Daily Archives: June 11, 2020

The Looming Bank Collapse

The U.S. financial system could be on the cusp of calamity. This time, we might not be able to save it.
By Frank Partnoy – The reforms were well intentioned, but, as we’ll see, they haven’t kept the banks from falling back into old, bad habits. After the housing crisis, subprime CDOs naturally fell out of favor. Demand shifted to a similar—and similarly risky—instrument, one that even has a similar name: the CLO, or collateralized loan obligation. A CLO walks and talks like a CDO, but in place of loans made to home buyers are loans made to businesses—specifically, troubled businesses. CLOs bundle together so-called leveraged loans, the subprime mortgages of the corporate world. These are loans made to companies that have maxed out their borrowing and can no longer sell bonds directly to investors or qualify for a traditional bank loan. There are more than $1 trillion worth of leveraged loans currently outstanding. The majority are held in CLOs.

Despite their obvious resemblance to the villain of the last crash, CLOs have been praised by Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin for moving the risk of leveraged loans outside the banking system. Like former Fed Chair Alan Greenspan, who downplayed the risks posed by subprime mortgages, Powell and Mnuchin have downplayed any trouble CLOs could pose for banks, arguing that the risk is contained within the CLOs themselves.

Banks do not publicly report which CLOs they hold, so we can’t know precisely which leveraged loans a given institution might be exposed to. But all you have to do is look at a list of leveraged borrowers to see the potential for trouble. Among the dozens of companies Fitch added to its list of “loans of concern” in April were AMC Entertainment, Bob’s Discount Furniture, California Pizza Kitchen, the Container Store, Lands’ End, Men’s Wearhouse, and Party City. These are all companies hard hit by the sort of belt-tightening that accompanies a conventional downturn.

Under current conditions, the outlook for leveraged loans in a range of industries is truly grim. Companies such as AMC (nearly $2 billion of debt spread across 224 CLOs) and Party City ($719 million of debt in 183 CLOs) were in dire straits before social distancing. Now moviegoing and party-throwing are paused indefinitely—and may never come back to their pre-pandemic levels.

Meanwhile, loan defaults are already happening. There were more in April than ever before. Several experts told me they expect more record-breaking months this summer. It will only get worse from there. more>

Updates from McKinsey

The economic impact of closing the racial wealth gap
The persistent racial wealth gap in the United States is a burden on black Americans as well as the overall economy. New research quantifies the impact of closing the gap and identifies key sources of this socioeconomic inequity.
By Nick Noel, Duwain Pinder, Shelley Stewart, and Jason Wright – The United States has spent the past century expanding its economic power, and it shows in American families’ wealth. Despite income stagnation outside the circle of high earners, median family wealth grew from $83,000 in 1992 to $97,000 in 2016 (in 2016 dollars).

Beyond the overall growth in top-line numbers, however, the growth in household wealth (defined as net worth—the net value of each family’s liquid and illiquid assets and debts) has not been inclusive. In wealth, black individuals, families, and communities tend to lag behind their white counterparts. Indeed, the median white family had more than ten times the wealth of the median black family in 2016. In fact, the racial wealth gap between black and white families grew from about $100,000 in 1992 to $154,000 in 2016, in part because white families gained significantly more wealth (with the median increasing by $54,000), while median wealth for black families did not grow at all in real terms over that period.

The widening racial wealth gap disadvantages black families, individuals, and communities and limits black citizens’ economic power and prospects, and the effects are cyclical. Such a gap contributes to intergenerational economic precariousness: almost 70 percent of middle-class black children are likely to fall out of the middle class as adults. Other than its obvious negative impact on human development for black individuals and communities, the racial wealth gap also constrains the US economy as a whole. It is estimated that its dampening effect on consumption and investment will cost the US economy between $1 trillion and $1.5 trillion between 2019 and 2028—4 to 6 percent of the projected GDP in 2028. more>

What’s the Difference Between Today’s US Space Force and the Reagan Era Star Wars?

By John Blyler – The U.S. Space Force is being brought to life with federal funding and contractor rockets and electronics. This might be a good time to remember the lesson’s learned from the earlier Reagon era Strategic Defense Initiative (SDI) program.

First, let’s check out what’s behind the Space Force. A few years back, President Trump floated the idea of a space force as a new branch of the military. The Pentagon was quick to remind the president that a space force already existed in the armed services, mainly under the purview of the Air Force. No matter, the White House believed a new initiative was needed especially in light of the tensions and trade war with China. Dominance in space was the rallying call.

For those of us working in the defense industry in the 1980s and 90s, this all seemed eerily reminiscent of the famous “Star Wars” program initiated by former US President Ronald Reagan during the Cold War era. Officially known as the Strategic Defense Initiative (SDI), the program focused mainly around a space-based anti-missile system aimed at protecting US from potential preemptive military strikes from the former Soviet Union.

At the time, the main components of the SDI were considered technologically impossible – i.e., anti-ballistic missiles including lasers and electromagnetic weapons. While there were some successes, the program failed to meet its loftier technical goals.

Now let’s fast forward to today. While many dangers persist in the world, it’s not clear that the most imminent threat is from space. For example, it would be far easier and less costly to launch a cyberattack against an enemy’s infrastructures, steal technology IP, rig an election process or upset financial markets than to dominate in space. Regardless, the race to create a space force has been awakened and – more importantly – funded. more>

Protection against hostile takeovers: rethinking the free movement of capital

Should free movement of capital any longer be sacrosanct when it leads to predatory takeovers and regional inequalities in a globalized economy?
By Susanne Wixforth and John Weeks – ‘Is China buying up Europe’s south?’ Such headlines have become frequent since the 2008 financial crisis. The Chinese takeovers include Greece’s biggest harbor in Piraeus, companies operating terminals in Romanian and Spanish harbors and the airport in Frankfurt-Hahn. And bear in mind that the United States accounts for 38 per cent of global foreign direct investment (FDI), Chinese capital just 2.2 per cent—though its share is increasing, especially via investments in strategic infrastructure as part of its ‘belt and road’ initiative.

European infrastructure and companies operating in the single market are open to the world because of perhaps the foremost of the famous ‘four freedoms’—the free movement of capital. The orthodox-economics claim is that free movement ensures the optimal allocation of capital.

The globalization of capital flows, in combination with digital communication, enables capital markets to be in motion around the clock. The result is an unprecedented market interdependency, with a simultaneous loss of state regulation and increased vulnerability to crises. The second global crisis of the 21st century caused by the Covid-19 pandemic has led to a dramatic drop in share prices and company valuations.

This collapse facilitates takeovers by foreign companies. Does the European Union need a different interpretation of free movement of capital, to protect European key technologies and strategic infrastructure?

Fourteen EU member states have adopted regulation to control FDI. The German government is considering use of its coronavirus-linked Economic Stabilization Fund for company ownership to protect against hostile takeovers, while the French government has created an investment fund (Lac d’argent) for that purpose. more>