The topsy-turvy world of finance and its ruinous impact

Post the 2008 global financial crisis, central bankers have followed an easy money policy and a low interest rate regime, as a medicine to boost global economic growth. They hoped that the liquidity would go on to spur consumption demand which, in the US, accounts for 70 per cent of GDP, or investment demand. Despite evidence that this was not happening, the central bankers continued with their mistaken beliefs in its efficacy to boost economic growth, and thus are paving the way for asset bubbles.

Today, some $17 trillion are invested in negative interest bonds. Some central banks are charging (instead of paying) commercial banks interest on their deposits.

In turn, commercial banks are charging interest to their depositors for keeping depositor money!

Some commercial banks in Belgium for example, are providing mortgage loans to citizens, with a negative interest rate, i.e. the borrower gets an interest from the bank to borrow money!

Think about that.

In any balance sheet, assets earn income and liabilities are expenses. But this is not overturned.

Bank assets such as mortgage loans by Belgian banks, or deposits with central banks have become liabilities as the assets result in an expense (interest outgo), as borrowers get interest to borrow money because of negative interest rate.

But deposits, which are liabilities, have become assets, because banks charge money from customers to keep their money!

The pension funds of all 50 states of the US are inadequately funded. They do not get the 7 per cent return on assets needed to meet their commitments.

French President Macron tried to change the benefits, anticipating the coming problems. The French people protested in riots.

Thus, the lower rates do not help borrowers to boost consumption or investment, but harm savers and deprive them of retirement benefits.

Just how bizarre this has become can be judged by one event.

Illinois does not have funds sufficient to meet its obligations, neither in the state pension funds nor the state government itself. If the pension liabilities are divided by the number of households, each would have to pay $75,000 to make up the shortfall. But most households cannot afford this. So there was a suggestion to make only those earning more than $200,000 to bear the burden of ‘shadow mortgage’ then each such household would need to shell out $1.3 million. It is incredulous to imagine they would. There would be legal challenges at first, and civic unrest later.

Now see the flip side. French luxury goods maker LVMH wanted to buy jeweller Tiffany for $ 16 b. It made a bod issue, in tranches. Tow of the five tranches were bought at a negative yield (including by ECB, European Central Bank) which meant that the profitable luxury goods maker was being paid interest by lenders. This, even as homeowners in Illinois were likely to be saddled with a shadow mortgage liability.

If this is not insanity, pray, what is?

The central bankers bent over backwards in 2008, and thereafter, to save ‘too big to fail’ banks. They continue doing so. A YouTube video ‘6 Mega Banks which may bail you in’ talks about the impending danger of ‘bail-ins’ by banks. A bail-in is when a bank seizes its customer deposits to pay for its losses, as distinct from a bail-out when it uses tax payer money to do so.

In order to get higher returns, the big banks have taken on huge exposures in the derivatives market. The outstanding derivatives run into trillions of dollars and the market, like a house of cards, is interdependent. What happened in 2008 after the collapse of Lehman is that banks refused to transact with each other, unsure of the toxicity of the counter party. The interdependency vanished.

More worryingly, as the YouTube video mentioned above points out, as per US laws, the rights of a holder of derivatives is higher than the rights of a depositor, who is, essentially, an unsecured creditor. So, if a big bank fails, the depositors lose their money not the banks which overexposed themselves.

Global stock markets fell last week, and blamed the coronavirus when it was actually the logical correction to a long rally. Yes, the virus will negatively impact global GDP growth. But the bigger virus is the huge derivative exposure of banks and the enfeebled condition of central banks to handle another 2008. This concern is reflected in the rising prices of gold.

The writer is India Head — Finance, Asia/Haymarket. The views are personal.

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