Mish's Global Economic Trend Analysis

EU Threatens New Sanctions; Russia Responds with Threats on Natural Gas and Airspace Flight Restrictions
Japanese Economy Contracts Bigger than Expected 7.1% in 2nd Quarter; Really Bad Theories
Should Banks Lend Money At All?

EU Threatens New Sanctions; Russia Responds with Threats on Natural Gas and Airspace Flight Restrictions

Posted: 08 Sep 2014 12:28 PM PDT

The tit-for-tat sanction madness in Europe took a huge leap forward today with new sanctions in the work on Russian energy companies.

Russia responded by threatening to restrict commercial flights over its airspace, by threatening to halt reverse flows of natural gas to Ukraine, and with a threat to reduce gas delivery to Europe.

EU Plans New Sanctions

The Wall Street Journal reports New EU Sanctions to Stop Fundraising by 3 Russian Oil Giants

New European Union sanctions on Russia will expand the number of Russian companies unable to raise money in the bloc's capital markets to include three state-owned oil companies, according to documents seen by The Wall Street Journal.

The documents show the EU seeking to hit Russian oil companies, but leaving unscathed those involved in gas production and export, which are critical to many European countries' energy supplies.

Under a modest expansion of sanctions introduced in late July, the three oil companies — Gazpromneft, the oil-production and refining subsidiary of OAO Gazprom, oil transportation company Transneft, and oil giant Rosneft — will be forbidden from raising funds of longer than 30 days' maturity.

Three companies involved in military production — Oboronprom, United Aircraft Corp., and Uralvagonzavod — will be barred from future EU fundraising. The sanctions will also bar new contracts for services needed for oil exploration and production in deep water, the Arctic or shale-oil projects.

Unacceptable Behavior

EC president José Manuel Barroso commented on the Unacceptable Behavior of Russia.

"We are showing to the Russians this kind of behaviour is not acceptable," José Manuel Barroso, the European Commission president, said on the sidelines of the Nato summit in Wales. "We believe it's extremely important to have a firm position in terms of making clear to Russia it should respect international principles."

Russia immediately responded to the threat of more sanctions with its own views on what is unacceptable behavior.

Airspace Restrictions

In part one of Russia's two-part asymmetrical response to the EU, Russia Threatens Flight Ban.

Blaming the West for damaging the Russian economy by triggering "stupid" sanctions, Prime Minister Dmitry Medvedev said Moscow would press on with measures to reduce reliance on imports, starting with increasing output of domestic aircraft.

Medvedev suggested Russia should have hit back harder over the action by the United States and European Union to punish Moscow for its role in Ukraine, saying it had been too patient in the worst confrontation with the West since the Cold War.

"If there are sanctions related to the energy sector, or further restrictions on Russia's financial sector, we will have to respond asymmetrically," he told Russian daily Vedomosti, adding the airlines of "friendly countries" were allowed to fly over Russia.

"If Western carriers have to bypass our airspace, this could drive many struggling airlines into bankruptcy. This is not the way to go. We just hope our partners realise this at some point," he said in the interview published on Monday.

Russia Threatens to Reduce Gas Supply

For part two of Russia's response to the EU regarding unacceptable behavior, please consider Russia Aims to Choke Off Gas Re-Exports to Ukraine.

Moscow is seeking to prevent its European customers re-exporting Russian gas to Ukraine, threatening to choke off a crucial lifeline for Kiev and deepen the energy crunch it faces this winter.

The threats come as EU officials geared up to announce sanctions against three state-controlled Russian energy companies – Rosneft, Gazpromneft and Transneft – that will sharply limit their access to western financial markets.

In an effort to offset lost volumes from Russia, Ukraine has sought to secure more gas from the EU, principally through "reverse flows" – re-exports of Russian gas via countries such as Poland, Hungary and Slovakia.

But Gazprom, Russia's state gas company, has long complained about the re-exports, with Alexei Miller, its chief executive, denouncing them as a "semi-fraudulent mechanism".

Senior officials in the European Commission and in eastern European governments say Russia has been raising the prospect of reducing export volumes so their customers have no gas left over for reverse flows to Ukraine. "They say this pretty openly," said one central European ambassador.

Why EU and US economic-jackasses think sanctions will accomplish anything positive or change Russia's behavior one bit is at first glance a bit of a mystery.

However, economic-jackasses by definition are going to do stupid things, so we should expect more and more of the same failed tactics.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Japanese Economy Contracts Bigger than Expected 7.1% in 2nd Quarter; Really Bad Theories

Posted: 08 Sep 2014 10:45 AM PDT

By now it should be pretty clear that Abenomics is a complete failure. Abenomics did not spur lending, investment, hiring, or wage growth.

It's one touted "success" is that prices have gone up. And for cash-strapped consumers facing higher taxes, that alleged "success" is actually a disaster.

Japanese Economy Contracts Bigger Than Expected 7.1% in Second Quarter

Please consider Japan says economy contracted 7.1 percent in April-June on bigger drop in business investment.

Japan's economy contracted at a larger than earlier estimated annual rate of 7.1 percent in April-June, as companies and households slashed spending following a tax hike.

The revised data released Monday show business investment fell more than twice as much as estimated before, or 5.1 percent, while private residential spending sank 10.4 percent, in annual terms. The earlier estimate showed the economy contracting 6.8 percent.

The recovery of the world's third-largest economy has slowed following the increase in the sales tax to 8 percent from 5 percent on April 1.

Really Bad Theories

Here's a statement from the article regarding theories that caught my eye:

"Theoretically, there should be no impact from the consumption tax increase on corporate spending or long-term corporate planning, but a large number of Japanese corporations seemed to see a large impact from the hike on final demand," said Junko Nishioka, an economist at RBS Japan Securities in Tokyo.

Good grief. Nishioka has theories, but they are as sound as a home foundation in a swamp. Here's an easy to understand explanation.

Eight Point Explanation

Japan's sales tax increased from 5% to 8%.
Wages did not go up.
Consumers have 3% less money to spend.
Consumers with less money, spend less.
Businesses faced with a slowdown in consumer spending reduce future plans.
Abe plans to hike the sales tax again and businesses know that as well.
Business sentiment sours.
Japanese demographics are such that businesses already have substantial worries.

What is it about those eight points that economist Nishioka fails to understand?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Should Banks Lend Money At All?

Posted: 08 Sep 2014 01:45 AM PDT

Banks are in the business of making loans. Is that the right model?

Before answering, please consider the model of Lending Club.

Lending Club is an online financial community that brings together creditworthy borrowers and savvy investors so that both can benefit financially. We replace the high cost and complexity of traditional lending with a faster, smarter way to borrow and invest.

Here is the initial process straight from the Lending Club Website.

Steps

You decide you want to borrow money
You go to the Lending Club website
You enter the amount
You specify what it is for
You answer a question regarding your credit
Lending Club evaluates the information with no impact on your credit score, determines an interest rate and instantly presents a variety of offers to qualified borrowers
If accepted, you can prepay at any time with no penalty

Lending club claims borrowers substantially reduce their rates over those offered by banks.

Exploring Lending Club

Bloomberg columnist Mat Levine explores the issue in Lending Club Can Be a Better Bank Than the Banks.

There are a lot of ways in which [Lending Club] is not a bank, but the big one is that basically all (95.6 percent) of its liabilities are "notes and certificates," that is, just unsecured structured notes tied directly to specific underlying loans.

Banks, on the other hand, are funded mostly by deposits and repo and other short-term senior borrowing.

Lending Club's assets and liabilities are perfectly matched in duration: Those notes and certificates mature when the corresponding loans mature. A bank, on the other hand, is in the business of borrowing short to lend long.
Lending Club's assets and liabilities are perfectly matched in loss bearing: Every dollar that a borrower doesn't pay back to Lending Club is a dollar that Lending Club doesn't pay back to note holders. The note holders know going in that they bear the entire risk of loss on the underlying loans. A bank depositor expects to get her money back even if the bank makes some bad mortgage loans.

This takes, in round numbers, all of the risk out of Lending Club's balance sheet.

In any useful sense, Lending Club is a 100 percent equity-funded bank: Every dollar that it lends comes from long-term, loss-bearing investors.

100% Equity-Funded Bank

Lending Club is effectively a 100% equity-funded bank with 0% lending risk!

Ironically, Lending Club does not make loans. Instead, it facilitates matching borrowers with creditors and takes a fee for its efforts.

So, what's not to like?

Unfortunately Levine jumps off the deep end with his next set of statements.

First: You wouldn't want all banks to be like Lending Club. People like having checking accounts. Even beyond checking accounts, people like having liquid risk-free money-like claims. Banks exist to turn risky investments -- loans to people and businesses! -- into risk-free money-like claims, whether those are checking accounts or certificates of deposit or repo agreements....

For starters, the idea that banks can turn risky investments into risk-free claims is preposterous. Second, the idea that checking accounts would disappear is preposterous. Third, I certainly would prefer lending banks to be legitimately risk-free operations like lending Club.

Advantages

Lending club does not print money into existence
Lending club does not offer loans of mismatched duration
There is a zero percent chance of a run on the bank with lending club
Investors in Lending Club take a risk in return for the opportunity to earn interest
There is no legitimate need for FDIC
Lending Club itself takes no lending risk, instead investors willing to lend money take a risk

Lending Banks vs. Safekeeping Banks

For all intents and purposes, Lending Club is the ideal risk-free lending bank. Given that it does not lend money, no bank-associated financial crisis is possible in such a model,

Does that mean checking accounts cease to exist? Hardly, and Levine should know better.

All that's needed is a separation of duties (lending vs. safekeeping): Safekeeping banks don't make any loans or facilitate making loans, ever. All checking accounts (demand deposit accounts) would reside in safekeeping banks.

In return for safekeeping, banks charge fees (just as they do now - ATM fees, transaction fees, checking account fees, etc.) There is no need for FDIC as no money is lent.

In this separation of duty model, lending banks would facilitate lending exactly as does Lending Club. Want to earn interest? OK you pick a loan you like, for a duration you like, and you invest in it.

Such loans would be term-duration loans, not FDIC guaranteed (and that is an added bonus, not a drawback). Those lending money for interest should logically assume some risk.

We might see some changes such as the end of cheap 30-year mortgages. Some might see that as a drawback, but that too is an advantage. Cheap, easy loans contributed to the housing bubble and a near financial collapse. If 10- or 15-year loans became the standard, so much the better. Houses should primarily be a place to live, not a speculative plaything.

Printing money into existence is at the forefront of every financial crisis, and it also helps explain the growing income inequality problem.

I am not against loans. Rather I am against borrowing money into existence, FDIC, duration mismatches, etc.

I suggest it's time to change the model to a 100% reserve system that eliminates duration mismatches, does not allow printing of money into existence, and also stops runs on banks without FDIC.

A distinct separation between lending banks and safekeeping banks appears to be a great starting point for discussion, not that peer lending itself is the perfect solution.

Note: I revised the last statement to make it clear that I am after a 100% reserve system model, not a peer lending model per se.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mish's Global Economic Trend Analysis

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