Another way of looking at a bank run is as a focused mania for cash. This is why the April issue of The Elliott Wave Financial Forecast reiterated this March 2000 forecast: “The luster of cash will burn brighter than ever.” “Cash will not be used to buy more stocks; stocks will be used to buy more cash,” EWFF added. In recent years, banks have been taking in cash and converting it into increasingly complex financial derivatives and exotic loans that rely on an expanding economy and confidence. Countrywide is the just the first of many that will face a withering demand for hard currency as the economy and the confidence that it's built on recede.
As EWFF has noted, earlier this year every bear market is a bull market in cash. The almost feverish demand for cash, is one of many signs that the bear market is underway. From August 8 to yesterday, one proxy for cash demand, the yield on 3-month U.S. Treasuries, tumbled 23%, from 4.95% to 3.79%. In the most intense cash bull markets, banks suffer when they cannot readily meet the panicy demands of depositors. The mini-debacle in Countrywide is a taste of the “risks in banking” that are described in Chapter 19 of Conquer the Crash, “How To Find a Safe Bank.” For those who read it initially and figured they would get back to this section when the time comes, the time has come. Here’s an applicable excerpt:
As most of us know, banks and mortgage companies lend money to consumers via credit cards, auto loans and mortgages. You may not know that they then package and re-sell those loans as investments to portfolio managers, insurance companies, pension funds and even trust departments at other banks. The issuing banks keep most of the interest paid by the consumers in exchange for guaranteeing a small interest payment (today less than 2.5 percent) on the package. These investments are called “securitized loans,” and banks and mortgage companies have issued $6 trillion worth of them. This high sum implies that if you have a managed trust, invest in a debt fund or have insurance or a pension, you are almost surely dependent upon some of these deals.
When banks sell the packages, they get back as much money as they lent out in the first place, so guess what. They can go right out and roll the same percentage of their deposits out again and again as new consumer loans. Investors in the packages are, in a sense, new depositors.
If the issuing banks get in trouble some day and can’t pay, the owners of the debt packages will then have dibs on the interest payments from the consumers. If those payments dry up, they have that great collateral to fall back on: vacant homes, used cars and truckloads of worn VCRs and other household junk. If a depression is on, what will that collateral be worth?
If such deals don’t sound that solid to you, then why are so many institutions making these investments? Because they’re buying them with OPM: Other People’s Money…your money. And besides, it’s “guaranteed” and backed by “collateral”!
This scheme, like so many others in existence today, works only as long as the debtors and the economy can keep up the pace of interest payments, some of which are as high as 17 percent. In a major economic downturn, this credit structure will implode. banks that have followed this course will be stressed, and so will their customers.
Many banks today also have a shockingly large exposure to leveraged derivatives such as futures, options and even more exotic instruments. The underlying value of assets represented by such financial derivatives at quite a few big banks is greater than the total value of all their deposits. The estimated representative value of all derivatives in the world today is $90 trillion, over half of which is held by U.S. banks. Many banks use derivatives to hedge against investment exposure, but that strategy works only if the speculator on the other side of the trade can pay off if he’s wrong.
Relying upon, or worse, speculating in, leveraged derivatives poses one of the greatest risks to banks that have succumbed to the lure. Leverage almost always causes massive losses eventually because of the psychological stress that owning them induces. You have already read of the billion-dollar debacles at Barings Bank, Long-Term [sic] Capital Management, Enron and other institutions that speculated in leveraged derivatives. It is traditional to discount the representative value of derivatives because traders will presumably get out of losing positions well before they wreak destruction. Well, maybe. It is at least as common a human reaction for speculators to double their bets when the market goes against a big position. At least, that’s what bankers might do with your money.
Today’s bank analysts assure us, as a headline from The Atlanta Journal-Constitution put it on December 29, 2001, that “banks [Are] Well-Capitalized.” banks today are indeed generally considered well capitalized compared to their situation in the 1980s. Unfortunately, that condition is mostly thanks to the Great Asset Mania of the 1990s. Much of the record amount of credit that banks have extended, such as that lent for productive enterprise or directly to strong governments, is relatively safe. Risky at this juncture are loans to weak governments, real estate developers, government-sponsored enterprises, stock market speculators, venture capitalists and consumers (via credit cards and consumer-debt “investment” packages). One expert advises, “The larger, more diversified banks at this point are the safer place to be.” That assertion will surely be severely tested in the coming depression.
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