BEWARE: ARTIFICIAL INTELLIGENCE BUBBLE

To buy a global bank run or not. This is the artificially intelligent question of the day...

Since the bank run started, NYSE stocks have become extremely oversold, especially financials. Banks are a crowded short. Conversely, Tech stocks are a very crowded long. Which is leading to a chasmic divergence. 

The question on the table is, does it resolve with NYSE rally or Nasdaq crash?

Banks are trying to rally, but they can't get off the mat. 

Meanwhile, there is zero fear in this market of a continuing bank run. It appears that bears went ALL IN back in December and now they've decided the market is going higher. 

We saw this level of divergence between large caps and the rest of the market back in 2008:

Nvidia is at the apex of the Artificial Intelligence bubble.

"Nvidia trades at an eye-watering 56 times projected earnings, nearly three times more expensive than the Philadelphia Stock Exchange Semiconductor Index’s 21 times and a near 150% premium to the Nasdaq 100, according to data compiled by Bloomberg. Nvidia’s average multiple over the past decade is 30 times"

With 42 buy-equivalent ratings, Nvidia has by far the most bullish recommendations of any chipmaker"

Based on this chart, you would never know that Nvidia earnings  just fell -50% year over year:

"Net income in the quarter ended Jan. 29 was more than halved from the prior year, falling to $1.41 billion, or 57 cents a share, from $3 billion, or $1.18 a share, a year earlier"

The A.I. bubble is just another empty load of bull shit.

Micron just reported their largest loss on record, but the stock is up today because analysts are praying that the worst is over for the semiconductor sector. It's a big bet to make going into near-certain recession. Why would semiconductor demand bottom BEFORE the beginning of the recession? You would have to be brain dead to believe that, hence it's Wall Street consensus.

The Nasdaq has been in a death cross for the longest period of time since 2008. Which means that the 50 day moving average is below the 200 day moving average. Given that bulls STILL haven't capitulated, it's extremely likely this death cross will last far longer than the last one. 

The bond market and the stock market are sending opposite signals. Which does not end well for stocks:

“Our 21 Lehman systemic risk indicators are pointing at the highest probability of a crash or a sharp drawdown in the next 60 days—the highest probability since COVID,”

McDonald believes investors are ignoring the risk of a “rolling credit crisis and focusing too much on the rise of new technologies like artificial intelligence"

In summary, this fake rally is driven by artificial intelligence. 

But, who to believe?

WORST OF ALL CASE SCENARIOS

Investors are trapped, but they are complacent because they are told constantly, don't worry, be fat, dumb, and happy...

Allow me to recap events to date:

The pandemic initiated the largest combined fiscal and monetary bailout in history. Record stimulus flowed from central banks and Federal governments into local bank deposits. Banks parked that money into long-term Treasuries creating a duration mismatch with their deposit base. 

Central banks were slow to withdraw stimulus believing that the inflation was caused entirely by the Federal unemployment programs. However, inflation accelerated AFTER the pandemic unemployment programs ended in September 2021. Subsequently, the Fed has panic raised interest rates at the fastest relative rate in history now at 4.75%. Fed rate hikes  .5% greater than the rate increases from 2003-2006. Short-term rates have increased 200% over where they were pre-pandemic (1.5%). Mortgage rates have doubled from where they were pre-pandemic. However, the balance sheet which is the true source of (asset) inflation came down only 7% year over year. The Fed balance sheet remains DOUBLE where it was pre-pandemic, which has kept asset markets and the CPI artificially inflated. The CPI is currently at 6%, or three times higher than it was pre-pandemic. 

In the event, growth stocks were annihilated. Pending home sales are now at the lowest on record. Consumer sentiment hit the lowest on record in October 2022. Meanwhile, we now learn that the record increase in interest rates was a ticking time bomb on regional bank balance sheets which have racked up ~$600 billion of unrealized bond losses pushing many banks into technical default. However, the Dodd-Frank regulatory rollback of 2018 exempted many mid and smaller banks from mark to market rules so regulators ignored the impending disaster. Ironically, the FDIC pointed out this massive risk the exact same week that Silicon Valley Bank failed. Coincidence?

March 6th, 2023:

"The total of these unrealized losses, including securities that are available for sale or held to maturity, was about $620 billion at yearend 2022. Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry."

"Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs. That is because the securities will generate less cash when sold than was originally anticipated, and because the sale often causes a reduction of regulatory capital"

One day later, Silicon Valley Bank initiates a capital raise and the bank was shut down within 24 hours. 

In addition, to the above risks, due to the unprecedented rise in interest rates, 2022 saw the largest and only net annual deposit outflow in U.S. history. Deposits have now declined $565 billion year over year.

We learned late on Friday that $100 billion of that came in the last week ALONE:

Monthly deposits, $ change:

This combination of unrealized losses AND deposit outflow is a ticking time bomb as Silicon Valley Bank found out the hard way. The new Fed "BTFP" facility put in place over the past two weeks allows banks to trade their underwater assets for Fed loans so they can avoid mark to market realized losses. However, most of their balance sheet assets are NOT eligible to be used as Fed collateral. Which means that eventually they will run out of liquidity to cover the accelerating bank run.

In the meantime, as I've pointed out many times, policy-makers have declined to provide blanket FDIC insurance because it's a political issue. Which is something NO ONE wants to admit. 

So instead, the FDIC is implementing full depositor bailouts on a case by case basis which is rapidly depleting their reserves. Meanwhile, this ad hoc approach is doing nothing to stem the deposit exodus because no one knows what will happen once the FDIC fund is depleted.

Once the fund is depleted this whole mess will come down to a congressional vote. Consider that the unrealized bond losses are six times larger than the FDIC insurance fund $600 billion v.s. $100 billion. 

What pretty much all of today's pundits forget is that the FIRST TARP vote in October 2008 FAILED. It was voted down. I am sure Mike Shedlock remembers that vote well since he led the effort to ensure it was voted down. However, after it failed, markets tanked so lawmakers panicked and a WEEK later the second vote passed. 

HOWEVER, by that time the damage was done. Because when the second vote passed, the market REALLY collapsed. 

It IS different. It's far worse. 

THE HARDEST LANDING

Bulls are locked in for a no bailout hard landing. They are systematically unaware of systemic risk, because this time their beloved bailout gurus ARE the systemic risk. Which means bulls are now trapped by idiots...

Yes, again. 

The Fed just pulled the trigger on another quarter point rate hike and said that another rate hike in May is likely. They are now expanding their balance sheet to create liquidity for failing banks which is creating more inflation via monetary expansion. And, at the same time, they are pushing the middle class into insolvency with rate hikes. The net effect of this hyper-moronic policy is that financial conditions are STILL too loose, as we see in the chart below. So, they really gave themselves no choice.  

In addition, during today's press release, Powell asserted that Silicon Valley bank collapse was an "outlier". So he is ignoring all of the dominoes falling, exactly as the Fed did in September 2008 when Lehman failed:

"On the morning after Lehman Brothers filed for bankruptcy in 2008, most Federal Reserve officials still believed that the American economy would keep growing despite the metastasizing financial crisis"

The Fed’s policy-making committee voted unanimously against bolstering the economy by cutting interest rates, and several officials praised what they described as the decision to let Lehman fail"

As we know, Treasury Secretary Janet Yellen was there in that exact same  FOMC meeting back in September 2008.

Today, in her testimony to Congress, after weeks of vacillation  she said that there is no plan to implement blanket FDIC insurance:

"U.S. Treasury Secretary Janet Yellen said on Wednesday that the Federal Deposit Insurance Corporation (FDIC) was not considering providing "blanket insurance" for banking deposits following the collapse of two prominent U.S. banks this month"

This is what Janet Yellen said yesterday:

"The treasury secretary, Janet Yellen, pledged to protect depositors at smaller US lenders on Tuesday from “contagion” after bank runs led to customers pulling billions in funds"

In comments after the speech, Yellen said the current situation was different from 2008, which she described as “a solvency crisis”, while “what we are seeing is contagious bank runs”

Let's unpack this: We are seeing a contagious bank run and pledging to protect small banks by not protecting uninsured deposits which is half the deposit base. 

No surprise, having just got double teamed by dumb and dumber, regional banks gave back most of their "gains" from this week's limp dick rally.

On Twitter I showed this chart indicating that only mega caps have been holding up the market since the bank collapse:

Look up, and look down. 

Now, bulls are going to find out what it's like to go through a financial meltdown WITHOUT any bailout insurance. 

Hint: It's not as much fun. 

In summary, I have said for months that this right shoulder would unleash biblical criminality. So far, it has shown its potential. However, in the analogy of making popcorn, all we are seeing so far are the first few kernels flying across the kitchen. 

Soon, the popping will explode in every direction. And, the bowl is far too small for what is coming.

Believe it, or not. 

THIRD WORLD BAILOUT

This is the quality of bailout you would expect in the Third World:  Rate hikes to curtail inflation as everything collapses in real-time...

Biden went to great pains last week to assure everyone that these latest bank bailouts were for depositors not for investors. Shareholders in several banks (SVB, Signature, Silvergate) were wiped out last week. This past weekend, with the Credit Suisse/UBS forced merger it was bondholders who got totally wiped out while stock investors got ~.50 on the dollar. Which is very unusual and probably illegal. I am guessing that regulators didn't want the public to see a fourth bank stock going to ZERO given that retail investors usually trade company stocks not company bonds. 

On the topic of depositor protections, consider that by this point in 2008 Congress had already taken steps to insure ALL deposits at ALL banks. Which is how they stemmed the bank run in that era. Last week, Goldman Sachs had this to say about universal deposit insurance passing Congress:

"Increasing deposit insurance without accompanying regulatory changes looks politically difficult, but an agreement on regulatory changes would substantially slow approval"

Elizabeth Warren just introduced a bill to rollback the 2018 Dodd-Frank rollback. Essentially closing the barn door now that the horses are out. To reimpose Dodd-Frank on small banks would immediately expose regional banks to ~$600 billion of unrealized losses due to the restoration of mark to market rules. Meaning it would precipitate the final collapse of the banking sector. Which seems like a bad idea at this point in time. 

Whether that bill passes or not, we now learn that another 190 banks are already teetering on the edge of collapse due to a combination of insolvent assets and high levels of uninsured deposits. The two main factors that catalyzed the Silicon Valley collapse. 

Close To 190 Banks Could Face Silicon Valley Bank's Fate

"On the heels of Silicon Valley Bank’s collapse earlier this month, 186 more banks are at risk of failure even if only half of their depositors decide to withdraw their funds, a new study has found"

“The recent declines in bank asset values very significantly increased the fragility of the U.S. banking system to uninsured depositor runs”

A run on these banks could pose potential risk to even insured depositors — those with $250,000 or less in the bank — as the FDIC’s deposit insurance fund starts incurring losses"

The FDIC deposit insurance fund ("DIF") has ~$128 billion insuring ~$18 trillion in deposits. Yes, you read that right. Roughly half of those deposits are uninsured. So without a Congressional backstop, this all gets ugly really fast. And in the meantime while that's not happening, CFOs are moving unprecedented amounts of money out of banks into money markets and t-bills. There are $9 trillion of uninsured deposits.

Next, from a fiscal perspective, consider that in March 2020 Congress enacted the largest fiscal bailout package in U.S. history. Whereas this year, the GOP is plotting to push Biden over the fiscal cliff as early as June by vowing not raise the debt ceiling until he reigns in spending.

Which is what they did to Obama in mid-2011. Which dropped the S&P 500 a cool -20%.

On the monetary side of things, by this point in March 2020, the Fed was cutting rates by .5%. Last week the ECB raised rates by .5% and this week the Fed is expected to raise rates by .25%. Again, the opposite of accommodative policy. Many bulls have been encouraged by the fact that the Fed balance sheet is now increasing once again. This was due to the global liquidity facility that central banks put in place last week. Nevertheless, it's a fraction of what took place in March 2020:

In other words, everything taking place now is the opposite of a bailout. Which is clear indication of societal bailout fatigue and the growing conviction of letting losses fall where they may. Which sounds great. However, what NONE of these people understand is that they have now put the entire system at risk with this late stage experimentation in REAL capitalism. Long overdue, but arriving at a time when the financial system is ready to collapse.  

Why? Because as Warren Buffett always says, what the wise man does at the beginning, the fool does at the end. 

GLOBAL BANK RUN aka. BTFP

A combination of factors have coalesced to make global banks uninvestable post-pandemic:

- Lack of regulation

- Bad investments

- Deposit exodus/higher interest rates

- Lack of depositor protection

- Lack of investor protection

The FDIC knew all along that a stealth bank run has been taking place for the past year. The first year of deposit outflows since 1948. Meaning by far the largest outflows in U.S. history:

"After years of earning next to nothing, depositors are discovering a trove of higher-yielding options like Treasury bills and money market funds as the Federal Reserve ratchets up benchmark interest rates. The shift has been so pronounced that commercial bank deposits fell last year for the first time since 1948 as net withdrawals hit $278 billion, according to Federal Deposit Insurance Corp. data"

The lenders getting hit hardest by rising funding costs are community and smaller regional banks"

Over this past week, the bank deposit outflow has become a torrent. Right after my last blog post when I said that no one knows what domino will fall next, Credit Suisse imploded the very next day. 

It was another "Black Swan event".

In this article, the former head of the FDIC confirms what I said in my earlier post about the "Minsky Moment" and depositor exodus due to uncertain protections:

March 15th, 2023:

FDIC May Need To Guarantee All Bank Deposits

"The Federal Deposit Insurance Corp may need to seek temporary guarantees for all uninsured U.S. bank deposits to stem a drain of funds from small and regional U.S. lenders following deposit bailouts for failed banks SVB Financial and Signature Bank, former FDIC chair Sheila Bair said on Wednesday"

Bair told Reuters that the "one-off" deposit guarantees for Silicon Valley Bank and Signature have left depositors elsewhere fearing for safety and fleeing to larger institutions"

The main issue, as I wrote in my Minsky blog post is that wealthy investors and companies with deposits > $250k don't know if they will get bailed out when the next bank fails. The FDIC fund has very limited funds that will be depleted by the blanket bailout of SVG and Signature. And, in order to guarantee ALL bank deposits without limit, the FDIC would need a vote from Congress. Which is very likely NOT forthcoming. 

Which is why the exodus has begun:

What we are witnessing now is the liquidation of regional stocks as a viable asset class:

This is the weekly volume as of Thursday close:

This BTFP stock market rally is a short-covering rally similar to the TARP rally in October 2008. When that rally ended, the market exploded lower. 

Today, the ECB tightened .5% which means they gave no allowance for the bank collapse taking place in real time. Which, guarantees the Fed will hike at least 1/4 pt next week as they move in lockstep.

Whereas the stock market is highly complacent, the bond market is seeing 2008 level distress. Note the disconnect between the Treasury Move index and the VIX:

The collapse in bond yields has caused a massive rotation to Tech stocks under the belief that they are a safe haven from global turmoil. Of course, nothing could be further from the truth. Investors are going out of the pan into the fire.

What today's Tech gamblers need to learn is that once a bubble bursts, it doesn't become a bubble again for a very long time. It took the Nasdaq 17 years to recover its Y2K high.  

For all of the various reasons that have led us to this lethal juncture, central banks are now doing now the EXACT opposite of what they did in 2008. They are tightening into a burgeoning credit crisis. 

Which means we have entered the most lethal financial crisis since 1930. 

In summary, the serial deregulation of criminality is coming to a final hard landing. 

When that happens, even the biggest dunce will understand the lessons learned in 1930 that stood for 70 years until the Idiocracy decided they were smarter than everyone who came before them. 

BETWEEN A ROCK AND A HARD PLACE

What we are witnessing in real-time is Lehman 2.0. Unfortunately, stock gamblers are always the last to know...

The right shoulder has now been amply confirmed as being the locus of global collapse. The dominoes are falling. A week ago, few people had ever heard of Silvergate Bank, Silicon Valley Bank (SVB), and Signature Bank - aka. the "Si" banks. Now they're all collapsed. The second (SVB) and third (Signature) largest bank failures in U.S. history in less than one week.

Recall that March 2021 was the peak for the pandemic IPO junk bubble. Two years later, the Silicon Valley bank collapsed.  Coincidence? No. Then, March 2022 was the first leg down of the Crypto collapse. One year later TWO Crypto banks collapsed. Coincidence? No. The Crypto "DeFi" movement has totally imploded and now it's imploding the traditional banking system. 

Who knows what will be the next domino to fall, no one saw these ones coming. 

Or did they?

Notwithstanding Fed members jettisoning stock in junk banks days ahead of collapse, most pundits are calling these bank failures a Black Swan event, meaning none of them saw it coming. And yet this bank collapse was totally predictable in the context of central banks tightening into an incipient credit crisis - which itself was the direct result of the super stimulus global central banks used during the pandemic. 

Central banks caused this crisis from over-easing to over-tightening.  

 

Today, was CPI day and while it's slowly coming down, it's still at 6%. The Fed is now boxed in between banks failing and a CPI that will sky-rocket if they stop hiking rates. In other words, the Minsky Moment has already started and it's unstoppable. 

Here we see the Fed took their foot off the gas in 2007 due to the housing bubble, and the CPI sky-rocketed from 1.5% to 5.5%. Of course, the same thing happened to Volcker back in 1980 when he prematurely stopped tightening. He was very quickly forced to restart tightening when the economy was in recession.

Imagine if the CPI rebounded back to 9%. That's the bull case right now. A cessation of tightening followed by a shock restart later this year. 

In summary, we are one week away from the Fed making an even bigger monetary policy error. And no surprise the market is rallying due to their first bailout.

The BTFP rally. What else?

THE MINSKY MOMENT

Latest update: March 12th, 10:00pm EDT

The Minsky Financial Instability Hypothesis:

"If an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values"

FDIC Q42022 Banking Profile:

What follows is a summary of the current crisis and my best guess as to what happens next.

This past week, the FDIC warned THIS exact scenario could happen as a result of the fact that U.S. banks are sitting on RECORD unrealized losses:

"On Monday, the chairman of the Federal Deposit Insurance Corporation (FDIC)—the agency that backstops depositors—addressed risks U.S. lenders faced three years after the outbreak of the pandemic. Chief among them was the potential for a bank run."

Gruenberg warned these unrealized losses “weaken a bank’s ability to meet unexpected liquidity needs,” and cautioned that mapping out a strategy to fund themselves profitably would prove a “complex and challenging task”.

Indeed.

See chart above of unrealized losses. Among the various causes of this crisis, chief among the immediate risks is that these banks are sitting on gargantuan unrealized losses while still passing regular FDIC-conducted audits. In other words, the FDIC itself is to blame for this fiasco. Clearly the magnitude of potential losses dwarfs any prior period INCLUDING 2008. 

All that was required to bring down Silicon Valley Bank was a small deposit flight which was taking place anyways as their base of bankrupt Tech firms was steadily going out of business. That left them forced to raise capital and sell bonds at a loss, thus revealing the chasmic hole in their balance sheet which had been there all along. It's the exact same thing that happened to Bernie Madoff in November 2008, he ran out of cash to pay redemptions. 

Which gets us to what happens next?

Clearly the lessons of 2008 have long since been forgotten. Back then companies having deposits larger than the FDIC limit were forced to move these large deposits to multiple different banks in order to maintain FDIC insurance which at the time was $100k limit. Now, it's a $250k limit. 

Therefore, any responsible and albeit amnesiac CFO this coming week will be scrambling to move their millions out of individual banks and diversifying their bank accounts. Compounding this crisis is the fact that average rates on money market funds are ~4% higher than bank deposit rates. Yes, you read that right. So moving money out of banks to broker accounts is a no-brainer from a Treasury standpoint. Personally, I recommend t-bill accounts over money market funds. DO NOT assume as Ackman says below that there is any such thing as a "Systematically Important Bank" that could prevent its own depositors with deposits > $250k from taking massive haircuts. That's asinine. 

Bill Ackman summarizes what I just said:

In other words, within the next 48 hours, the government must raise the FDIC insured deposit limit from $250k to infinity. Something that would require an act of Congress.

While that's not happening, the cries for bailout will get louder by the minute.

"Voices from tech and finance are increasingly calling for the federal government to push another bank to take over the failed Silicon Valley Bank to protect uninsured deposits. Their main concern is that a failure to protect deposits over $250,000 could cause a loss of faith in other mid-sized banks"

"Observers are calling out the irony as some VCs with notoriously libertarian free-market attitudes are are now calling for a bailout"

[Update: Sunday March 12th, 10:10pm]

Ok, so we now know they got their bailout which comes in the form of an asset exchange program. Banks can use their "illiquid" aka. underwater assets for a short-term loan from the Fed. This way they can ensure ample liquidity in the event of a bank run without having to sell down their assets and otherwise expose their true capital deficit. 

However, the Fed just promised to make ALL depositors at SVB/Signature whole even beyond the $250k FDIC insurance limit. To do this, they will tap the FDIC Deposit Insurance Fund which has ~1% of assets relative to the U.S. deposit base. Yes, you read that right. Which means sure they will bailout everyone this time, but can they bailout every regional bank and ALL of their depositors? Of course not. Ex-Congress, the FDIC just unilaterally raised the $250k limit for those depositors who are part of the very first banking dominoes to fall. I have no doubt that's not actually legal. Basically throwing everyone else under the bus to bailout companies with millions of deposits.  

"The DIF currently has over $100 billion in it, a sum the Treasury official said was “more than fully sufficient” to cover SVB and Signature depositors"

CFOs, get busy...