Monday, January 18, 2016

Dodd-Frank Test Looms

Financial markets across the world plunged during the first two weeks of 2016. Global equity markets, for exmple, suffered the worst first two week loss in 20 years. The problem is continued signs of severe macroeconomic weakness which this blog highlighted starting in late 2014, and throughout 2015. Thus, RBS recently advised investors to sell everything to avoid a deflationary vortex.

China in particular has slowed down, dragging most other emerging markets down with it. Chinese stocks are down nearly 20% just in 2016. Emerging markets shares have shed 35% since their recent peak in 2014. Oil prices literally collapsed over the last year (see chart) along with commodities generally, suggesting chronically weak demand. Non-energy commodities crashed by 33% just since mid-2014. Thus, there will be massive financial losses arising from emerging markets, China, energy, and commodities, much of it debt.

In fact, as recently as last week, the megabanks started recognizing losses in their energy loan portfolios. While the losses remain contained right now, one wonders what lies buried in the derivatives books of the megabanks. One indication of the possible losses in derivatives related to energy and other non-performing debt is the fact that the megabanks lobbied successfully to continue selling FDIC-backed derivatives within their banking subsidiaries, as discussed in real time about a year ago on this blog. This indicates there are likely more losses buried in the derivatives markets that logically should end up hitting the capital of the megabanks. Further weakness will inevitably lead to further loss recognition at the megabanks.

The Fed's recent efforts to hike interest rates only exacerbates this global macroeconomic weakness. One commentator termed the Fed's rate hike a policy "blunder." The case for a deflationary vortex, first highlighted in late 2014 on this blog, now seems compelling. The Fed seems as oblivious as it was in mid-2007 to the potential for another financial crisis.

All of this led George Soros to recently raise the specter of a financial crisis like 2008. Soros, of course is a financial genius, with a long record of powerful financial insights and trading successes. Betting against Soros is not a path to success. Soros stated: "When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008.” Former US Treasury Secretary Lawrence Summers recently stated: "the global risk to domestic economic performance in the United States, Europe and many emerging markets is as great as any time I can remember. It is time for policymakers to hope for the best and plan for the worst."

Which brings me to the point of this post: Can policymakers count on the Dodd-Frank Act to save us from the horrors of 2008-2009? 

In my next post, I will explain why the answer to that question is a resounding NO!


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  2. As we continue to see the massive negative effects of the Dodd-Frank Act, the tightness in the financial belts of middle class America is stifling economic gains. Most of these regulations are arbitrary and worthless to the normal consumer. As you stated, the mere press releases of hot shot bankers being brought down due to the Dodd-Frank Act are used for puffery. I am confident many of these arrests or charges could still happen even without the Dodd-Frank Act. The act was a knee jerk reaction, instead of a solid approach to the actual culprits. Local small town banks are unable to lend money at a lower rate due to the high cost of these regulations. Small towns and rural America generally do not lend from large corporate banks, although some use online services. They tend to go to their local bank, credit union, where their neighbor or friend works. By doing so, they are getting higher interest rates and higher bank fees all because of the Dodd-Frank Act.
    Just as many items are passed by legislation, knee jerk reactions tend to be terrible policy items and in the long haul the devastating impact becomes apparent.