Wednesday Open Thread: Deja Vu, Vu, vu, vu
It's Day 311 of the Year 2018 CE
So, November 7, 2018 - for my reference if nothing else.
Monday I gave Bank Transfer Day sort of short shrift. Not because it was a bad idea but because the execution was soooo miserable and half-assed. Actually, it is a great idea for everybody except banks and banksters, and everybody should really go ahead and follow through on it. Credit Unions generally pay better interest rates and have fewer and lower fees than banks. They are less likely to indulge in criminality too.
That's not why this is titled as it is, or why I used the same image, but there is some serious bankster deja vu going down. History, they say, has a tndency to rhyme and I wish to take a peek at a longer cycle that the obvious one, one that I fear is getting ripe for yet another repeat real soon now.
The first obvious echo is from the S&L Crises of the 80s and 90s that is generally blamed on Jimmy Carter's Depository Institutions Deregulation and Monetary Control Act of 1980. That resulted in the failure of about 1/3 of the nations S&Ls because they were suddenly free to act like banks and didn't know how. There was a lot of wrongdoing, and also a lot of failure to perform due diligence. Keating and a (very) few others went down. That worked so well that bank deregulation became part of the DLC/New Democrats ideological vision. Bill Clinton made bank deregulation part of his "New Democrats" Reaganomics 2.0 platform and package. The best known part was the repeal of Glass-Steagall. This permitted banks to gamble with ordinary depositors money and pushed the formation of "too big to fail" omni-banks. Less well known is Clinton's Commodity Futures Modernization Act of 2000, enacted to protect any and all existing and as of yet to be invented schemes and scams that could be shoehorned into the concept of over-the-counter derivatives from those evil gummit regulators. This included a host of such products like credit default swaps that helped create and/or exacerbate the next bank meltdown when it came. Those chickens came home to roost in 2008, wherein the financial crisis of 2008 rapidly became the global recession of 2008 - 2012. (The end of the recessin in 2012 is probably definitional in the same way that one can have endless increases in the cost of living without there existing any "inflation".) Again, the failure to perform due diligence was rampant, as was fraud, but most of the malfeasors skated this time around. For example, the California Attorney General let Steve Mnuchin and his One West Bank walk despite numerous foreclosure law violations. (No she was neither a Republican nor a Russian.)
The 2008 bank crash, enabled and or propelled by Clinton's repeal of Glass-Steagal and enactment of the CFMA, echoes something similar other than the S&L crises, something that looks to be getting ready to bite us again, and that is where I'm going with this. Where? Continental Illinois. The Continental Illinois National Bank and Trust Company was a very large bank in its day with around $40 billion in assets. That large size enabled it to become the largest bank failure in US history as of 1984 and right up through WaMu's failure in 2008. It was mostly brought down by bad loans it had purchased from another failed bank which it hadn't known to be bad at the time of purchase. There was a lack of due diligence and one bank officer also received some kickbacks for approving loan applications. At any rate, when the smaller, downstream bank failed, that started a run on Continental Illinois that brought it down.
Zo, who was the smaller bank and how did they come to have so much bad paper to upstream to Continental Illinois? Penn Square Bank was a small shopping center bank in Oklahoma. There was an oil and gas boom in Texas and Oklahoma and everybody wanted a piece of the action. Penn Square was there to lend money to anybody and everybody who had or could beg, borrow, lease, or contract to buy a drilling rig. Penn Square discovered that they had an infinite supply of lendable funds because they could upstream the loans that they made almost as fast as they made them. The bigger upstream banks were happy to cash in on the earnings from the loans without having to service them or do any due diligence (because Penn Square, the initial lender, had done the due diligence and was on the hook for servicing the debts). Penn Square sold over a billion dollars worth of loan participations, often 100% of the loan.
A lot of the drilling financed by Penn Square's loans was into deep, extremely high pressure gas deposits and the projects failed. No project, no gas, no revenue to pay the loans back with. In addition, the 1980 saw a massive oil glut, driving energy prices way down. Projects that didn't outright fail still couldn't pay their loans back. And -- with an oil glut, the drilling rigs that were artificially overvalued as collateral for many of the loans became worthless. Penn Square's loans became worthless in vast numbers, as did those billion dollars worth of loan participations. Penn Square was allowed to go under, no other bank was willing to pick up its deposits and liabilities. SeaFirst, Michigan National and Chase Manhatten all took major losses. SeaFirst went down later in the year and was gobbled up by B of A. Relative giant Continental Illinois, one of the country's ten largest commercial banks, was saddled with a half a billion of Penn Square's worthless paper and finally went under 2 years later. It too was gobbled up by B of A.
Due Diligence was presumed to be being undertaken by Penn Square. They didn't need to, they had a money machine. The revenues kept pouring in from upstreaming their loans to bigger banks and all they had to do was find money to pay those banks their share of the interest on those loans. Since money is fungible, this was a self-sustaining Ponzi scheme up until the day came that nobody was buying those loans while they simultaneously went bad in droves. Basiclly, those in charge of due diligence, in effect, saw themselves as having no economic stake in the soundness of the loans and no need to make sure that they were good. They also had a world of rosy assumptions to fall back on. For starts, isn't "having your own oil well" the very definition of wealth?
Back in the late seventies or early eighties I became aware of Mortgage Brokers, in part because they were suddenly everywhere, and inpart because I actually knew people who quit real jobs to get in on the racket. Really? thought I. At that point I began to detect a faint aroma of Penn Square. The brokers weren't on the hook for anything, were paid on commission, and were almost certainly being relied upon to do due diligence. Why in hell would they? That would slow them down, reduce the number of mortagages they could move as well as the size thereof, and seriouosly reduce their income. This will surely bite us in the butt some day, thought I. But WAIT! Maybe 20 years down the road I found out about the growing popularity of Mortgage Backed Securities. I suddenly began to see faint visions of Continental Illinois. Brokers, paid on commission to sell debt are being largely relied upon to do due diligence by and for banks which are in turn packaging those loans and moving them upstream, making their revenue stream independent of the quality of those loans or the ability of the borrowers to repay them Meanwhile, housing prices were skyrocketing as Realtors began pushing houses not as "homes", places to live in, but as "investments" things to gamble on. Buy at any price and interest rate, the
price "value" will continue to skyrocket generating "equity" which will qualify you for a lower rate loan allowing you to pay off your original one, balloon and all. Balloon? Oh of course, interest only and/or minimum payment loans, how silly of me no to think of that. At that point I actually saw 2008, it was as certain as the sun coming up tomorrow.
A not too interesting peek at a little financial history. Shallow and oversimplified at that. So what? Fracking An oil and gas drilling boom that has lost 280 billion dollars in the last decade and is being financed by banks and wall street. Companies that can't even pay the interest on their debt getting even more loans and investment capital in a market area that is guaranteed to produce only gluts and reduced prices the more it succeeds. Does this sound at all reminiscent of Penn Square? I tried to ferret out the total debt load of this industry and came up blank. Not the most prolongued, sophisticated or dedicated search, but everybody is talking about the losses, and even the debt, but no numbers for the debt. The losses will have to tell the story. Back in 2014, during an oil price dip, about 100 frackers walked away from some 70 billion in debt. Bankrupt. Who held it? Dunno. It is clear that the banks and brokers are now in it strictly for the commissions (and why not with interest rates so low?), and the fracking company CEOs are in it for their obscene compensation. Their compensation and bonuses come not from finding, extracting and selling product, but from finding and extracting money in the form of debt and even capital.
Like I said, no debt data, but the stuff that did surface is veerry interesting. Some samples:
“Fracking is a business built on attracting ever-more gigantic amounts of capital investment, while promises of huge returns have yet to bear out,” says an introduction to McLean’s book. In fact, North American exploration and production companies saw their net debt balloon from $50 billion in 2005 to nearly $200 billion by 2015, according to a recent research paper by Amir Azar, fellow at Columbia University’s Center on Global Energy Policy.
Beyond the debt overhang, the fracking industry’s fortunes directly impact oil prices and the rest of the economy, while also being a significant job creator,
listed E&P firms would over time need to make about $60bn of free cashflow each year. Assuming that both energy prices and capital spending stay flat, that would require them roughly to double production from current levels.
The trouble is that this is a circular argument. If achieved across the whole shale industry it would mean that output would be twice as high as it is now, leading to a 5% increase in global supply, which might in turn lower the oil price. There is something heroic—and baffling—about America’s shale firms. They are the marginal producer in a cyclical industry, and that is usually an unpleasant place to be. The oil bulls of Houston have yet to prove that they can pump oil and create value at the same time.
To make matters more complicated, many of these energy companies are financing their operations by borrowing in the junk-bond market, which means borrowing rates are relatively high.
"As oil prices have fallen recently, so have prices of high-yield bonds," Charles Schwab's Collin Martin wrote in October. When bond prices fall, rates rise.
"Oil prices can have a broad impact on the high-yield bond market because energy corporations have been increasing their share of the high-yield bond market. Today, energy companies make up more than 15% of the Barclays U.S. Corporate High-Yield Bond Index.
The DESMOG blog makes no bones about it, declaring this to be "The Great American Fracking Bubble". https://www.desmogblog.com/2018/04/18/finances-great-american-fracking-b...
And, piece de resistance, loan participations appear to also be part of the process. From none less than The American Banker:
Since 2013, the federal regulatory agencies have been warning banks and investors about the potential risks in leveraged lending. These warnings have been both timely and prescient, particularly in view of the ongoing credit debacle in the energy sector. In addition to the well-documented credit risk posed by leverage loans, we believe that the widespread practice of selling participations in leveraged loans represents a significant additional risk to financial institutions and other investors from this asset class.
The investor exodus away from leveraged loans with exposure to the petroleum sector brings back memories of the 1970s oil bust, an economic shock that led to the failure of Penn Square Bank in 1982, the subsequent failure of Seafirst Bank later in that year, followed by Continental Illinois Bank in 1984. Before its failure, Penn Square technically continued to "own" — and service — loan interests held by other banks with participations. As receiver for the failed bank, the Federal Deposit Insurance Corp. deemed those investors to be nothing more than general creditors of the failed bank's estate. Those participating banks lost their entire investment.
As in the 1970s, today a substantial portion of the leveraged loan market has been "participated" to other banks and nonbank investors.
But, in the end, it is our money. We will all take the hit sooner or later. Simple self defense says to get your money out of those institutions and into Credit Unions, where it will be far safer because they aren't directly involved in that crazy shit. Beyond that, every buck that we move out of them gives them less money to be wildly speculative with, though that might simply prolong the agony.
(Image: "Wanted Poster at Holburn Station (London, UK)" (public domain)
OK, it's an open thread, so go for it ...