• Read my latest article for the Australian titled, Why the onward march of AI and the tech titans demands change READ NOW

Returning to regular programming shortly…we hope!

Returning to regular programming shortly…we hope!

Continuing on our hypothecation theme, David Stockman, former Director of the White House Office of Management and Budget during the Reagan Administration penned the following to Mrs Lee Adler of the Wall Street Examiner. Stockman is currently writing a book on the financial crisis and some of the thoughts he expresses in his exchanges with Adler relate to the ideas he is developing in the book.

Those you hoping for a quick end to the ructions in Europe and a return to normal levels of volatility may wish to ponder Mr Stockman’s thoughts on why European Banks are on the verge of collapse:

“The real story of the present is the shadow banking system, the unstable and massive repo market, and the apparent daisy chain of hyper-rehypothecated collateral. It looks like the sound bite version amounts to the fact that the European banking system is on the leading edge of collapse for the whole system. These institutions are by all evidence now badly deficient of the three hallmarks of real banks—deposits, capital and collateral.


BNP-Paribas is the classic example: $2.5 trillion of asset footings vs. $80 billion of tangible common equity (TCE) or 31x leverage; it has only $730 billion of deposits or just 29% of its asset footings compared to about 50% at big U.S. banks like JPMorgan; is teetering on $500 billion of mostly unsecured long-term debt that will have to be rolled at higher and higher rates; and all the rest of its funding is from the wholesale money market , which is fast drying up, and from repo where it is obviously running out of collateral.

Looked at another way, the three big French banks have combined footings of about $6 trillion compared to France’s GDP of $2.2 trillion. So the Big Three [F]rench banks are 3x their dirigisme-ridden GDP. Good luck with that! No wonder Sarkozy is retreating on France’s AAA and was trying so hard to get Euro bonds. He already knows he is going to be the French Nixon, and be forced to nationalize the French banks in order to save his re-election.

By contrast, the top three U.S. banks which are no paragon of financial virtue—JPM, Bank of America, and Citigroup—have combined footings of $6 trillion or 40% of GDP. The French equivalent of that number would be $45 trillion. Can you say train wreck!

It is only a matter of time before these French and other European banks, which are stuffed with sovereign debt backed by no capital due to the zero risk weighting of the Basel lunacy, topple into the abyss of the shadow banking system where they have funded their elephantine balance sheets. And that includes Germany, too. The German banks are as bad or worse than the French. Did you know that Deutsche Bank is levered 60:1 on a TCE/assets basis, and that its Basel “risk-weighted” assets are only $450 billion, but actual balance sheet assets are $3 trillion? In other words, due to the Basel standards, which count sovereign and other AAA assets as risk free, DB has $2.5 trillion of assets with zero capital backing!

This is all a product of the deformation of central banking and monetary policy over the last four decades and the destruction of honest capital markets by the monetary central planners who run the printing presses. Furthermore, this has fostered monumental fiscal profligacy among politicians who have been told for years now that the carry cost of public debt is negligible and that there would always be a central bank bid for government paper. Perhaps we are now hearing the sound of some chickens coming home to roost.”

Posted by Roger Montgomery, Value.able author and Fund Manager, 16 December 2011.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Dr. S A Visotsky

    Finally, someone tells the truth.

    We have been negative on Germany since 2010.

    Their fraud is endemic at this stage. That they are allowed to continue lying to the world and manipulate their own figures, is beyond reproach.

    *Short the DAX, ALL German Industrials, as the market manipulation in Germany was reported yesterday, mentioning “wide spread endemic manipulation of a systematic nature”.

  2. Great article and thanks for bringing it to our attention . Sitting back looks like the thing to do at the moment , markets particularily the US look like a lot more factoring in needs to be done .

    • Today K. Maley at Business Spectator picked up on some comments by a leading US bond fund manager in an interview a few days ago with Barrons here: http://online.barrons.com/article/SB50001424052748704746704577094501097288154.html#articleTabs_article%3D1

      Here’s Karen’s summary:

      “Wall Street may have staged a spectacular rally overnight, but the outlook for the US economy next year is bleak, according to a leading US bond investor, Van Hoisington.

      In an interview with Barron’s, Hoisington, who heads up the $US5.7 billion specialist bond fund, Hoisington Investment Management, argues that the US is set to fall back into recession next year, and that long-term US interest rates will tumble even lower.

      “In the US, we have $15 trillion in gross domestic product, and we have $52 trillion in debt, which is 350 per cent of GDP. Since 1998, we went from 250 per cent to 350 per cent and the debt was for mainly non-productive investments. The prices of those investments – houses, commercial real estate, even stocks – have been falling since ’08. Actually, stock prices are down since 2000. So we are in a circumstance of over-indebtedness.”

      He notes that when debt-to-GDP ratios climb too high, economic growth is hobbled. “That is exactly what is happening. Through the third quarter, year-over-year growth rates are about 1.5 per cent. In the last 40 years, every time you have had a 1.5 per cent growth rate – they call it ‘the stall speed’ – you have slipped into recession because the economy is too weak to sustain any shocks. Unfortunately, we have had some shocks.”

      At present, he says, the US government is spending about $US3.6 trillion each year: its revenues are $2.3 trillion and it borrows an extra $1.3 trillion. But this pattern cannot continue indefinitely. Studies show that once a country’s government debt reaches 100 per cent of GDP, its growth rate slows by at least 1 per cent. “Since we are only growing at 1.5 per cent, that takes you down to 0.5 per cent. Plus or minus 0.5 per cent is recessionary conditions.”

      At the same time, he says US consumers are in trouble. “Real disposable income is down over the last 12 months, and because people have tried to maintain their spending, the savings rate has fallen to about 3.5 per cent. You have very little savings going into next year, falling disposable income, and no stimulus scheduled.” On the other hand, he says, about 35 states raised taxes last year, and are expected to do so again. “So the effective tax rate on consumers, if you take state, local, and federal taxes, is up $260 billion over the last two years. It’s very difficult for us to see how consumer spending can sustain itself or get a lift.”

      Business spending is also likely to slump when the special tax concession allowing 100 per cent accelerated depreciation on capital equipment expires at the beginning of January. “In the past, when accelerated depreciation charges were taken off, new manufacturing orders fell rather dramatically,” he notes.

      What’s more, global economic growth is faltering. “We have the unfortunate circumstance that basically 60 per cent of the world is in recession: Europe, Japan. China is looking recessionary, because for them, a 7 per cent growth rate is not that good. Brazil recently reported a flat-to-slightly down quarter. And Korea has slowed to the slowest growth rate in three or four years.

      “No matter where you look, there is a global recession starting. That means our exports and consumption aren’t there. There won’t be any increase in government spending. So we don’t see how in the world you don’t have a recession.”

      Hoisington predicts that the real growth in the US economy will be between 0.5 per cent to 1 per cent next year, with the core growth rate falling close to zero by mid-year. At the same time, downward pressure on prices will push US long-term interest rates even lower. Next year, he says, yields on 30-year bonds could trade down close to the 2 per cent level (compared with around 3 per cent at present), while 10-year bond yields could trade between 1.25 per cent and 1.5 per cent (compared with around 2 per cent at present).

      Hoisington believes that there’s about a 50-50 chance that the US central bank will launch a third massive bond-buying program, known as quantitative easing or QE. But, he argues, QE2 was actually responsible for the US slowdown because it pushed up commodity prices and long-term interest rates (including mortgage rates) and lowered real income. “If they happen to do another quantitative easing, all they will do will help the top 10 per cent by raising stock prices, but kill everybody else, like they did last time.”

  3. Thank you Roger for enlightening us on the hypothecation theme. It’s truly frightening and reminds me of the story of ‘the three little pigs’. Banks are a fundamental part of life for most of us on this planet and when the chickens come home to roost the rebuilding of trust required will be enormous. I can only hope that after the blood bath some wiser heads rebuild a principled system our children can trust; until the next time, given that we humans have a propensity to repeat history.

  4. thank you very very much for this article and the one on hypothecation article.

    Two very much ‘valuable’ non stock specific articles.

    Again i emphasise my appreciation.

  5. Roger,

    The above comments should not be taken as a slight, but I am just stating that we have all these talking heads on business TV who come up with these picks and no one holds them to account for these predictions. I am sure you probably agree with this. In the past from when I have seen you on TV, you were never some one who was keen on providing “tips”.


  6. Just wondering what this means for our banks? Do our banks have such leveraging issues as well? What does that mean for depositors bearing in mind Roger’s recent article on changes to banking regulations? Just wondering also, this is not the first article I have read on the EU banking system being on the edge of collapse but the price of gold does not seem to be increasing rapidly. What are people investing in considering the possibility of a total collapse of the banking system? Very interesting times ahead and I don’t mean that in a good way. Merry Christmas one and all.


  7. Roger, are you doing the 12 stocks of X mas this year for Sky business.
    Unfortunately your pick from last year MCE is down 50 % from the 25/12/10. Best pick was from the analyst who picked QRN, up 27 %. I think these shows need to hold the analyst from last year to account for their picks before asking them for their new picks.
    Analyst’s never get held to account for their picks.


    • The lesson is to pay no attention to the top picks for the next year. Why? because facts change during the year and as more information comes to hand, you have to change your stance.

  8. Yep,

    They are all broke.

    And who has been lending them money?…………The american banks………..I can’t give financial advise………I do not have a licence.

    This is a bit scary……

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