Bank Risk Escalates At The Worst Time

Written by Dennis Slothower
Posted March 17, 2018

The Dow broke its downward trend going into Thursday, led largely by the bank stocks.

After the close on Wednesday, the Senate voted 67 to 31 to ease banking rules, bringing Congress closer to passing the first rewrite of the Dodd-Frank banking reform law enacted in 2010, which was a result of the Great Recession. The law essentially made it harder for smaller banks to take riskier positions.

Reuters noted that:

"The bill would raise the threshold at which banks are considered systematically risky and subject to stricter oversight from $50 billion to $250 billion. It also exempts banks with less than $10 billion in assets from rules banning proprietary trading, as well as exempts small banks from several other post-crisis rules”.

The bill now goes to Congress for its rewrite.

I am all for helping community banks, but is this the time to encourage less capitalized banks to be taking greater risk — just as the Fed is tightening monetary policy?

The Federal Reserve is shrinking its $4.4 trillion balance sheet. That means there’s less in reserves moving about in the financial system between the banks and this means banks are going to have to compete more and more for funding, causing a higher demand for dollars. A higher demand for money causes short-term interest rates to drive higher.

Notice what is happening to the Dollar Libor/OIS spread?

This spread is the difference between the Libor Eurodollar rate and the Overnight Index Swap (OIS) based on the Federal Reserve Fed Funds rate. The fact that this spread is spiking suggests sharply rising risk because this is the rate at which banks lend to each other.

This gauge of stress in the U.S. money markets grew to its highest level in more than six years on Thursday, bolstering the risk of further increase in the costs for banks and other companies to borrow dollars.

Just a side note, this development is setting the stage for a violent reversal in the dollar, as short positions get increasingly more expensive to hold!

So now legislation is being pushed by the big banks to loosen lending, exactly at a time when the yield curve is about to invert!

Naturally, the reform of Dodd-Frank boosted big bank stocks Friday, helping the Dow to rally.

When Washington rolls back banking rules — watch out! Do you remember when they deregulated the savings and loan associations — which led to a real estate collapse?

Or after the investment bankers pushed hard to repeal the Glass-Steagall Act in 1999? That merged commercial banks with investment banks and that created a bubble in real estate that led to the 2008 crash.

Speaking of the Glass-Steagall Act, where’s the President’s proposal that he campaigned on? Or do we have to have a depression first?

As Lisa Gilbert, vice president of legislative affairs for Public Citizen, put it:

“Masquerading as aid for community banks, this legislation reduces oversight of 25 of the largest 38 banks, a group guilty of misconduct and recipients of some $48 billion in bailout money after the 2008 crash. In addition to setting the stage for another taxpayer-funded bailout, this bill also reduces safeguards against discriminatory, predatory lending for some of the most vulnerable consumers.”

It is very worrisome that we are watching the money supply and bank credit start to collapse. The money supply velocity is at the lowest rate since 1949.

Notice, the financial powers are trying to keep the 10-year Treasury yield from breaking above 3% but, at the same time, the 2-year Treasury yield continues to creep higher given next week’s rate hike coming.

The difference between the 2- and 10-year yields is only 55 basis points before going to zero, again, with almost guaranteed interest rate hikes next week.

A pop above 3% in the 10-year Treasury yield could bring on more serious selling in the stock market, where the 10-year yield could pop to 3.5% as U.S. Treasury bonds are bought for safety.

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Stealth Stocks Daily Alert and Wall Street's Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.

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