How Dimon and Yellen Helped Secure $30 Billion Lifeline for First Republic

Jamie Dimon and Janet Yellen were on a call Tuesday, when she floated an idea: What if the nation’s largest lenders deposited billions of dollars into First Republic Bank, the latest firm getting nudged toward the brink by a depositor panic.

Dimon was game — and soon the chief executive officer of JPMorgan Chase & Co. was reaching out to the heads of the next three largest US lenders: Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. (…)

Already the rescue spearheaded by Dimon is sparking comparisons to the Panic of 1907, when J. Pierpont Morgan — who built up the company Dimon now leads — corralled Wall Street financiers into his private library and browbeat them into propping up the Trust Company of America, seeking to stop a string of bank runs that threatened to upend the industry.

One reason strong banks stepped forward then was that US authorities had little ability to do so, which led to the creation of the Federal Reserve. (…)

• Biggest U.S. Banks Deposit $30 Billion in First Republic JPMorgan, Citigroup, nine others lead rescue

The bank’s executives came together in recent days to formulate the plan, discussing it with Treasury Secretary Janet Yellen and other officials and regulators in Washington, D.C., people familiar with the matter said.

JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. are each making a $5 billion uninsured deposit into First Republic, the banks said in a statement, confirming an earlier report by The Wall Street Journal. Morgan Stanley and Goldman Sachs Group Inc. are kicking in $2.5 billion apiece, while five other banks are contributing $1 billion each. (…)

Big banks received an influx of billions of deposits from midsize lenders including First Republic over the past week in the wake of the collapse of Silicon Valley Bank and Signature Bank. JPMorgan and the others are now effectively giving back some of the money they have raked in.

The deposits don’t carry any special deal and earn a rate in line with those of the bank’s other depositors, according to people familiar with the matter. (…)

The pact is an extraordinary effort to protect the entire banking system from widespread panic by turning First Republic into a firewall. (…)

First Republic said Thursday that it had borrowed as much as $109 billion from the Fed one night within the past week. It said that insured deposits have remained stable over the past week and that deposit outflows have “slowed considerably.” (…)

The industry has tried to come together before in times of crises, but with mixed results. In 1998, the hedge fund Long-Term Capital Management suffered steep losses, and most of the biggest banks agreed to bail it out for fear of their own exposures. In 2008, their chief executives tried a similar approach to bail out Lehman Brothers but failed to reach agreement. (…)

The other banks contributing to the First Republic rescue package are U.S. Bancorp, PNC Financial Services Group Inc., Truist Financial Corp., Bank of New York Mellon Corp. and State Street Corp.

• Banks’ Big Plan Might Solve the Immediate Problem, but Not the Bigger Ones

(…) But even this novel rescue will raise questions. For one, it may bolster the emerging narrative that the post-2008 regulatory regime has resulted in a two-tier system: Megabanks where it is always safe to deposit and do business, and everyone else.

At the same time, it might not succeed in putting to rest any fears that might arise about other smaller banks still at risk. The biggest lenders might be able to do this for one bank now. But they can hardly play that role systemically, continually sending deposits to whoever is leaking them. It also doesn’t address banks’ longer-term challenges with rising interest rates. (…)

Question? What if First Republic’s problems move from deposit outflows to significant asset impairment.

Most of the bank’s assets consist of commercial and residential real-estate loans. “Our loan portfolio is concentrated in single family residential mortgage loans, including non-conforming, adjustable-rate, initial interest-only period and jumbo mortgages,” its investor report warns, adding these may be vulnerable to defaults as interest rates rise. Uh-oh.

Defaults on commercial real-estate loans have been increasing, especially in First Republic’s chief lending markets. Housing prices have crashed in California’s Bay Area to near pre-pandemic levels, and tech layoffs raise another credit risk. The risk of loan losses could explain the government’s rush to shore up First Republic with a capital infusion. (WSJ)

This is a “cash bailout”, nothing on the equity side if loan losses erupt. Finger in a weakening dike?

• There Is a Cost to Moral Hazard 

(…) The deposit backstop could in theory be a one-off, but it is hard to see how the government can avoid using it again next time a midsize bank wobbles (and many are losing deposits fast amid the current uncertainty). Too big to fail is in the process of being extended to a whole new set of banks. (…)

And regulators seem to have ignored the danger that the Federal Reserve itself would raise rates aggressively and so hit banks that believed its predictions of low rates for a long time. The Fed’s last stress tests didn’t include the danger of soaring interest rates, instead fighting the last war by focusing on a deep recession and counterparty risk.

“Maybe the Fed’s low-for-long promise was the problem—not only did the SVB CFO believe it but the Fed’s stress test designers believed it too,” said Prof. Douglas Diamond, of the University of Chicago’s Booth School of Business, who won the Nobel Memorial Prize in Economic Sciences last year for his work on bank runs. “Supervisors didn’t do their job here.” (…)

More deposit insurance—even if merely implied, rather than written into the rules—means even more regulation, to attempt to counter the moral hazard. More regulation means higher costs, less competition and credit that is harder to obtain, as well as more bureaucracy. (…)

• What I Think About the Silicon Valley Bank Situation (Ray Dalio)

I think that it is a very classic event in the very classic bubble-bursting part of the short-term debt cycle (which lasts about seven years, give or take about three) in which the tight money to curtail credit growth and inflation leads to a self-reinforcing debt-credit contraction that takes place via a domino-falling-like contagion process that continues until central banks create easy money that negates the debt-credit contraction, thus producing more new credit and debt, which creates the seeds for the next big debt problem until these short-term cycles build up the debt assets and liabilities to the point that they are unsustainable and the whole thing collapses in a debt restructuring and debt monetization (which typically happens about once every 75 years, give or take about 25 years). (…)

ECB Defies Mounting Banking Strains With Half-Point Rate Rise The European Central Bank is pressing ahead with its fight against inflation despite concerns it could exacerbate strains in the financial system.

China Cuts Reserve Requirement Ratio To Boost Economy The economy is recovering from pandemic restrictions and a property market slump.

Philly Fed Manufacturing survey: Current Indicators Weaken

• The indicators for new orders and shipments both declined to their lowest readings since May 2020: The shipments index dropped sharply from 8.7 last month to -25.4 this month, and the new orders index fell 15 points to -28.2.
• The employment index decreased from 5.1 to -10.3, the index’s second negative reading since June 2020 and its lowest reading since May 2020.

This one can’t be good, can it?

Yesterday we got the NY Fed survey, also weak across the board. Manufacturing employees are keeping their job but spending a lot more time at home:

HOUSING

• Housing starts increased by 9.8% to 1,450k in February from an upwardly revised January level (+2.5pp to -2.0%). Both single family starts (+1.1%) and the more volatile multi-family starts (+24.0%) increased.
• Building permits increased by 13.8% to 1,524k in February. Both single family (+7.6%) and multi-family (+21.1%) permits increased.
• Completions jumped to their highest level since 2007 but units under construction have yet to decline, which would likely trigger layoffs in construction.

Labor Market Conditions Indicators Momentum has been negative for four consecutive months. However, the level of activity remains high.

The Kansas City Fed Labor Market Conditions Indicators (LMCI) are two monthly measures of labor market conditions based on 24 labor market variables. One indicator measures the level of activity in labor markets and the other indicator measures momentum in labor markets.

Indeed’s Job Postings have also lost momentum through March 10, suggesting that the BLS Job Openings (thick black, last data is January) will also decline meaningfully in coming months. The horizontal line is where we were pre-pandemic.

• There’s a warning sign in this otherwise hot economy

(…) Nearly 25 million people are behind on their credit card, auto loan or personal loan payments, according to a Moody’s Analytics analysis of Equifax data. The nation has not seen anything that high since 2009 in the midst of the Great Recession. (…)

Many households are also behind on their utility bills: 20.5 million homes had overdue balances in January, according to the National Energy Assistance Directors Association. The number of households applying for help to pay their utility bills is the highest it has been since 2011. (…)

Food stamp benefits were cut on March 1, slashing $182 a month for the average recipient. Mile-long lines at food banks are back in some parts of the country, and families say they can’t afford meat or more than one meal a day. The more generous Medicaid rules are rolling back on April 1. Student loan debt relief is likely to end in the coming months. Tax refunds that many lower-income families rely on all spring and summer are far smaller this year as child tax benefits have been reduced. Goldman Sachs is warning that lower-income households are facing a substantial hit. (…)

The bottom 60 percent of earners contribute about 40 percent of U.S. consumption, which drives growth, Daco notes.

Some charts:

(Jefferies)

Per Edmunds:

• 15.7% of consumers who financed a new vehicle in Q4 2022 committed to a monthly payment of $1,000 or more — the highest it’s ever been — compared to 10.5% in Q4 2021 and 6.7% in Q4 2020.
• 17.4% of new vehicle sales with a trade-in had negative equity in Q4 2022, compared to 14.9% in Q4 2021.
• The average amount owed on upside-down loans was $5,341 in Q4 2022 compared to $4,141 in Q4 2021.

Not just consumers:

With the benchmark Fed Funds rate now parked at 4.57%, compared to 0.2% a year ago, the bottom of the ratings barrel has precious little room for error.  Operating income among domestic triple-C-rated firms now covers interest expense by 1.6 times on average, BofA credit strategist Oleg Melentyev relayed last Friday, compared to 5.5 times interest coverage among high-yield as a whole.

Sure enough, the ranks of those unable to service their debts are expanding.  Global corporate defaults numbered 15 in February for the busiest single month since November 2020, a Monday analysis from S&P Global finds, while the two-month tally of 23 represents the highest over that stretch since 2009.  The bulk of that action comes from the U.S., with 16 defaults in the year-to-date through February, up from six over the same period in 2022. 

Stateside restructuring activity remains muted on a longer horizon, however, as the trailing 12-month U.S. speculative-grade default rate sits at 2.02%. That remains well below the long-term average of 4.1%, the rating agency relays, though those figures are up from 1.5% on July 31.  Meanwhile, the ranks of so-called weakest links, or firms rated single-B-minus or lower along with a negative credit outlook, stood at 191 at the end of January, up 50.3% from the end of June.

Might the placid default environment that has long predominated be set to give way to some choppier financial seas? A Monday Bloomberg law analysis from Geoffrey Frankel, CEO of Hilco Corporate Finance, notes that total U.S. bankruptcies have been in near-constant retreat since 2009, reaching new cyclical lows in 2021 and 2022. (Almost Daily Grant’s)

But Goldman Sachs keeps it landing softly. Crucially (!), so is Jim Cramer:

I love this collage by PiperSandler…

…which adds this scary one:

But Goldman says a soft landing may not save us:

Despite the prospects for a relatively soft landing, we see little earnings upside in most markets given where profit margins are. So far, corporate margins have been resilient to rising input costs as companies have generally been able to pass on prices.

But we are starting to see signs of deterioration. In addition to input costs such as materials and labour, margins are also coming under pressure from interest costs, regulatory costs, de-globalisation trends, ESG requirements and higher taxes to repay government debt.

We are transitioning from a cycle focusing purely on top-line growth to a cycle in which investors will focus increasingly on profitability and margins. In this ‘Post-Modern Cycle‘, we expect nominal GDP to be higher, and hence top-line growth to be less scarce. Instead, the higher inflation puts greater value on margins.

 

• Fourth quarter productivity was revised sharply lower from 3% to 1.7%. The culprit was an upward revision to unit labor costs from 1.1% to 3.2%. The data indicates corporate margins may be under pressure due to sharply rising wages. The graph below from John Hussman shows the correlation between labor costs and profit margins. (Real Investment Advice)

• The graph below shows that annualized unit labor costs and the employment cost index are double their pre-pandemic run rate.

How is this bear market doing?

Pretty well compared to previous bears markets… (The Market Ear)

(Tier1Alpha)

Japan’s labour unions confirm three-decade-high wage hikes of 3.8%

Wave of Stealthy China Cyberattacks Hits U.S. State-sponsored hackers have developed techniques that evade common cybersecurity tools and enable them to spy on victims for years without detection, Google researchers found.

Pornhub owner sold to Canadian private equity firm Ethical Capital 

To Ethical Capital?

Market Stress Snarls Trading in U.S. Treasurys Making deals now is as hard as in early days of Covid-19, traders say

The markets for the world’s safest and most liquid assets, the government bonds issued by the U.S. and other rich countries, came under immense stress on Wednesday following a week of worries about the health of global banks.

Liquidity, the capacity to trade quickly at quoted prices, has fallen sharply in two of the keystone markets, those for U.S. Treasurys and German bunds, traders said. Difficulties including wider price spreads and slower executions are now spreading to many other markets, they said, including those for derivatives that firms and traders use to lock in prices and hedge risks weeks and months ahead of time, such as options, futures and swaps. (…)

Trading was frenetic. Trading volumes in the Treasury market Wednesday appeared to be about twice typical levels, said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.

But the spreads quoted in markets for Treasurys and derivatives tied to other government bonds, reflecting the gap between quoted prices to buy and sell, were far wider on Wednesday than they were last week, traders said, typically a sign of market anxiety.

The ICE BofA Move Index, a measure of volatility in the bond market, rose to the highest levels in at least three years, surpassing levels recorded during the March 2020 market crash.

The ease of buying and selling Treasurys makes them the bedrock of Wall Street trading, used to park money or as collateral on loans. When the market breaks down, the resulting turmoil can rapidly spread to other assets, hitting everything from stocks to currencies—as well as, eventually, the rates for mortgages and other loans.

Investors generally agreed that fear of economic distress was driving down interest-rate expectations and pushing investors to dump riskier assets in favor of safer ones, following the U.S. bank and Credit Suisse routs. (…)

One driver of the unruly trading: the significant change over the past week in the outlooks for global growth and inflation, reflecting concerns that the U.S. bank mess and trouble in Europe might signal a sharp slowdown ahead. (…)

“Markets operate on greed and fear,” Mr. Bass said. “Fear is overriding greed right now.” (…)

Some traders said that the market moves were some of the wildest they had seen in their careers. Government bond prices have logged swings not recorded in decades, when Paul Volcker was chairman of the Federal Reserve. (…)

Quantitative investment strategies also helped fuel the price swings.

After enjoying a record-breaking year betting bond prices would fall, algorithmic money managers that ride market trends are racing to close out their short positions, or purchasing securities previously borrowed and sold in a bid to benefit from falling prices.

Computer-driven funds such as commodity trading advisers, or CTAs, took large bearish positions in the Treasury market in recent weeks, according to Société Générale SA. Then bonds rallied and yields dropped, wrong-footing some traders and adding to the price swings. (…)

Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?

This March 13 paper (post SVB) is from 4 researchers at USC, Northwestern, Columbia and Stanford universities.

The short of it is that the U.S. banking system is “a lot more fragile than commonly assumed”:

Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs.

Post the GFC, the Fed’s QE policies brought real long-term rates substantially below normal, often driving them below zero. Its narrative of “lower-for-longer” and “transitory inflation” in 2021 convinced many investors that the Fed was in control and that bonds were relatively safe investments even if earning little in real terms.

Demand for bonds exploded in 2021 and nobody should be surprised that most financial institutions yearned for yields.

US Bond Mutual Fund Flows

  

Obviously, some went too far and are now facing losses if forced to sell to meet withdrawals.

So, what does the Fed do?

1. Backstop depositors to prevent more bank runs.
2. Provide low cost liquidity if needed.
3. Set policies so that LT rates decline to restore bond portfolio values.
1. A new QE. Really?
2. First, stop QT.
3. Anything else? If not…
4. …Bring inflation down, i.e. recession, soon.

• JPMorgan Says Fed’s Loans Will Provide $2 Trillion of Liquidity

“The usage of the Fed’s Bank Term Funding Program is likely to be big,” strategists led by Nikolaos Panigirtzoglou in London wrote in a client note Wednesday. While the largest banks are unlikely to tap the program, the maximum usage envisaged for the facility is close to $2 trillion, which is the par amount of bonds held by US banks outside the five biggest, they said. (…)

• ‘QE in Another Name’: New Bank Backstop Points to the End of Fed QT

The Federal Reserve may need to end its quantitative-tightening program early to preserve the amount of bank reserves in the financial system while also maintaining its hawkish signaling on interest rates, according to Citigroup Inc. (…)

“Their new BTFP facility is QE in another name – assets will grow on the Fed balance sheet which will increase reserves,” Citi strategists Jabaz Mathai, Jason Williams and Alejandra Vazquez Plata wrote in a note to clients on Monday. “Although technically they are not buying securities, reserves will grow.” (…)

The strategists see three options for the Fed. One would be stopping QT early or reducing the monthly amount of bonds it allows to roll off, to ensure reserves are relatively stable for the rest of the year.

Another choice would be to lower the maximum amount each money-market fund is allowed to park at the Fed’s reverse repurchase agreement facility from $160 billion, while allowing QT to run in the background.

A third possible route, according to Citigroup, is that the Fed stops hiking but continues its balance-sheet unwind, forcing money funds to extend the weighted average maturity of their holdings and pulling cash out of the RRP as they buy longer maturities. The strategists see this as unlikely since the Fed has shown it’s more comfortable tightening economic conditions via short-end rates. (…)

Bank Failures, Market Turmoil Fuel Bets on a Pause in Fed Rate Increases Interest-rate futures markets indicate a 50% chance of no increase at the central bank’s next meeting.

(…) “A pause now would send the wrong signal about the seriousness of the Fed’s inflation resolve,” said Michael Feroli, chief U.S. economist at JPMorgan Chase. It could also fuel fears that the Fed is hesitant to raise rates but quick to cut them, he said, because of concerns about financial stability—something economists refer to as “financial dominance.” (…)

• Big ECB Hike Called Into Doubt by Credit Suisse A half-point increase once seen as a sure thing has been thrown into question.
• Swiss central bank throws financial lifeline to Credit Suisse after shares pummelled Swiss regulators pledged a liquidity lifeline to Credit Suisse in an unprecedented move by a central bank after the flagship Swiss lender’s shares tumbled as much as 30% on Wednesday. ($54B)
• Large U.S. banks view Credit Suisse exposure as manageable -sources Bankers were more concerned about contagion or unexpected effects of the Swiss lender’s troubles that are not yet understood

Economy Shows Signs of Cooling as Bank Troubles Spread A drop in retail sales and an easing of inflation pressures last month shows the economy may be cooling after a hot start to the year.

(…) Spending fell at stores, online and in restaurants by a seasonally adjusted 0.4% in February, the Commerce Department said Wednesday, following a 3.2% jump in January.

A separate report Wednesday showed a measure of supplier inflation cooled last month. The producer-price index, which generally reflects supply conditions across the economy, fell 0.1% in February from the prior month, the Labor Department said. On a 12-month basis, producer prices rose 4.6% in February, slowing from January’s downwardly revised 5.7% gain. (…)

Over the past year retail sales have advanced 5.4%. (…)

In reality, retail sales were fairly strong last month. The 2.2% MoM drop in Food Services (still up 15.3% YoY!), quite normal after January’s huge 5.6% jump, masks the continued demand for goods (blue bar), up another 0.5% following January’s +2.3%.

On a YoY basis, total sales are up 5.4% and control sales 7.1%. Goods inflation (35% CPI-Durables + 65% CPI-Nondurables) was 3.5% in February, down from 4.4% in January and 4.7% in December. It peaked at 14.6% in March 2022.

U.S. Producer Prices Dropped in February

The producer-price index, which generally reflects supply conditions across the economy, fell 0.1% in February from the prior month, compared with a downwardly revised 0.3% increase in January, the Labor Department said Wednesday. That compared with a 0.2% average monthly rise in the two years before the pandemic.

The so-called core price index—which excludes the often-volatile categories of food, energy and supplier margins—climbed 0.2% in February from a month earlier, compared with a downwardly revised 0.5% in January.

On a 12-month basis, prices rose 4.6% in February, slowing from January’s downwardly revised 5.7% gain. Last month’s rise was down sharply from the 11.7% peak in March 2022, and was the lowest reading since March 2021. Core PPI increased 4.4% from a year earlier, the same pace as January’s revised gain. (…)

Not as good as it seems:

• Core PPI is up 4.2% annualized in the last 2 months from 3.6% in the previous 2 months.
• Core PPI-Goods is up 0.3% in February after 0.6% in January. Last 2 months: +5.5% a.r. vs 2.4% in the previous two.
• Total PPI-Services declined 0.1% in both January and February but only because retail margins and transportation and warehousing costs dropped. Excluding these items, PPI-Services rose 0.3% in February after 0.6% in January. Last 2 months: +5.6% a.r. vs 4.9% in the previous two.

JPMorgan Joins Those Saying Cash in Bond Gains The Fed may still raise rates, casting doubts on a recent rally.

ALL FED, AGAIN!

Still needing to fight inflation, it now has to mind the financial system its own policies drove into a bad pickle. The economy remains too strong, requiring more tightening, but financial markets need more liquidity while long rates must come down.

Good luck!

BTW: Empire State Manufacturing Survey: Activity Continues to Contract

Manufacturing activity continued to decline in New York State, according to the March survey. The general business conditions index fell nineteen points to -24.6, continuing the see-saw pattern of ups and downs within negative territory seen in recent months.

The new orders index fell fourteen points to -21.7, indicating that orders declined substantially, and the shipments index fell fourteen points to -13.4, pointing to a decline in shipments.

The index for number of employees fell four points to -10.1, its second consecutive negative reading, indicating that employment levels continued to decline. The average workweek index fell six points to -18.5, its lowest level since early in the pandemic, indicating that hours worked shrank for a fourth consecutive month.

Input prices and selling prices increased at a somewhat slower pace than last month: the prices paid index fell three points to 41.9, and the prices received index moved
down six points to 22.9.

U.S. Maternal Mortality Hits Highest Level Since 1965 The 2021 surge in maternal deaths exacerbated a yearslong trend that has made the U.S. the most dangerous place among high-income countries to give birth.