Bigger Isn’t Better

What caused the overnight lending market to unexpectedly seize up in September? There’s a good reason to believe JPMorgan Chase (JPMC) may have been at the heart of it.

JPMorgan Chase is the largest bank in the U. S., and has about $1.49 trillion in deposits. It’s one of the big banks that provide much of the loans in the overnight money markets.

But it seems the mega-bank had gone on a stock buyback spree from January through September of this year.

Buybacks, which are designed to boost stock prices, have been enabled for years by the Fed’s artificially low-interest rates. Corporations, in fact, have been the largest purchasers of stocks, which is heavily responsible for the bull market that’s now over a decade old.

According to the SEC, JPMC has spent about $77 billion on buybacks since 2013. But the money JPMorgan Chase used for buybacks on its most recent buyback binge was, therefore, unavailable to be loaned out in the repo market.

This information is from the bank’s annual SEC filing (hat tip to the Wall Street on Parade blog):

In 2019, cash provided resulted from higher deposits and securities loaned or sold under repurchase agreements, partially offset by net payments on long-term borrowing… cash was used for repurchases of common stock and cash dividends on common and preferred stock.

That diversion of money likely contributed to the liquidity crunch, which forced the Fed had to intervene in order to make up the difference.

Here’s how Wall Street on Parade sums it up:

Had JPMorgan Chase not spent $77 billion propping up its share price with stock buybacks, it would have $77 billion more in cash to loan to businesses and consumers — the actual job of its commercial bank. Add in the tens of billions of dollars that other mega banks on Wall Street have used to buy back their own stock and it’s clear why there is a liquidity crisis on Wall Street that is forcing the Federal Reserve to hurl hundreds of billions of dollars a week at the problem.

But altogether, JPMorgan has actually withdrawn $158 billion of its liquid reserves from the Fed in the first half of this year. That’s an extraordinarily large amount of money to withdraw in such a short amount of time, as my friends at Wall Street on Parade point out. That’s bound to have an effect on the market.

And that’s what we’ve seen.

Of course, JPM is one of those Wall Street banks that are “too big to fail.” It’s the largest commercial bank in the nation, with $1.6 trillion in deposits.

But it’s not just JPM.

It’s just one part of a system rigged in favor of Wall Street that has been deemed too big to fail. It’s a corrupt and incestuous system filled with perverse incentives and conflicts of interest. Here’s an example…

82% of bank analysts on Wall Street recently gave Citigroup stock a “buy” rating. What you didn’t hear reported on CNBC or Fox Business News is that the major banks they work for — like JPM, Goldman Sachs, Morgan Stanley, Deutsche Bank, UBS and Bank of America — have strong incentive to recommend Citigroup.

That’s because all the major banks are interconnected through derivatives. And weakness in one bank could spill over into the others. So it’s not a level playing field at all. It’s tilted in favor of the big banks.

But as one observer asks, “Why should any Wall Street bank be allowed to make research recommendations on stocks and then trade in those very same stocks?”

It’s a corrupt system designed by insiders for insiders. I should know because I used to be one of them.

I worked at four of the world’s major banks for a decade and a half until I finally had enough and walked away. Two of the four banks I worked for, Bear Stearns and Lehman Bros., were destined to implode.

That’s because they overleveraged themselves, taking on too much debt to bet on risky credit instruments. These credit instruments included subprime loans, credit derivatives and Wall Street’s version of a debt buffet called CDOs, or collateralized debt obligations.

It’s now been over a decade since the world’s major central banks reacted to the financial crisis with record-low interest rates and quantitative easing.

Today the big banks are bigger than ever and the amount of debt in the system is larger than ever. There’s been no substantial reform since the financial crisis, just some cosmetic moves that have been passed off as major reform. The big banks are always ahead of the regulators.

My research for my bookCollusion: How Central Bankers Rigged the World revealed how central bankers and massive financial institutions have worked together to manipulate global markets for the past decade.

Major central banks gave themselves a blank check with which to resurrect problematic banks; purchase government, mortgage and corporate bonds; and in some cases — as in Japan and Switzerland — buy stocks, too.

They have not had to explain to the public where those funds are going or why. Instead, their policies have inflated asset bubbles while coddling private banks and corporations under the guise of helping the real economy.

The zero-interest rate and bond-buying central bank policies that prevailed in the U.S., Europe and Japan were part of a coordinated effort that has plastered over potential financial instability in the largest countries and in private banks.

It has, in turn, created asset bubbles that could explode into an even greater crisis the next time around.

The world’s debt pile sits near a record $246.5 trillion. That’s three times the size of global GDP. It means that for every dollar of growth, the world is borrowing three dollars.

Of course, this huge debt pile has done very little to support the real economy. Even the IMF now admits that global central bank policies to lower interest rates in order to stave off immediate economic risks have made the situation worse.

Their actions have led to “worrisome” levels of poor credit-quality debt as well as increased financial instability.

The IMF noted that 40% of all corporate debt in major economies could be “at risk” in the event of another global economic downturn, with debt levels greater than those of the 2008–09 financial crisis.

That huge pile of debt is basically the kindling for the next financial fire. We’re just waiting for the match to light it.

So today we stand near — how near we don’t yet know — the edge of a dangerous financial conflagration. The risks posed by the largest institutions still exist, only now they’re even bigger than they were in 2007–08 because of the extra debt.

It’s not sustainable. But that doesn’t mean the central banks won’t try to keep it going with monetary easing policies in place.

It could work for a while, until it doesn’t.

Regards,

Nomi Prins
for The Daily Reckoning