"Death by starvation is slow." - Mary Hunter Austin, American writer
"For us, NIRP is a "reverse Tobin tax" leading in the end to the "euthanasia of the rentier" as more and more government bonds fall into negative yield territory, hence our chosen title. If indeed James Tobin tax was supposed to lead to lower volatility in the FX markets, the reverse Tobin tax aka NIRP is leading to the reverse, that's a given but we are rambling again..." - source Macronomics, March 2016
- Macro and Credit - Yen depreciation and financial repression? It's only starting
- Macro and Credit - Credit tightening is already starting to bite a leveraged world
- Final chart: Bank stocks on the "Road to Nowhere"
- Macro and Credit - Yen depreciation and financial repression? It's only starting
"Overview of postwar deposit blockade
The postwar deposit blockade can in our view be seen as an exit from the monetary easing policies before and during the war in the shape of the BOJ's government bond underwriting. This method allowed the government to recover currency supply that had become bloated during the war while simultaneously defaulting on government debt that had become virtually unpayable with the end of the war. The deposit blockade was a scheme to write off wartime compensation at one go and eliminate financial institutions' bad debts by imposing temporary limits on some withdrawals of deposits and rescinding claim rights on some of the blockaded deposits.
Is a deposit blockade possible today?
It should not be overlooked that when the Japanese government allowed the policy-driven erosion of people's assets by sacrificing some deposits through the deposit blockade, it did so under the former Constitution of the Empire of Japan and before the adoption of the current Constitution of Japan, which stipulates that any deposit blockade must protect the property rights of the people. If the Japanese government were to adopt and implement such a scheme to write off debt, that could be ruled unconstitutional, making such a move very dubious from a legal perspective. We think helicopter money policies involving, for instance, the conversion by the BOJ of the JGBs it has purchased into perpetual bonds would risk similar legal problems because they would in effect institutionalize the degradation of JGB redemption terms. From this standpoint, we think helicopter money policies are unlikely to be adopted." - source Nomura
"An information (or informational) cascade occurs when a person observes the actions of others and then—despite possible contradictions in his/her own private information signals—engages in the same acts. A cascade develops, then, when people “abandon their own information in favor of inferences based on earlier people’s actions”." - source Wikipedia
"Growing helicopter money debate and BOJ underwriting of JGBs before and during the Pacific War
The helicopter money policy debate has been heating up. Although there are various definitions of helicopter money, the basic concept involves the direct financing of fiscal spending by the central bank (and its issuance of currency). Specific forms this might take include the central bank directly and without limit underwriting the increased issuance of government bonds to pay for large-scale increases in government spending and the central bank, through quantitative easing, converting the government debt it already holds into perpetual bonds or other bonds with very long maturities or else getting rid of redemption altogether.
Recently, it has become well known that the BOJ directly underwrote government bonds before and during the Pacific War (Figure 1).
Perceptions that this triggered the outbreak of war by supporting unlimited growth in military spending and was an underlying cause of hyperinflation following the war are seen as lying behind the provision in the current Fiscal Act (Article 5) prohibiting the BOJ from directly underwriting government bonds.Considering this historical background, we think there is little prospect of the government and the BOJ cooperating in the adoption of a helicopter money-type measure. However, not only is it now the mainstream view that the current quantitative and qualitative monetary easing (QQE) policy with its negative interest rate policy (NIRP) is unlikely to achieve the BOJ's inflation target (or the assumption behind its attainment of pushing up inflation expectations by giving a boost to the real economy) but also there has been growing criticism that NIRP will actually have a greater adverse impact by depressing earnings at financial institutions, impeding financial intermediary functions, raising uncertainty in the household and corporate sectors, and reducing those sectors’ willingness to spend.If this situation persists, the possibility that momentum may grow for the adoption a helicopter money approach as an emergency measure cannot be ruled out.
Assessment of BOJ government bond underwriting: lessons from the past
In considering how the risk scenario of helicopter money policy might unfold after its introduction, we think it instructive to look back to when the BOJ underwrote government bonds before and during the war and how the aftermath of hyperinflation was dealt with.
First, let us look at the position with the BOJ's underwriting of JGBs. The roots of the BOJ's government bond underwriting date back to the expansionary fiscal policy (from 1931 onward) under then Finance Minister Korekiyo Takahashi aimed at escaping the deflationary recession known as the Showa Financial Crisis, triggered by the Great Depression in 1929. The general view is that the BOJ's direct underwriting of JGBs accompanying the aggressive fiscal policies was adopted as a "temporary expedient" by the bank under heavy pressure from Finance Minister Takahashi.
As noted earlier, the direct underwriting of government bonds by the BOJ acted as a trigger for the outbreak of war by allowing military spending to grow without limit and is generally viewed as having been the underlying cause of hyperinflation in the postwar period. However, we think a closer look at the causal relationship between the BOJ's government bond underwriting, inflated fiscal spending, and hyperinflation is needed in considering the current monetary easing and the impact of helicopter money. From a broad perspective, we think the relaxation of fiscal discipline and hyperinflation cannot all be blamed on the BOJ's underwriting of government bonds.
Was underwriting JGBs the main cause of relaxation in fiscal discipline and hyperinflation?
First, let us consider the impact of the BOJ's underwriting on JGB yields and the relaxation of fiscal discipline. Some, for example, have criticized the current large-scale JGB purchases under QQE and the adoption of NIRP as having greatly lowered government bond yields across all maturities, saying that the exceptionally low yield they have brought about have already given rise to a relaxation in fiscal discipline even without waiting for the introduction of any helicopter money measure.
However, we think it is rash to blame the BOJ's underwriting of JGBs before and during the war for the relaxation of fiscal discipline by holding down JGB yields and for supporting military expansion and triggering the outbreak of war.
From before the war to during it, JGB yields actually declined despite deterioration in the government's fiscal balance and growth in outstanding debt (Figure 2).
We think it inappropriate to blame the BOJ's JGB underwriting for the following two reasons. First, although after the underwriting of JGBs began the BOJ did underwrite a large proportion of newly issued bonds, at almost 80%, the great majority of the JGBs underwritten by the BOJ were subsequently sold in the open market. We see the BOJ's government bond underwriting as in a sense having compensated for inadequacies in the bond underwriting capacity of private-sector financial institutions. With the decline in JGB yields in the market, meanwhile, we see this as due more to the impact of the introduction of a system in 1932 whereby JGBs could be listed at book price equivalents to standard issuance prices stipulated by MOF. Exempting financial institutions from booking their JGB holdings at current value appears to have greatly eased the selling pressure on JGBs.
How about the view that the BOJ's government bond underwriting was the cause of hyperinflation in the postwar period? Although most of the bonds underwritten by the BOJ were subsequently absorbed by the market, the large increase in fiscal spending in parallel with the BOJ underwriting did lead to a large expansion in the money supply. It is possible to see hyperinflation as the result of this not being absorbed even after the war.
From the perspective of the real economy, however, we think there was a greater impact in opening the way for hyperinflation from the extreme diversion of production capacity to military purposes during the war, from damage caused by wartime fires, and from a rapid narrowing in the output gap as private-sector demand quickly recovered with demobilization after the war.
Deposit blockade as an exit strategy for JGB underwriting
With helicopter money now being actively discussed as an option for what could be seen as a move toward a more radical form of conventional QQE, we believe it is crucial to look at how the authorities finally addressed the BOJ’s JGB underwriting during World War II and the swollen currency supply and hyperinflation caused by the massive expansion in wartime spending by the government.
A deposit blockade could be viewed as an exit strategy for monetary policy after the start of JGB underwriting by the BOJ. This method allowed the government to recover the excess currency supply that had emerged during the war while simultaneously defaulting on government debt that had become virtually unpayable with the end of the war. Below we take a look at the effects of this deposit blockade, both on the monetary side in areas such as currency supply and on the fiscal side in areas such as adjusting government debt.
Overview of deposit blockade
Here we examine the concept of a deposit blockade and the processing of government debt that accompanies it.
During World War II, the Japanese government attempted to manage the fiscal imbalance caused by the massive increase in military spending and the drop in tax revenues from the halt of private-sector industrial activity by increasing the issuance of government bonds, the underwriting of those bonds by the BOJ, and debt guarantees known as wartime compensation given to arms companies for accounts receivable related to military procurement.
Of course, Japan's defeat and the war's damage to its domestic production capacity deprived the government of its means to repay these wartime compensation debts. This resulted in many loans turning bad at the Japanese financial institutions that had supplied credit to these arms companies with wartime compensation as effective collateral. At the same time, the money created by this supply of credit collateralized by wartime compensation, alongside the destruction of supply capacity in the real economy, was a root cause of the excess liquidity and hyperinflation that followed the war.
As a measure to simultaneously reduce both the resultant risk of default on government debt and this excess liquidity, it was proposed that withdrawals be temporarily restricted for some sorts of market deposits, allowing the government to write off its wartime compensation debt while financial institutions disposed of their bad debt, while also effectively devaluing these market deposits via the currency redenomination (shift to the new yen) also carried out during the deposit blockade period (Figure 3).
The deposit blockade was put into effect with the emergency financial measures ordinance of 17 February 1946. In accordance with the simultaneously announced special asset audit ordinance, the government began the process of assessing the total amount of wartime compensation debt and the amount of citizens' assets subject to writeoffs. Following this, on 24 July of the same year, the cabinet officially decided to cancel all wartime compensation and the blockaded assets were categorized into type 1 blockaded assets and type 2 blockaded assets to reflect the amount of compensation to be written off. Figure 4 shows the extent of the blockaded deposits subject to withdrawal restrictions and the debt with which they were matched.
Unregulated deposits with no withdrawal restrictions accounted for 15.4% of total deposits at Japanese banks (as of August 1946, when blockaded deposits were categorized), while type 1 blockaded deposits accounted for 37.5% and type 2 blockaded deposits accounted for 21.9% (Figure 5). For individuals, withdrawals from these blockaded deposits (in new yen) were limited to ¥300 per household per month and ¥100 per household member.
On 18 October 1946 the government enacted the Wartime Compensation Special Measures Law, which imposed a special tax for wartime compensation equal to the amount of wartime compensation debt. With this special tax, the government effectively defaulted on its wartime compensation debt. To address losses on the financial institution debt that consequently became unrecoverable, the type 2 blockaded deposits were allocated to fund debt writeoffs at private-sector financial institutions under the Financial Institution Reconstruction Law and Business Reconstruction and Adjustment Law implemented on the same date. Roughly 57.5% of the total balance of type 2 blockaded deposits as of directly after their categorization in August 1946 was eventually used for these writeoffs (Figure 6).
Is a modern deposit blockade possible?
Under QQE, the BOJ has come to hold an increasing percentage of the overall JGB balance, while JGBs have come to account for an increasing percentage of the BOJ's assets. With large-scale monetization of government spending via helicopter money policies now also being debated, some now express concern that such policies could lead to conditions similar to the postwar deposit blockade.
As described above, the postwar deposit blockade was implemented under the assumption that some of depositors' deposits would be written off in order to prevent a chair reaction of bankruptcies among Japanese businesses and financial institutions caused by the government's inability to follow through on its wartime compensation. It should not be overlooked that when the Japanese government allowed the policy-driven erosion of people's assets, it did so under the former Constitution of the Empire of Japan and before the adoption of the current Constitution of Japan, which stipulates that the property rights of the people must be protected if deposits are blockaded.
If the Japanese government were to adopt and implement such a scheme to write off government debt, it could be judged unconstitutional, making such a move very dubious from a legal perspective.
Helicopter money policies that in effect institutionalize the degradation in redemption conditions for the JGBs purchased by the BOJ could risk raising similar legal issues." - source Nomura
"The consequences of financial repression
The consequences of financial repression policies could show most strongly in forex rates as a result of the contradiction that would arise from maintaining policies to artificially suppress JGB yields even when the rise in the inflation rate would suggest that monetary easing should be ended.
Offsetting in part or in full the negative impact of inflation on the real prices of financial assets is one of the basic effects of a rise in interest rates. However, under a policy of artificially ultra low interest rates aimed at preventing government debt defaults, we would expect a decline in domestic financial assets that could not increase in real value without a rise in interest rates and we would expect an outflow of funds into overseas assets. The resultant drop in yen forex rates could further accelerate inflation and without a rise in interest rates to counter this, we would expect further acceleration in both the outflow of assets and the devaluation of the yen. It should therefore be kept in mind that the price of avoiding government debt defaults with the minimum of political and legal friction may well be quite a rough decline in forex rates." - Source Nomura
- Macro and Credit - Credit tightening is already starting to bite a leveraged world
"Suburban Detroit’s Lakeside Mall, with mid-range stores such as Sears, Bath & Body Works and Kay Jewelers, is one of the hundreds of retail centers across the U.S. being buffeted by the rise of e-commerce. After a $144 million loan on the property came due this month, owner General Growth Properties Inc. didn’t make the payment.
The default by the second-biggest U.S. mall owner may be a harbinger of trouble nationwide as a wave of debt from the last decade’s borrowing binge comes due for shopping centers. About $47.5 billion of loans backed by retail properties are set to mature over the next 18 months, data from Bank of America Merrill Lynch show. That’s coinciding with a tighter market for commercial-mortgage backed securities, where many such properties are financed." - source Bloomberg
"We have told you recently we have been tracking the price action in the Credit Markets and particularly in the CMBS space. What we are seeing is not good news to say the least and is a stark reminder of what we saw unfold back in 2007.Among the more recently issued CMBX series (6-9), CMBX.6 has the highest percentage of retail exposure.Sorry to be a credit "party spoiler" but if U.S. Retail Sales are really showing a reassuring rebound in January according to some pundits with Core sales were 0.6% higher after declining 0.3% in December and the best rise since last May, according to official data from the Commerce Department, then, we wonder what's all our fuss about CMBS price action and SEARS dwindling earnings? Have we lost the plot?" -source Macronomics, February 2016Also, in our May conversation "Through the Looking-Glass" we reiterated the importance of tracking the "price action" in the CRE space has a further indication of the deterioration in credit financial conditions and deterioration in economic fundamentals:
"As indicated in our conversation "The disappearance of MS München", we have been tracking the price action in the Credit Markets and particularly in the CMBS space. The reason behind us starting to track à la 2007 is that the CMBX price action indicates that a growing number of investors may have begun to short it since it is a liquid, levered way to voice the opinion that CRE (Commercial Real Estate) is considered to be a good proxy for the state of the economy. And, if indeed investors are pondering the likelihood that the US economic growth is slowing and that CRE valuations have gone way ahead of fundamentals, then it makes sense to track what is going on in that space for various reasons, particularly when it comes to assessing lending growth and the state of the credit cycle we think.
As a reminder from our February conversation, CRE portfolio lenders also tighten credit standards, it stands to reason that some proportion of borrowers that would have previously been able to successfully refinance may no longer be able to do so in the future." - source Macronomics, May 2016
"Figure 6 shows how lending volumes in CCCs, while having thawed a bit from a completely frozen state in Jan-Feb, remain at some of the lowest levels seen in the past 15 years. Investors are not exactly going after all the 13% yield opportunities in the ex-commodity HY CCC segment, and there could only be one explanation for such a behavior in a yield-starving world.
Such a behavior also naturally translated into higher realized credit losses in the ex-commodity sectors, with our default rate calculations showing an annualized 3mo issuer-weighted rate reaching 4.6% in May. Overall HY defaults, including energy and other commodities, were trending at a 9.8% issuer-weighted rate over the past three months! Trailing 12mo rates for both market segments currently stand at 2.7% and 5.8% respectively.
So, if investors are skittish about credit risk, do extreme steps taken by central banks help in reopening the credit channel? The evidence we see provides little support to that claim. Figure 7 shows overall corporate bond issuance volumes (IG+HY) in the US and EU over the past five years, presented here as a percent of respective market sizes.
Of a particular interest is the reaction function in EU credit, where new issue volumes have peaked in Apr 2015, or a month after that ECB engaged in the original QE last year. Since then volumes have dropped precipitously, currently sitting near their lows over the past four years.You can lead a horse to water, but you can’t make it drink." - source Deutsche Bank
"While many borrowers will be able to successfully refinance their loans, it is inevitable that some will not. To the extent that borrowers with higher quality properties have already refinanced, we think that many of the outstanding 2006 vintage loans are adversely selected. If they can’t refinance we anticipate that the 60+ day delinquency rate (Chart 46) and special servicing rate (Chart 47) for legacy loans could increase sharply over the next six months.
The inability for some legacy borrowers to refinance will likely be exacerbated by the recent slowdown of CRE price appreciation.
To this point, April 2016 Moody’s/RCA CPPI data were released this week and offered mixed results. Although the data indicate that the index increased 16bp month/month at the national level, the index that represents assets in major markets fell (Chart 48).
Furthermore, price change by property type was mixed as well. At the property level, prices for retail, apartment and industrial properties increased, while office prices fell.
When we analyzed the long term commercial real estate price trends by property type, the slowdown in commercial real estate price appreciation for assets located in major markets was especially noticeable. This held true for each of the core property types." - source Bank of America Merrill LynchOn top of this surging overall weakness trend in CRE, you will probably understand our "interest" in tracking the "Ubasute" fate of CMBX series 6 and why, we continue to think it should be "shorted" from Bank of America Merrill Lynch additional comments from their note:
"Within the mall space, quarter-to-date returns don’t look particularly attractive as only one of the eight companies our equity mall REIT analysts cover posted positive returns (Chart 53).
Along this line, Ralph Lauren announced this week that it plans to cut 8% of its workforce and close more than 50 stores.
Despite feeling like we read these types of announcements several times a week, store closings so far this year are not only lower than they were last year at this time, but are at levels last seen in 2013 (Chart 54).
Bringing this back to what retail sector weakness means for the CMBS market, we think that the weakness, coupled with slowing CRE price growth, imply that loss expectations for cuspy legacy bonds may be too low. This could be particularly painful for bonds in this category that are priced at levels that don’t incorporate unexpected downside. For example, many legacy deals only have a small handful of loans left, many of which are, and have been, current. Despite this, if a tenant has (or plans to) vacate the building but is still paying rent, this might result in a loss that has been neither considered nor accounted for. When we plotted 2006 vintage AJ current subordination levels against our credit model’s expected deal losses, we found that a number of AJs were very close to taking an expected loss (Chart 55) – even without taking into the account unknown unknowns that could cause performance to deteriorate relative to one’s current expectations.
The way to interpret Chart 55 is that any “dot” above the diagonal red line indicates that expected deal losses exceed the amount of subordination for the AJ represented by the dot. While it is likely that many of these AJs already trade at discounted dollar prices given the expectation that they will incur some loss, what about bonds trading at mid-to-high $90s (or higher) that are not expected to take a loss? These bonds are represented by dots below the diagonal line. Obviously, dots closer to the line indicate that less cushion exists to absorb any unanticipated negative surprises.
Although greater market stability may lead to better refinance success, it appears that fewer loans are being recycled back into the CMBS market. To the extent that the alternate lender has tighter underwriting standards, it is possible that losses could increase relative to many investors’ current expectations. In fact, despite recent comments from regulators noting the increase in CRE exposure on bank balance sheets, many local, regional and national banks continue to increase their CRE loan
origination activity and market share. This holds true both for all commercial real estate lending (both acquisition and refinance) as well as for only loans that are refinancing. While we aren’t suggesting that losses may increase significantly from current levels, we think that it makes sense to price “cuspier” bonds to a slightly more negative scenario in order to buffer against unanticipated negative events." - source Bank of America Merrill Lynch
This leads us to our final chart given than some pundits continue to believe in the attractiveness of bank stocks, in particular in Europe from a "valuation" perspective.
- Final chart: Bank stocks on the "Road to Nowhere"
Long Japan banks - The banks de-rating has been an important factor behind the lower valuation of the overall market. In particular, the sector has massively underperformed due to concerns of deepening deflation caused by rising yen. The negative interest rate policy framework has exacerbated these concerns." - source Société Générale.
- source Société Générale"Ubasute" in Japan might have reached "full-employment" but, when it comes to inflation and banks stocks, it is clear that it has been an utter failure. NIRP has in fact created a dangerous situation with now CDS spreads widening and banks stocks going lower.
In a world stifled by too much debt therefore weighting on global growth we can not envisage seeing any value in this environment in owning bank stocks as illustrated by Bank of America Merrill Lynch in their Thundering Word note from the 16th of June entitled "Barbells, Banks, Fizzy Bonds & Brexit":
"Year of the Barbell, not Year of the Banks
“Deflation assets” & “inflation assets” winning in 2016: gold & bonds; resources & defensives; Brazilian real & Japanese yen all outperforming. Tail assets stretched (e.g. HY energy most overbought in 7 years) but banks have “funded” barbell (Chart 1) and reversal of long barbell-short banks trade requires EPS & GDP upgrades. Neither visible." - source Bank of America Merrill Lynch
"Walking from crisis to crisis
Switching tack slightly, macroeconomic uncertainty in the Eurozone and US remains elevated; the high correlation between US potential GDP growth and gold (Chart 15) highlights how important this is for the precious metal. While the underlying ills are nuanced between countries, an increasing polarization of politics and a rise in populism have been common by-products; to that point, wealth generation/wealth distribution, immigration and sovereignty have caused contentious debates. Of course, this has not helped confidence and did not make it easier for governments to implement the measures necessary for putting economies on a more sustainable footing. As a result, a host of countries has moved through a series of mini-crises in recent years. This dynamic has also tied the hands of central banks and persistently loose monetary policies have, through various transmission channels, been supportive of gold. As such, even if the UK remains part of the EU and gold corrects, we believe prices below $1,200/oz would be a buying opportunity." - source Bank of America Merrill Lynch
"The voice of conscience is so delicate that it is easy to stifle it; but it is also so clear that it is impossible to mistake it." - Madame de Stael, French writer