Sunday, September 29, 2013

Sunday, May 19, 2013

Risk Analysis - Quantitative Easing

Is Quantitative Easing (QE) akin to a magnetic suspension on a high end car?  Magnetic suspensions benefit from the selective application of a magnetic field to iron particles suspended in hydraulic oil.  Different settings impact the viscosity of the oil and resulting stiffness or softness of the suspension.  Quantitative easing involves the purchase of government bonds and other assets by the government.  Different purchase programs impact the real (inflation adjusted) interest rate and associated demand and consumption.  Bumpy roads conquered?

There are suggestions that the QE control algorithm may receive an update which will result in a change in asset purchases and eventually interest rates.

Traders and investors would do well to consider the potential impacts, to their holdings, of the next version of QE (QE1, QE2, Operation Twist, QE3...).  Let's briefly look at three possible scenarios:  no change, bumpier ride, and smoother ride using six indicators.  The Federal Reserve and the ECB set interest rates and auto sales and unemployment are a proxy for demand and consumption.  The time periods used in the three scenarios are completely subjective:  

No Change (2012 historic average annual data):
  • Fed rate:  0.3%
  • ECB rate:  0.0%
  • Auto sales, US:  14.5 million
  • Auto sales, EU:  12.9 million
  • Unemployment, US:  8.1%
  • Unemployment, EU:  9.1%
Bumpier Ride (2008 historic average annual data):
  • Fed rate:  1.9%
  • ECB rate:  2.9%
  • Auto sales, US:  13.4 million
  • Auto sales, EU:  13.5 million
  • Unemployment, US:  5.8%
  • Unemployment, EU:  6.0%
Smoother Ride (2006 historic average annual data):
  • Fed rate:  4.9%
  • ECB rate:  2.0%
  • Auto sales, US:  16.6 million
  • Auto sales, EU:  14.8 million
  • Unemployment, US:  4.6%
  • Unemployment, EU:  7.1%

Sunday, March 31, 2013

Risk Analysis - EU Banking Union

There are approximately 6,000 banks spread across the 27 nations/member states of the EU.  They are not subject to centralized supervision/regulation, not subject to a centralized resolution mechanism, nor protected by a centralized safety net.  Basic probability theory would seem to suggest that 16% of these 6,000 banks should have little or no issues, 68% will muddle along, and a trailing 16% can be expected to struggle.  The potential for a banking catastrophe to significantly impact the world's largest economy, which has a combined annual GDP of approximately 16 trillion USD, is exacerbated by a lack of unity regarding supervision and monetary policy.

Berlin, Paris, and London appear to be, in many ways, conflicted about this state of affairs.  Politicians, of all nationalities, continually seek maximum flexibility in allocating resources to their supporters. Historical events such as the Hundred Years War, WWI, and WWII have left their mark upon European society as a whole however.  With the recent events in Cyprus, Greece, Ireland, Portugal, and Spain fresh in everyone's mind, the European Central Bank gained provisional oversight for 150 banks on the 19th of March 2013. These 150 banks manage approximately 80% of the EU's assets.  Economic and Monetary Union, defined by the European Commission as a single market with a common currency and monetary policy, continues to be a work in progress.

Tuesday, March 26, 2013

Risk Analysis - Cyprus

Memes such as Too Big To Fail, Privatize Gains and Socialize Losses, Casino Wirtschaft, and others attempt to describe the negative aspects of complex banking business models in a way that is simple and easily accessible to many.

Jeroen Dijsselbloem has been the public face of the EU's recent attempt to reapportion banking risk between sovereigns and the private sector...via a 'new' business model.  He is a government minister from the Netherlands and the head of the eurozone group of finance ministers.  In spite of this or perhaps because of this he is experiencing a tough fight and an uncertain outcome.


Saturday, March 23, 2013

Risk Analysis - Cyprus

An estimated 10 billion Euro bailout to be provided to Cyprus by 'The Troika' (European Central Bank, European Commission, and International Monetary Fund) is ensnared in regional energy, financial, geopolitical, and security concerns.  China, Germany, Israel, Russia, Turkey, the EU, the UK, and the US all have competing and overlapping concerns regarding the structure and implementation of Cyrpus' bailout from the Troika and it's accompanying 5.8 billion Euro bail-in to be funded by bank depositors and investors.  An estimated total of 15.8 billion euros is needed to recapitalize Cyprian banks and refinance it's national debt.  The ECB is scheduled to cut off short term financing to Cyprus on the 25th of March if a deal cannot be reached by then.