IMF Declares Bulgarian Banks Safe Two Weeks before Bank Runs

This serves as a classic example of the establishment’s “kiss of death”

About two weeks ago, two major Bulgarian banks suffered a classic bank run where the European Commission bailed out the banking system with a €1.7bn emergency credit line.

The fun part has been that the IMF gave Bulgaria’s banking system a clean bill of health two weeks prior the crisis.

From the Macedonian International News Agency

Earlier this summer, IMF bureaucrats went to Sofia, Bulgaria to study the country’s economic progress.

And roughly a month ago, they released an official report which stated, among other things, that Bulgarian banks are “stable and liquid.”

Talk about epic timing. Because less than two weeks later, Bulgaria’s banking system was in the throes of a full-blown crisis.

There was a run on two of the nation’s largest banks—several hundred million dollars had been withdrawn in a matter of hours.

And the Bulgarian central bank had to step in and take over both of them or risk a collapse in the entire system.

From 'Stable and liquid' into a banking crisis.

The same mainstream article seems to have been aware of perils of the fractional reserve banking system

This is the modern miracle of fractional reserve banking. When you make a deposit, your bank only holds a tiny percentage of that cash.

The rest of it gets loaned out or invested in securities that pay a much higher rate of return than the pitiful amount you receive in interest.

Needless to say, the less money banks hold in reserve, the more money they’re able to invest… and the more profit they make.

This puts their incentives and our incentives at odds. Because as depositors, it’s better for us if the bank holds most (if not all) of our funds.

In typical form, though, governments stepped in to settle this dispute. And a century ago, they sided with the banks.

Because of this, it’s perfectly legal for banks to hold a tiny percentage of customer deposits. So now, anytime there’s the slightest spook (as happened in Bulgaria), it creates a panic.

‘Slightest spook” which “creates panic” has been implicitly attributed to either depositor’s irrationality or sabotage.

But such hasn’t really been the case with Bulgaria’s bank runs. 

For instance, the license to operate of Bulgaria’s fourth largest bank, the Corporate Commercial Bank, has just been revoked by the Bulgaria’s central bank, Bulgaria’s National bank. This has reportedly been due to the deficits or “‘hole’ in the bank” amounting to 3.5 billion leva as the majority stockholder Tsvetan Vassilev has allegedly been “draining his own bank”, according to a report from The Sofia Globe

In short, what “spooked” depositors had fundamental basis. The report also says that the Corporate Commercial Bank will be allowed to collapse. This means that the affected bank had more than just liquidity issues, it has a solvency problem. Depositors sensed this and the bank run ensued.

Yet the same fundamental basis has apparently been ignored or overlooked by the IMF. 

As you can see, mechanical quant or math model based analysis will hardly ever capture human activities operating behind scenes.

And without understanding the socio dynamics operating behind the numbers, pure number crunching will lead statisticians astray. This is because financial ratios or economic statistics can just be fabricated to look robust. Also since statistical models have been designed to incorporate certain variables, this tends to leave out other relevant factors, when everything in this world is interconnected.

Importantly, since numbers represent history, it would be patently misguided to simplistically extrapolate the past into the future. This should be emphasized considering that the world operates in a complex dimension.

And it is not just the IMF, Sovereign Man’s Simon Black writes,

In the case of Bulgaria, the EU Commission soothingly announced that “the Bulgarian banking system is well-capitalized and has high levels of liquidity compared to its peers in other member states.”

Whoa whoa wait a minute.

Are these geniuses really saying that the country experiencing a bank run due to its LACK of liquidity is MORE liquid than the rest of Europe??

Yes, that is exactly what they’re saying.

So it begs the question– if Bulgarian banks with their “high levels of liquidity” can suffer such shocks, what can happen to other European banks which are worse off?

I think the lesson here is clear: The people in charge of regulating the system and making these proclamations about bank safety are totally CLUELESS.

And the lesson from the miscalculation of Bulgaria’s case can likewise be seen in the risk asset markets around the world, including the Philippines.

In the US, record stocks have been construed by the mainstream as headed for "infinity and beyond" even when the consensus projections of the economic performance have repeatedly been downscaled over the past 4 years. The 2014 projections has shown to be the deepest (see chart above).

In short, while the consensus continues to predict the economic performance with consistent brazen inaccuracy, the record breaking stock markets streak means that the gullible public continues to believe in the "growth" story peddled by Wall Street.

As Contra Corner’s David Stockman wryly observed

There is nothing more predictable than the bevy of Wall Street economists who come charging out of the blocks early each year proclaiming that money printing by the Fed will finally work its magic, and that real GDP growth will hit “escape velocity”. But this year the markdowns have come fast and furious. After the disaster of Q1 and the limp data reported for Q2 to-date, the revised consensus outlook for 2014 at 1.7% is already below the tepid actual results of the last three years. So much for the year when “screaming” growth was certain to happen.

Such kind of outlook has been common in a manic phase.

In a post mortem analysis of pre Lehman crisis bubble deniers, Doug Noland of the Credit Bubble Bulletin at the PrudentBear.com refers to this piece by popular mainstream economist Ben Stein at the New York Times in August 12, 2007 (bold mine, italics original)

The job of an economist, among many other duties, is to put things into perspective. So, because I am an economist, among other duties, here is a little perspective on the recent turmoil in the stock and bond markets. First, when the story of this turbulence is reported, the usual explanation mainly has to do with some new loss in the subprime mortgage world… Here is the first instance in which proportion tells us that something is out of whack: The total mortgage market in the United States is roughly $10.4 trillion. Of that, a little over 13%, or about $1.35 trillion, is subprime — certainly a large sum. Of this, nearly 14% is delinquent, meaning late in payment or in foreclosure. Of this amount, about 5% is actually in foreclosure, or about $67 billion. Of this amount, according to my friends in real estate, at least about half will be recovered in foreclosure. So now we are down to losses of about $33 billion to $34 billion… The total wealth of the United States is about $70 trillion. The value of the stocks listed in the United States is very roughly $15 trillion to $20 trillion. The bond market is even larger… This economy is extremely strong. Profits are superb. The world economy is exploding with growth. To be sure, terrible problems lurk in the future: a slow-motion dollar crisis, huge Medicare deficits and energy shortages. But for now, the sell-off seems extreme, not to say nutty. Some smart, brave people will make a fortune buying in these days, and then we’ll all wonder what the scare was about.”

The above is a splendid example of statistical analysis clothed in economic wardrobe that hardly covers substantial investigation of the entwined dynamics of credit, money, prices and capital. In short, economic reasoning has been muddled with statistical reading predicated on data mining.

Secondly, fixation on the past numbers has led to the gross underestimation of risks. This has primarily been due to the misappraisal of the proportionality of risks that basically omitted the potentials of a contagion. Again numbers (or models) hardly ever captures the dimension of human response in the face of a meltdown.

This means that like the IMF, the EU Commission and conventional analysis, shouting and obsessing over statistics or historical numbers produces incorrigible myopia or hopeless cluelessness.

Ironically instead of the sell-off being “extreme” and “nutty”, from an ex-post perspective, the above article turns out to be a comic riffraff, a paragon of contorted perception of reality, mania ‘this time is different’ blindness, and importantly, a principal reason why one should not trust mainstream economists or experts.

As post Keynesian monetarist Joan Robinson rightly pointed out “The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.”

Bulgaria’s Bank Runs: The Europe Commission Rides to the Rescue

With stock markets on a bullish shindig, the idea of financial instability has almost been out of the picture. But wait, one of Europe’s poorest countries just suffered TWO bank runs on "two of the country's biggest lenders" that has prompted the European Commission (EC) to ride to the rescue. 

From the Financial Times:

Bulgaria’s banking system appeared to be stabilising late on Monday after the EU approved a Lev3.3bn (€1.7bn) emergency credit line from the central bank, following runs on two of the country’s biggest lenders in a week.

The public as scapegoats…

The Bulgarian National Bank had warned on Friday of an “attempt to destabilise the state through an organised attack against Bulgarian banks”, as Bulgarians withdrew Lev800m from branches of First Investment Bank, the country’s third-biggest lender.

Those withdrawals came just days after a run on Corporate Commercial Bank, the country’s fourth largest bank.

Six people were arrested over the weekend, accused of sending electronic warnings that FIB was about to collapse; two were indicted on Monday for spreading false information on banks.

Oops, but there is a political dimension… (bold mine)

Rosen Plevneliev, Bulgaria’s president, also announced late on Sunday that after talks with party leaders he would dissolve parliament by July 25 and then name a caretaker administration, ahead of early elections called for October 5. That move helped ease political uncertainty that had fuelled the crisis…

Despite strong fiscal management and a stable exchange rate backed by a currency board arrangement pegging the lev to the euro, Bulgaria is criticised by EU partners for weak governance resulting from close ties between business, politicians and the judiciary.

Corpbank reportedly will be nationalized.

Why would a truly sound banking system be subject to destabilization by merely false information?

The dean of the Austrian school of economics Murray N. Rothbard explains

The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual-savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding...

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided.

So all it takes is for political uncertainty to surface to expose on the shroud of tenuous confidence from a fractional banking system which has been blamed on to the public.

The bailout means resources from European taxpayers will be used as subsidy to Bulgarian banks.

Yet with almost every nation engaged in their homegrown variety of bubbles, it is just a wonder what would happen if today’s colossal imbalances unravels? Will there be massive bank runs in many countries simultaneously? If so, does the respective governments have resources to bail them out? If not, will multilateral institutions also have resources for these rescues? Or will there be a massive recourse to save banks via deposit levies?

Chinese Mini-Bank Runs: Show ‘em the Money and Deposit Insurance

The other day I posted here of a mini-run of a small Chinese rural bank in progress. 

What course of action has been taken in order quell the run? 

Well, Show ’Em the money!!! Literally.

From the Guardian: (bold mine)

Rural banks in China's eastern city of Yancheng stacked piles of money in plain view behind teller windows to calm depositors queueing at bank branches for a third consecutive day, following rumours they had run out of cash.

According to residents of Sheyang county, panic began on Monday with a rumour that a branch of one local bank turned down a customer's request for a 200,000 yuan (£19,500) withdrawal. Banks declined to comment and Reuters was unable to verify the rumour.

The affected institutions are tiny compared with the scale of China's financial sector, and the rush for cash appears to be an isolated incident so far. Rumours found especially fertile ground there after a failure of three less-regulated rural credit co-operatives last January. Yet the news caught nationwide attention, reflecting growing public anxiety as regulators signal greater tolerance for credit defaults.

Well did show 'em the money work? Unfortunately not. (bold mine). From the same article...

Despite repeated appeals from local officials for calm, by Tuesday the run had extended to another local bank, the Rural Commercial Bank of Huanghai, residents said.

Earlier on Wednesday police and security guards stood by as dozens formed a long queue outside while an electronic sign urged depositors not to be worried by rumours.

The governor of Sheyang county, Tian Weiyou, posted a two-minute video statement on the county government's website on Wednesday, urging depositors not to panic. In it he said: "Please be assured that the People's Bank of China and the rural commercial bank system will ensure the interests of all depositors will be protected. The county's rural commercial banks will ensure that there will be enough funds for depositors to withdraw at any given time."

As one would note, "tiny" and "isolated" in the above report seem to have been negated by "extended to another local bank"

What this instead shows is the periphery-to-the-core dynamic in motion or the contagion from the fringe moving into the center.

The article goes on to advocate deposit insurance as a solution to the banking system's debt problem. 

But deposit insurance will signify a short term solution that comes not only at the cost of taxpayer money but also increases systemic risks from moral hazard—tendency to take on more risks because the costs of the risks will be borne by another party—in the long run.

As International University of Geneva Professor Frank Hollenbeck explained at the Mises Institute (as applied to the US) [bold mine]

Deposit insurance is one of the two factors which allows banks to take such risky gambles. Created in 1933, it is a perfect example of government policy that ultimately will be determined to have done more harm than good. It was supposed to reduce risks, but has done just the opposite. When governments provide flood insurance the private sector would never consider, people then build homes in areas prone to suffer from severe flooding.

Prior to deposit insurance, people were careful about where they deposited their money to pay rent or food bills. If a bank ran into trouble by undertaking poor lending practices, people would quickly try to pull their money out of the bank. Bank runs were a good thing because runs served to force banks to be extremely careful about their lending practices. The threat of a bank run maintained sound incentives.

Deposit insurance is a perfect example of Frederick Bastiat’s parable of the broken window: what is seen, and what is not seen. For about 70 years, bank runs have been eliminated; giving depositors what some would say is the illusion of protection. That is what is seen. What is not seen is, without insurance, banks would have been taking much less risks with deposits, and governments would have been less able to finance spending through bank purchases of their bonds.

In other words, deposit insurance is a privatize profits-socialize losses transfer mechanism that works in favor of the banking system charged to taxpayers.

And this also means that a lot today’s global financial and economic imbalances, aside from inflationism, stems from many other price distorting regulations such as deposit insurance. 

Two wrongs don’t make a right. 

China's problems has been about massive accumulation of unproductive debt fueled by fractional reserve banking, thus markets should clear such imbalances.

Meanwhile, the periphery to the core “run” on Chinese institutions continues…
 
Updated to add: With the shrinking availability of domestically sourced liquidity as the financial spigot have been closing, Chinese developers have reportedly tapped on a new way of financing: cross border Commercial Mortgage Backed Securities (CMBS).

China Crisis Watch: Mini Run at a Small Chinese Rural Bank

The economic and financial conditions in China remains highly fragile and increasingly tense as more and more accounts of debt problems surface.

From Reuters:

Hundreds of people rushed to withdraw money from a branch of a small Chinese bank on Monday after rumors spread about its solvency, local media reported, reflecting growing anxiety among investors as regulators signal greater tolerance for credit defaults.

The incident occurred at a branch of Jiangsu Sheyang Rural Commercial Bank in Yancheng in Jiangsu province, about 300 km (185 miles) north of Shanghai, the semi-official China News Service reported late on Monday.

Bank chairman Zang Zhengzhi was quoted saying the bank would ensure payment to all the depositors. The report did not say how the rumor originated.

Jiangsu Sheyang Rural Commercial Bank is subject to formal reserve requirements, loan-to-deposit ratios and other rules to ensure they keep sufficient cash on hand.

Depositor sentiment in Yancheng was rattled in January, when some local rural cooperatives -- which are not subject to the supervision of the bank regulator -- ran out of cash and locked their doors.

UPDATED to ADD: A Reuters report notes that 15.8% of the US$1 trillion owed, via domestic bonds, by Chinese companies will be due this year. In addition, of the 2,600 companies recently surveyed credit metrics has been worsening "across a range of industries" with the software carrying the largest debt load with an average of 3.4 times more debt than equity.

And compounding the backdrop of China’s jittery financial conditions has been growing signs of an economic slowdown.

From Wall Street Journal:

The latest sign of a sharp slowdown came from a measure of manufacturing activity. The preliminary HSBC Purchasing Managers' Index remained in contraction territory for the third straight month in March, HSBC said Monday. At 48.1, the PMI was the lowest in eight months. A reading above 50 shows expansion, while a reading below denotes contraction. Subindexes for output and new orders were down, while employment improved but was still in contraction territory.The preliminary PMI figure is based on 85% to 90% of total responses to HSBC's survey.

So we have a developing feedback mechanism between debt and the economy: debt problems have increasingly been affecting the economy, while at the same time, the intensifying economic slowdown amplifies on the debt problems

But don’t worry, be happy. China's stock markets sees that the Chinese government, will ride like a knight, to save the damsel in the distress.

From the same WSJ article:

China's leaders are beginning to ramp up spending to stem a deepening decline in economic growth as indicators of distress mount.

In recent weeks, the government has quietly taken piecemeal measures to arrest the slowdown—from lining up new infrastructure spending to easing access to money.

Of course the question is how will all these be spending be funded? The likely answer is debt. So in essence, solve a debt problem with more debt.

The Shanghai index closed almost unchanged today following a 2-day ramp. Nonetheless yields of 10 year Chinese sovereign remains elevated at 4.52% as of this writing while the USD-yuan rose modestly +.11% today after yesterday’s broad rally on Asian currencies.

China’s Bear Stearns Moment? First Bond Default Looms

Following the bailout of a delinquent trust company late January, China’s credit markets seem to have returned to a placid state, thereby signaling a possible easing of credit woes. 

Well it turns out that such credit tranquility has only shifted the financial pressures to the currency market, the yuan.

Now even as the agitations in the currency markets remain unsettled, reports say that a debt delinquent solar company may spark a “Bear Stearns moment” with China’s first possible bond default.

From Bloomberg: (bold mine)

The growing risk of default by Shanghai Chaori Solar Energy Science & Technology Co. may become China’s “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, according to Bank of America Corp.

“We doubt that the financial system in China will experience a liquidity crunch immediately because of this default but we think the chain reaction will probably start,” Hong Kong-based strategists David Cui, Tracy Tian and Katherine Tai wrote in a note yesterday. During the U.S. financial crisis, it took a year “to reach the Lehman stage” when investors began to panic and shadow banking froze, the strategists added.

The maker of solar cells said March 4 it may not be able to make an 89.8 million yuan ($14.7 million) interest payment in full by the deadline tomorrow. As sub-prime mortgages fell amid the 2008 U.S. financial crisis, banks began hoarding cash, causing two Bear Stearns Co. hedge funds to seek bankruptcy protection. The troubled bank was sold to JPMorgan Chase & Co. in March of that year in a deal facilitated by the U.S. Federal Reserve. Six months later, Lehman Brothers Holdings Inc. collapsed in the biggest bankruptcy in U.S. history.

Chaori’s potential failure to pay investors would mark the first bond default in Asia’s largest economy, highlighting the strain in China’s $4.2 trillion bond market after a trust product issued by China Credit Trust Co. was bailed out in January. There haven’t been any defaults in China’s publicly traded domestic debt market since the central bank started regulating it in 1997, according to Moody’s Investors Service.

Will this lead to another bailout within the week?

Let me add that China’s troubles have not been entirely captured by Western media. For instance, a report just surfaced that in late January, there has been a reported “run” on three cooperatives

From the Chicago Tribune

In the run-up to the holiday in late January, word had spread that at least three rural cooperatives were running short on funds. In what the local government described as a "panic", depositors rushed to withdraw cash. Local officials say several co-op bosses fled after committing fraud…

Depositors would normally be protected by China's banking regulator, which requires lenders to keep a certain amount of cash on reserve to meet depositor demand.

But as participants in a pilot program, the depositors quickly woke up to an unpleasant reality: so-called "Farmers' Mutual Help Funding Cooperatives" aren't technically banks. Not only did they not have sufficient reserves on hand, they weren't legally required to.

Farmer’s cooperatives reportedly emerged in 2006 and ballooned fast over the years. According to the  same report

By the middle of last year, 137 such co-ops had been established in Yancheng, with total membership reaching 170,000, deposits of 2.3 billion yuan, and total loans outstanding of 1.9 billion yuan, according to figures cited by official media.

But in practice, many co-ops shifted into riskier forms of lending. Jiangsu, along with neighboring Fujian province, is known for its vibrant grey-market lending networks, serving small factory owners and real estate developers who often cannot obtain bank loans.

Informal lending generally occurs through family and friends, but the rise of farmers' co-ops created a platform for informal lenders to scale up their operations by collecting funds in a bank-like setting.

If you might notice China’s financial markets seem to have been faced with increasing frequencies of financial tremors. This may lead to a financial Pompeii.

I am not sure if Bear Stearns should even be the right parallel. That’s because all it takes is for China’s fragmented highly indebted financial system to become unglued, as the Chinese government to lose control that results to the crumbling of the castle built on the proverbial sand. 

Remember financial strains will always function as the initial symptoms. Then a liquidity squeeze follows (this is where the PBoC has been actively intervening in the hope to kick the can). After, the contagion spreads to the real economy via a financial crisis that leads to a economic crisis or vice versa.

Interesting times indeed.

Emerging Market $2 trillion Carry Trade: The Pig in the Python

Last week, I reasoned that changes in US monetary policies and changes in the interest rate signals in the US will naturally force adjustments based on “yield spreads” which eventually will be transmitted (whether you like it or not) as emerging market monetary policies. I stated that such alterations will expose (bold original) “on the distinct vulnerabilities of these economies thereby leading to massive outflows.”[1]

I did not go further. However, one mainstream report seems to have picked up where I left off. And they came with a gala performance

As a side note, signs are that the mainstream has increasingly been recognizing that the problem of emerging markets has not been due to demons or bogeymen of current accounts, exchange rate mechanism or Non Performing loans but rather on debt, debt and debt.

The following quote is from Kermal Dervis former Minister of Economic Affairs of Turkey and Vice President of the Brookings Institution[2] (bold mine)

Unfortunately, the real vulnerability of some countries is rooted in private-sector balance sheets, with high leverage accumulating in both the household sector and among non-financial firms. Moreover, in many cases, the corporate sector, having grown accustomed to taking advantage of cheap funds from abroad to finance domestic activities, has significant foreign-currency exposure.

Where that is the case, steep currency depreciation would bring with it serious balance-sheet problems, which, if large enough, would undermine the banking sector, despite strong capital cushions. Banking-sector problems would, in turn, require state intervention, causing the public-debt burden to rise.

Mr. Dervis’ observation “taking advantage of cheap funds” and my theory “ expose on the distinct vulnerabilities that leads to massive outflows” brings into light the missing factor: the US$ 2 trillion EMERGING MARKET CARRY TRADE

In a report by Bank of America Merrill Lynch (BofAML), the troika of authors Ajay Singh Kapur, Ritesh Samadhiya,and Umesha de Silva wrote that the Fed motivated an Emerging market credit bubble and called this “the Pig in the Python”[3]. 

The QE channel worked through Emerging Markets too. By lowering the US government bond yields to a bare minimum, and zero—ish at the short end, a search for yield ensued globally. Emerging market banks and corporates have gone on an international leverage binge, yet another carry trade, the third in 20 years. The first one was driven by European banks, financing East Asian capex –that ended in 1997. The second one was global banks and equity-FDI supporting mainly capex in the BRICs. That ended in 2008. This time, it is increasingly non-equity flows: commercial banks and, more importantly, the bond market –undercounted in the BoP and external debt statistics that conventional analysis looks at.

Like me, the authors question on the accuracy of statistics where they delve deeper only to discover many unreported debt. They write of the difference between resident borrowing from a foreign bank branch in a country as loans issued by residence that is counted in the Balance of Payment (BoP) and from borrowing by the same resident in the offshore bond and inter-bank markets which they consider as loans by nationality, which appear to be unaccounted for in the BoP calculations. The difference according to them have been substantial. 

For externally-issued bonds, USD1042bn has been raised by the nationality of the EM borrower since 2009, USD724bn by residence of the borrower – a gap of USD318bn, or 44%. This undercount is USD165bn in China, USD100bn in Brazil, and USD62bn in Russia. There is evidence that this bond borrowing overseas by EM non-financial corporates is part of a carry trade, with these corporates acting like financial intermediaries. EM banks have also been busy issuing bonds overseas, a part of this carry trade. We do not have the breakdown for international bank loans by residence and nationality

Oh I noted that contra cheerleaders who think that by shouting “forex reserve!” “forex reserve!” “forex reserve!” they can drive away EM demons[4], the authors like me also note how forex reserves have been manifestations of the ‘sins’ of the credit inflation binge rather than as signs of strength.

Since 3Q2008, the US Federal Reserve QE has unleashed a massive USD2tn debt-driven carry trade into emerging markets, disproportionately increasing their forex reserves (by USD2. 7tn from end-3Q2008), their monetary bases (by USD3.2tn), their credit and monetary aggregates (M2 up by USD14.9tn), consequently boosting economic growth and asset prices (mainly property and bonds). As the Fed continues to taper its heterodox policy, we believe these large carry trades are likely to diminish, or be unwound

And here is where it gets more interesting. 

In Asia, the authors worry about the explosive external debt growth from time period of 2008 and 2013 (blue rectangles), mainly from China and Thailand in terms of bank lending and bonds. The red rectangles are the other ASEAN debt position acquired from the FED sponsored EM carry trade.

While the Philippines have the least exposure in nominal US dollar based loans, at 4.34x (!) the Philippines has the 2^nd biggest growth rate after Thailand.

This report seems consistent with the Deutsche Bank report I earlier noted which showed how the companies from the Philippines ramped up on US dollar loans in the global corporate bond markets in 2013.

And it would be natural to see a limited but concentrated bond market growth in the Philippines for one simple reason as I noted[5]

The small size of bond markets fit exactly with the low penetration level of households in the banking and financial system. This means that the dearth of savings being intermediated into investments via the banking sector or via the capital markets have hardly been signs of real growth.

Importantly, because of the small size of the corporate bond market, the top 10 share in terms of % to the total is at 90.8%. Said differently, the benefits and risks of Philippine corporate bonds have been concentrated to these top 10 issuers.

So should the BofAML’s fear of the risks from the unwinding of the massive EM carry trade materialize, it would seem unfortunate that based on the data from both Bank of America Merrill Lynch and Deutsche Bank, the Philippines or ASEAN major hardly be immune from a contagion.

Don’t forget we seem to be seeing accelerating signs of bank runs in emerging markets. Over the past one and a half weeks, Kazakhstan following the massive devaluation endured three bank runs[6], Ukraine suffered a bank run[7] and our neighbor Thailand just had a bank run on a state-owned bank[8]!

And while China hasn’t had a bank run yet, they seem to have undertaken a series of bailouts of delinquent financial institutions.

Sharp volatility in EM financial markets, stock markets fighting off bear markets, rising rates amidst spiraling debt loads, risk of unwinding of carry trades and bank runs, great moment for stocks right?

A final comment on the pig in the python EM carry trade, the above charts seem to suggest that there has been some correlation between US stocks as measured by the S&P 500 (yellow), the USDollar Yen (orange) and Emerging Markets stocks (EEM green) where all three seem to be moving in a synchronous fashion.

While correlation isn’t causation, could such synchronicity be a function of the carry trade in motion? Are performances of stocks based on ‘fundamentals’ or based on the carry trade anchored on US Federal Reserve policies?

Interesting.

---

[1] See Emerging Markets: Why Adjustments For Relative Yield Spreads has been Disorderly February 17, 2014

[2] Kermal Dervis Tailspin or Turbulence? Project Syndicate February 17, 2014

[3] Ajay Singh Kapur, Ritesh Samadhiya,and Umesha de Silva Pig in the Python –the EM carry trade unwind Bank of America Merrill Lynch February 18, 2014

[4] See Emerging Market Turmoil: The Fallacy of Foreign Currency Reserves as Talisman February 3, 2014

[5] See Phisix: Will the Global Risk OFF Environment Intensify? February 3, 2014

[6] See Kazakhstan’s Devaluation Triggers Bank Runs February 20, 2014

[7] See Behind Ukraine’s Bank Run February 22, 2014

[8] See EM Crisis Over? Thailand Hit by a Bank Run February 19, 2014

Behind Ukraine’s Bank Run

The emerging market Bank run has now spread to political crisis stricken Ukraine. 

From Bloomberg:

Ukraine’s deadly clashes prompted OAO Sberbank to stop offering loans to individuals in the country less than one year after it opened 50 branches there, Chief Executive Officer Herman Gref said.

Russia’s biggest bank, which closed three branches in downtown Kiev this week as violent clashes killed at least 77, has also witnessed a “run on” its automatic teller machines in the country, Gref told reporters in Moscow today. The hryvnia, which is managed by Ukraine’s central bank, plunged almost 8 percent against the dollar this year and non-deliverable forward rates show it will slump another 11 percent in three months….

Growing pressure on the currency could lead individuals to rush to pull money from Ukrainian bank accounts, Dmitri Barinov, a money manager overseeing $2.5 billion of debt at Frankfurt-based Union Investment Privatfonds, said Feb. 18.

Political instability has been blamed on the “bank run” while ignoring the fact that Ukraine has been in a recession even prior to the current political crisis. 

The World Bank during the 2nd quarter of 2013 outlook even notes of the Ukraine’s government’s spendthrift ways even during the recession. (bold mine)

Weak economic performance resulted in a significant budget shortfall in the second half of 2012. Actual revenue of the central budget was UAH 33 billion (2.5 percent GDP) lower than initial budget plan because both real GDP growth and inflation were lower than the forecast on which the budget was based. Meanwhile, expenditures remained inflated due to a hike in social spending (by over 2 percentage points of GDP) introduced in Spring 2012. Fiscal deficit (general government definition) reached 4.5 percent GDP in 2012. In addition, structural deficit of the state-owned company “Naftogaz” was not addressed.

I also pointed out that this has not just been the government, but the private sector sector has been engaged in a debt financed-borrowing spree.

Ukraine’s credit as % to gdp as of 2012 (based on World Bank Data)

Ukraine’s banking sector credit as % of gdp as of 2012.

As you can see Ukraine’s debt levels in both dimensions has more than doubled since 2005.

What the credit inflation has done? Well it has inflated two incredible stock market bubbles in a span of about 5-6 years (2007-12).

Like the first stock market bubble collapse, the second coincided with a recession. The imploding stock market bubbles has now segued into a currency meltdown.

The question unaddressed is how much of money has been lent by the banks to the private sector that had been funneled to inflate such stock market bubbles? How much had been borrowed in foreign currencies?

To what degree have Ukraine’s banks have been affected by deterioration in loan quality? 

So given Ukraine’s Wile E. Coyote moment, 'bank runs' would seem as natural consequence as bank assets deteriorate in the face of fractional reserve banking, a recession, escalating shortage of liquidity and debt deflation.

And banks can hardly rely on the public sector support because Ukraine government has been cash strapped, she desperately sealed a financing deal with Russia in December 2013

In short Ukraine’s economic crisis, primarily due to inflationism or bubble blowing policies, set stage for this political crisis. The likely ramification from the Ukraine's economic crisis is that more bank runs will occur.

I don’t deny that politics have become a factor. But this is a consequence rather than the cause. 

Ukraine’s economic crisis has only deepened the polarization of Ukraine’s fragmented society via partisan politics. Geopolitics may even have been involved here. Some have even alleged that the US has been operating behind the scenes in fomenting another Orange revolution

Because of Russia’s intensive exposure in Ukraine in terms of culture (Russian population in Ukraine) and embedded interests in the energy sector, aside from perceived threats from a supposed US ‘encirclement strategy’ of Russia, where a new US friendly government in Ukraine will be enticed to join NATO.…Russia has reportedly declared that she is “prepared to fight a war over the Ukrainian territory” using the Russian population as cover.

So Ukraine’s crisis can easily metastasize into a international geopolitical crisis. 

And while Ukraine has just signed a peace deal, this serves as no certainty that the political crisis has passed. Russia, a major influence to Ukraine's politics, didn’t join the accord.

What is likely to aggravate the political conditions will be sustained economic uncertainty brought about by Ukraine’s earlier bubble blowing policies amidst heated tensions from culture based politics inflamed by geopolitical interventions.

Anyway the above charts from the World Bank demonstrates why relative debt position seem irrelevant in the measuring of credit risks.

Ukraine’s debt in terms of nominal USD stock has been lower than many developing nations or emerging markets equivalent. This can also be seen in terms terms of % of gdp but at a much lesser scale. Yet Ukraine’s government recognized her near bankruptcy last year.

Debt tolerance has been always based on independent valuations from creditor’s perception of the capacity and willingness of debtors to settle indentures which differs from country to country. When a critical mass of creditors begin to call on the loans, the crisis becomes apparent--one symptom "bank runs".

Going back to the bank run, again if Ukraine’s economic crisis intensifies then more bank runs should be expected.

Yet increasing accounts of emerging market bank runs such as in Thailand, Kazakhstan and now Ukraine, aside from China’s continuing bailouts of delinquent financial institutions demonstrates why the EM crisis have not been over. And as reminder, all these has transpired in a span of two weeks.

And contra the bulls, this may just be the tip of the iceberg.

Kazakhstan’s Devaluation Triggers Bank Runs

A few days back I wrote about Kazakhstan’s surprisingly huge devaluation despite what mainstream would see as strong statistical data. 

As one would realize, Kazakhstan’s dilemma has not been revealed by the current and trade balances but on her currency tenga, forex reserves, external debt and importantly M3. And another thing, given the 19% devaluation, this shows that the alleged low inflation figures have also been patently inaccurate.

Well my suspicion seems right, the devaluation exposed on Kazakhstan’s debt problems via a run on three banks

From EuroAsianet.org

Kazakhstan’s central bank is appealing for calm as rumors that some financial institutions are in trouble following last week’s currency devaluation have provoked a run on three banks.

On February 19 the National Bank sent text messages to the public urging people to disregard the “false information” and not succumb to panic.

“All Kazakhstani banks have sufficient funds in national and foreign currency,” the messages read; people should not submit to “provocations” and “keep calm.”

Large queues formed at some banks in the financial capital, Almaty, for a second day on February 19 as customers rush to withdraw funds, fearing a bank collapse.

Media and officials blame it on rumors.

But logic tells us that if the banking system stands on a firm ground then they wouldn’t be vulnerable to rumors. 

The reason banks are prone to runs aside from Kazakhstan’s existing debt problems has been the roots of the monetary system: central bank fractional reserve banking standard.

"The answer lies in the nature of our banking system", writes the great dean of Austrian economics Murray N. Rothbard, that’s because “they have far less cash on hand than there are demand claims to cash outstanding.”

Professor Rothbard further explains:

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.

Given the recent bank run Thailand, it has been interesting to see what seems as increasing frequency of bank runs in emerging markets or failing financial institutions such as in China.

More signs that emerging markets could be the modern day version of "subprime". 

We live in very interesting times

EM Crisis Over? Thailand Hit by a Bank Run

The emerging market turmoil is over eh?  

Well, one of Thailand’s state owned bank just experienced a bank run. Yes you read it right…state owned.

From the Wall Street Journal (bold mine)

Depositors have withdrawn nearly $1 billion from a bank linked to a foundering rice-subsidy program, the bank said Monday, in one of the first signs that Thailand's months-old political stalemate is starting to affect the economy.

Adding to the pressure on Prime Minister Yingluck Shinawatra, a government agency Monday forecast economic growth rates would slow in the months to come because of the unrest. The prime minister has faced street protests since November calling on her to resign.

Woravit Chailimpamontri, chief executive at Government Savings Bank, said that depositors withdrew 30 billion baht, or $930 million, over the past three days after the bank extended a 5 billion-baht loan to a financial cooperative involved in a state-subsidy program.

The cooperative, which buys rice from farmers at up to 50% above market prices, has been singled out by the antigovernment protesters as representative of the kind of damaging populist policies pursued by the prime minister to build rural support, which has translated into large parliamentary majorities.

As the withdrawals at Government Savings Bank worsened, Mr. Woravit said it wouldn't extend any further loans to the Bank for Agriculture and Agricultural Cooperatives, which manages the rice subsidy program.

In recent weeks, the Yingluck administration has struggled to secure loans from commercial banks to pay the rice farmers, who are demanding payment for grain they already handed over to the government.

This is a prime of example of the realism of UK Prime Minister’s popular quote “The problem with socialism is that eventually you run out of other people's money”. 

Thai’s government extended subsidies to farmers at the expense of the rest of the society in order to buy popular votes via state sponsored loans. However economic reality eventually exposed on the mirage of such free lunch policies. 

Now the foolishness and resource draining activities by the government has been seen by the financial institutions. So they withhold from further extending loans to Thai’s Government Savings Bank. In short, other financial institutions have become aware of the risks of potential financial losses. So depositors stampede out from the bank, while other banks withhold provision of financing.  The mass withdrawals in the face of unbacked or insufficient reserves now extrapolates to a classic bank run.

Naturally, the Thai central bank will step in to bail out the Government Savings Bank. But of course the question is how will the bailout be done? Loans in exchange for what? Another question: what will be the real effects of such bailout? Intensifying consumer price inflation? 

And there is also the issue of which banks or financial institutions have significant exposure in the government bank. Will there be a contagion? Or will Thailand’s central bank, the Bank of Thailand, like China’s PBOC, do a “whack a mole” approach of bailing out any delinquent debt burdened entities that surface? 

Remember, Thailand like any ASEAN has been a bubble economy, whom has largely depended on credit inflation that has bolstered asset prices to generate statistical growth.

Nevertheless it’s been a don’t worry be happy for Thai’s financial markets.

Yields of Thai’s 10 year sovereign has declined (bond rallied) even in the face of the 3 day mass bank withdrawal.

The Thai baht which has been bludgeoned since Abenomics-Taper seems to be having an oversold bounce.

And Thai stocks as benchmarked by the SET has been having a field day. Like the Philippines, they are in a denial rally mode.

But some segments of the credit markets haven’t shared the same enthusiasm as with the stock market punters and treasury bulls. 

Default risks as measured by the 5 year CDS has topped the 2013 Abenomics-Taper highs. Will this bank run up the ante?

Now some harsh reality for the mainstream throng afflicted by the Aldous Huxley syndrome who keeps chanting “forex reserves”, “forex reserves”, “forex reserves”!

Realize that Thai forex reserves from a high of US $189 billion has now declined to US 167 billion (top) (most likely used to defend against tanking baht)  whereas government external debt keeps advancing (bottom). External debt has reached $139 billion and continues to grow. Thus in the context of proportionality, external debt now comprises 83% of Thai’s forex reserves. That’s a very slim cushion.

But but but…now if we reckon Thai’s overall debt levels which has been at nearly 200% of GDP according to estimates from the World Bank, with Thai’s GDP at US$ 366 billion in 2012, this means that Thai’s debt should be way above $500 billion. This means that any contagion from a credit event would render forex reserves a puny shield which seems a "laughable" alibi based on attribute substitution fallacy--because the forex defense smoke screen is a 'fugasi'.

If you fail to notice, we seem to seeing INCREASING account of debt problems surfacing in Asia. These are signs that current conditions are hardly hunky dory. And equally these are signs that the current episode of debt problems have been most likely the icing on the cake. This serves as more evidence of the periphery to core dynamic of a typical credit bubble cycle. As Doug Noland of the Credit Bubble Bulletin nicely puts it “EM is the global “subprime.”

There is no such thing as free lunch. Excessive debt will have its day of reckoning, which seems sooner rather than later.

Of course, the worst part is that when (and not if) these imbalances come unglued, the reaction should be swift and dramatic. That’s why I see the 2014-2015 window as very fertile environment for a global black swan event. 

Caveat emptor.