by Chris Marcus, Miles Franklin:
The tone in the 2018 financial markets has been considerably different from past years, as the events that many in the Austrian Economics community have long forecast appear to finally be manifesting. One of which is that as interest rates rise, many (including myself) have expected significant pressure on the banking sector. Which is exactly what’s happening now.
Just this week alone Deutsche Bank was downgraded, it was revealed to have been on the Federal Reserve’s “troubled condition” status for over a year (why that remained a secret is a whole other discussion), the Italian government has fallen into chaos with bond yields spiking in response, and even U.S. domestic banks like J.P. Morgan have issued revenue warnings.
“This morning JPM had news that were almost as unpleasant, when investment bank chief Daniel Pinto said that second-quarter markets revenue would be flat compared with a year earlier…and by implication, also 15% down from 2016.
Concerns about a global credit blight and anemic interest rates appeared to weigh on U.S. financial stocks Tuesday, sending shares of the nation’s largest banks tumbling. Goldman Sachs, J.P. Morgan, Citigroup, Morgan Stanley and Bank of America all lost more than 3 percent.”
So why is all of this happening now?
For the same reason that the Austrian economists have written about for the past decade.
Specifically, that in the same way that printed money leads to seemingly better economic conditions in the short-term, the problem with lowering interest rates is that when they’re eventually raised, all of the malinvestment that occurred during the period of lower rates is finally exposed.
So with interest rates now rising, these developments are not unrelated. Especially with the massive amount of derivatives that now exists, all of these banks and governments have become highly interconnected. Which means that similar to what happened in 2008 when Lehman Brothers failed and many others almost followed suit, if one bank like Deutsche Bank goes down, or the Italian debt defaults, that could lead to the possibility of widespread contagion.
The Deutsche Bank downgrade in particular is significant news, because it’s possible it could trigger a credit event that would impact their derivatives book at a time when they can least afford it. And if that occurred, the impact would not be limited to just Deutsche Bank.
Consider what’s happening right now in the Italian debt markets. Which was eloquently explained by friend and brilliant financial analyst Dave Kranzler in the latest edition of his Short Sellers Journal.
“I suspect GS may have the 2nd highest exposure to Italian credit default swaps. Not widely acknowledged, but GS takes home run swings on underwriting OTC derivatives and I know that it has been active in Italy. Before taking the reins at the ECB, Mario Draghi was the head of the Bank of Italy from 2005-2011.
Before that: Vice Chairman of Goldman Sachs International and a member of the firm-wide management committee. Goldman was instrumental in the financial collapse of Greece. Furthermore, Goldman would have collapsed in 2008 from its exposure to AIG credit default swaps if the bank bailout was not arranged. For these reasons, I suspect Goldman could have issues if Italy continues to melt down.”