Monday, October 27, 2014

Phisix: More Panic? BSP Orders Banks to Raise Capital as 2Q Consumer Property NPLs Swells!

"But I don’t want to go among mad people," Alice remarked.
"Oh, you can’t help that," said the Cat: "we’re all mad here. I’m mad. You’re mad."
"How do you know I’m mad?" said Alice.
"You must be," said the Cat, "or you wouldn’t have come here.”
― Lewis Carroll, Alice in Wonderland

In this issue

Phisix: More Panic? BSP Orders Banks to Raise Capital as 2Q Consumer Property NPLs Swells!
 -Asia’s Diverse Performance in the Face of Central Bank PUT
-Phisix Rebounds On Collapsing Peso Volume
-Stock Market Operators: Desperately Seeking 7,400
-Panic Again? BSP Orders A Broad Based Capital Increase for Philippine Banks!
-2Q Property Non Performing Loans Zoom!
-The Narrowing Window of ECB’s Risk ON Joy Ride

Phisix: More Panic? BSP Orders Banks to Raise Capital as 2Q Consumer Property NPLs Swells!

Asia’s Diverse Performance in the Face of Central Bank PUT

The US Federal Reserve (& Plunge Protection team?), the European Central Bank, Bank of England and reportedly Japan’s Government Pension Investment Fund (GPIF) instigated a gigantic rally in risk assets last week which incited a virtual recovery in most, if not all, of last week’s return of downside volatility. Like Pavlov’s dogs or Zombies from World War Z all it took had been soothing words and easing actions from governments to ensure the steroid laced shindig goes on.



In Asia, the response to the developed world’s Central Bank-Government Put had been divergent.

Among the three national bourses which experienced a quasi-crash, only the Nikkei’s 5.02% collapse had been more than fully recovered with this week’s 5.22% melt-UP. The other major losers, Taiwan’s TWII and Vietnam’s Ho Chi Minh index only regained 30.83% and 20.19% of their respective slump.

Among the outperformers, Australia and Indonesian bellwethers, having been untainted by the meltdown, added to last week’s gains. New Zealand’s benchmark erased last week’s dip with a fabulous run which led to fresh record highs. India’s Sensex gains tripled from last week’s decline as with Hong Kong’s Hang Seng.

As for the ASEAN majors, returns on Malaysia’s KLSE covered all of last week’s fall with a substantial premium. Singapore’s STI zeroed out the previous week’s negative return. Curiously, the ASEAN charting twins of Thailand’s SET and the Philippines Phisix offset only 47.1% and 62.44% of the previous week’s slide.

Phisix Rebounds On Collapsing Peso Volume


A closer view of the activities of Philippine Phisix reveals of an even prosaic performance.

One of the distinguishing characteristic of Phisix at record high 7,400 circa 2013 and 2014 has been in the Peso volume, where today’s fresh record high has been accompanied by 30-35% less volume as previously described[1].

Such phenomenon has even been magnified this week where this week’s rallying Phisix (left window) comes curiously with a collapsing Peso volume (right window).

The average daily volume peso for this week’s ‘pump’ has been at P 6.467 billion which accounts for only 49% from last week ‘dump’.

In the two days where the bulk of this week’s rally came from October 20 (+.78%) and October 22 (+1.22%) peso volume had been at Php 6 billion and Php 6.7 billion respectively.

Last week’s average Peso volume has been a rarity in the current manic phase.

Previous episodes with similar peso volumes from 2013 to-date reflect on consolidation phases, mostly as ramifications from a steep selloff, as in July 2013 and January 2014. In July 2014, this has been merely from consolidation which followed a sharp upside move.

While from the short term perspective, the upside momentum may have been partially impaired, say for instance 50 day moving average have been broken, this can’t be true for the medium term as current Phisix levels remains heftily above the 200 day moving averages (not shown in charts).

The Phisix hasn’t had a typical correction phase in 2014 (defined as 10% retracement).

And since in the past such languid volumes manifest range bound actions, price actions have hardly been volatile.

Considering the sharp price gyrations, last week’s activities hardly signal a consolidation phase in the Phisix. Instead they seem to reflect signs of a struggle—stock markets bulls have been laboring to recapture price levels which they believe are key to reviving momentum…and glory.

Current stock market bulls are territorial. They hardly bother about valuations or risks. They see price levels as ultimately determining the outcome “win” or “loss”, thus the implied emphasis on 7,000 or 7,400.

Yet market actions suggest that despite the recent gains, bulls may be losing ground in terms of market internals or in this case plummeting peso volume.

And it’s even extraordinary to see over 1% one day advance with less than P 7 billion of peso volume traded.

Stock Market Operators: Desperately Seeking 7,400

Moreover, the recent rebound amidst swooning volume comes in the visage of support from undefined or unidentified stock market operator/s. These faceless entities appear to have been responsible for most of the rallies over the past two consecutive weeks.

During the week of meltdown, on Thursday October 16[2], domestic panic buying from the opening bell until the session end, focused mainly on three major issues, weightlifted the Phisix to bizarrely outperform the region immersed in losses.

Such move may not only have been intended to generate a bandwagon effect but likewise seem to have been meant to broadcast persistent confidence over the stock market which is supposed to reflect on the system.

Yet a bulk of this week’s gains emanated with a major “marking the close”. An astounding 54.5% of Wednesday’s 1.22%[3] low volume surge came at the final minute. Again the price massaging has been centered on 3 major issues.

Marking the close attempts to manage price levels at the close of the trading day or could be engineered to craft the charts intended to influence the ‘chartists’, a popular tool used by market participants.

In my view, intraday massaging of the markets would have a better chance of attaining a herding or bandwagon effect, but it could be more costly. So the frequent recourse to “marking the close”, which ironically has become an almost regular feature in the denial rally of 2014.

Nonetheless, the common trait in the massaging the index, either via intraday “pump” or “marking the close” have been to massively push up prices of at least 3 issues with combined market cap weighting of 15-20%. In panic buying episodes, (September 24 and October 16), the kernel of these activities transpire after lunch break. 

The likely objective for massaging of the domestic index has been to convince the public in order to draw them in. 

Yet such has political, economic and ethical implications.

Since stocks have been popularly associated with G-R-O-W-T-H, higher stocks should imply sustained levitated G-R-O-W-T-H.

In politics, popular approval ratings would accrue to the political leadership from which G-R-O-W-T-H and soaring stocks have occurred. And for politicians to successfully push for their agenda, this depends on political capital from which approval ratings have been a key component of.

In the markets, since stocks have been popularly associated with G-R-O-W-T-H, pushing G-R-O-W-T-H to justify higher prices of already exceedingly overvalued securities extrapolates to the luring of “greater fools” from which vested interest groups can unload to or profit from a transfer of risks.

In addition, resources have been used in the price management of the index. It would be highly doubtful if such actions have been funded from personal accounts of the operator/s. The likelihood is that the risk money exposed in such schemes have been through third party account, whether from taxpayers (in case of public money) or from depositors (if private money).

Nevertheless an index ‘pump’ signifies reckless and negligent use of fiduciary money/resources. This may be part of the entrenched or unwavering belief of the infallibility and perpetuity of the populist G-R-O-W-T-H model. Or it could be part of political agenda.

Yet the easiest part is to gamble people’s money away. And when untoward time surfaces, these entities would most likely abscond responsibility and just seek safety with the crowd. As the chief proponent of the inflationism John Maynard Keynes wrote[4] “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.”

Yet of course, the crowd never questions the QUALITY of economic growth and or of the stock market boom. Such flagrant misperceptions embody a mania. And since manias are a self-reinforcing process, they take a life of its own. Reasoning alone will hardly convince many of the errors of their convictions. Perhaps not even authorities may persuade them.

Hardly would anyone dare ask; what would have been the outcome of today’s Phisix outside these operators?

And will the crowd will heed the admonitions aired by the Bangko Sentral ng Pilipinas Chief Amando M Tetangco Jr who in August said, as I previously quoted[5], “So in a period of low volatility such as what we have been experiencing, practice the discipline of setting limits. This discipline will not only help you to avoid the pitfalls of “chasing the market”… (bold mine)???

Despite coming off the recent record highs, current price levels still reflect on the salad days of the easy money regime, which accommodated the “chasing the market” via price multiple expansions. These easy money days are over.

Overvalued securities will even become more mispriced once the misallocation of capital will be exposed in the formal economy, where the earnings part of the PER ratio or book value of the PBV ratio will substantially shrivel. So even if the Phisix retrenches to 7,000 or 6,000 or 5,000 levels, the crowd hardly realizes that these will still reflect on the “pitfalls of chasing the market”.

And early this month, the BSP chief became more explicit, again as previously quoted[6] “While we have not seen broad-based asset mis-valuations, the BSP remains cognizant that keeping rates low for too long could result in mis-appreciation of risks in certain segments of the market, including the real estate sector and the stock market as markets search for yield.” (bold mine)

Let me improvise. Keeping rates low for too long could result in results to mis-appreciation of risks in certain considerable segments not only of the markets but of the real political economy. Free money from zero bound rates distorts the pricing system, economic calculation and economic coordination, thereby creating imbalances and amplifying financial instability risks. Such risks I have long warned about has now been part of the BSP’s chief speech.

Keeping rates low for too long has political repercussions too. It serves as free lunch for government spending, as well as free lunch to the political economic elite whom has a free hand access to banking and the capital markets at BSP’s subsidized rates which has ballooned asset prices which consequently inflated the elite’s asset based wealth.

All these have been financed by the currency holders (as seen by the 30%+ money supply growth, floundering peso, and government inflation numbers at the top end of the target), thereby ballooning inequality.

The bottom line is that there is no free lunch. What goes around comes around.

Panic Again? BSP Orders A Broad Based Capital Increase for Philippine Banks!

I have said that the BSP’s obfuscating statements on their policy actions has hardly been what they really are.

For instance when the BSP raised for the second time simultaneously official policy rates and Special Deposit Account (SDA) rates in September, I asked the following questions[7] on their official statement:
So why should a supposedly “sound” boom be accompanied by symptoms of overvaluations and consumer price pressures? Why the need to tighten if the predicament has been one of supply side pressures where liberalization of imports would be the simple and commonsensical answer to address price pressures? What is the relationship of tightening (money) with supply side (real economy) constraints? What is the relationship of tightening (money) with massive asset overvaluations (financial assets)?

Since the BSP’s message has become repeatedly been opaque, evasive, contradictory and non-transparent, I provide the answer: Credit.
For a terse background or chronicle on the BSP’s path to curb credit expansion; as baptism, bank reserve requirements had been raised twice—first in the last days of March and second in May. Then the BSP called for a banking stress test, as well as, increased the SDA rates for the first time in June. The first official rate hike was announced at the end of July. In September, the BSP lifted both SDA and official rates. So the BSP implemented SEVEN policy actions in SIX months.

The BSP’s recent panicking has hardly been over.

While it is true that the BSP has kept official and SDA rates at current levels this week, they merely shifted their thrust from monetary policies to regulating banking system’s balance sheets.

The alleged reason for the keeping rates steady has supposedly been due to “easing pressures on commodity prices. Inflation expectations have also remained broadly stable and aligned to the inflation target.”[8]

The slowdown consumer price inflation (4.4% in September[9]) can easily be spotted by the sharp retrenchment of money supply growth from its 9 month 30%++levels, as I previously projected[10], “While the slowing liquidity would be theoretically good for currency holders as the pressures from price inflation should eventually ease, this would mean bad news for asset speculators and the asset inflation based growth model which the statistical economy has been pillared on”.

This has been compounded by plummeting commodity prices abroad.

And I anticipated the substantial decline on the 30++% money supply growth as indications of systemic credit strains[11]
And current developments will slam the local economy in two ways, money inflation percolates into the economy in a time lag, or it takes time for the increases of money supply to show up in relative prices. Price increases will not be equal as some will rise ahead and or faster than the rest.

This means the huge 30+%% money growth in the second half of 2013 will continue to exert pressure on prices. So companies will see an increase in input prices which may begin to strain profits.

Second, the recent slowing of money supply growth will mean lesser support for the bubble activities. If it is true that a growing segment of borrowing are being rechanneled just to payback existing loans then Debt in-debt out will mean added strains on balance sheets of firms as cost of servicing debt rises.

And slowing money supply will now put pressure on profits derived from the narrowing window of price arbitrages from previous money supply expansion. This will begin to negatively impact capital expansion, thereby slowing increases in income that will be reflected on reduced demand or consumer spending. As the supply side growth skids, malinvestments will begin surface in terms oversupply and debt burdens. This means that the process of diversion of resources—from productive to non-productive speculative capital consuming sectors—will slowdown. There will be a feedback loop between debt burden and growth. And once the problems become evident, the process of market clearing via liquidations and asset value mark downs will accelerate. Boom will morph into a horrific bust.
The recent deceleration of money supply growth may have been forerunner to the second abrupt surge in real estate NPLs (as discussed below)

The shift in policy maneuver, however, as I noted above is that the BSP, using the Basel Rules as smokescreen, has ordered ALL banks to increase capital!

From the BSP (bold mine)[12]: The Monetary Board (MB) decided to increase the minimum capital requirement for all bank categories: universal, commercial, thrift, rural, and cooperative banks in line with efforts of the Bangko Sentral ng Pilipinas (BSP) to further strengthen the banking system. The upward revision in minimum capital levels is a separate requirement from compliance with risk-based capital adequacy ratios in accordance with Basel 3 requirements as implemented by BSP Circular Nos. 781 and 822 dated 15 January 2013 and 13 December 2013, respectively…Under the new regulation, the minimum capital level of universal and commercial banks will be tiered based on network size as indicated by the number of branches. Minimum capitalization increases in tiers as the branch network gets bigger.  For thrift, rural and cooperative banks, both the location of the head office and size of the physical network are considered in tiering the minimum capital requirements

For banks which may not be able to immediately comply, they are given a five year transition period provided they “submit an acceptable capital build-up program”

We are talking here of about 700 banks (36 universal commercial, 70 thrift banks, 552 rural banks and about 83 quasi banking-savings loans associations ‘cooperative banks’ based on BSP’s directory)

Not only has the BSP ordered banks to raise capital, they have delineated the domestic version of “too big to fail”, particularly Deemed Systemically Important Banks (D-SIB) which firms would require higher capital buffer ratios.

Again the BSP (bold mine)[13]: The Monetary Board (MB) approved guidelines for determining so-called “D-SIBs” or those banks which are deemed systemically important within the domestic banking industry. This is in line with initiatives pursued under the Basel 3 reform agenda. Global reforms on the treatment of systemically important financial institutions (FIs) have been initiated in light of the socio-economic costs arising from the financial crisis. This includes the government bailout of failed FIs particularly in advanced economies. In an effort to strengthen financial markets and remove the moral hazard of publicly-funded bailouts, the Basel 3 reform agenda requires systemic FIs to set aside more funds as buffer for potential losses. D-SIBs are characterized as banks whose distress or disorderly failure would cause significant disruptions to the wider financial system and economy…Banks will be evaluated based on measures for (a) size (b) interconnectedness (c) substitutability/financial institution infrastructure and (d) complexity. Although these measures are largely quantitative, supervisory judgment may also be applied as warranted in determining a bank’s systemic importance. Based on their composite score, each bank will be slotted into one of three “buckets” of systemic importance. Systemically important banks will be required to increase their minimum Common Equity Tier 1 (CET1) ratio by 1.5 to 3.5 percentage points depending on which bucket they are classified. This will be on top of the existing CET1 minimum of 6 percent and the capital conservation buffer of 2.5 percent.  DSIBs whose capital ratio falls below their corresponding regulatory minimum will be subject to constraints in the distribution of their income.

So the bigger the bank, the greater the required capital and capital adequacy ratios. One can get a clue from BDO’s market share presentation of Philippine commercial banks here.

Not content with raising capital and instituting more regulations for Philippine version of Too Big To Fail (D-SIB), the BSP will add more regulations on banking system’s in order to enhance ‘credit management’

From the BSP[14] again (bold mine): The Monetary Board (MB) has approved major amendments to the regulations governing credit-risk taking activities of banks and quasi-banks (B/NBQBs) following a comprehensive policy review undertaken by the BSP.  The amendments seek to fundamentally strengthen credit risk management in these financial institutions in line with global best practices and Basel Core Principles for effective bank supervision. Under the enhanced regulations, the critical role of the Board of Directors and Senior Management in promoting a prudent and sound credit environment in their organization is emphasized.  The credit risk management framework should be comprehensive and cover the entire process end-to-end, from credit policy strategy to credit underwriting to credit administration to maintaining the appropriate control environment. On the back of strong credit risk management, banks stand to gain greater flexibility to extend credit, innovate credit products, and develop lending programs.  The new rules are also based on proportionality principles that allow BSP supervised FIs to adopt appropriate credit risk management practices commensurate to their size, scale, complexity.

So whatever happened to the recent bank stress tests? Has the BSP not secured sufficient confidence from the recent results? Or has the results increased their anxieties which instead has prompted them for a massive revision for capital requirements?

Why the sudden raft of mandates: from huge increases in capital requirements to a definition of D-SIBs and their attendant controls and to a torrent of bureaucratic regulations on credit management? Such would mark the EIGHT policy action in SEVEN months!

WHY???

The BSP thinks that more mandates on the banking system will wish away a crisis. They hardly realize that it has been the one-size-fits all aggregate policies (despite the numerous categorizations) of a complex and highly diversified system that creates imbalances.

This piggybacks on the much significant and more fundamental one-size-fits-all monetary “aggregate demand” policies which the BSP governor cautioned at “keeping rates low for too long could result in mis-appreciation of risks”.

Yet the more the concentration and the centralization, the greater the risks of imbalances.

It would seem that the BSP realizes that incremental increases in policy rates (official and SDA) would do little to forestall the current rate of credit growth. Yet to increase these sizably would send alarm bells to the public. I estimate that banking system’s September report due next week will see a still considerable increase in credit expansion rates.

So they resorted to an alternative “macroprudential approach”: attack the banking system’s balance sheets.

And here is what the BSP didn’t say.

Banks can raise capital through the stakeholders and or shareholders (sell shares) or by borrowing from the markets or from the government[15]. Unless the government would function as the source for capital, domestic banks will be forced compete with all other industries for resources during the capital raising period.

Since there are relatively a few participants in the Philippine real economy that have been involved or have stakes in the formal banking system, bank capital raising activities will likely drain resources from the system. This implies higher rates

However, part of the capital increases may be financed overseas or by foreign investments as the Philippines government has thankfully liberalized the Philippine banking system.

As a side note, money flows where it is treated best. Liberalization of ownership while necessary isn’t sufficient. A free flow or movement of capital precedes ownership in economic importance. Capital controls reduce incentives for foreign ownership. Having 100% foreign ownership with highly restrictive capital movements will function like a roach motel for foreigners—you can check in but you can’t check out. Whereas a free flow of capital will have the opposite effect, viz. increase the incentives for ownership. So to increase foreign ownership, the Philippine government will need to materially deregulate capital flows.

Going back to bank capital increase, in addition, when banks issues and sells equity which investors/shareholders/stakeholders buys with funds from a bank deposit, the reduction of deposit liabilities destroys money. The same applies with bank issuance of long-term debt which the private sector buys. As per the Bank of England[16] “Money can also be destroyed through the issuance of long-term debt and equity instruments by banks.”

And since such bank capital raising activities extrapolates to money destruction this means reduced lending activities in the banking system.

Thus BSP’s mandate of broad based capital increase for the Philippine banking system seems tantamount to tightening on the banking system’s balance sheets.

2Q Property Non Performing Loans Zoom!

I mentioned above that the recent deceleration of money supply growth may have been forerunner to the second abrupt surge in real estate NPLs.



Could this be the reason why the BSP seem to be in a state of desperation?

The data on the consumer loan report which is due out next week can be seen from the current BSP statistical page. 2Q Non performing loans jumped 5.4% quarter on quarter, although NPLs constitute only 5.04% share of consumer loans.

NPL growth of auto loans remains elevated at 6.01%. Nonetheless NPL share of outstanding car liabilities are only 4.26%.

Importantly NPL growth in real estate loans continues to bulge at 9.1%! NPLs represent a measly 3.2% share of total property loans.

Real estate loans accounts for 43.34% of total consumer loans over the same period

The 2Q jump in Property NPLs adds to the 7.78% growth rates during the 1Q.

Anent the 1Q NPLs I wrote then[17],
The more than doubling of the growth rates of the real estate consumer NPLs in the 1Q 2014 vis-à-vis the average of the last three quarters of 2013 can be juxtaposed to the breathtaking 8.95% 1Q 2014 spike in the prices of 3 bedroom condominium units in Makati, the cresting of money supply growth rates also in Q1 2014, the intensifying official inflation rates and the below consensus expectations of 5.7% 1Q 2014 GDP growth rates.

It is striking to observe that as speculators fervently bid up on Makati condos at an 8.95% inflation rate which became a world sensation (see below on IIF), other buyers of condos have become delinquent. In other words, the growth rates of real estate NPLs (bad debts) have nearly caught up with the Makati’s property inflation.

Also we can deduce that inflation’s substitution and income effect has begun to hamstring on consumers spending by diminishing disposable income, thereby most possibly contributing to the 1Q rise in bad debts.
And to expand the perspective of 2Q data on a Year on Year, Year to date and Quarter on Quarter using BSP’s current and previous figures…

Phil Banking System Consumer Loans Billions In Pesos Y-o-Y Y-t-d Q-o-Q
Non-Performing Loans (NPLs) June 2013 Dec 2013 Mar 2014 June 2014 % chg % chg % chg
Total consumer loans 41.459 38.508 38.414 40.482 -2.3 5.12 5.4
Auto loans 7.981 7.768 8.313 8.813 10.42 13.45 6.01
Real Estate loans 9.181 9.473 10.255 11.187 21.85 18.09 9.09

While auto loans have also been surging, property NPLs seem as accelerating. I’ll focus on property NPLs.

Year to date real estate NPLs zoomed 18.09%. The Y-T-D growth has nearly reached the Year on year the growth rate at 21.85%.

Last year I noted of the role of NPLs as statistical indicators[18]: Non Performing Loans (NPLs) are coincident if not lagging indicators. NPLs are low because the current boom continues. NPLs become reliable indicators, when asset quality deteriorates or when the credit boom is in the process of reversing itself into a bust. Again they are coincident if not lagging indicators.

Because economics and markets represent a process, things/events evolve at the margins. Rising consumer NPLs are likely symptoms of the developing deterioration in consumer finance.

While NPLs as a share of the overall loans remains small, they could rapidly surge. Since real estate loans are two fifths of overall loans, any dramatic rise in property NPLs could amplify the overall share of NPLs to overall loans.

I have been saying here that the current aggregate demand Philippine growth model has been anchored on supply side growth financed heavily by debt. At current conditions, where the growth rate of debt expansion remains robust, there have already been signs of credit strains. Yet the recent decline in the rate of money supply growth, as noted above, could be symptoms of the domestic credit system having reached its peak, where instead of people borrowing to finance expansion, borrowed money have been used liquidate existing liabilities.

Money supply growth rate seem to have popped to the upside again in July and August, but given the sustained pressures applied by the BSP on the banking system eventually these policies will most likely impact growth rates of credit, consequently money supply and subsequently G-R-O-W-T-H.

Remember the Philippine banking system has accounted for about 70% of money supply.

So how much more when credit expansion materially slows? Then all those inflated earnings, profits, income, and taxes will come under pressure.

Unlike ebola whose transmission mechanism is through body fluids, all it takes for credit risks to surprise the overconfidently blinded public will be a material slowdown in real economic growth. Built in imbalances will merely surface on the account of a downturn.

And any slowdown in economic growth will have a feedback loop of magnifying credit risks.

Given the relatively low penetration level by the Philippine populace on the banking system, which implies low exposure on loans by the average citizens, thus the relative low consumer debt compared to her neighbors.

So I doubt if NPLs in banking consumer loans alone would be a threat. But NPLs in consumer loans will never be a standalone variable. As said above, rising consumer NPLs implies developing strains on consumer finances.

Rising consumer NPLs will likely be transmitted to affect bank profits and add, if not incite, balance sheet problems. Generally speaking, developing strains on consumer finances will impact the heavily leveraged supply side, whom has been dependent on a geometric expansion in the growth rates of consumer finance. Thus the radical departure between supply side expectations and the real conditions of consumer finance will bring to the surface the unsustainable conditions that have underpinned the maturing inflationary boom: malinvestments.

Yet once the statistical economic G-R-O-W-T-H takes a hit, I expect the hawkish tones of the BSP chief to reverse. However this won’t save the bust in the stock market, the property sector and the delusional G-R-O-W-T-H.

The Narrowing Window of ECB’s Risk ON Joy Ride

From a massive Risk OFF to an even more colossal Risk ON.

The central bank put has been acknowledged by mainstream media.

This article from Bloomberg captures the zeitgeist of the return of the Risk ON[19]: The central-bank put lives on. Policy makers deny its existence, yet investors still reckon that whenever stocks and other risk assets take a tumble, the authorities will be there with calming words or economic stimulus to ensure the losses are limited.

The article goes on to suggest that it would require some $ 200 billion every quarter from central banks’ “nothing for something” to keep global risk markets from falling apart.

One of the analyst quoted in the report speculated that a 10% decline in US stocks will prompt the FED to a fourth round of Quantitative Easing.

This shows how mainstream experts and mainstream media has come to believe of the invincibility of central bankers to manipulate markets to ascend perpetually without consequences

Aside from the verbal support provided by several central bank personalities[20] as the Fed’s John Williams and James Bullard, ECB’s Benoit Coeure and Bank of England’s Andrew Haldrane at the end of last week.

It was the ECB which revived the QE last week with covered bonds. Unfortunately, the ECB’s actualization of the QE seems to have been insufficient as Europe’s markets exhibited signs of pressures anew[21].

So the following day rumors flew that the ECB would be considering corporate bonds as part of the easing program. Markets went into bacchanalia again[22].


Almost every day during the last week required some verbal interventions by monetary authorities. 


And like Pavlov’s dogs (or World War Z zombies), markets conditioned to stimulus went into a mindless panic buying spree

So the above actions confirm my theory of the politics of monetary easing policies: I recognize the problem of addiction but a withdrawal syndrome would even be more cataclysmic.

Yet the focus on withdrawal syndrome (short term fixes) will only aggravate the (long term) entropy from sustained substance abuse.

And perhaps in the realization that the results of the ECB bank stress may engender more market mayhem, the ECB confirms as of this writing of the 25 banks that failed in the stress tests for banks mostly in Cyprus Greece and Italy but has downplayed its impact noting that “banks' capital holes had since chiefly been plugged and that only 10 billion euros remained to be raised.”[23]

So this supposedly good news may reverse Europe’s Friday decline.

But the ECBs proposed buying programs has technical and legal hitches.



The chart above from Citi Research published by Zero Hedge reveals of the limitations of the potential purchases of covered bonds, Asset Back Securities (ABS) and even corporate bonds potential purchases by the ECB.

The Reuters quotes Rabobank estimates of ECB purchases of covered bonds at 100 billion euros and a tenth of ABS, whereas a Reuters’ survey shows that economists expect 250 billion of purchases. 

Excluding short maturities foreign currency issues and junk ratings only 700 billion to 1.1 trillion euros of corporate bonds could be considered as eligible for ECB purchases but many expect that the ECB’s prospective purchases “would be very much smaller”[24]

Even during the last covered bonds buying program in 2011-12, the ECB failed to meet its target according to the Wall Street Journal.

The point of the above is that unless the ECB decides to throw in sovereign bonds in the cauldron of asset purchases, the much hoped for expansion of ECB’s balance sheets by 1 trillion+ euros may unlikely be met.

But there are legal impediments for direct purchases by the ECB on sovereign bonds. 

Article 104 of The Maastricht Treaty, the treaty that created the euro states that
1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.
Yet the ECB has previously defied those rules, and as of 18 June 2012, according to the Wikipedia.org, the ECB in total had spent €212.1bn (equal to 2.2% of the Eurozone GDP) for bond purchases covering outright debt, as part of its SMP running since May 2010

The political roadblock lies from the resistance by many Germans to the ECB programs. This month Germans opponents to the ECB’s project which included a lawmaker charged before Europe’s highest court “that the ECB’s Outright Monetary Transactions program violates an EU treaty, which sets controlling inflation as the ECB’s primary goal”[25].

Last week, lawmaker members of Chancellor Angela Merkel's conservative party excoriated the ECB for floating hints to include corporate bonds in the recently revived QE reports the Reuters. 

The ECB has been swiftly losing its support with the German government notes another report from Reuters. Aside from the breakdown in the relationship with Bundesbank President Jens Weidmann, a full-blown government bond buying by the ECB, may further ignite the already growing new anti-euro party, the Alternative for Germany (AfD).

There is no free lunch even for the ECB. Germany’s domestic politics will function as natural constraint to Merkel’s accommodation of ECB’s Draghi. That’s aside from the court case filed before the European Court of Justice. 

Should the ECB lose Germany’s total support, then perhaps all hell may break loose in the EU.

The tussle has not just between Germany and ECB. Even the UK has its own non central bank beef with the EU. The UK government refuses to increase its funding of EU institutions in Brussels. The current squabble over UK’s EU financing reports the Irish Times has the potential to shift UK public opinion toward quitting the 28-nation bloc.

Risk ON for asset markets from ECB’s myriad promises of other forms of easing may continue but current developments suggest that such joy ride may be for a short time only.





[4] John Maynard Keynes 7. The Consequences to the Banks of the Collapse of Money Values (Aug. 1931) ESSAYS IN PERSUASION Gutenberg.ca




[8] Bangko Sentral ng Pilipinas Monetary Board Keeps Policy Rates Unchanged October 23, 2014

[9] Bangko Sentral ng Pilipinas September Inflation Slows Down to 4.4 Percent October 8, 2014



[12] Bangko Sentral ng Pilipinas MB Increases Minimum Capital Level Requirement for All Banks October 20, 2014

[13] Bangko Sentral ng Pilipinas MB Issues Framework for Systemic Domestic Banks October 21, 2014

[14] Bangko Sentral ng Pilipinas MB Approves Enhanced Regulations on Credit Risk Management October 20, 2014


[16] Michael McLeay, Amar Radia and Ryland Thomas of the Bank’s Monetary Analysis Directorate Money creation in the modern economy Quarterly Bulletin Q1 2014









[25] Wall Street Journal Europe’s Highest Court Hears Clash on ECB Policy October 14 2014
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