I heard a rumor the other day that Democrats are throwing the Presidential election. Party apparatchiks believe the stock market will crash, sinking the economy and they would rather have it all implode on Donald Trump’s watch, paving the way for having a Democrat in the White House from 2028 until eternity.
This sort of conspiracy theory seemed spectacularly implausible until I read in the New York Times, that anti-Trump Republicans believe the Biden campaign is ghosting them. “Some Republicans blame the Biden campaign, saying they’ve heard practically nothing from an operation they think could use their help. And they worry that the omission represents a broader failure to bring moderate Republicans into the fold.”
Susan Molanari told the NYT’s Jess Bidgood, “I’m concerned about the state of the campaign, that there has been little to no outreach to almost every Republican that I know who wants to help.” The Republican from New York who spoke at the 2020 convention told the Times the silence seemed out of character for the Biden she knew. “I think everyone’s just sort of scratching their head.”
Everything seems A-OK with the U.S. economy on the surface. But, the latest Grant’s Interest Rate Observer’s lead story, entitled “The case of the fragile 27%” uses the report by Paul Kupiec, a senior fellow at the American Enterprise Institute in Washington, D.C., to make the case that systemic risk to the nation’s banking system is bubbling just below the economy’s surface.
Kupiec has analyzed the banking system for decades. Grant’s summarizes the findings laid in his recent report, “the bear market in commercial real estate, the zero-percent-to-5%- plus moonshot in the federal funds rate and the high concentration of troubled CRE assets in too many bank portfolios have created ‘significant systemic risk.’”
“After incorporating unrecognized interest rate losses into the CRE loan concentration measure,” Kupiec reports, “the number of banks with market value– adjusted CRE concentration ratios above 3(times equity) swells to 2,916 institutions, including 19 banks with assets between $50 billion and $250 billion and 2 banks with assets greater than $250 billion.”
The 500 basis point jump in Fed funds rates has banks carrying a collective billions of dollars in unrealized losses. If bankers call their securities portfolio “held to maturity” which is years or decades away they can hold the securities at par. Everything looks good on paper and depositors are none the wiser.
But, Kupeic writes, “as of Dec. 31, 2023, there was but a single bank with a Tier-1 leverage ratio under 3%. In contrast, after adjusting banks’ reported Tier-1 capital balances for unrecognized interest rate–related losses in asset values, 1,036 banks have market value–adjusted Tier-1 leverage ratios at or under 3%, including 165 banks with negative Tier-1 capital on a marketvalue–adjusted basis. . . .The magnitude and prevalence of unrecognized interest rate losses create the potential for substantial losses for the FDIC’s deposit insurance fund should many of the banks with weak market value–adjusted Tier-1 leverage ratios fail as a consequence of CRE loan defaults.”
Not only does Kupeic’s analysis paint a dire picture for hundreds of the nation’s banks but makes the case that the FDIC (Federal Deposit Insurance Corporation) itself may not survive even a moderate commercial real estate meltdown. Some may remember another deposit insurer no longer with us, the FSLIC.
“All told,” Kupiec continues, “a 10% across-the-board CRE loss rate would render 628 banks holding 6.10% of the banking system’s total assets insolvent on a mark-to-market basis. If all of these banks failed with exactly zero market value–adjusted Tier-1 capital [plus loan loss balance], and should the FDIC receiverships incur only an 8.4% discount selling those assets [a 23% discount is more in keeping with the FDIC’s decades-long experience], the losses would completely consume the current FDIC deposit-insurance fund balance.”
Grant’s emphasizes that the above-referenced 628 banks at risk of failure under the assumption of 10% across-the-board declines in CRE loan values do not include the aforementioned 97 “that are already insolvent on a mark-to-market basis.”
In his GnS Economics newsletter on substack TUOMAS MALINEN is also keeping an eye on the banks and using his stress test criteria, 96 banks are currently insolvent. That is 12 more than when he ran the bank numbers at the end of last year’s fourth quarter. In Malinen’s most likely scenario, he writes, “we are assuming higher loan losses than what manifested during the Great Financial Crisis. We assume steeper losses, because the situation is in many ways more worrisome than what it was, when the U.S. entered the GFC in 2008.”
Malinen reminds us that geopolitical tensions are rising around the globe. A BBC China correspondent uncovered a video on China’s state television which shows that China seems to be preparing its populace for a war with Taiwan. A Chinese Foreign Minister recently stated that Taiwan independence forces will be left with their heads broken and blood flowing, if they try to fight China’s pursuit for “achieving complete unification”.
Meanwhile in Ukraine. “Now reports state that Volchansk, a town near Kharkiv in north-eastern Ukraine, would have been around 50% captured by slowly progressing Russian forces. Some reports indicate that Russian troops would be within artillery range of Kharkiv, a second largest city in Ukraine,” writes Malinen. “Reports of collapsing morale among Ukrainian troops, due to lack of ammunition and forced conscriptions, have also been rolling in. The much-anticipated additional U.S., and European, aid to Ukraine will also not turn the course of the war, because it’s too small and lacking crucial supplies of, eg. artillery shells.”
As for the Middle East, in an under-reported story, the Iranian President, Ebrahim Raisi, was killed in a helicopter crash. Israel has started its military operation in Rafah. An Israeli government spokesperson said “no power on Earth will stop Israel from protecting its citizens and going after Hamas in Gaza”. Saraya al-Ashtar, a Shia armed faction in Bahrain, attacked an Israeli transportation company in the southern port city of Eilat. Houthis are continuing their attacks in the Red Sea, which has contributed to the quite notable increase in freight rates.
Fidelity reports the number of 401k millionaires, with accounts at Fidelity, hit an all-time high at the end of the first quarter. After the rosy headline the Bloomberg article quickly pointed out “close to 40% of all workers aren’t even in a workplace retirement program, according to 2023 Bureau of Labor Statistics data. Some 40% of retirees, meanwhile, rely entirely on Social Security income.” And, Bloomberg scribe Suzanne Woolley adds that million dollar accounts are a rarity and “The median balance for 401(k)s at Fidelity is $28,900, and $15,000 for IRAs.”
The election seems to be about the border, abortion, and inflation. But, Black Swans are everywhere.
