FED regulators in hot seat

The timing of JPMorgan's $2 billion-plus trading loss made public last week by Jamie Dimon over an emergency call with analysts was an awkward timing for the Fed. It raised serious questions about whether the New York Federal Reserve and other regulators were asleep at the wheel or whether it is asking too much of them to keep up with the financial engineering conducted by complex institutions with diverse, global operations. Despite the Fed ramping up the number of staff embedded at JPMorgan Chase & Co since the financial crisis, it is unclear whether any of these regulators detected something high-risk and untoward going on in JPMorgan's Chief Investment Office in New York or in London. This will raise issues again on the appropriateness of using Value at Risk (VaR) models by banks given its inherent limitations as a way of measuring risk. VaR represents the potential losses in a trading portfolio over a given period of time at a given level of market confidence. That covers almost all eventualities. The trouble is that problems almost always arise in the ones that are not covered… Eric Tan, London

UK banks : international in life but national in death?

The discussions in Brussels by European Union finance ministers this week follow an agreement among major economies, known as Basel III, to raise the requirement for the minimum amount of highest-quality capital held by banks so they can absorb sudden losses, like those associated with the collapse of Lehman Brothers in September 2008. Britain is amongst the countries likely to press for the right to require its banks to hold more capital than the E.U. minimum to try to reduce the risk that its taxpayers will be called on to finance future bailouts. But other countries argue that allowing governments the latitude to raise capital requirements could undermine parts of the European banking sector and might push banks to tighten their belts when they are already wary of lending because of the shaky economy. That, in turn, could further dent sluggish growth prospects in Europe. Given Spanish banking sector’s heavy exposure to real estate and risks further state bailout or nationalisation, and concern that capital for shoring up bank reserves across Europe is limited, the EU has to decide if to agree on the single rule or not... Eric Tan, London

US Housing Market - Are the early signs of recovery emerging?

Early indicators are hinting that the battered US housing market is showing signs of recovery. The NAHB index continues to rise and is close to a 5-year high.

We feel that the US housing market cheap on the below measures:
1) low house price-to-wage ratio,
2) low house price-to-rent ratios,
3) attractive rental yield versus mortgage rate and
4) low house prices versus their 100-year trend
5) further central bank policy on QE and Fed buying of mortgage backed securities

Further evidenced last week is the sharp jump in US 10 year bond yields by 33 basis points to 2.30% which signals that investors are now less fearful and is prepared to take on risk and switch from lower risk assets to higher risk. This is a positive signal for home owners.

This week's the latest report on US housing starts and sales figures for new and existing homes may just provide the confirmation to the recent trends.

Eric Tan,
London

So, what next?

This week, Bank of England has decided that the economy needs another round of QE and agreed to inject a further £50bn of monetary easing via Gilts purchasing.

On surface, it looks logical that more money in the financial systems, leads to more money in circulation but economists have argued about the effectiveness of the QE1 and QE2 since central banks in developed economies went full throttle into it 3 years ago as a means to fix the financial systems.

However, one thing for sure, by driving up the price of gilts, the Treasury is depressing the yield of these bonds and the income received by pension funds and annuity payouts. Pension funds and insurance companies who are already heavily under-weight equities, will have more reason to buy into the current equity rally when they next meet in their monthly asset allocation committees in February.

Note these committees didn't meet in Dec and when back in Jan, the market was already 7-10% ahead, so a pull-back in the equity markets would probably see the long funds and insurers scrambling back in...

Eric Tan
London

Two-speed Europe

After this weekend's EU summit, we are further away from a EU single market than ever and Britain looks to be on its own. This brings back to mind how Henry VIII separated England from Rome in 1534.

Theological history aside, what Cameron has disagreed with the other EU states means that Britain will be outside a new intergovernmental treaty that has the backing of EU's other 26 states.

Below is a summary of the treaty details:
- The EU commits to a new “fiscal rule” that will be legally enforceable and will seek limits on structural deficits
- States running large deficits will face automatic consequences including sanctions
- The EFSF leveraging will be deployed more quickly, using the ECB as an agent in transactions
- EFSF financing will remain active until mid-2013
- The ESM will enter into force with a target date of July 2012
- The overall ceiling of the EFSF/ESM remains at €500bn, but will be reviewed in Mar 2012
- The EU will ensure that ESM paid in capital is at least 15% of ESM issuances
- Member States have 10 days to confirm provision of additional €200bn in bilateral loans to the IMF
- The EU “look forward” to parallel bilateral loan contributions from the “international community”

Looks like the Prime Minister will win some plaudits from his backbenchers tomorrow, but in the long term, Britain's influence in Europe has started diminishing...

Eric Tan,
London

23 October 2011

The Market is fixated with 23 October. People think that the European leaders are going to come up with a bazooka solution to the European crisis...
The Guardian this morning announced the prospects of a 2trillion euros EFSF bailout fund which no doubt will spur the market to continue it's wishful thinking, but why would investors want to plough their money in when European banks are trying to reduce their assets to raise capital. Think 1 trillion euros...or more... What they will end up selling will be the liquid assets and end up being stuck with a bigger proportion of the same assets that got them into trouble in the first place...

At what rate could you borrow? A question of LIBOR.

At the moment the spread between the high and the low fixing banks still stand at around 11bps. This shows how banks continue to just pay lip service to the definition if LIBOR. Result is that the rate remains lower than it ought to be expected if banks use this as a PR exercise to artificially manage expectations instead to reflecting their true cost of borrowing in this market condition. If you believe the numbers published, we should all go long the French banks...

Eric Tan,
London