Mish's Global Economic Trend Analysis

Pigs at the Trough: Rating Agencies as Corrupt as Ever
Investigating Claims "North Atlantic Trade Ground to a Halt, No Ships Moving"; The Real Shipping Story
China Declares War on Currency Speculators; Interbank Yuan Rates Spike to Record High 13.4%
Europe Fears Bail-Ins: Capital Flight Intensifies in Italy, France, Spain; Are German Banks Safe?

Pigs at the Trough: Rating Agencies as Corrupt as Ever

Posted: 11 Jan 2016 06:11 PM PST

Pigs at the Trough

The big rating agencies are as corrupt as ever. But don't blame them. That would be like blaming pigs for feeding at the trough.

Please consider the New York Times article Ratings Agencies Still Coming Up Short, Years After Crisis by Gretchen Morgenson.

The mistakes that led to the 2008 mortgage crisis can't happen again, right?

Not so fast, particularly if you're talking about credit ratings agencies like Moody's Investors Service and Standard & Poor's. Eight years after these companies were found to have put profits ahead of principle when they assigned high grades to low-quality debt securities, some of the same dubious practices continue to infect their operations. That's the message in the most recent regulatory report on the companies from the Securities and Exchange Commission.

The credit ratings agencies played an enormous role in generating billions of dollars in losses during the debacle. Internal emails that emerged in congressional investigations were especially revealing of the problems at these companies. "We rate every deal," one Standard & Poor's employee famously wrote. "It could be structured by cows and we would rate it."

There's an entertaining — and illuminating — scene in the movie "The Big Short" that perfectly captures the pathology. As a Standard & Poor's employee played by Melissa Leo replies when asked why the ratings agency didn't insist on higher standards: "They'll just go to Moody's."

Pigs Will Be Pigs

Morgenson explains the new SEC findings in detail.

However, Morgenson failed to mention it was the SEC who created the pigs when it mandated all debt must be rated by a recognized rating agency.

I have written about this problem on many occasions, including a post in 2007 before the financial crisis hit.

Time To Break Up The Credit Rating Cartel

Please consider a few excerpts from my post Time To Break Up The Credit Rating Cartel, written September 28, 2007.

The rating agencies were originally research firms. They were paid by those looking to buy bonds or make loans to a company. If a rating company did poorly it lost business. If it did poorly too often it went out of business.

Low and behold the SEC came along in 1975 and ruined a perfectly viable business construct by mandating that debt be rated by a Nationally Recognized Statistical Rating Organization (NRSRO). It originally named seven such rating companies but the number fluctuated between 5 and 7 over the years.

Establishment of the NRSRO did three things (all bad):

1) It made it extremely difficult to become "nationally recognized" as a rating agency when all debt had to be rated by someone who was already nationally recognized.
2) In effect it created a nice monopoly for those in the designated group.
3) It turned upside down the model of who had to pay. Previously debt buyers would go to the ratings companies to know what they were buying. The new model was issuers of debt had to pay to get it rated or they couldn't sell it. Of course this led to shopping around to see who would give the debt the highest rating.

The Solution is Amazingly Easy

Government sponsorship of organizations and intervention into free markets always creates these kinds of problems. The cure is not an executive shuffle, third party verification or half-measures and more regulation that mask over the issues by splitting functions within an organization. The SEC created this problem by creating the NRSRO. The problem is easily fixable. It's time to break up the cartel by eliminating the rules that created it. Moody's, Fitch, and the S&P should have to sink or swim by the accuracy of their ratings just like everyone else. Ratings would be a lot better if corporations had to live or die by them. Free market competition, not additional regulation is the cure.

Current Model Less Than Useless

Any rating agency that gets paid on volume rather than accuracy is less than useless.

Those who want a true rating on an issue go to someone like Egan Jones. They do have to pay for the analysis.

Chicago Pigs

I discussed rating agency fraud as pertains to Chicago on May 20, 2015 in
CNBC's Santelli and Mish Discuss Municipal Bonds; Egan-Jones on Chicago; S&P Blames Moody's; Message to Bondholders.

On Monday, I gave Sean Egan of the rating agency Egan-Jones a ring. I asked him how he would rate Chicago General Obligation bonds. Egan replied "deep in junk territory".

Here is a table I put together that shows how various agencies rate Chicago debt.

Rating Agency Date Rating Level Outlook
S&P 5/14/2015 A- 3 Levels Above Junk Negative
Kroll 5/11/2015 A- 3 Levels Above Junk Stable
Fitch 5/15/2015 BBB+ 3 Levels Above Junk Negative
Moody's 5/12/2015 Ba1 Junk Negative
Egan-Jones 5/18/2015 "Deep Into Junk" Negative

Eliminate the Pigs

When Moody's rated Chicago debt Junk, the city shopped around and went to Kroll instead.

For a detailed explanation as to how Kroll came into existence, please see Rate Shopping Whores and Chicago's Bond Rating.

The solution is clear: Get rid of pigs and take away the trough.

Mike "Mish" Shedlock

Investigating Claims "North Atlantic Trade Ground to a Halt, No Ships Moving"; The Real Shipping Story

Posted: 11 Jan 2016 01:31 PM PST

Commerce Ground to a Halt?

Claims have surfaced that not a single transport ship in the North Atlantic is moving.

For example, "Superstation" claims that in a Historic First, hundreds of ships are said to all be anchored along coasts, with nothing moving.

ZeroHedge picked up the story in "Nothing Is Moving," Baltic Dry Crashes As Insiders Warn "Commerce Has Come To A Halt".

Countless others picked up the story from ZeroHedge who "confirmed" the story.

ZeroHedge said "We checked VesselFinder.com and it appears to show no ships in transit anywhere in the world. We aren't experts on shipping, however, so if you have a better site or source to track this apparent phenomenon, please let us know. We also checked MarineTraffic.com, and it seemed to show the same thing. Not a ship in transit…"

The Real Shipping Story

Let's sort out reality from hype from Marine.Com.

Cargo Vessels and Tankers Anchored

click on any image for sharper view

Cargo Vessels and Tankers Underway

Tankers Underway

As you can easily see, the numbers vary from chart to chart. Ships are moving.

The first thing I do when I see reports like "No Ships Moving" is look for mainstream news confirmation.

If no ships were moving, this would indeed be news and some reputable news site would have the story. The "no ships moving" story failed the "sniff test" from moment one.

Confirmation of economic stories is different than confirmation of political stories. Coverups of sex attacks in Germany and Sweden, and police killings in Chicago and other US cities highlights the difference.

Other Shipping Measures

Let's now investigate other indicators of slowing shipments Including the Baltic Dry Index and the Harper Petersen shipping Index.

Baltic Dry

The above chart from Bloomberg.

The Baltic Dry index measures shipping rates for dry goods.

The problem with Baltic Dry is the index is a function of excess shipping capacity and volumes shipped. It provides little information on shipping container sizes. Rates can sink because of increased shipping capacity (new ships) or sinking demand, or both.

Week after week I receive emails telling me the Baltic Dry Index is plunging. Stop the Emails! I know.

Harper Petersen provides much more information.

Harper Petersen Shipping Index - 10 Year History

Harper Petersen Shipping Index - 2 Year History

Harper Petersen Vessel Size Rates - 2 Year History

TEU

TEU stands for twenty-foot-equivalent unit. It's an imprecise term because lengths have a 20-foot long (6.1 meters) standard but heights vary. Heights range from 2 feet three inches to 9 foot six inches. The most common heights are 8 feet 6 inches (2.6 m) and 9 feet 6 inches (2.9 m).

Myth vs. Reality

Contrary to popular myth, shipping has not ground to a halt. However, shipping volumes and shipping rates have both plunged. 2015 was a disaster by any measure.

There's no need to exaggerate. Reality is bad enough.

Mike "Mish" Shedlock

China Declares War on Currency Speculators; Interbank Yuan Rates Spike to Record High 13.4%

Posted: 11 Jan 2016 11:10 AM PST

In yet another example of currency intervention madness that will fail soon enough, China Declared War on Currency Speculators.

China has opened a new front in its war to curb currency depreciation by buying up renminbi offshore, foiling the burgeoning carry trade and driving the cost of borrowing to a record high.

The elevated overnight CNH Hong Kong Interbank Offer Rate (Hibor) shows how volatility in China's currency. It is also a potent sign of the lengths to which China's central bank is prepared to go to support the value of offshore renminbi, known as CNH.

The overnight CNH Hibor, a daily benchmark for offshore renminbi interbank lending, hit a record-high 13.4 per cent on Monday, up from 4 per cent on Friday and the highest level since the benchmark was launched in 2013. The one-week rate surged from 7.1 per cent to 11.2 per cent.

The People's Bank of China, acting through state-owned banks in Hong Kong, is buying up renminbi to curb CNH weakness and narrow the gap between CNH and onshore renminbi, known as CNY, analysts say.

"It looks like PBoC wants to maintain a high cost of shorting CNH," said Zhou Hao, Asia economist at Commerzbank in Singapore.

"On the other hand, it also shows that positioning is quite crowded — everyone borrows CNH to short — which means that a short covering could be very wild if it takes place."

Overnight Lending Rates

HIBOR is the overnight lending rate between banks for loans denominated in yuan.
LIBOR is the rate for dollars.
EURIBOR is the rate for euros.

Short Covering Spike

Meaningless Reaction

For now, China got the reaction it wanted. But it's meaningless. Such efforts always fail.

Driving out shorts does not change fundamentals. China found that out with ill-advised attempts to shore up its stock markets.

Apparently it needs a lesson in regards to currency prop jobs.

The difference between the onshore and offshore yuan is a symptom of capital flight, not a symptom of speculation. All China did was create a pent-up demand to sell yuan.

The fact remains China has a Boatload of Insolvable Problems caused by conflicting goals between growth and rebalancing.

Draining liquidity to drive out shorts cannot solve any problems. It's a war China will lose.

Mike "Mish" Shedlock

Europe Fears Bail-Ins: Capital Flight Intensifies in Italy, France, Spain; Are German Banks Safe?

Posted: 11 Jan 2016 12:45 AM PST

Fear!

Money parked at the ECB at a negative rate of 0.3% hit a new high at the beginning of 2016.

Above chart from Statista.

Possible Explanations

Fear of losses elsewhere
No demand for loans
No creditworthy borrowers
Capital impairment at banks
Failure of ECB policy

To encourage more lending, ECB president Mario Draghi cut the deposit rate for money parked at the ECB from -0.2% to -0.3% on December 3.

Clearly that did not work.

Let's now take a good look at Target2 imbalances, an excellent measure of capital flight from eurozone countries to other eurozone countries.

Target2 Imbalances in Billions of Euros

Country	Symbol	Target2 Balance	Comment
Spain	ES	-241.8	Worst Negative Since 2012
Italy	IT	-229.6	Worst Negative Ever
Greece	GR	-97.3	Least Negative Since 2015 Q1
ECB	ECB	-73.8	Worst Negative Ever
France	FR	-73.5	Worst Negative Since 2011
Germany	DE	592.5	Highest Since 2012
Luxembourg	LU	140.4	Highest Ever
Netherlands	NL	49.4	Highest Since September 2015
Finland	FI	31.8	Highest Since August 2015
Cyprus	CY	2.4	Second Highest Ever

I created the above table using data from the ECB Statistical Data Warehouse

European Country Codes

The above from Eurostat Country Codes.

Lack of Trust

Target2 is a measure of capital flight between eurozone countries. For example: A depositor in a Greek, Spanish, or Italian bank does not trust their bank so the depositor opens up a new account and transfers the balance to a bank in Germany, the Netherlands, or Luxembourg instead.

The recipient banks then park the money at the ECB at negative interest rates instead of buying Greek, Spanish, or Italian bonds.

Europe Fears Bail-Ins

Stepping back a bit, here's a key question: What caused the depositors to flee their banks in the first place?

The answer is fear of bail-ins, confiscations, capital controls, and bank failures like we have seen in Greece and Cyprus.

Recent examples include Portugal and Italy.

No Demand For Some Italian Bonds

Reuters reports Worried Italians Seek to Sell Out of Bank Bonds

Dec 11 Italians rushed to try to sell their bank bonds on Friday after taking fright at losses imposed on investors in four small lenders which had to be rescued last month.

Italy rescued Banca Marche, Banca Etruria, CariChieti and CariFe at the end of November under new European Union rules that shift losses to investors when a bank runs into trouble, moving the burden from taxpayers.

Some 130,000 shareholders and holders of 790 million euros ($864 million) in junior debt saw the value of their investments wiped out. It was the first time since the 1930s that bondholders suffered losses in a banking crisis. The suicide of a pensioner who lost money in the rescue has added to the outcry.

"People in Italy are rushing to sell subordinated bank bonds," said Giuseppe Sersale, a fund manager at Anthilia Capital. "Retail investors scared by the protests triggered by the rescue of the four banks are trying to sell, but there is no demand for them."

Dark Clouds Gather

Fears grow every day. And why shouldn't they?

Pater Tenebrarum at the Acting Man blog writes The EU Bail-In Directive: Dark Clouds are Gathering

In the article, Tenebrarum discusses forced bail-ins, noting two recent cases, one in Austria and one in Portugal.

In the case of Portugal, five bonds were moved from the BES "good bank" to the "bad bank" overnight wiping out everyone holding those bonds when the ECB suddenly discovered a financial hole in a bank thought to have been bailed out in 2014.

The bail-in mechanism is not the problem.

Tenebrarum writes (and I agree) ...

"In principle, the BRRD, or 'bail-in directive' as it is also known, is quite a good idea. The fact that lending money to fractionally reserved banks or even merely depositing it with them, involves risks needed to be firmly reestablished. One simply cannot expect that banks and their creditors will be bailed out by taxpayers at every opportunity. By arbitrarily meting out unequal treatment to similar classes of creditors, they are unwittingly hastening this process of recognition."

Bail-in Jitters

These bail-ins are causing jitters. Can you trust Spanish banks? Italian banks? French banks? Greek banks?

Depositors increasingly say no. And the recipient banks in Germany, Netherlands etc, don't want to risk bonds in those countries when the deposits are transferred.

Target2 imbalances rise nearly every month as a result.

Your Choice

Tenebrarum concludes with few statements that go to the heart of the matter. This one says it best.

"Sorry boys and girls, you will have to choose. You can either have capitalism, freedom, prosperity and personal responsibility, or you can have socialism, tyranny, poverty and 'security'. You cannot have both."

Correction: I attributed that quote to Mises but Tenebrarum explains: "That was supposed to be the caption under his photo. My editor apparently mixed something up. So it is actually a Pater Tenebrarum quote."

Are German Banks Safe?

Here's an important question I leave you with: Do you think German banks are safe?

If so, you are badly mistaken. Think about Target2 for a second: If Spain, Italy, Greece, or any country leaves the eurozone, someone will have to eat those Target2 imbalances.

How would the ECB allocate those losses?

Taxpayers, depositors, or bondholders will be bailed-in directly. Alternatively, the ECB will violate the Maastricht treaty and print the money to cover the losses. In that case, the euro will take a hit.

Nothing in Europe is safe!

Mike "Mish" Shedlock

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Mish's Global Economic Trend Analysis

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