I think too much credit and too much leverage got us into this problem. I don’t have a problem with debt because I think debt is a good thing – debt leads to construction projects, infrastructure spending and capital expenditure. The problem I have is with the structures of all these debt time-bombs with leverage of 100 or in some cases 500-1. We saw one of them blow up in the form of Fannie mae and Freddie mac, with the sub-prime housing bust. Now the US Government (read taxpayer) owns 94+% of mortgage
The thing that got us into this problem is the reckless abandon with which a lot of the banks and the financial system have taken on these ridiculous securitized structures and the leverage that goes into them, which all started out back in the late 90s when Glass-Steagall was abolished by Bill Clinton at Larry Summers insistence. That opened the door to create massive tools of leverage aka weapons of mass financial destruction; a massive build-up of an unregulated highly leveraged derivatives products market.
Of course, now what they have done is the politicians and the bankers have refined the dialogue and the narrative, so they come out and say one thing that soothes the public but the reality of what they do is 180 degree opposite. For example, Dodd Frank was implemented to reign in the reckless leverage and credit and the too big to fail banks but if you look at the reality of what has happened since the credit crisis, too big to fail banks have gotten much bigger. You have banks like Deutsche Bank who have on balance sheet derivative exposures of US$75 trillion and JP Morgan $70 trillion, not including off-balance sheet exposures! So that leaves us with significant problems that have to be addressed as regulators are clueless as to the size of the notional global derivatives markets some estimates are in the 900 trillion Dollar range – I think it’s significantly higher – nearly 20 times greater than global GDP.
Europe hasn’t de-leveraged at all. I think Mario Draghi, who is ex-Goldman and Mark Carney, who is also ex-Goldman and runs the bank of England, are going to come up with a new programme to bundle more securitized, leveraged assets, which will create a problem that’s exponentially larger than current exposures. More leverage is not a solution for insolvency.
If you look at where the French 10-year is trading, about 40 basis points above Germany, and if you look at where Italy is trading relative to the US, it is trading about 40 basis points above the US for 10-year financing. If you also look at Spain, Spain is about 30 basis points over the US. Ireland’s debt is trading below the US. Does it mean they are less risky?
These bond yield numbers, where these countries can borrow money, is a prime example of not only of ‘irrational exuberance’, but it points out the biggest misallocation of capital in financial history due to ‘temporary’ central bank initiatives such as quantitative easing and money printing. 6 years later these programs have had little if any success as GDP remains grim, debt, credit leverage hit historic new highs and too big to fail is bigger.
If you take Italy, for example, their debt-to-GDP ratio is the second highest behind Greece, it is 140%. Greece is probably around 180%, Portugal is 129%, Ireland 125%, Spain near 100%, France around 95%. But the limit in the EU is 60%.
You can carry it on for quite a while, and they have, but when not if interest rates go up all of these guys default.
My question is: who’s buying these bonds and do they think risk is fairly priced? I’m sure that the identical timings of European Central Bank Stress tests Asset Quality Review (AQR) has nothing to do with this bizarre rally.. After all the Italian, Spanish, Irish, Portuguese banks have borrowed money and are loaded to the gills with these bonds…
I have been in this business 35 years and I think this is one of the most egregious misprices I have ever seen. So what these guys have done, all these Goldman-leveraged central bankers, is they have encouraged massive amounts of risk and they’ve heavily punished every saver and student on the planet.
If you look, your parents and grandparents were prudent savers all their lives and put all their money into a bank account and expected to get about 4% or 5%. That is out of the window now and they have 50-70% less to live on during their golden years and they have bailed out reckless bankers.
Not only that, but the savers and the students are the biggest ones taking the hit right now, because when the next crisis hits there are going to be massive ‘bail-ins’. What they are going to do is confiscate, like they did in Cyprus, all the prudent savers’ money and say: “Yes, they were reckless speculators and now you are going to have to bail them out with your life
savings.” Anything over £85,000 you have in the UK ($250,000 in the US) per account, governments are just going to confiscate.
Moral hazard is the new normal, actually, because the banks and the funds know they can do whatever they want with impunity because they are going to get bailed out.
Chris Menon: Do you make any distinction between private and public (government) debt?
Mitch Feierstein: You can go into that but it is a discussion for another book.
Let’s look at the ratios of debt-to-revenues. I think this is an important metric for us to examine as we are time limited and we can discuss politics and the way the political narrative is created.
How many times have you heard a politician say we’ve cut the deficit. Yet none of them have ever said they’ve cut the total debt because they haven’t. In fact, debt is much higher and growing out of control every day. I get infuriated when I hear these narratives because they are playing games with semantics.
Despite the talk about reduced budget deficits, if you look at the absolute amount of debt it is rising all around the world.
One option governments have to reduce the debt is by manipulating currency exchange levels and pushing interest rates to artificially low rates. But what that does, unfortunately, is create gigantic unintended consequences; along with massive asset inflation, which leads to the current misallocation of capital we are witnessing today.
Now you have some junk bonds trading below 5%, non-investment grade trades at below 5%. Does that mean we’re in a new world where there is less probability that these companies will default?
Absolutely not. It is absolute insanity, but the Fed, European Central Bank, Bank of England, and Bank of Japan have manipulated these rates.
You get all the central bank statisticians saying there is “no inflation”. “Don’t worry there’s no inflation.” But they don’t include food
prices and don’t include energy prices in their calculations.
When you ask me about the debt, I am like, okay: well how are you going to calculate that? We can talk about the methodology but the government is going to give you a statistic that fits their purpose. They are not going to give you one for you. I’m going out to the supermarket and saying, “Hey shit, man, my milk is costing me three times what it did last year.”
For example, I do all my own shopping. I am not like Ed Miliband. I have a dog and myself. I tell you what, I can’t survive on £70 a week on my food budget, so I don’t know how he does that with a family of four. You honestly can’t tell me that you can get by on £70 a week.
I happen to know that the price of chicken breast has nearly doubled over the past year-and-a-half to two years.
House prices in central London, as you know, have gone ballistic. In 10 or 12 years it has probably gone up 500%.
Even if, on an inflation-adjusted figure, house prices are 9-10% below their 2007 peak everywhere in the UK, what does that mean?
Prices were entirely irrational in 2007 and since the beginning of this crisis real wages have dropped, according to some economists, as much as 11%.
Does that mean house prices should go up? No, it doesn’t! It’s a bubble that’s causing massive systemic financial risk to a stressed banking system where that central bank is out of bullets. Banks will fail.
Let me explain something, since the beginning of time there has been a correlation between the house prices and income. There has to be.
Housing is not an asset class. It is asset but it is certainly not an asset class because it lacks liquidity.
Property is probably one of the most illiquid assets you can have, foreign exchange is probably the most liquid.
Right now we are in the mania stage of a bubble and everyone wants to buy because they don’t want to miss out.
Chris Menon: How much longer do you think this bubble will last?
Mitch Feierstein: It has lasted probably a year-and-a- half longer than I thought. Unfortunately, David Cameron and Osborne are trying to be re-elected in 2015 so they came up with this ‘Help to Buy’ Ponzi scheme. The best example; it’s like filling up Boris Johnson’s water cannons with petrol or jet fuel and spraying it on a bonfire. What they are hoping it is going to do is create a bubble that generates aggregate trickle down demand, which creates the illusion of a healthy economy.
But I would argue that there is no recovery. I would argue, further, that you are seeing stock markets go up and you are seeing asset inflation, sure. But do you know why stocks are going higher to a large extent?
Chris Menon: I presume it is QE being pushed into the market?
Mitch Feierstein: The QE money has got to end up somewhere, that is part of it. A lot of the earnings that are out there…corporations are borrowing money at record low yields. So, where is that money going? They are borrowing to pay dividends and they are borrowing to buy back their shares.
We are seeing a record number of share buy-backs at market tops (always a terrible and dangerous sign) top executives get gigantic bonuses when shares rise… If corportions have fewer shares (via buybacks) their earnings are going to go up, right? So it doesn’t take a genius to work out that this is all coming down to the state manipulating the market. Problem is no organic growth is created and zero capital expenditures.
But is this helping British citizens? No, it is not. I would argue that it is hurting them.
We don’t have capitalism any more, that is the problem. The fundamental issue here is that we have some quasi form of socialism, supported by moral hazard with government intervention in the form of back-door-banking bailouts at the expense of Main Street.
Chris Menon: Do you think it is going to take a financial collapse before things are reformed? Before people realise the financial sector is too powerful and isn’t acting according to the tenants of capitalism?
Mitch Feierstein: Well, there is going to be another financial collapse.
It would have been a lot healthier if they had taken advice from people like me who said, “In capitalism you have a mechanism that deals with failure. Its called bankruptcy ” Right?
Chris Menon: Theoretically, yes.
Mitch Feierstein: Yer, right. If a company doesn’t perform they are out of business. My most memorable quote is: “ ‘Heads you win, tails I bail you out’; that’s not capitalism that is extortion.”
The first bail out came with Long Term Capital Management back in 1999. I remember sitting at the trading desk when the Fed bailed them out. That opened the door for the attitude: “We can take any risk no matter how large that we want and the Fed is going to bail us out because we are going to claim we are systemically too big to fail.”
So that is where we are. No lessons have been learned from 1999, the Dotcom bust or the housing bust of 2007. What has been learnt is the art of spin and how to manipulate the main street media and buy influence in Washington DC, UK’s Parliament and of course Brussels the home of the EU.
Mark Carney joined the Bank of England, hired by George Osborne and tells people anything they want to hear. He is getting paid $6m for the duration to be here, with a housing allowance of £5,000 a week. He doesn’t care, he has created the biggest housing bubble in Canada, he’s going to replicate the bubble in the UK to create a wealth effect ahead of the 2015 elections.
First of all I’m apolitical, I don’t really care….Quite frankly, any party that has lied shouldn’t get another chance.
Chris Menon: Then we wouldn’t have any of the three major parties, probably.
Mitch Feierstein: I don’t know, there are four parties now. I think the other politicians were bitter that UKIP took the majority of the votes in the European election.
The Labour party hired David Axelrod as an advisor to spin things so they would vote for the Labour Party, and the Tories hired Jim Messina. They both worked for Obama on how to manipulate voters into voting the way they want.
Both parties came out after UKIP’s sweep of the European election and said what a terrific job they did, the spin was ridiculous. People are fed up with that, they’re not stupid. I think British voters have more savvy than American voters. I think American voters are hooked by the same old Hollywood-scripted election screenplays and multi-million dollar TV advertisements created by Stephen Spielberg. Obama and Romney spent over 2 billion dollars on the 2012 presidential elections. I think British voters give you the rope to hang yourself. To me it appears, the rope is taut and people have lost all faith and confidence in politicians, and for very good reason. Politicians can’t just come in and keep spinning the same old lines anymore that they have been spinning the past ten and fifteen years. People realise that things just aren’t getting any better they can’t be fooled. Besides you can’t spend a billion on a UK campaign.
Real wages go down, property goes up. When the cost of living reaches the point when most people can’t afford stuff they will have a problem and we may be close to that point.
Chris Menon: But none of the political parties, none of them – UKIP included as far as I know – are willing to confront the bias towards the financial sector.
Mitch Feierstein: I don’t think that is 100% accurate or fair: we don’t know what UKIP’s policy is on that because they haven’t come out and said it…
I can share that UKIP probably isn’t given a fair shout as all of the media is against UKIP, as all of the media endorsed Labour or the Tories. Main stream media want only status quo because if BBC or Sky for example upset or alter the status quo then BBC or Sky lose interviews and people won’t go on and officals won’t give them access. For example: President Obama regularly excludes FOX Broadcasting.
It is an interesting line to be on, but it is going to have to play out. Unless the banks are massively reigned in yesterday, I think it is going to take another disaster or catastrophe to force the necessary actions.
If you think about what is going on: the Federal Open Market Committee is run by Bill Dudley, who is ex-Goldman. Add to the chorus ex-Goldman: Draghi at the ECB, Monti ex-bank of Italy and PM of Italy, Carney, ex-Bank of Canada and now BOE. All the ex-Goldman guys they believe in heavy amounts of leverage.
They don’t have a problem with this. They didn’t see it coming last time and they aren’t going to see it again. The refrain will be predictable; “No one could have ever seen this coming”
As Albert Einstein said, “Doing the same thing over and over again and expecting a different result is the definition of insanity.”
That’s what we are doing, because the leverage in absolute terms is higher than it was before we crashed the first time.
Chris Menon: In practical terms, what would you like to see happen? The return of the Glass-Steagall Act in the US?
Mitch Feierstein: I think what we need to do is to create an appropriate narrative to get back on track. Bad businesses need to be let go, bubbles need to be pricked and the US Federal Reserve Bank needs a good audit. Economic prosperity is created by an increase in capital expenditures and savings. We don’t have either of those and until we do we cannot have a sustainable recovery.
Do we have a problem in the banking system? I would argue that we do because we are not valuing assets or ‘marking’ anything to market properly. The EU has heinous exposure to a lot of European institutions. They have the long term refinancing operation (LTRO), which has a trillion outstanding in that. They keep lending.
On May 28 it was announced that the French government faces a revenue Euros-14bn black hole after overestimating tax income for the last financial year. Yet, you are lending that government at 1.76% for 10 years. Think about that for a minute.
Italy is in a perilous situation. If you go back and you look at the last four years on their GDP, it is an economic depression. Their general unemployment rate is probably about 13% and youth unemployment rate is very high, in the 40-50% bracket. Not as bad as Spain, which has over 60% youth unemployment.
When you have students and the younger generation being dispossessed, pretty much, do you really think you are going to stimulate growth by just pumping money into that system?
The problem there is that they didn’t get rid of the excesses and the bad credit in the system. All they have done is say, “Let’s add more liquidity to the system and maybe the prices will come back.”
Liquidity is not a cure for insolvency. If there is a basic solvency issue that needs to be dealt with on its own. You need to take the asset and write off the bad debt and whoever was left holding it needs to pay, not the taxpayer.
Chris Menon: So you think some banks should be allowed to fail?
Mitch Feierstein: Of course they should! Why shouldn’t they? RBS should have been shut a long time ago, so should Lloyds. It is not up to the taxpayer to bail out financially profligate institutions.
Eventually, we will see sovereign defaults.
The latest thing that is coming out now is this European system of accounts, ESA 2010. Basically, in September they are changing the way that Greece accounts for its GDP.
So basically, they are going to turn losses into gains. Even in the UK they are using ridiculous stuff, like adding the proceeds from selling heroin and prostitution to GDP. Now, first of all how do you calculate this stuff?
The US always does that by the way….The US employment figures are probably the most ridiculous. The US Census Bureau also has the ‘Birth Death adjustment’, where they make up a statistical number for the ‘birth’ and ‘death’ rates of American companies. I think in last month’s component they said “We estimate the birth of new businesses created 179,000 or 210,000 new jobs.”
They are just making that number up out of thin air. Although I am sure they are going to justify their statistical basis for making it up. I would doubt that is even close to reality but it gives the politicians a narrative to spin to people.
Chris Menon: What should ordinary people be doing now to protect themselves?
Mitch Feierstein: The most important thing for everybody is: if you don’t understand something don’t invest in in it.
I don’t like property in the UK. I think it is overpriced and close to collapse.
I think everybody should be buying physical gold 1 oz coins at around these levels. My average purchase price is a lot lower because I started buying about 10 years ago. Physical gold in the form of 1 ounce coins is attractive at current prices below $1250.
I don’t think I had bought gold for six years before last summer but I added to my positions in July or August when it was around $1200. I bought then and I also bought some silver. I like silver. I bought a lot of physical gold and silver years ago then added to it.
Every investor should have a certain amount of their portfolio in physical gold and silver. I make that distinction because I think there will be an exchange failure eventually.
Chris Menon: What do you mean by an ‘exchange failure’?
Mitch Feierstein: I don’t know when it is going to happen but I think ETFs are a wolf in sheep’s clothing. Those things are going to blow up. Because, if you look at the documentation it is 200 pages of legal fluff, basically guaranteeing you anything. It has a lot of disclaimers saying if you put money in this we don’t guarantee that we are going to correlate this to the underlying asset class.
The exchange failure I am talking about with gold is that if you do your homework and you look at the amount of open interest in all the gold futures and options contracts, if only a fraction of that open interest demanded delivery of the gold on the outstanding contracts the exchange would be unable to deliver and fail….Do you know how future’s contracts work?
Chris Menon: Maybe you could explain for our audience?
Mitch Feierstein: The way that a futures contract works it’s a vehicle for producers to hedge commodities or speculators to “invest” or manipulate and it works via contracts, usually 3 months duration a piece.
A contract specifies parameters for delivery. So you could say I will take physical delivery of my gold contract when it expires. Each gold contract represents 100 ounces of gold, so each contract is worth about $124,400 in gold.
The concept is futures allow a lot of leverage. So, for a fraction of the 124,400 you can control 100 ounces of gold.. So we calculate the sum of all the contracts and options with open interest, (noting most participants NEVER take physical delivery) if even a small fraction of the open interest demanded physical delivey the exchange doesn’t have enough gold to deliver.
At the current gold price we are very close to what it costs miners to pull gold out of the ground.
Chris Menon: What does that mean?
Mitch Feierstein: When it costs miners more to pull it out of the ground than the price in the futures market, they are going to close down their production. And if they need to deliver some, if they are smart they will buy it in the futures market and take delivery as long as it is below their production cost.
It doesn’t take a genius to work out that that trick is not going to work for much longer. Because all of this gold manipulation, everybody used to say it is a “conspiracy theory”, but it is not. I could write a book on it.
When the US Government loses control of gold it loses control of the value of the currency. The currency will go to zero eventually because it is not backed by anything.
If tomorrow Russia or China came out and said, “Look: we have Renminbi or Roubles backed by gold,” that is the end of the Ponzi scheme.
Chris Menon: I have heard talk that China has amassed 6,000 tonnes of gold and ultimately the aim is to challenge the hegemony of the US dollar.
Mitch Feierstein: I would bet that they have more than 6,000 tonnes of gold. It’s impossible to tell what they have.
Chris Menon: Any last piece of advice for our readers?
Mitch Feierstein: If you are a British citizen you should buy British gold sovereigns and you won’t pay capital gains tax. Any of the British gold coins that are currency aren’t liable for capital gains tax.
And we are probably seeing Sterling at its peak for our lifetime. Sterling is only going to go down from here against everything. It is not going to strengthen. If you buy gold it is a great hedge.