsured depositors of bank of Silicon Valley we're going to take was not acceptable for the banking system as a whole. And how they moved from one position to the other position is probably, it's possible. Interesting. And, it would be interesting to be the fly on the wall there because Peter, you're probably much more well versed on Central Bank policy regarding moral hazard and preventing moral hazard situations. Not necessarily but there's a lot to unpack here. And I'd say, there are a few pieces of this. One of them is, I went through a bank training program in New York in the early 1980s. And we were not a very sophisticated bank. We were big, but we were not necessarily the sharpest knives in the drawer. But two of the things that they taught us which was always, very basic risk management, was diversification. And and timing. Get the, getting the, being careful of your mismatches, which of course are inherent in a bank balance sheet, but they have to be managed in a very careful way. And the monoline banking model, which is what, svb Silicon Valley Bank was the prototype of it, it was really a one business, the one one trick pony. which is not what you want in a bank. And their reliance on a certain type of client on both sides of the balance sheet was really just a recipe for, it was concentration of risk that a good risk manager and a good supervisor especially should have been, have had an eye on. In the case of the supervisors and their speed of action. You're absolutely right. It's I'd say that the difference here is this happens or seemed to have happened so quickly, it seemed to have come to life so quickly. Although in the market it was, apparently known since the second half of 2022 that this bank was suffering significant withdrawals. And yeah, a supervisor should have been on that. What and I guess we will find out, as you say, why it wasn't in the capital increase. I went through a capital increase in 2008 when this was just a few weeks after Lehman's when the market would still invest in banks. And one of the things, that was clear as we were doing this, was, yeah, the underwriting had to be 100%. You couldn't, you didn't go to market without the issue being underwritten. And if you needed 2 billion in capital, you went to the market for six or seven. You went big because the market wasn't gonna give you a second chance two months later. And that's and it worked out. But those were different times when investors were still willing to invest in banks, even in the midst of the biggest financial crisis that we had lived through. So I guess the question now is, where does it go from here? It, you would think. It's absolutely the case that many small banks or, anything from the mid-size to the small ones, were making money on this carry trade, which is investing in treasuries at 4% or whatever they're yielding and paying the one or two on their deposits or less. So it's gotta be cooked, baked into balance sheets all over the country. Now they've got a solution for that, perhaps for a year or so due to the Fed temporary facility that it announced over the weekend. But there's a lot of repair work to be done on balance sheets in US banking and the, and it involves losses and could involve another wave of consolidation. And it could involve another bank run. And the big question is the next guy gonna be bailed out the same? Alex, you sent us an article earlier today about how furious European regulators and authorities are that the US did this guarantee on deposits, which, flies in the face of what you were supposed to do as a Yeah. As a as it too big to fail or a non too big to fail regulator or supervisor. You weren't supposed to allow this to happen, but there it is. It happened. Yeah. I think it's like Mike Tyson said, everybody has a plan till they get punched in the face. And the European approach is very different. But it, when it's tested, it's, at the end. But it hasn't been tested. Yeah. No, it has been, no, it has been tested yet, yet, yet. What do you mean? It has been tested? Bangkok went to, it's been tested by bang of Poplar and the two banks in Italy that were, yeah. And they went into resolution, but there was no touching un in uninsured depositors mainly in the case of Bangkok because they had already taken their money out and that's what led the bank to, I don't know the situation as well as you do, and I'll argue let me try to be a c There's no arguing. It's what happened. It's a case and it's a case study and it's very interesting. Have we already forgotten credit risk getting 52 billion from Central Bank of Switzerland? Understand it's a different jurisdiction, but still that's what, that's the issue. Fe suis is in Switzerland, which is not in the European Union. Understood. Yeah. Yeah. But no. Yes. Look, I it's a, I benefit from being able to form an opinion with very little facts. And I will do so in this case with pleasure, which is that? Yeah, sure. So far so good. No problem. Can I go on, can I finish my sentence? Maybe because it was going to be interesting if I finish. The resolution process is designed to make sure that banks don't get state aid until all the bailing capital has been disposed of. And that in the original plan included up to 8% of the balances of senior and secure debt and uninsured depositors. And the test, therefore is whether they're going to go for that haircut if necessary of 8%. It's not that it's not a evaluation exercise, it's that you need it's a just a legislative decision. I think there might be another precedent here that doesn't directly involve depositors, but it does involve, public money, the money of the public. And that is the pension funds and the similar mismatch in September that slightly, that somewhat blew up in the uk. Yes once again the moral hazard got ditched or concerns about moral hazard got ditched and the Central Bank stepped in, in the name of financial stability. That's about the closest parallel, I think Recent parallel as well as credit suis color, Luis Color Sinek. But I just don't believe that the great pronouncement of the great Christine La and the. Or they sound, this is the blowing with the win or against the win story from, basic economics, 50 years ago of central banking. Perhaps they will be right. Perhaps they'll be able to hold to the, to, to those situations. Let's step back for one second. Just look at what happened, the problem. Silicon Valley Bank. They had two problem. They had three problems, right? They had yes, indeed. Extremely bad gap risk management. And when they were flushed with same amount of VC money in a 2120 2021, they put it where, they idiotically thought it was a safe, long-term end of the treasury curve, thinking, you can't get fired for investing my season into treasuries and trying to extend their, just as a still the average life was three and a half years. Okay. Agreed. And still the blue. Yeah. And still the available, the available for sale portfolio took a 10% haircut. The second thing that they've suffered, is enormously bad communications management over a one week period on from the management team, which is the idiocy of trying to go around and essentially selectively leaking the fact that they had a problem going through the sale and first for the sale and second through the financing. And instead of having some kind of logic with the regulators and staying close to the regulators and basically thinking that they were going to try to find a solution by themselves, seems to me as that will be studied as extremely bad crisis management from their side. And again we can move on. But the third part and to it's reminds you a little bit of long-term capital management. Like you go to, yeah. Hubris. Listen, I have this problem. Can you tell exactly. Same counter party for a minute. And I Exactly. Let me call you back in a few minutes. I'm gonna, I'm gonna help you in a few minutes. Don't worry about it. Exactly. I'll be right there. And by the way, by the time I finished front running you would you like 20 cents on the dollar for your portfolio? Yeah, absolutely. I just think we're being facetious, but I'll tell you what happened, okay. And this is a problem that I have on a daily basis. It was so out of modeling to think of rates going where they have Yes. And long-term rates to go where they have and we and I tell you that the position that we have is in 50 year European swaps, which I at 1.8% or 1.9%, not at five. Okay? They move from zero to 1.8, that the counter party on a long dated option on that trade, which is one of the main banks in the world. And it has been mentioned in this podcast already once. SU is suggesting to us that we tricked them when we put on the trade in 2019, with a team of two guys in Madrid with a Bloomberg. We tricked one of the mighty banks in the world in the pricing of two options on swaps. So I am not surprised therefore, that unless sophisticated bank in California that caters to technology companies made a miscalculation on the pace of rate of rate hikes that could be facing and the impact that, that would have on their one portfolio. I'm not trying to the first pack that the banks that are totally insolvent, by the way, and we have discussed this in previous podcasts, are the central banks. As a matter of fact, the only central bank that is al that has already acknowledged its insolvency is the National Bank of Switzerland. Yes, exactly. Which reported a loss of$130 billion for, sorry, not dollars. Swiss Frans for 2022, but also is an equity, it's also an equity holder. I It's a very bizarre Yeah, but they lost equally inbound are inequity because the bond index last year was as down as much as the s and p as the NASDAQ and European markets were actually not did. Okay. So they lost more money on bonds than they lost on equities. Okay. For the record, because you can lose a lot of money on bonds as well. And I think that, it, not only are they, have they taken that loss, but now that they're paying the deposits that banks have a central bank, they have a negative operating income. So nobody's talking about that because nobody seems to worry about that. And they say worse comes to worse, the treasury will put in some money. I'm not sure that, okay. Do Do me a favor, I'm gonna interrupt you because I think I was trying to say something in a similar to you. You let me just finish this. I don't think the treasury of Portugal. Has the money to put into the central bank. That's what I'm saying. Yeah, of course. Of. of course. But let me try to make a point, cause I really wanna get your thoughts on this, my argument my, my thinking here though is that compared to other banking crises that have ha happened in the past, right? It is very difficult to apportion a hundred percent of the blame to the target here. The argument still remains, I think that SVB and some of these other companies had somewhat of a core business and they made a massive risk management error in the face of, as you say unprecedented actions by a consolidated aire who has impact on the market I either fed, right? So Correct. So the issue here becomes a little bit different, right? While you could have faulted, essentially the whole banking system back in 2008 for having had idiotic and shamanic views about credit, right? In this particular case, what you had is that those people were spending many percent of their time thinking about, what risk am I doing lending against restricted stock and what kind of weird products and what, they was thinking all their time trying to figure out how to adapt the banking system for the technology, air business and doing all that and probably doing a reasonably good job at it profitably and actually, providing services that their customers if they disappear, are going to regret not having, but ultimately, clearly they made a mistake. Clearly, they're not a trading shop, they don't have a trading, I don't know if they have a trading for, but they don't have a, they don't do all these things. If I may, lemme finish. Let me, lemme finish please. Lemme finish. So my point remains that what's interesting about this is that the Fed is put in a position, which is of weird because it is an actor in this. In this system. And just similarly to what you told me earlier about what the Europeans think about regulation, the Europeans have been exactly the same in terms of this behavior on rates universally. So the problem that you have is that it's a systemic problem. What happened is everybody around and this is to me the most ironic thing and the funniest thing is that if you go back 20 years ago, people decried derivatives as being risky as being idiotic for, for working at it. And the people pushing in, obviously we're talking about risk management and many people use derivatives, to add risk. I get that. But the point is that if you were running and accepting deposits in 2021 in the size that these comp that these banks did, and you did not run a hedging, right? And you were going where the liquidity was. I think pretty much every bank bought along the curve. But I'm guessing that the more astute banks ran a better hedging book in order to swap it out or otherwise manage their risk in a better way. What you have now is you have the, and on the Federal Reserve saying we are going to have enormous impact on the cur on, on the rate behavior which is, it's gonna have an impact, yet we're gonna ignore the fact that it's having an eroding impact to the capital base of the banking system. Because the banking system, either through conservatism or because they've forgotten their banking basics, or they had their, they were learning the lessons from. Issues of the 2008 and have forgotten, like they were solving the last war as opposed to the next war. The actions of the Fed have had an enormously destructive impact on the very basis of a fractional lending of the, on the capital of fractional lending industry for which ultimately they're the only solution to. I agree that they that, I agree with the Europeans, if you want the central bankers that the Americans just threw out the playbook. But in some ways this was predictable. Let's put it this way. If you could transfer the deposits, it costs nothing for a c f O to take their balances and deposit in size, particularly the obviously the unsupported balances the uninsured balances and move them somewhere else. They're not earning anything now. They're not gonna earn anything in destination and everybody should be sending it to Bank of America and the systemic banks. That's the point there that you make is very interesting. In previous crisis, JP Morgan has refused to take on deposits because they couldn't, there was no benefit to them to have more deposits cuz they couldn't do anything with them. And they said, sorry, you're not a customer. We're not taking your money. Take it somewhere else. These guys might have thought of. Knowing enough about finance to know that JP Morgan had done that. The thing that I find flabbergasting is that, at the end of the day I am, I, all of us have worked on Wall Street, but I haven't been in a bank since 1997 or actually to be factually correct since 1998, because even though I was in on, in the asset management division of a bank, it was still a bank. But the, you, you still, if you are in the financial profession, you still need to know what that, certain things and there is a cost to having deposits because you need to have, it, there's certain things that you need to do with the deposits in terms of regulatory stop gaps, et cetera. I cannot understand what these guys were thinking to begin with because they had nothing to do with that money, with absolutely nothing to do with that money. They could have said, listen, you know what? We want your business, so we're gonna have a fee income out of you, which is what I would've done. And I said, this is the Bank of Silicon Valley money market fund. We're going to invest your money in treasuries and charge you 25 basis points. Yes, that would've been fine and everybody would still be alive, and it would've been an easy thing to do. Agreed. One little anecdote just for fund that I find hilarious is at least a half a dozen time over the last 10 years, people have come to the Fed trying to build a bank where the, all of the deposits are held at the Fed. And they came and asked for authority to be able to take in deposits, build a new bank, and then put dollar for dollar with no fractional reserves fully reserved to the to the Federal Reserve and have been turned down by the Fed. And I've been shut, torn down. Shit. Doesn't know what to do with the money either. Yeah. No but agreed. But, and that's just a transfer of profits to the bank. That's the, that's a carry trade that would make, that would be a political time bomb. I, let me, I I'd love to do that too. Everybody would take that turn. Everybody would take that trade, right? I'll do that's, yeah. Lemme tell you something. That's the discount window. We talked about it before this week. Everybody's talking about the fact there's$120 billion of things repo at the discount window. And it's a record number. It's a meaningless number because obviously the size of the financial market is very different today and 10 years ago, 20 years ago. But what's interesting is that going to the discount window has always had, A bad karma about it. If you go to the discount window, you're telling the world we have a problem. Okay. Yeah. Yeah. It's not it's like you have this solution, but it's a solution. Then damn, if you do it, damn if you don't. And it's so I think people are reluctant to go to the discount window in general. And there's a, there is a solution to that, which is you, everybody has to go to the discount window X times a month. Correct. Time you have to do it. That would be wonderful. Absolutely. You just and it's they lose a little money on it. Maybe not, but you have to go to the discount window x times a month, which is what they it's exactly what the policy was with the preferred securities that the treasury on the road for banks, everybody had to take it. Remember? Because that way, no, there was no signaling effect, and the other thing that, I find, in Europe, and we're gonna be testing this, and I agree with you, Alex, that we're gonna see how they blink. First of all the E ECB does is not the bank supervisor in Europe. There's a separate office called the single supervisory mechanism, which is independent from the e cb and, and the national central banks are co supervisors. That is the correct framework, I believe. Peter? I think that s M ultimately reports into the E C B. Yeah, but they have authority right. To Yeah, but they have authority. They are, yes. So in some cases, the European Commission takes, which is this weird thing we have in Europe, which is unelected officials that are appointed to a government that is a bureaucratic gov government. Okay. So these guys sometimes come in and say maybe the statute or maybe the European regulation says this, but in this particular case, we're going to allow based on exception 1 20 79 slash 27 or state A to come before resolution. This has been the case with Panko Monte PAs, for instance. There's been no resolution of the bank and the Italian treasury has taken control of the bank. So there is a flexibility here as well that has been tested. And I think that maybe because there's no Euro area wide in banking union and deposits are guaranteed by national deposit agencies that may be funded more better in some places than in others. They're gonna have to be creative. Now the other area, which maybe you guys wanna discuss, where there's a lot of problems because of the higher yields, is in knife insurance. Shall we go there? Yes. Okay. Go ahead. don't know the story well, so I'd love to be Okay. You neither. A life insurance company would guarantee you a certain a certain payout on a policy, and you make contributions to that. And what they do is that today you say, you, you under, they underwrite a policy that pays you, let's go to the situation of three years ago in Europe, they would say, I guarantee you 0%. I kid you not. They keep, I keep you not, they sold policies that guaranteed 0%. And so their customer would put in money every periodically into the, into that policy and would be guaranteed to earn a whopping 0%. When he redeemed the policy, then that 0% became 0.5%, then 1% once the number was positive. The insurance company went back to doing what they normally do, which is, you buy the bonds that match the policy payout that you have offered the customer. And you have all these actuarial tables and then, and the actuarial tables estimate persistency and they estimate longevity and they estimate a lot of things and they come up with the number of bonds. The percentage of the policy that to be bought in bonds find so far everybody is on with this. Now comes this problem again, multi standard deviation, moving yields, and all of a sudden the agent who sold that policy to the, to his client sees that the same company that was selling policies that guarantee 0.5% payout, is selling a policy that guarantees a 3% payout. So he says, oh, you know what, let's call the guy who I sold the 0.5% policy to. He has no penalty for early redemption. and I just rolled it into this new policy at 3%. Now the problem with this is that it has taken down already one life insurance company in Italy because they were holding all these bonds to hedge the policies, and they're, and they lost the policy. So now they had to take the loss. There was nothing to hedge. And this is a small problem that nobody's talking about, which I think is not so small. The second thing that nobody's talking about, but we will, is how these higher rates affect marketing to market various things. Now, the stock market obviously corrected in a particular way. There is a market that doesn't seem, that seems to be far more resilient to higher rate long data rates than anything else. And that's many private equity funds that invest in. Buyouts or infrastructure Yes. Or real estate? Real estate less so because I, we are already seeing some blowups. But yeah. And these funds are widely held by insurance companies in Europe, as they have been bought as a proxy to fixed income for the past few years. And some of these companies have exposure to these illiquid funds in, which is in excess of their equity capital. In particular, there's one of them, and, they should remain nameless for now, which has nearly three times. It's equity capital invested in level three assets in private equity guard. Now, most of these private equity funds obviously are not going to be worth nothing. They're gonna, but they may be worth less than the money that you committed. It's a, there's a possible scenario where you have losses there, and if you have three times your capital in these investments and you lose, 30%, then you don't have capital anymore. Okay? So it's, now this is another area where people in general are very excited about banks, but they're forgetting that insurance companies are also in the financial markets and that they, and they're an integral part of the financial infrastructure amongst other things. Because typically they are the largest buyers of bank debt around. So the circularity is there and I'll, and we'll, I'll leave the floor to you see what you think about this. And the other segment, of course, is asset management. If you really get a breakdown in confidence and again, mismatched between the liquidity needs if you have redemptions and withdraws and the nature of the portfolio that the asset manager's holding, oh, that's a one. That's a very good thing. And you know what happened in the US several years ago, right? Oh yeah. That, that the I don't remember whether it was the Fed or the s e c or both required that fixed income funds in the United States would put into the prospectus language where they could have gates Yeah. To prevent these orderly liquidations. Alex, I think we lost you, but I believe even with gates flood accumulates behind the gate. But so lemme ask. No. I mean, It's not a solution. It's just postponing a problem and problems don't h well. So it's, exactly. And in private equity, as you say, there's already gates up around riots and and other real estate funds. So Yeah. It's all there and it's not as transparent as the banking system. It's, they're not as capitalized as banks are. Yeah. And I think you're absolutely right. It's the one to watch, but I wouldn't even, I don't even know how to watch it as a layman. You, and if you are to agree that we are seeing financial conditions tightening as we speak then all the non-bank financial inter theories are going to have issues with their funding too, right? Cause they're gonna have to get funding somewhere so on and so forth. I am not saying that this is a horrible situation, but I think that first, the yield curve is telling you that we're going into some kind of a big slowdown in economic activity, the way it's inverted. Secondly you have tighten financial conditions. There's a lot of, there's still significant leverage in the system. It's not like we have deleverage, some countries have more leverage than ever. For instance, the and, and so on and so forth. I, we, I don't want to sound overly pessimistic, but we're gonna have, I think we're gonna have to be very attentive to how this develops and what the market obviously is hoping for and is that they have finally cornered the central banks into discontinuing the tightening. I think politically it's very difficult to see with inflation as hot as it's running. And with elections in the United States in 2024, I don't know what's preferable to have a lot, most of the voters, I'm unhappy because their purchasing power is being attacked by high inflation. or the stock market doing okay. And I would think that it's probably with unemployment at 3%, it's probably better to keep the voter happy. I don't know what you guys think. Yeah, I was gonna try to have a conversation. we step back for a second and try to elucidate what is impossible, which is what has caused inflation and I, in the last couple of years. And so I get the point that historically raising rates and, crashing demand and a recession should have dampening impact on rates. And I would argue that technology is also having. There's a facet just as a complete aside right, Porsche release numbers. This week they had phenomenal numbers up 10 to 20% across all metrics. And then they announced happily that they were gonna keep 20% margin and increase the prices in order to maintain 20% margins, essentially in two infinity and certainly next year, right? While you have, the yds, not to mention Tesla, but the Yds and other volume manufacturers with many times, the volumes that the, you know, that these manufacturers have, are actually on a cost a community cost reduction curve, trying as much as they can to reduce prices across the board. Because for them it's a different story. They need to get volume and in a recession, the only way to get volume is to reduce prices, right? F forget whether they make money at it or not, which they do, and what they will no, what they don't make in the margin, they make up in the volume. Yes. Funny. You can say that, but okay. I'm happy to go through the Tesla and b y d financials to show that they are not cashflow negative in any no, you're right. The German manufacturers are hiking prices because there's con constraints on capacity and they're eliminating the small the small cars from their lines. And they're just hiking prices on the rest, and they're making a shortage of cars, which is possible because of these supply disruptions. And, maybe they, everybody's colluding in Europe. I don't know. But the reality is that car prices are through the roof. I'm the supposed to be one of the luckiest people life because I'm gonna buy A B M W station where I'm coming out of a lease from a very good friend of mine for a song like, cause I'm, know, I'm gonna pay 39,000 euros for a car that retails now for 125,000 euros. So it's just crazy what's happened to car prices. So to, to that point. And I would love to talk about G P T four and some of the other things that happened this week, which I think are absolutely fascinating. But did it die? Did it have problems? Did it no. They, something that was supposed to be released in about a year, ended up getting released last week and this week and is significantly more powerful. It is multimodal, which means that you can feed it a text and images. It'll do all kinds of things. We can have the whole conversations another time. It is actually fascinating. Let's talk about it next time when we can talk about interesting stuff. But what I wanna point out is something different on inflation, right? I think that we have gotten used to a model. And I actually think that Walmart, for example, is gonna be the biggest loser in that logic where we are sourcing in a complex supply chain from across the world. Let think of it this way 1,500 SKUs per Walmart for mustard or for, dining plates or whatever, it's that if you are if you want to have a choice of, if you walk into a store and you're expecting to have the choice of your brand because you were convinced by advertising or that you want to have tons of choice in order to make the choice. You are going to have a certain retail experience. And that retail experience has consistently gone up because all of those supply chains are trying to get filled the same way they did before. Or you have the other model, which is, which to me is obviously the Tesla model, the Apple Model, trader Joe's, Costco many others, where you have much fewer choices. the choices themselves are much better thought through. And there you haven't really seen there the supply chains are much easier to reconfigure as problems happen because you have way fewer SKUs, you have much less in the channel, many more, many, many fewer inventory issues across. And so what I find interesting is that to me I really wonder what is the inflation we're fighting, right? I get the point that we are, I flashing inflation of free money and it was very easy for asset prices to be support and all that kind of stuff. We can have a conversation about asset prices, but I'm talking about in the real world, what I'm seeing is a difference between convoluted supply chains. That we are optimized for a world situation, shipping cost openness of China, any of the things that you want to talk about, container supply at Long Beach. If I can I, you're absolutely right. I think Alex and, but the two drivers of inflation are not necess, they're not mutually exclusive. They're not incompatible with one another. And they both have the same solution because there really is only one solution, which is a tighter monetary policy. I wonder about that. I wonder about that. Just just to make a last point, this is my point, right? If C P I turns out to go down, because it was a mostly of supply chain issue and people have substituted and they no longer care about, let's say, if one more prices go up, the equivalent prices go down, or if Amazon turns out to be a better distribution system than whatever retail dis whatever it is, that the supply chain gets reconfigured after Covid and after the China. Sure. The China issues insofar as things will get cheaper, lumber gets cheaper, raw materials get cheaper, energy is cheaper, all that kind of stuff. And the c p I is down then I would not be surprised at all to see the Fed abandon a tightening monetary supply because it solves all their problems. It's solves problem. You mentioned that supply, if that supply side problem does get solved. Yep. You're absolutely right. Although I don't think, really hope that. I don't, and I have a chart posted to the chat that, ah, that you who are a magic guy can post to everybody enlarged, and this is a chart of the M two money supply measure to, and the GDP of the United States in nominal dollars. And what you'll see in the chart is that as a result of COVID, there was a jump in the ratio of the money supply to G D P two levels that have never been seen in the past 22 years and or in history, I would say. And that in my opinion, is the reason for the inflation. That in both in the US and Europe, you've seen a jump in money supply that is unprecedented and therefore because the velocity of circulation did not Go down, you have too much money chasing too few goods, and unemployment is at a record low in many places, and populations are aging, et cetera. Immigration has been suppressed in many, especially in the United States with a new legislation and all these factors combined make it for a very inflationary backdrop. And I would say that monetary policy is very loose today. The Taylor rule would suggest a Fed funds rate of 6% and we don't have a Fed funds rate of 6%. So I, what I would recommend to a lot of people is that they be patient because this is a problem that has monetary, a monetary Reason to it. And as you will see in the chart, the money supply is beginning to taper taper off but you still have a ratio of money supply to gdp. That's kind now what's happened to the banks now, I think it's gonna slow down the velocity of money and the airport's gonna do the Fed's job for them. And maybe that's what allows them to ease earlier. But other people would tell you that what the Fed has done to guarantee deposits is another q quantitative easing. So I don't know. Also the, as, as long as the, even if the supply side issues that you mentioned, Alex, are the driver. The institution that we have charged with with price stability are central banks and they only have, so much they only have one or two arrows in their quiver. But that's why they said, that's why they said that inflation was going to be temporary because they bought into this, they bought into it, yeah. They bought into the supply chain disruption and inflation has not, has had that influence. It's had many different influences. Yeah, agreed. But they could have been wrong then. And right now, right? Yeah, no, I think it's, inflation is a monetary phenomenon, not a supply phenomenon. So if I if I can and this this is an eternal argument. It's an old one and our. Are on it but I just like to look at credit suis for a moment. Yes. And to see if either of you think what happened last week is the beginning of is this fixed? I don't, I'll tell you my opinion, I don't think it is fixed. 52 billion Swiss Frans, over 54 billion Swiss francs is about 10% of credit SU's balance sheet, maybe a little less since they've been unwinding it. It probably it wouldn't even meet the standards for the liquidity coverage ratio of the bank recalculated on the basis of the most recent withdrawals. I, if you've, if you're a private banking client, I can't imagine you're gonna stick around credit sus to see what happens. I and I'm just wondering. Yeah. What what the next ch what the next stage, what the next chapter there is, because I, neither do I know what a resolution plan would be. I think this Swiss National Bank's reaction was a strange one to leave it twisting in the wind as long as it did. I, people tell me it's because there's been terrible relations between the Swiss National Bank and credit suis, which wouldn't surprise me, but they did leave interesting in the wind there. Anyway. Yeah I have done a lot of work on credit suis because we're been short for a while. So I the, this bank has an existential problem. It's lost money, five out of the la the last nine years. The book value per share is declined by 50% over the past 10 years. The share count is up 280%. It, they've lost some of the best businesses to accidents because the prime brokerage business between before the Archus thing was a great business for them. I think what does are the negatives, the positives is that it has 110 million switch Frans of tlac, which is total loss absorbing capital. So relative to the size of the balance sheet, that is a lot of capital. Okay. Because it's not just the equity, it's all the other instruments, right? Sure. So I think the tlac and the liquidity should provide time for an orderly liquidation. But I think that in that liquidation, because it's such a motivated seller, there might not be a lot left for current shareholders. And I think the best that can be hoped for in this liquidation is for unsecured creditors to make. Most of their money back. I don't know if you looked at the bonds. The bonds, I think some of the bonds we shouldn't be giving financial advice here, but I, some of, there's two entities that issue bonds. There's an op, an operating company, and a holding company. Just to make it simple and probably the operating company bonds are fine. But at the end of the day it was just not it was like in every end of a cycle, there's one large investment bank that is not needed anymore, whether it's Drexel, Bernard Lamber, or it's Lehman Brothers or Bankers Trust in, sorry I've got Bankers Trust in 1998, or it's Lehman Brothers in 2008, and maybe Caris is the one that the world doesn't need today. So you are assuming liquidation? No I'm assuming that they're selling things to different people. Yeah. So that the bank is dismembered, and then there's a. You have maybe I'm not sure about the investment bank. I don't know if anybody, Alex probably has a better sense of that because he's much more knowledgeable about investment banking than there's a plan for the investment bank, although I don't know how that will work out now that the Swiss National Bank is, has stepped in the way. It has many of the best team left. The problem is an investment bank take, investment bank reputation, and reason for being in the minds of corporate is something that you build slowly over time and gets destroyed quickly. It's hard to see from the outside. It's hard to see depositors wanting to keep deposits there. People want. Them in their syndicates. It's, it really is too big to fail, but has to fail. So you tell me which one of the irresistible force and immovable object is going to break first. Feels like the return on the 52 billion is just kicking the de count down the road until such time as, they need to put more money in. And look I, what I worry about is this idea that if you make things too big to be systematic, systematically poisonous you you keep on having to avoid the problem for a long period of time. Yeah. And I, that's every so often there's a European one that, that goes through this. This is, I would agree with Luis. I think this one, if they could be an orderly liquidation and we could all move on, I think the market would be saner. Sure. With that, maybe we should draw it to a close, but should we do the should we do the flash survey of what's up, what's down, who's up, who's down? I wanna ask us re regional banks. Okay. From where they are now which is down 80 to I see only downside for the reasons that we've discussed this. The carry trade lack of confidence in certain banks. Some of them are monoline. Silicon Valley Bank isn't the only monoline bank in, in the country. So I think down, shall I ask now, Jerome Powell, does he get is your point, does he get reappointed. Sure. Let's say does he get reappointed? Does he get, is he, I'm gonna say, I'm gonna say is heed, or he vilified or is he praised? I don't think he gets praised in the long term, and I don't think he gets re conducted, but I think he was mediocre. And it was a tough job. He's I think he's a truly talented guy who made this job look even more difficult than it had to be. It's almost as if there, there had never been a central banker before him, and he is learning the lessons for the first time. Yeah. Yeah. Luis I don't have an opinion on Jerome Powell, okay. I think he was Delta. Every person who takes on that job needs to know that they're gonna see a lot of six Sigma events because our models for understanding our world. Are very bad, right? So there's no such thing as a SixSigma event, but there's a lot of things that happened that were not anticipated, or the consequences of the actions were not anticipated. And he had the fiscal response to the pandemic to deal with without being able to do anything about it. As a central, when you see that kind of fiscal stimulus and you're the central banker, normally you need to act quickly because obviously the treasury and the parliament are going against your mandate or one of your mandates. So I don't know. Okay. Let's make these flash answers. US equities Bull. I'm bullish on tech Bearish of the Dow Jones. Yeah, same. Alex, same. Yeah I'm perhaps the opposite. I'm more bullish on growth. I'm sorry, more bullish on value than growth, but that's just me fed funds rate By your end. Let's give it a time. Yeah. Is it going up or down? I think in spite of everything the Fed will do what the e ECB has done, which is continue updates may be at a slower pace because again this inflation thing is not a joke. You're right. I think I agree. I agree. Alex, 4%. Oh, ooh, 4% by the end of the year. Okay. Yeah. E ECB rates I think they're probably pause around here for a while. Yeah. And they'll fuck it up again. Sorry, did I say that No. Not at all. Not at all. Not hear that at. Okay, Alright. Sorry. Switching switch, switching speeds a little bit to politics. Bullish or baris? She of China. Barish. I mean for him, I think he's going to be fine for us. It's a problem. Yeah. I think he's I think he's on a roll right now, which is frightening. Which is not good. Exactly. Putin, bearish. I'm bearish on Putin. And bearish in the sense that he of his bear, that he used to get drunk or no, bearish in the sense that you, Barry is the big red bear. What is this? He's not gonna fix, he's not gonna fix his biggest problem. Yeah. Yeah. Biden, I don't follow the day, the blow to blow, but he seems to be having some victories in some of these things that he finds and I don't know, but Okay. Okay. I would say. Okay. I agree. I'm neutral. I'm Biden. Yeah. I am, I don't think he gets reelected or he runs again, but I think he will be seen as a fine president, not, middle of the pack. Excellent. All right. Very good. I'd asked you about March Madness, but it's early days yet, so we can look at that. Not, I don't know that we are allowed to talk about sport betting on this podcast. I don't follow. I don't follow golf. my, all on that note, thank you both. Oh, thank you. Thank you guys. Thank you. Have a phenomen weekend. Much love. You too. Take care. Bye. Bye.