Druckenmiller: "I"ve Had A Terrible Year... It’s Going To Be My First Down Year In Currencies Ever"

With the B in CNBC now officially standing for "Bitcoin", it was inevitable that Stanley Druckenmiller, the CEO of the Duquesne family office would immediately get a question about the soaring cryptocurrency during his Tuesday interview with Kelly Evans, whose explosive price the Dusquesne asset manager attributed - just like Citi did back in June - to capital misallocation, and hence bubbles, created by central banks.

Druckenmiller: If you took the taylor rule a normal interest rate given our economic circumstances would be 4% interestingly. We’re at 1%. In europe, it would be 2%. They’re at minus 40%. In sweden, it would be 3.75%. They’re at minus 50%. That doesn’t even count the bond buying we’re talking. But this is all in the name of this 2% inflation target.

Evans: if they’re keeping rates in this country, you know, barely above zero, in other countries, below zero, what are the consequences of all of this?

Druckenmiller: well the consequences are huge because we’ve distorted market signals and we’re causing all sorts of what i would call misallocation of resources.

Evans: Like bitcoin? or is that unrelated?

Druckenmiller: No, it’s not unrelated at all. Bitcoin, art, wine, equities, credit, you name it. everything is one way up and there are huge distortions taking place, and it’s all in the name of this 2% inflation target. And when you get a misallocation of resources, it really hinders growth over the longer term. 

For those who may not remember, Citi laid out very much the same half a year ago, pointing out that facilitating the recovery is coming at an increasingly higher cost to the future, in terms of real estate, crypto and even old car asset bubbles. 

Back to Bitcoin: when asked by Kelly Evans if he owns any, Druckenmiller responds "no", and adds that "obviously as a trader I should have, but I only trade what i know. What I do know is it takes the same amount of energy to do one bitcoin transaction that it takes to power nine homes in the US. By 2019 it’ll take up half the energy in the united states to run the bitcoin network" 

And then this humorous tangent on bitcoin fanatics and fake liberal concern about the climate: "I find it interesting that most people in bitcoin are climate people. They’re west coast people. I don’t quite get the connection. We’ve got this rogue currency that we’re all going to support that is destroying the climate in some extent, but whatever."

Undeterred, Evans tried to get an explicit answer from Druckenmiller on his bitcoin price target, however unlike Novogratz, Druck was relentless. Here is his response to whether bitcoin is the greatest bubble ever seen, something which at least in historical terms...

... now appears to be the case:

"i don’t know whether it’s the greatest [bubble] we’ve ever experienced. Look bitcoin is like anything else, it’s worth what people are willing to pay for it. And right now people are willing to pay -- i haven’t looked in the last five minutes so it could have varied – but let’s say they’re willing to pay $17,000. That’s what it’s worth. The tulips were worth what people were paying that for them. Gold is what it’s worth. What I do know about bitcoin is the concept that it could ever be a medium of exchange has been eliminated because you can’t do transactions, particularly retail transactions with something with this kind of volatility. But if people think bitcoin is worth $17,000, that’s what it’s worth today."

Price targets aside, Evans then asked the right question, noting that "there are people that want to hold bitcoin because they’re as critical of the Fed and central banks as you are. So if they agree with your philosophy that central banks are screwing this up then what would be a better way to express that than holding bitcoin?"

His response: "That’s an excellent question. I think at some point figure out when this is going to end and then either get out or go short. Because, by the way, when this ends and it will, i’m talking about this monetary radicalism period we’re in, bitcoin will probably go down with the rest of the stuff."

* * *

Yet while Druckenmiller"s insights on bitcoin were notable, what we found especially interesting was the legendary hedge fund manager"s recap of his trading and P&L in 2017. We were hardly surprised to learn that - just like everyone else - Druckenmiller also has no idea how to make money in a world dominated by central banks. In fact, as he put it, it"s been a "terrible year", and his first down year in currencies ever.

Evans: How has the year been for you?

Druckenmiller: i would have to say it’s probably the worst year i’ve had relative to the set of opportunities out there, i can never recall. I mean, for me, 1997 was close.

Evans: But that was an asian financial crisis.

Druckenmiller: Well, that was pretty good opportunity. I have done very well in stocks. I’ve really, really mistraded macro. It’s going to be -- if it was up to macro, i’d have my first down year but stocks have bailed me out, so barring a miracle, that’s not going to happen.

Evans: but you’re not up 30%?

Druckenmiller: I’m not up anywhere near 30%. i’m not up double digits. You know, I’m having, again, relative to the opportunity set a terrible year, barring a miracle - it’s going to be my first down year in currencies ever.... It"s just me just overtrading and being cold at the wrong time and since it’s been my bread and butter for years, I tell you overallocating exposure there relative to equities. Somebody on your network said a week ago all you had to do this year was roll out of bed and you’re going to be up 20% or 30%. apparently i got out of the wrong side of the bed.

Druckenmiller wasn"t done, and in the second part of his interview, he lashed out at certain parts of Trump"s tax reform, most notably the carried interest provision, which he called "outrageous."

Trump had promised during his campaign that he would eliminate this loophole, saying hedge fund managers were "getting away with murder." But having packed his administration with billionaires and former Wall Street executives, the promise was quickly forgotten as the finance industry pressed hard to preserve carried interest.

As a result, Druckenmiller said the tax proposal is unfair to doctors and lawyers in states where taxes will go up dramatically, while "you have these multi, multi billionaires—with carve outs—let"s be clear. Carried interest...you"re making money on somebody else"s capital. It"s not on your own. If that"s not income, I don"t know what is."

"First of all, the billionaires lobbying the Congressmen for this oughta be ashamed of themselves because we"re asking doctors and lawyers and other Americans in blue states to take tax increases so we can fund this kinda nonsense," Druckenmiller told Kelly Evans. Asked whether it would be enough to entice him back to the business, Druckenmiller, an avid golfer, said no, "partly "cause I keep missing putts."

Venezuela Signs $3.2 Billion Debt Restructuring Deal With Russia

As Venezuela teeters right on the brink of complete financial collapse, Bloomberg reports that Russia has agreed to restructure roughly $3.2 billion in outstanding obligations.  While details of the restructuring agreement are scarce, both sides reported that the deal spreads payments out over 10 years with minimal cash service required over the next six years.

Russia signed an agreement to restructure $3.15 billion of debt owed by Venezuela, throwing a lifeline to a crisis-wracked ally that’s struggling to repay creditors.

 

The deal spreads the loan payments out over a decade, with “minimal” payments over the first six years, the Russian Finance Ministry said in a statement. The pact doesn’t cover obligations of state oil company Petroleos de Venezuela SA to its Russian counterpart Rosneft PJSC, however.

 

“The terms are flexible and very favorable for our country,” Wilmar Castro Soteldo, Venezuela’s economic vice president, told reporters in Moscow after the signing. “We will be able to return to the level of commercial relations with Russia that we had before,” he added, noting that a deal to buy Russian wheat will be signed next week.

This is the second time Russia has agreed to reschedule Venezuela’s debt payments after agreeing to an extension last year. Still, Caracas failed to make payments amid an economic crisis triggered by low prices for oil. Rosneft has also provided several billion dollars in advance payments for Venezuelan crude supplies.

The rescheduling pact is a “demonstration of the desire to maintain ties with the current Venezuelan leadership,” Viktor Kheifets, an expert in Venezuela at St. Petersburg State University, said by phone. “Russia isn’t happy with everything that the government there is doing but Venezuela is an ally where Russia has economic interests and Moscow is firmly against a forcible change of regime there.”

 

In a website statement announcing the deal, Russia’s Finance Ministry said, “The debt relief provided to the republic from the restructuring of its liabilities will allow funds to be allocated for the country’s economic development, to improve the debtor’s solvency and increase the chances of all creditors to recoup loans granted earlier to Venezuela.”

Of course, the deal with Russia comes as attempts to hold talks with Venezuela"s other creditors faltered this week. President Nicolas Maduro had summoned holders of some $60 billion of bonds issued by the government and PDVSA to begin a renegotiation as the nation’s cash crunch worsens, but as we noted previously (see: S&P Downgrades Venezuela To "Selective Default" After Bondholder Meeting Devolves Into Total Chaos), the meeting turned out to be nothing more than a photo op. 

Meanwhile, as the Financial Times noted yesterday, failure of ISDA committees to determine whether or not a default event actually occurred when Venezuela blew through its grace period, has only added to the confusion of the restructuring process.

A finance industry committee convened to discuss whether Venezuela’s state oil company has defaulted on its debts has elected to delay the decision once again, underscoring the uncertainly swirling around the country’s bond payments.

 

Venezuela belatedly came through with a $1.1bn PDVSA bond payment last week, but only well after a three-day grace period following the bond’s maturity on Nov 3. That led to a request that the International Swaps and Derivatives Association’s “determinations committee” consider whether PDVSA was in default.

 

The Isda committees have the power to declare a “failure to pay”, which would trigger insurance-like contracts on PDVSA’s bonds, known as credit-default swaps, even if the actual bondholders haven’t declared it a default. But in a statement on its website on Monday, Isda said that the committee had decided to reconvene on Tuesday at 11am to discuss the PDVA question further.

All of which has left bondholders in limbo...

"Google & Facebook Are 1984" - Tax Them "Til They Bleed

Authored by Raul Ilargi Meijer via The Automatic Earth blog,

An entire library of articles about Big Tech is coming out these days, and I find that much of it is written so well, and the ideas in them so well expressed, that I have little to add. Except, I think I may have the solution to the problems many people see. But I also have a concern that I don’t see addressed, and that may well prevent that solution from being adopted. If so, we’re very far away from any solution at all. And that’s seriously bad news.

Let’s start with a general -even ‘light’- critique of social media by Claire Wardle and Hossein Derakhshan for the Guardian:

How Did The News Go ‘Fake’? When The Media Went Social

Social media force us to live our lives in public, positioned centre-stage in our very own daily performances. Erving Goffman, the American sociologist, articulated the idea of “life as theatre” in his 1956 book The Presentation of Self in Everyday Life, and while the book was published more than half a century ago, the concept is even more relevant today. It is increasingly difficult to live a private life, in terms not just of keeping our personal data away from governments or corporations, but also of keeping our movements, interests and, most worryingly, information consumption habits from the wider world.

 

The social networks are engineered so that we are constantly assessing others – and being assessed ourselves. In fact our “selves” are scattered across different platforms, and our decisions, which are public or semi-public performances, are driven by our desire to make a good impression on our audiences, imagined and actual. We grudgingly accept these public performances when it comes to our travels, shopping, dating, and dining. We know the deal. The online tools that we use are free in return for us giving up our data, and we understand that they need us to publicly share our lifestyle decisions to encourage people in our network to join, connect and purchase.

 

But, critically, the same forces have impacted the way we consume news and information. Before our media became “social”, only our closest family or friends knew what we read or watched, and if we wanted to keep our guilty pleasures secret, we could. Now, for those of us who consume news via the social networks, what we “like” and what we follow is visible to many [..] Consumption of the news has become a performance that can’t be solely about seeking information or even entertainment. What we choose to “like” or follow is part of our identity, an indication of our social class and status, and most frequently our political persuasion.

That sets the scene. People sell their lives, their souls, to join a network that then sells these lives -and souls- to the highest bidder, for a profit the people themselves get nothing of. This is not some far-fetched idea. As noted further down, in terms of scale, Facebook is a present day Christianity. And these concerns are not only coming from ‘concerned citizens’, some of the early participants are speaking out as well. Like Facebook co-founder Sean Parker:

Facebook: God Only Knows What It’s Doing To Our Children’s Brains

Sean Parker, the founding president of Facebook, gave me a candid insider’s look at how social networks purposely hook and potentially hurt our brains. Be smart: Parker’s I-was-there account provides priceless perspective in the rising debate about the power and effects of the social networks, which now have scale and reach unknown in human history. [..]

 

“When Facebook was getting going, I had these people who would come up to me and they would say, ‘I’m not on social media.’ And I would say, ‘OK. You know, you will be.’ And then they would say, ‘No, no, no. I value my real-life interactions. I value the moment. I value presence. I value intimacy.’ And I would say, … ‘We’ll get you eventually."”

 

“I don’t know if I really understood the consequences of what I was saying, because [of] the unintended consequences of a network when it grows to a billion or 2 billion people and … it literally changes your relationship with society, with each other … It probably interferes with productivity in weird ways. God only knows what it’s doing to our children’s brains.”

 

“The thought process that went into building these applications, Facebook being the first of them, … was all about: ‘How do we consume as much of your time and conscious attention as possible?"” “And that means that we need to sort of give you a little dopamine hit every once in a while, because someone liked or commented on a photo or a post or whatever. And that’s going to get you to contribute more content, and that’s going to get you … more likes and comments.”

 

“It’s a social-validation feedback loop … exactly the kind of thing that a hacker like myself would come up with, because you’re exploiting a vulnerability in human psychology.” “The inventors, creators — it’s me, it’s Mark [Zuckerberg], it’s Kevin Systrom on Instagram, it’s all of these people — understood this consciously. And we did it anyway.”

Early stage investor in Facebook, Roger McNamee, also has some words to add along the same lines as Parker. They make it sound like they’re Frankenstein and Facebook is their monster.

How Facebook and Google Threaten Public Health – and Democracy

The term “addiction” is no exaggeration. The average consumer checks his or her smartphone 150 times a day, making more than 2,000 swipes and touches. The applications they use most frequently are owned by Facebook and Alphabet, and the usage of those products is still increasing. In terms of scale, Facebook and YouTube are similar to Christianity and Islam respectively. More than 2 billion people use Facebook every month, 1.3 billion check in every day. More than 1.5 billion people use YouTube. Other services owned by these companies also have user populations of 1 billion or more.

 

Facebook and Alphabet are huge because users are willing to trade privacy and openness for “convenient and free.” Content creators resisted at first, but user demand forced them to surrender control and profits to Facebook and Alphabet. The sad truth is that Facebook and Alphabet have behaved irresponsibly in the pursuit of massive profits. They have consciously combined persuasive techniques developed by propagandists and the gambling industry with technology in ways that threaten public health and democracy.

 

The issue, however, is not social networking or search. It is advertising business models. Let me explain. From the earliest days of tabloid newspapers, publishers realized the power of exploiting human emotions. To win a battle for attention, publishers must give users “what they want,” content that appeals to emotions, rather than intellect. Substance cannot compete with sensation, which must be amplified constantly, lest consumers get distracted and move on. “If it bleeds, it leads” has guided editorial choices for more than 150 years, but has only become a threat to society in the past decade, since the introduction of smartphones.

Media delivery platforms like newspapers, television, books, and even computers are persuasive, but people only engage with them for a few hours each day and every person receives the same content. Today’s battle for attention is not a fair fight. Every competitor exploits the same techniques, but Facebook and Alphabet have prohibitive advantages: personalization and smartphones. Unlike older media, Facebook and Alphabet know essentially everything about their users, tracking them everywhere they go on the web and often beyond.

 

By making every experience free and easy, Facebook and Alphabet became gatekeepers on the internet, giving them levels of control and profitability previously unknown in media. They exploit data to customize each user’s experience and siphon profits from content creators. Thanks to smartphones, the battle for attention now takes place on a single platform that is available every waking moment. Competitors to Facebook and Alphabet do not have a prayer.

 

Facebook and Alphabet monetize content through advertising that is targeted more precisely than has ever been possible before. The platforms create “filter bubbles” around each user, confirming pre-existing beliefs and often creating the illusion that everyone shares the same views. Platforms do this because it is profitable. The downside of filter bubbles is that beliefs become more rigid and extreme. Users are less open to new ideas and even to facts.

 

Of the millions of pieces of content that Facebook can show each user at a given time, they choose the handful most likely to maximize profits. If it were not for the advertising business model, Facebook might choose content that informs, inspires, or enriches users. Instead, the user experience on Facebook is dominated by appeals to fear and anger. This would be bad enough, but reality is worse.

And in a Daily Mail article, McNamee’s ideas are taken a mile or so further. Goebbels, Bernays, fear, anger, personalization, civility.

Early Facebook Investor Compares The Social Network To Nazi Propaganda

Facebook officials have been compared to the Nazi propaganda chief Joseph Goebbels by a former investor. Roger McNamee also likened the company’s methods to those of Edward Bernays, the ‘father of public’ relations who promoted smoking for women. Mr McNamee, who made a fortune backing the social network in its infancy, has spoken out about his concern about the techniques the tech giants use to engage users and advertisers. [..] the former investor said everyone was now ‘in one degree or another addicted’ to the site while he feared the platform was causing people to swap real relationships for phoney ones.

 

And he likened the techniques of the company to Mr Bernays and Hitler’s public relations minister. ‘In order to maintain your attention they have taken all the techniques of Edward Bernays and Joseph Goebbels, and all of the other people from the world of persuasion, and all the big ad agencies, and they’ve mapped it onto an all day product with highly personalised information in order to addict you,’ Mr McNamee told The Telegraph. Mr McNamee said Facebook was creating a culture of ‘fear and anger’. ‘We have lowered the civil discourse, people have become less civil to each other..’

 

He said the tech giant had ‘weaponised’ the First Amendment to ‘essentially absolve themselves of responsibility’. He added: ‘I say this as somebody who was there at the beginning.’ Mr McNamee’s comments come as a further blow to Facebook as just last month former employee Justin Rosenstein spoke out about his concerns. Mr Rosenstein, the Facebook engineer who built a prototype of the network’s ‘like’ button, called the creation the ‘bright dings of pseudo-pleasure’. He said he was forced to limit his own use of the social network because he was worried about the impact it had on him.

As for the economic, not the societal or personal, effects of social media, Yanis Varoufakis had this to say a few weeks ago:

Capitalism Is Ending Because It Has Made Itself Obsolete – Varoufakis

Former Greek finance minister Yanis Varoufakis has claimed capitalism is coming to an end because it is making itself obsolete. The former economics professor told an audience at University College London that the rise of giant technology corporations and artificial intelligence will cause the current economic system to undermine itself. Mr Varoufakis said companies such as Google and Facebook, for the first time ever, are having their capital bought and produced by consumers.

 

“Firstly the technologies were funded by some government grant; secondly every time you search for something on Google, you contribute to Google’s capital,” he said. “And who gets the returns from capital? Google, not you. “So now there is no doubt capital is being socially produced, and the returns are being privatised. This with artificial intelligence is going to be the end of capitalism.”

Ergo, as people sell their lives and their souls to Facebook and Alphabet, they sell their economies along with them.

That’s what that means. And you were just checking what your friends were doing. Or, that’s what you thought you were doing.

The solution to all these pains is, likely unintentionally, provided by Umair Haque’s critique of economics. It’s interesting to see how the topics ‘blend’, ‘intertwine’.

How Economics Failed the Economy

When, in the 1930s, the great economist Simon Kuznets created GDP, he deliberately left two industries out of this then novel, revolutionary idea of a national income : finance and advertising. [..] Kuznets logic was simple, and it was not mere opinion, but analytical fact: finance and advertising don’t create new value, they only allocate, or distribute existing value in the same way that a loan to buy a television isn’t the television, or an ad for healthcare isn’t healthcare. They are only means to goods, not goods themselves. Now we come to two tragedies of history.

 

What happened next is that Congress laughed, as Congresses do, ignored Kuznets, and included advertising and finance anyways for political reasons -after all, bigger, to the politicians mind, has always been better, and therefore, a bigger national income must have been better. Right? Let’s think about it. Today, something very curious has taken place.

 

If we do what Kuznets originally suggested, and subtract finance and advertising from GDP, what does that picture -a picture of the economy as it actually is reveal? Well, since the lion’s share of growth, more than 50% every year, comes from finance and advertising -whether via Facebook or Google or Wall St and hedge funds and so on- we would immediately see that the economic growth that the US has chased so desperately, so furiously, never actually existed at all.

 

Growth itself has only been an illusion, a trick of numbers, generated by including what should have been left out in the first place. If we subtracted allocative industries from GDP, we’d see that economic growth is in fact below population growth, and has been for a very long time now, probably since the 1980s and in that way, the US economy has been stagnant, which is (surprise) what everyday life feels like. Feels like.

 

Economic indicators do not anymore tell us a realistic, worthwhile, and accurate story about the truth of the economy, and they never did -only, for a while, the trick convinced us that reality wasn’t. Today, that trick is over, and economies grow , but people’s lives, their well-being, incomes, and wealth, do not, and that, of course, is why extremism is sweeping the globe. Perhaps now you begin to see why the two have grown divorced from one another: economics failed the economy.

 

Now let us go one step, then two steps, further. Finance and advertising are no longer merely allocative industries today. They are now extractive industries. That is, they internalize value from society, and shift costs onto society, all the while creating no value themselves.

 

The story is easiest to understand via Facebook’s example: it makes its users sadder, lonelier, and unhappier, and also corrodes democracy in spectacular and catastrophic ways. There is not a single upside of any kind that is discernible -and yet, all the above is counted as a benefit, not a cost, in national income, so the economy can thus grow, even while a society of miserable people are being manipulated by foreign actors into destroying their own democracy. Pretty neat, huh?

 

It was BECAUSE finance and advertising were counted as creative, productive, when they were only allocative, distributive that they soon became extractive. After all, if we had said from the beginning that these industries do not count, perhaps they would not have needed to maximize profits (or for VCs to pour money into them, and so on) endlessly to count more. But we didn’t.

 

And so soon, they had no choice but to become extractive: chasing more and more profits, to juice up the illusion of growth, and soon enough, these industries began to eat the economy whole, because of course, as Kuznets observed, they allocate everything else in the economy, and therefore, they control it.

 

Thus, the truly creative, productive, life-giving parts of the economy shrank in relative, and even in absolute terms, as they were taken apart, strip-mined, and consumed in order to feed the predatory parts of the economy, which do not expand human potential. The economy did eat itself, just as Marx had supposed – only the reason was not something inherent in it, but a choice, a mistake, a tragedy.

 

[..] Life is not flourishing, growing, or developing in a single way that I or even you can readily identify or name. And yet, the economy appears to be growing, because purely allocative and distributive enterprises like Uber, Facebook, credit rating agencies, endless nameless hedge funds, shady personal info brokers, and so on, which fail to contribute positively to human life in any discernible way whatsoever, are all counted as beneficial. Do you see the absurdity of it?

 

[..] It’s not a coincidence that the good has failed to grow, nor is it an act of the gods. It was a choice. A simple cause-effect relationship, of a society tricking itself into desperately pretending it was growing, versus truly growing. Remember not subtracting finance and advertising from GDP, to create the illusion of growth? Had America not done that, then perhaps it might have had to work hard to find ways to genuinely, authentically, meaningfully grow, instead of taken the easy way out, only to end up stagnating today, and unable to really even figure out why yet.

Industries that are not productive, but instead only extract money from society, need to be taxed so heavily they have trouble surviving. If that doesn’t happen, your economy will never thrive, or even survive. The whole service economy fata morgana must be thrown as far away as we can throw it. Economies must produce real, tangible things, or they die.

For the finance industry this means: tax the sh*t out of any transactions they engage in. Want to make money on complex derivatives? We’ll take 75+%. Upfront. And no, you can’t take your company overseas. Don’t even try.

For Uber and Airbnb it means pay taxes up the wazoo, either as a company or as individual home slash car owners. Uber and Airbnb take huge amounts of money out of local economies, societies, communities, which is nonsense, unnecessary and detrimental. Every city can set up its own local car- or home rental schemes. Their profits should stay within the community, and be invested in it.

For Google and Facebook as the world’s new major -only?!- ad agencies: Tax the heebies out of them or forbid them from running any ads at all. Why? Because they extract enormous amounts of productive capital from society. Capital they, as Varoufakis says, do not even themselves create.

YOU are creating the capital, and YOU then must pay for access to the capital created.

Yeah, it feels like you can just hook up and look at what your friends are doing, but the price extracted from you, your friends, and your community is so high you would never volunteer to pay for it if you had any idea.

The one thing that I don’t see anyone address, and that might prevent these pretty straightforward ”tax-them-til they-bleed!” answers to the threat of New Big Tech, is that Facebook, Alphabet et al have built a very strong relationship with various intelligence communities. And then you have Goebbels and Bernays in the service of the CIA.

As Google, Facebook and the CIA are ever more entwined, these companies become so important to what ‘the spooks’ consider the interests of the nation that they will become mutually protective. And once CIA headquarters in Langley, VA, aka the aptly named “George Bush Center for Intelligence”, openly as well as secretly protects you, you’re pretty much set for life. A long life.

Next up: they’ll be taking over entire economies, societies. This is happening as we speak. I know, you were thinking it was ‘the Russians’ with a few as yet unproven bucks in Facebook ads that were threatening US and European democracies. Well, you’re really going to have to think again.

The world has never seen such technologies. It has never seen such intensity, depth of, or such dependence on, information. We are simply not prepared for any of this. But we need to learn fast, or become patsies and slaves in a full blown 1984 style piece of absurd theater. Our politicians are AWOL and MIA for all of it, they have no idea what to say or think, they don’t understand what Google or bitcoin or Uber really mean.

In the meantime, we know one thing we can do, and we can justify doing it through the concept of non-productive and extractive industries. That is, tax them till they bleed.

That we would hit the finance industry with that as well is a welcome bonus. Long overdue. We need productive economies or we’re done. And Facebook and Alphabet -and Goldman Sachs- don’t produce d*ck all.

When you think about it, the only growth that’s left in the US economy is that of companies spying on American citizens. Well, that and Europeans. China has banned Facebook and Google. Why do you think they have? Because Google and Facebook ARE 1984, that’s why. And if there’s going to be a Big Brother in the Middle Kingdom, it’s not going to be Silicon Valley.

Fintech Revolution - Finance Professionals Rushing To Take Courses As Career Hedge

Fintech, blockchain and A.I. are revolutionising the banking industry and have the potential to replace a significant percentage of the human capital, eliminating a chunk of their cost bases. Last month, former Citi CEO, Vikram Pandit, was particularly pessimistic, claiming that 30% of jobs could be lost in the next five years.

As CNBC reports, finance professionals, especially “more experienced” ones, are acutely aware of the risk and are rushing to educate themselves via online learning.

Financial professionals are taking online financial technology (fintech) courses to fend off competition and stay ahead of disruption. The boost in uptake is due in part to a feeling among those in the industry that financial technology has reached a turning point in its evolution. A report from Citigroup in 2016 caused widespread debate when it estimated that between 2 million and 6 million jobs would be lost in banking across the U.S. and Europe over the next 10 years. That was attributed to both automation and artificial intelligence (AI), innovation and the rise of more efficient and less cost-intensive challenger banks. Santander"s fintech-focused venture capital fund, Santander InnoVentures, estimates cost savings for banks that implement blockchain technology as high as $20 billion per year by 2022.

Blue chip educational establishments launching new courses and corporate M&A are features of this growth market.

Highly-regarded educational institutions are also being forced to innovate and provide the resources to the financial industry to up-skill and stay ahead of an ever-steepening curve. The likes of Oxford University, Princeton and Massachusetts Institute of Technology (MIT) now all offer online courses aimed at busy and high-level banking executives. According to a report from e-learning software provider Docebo, online education in general is set to grow by 5 percent over the next decade and generate over $240 billion by 2023. LinkedIn also joined the sector as early as 2015, buying online education firm Lynda for $1.5 billion. Lynda has finance and technology courses, including ones that aim to help business executives implement tech into their firm…

GetSmarter was acquired by American education technology giant 2U for over $100 million in July as it looks to join the non-degree focused line of online course offerings. The Nasdaq-listed 2U has had a good 2017 itself after posting a year-on-year increase of 32 percent on its top line in the second quarter. The company"s stock is up over 110 percent year-to-date and it is scheduled to report third-quarter figures on November 7.

Oxford University’s new course is attracting seasoned pros and executives from the world’s biggest banks.

GetSmarter has capitalized on the uptrend and is the software and online campus provider for the Said Business School at Oxford University"s new online fintech course. At the time of the program"s mid-October start date, nearly 1,000 people from across 71 countries had enrolled, with the U.K. accounting for a third of sign-ups. Here"s where the numbers get interesting. About three-quarters of participants are currently working in financial services, with half having more than 15 years" experience in the industry. Over half the students are company leaders, with many listing job titles such as managing director. And a large proportion are employed by the world"s biggest banks, including Bank of America, Barclays, CitiBank, Deutsche Bank, HSBC, Standard Chartered and UBS. Peter Tufano, dean at Oxford"s Said Business School, told CNBC:

"Fintech is an exciting, fast-moving and important phenomena. By collaborating with partners from around the world, practitioners in all the major financial sectors, and GetSmarter, we are able to offer something that is up-to-date and useful to not just our program participants, but the world."

Another major financial hub, Singapore, is targeting a more constructive approach to the fintech revolution. According to The Straits Times, a road map to transform the financial services industry is targeting the creation of 3,000 net jobs annually, with another 1,000 in fintech alone.

The industry transformation (ITM) also aims to achieve growth in financial sector real value-added of 4.3 per cent and productivity of 2.4 per cent annually, faster than the overall economy. At the same time, banks and financial institutions have to do more to retrain workers whose jobs are affected by disruptive changes in the finance industry and match them to new jobs, Education Minister Ong Ye Kung said on Monday (Oct 30). Speaking at the launch of the financial services ITM, Mr Ong noted that the most important aspect of any transformation plan lies in people. However, he noted, when an existing activity is disrupted and jobs become at risk, the tendency is to lay off staff.

 

"But this cannot be the solution of first resort," he said. "For professionals who have honed their craft over many years, a large part of what they already know can be reapplied within the financial services sector or in other adjacent sectors."

 

Without addressing the concerns of those affected by change, there can be no change, and by extension, no innovation, he added. And so the Monetary Authority of Singapore will work with key financial institutions to make a strong push in implementing Professional Conversion Programmes (PCPs) to help their staff move into new jobs, including in growth areas such as technology and compliance.

There is an online forum for students participating in Oxford University’s new fintech course. Courtesy of CNBC’s report, we know their favourite topic of conversation…

 An online student forum for a course from Oxford University showed that the main topic of conversation was cryptocurrency bedfellows, bitcoin, and ether.

…which is unlikely to change while the cryptocurrency bull market continues.

 

How A Quant Hedge Fund Surpassed Renaissance And DE Shaw To Become A $50 Billion Behemoth

In a time when traditional long/short, macro and other fundamental-analysis based hedge funds are losing the war to ETFs and passive investing...

... one group of funds is thriving, and none more so than quant powerhouse Two Sigma which according to the FT, has quietly grown assets under management mark over $50 billion "putting it on a par with Renaissance Technologies as the biggest global quantitative hedge fund, as investors continue to pile into computer-powered investment strategies."

Putting Two Sigma"s staggering growth rate in context, the New York-based hedge fund, which was launched in 2001 by computer scientist David Siegel and mathematician John Overdeck, had $6bn in 2011 but soared past the $50bn mark earlier this month, according to FT sources:

"That puts it roughly level with Renaissance Technologies, which manages just over $50bn, and more than DE Shaw’s $45bn. Both are older than Two Sigma."

The reason for the unprecedented growth rate is that while the rest of the hedge fund industry has struggled with poor performance and outflows, investor demand for lower-cost, quant and algorithmic investing has exploded in recent years.  Morgan Stanley recently estimated that various quant strategies, ranging from cheap next-generation exchange traded funds to pricey sophisticated hedge fund vehicles, have grown at 15 per cent annually over the past six years, and now control about $1.5tn.

As MS reported in early October:

"$1.5 trillion of AuM currently managed under quantitative guidelines could continue its double-digit growth over the next five years. Part of this growth is a  ‘pull’ from investors broadening their search for risk premium and uncorrelated returns at lower fees than traditional alternatives. Part of this is a ‘push’, as asset managers see systematic strategies that lend themselves well to automation and scale, offering value over pure ‘beta’ in a traditional active management framework. Relatively small further reallocation by asset owners towards these strategies could still drive significant growth."

To be sure, this invasion of Math Ph.D will harldy come as a surprise to regular readers: back in 2009 we predicted that with central banks obviating fundamentals, it was only a matter of time before the mathematicians and physicists took over. Well, they have:

Quants tend to have a different background to typical hedge funds. More than half of Two Sigma’s 1,200 staff come from outside the finance industry, with most educated in mathematics and computer science. They include the winner of a Japanese backgammon tournament and the “world’s first open-source software artist”, according to a graphic novel handed to new recruits.

As programmers and data scientists have taken advantage of ever-cheaper computing power and ravenous investor appetite, a flurry of new start-ups have emerged in the quant investing field in recent years, But the biggest growth is happening at the largest, most-respected players, according to Emma Bewley, head of fund investment at Connection Capital.

“The big firms are getting bigger,” she said. “There’s a real sense that while a lot of hedge funds are building out their quantitative side, they don’t have the know-how of the established quant firms.”

There are pros and cons to this substantial reallocation to quant funds away from conventional, fundamental "active" managers: on one hand, "the rapid growth of quantitative investing has sparked a ferocious war for talent, with banks, traditional asset managers and hedge funds desperate to attract more coders." But, as the FT"s Robin Wigglesworth observes, such clustering creates a risk of all "traders" being on the same side at the same time:

The greater worry for investors and the industry is that the inflows of money into the space is ramping up risks to markets.  While strategies can vary greatly, there is concern that with more money gushing in some trades can become “crowded”, and unravel quickly if the market environment shifts.

To avert such concerns, many quant funds are careful to monitor for signs of crowding, and limit how much money a strategy or fund manages at any time.

For example, Two Sigma’s equity and macro hedge funds, which manage about $35bn, have long been closed to outside investors.

And while quants claim their strats are now less aggressive, and use less leverage and deploy more varied strategies, there is no way to know until the next downturn, a downturn which refuses to occur precisely because of quants, whose primary directive it appears is to Buy The Dip, Any Dip before the other Math PhD does, and not only ask questions later, but ideally never ask anything as more greater fools emerge to bid up risk even higher, which luckily these days also includes central banks.

A Simple Method Of Risk Management

Authored by Lance Roberts via RealInvestmentAdvice.com,

Yesterday, I addressed the issue of how market innovations and “crowding” into specific trades have been signs of market excesses in the past. To wit:

“That is the cycle of innovation in the financial marketplace. Despite the best of intentions, and advances in innovation, humans will always seek out the comfort of other humans in times of distress. The rising notoriety of Robo-advisors and the crowding of investors into ‘passive indexing’ are the current symbols of excess in the markets today. They will also be the ‘whipping boy’ of the next decline as ‘passive indexing’ is realized as a ‘foolish’ investment strategy.” 

“I have been around long enough to see many things come and go in the financial world, and there is only one truth: ‘The more things change, the more they stay the same."”

Just recently, Scott Nations via MarketWatch also made an interesting point with respect to the “psychological” influences that drive behaviors in the longer term:

“One problem investors face is the concept of the ‘anchor’ price, first described by Daniel Kahneman and Amos Tversky. Regardless of the value of a share of stock, we tend to believe that value must be close to the only bit of information many of us have — the current price. This anchoring effect makes it easier to justify paying a wildly inflated price for a company that is operating at a loss or for a market that is hugely overvalued by any objective measure.

Another common fallacy investors face is ‘herding,’ or the tendency to use the actions of others as a measure of sensible behavior. Fads, fashion, and stock-market bubbles are three examples of this mindset. When investors lose the sort of hard-nosed skepticism and difference of opinion that marks a healthy market, it becomes fashionable, and nearly unavoidable, for too many investors to buy too many stocks that have too little going for them.”

The psychology behind “market exuberance,” is an issue that has recurred with regularity in the financial markets and was always dismissed as “this time is different.” Unfortunately, for investors, it never was.

As Scott notes:

“If it were just psychological quirks that lead to runaway stock market rallies, the bubble might deflate itself slowly as the anchor price is gradually lowered and as financial fads and fashions change.

But the stock market isn’t a purely psychology exercise; too often the real world intrudes. Each modern stock-market crash has been precipitated by a catalyst that has little to do with finance and that catches us off guard. These catalysts push a system barely able to maintain equilibrium into chaos.”

Actually, it’s every time.

The market always “prices in” events or issues it is aware of such as economic data, earnings estimate changes, and even geopolitical events. In other words, it isn’t the thing that markets are aware of, but the unexpected event which sends traders, and algorithms, rushing for the exits. But, as Scott notes:

“And the raw material for a crash is a buoyant stock market.”

Despite the fact we know this is the issue and that such will happen again, according to the financial media, there is simply no way to avoid it, so we must simply “ride it out.”

Why?

Because we are told we can’t do better?

You Can Manage Your Risk

For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times,  no matter how high stocks go or what’s going on in the economy. Investors are repeatedly warned that doing anything otherwise is simply foolish because “you can’t time the market.” As I noted yesterday, there is a reason for this:

“Wall Street firms, despite what the media advertising tells you, are businesses. As a business, their job is to develop and deliver products to investors in whatever form investor appetites demand…Wall Street is always happy to provide ‘products’ to the consumers they serve.

As Wall Street quickly figured out that it was far more lucrative to collect ongoing fees rather than a one-time trading commission…The mutual fund business was booming, and business was ‘brisk’ on Wall Street as profits surged.”

Here is the interesting question as I noted in “Spot What’s Missing.”

“Every day the media continues to push the narrative of passive investing, indexing and ‘buy and hold.’ Yet while these methods are good for Wall Street, as it keeps your money invested at all times for a fee, it is not necessarily good for your future investment outcomes.

You will notice that not one of the investing greats in history ever had ‘buy and hold’ as a rule.

So, the next time that someone tells you the ‘only way to invest’ is to buy and index and just hold on for the long-term, you just might want to ask yourself what would a ‘great investor’ actually do. More importantly, you should ask yourself, or the person telling you, ‘WHY?’”

The reason is simple, “getting back to even” is not an investment strategy.

Every great investor has one facet of their investment discipline in common – loss avoidance. Why? Because avoiding major drawdowns in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time compounding my invested dollars towards my long term goals.

The reason that the finance industry doesn’t tell you this is because it is NOT PROFITABLE for them. The finance industry makes money when you are invested – not when you are in cash.  Therefore, it is of no benefit to Wall Street to advise you to move to cash.

A Simple Method Of Risk Management

Now, let me be clear. I am discussing “market timing” which is specifically being “all in” or “all out” of the market at any given time. The problem with trying to time the market is consistency. Being all in, or out, of the market will eventually put you on the wrong side of the ‘trade’ which will lead to a host of other problems.

As I stated, there are no great investors of our time that “buy and hold” investments. Even the great Warren Buffett occasionally sells investments. (He just recently sold almost his entire stake in Walmart and IBM) True investors buy when they see value, and sell when value no longer exists.

While there are many sophisticated methods of handling risk within a portfolio, even using a basic method of price analysis, such as a moving average crossover, can be a valuable tool over the long term holding periods.

Will such a method ALWAYS be right? Absolutely not.

Will such a method keep you from losing large amounts of capital? Absolutely.

The chart below shows a simple moving average crossover study. The actual moving averages used are not important, but what is clear is that using a basic form of price movement analysis can provide a useful identification of periods when portfolio risk should be REDUCED. Importantly, I did not say risk should be eliminated; just reduced.

Again, I am not implying, suggesting or stating that such signals mean going 100% to cash. What I am suggesting is that when “sell signals” are given that is the time when individuals should perform some basic portfolio risk management such as:

• Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run


• Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short


• Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

By using some measures, fundamental or technical, to reduce portfolio risk by taking profits as prices/valuations rise, or vice versa, the long-term results of avoiding periods of severe capital loss will outweigh missed short term gains. Small adjustments can have a significant impact over the long run.

This is shown in the chart below. There is always a big difference between market prices and the impact of losses on an actual dollar-based portfolio. Buy using a simple method to avoid losses, the differential over the long-term on $1000 is quite significant. (Chart below is capitalization only for example purposes.)

As shown in the chart above, this method doesn’t avoid every little twist and turn of the market. But what it does do is help avoid a bulk of the major market reversions. While it may not be possible to “time” the market, it is possible to reach intelligent conclusions about whether the market offers good value for investors on a risk/reward basis.

Yet, despite two major bear market declines, it never ceases to amaze me that investors still believe that somehow they can invest in a portfolio that will capture all of the upside of the market but will protect them from the losses. Despite being a totally unrealistic objective this “fantasy” leads to excessive risk taking in portfolios which ultimately leads to catastrophic losses. Aligning expectations with reality is the key to building a successful portfolio. Implementing a strong investment discipline, and applying risk management, is what leads to the achievement of those expectations.

Conclusion

There are many half-truths perpetrated on individuals by Wall Street to sell product, gain assets, etc. However, if individuals took a moment to think about it, the illogic of many of these arguments are readily apparent.

Chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk that you realize. Two massive bear markets over the last decade have left many individuals further away from retirement than they ever imagined. Furthermore, all investors lost something far more valuable than money – TIME needed to achieve their goal.

To win the long-term investing game, your portfolio should be built around the things that matter most to you.

• Capital preservation


• A rate of return sufficient to keep pace with the rate of inflation.


• Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4% every year, losses matter)


• Higher rates of return require an exponential increase in the underlying risk profile. This tends to not work out well.


• You can replace lost capital – but you can’t replace lost time. Time is a precious commodity that you cannot afford to waste.


• Portfolios are time-frame specific. If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

The index is a mythical creature, like the Unicorn, and chasing it has historically led to disappointment. Investing is not a competition, and there are horrid consequences for treating it as such.

In hindsight, it is easy to see that investors should have been out of the market in 2001 and 2008. However, remember just prior to those two major market peaks the Wall Street mantra was the same then, as it is today:

“This time is different.”

Financialization & The Erosion Of Growth

Authored by Ben Masters via RealInvestmentAdvice.com,

One of the common side effects of debt-fueled speculation/spending is financialization, and one should immediately look to the growth and prominence of the financial industry (since the 1980s) with alarm, hesitation and concern; how and why is it that an industry that produces no physical product has grown to its current size?  After all, the financial industry exists as a non-production-utility — its very purpose is to properly allocate capital and resources to desirable (in-demand) industries; it’s an industry whose very existence relies on the success of other industries. If the financial industry is able to properly allocate capital/resources to desirable industries, it’s rewarded and is able to grow along with those other fundamental industries; and if a misallocation occurs, capital/resources are allocated to (and used up by) unsuccessful industries — those industries then shrink, along with the finance industry and economic growth.

The concern then is that if a general “hollowing out” of production occurs in a country — something that is rarely disputed these days when addressing U.S. industry — this would typically result in a smaller financial industry, not a larger one; yet the explosion of growth in the finance industry since the 1980s has been in stark contrast.  Why is this?  Put simply, debt-fueled investment speculation and debt-based spending has exploded since the 1980s.

Debt-fueled investment speculation can be seen in this visual of the three instances of the 21st century where long-term returns for stocks have been reduced — each peak fueled by different forms of speculation that ensure low future returns:

Tradable securities far outpacing economic growth…

The three speculative episodes of the 21st century, and dangerous transition periods…

Each of these speculative episodes have been addressed in The Orchestration of Debt-Based Expansions; and the topic of debt-based spending (pursued since the 1980s) has been written about as well, and includes government debt and consumer debt (mortgages, credit cards, student loans, car loans, borrowing to supplement falling incomes, etc.): see Debt Levels, Why does college cost so much?, Why doesn’t anyone earn anything in a bank account anymore?, and Income Stagnation.

The dilemma is that debt temporarily inflates the price of desirable assets (until the point in time where that debt needs to be paid back), and if a majority of the economy has debt that needs to be paid back economic growth is constrained — at some point in time those individuals are paying back loans instead of boosting economic growth through spending.  And if the majority of the economy has unproductive debt (debt that has not created an income stream to repay the principal amount borrowed and interest on the debt) then defaults, write-downs, etc. have a punishing affect on the economy and financial system.

For many, that punishing affect is a destruction of investments (which are not the same as wealth… see Fundamental Wealth).  Their “assets” evaporate, prices plunge, and they don’t know why…  The reason that assets vanish in a market crisis is because debt is always considered an asset by the issuer, yet in reality debt isn’t always an asset for the issuer; there are improper claims of assets — assets that don’t exist (loans that won’t be able to be paid back).  In effect, there are claims of assets (and securities issued on those “assets”) that outnumber the actual underlying assets.

It’s the financialization due to debt/leverage/speculation — the adding of layers and complexities — that can lead to a weakening of the market structure; one need only look to Charles Kindleberger’s work Manias, Panics, and Crashes to see how this process has unfolded over and over throughout history.

“Speculative manias gather speed through expansion of money and credit. . .there are many more economic expansions than there are manias.  But every mania has been associated with the expansion of credit.  In the last hundred or so years the expansion of credit has been almost exclusively through the banks and the financial system.

In boom, entropy in regulation and supervision builds up danger spots that burst into view when the boom levels off.” – Charles Kindleberger

And so financialization — the prominence of the finance industry and the growing dominance of obscure types of investments (many of which are simply more expensive packages of existing investments) — is made plain and clear: since the 1980s, it has grown due to temporary debt-based investment speculation and debt-based spending.  And although financialization is temporary (debt constraints eventually cause a readjustment), the real danger is that the temporary misallocation-of-wealth that occurs rewards the financial industry in a boom/bust cycle; wealth and capital that would have been used in other in-demand industries (had productive debt been pursued) is instead concentrated and used up in the financial industry, and when coupled with the ability to influence politics this temporary reward/misallocation can cause a further entrenchment of the undeservedly rewarded industry — a further misallocation of wealth.

Said in 2009 by Jeremy Grantham, co-founder and chief investment strategist of Grantham, Mayo, & Van Otterloo — one of the largest investment companies in the world…

“I’d like to challenge the usefulness — not just of new instruments — but of large tracts of the whole financial industry, much of which is a net drag.  Let’s start with the investment management business, because I think intuitively, obviously, you can see that we collectively add nothing.  We produce no “widgets”, we shuffle the existing value of all corporations and bonds around, in a cosmic poker game.  At the end of each year, the investment community is down by one percent (cough)…the individual is down by two, and aggregate fees have steadily grown.  As we grew by ten times from ’89 to ’99 huge economies of scale were existing, but the fees-per-dollar-managed grows — no fee competition at all, contrary to theory.  Why?  Agency problems, asymmetry of information, the client can’t tell talent from luck or risk taking, and as we add new products (options, futures, CDOs, hedge funds, private equity) aggregate fees rise as a percentage of assets; there becomes a layer of fees and another layer of agents and fees — the more complicated and opaque, the more the client need us. . .

As fees go up by half-a-percent, we reach into the client’s balance sheet, snatch the half-a-percent, and turn it into income; it’s almost magic — capital into income… but we lower the savings rate of our clients (savings and investment rate) by half-a-percent as our fees go up, so we get short term GDP kick from our income, at the expense of lower long-term growth on the part of the system.  Similarly with the whole financial system… let us say by 1965 (the best decade we ever had, the ’60s) there was a very financial financial-service arrangement — enough banking, enough letters of credit, to get the job done. 

Adequate tools are vital — that’s not the issue.  We’re talking the razzmatazz of the last ten or fifteen years…  The financial system was 3% of GDP in 1965 — it’s now 7 1/2; this is an extra 4% load that the real economy carries.  The financial system overfeeds and slows down the real economy.  The first hundred years, up to 1965, the economy was like a battleship, growing at 3.5% a year.  Even the great depression bounced off it.  After 1965 the GDP (ex-financials) grew at 3.2; after 1982, at 3.1; after 2000, at 2.3; all of these to the end of ’07 (not including the current problems).  From society’s point of view this 4% works like looting, or an earthquake — both increase GDP short term, but chew up capital.  They might as well be retirees or children — all these extra people in the financial business— but they are much, much more, expensive. 

Economists have not studied the optimal size for finance — indeed, a learned journal recently rejected a paper on the grounds that finance does not comment on social utility; that is perhaps why the risks are little. 

The underlying problem recently has been touching faith in capitalism, this faith was based on 50 years of a dominant economic theory that was shockingly not based on facts but on unestablished, unprovable, assumptions: “rational expectations” — this has given us efficient markets. So why regulate new instruments, if capitalism and markets are efficient?  Or why regulate anything?  So Greenspan, Rubens, Summers, and the SEC, happily beat back Brooksley Borne trying to regulate new instruments. But as Keynes knew in 1934, markets are behavioral jungles, racked by changing animal spirits, and by agency problems.  Efficient markets assume symmetry of data on all sides.  In real life, agents have all the data and the principal clients know little. It’s like taking candy from babies, the more opaque and complicated the new instruments, the easier the ripoff.  There is now — at LSE [London School of Economics] — a Centre for the Study of Capital Market Dysfunctionality, started by my former colleague, Paul Woolley, that is even now, attempting an academese, to establish that in the real world condition, agents in finance tend towards getting everything.”

- Jeremy Grantham, 5:33 mark of 2009 Buttonwood Gathering

Mnuchin Dashes Banker Hopes That Prop Trading Is Coming Back

What a difference a week makes.

On January 23, Reuters reported that dialing back the Volcker Rule which limits banks" ability to engage in speculative investments using their own balance sheet, has emerged a top priority for President Donald Trump"s nominee for U.S. Treasury secretary, Steve Mnuchin.  In written responses to questions posed by members of the U.S. Senate Finance Committee, Mnuchin said he would use his role as head of the interagency Financial Stability Oversight Council to give the Volcker Rule a stricter definition of proprietary trading.

At issue is the Volcker Rule, a contentious provision in the 2010 Dodd-Frank Act that sought to prevent lenders from putting federally-insured deposits at risk through wagers on stocks, bonds and other assets.

"As Chair of FSOC I would plan to address the issue of the definition of the Volcker Rule to make sure that banks can provide the necessary liquidity for customer markets and address the issues in the Fed report," Mnuchin wrote in the document, which also included senators" questions and was verified by a Senate aide.

According to Reuters, Mnuchin also said that "regulators have applied proprietary trading prohibitions to too many activities" adding that "In the responses Mnuchin also made it clear he believes the rule should only apply to "a bank that benefits from federal deposit insurance." The Federal Deposit Insurance Corporation guarantees retail deposits at about 6,000 banks, including the consumer banking arms of the country"s largest investment banks."

Just a few days later, in a follow up to Mnuchin"s written responses, this time from Bloomberg, the interpretation of his statement was 180 degrees opposite, and as Bloomberg reported, "Steven Mnuchin made clear he doesn’t want Wall Street banks getting back into the business of making risky market bets with their own capital, after Senate Democrats pushed him to clarify his responses to questions they asked during his confirmation process to be Treasury secretary."

Why the difference? Because in the span of just two days, Mnuchin appears to have flip-flopped on Volcker:

Mnuchin’s updated comments, which Bloomberg News obtained, were made after several Democrats on the Senate Finance Committee felt his earlier responses weren’t adequate, according to a Jan. 25 letter that Senator Ron Wyden of Oregon wrote to Utah’s Orrin Hatch, the panel’s Republican chairman.

It appears that the biggest variance between the two sets of responses had to do with the new Treasury Secretary"s outlook on prop trading. Mnuchin"s Bloomberg added that in his written remarks to lawmakers, "Mnuchin said that even banking units that lack a government backstop should be restricted from making speculative trades." 

“A legal distinction between the insured and non-insured entity is an important factor in eliminating risky activities within the institution that has” insured deposits, Mnuchin said in an amended response to a senator’s question about Volcker. “I do not believe that the uninsured entity should be able to perform proprietary trading."

If Bloomberg"s interpretation of Mnuchin"s statement is accurate, it could cause substantial headaches for bank investors, many of which have priced in substantial deregulation, among which the return of the Volcker rule, as banks were once again expected to have free reign in a Dodd-Frank free environment.

* * *

In addition to Volcker, Mnuchin also weighed in on the issue of how to reform America’s GSE in particular, and mortgage-finance system in general, a topic that has huge consequences for the multitrillion mortgage industry and the fate of shareholders who’ve invested billions of dollars in Fannie Mae and Freddie Mac.  In his response, Mnuchin wrote that “any solution will be dependent upon the GSEs being capitalized properly and other such controls that eliminate risk to taxpayers.”

The answer could cheer some advocates of preserving Fannie and Freddie, including investors, small lenders, and some affordable housing groups. Over the past few years, those groups tried to convince the Obama administration to allow the companies to rebuild capital to no avail. In the days after President Donald Trump’s surprise election win in November, his advisers pledged to dismantle Dodd-Frank and cut regulations broadly.

Mnuchin took a softer tone at his hearing before the Finance Committee. He said he mostly favors making changes to rules put in place in the wake of the 2008 financial crisis, not repealing the law entirely. In his amended responses to the Finance panel, Mnuchin said he’d like to use “empirical assessments” to monitor the effects Dodd-Frank has had on the finance industry. He also said that he’ll advocate that any rules needed to protect “public safety” shouldn’t be included in the regulatory freeze Trump has ordered across all federal agencies.

* * *

Assuming that Mnuchin"s harsher, second set of responses is accurate, it may also be one of the reasons for today"s bank stock selloff, as yet another significiant decoupling between the post-Obama reality and the Trump hope was gently squeezed, prompting traders just how much will really change under Trump who is increasingly getting bogged down in day to day scandals and minutiae - involving both republicans and democrats - that have little to do with his economic promises, something which infurated none other than Matt Drudge earlier today.

As Mystery Of China's Multi-Billionaire Default Deepens, A New "Bond Scare" Emerges

Last week, in a largely "under the radar" event, one of China"s wealthiest billionaires (if only on paper), Wu Ruilin, chairman of the Guangdong based telecom company Cosun Group, and whose personal fortune of 98.2 billion yuan ($14 billion) makes him wealthier than Baidu founder Robin Li who is ranked 8th on the Hurun Rich List 2016, shocked Chinese bond market watchers when he defaulted on a paltry 100 million yuan ($14 million) in bonds sold to retail investors through an Alibaba-backed online wealth management platform, citing "tight cash flow."

Needless to say, many were stunned that a billionaire for whom $14 million is pocket change, blamed "tight cash flow" for defaulting on mom and pop investors. In any case, as South China Morning Post reported, despite the founder"s personal fortune, according to a notice put up by the Guangdong Equity Exchange on Tuesday, two subsidiaries of Cosun Group are each defaulting on seven batches of privately raised bonds they issued in 2014. According to the notice, “the issuer had sent over a notice on December 15, claiming not to be able to make the payments on the bonds on time, due to short-term capital crunch."

To be sure, yet another default in a Chinese landscape suddenly littered with bankrupting debt dominoes would have been the end of it, however this morning Reuters added to the mystery when it said that the fate of the defaulted $45 million Chinese corporate bond sold through an Alibaba-backed online wealth management platform was thrown into doubt on Monday, after a bank said letters of guarantee for the bonds were counterfeit.

Quoted by Reuters, China Guangfa Bank Co Ltd (CGB) said guarantee documents, official seals and personal seals presented by the insurer of the bonds "are all fake" and that it has reported the matter to the police.

The dispute highlights challenges in China"s loosely regulated online finance industry, where retail investors often buy high-yielding bonds and other assets, expecting them to be "risk-free" due to guarantees provided by various parties.

As first reported last Wednesday, at the center of the latest dispute are up to 312 million yuan ($45 million) worth of high-yielding bonds issued by southern Chinese phone maker Cosun Group that defaulted this month. The bonds were sold through Zhao Cai Bao, an online platform run by Ant Financial Services Group, the payment affiliate of e-commerce firm Alibaba Group Holding Ltd.

Ant Financial has asked Zheshang Property and Casualty Insurance Co Ltd, which wrote insurance on the bonds, to repay investors. On Sunday, Zheshang Insurance published two documents on its website that it said were from CGB carrying the bank"s official seals, and that guaranteed Zheshang Insurance policies for the Consun bonds. The letters were issued at CGB"s Huizhou branch in December 2014, when the Cosun bonds were sold, Zheshang Insurance said.

And yet, suggesting there is a massive landmine hiding just below the surface of China"s bond market, far worse than merely the consequences rising interest rates, on Monday, CGB said the documents were fake and that it had reported the incident to police as "suspected financial fraud."

While material misrepresentation of facts in Chinese finance is hardly new, the recent alleged violations usher in a whole new breed of fraud, one which is far less nuanced and far more simpllistic and includes outright forgeries of documents that backstop tens if not hundreds of billions in debt. The Cosun dispute follows similar instances of financial fraud this year including forged bond agreements that led to brokerage Sealand Securities sharing potential losses of up to $2.4 billion. In May, the government advised banks to be vigilant after several cases of bill fraud.

Ant Financial on Tuesday said Zheshang Insurance "hasn"t any reason to refuse repayment" which it was obliged to do "within three days" of default.

Making matters worse, the fraud has taken place in the context of a bond default that, according to an Ant Financial spokeswoman cited by Reuters, was a "a one in billions incident" on the platform.

Incidentally, Cosun"s bond issuance totals 1 billion yuan, according to Zheshang Insurance. The insurer"s total registered capital is 1.5 billion yuan.

Should more such "one in billions incidents" emerge, Chinese bond investors - already freaked out by the recent record plunge in Chinese govt bond futures, soaring overnight funding rates, and fears over Fed rate hikes - will rush for the exits just as China"s housing bubble is also popping as reported yesterday, leading to a rerun of the US 2006/2007 dual bursting of the housing/credit bubbles, only this time instead of an $8 trillion financial system, the world will have to backstop China... whose banking system at last check had over $30 trillion in liabilities.

Incidentally, we wonder if now that China"s bond insurers are also under the spotlight, if that means China"s very own MBIA/Ambac moments is imminent, as billions in bond insurance contracts are deemed "fake" by the insurers who would rather not pay up on what is set to be an avalanche of defaults.

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Finally, for those interested in what Bloomberg last week dubbed the "latest China Finance Scare", namely outright forgeries in various debt products, mostly focusing on Entrusted Bonds, here is a useful primer courtesy of BBG:

There’s another Chinese financial practice that’s prompting high-decibel warnings. So-called entrusted bond holdings are a way for financial institutions to skirt rules on using borrowed money to invest in bonds. How? By getting a third party to buy the bonds and agreeing to purchase them at a later date. What could possibly go wrong? How about the worst rout in China’s bond market in a decade. That’s left regulators concerned about the prospect of investors failing to make good on such arrangements, estimated to involve at least $144 billion of bonds.

1. Why entrust us with this news only now?

Concerns about entrusted bond holdings have worsened the tumble in the debt market. Last week, Caixin cited market rumors when it reported a brokerage called Sealand Securities Co. had refused to take over bonds held by a counterparty. That got investors worried. Oversea-Chinese Banking Corp. then said in a note, citing media reports it didn’t identify, that the entrusted holding agreement may have been tied to alleged fraud by ex-staff. Sealand cleared the air when it said it would in fact fulfill the bond contracts that had been stamped with a forged seal. The whole incident was enough to frighten an already jittery market.

2. So why do investors use entrusted holding agreements?

Brokerages and other institutional investors ask counterparties to buy bonds from them when they need to circumvent internal rules on note holdings and leverage, according to Xu Hanfei, a bond analyst at Guotai Junan Securities Co. Or they can simply have third parties buy the notes directly from the market. The practice boosts leverage by effectively giving the financial institutions loans: As brokerages and institutional investors don’t carry the bonds on their books, they can use the funds freed up on paper to purchase more bonds, which can then be rolled into more such agreements. “Non-bank financial institutions, which emphasize returns, have more motivation to amplify leverage through entrusted holdings,” said Li Liuyang, a market analyst at Bank of Tokyo-Mitsubishi UFJ in Shanghai.

3. How widespread is the practice?

Outstanding entrusted holdings are "in the trillions of yuan," according to Guotai Junan’s Xu. That estimate is based on the bond holdings of the brokerages and smaller banks that are major participants in such transactions. That means the amount of money tied up in such deals is at least 5 percent of the 21 trillion yuan ($3 trillion) of outstanding corporate notes in China, according to data compiled by Bloomberg.

4. What broader risks does it pose to China’s financial markets?

A default in an entrusted holding could turn what otherwise might have been a problem with one company’s liquidity into a broader credit event, given that multiple parties may be involved, according to Li at Bank of Tokyo-Mitsubishi UFJ. Li says “everyone is worried about similar situations in their transactions with non-bank financial institutions.” OCBC said that things had got so bad that banks were reluctant to lend to non-bank institutions amid a breakdown in trust between investors.

5. What are regulators doing about it?

Authorities including the central bank and the China Securities Regulatory Commission are investigating some financial institutions’ entrusted bond holdings after the Sealand incident, people familiar with the matter said Tuesday. The holdings run contrary to the central bank’s push to trim investments made on borrowed money, according to China Merchants Bank Co. “It’s just a question of when Chinese regulators will clean up entrusted bond holdings,” said Liu Dongliang, a senior analyst at the bank. Tommy Xie, an economist in Singapore at OCBC, says China’s market rout may prompt regulators to strengthen rules on entrusted holdings. He describes them as "a common practice in the grey area of the bond market.”