Monday, October 27, 2014

Why So Much Official Planning for Another Crisis?

We have already noted the numerous warnings issued recently by both the IMF and the BIS (Bank of International Settlements. A review of the links on the right hand side of this blog will lead you to several of these warnings in the past 2-3 months. Here are a couple of recent examples. First, this one from the IMF and then this one from the BIS.


We have also seen a lot of official planning and stress testing in regards to how the system can handle another major financial crisis. In this post we will look at two articles related to that. Below we will paste some quotes from each article and then add some comments further below that.

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(note: because the Finacial Times requires you to register to read their article directly (its free), we have linked to a reprint version. Here is a direct link to the FT article). We encourage readers to read the entire article on Financial Times if possible.

Here are a few quotes:


"The world's biggest banks have agreed to tear up the rulebook on derivatives to make it easier to resolve a future failing institution like Lehman Brothers."
"People familiar with the matter said 18 bank "dealers," ranging from Credit Suisse to Goldman Sachs, have agreed to give up the right to pull the plug on derivatives contracts with a crisis-stricken institution."
"Several months of complex talks involved regulators and asset managers but were led by dealers under the umbrella of the International Swaps and Derivatives Association (ISDA)."
"US regulators, who have previously condemned the industry's crisis planning as inadequate, had demanded banks come up with a plan to stop their counterparties terminating derivatives contracts in the event of a crisis. The banks portrayed the success of the talks as a rare positive example of industry collaboration."
"ISDA is due to announce the agreement to change its "protocols," which govern the $700 trillion market, in the next few days. They will take effect from January 1, 2015."
"The current thinking among regulators is that the core of a failing institution should be preserved. Although shareholders would be likely to be wiped out, the operating company would be recapitalised or sold to mitigate the shock to the broader financial system."
"You have the financial sector absorb the losses but you have the company stay in business," said another industry negotiator. "Assuming it gets signed up, it's a very important step in ending 'too big to fail.'"
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Next we have this Bloomberg Article - Would Your Bonds Survive a Trading Freeze?
Here are a few quotes from this article (we encourage readers to read the whole article)
"Surging market volatility is making regulators increasingly concerned that bond funds have loaded up on hard-to-sell assets."
"The U.S. Securities and Exchange Commission has stepped up exams of money managers, while pushing mutual funds to test whether they could satisfy customer redemptions during periods of financial stress, said people with knowledge of the plans. Federal Reserve officials have reached out to the biggest investment firms to quiz them on markets after price swings for stocks, currencies and commodities hit a 13-month high last week, said a person briefed on the discussions."
"Concern is mounting that as the U.S. central bank exits from almost six years of easy-money policies, debt that’s benefited most from the stimulus will lose value and investors as yields rise."
"A big concern is that some firms are investing in infrequently-traded leveraged loans and high-yield corporate bonds, while adhering to a mutual-fund requirement that clients be able to pull their cash daily."
"IMF analysts have called on regulators to bridge the gap between mutual-fund shares that trade daily and underlying assets that may take weeks to sell. An option that should be considered is making it harder for investors to flee certain funds all at once, the analysts wrote in a report this month."
"The idea is radical, because federal rules are based on the premise that retail investors shouldn’t find themselves trapped in funds they can’t pull money from. At the same time, the popularity of mutual funds has been fueled, in part, by the ease at which clients can take cash out."
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My added comments: The warnings and crisis planning just keeps on coming. A fair question to ask at this point is: Why so many warnings and so much crisis planning?
The answer to that question is very clear if you just read the articles we have linked here. Without any doubt, officials are concerned about how the markets are going to react with the US Fed ending its QE program and talk continuing that interest rates may start rising in 2015. Almost every warning article we have linked here has noted the official concern about that.
We have noted here that since the last financial crisis in 2008, the economy and the markets have not shown any credible evidence they can stand on their own feet without all the continued monetary stimulus from Central Banks with the US Fed being the leader of course.
It is very clear that the whole world is watching and waiting to see how this experiment is going to turn out if they seriously curtail the monetary stimulus. Officials are so concerned they are flooding us with warnings and working overtime doing stress testing and crisis planning. 
This is one of those good news/bad news situations. On the one hand it is good that they are concerned and are warning the public and doing what they can to stress test the system. On the other hand, it shows they really do not know what is going to happen and they want to be covered if things go south. It continues to look more and more like 2015 is going to be a critical year for finding out if things go south or not.
Given all this official concern and uncertainty, what are we to do in this kind of environment? The premise on this blog is that it is vital for people to stay alert and informed first of all. This blog is devoted to trying to help with that. It is also important for people to think about various potential future outcomes (scenarios) and have some kind of plan in mind in case things do go south. Monetary officials have warned us of the potential so there is no real excuse to just ignore everything and pretend there is nothing to prepare for.
How can we prepare? Staying informed is the first priority. After that, we recommend following the suggestions Jim Rickards makes in his books and interviews. Dedicate some reasonable portion of your savings to hard assets as a form of insurance. If you never need this insurance that will be great (it will still have value). If you ever DO need this insurance, you will be very thankful you have it. Trying to cope with another major financial crisis with no insurance at all is the most foolish course of action possible in our view here.

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