Speaker 1: This is the Bloomberg Surveillance Podcast. I'm Lisa A. Bromoid's
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Speaker 2: Chris Maronak joins us now director of Research at Jenny Montgomery. Scott, Chris,
Speaker 2: We've been on this journey with you. We've appreciated it
Speaker 2: every step of the way. We've got some kind of resolution.
Speaker 2: I think what's interesting for us this morning is JP
Speaker 2: Morgan is positive in the pre market when they say
Speaker 2: things like our government invited us and others to step up,
Speaker 2: and we did. Are they doing us a favor or
Speaker 2: have they got something good here?
Speaker 3: Well? I think they did both.
Speaker 4: I think they did us a favor because they were
Speaker 4: able to do this at a lower cost to the government.
Speaker 4: If you look at the bid that they made and
Speaker 4: the gain that they're booking, it's a lesser gain than
Speaker 4: what we've seen at the other transactions, particularly comparing the SVB.
Speaker 3: For Citizens deal for Citizens.
Speaker 4: Had a real excellent transaction a month ago. This is
Speaker 4: a less of a gain for JPM, But I also
Speaker 4: think it represents the upside to the wealth management business
Speaker 4: the FRC had. So that's really the honeyhole that JPM
Speaker 4: Morgan sees, and that's where I think that there's opportunity
Speaker 4: for them in the long term with the assets and
Speaker 4: the asset management clients.
Speaker 1: Chris, is this a bailout by the FDIC.
Speaker 4: Not really, because the FDIC could have made much better terms.
Speaker 4: I think that's ultimately why PNC or other bidders were
Speaker 4: not successful. I think JPM was willing to come in
Speaker 4: at at a less of a data, less of a discount.
Speaker 3: So at the end of the day, the FDIC is
Speaker 3: seizing the.
Speaker 4: Assets, they are going to do a loss share, similar
Speaker 4: to other smaller transactions we saw back in twenty eight,
Speaker 4: nine and ten, and really the SVB and signature transactions too.
Speaker 4: But I think at the end of the day, it's
Speaker 4: a better transaction for the system and the DIF.
Speaker 1: Did the FDC wait too long, Chris to allow this
Speaker 1: crisis to continue to allow the drip drip of good assets,
Speaker 1: of good workers at this bank to leave.
Speaker 4: I think in a case of a week or two, yes,
Speaker 4: I would have preferred to see this resolved earlier in April,
Speaker 4: But at the end of the day, I think we
Speaker 4: got where we needed to go.
Speaker 3: I think they were trying to see if there was a.
Speaker 4: Private market solution, perhaps private capital, perhaps the equity markets
Speaker 4: would step up with the preferred or an equity raise,
Speaker 4: but that was just not in the cards for a
Speaker 4: first republic.
Speaker 3: So this was the best alternative.
Speaker 2: Chris, when you read lines like and you mentioned it
Speaker 2: a moment ago that jp Morgan and the FDIC have
Speaker 2: agreed to share the burden of losses, what does that
Speaker 2: actually mean in practice?
Speaker 5: Can you explain that for our audience?
Speaker 4: Sure, so, as JPM now has the assets and deposits,
Speaker 4: they will work through those and particularly loans. As they
Speaker 4: collect those loans, there'll be a laws share agreement for
Speaker 4: any losses that come out, and then that will be
Speaker 4: shared with the FDIC. It's very similar to what we
Speaker 4: had in twenty eight, nine and ten. Typically the assets
Speaker 4: back then were much worse. These are assets that are
Speaker 4: simply marked for interest rate risk, not for credit n
Speaker 4: so Ultimately, I think you'll see JP Morgan sit with
Speaker 4: these assets and sell them and move forward. It's possible
Speaker 4: that much of what they are holding here comes back
Speaker 4: to them in the next twelve day, ten months of
Speaker 4: interest rates change and the FED change is policy perhaps
Speaker 4: a quarter or two from now, that's going to have
Speaker 4: a ce change to how these assets are valued.
Speaker 3: So timing is everything, and I think.
Speaker 4: That's ultimately why the bid end up being less of
Speaker 4: a discount for JP Morgan than the other banks.
Speaker 5: Did they share the upside as well than Chris?
Speaker 4: They capture most of the upside, so I think the
Speaker 4: upside all goes to JP Morgan.
Speaker 5: That's fascinates in Premo well, especially fasciniting.
Speaker 1: Especially because in the stories it actually said they shared
Speaker 1: the upside as well as a downside. So it's confusing
Speaker 1: that basically JP Morgan ends up with the entirety of
Speaker 1: the upside at a time where the FBIIC wants to
Speaker 1: mitigate socializing the losses and privatizing the games.
Speaker 5: Chris, can you give us a little bit more clarity
Speaker 5: on that.
Speaker 2: What are you reading at the moment that gives you
Speaker 2: a better idea of what's going to happen there.
Speaker 3: Well, I think the laws share agreement's going to be
Speaker 3: very typical.
Speaker 4: And what we saw back in the transactions in twentyd
Speaker 4: and eight, nine and ten it was a very typical
Speaker 4: law share arrangement where the FDIC sees the bank, they
Speaker 4: cut the law share arrangement, and then the bank collected
Speaker 4: the assets. The bank becomes the conduit for the FBIC
Speaker 4: to collect the money to collect the loans. It's less
Speaker 4: of an issue with deposits. It's much more with the
Speaker 4: loans that were made. To remember, the loans the First
Speaker 4: Republic had were largely.
Speaker 3: Low rate mortgages with low loan to value.
Speaker 4: So these are not risky loans that in many cases
Speaker 4: these are very low risk loans. They simply had interest
Speaker 4: rate risks because they were done at three and a
Speaker 4: quarter three and a half, and the mortgage market today
Speaker 4: is closer.
Speaker 5: To six chris.
Speaker 2: As you know, and as we know because we've talked
Speaker 2: about this over the last couple of weeks in a
Speaker 2: much bigger way. JP Morgan already had more than ten
Speaker 2: percent of US deposits. Now that's been seen as problematic
Speaker 2: for the regulator. We assume in this morning that that
Speaker 2: exception has been granted already just by the very nature
Speaker 2: of this being authorized.
Speaker 5: At the moment.
Speaker 2: Correct, absolutely, So can I ask the question, then, does
Speaker 2: this become a problem if they hold more than ten
Speaker 2: percent of US deposits. I assume that was a line
Speaker 2: in the send for a reason. Why are we willing
Speaker 2: to go beyond it?
Speaker 4: Well, I think at the end of the day, if
Speaker 4: you had to take a lower bid and therefore a
Speaker 4: bigger loss for the FDIC and for the Deposit Insurance Fund,
Speaker 4: it would have been problematic for the other banks. The
Speaker 4: other banks would have had to pay more than they
Speaker 4: already are paying. The cost of FDS insurance will go
Speaker 4: higher in the coming quarters the next year. So if
Speaker 4: you could limit the hit to the DIIF to the
Speaker 4: Deposit Insurance Fund, that really is the best outcome for
Speaker 4: both the banks and for the system. So ultimately, this
Speaker 4: is about building confidence, and I think you build confidence
Speaker 4: a by having first Republic result and b by seeing
Speaker 4: that a very good operator who has strong capital, remember
Speaker 4: the Fortress balance sheet that JP Morgan has always advocated
Speaker 4: that allows them to do the transaction.
Speaker 3: I think it's going to be rare. I don't think
Speaker 3: we're going to see others like this.
Speaker 4: It really was the bank that was caught by the
Speaker 4: Friendly five A BESTVB six weeks ago.
Speaker 5: Chris, is too big to fail a good thing?
Speaker 3: Now? Well, not necessarily.
Speaker 4: I feel that the regional banks and mid sized community
Speaker 4: banks are in a great position to step up and
Speaker 4: serve the businesses and the households of the country, So
Speaker 4: too big to fail is not necessarily the outcome that
Speaker 4: I'm looking for. I think there's a many banks who
Speaker 4: are well capitalized that can step up, So the su
Speaker 4: regards having this episode resolved is a good thing. I
Speaker 4: do think you're going to see that part of the
Speaker 4: credit solution in the country is seeing these mid.
Speaker 3: Sized banks perform and perform well.
Speaker 4: I think you're correct that the credit is tightening, but
Speaker 4: I don't think it is being shut off.
Speaker 5: Hey, Chris Wonderfu to get your view on things.
Speaker 2: No down will catch up again soon, Chris marinak there
Speaker 2: of Jenny Montgomery's scuff. Kathy James with this around the
Speaker 2: table from Schwab Kathy Wander for to catch up with you.
Speaker 2: I can't believe it's the first time we're talking in person.
Speaker 2: It's under like three years because I get to talk
Speaker 2: to you so often. It feels so bizarre.
Speaker 6: I know, just great to be back in the studio.
Speaker 5: Wonderful to be with you.
Speaker 2: This is another bank that's gone under in the United
Speaker 2: States for America, another last minute deal, spending the whole
Speaker 2: weekend negotiating this mess, and here we are. The Federal
Speaker 2: Reserve gets to decide to high interest rates on Wednesday,
Speaker 2: and seemingly it is going to go another twenty five
Speaker 2: basis points. And I'm sure you've heard the same commentry
Speaker 2: we have that every single bank that goes under is idiosyncratic,
Speaker 2: and this isn't about what the Federal Reserve's done. In fact,
Speaker 2: we heard from John Williams, the New York Fed President,
Speaker 2: just say a couple of weeks ago that he doesn't
Speaker 2: think it's because they went from zero to five so quickly.
Speaker 5: How do you respond to.
Speaker 6: That, Oh, I think it has a lot to do
Speaker 6: with how much the Fed has tightened and how rapidly
Speaker 6: they've tightened. You know the old saying that the Fed
Speaker 6: titans until something breaks. I think that clearly they've moved
Speaker 6: at such a rapid pace that there's an impact on
Speaker 6: financial stability, and we're seeing it in some of the
Speaker 6: bankings areas now. It doesn't mean that credit risk, which
Speaker 6: is what they normally get concerned about, is a big issue.
Speaker 6: But I think it's hard to divorce the Fed's actions
Speaker 6: from what's happening in the banking sector.
Speaker 2: Do you think it gets worse then, given that they're
Speaker 2: going to keep on hiking, or at least we'll hid
Speaker 2: one more time this week.
Speaker 6: Yeah, we're kind of hoping this is the last rate hike.
Speaker 6: But it tells you a lot about this FED that
Speaker 6: they hiked in March when we had banking sector problems,
Speaker 6: and they look like they're going to go ahead in
Speaker 6: May when they have banking sector problems. One would think
Speaker 6: that this is probably the end of the rate hike
Speaker 6: cycle at this stage of the game.
Speaker 1: I wonder what kind of key man risk there is
Speaker 1: for the Federal Reserve at this point, given the fact
Speaker 1: that on Friday they did put out a report talking
Speaker 1: about what went wrong with SVB, seem to have passed
Speaker 1: in the back few mirror, but there are ongoing questions
Speaker 1: about how accurately they are regulating some of these banks.
Speaker 1: I mean, is this potentially going to, I don't know,
Speaker 1: up end the leadership at the fed at a certain point.
Speaker 6: Well, I would think at least we're going to get
Speaker 6: some dissenting boats this week, or at least one or two,
Speaker 6: and I think that, yeah, they have to reconsider the
Speaker 6: regulatory environment that they're in as a banking regulator and
Speaker 6: supervisory capacity. So I would think, you know, I don't know.
Speaker 6: I don't have any particular predictions in that, but I
Speaker 6: do think that there may be certainly some rewritten rules
Speaker 6: and certainly a re examination of what's been going on.
Speaker 1: We were just talking with Michael Showell and he was
Speaker 1: talking about how for now it's interest rate risk, but
Speaker 1: that eventually it could very easily become credit risk, especially
Speaker 1: as a lot of companies and individuals have a trouble
Speaker 1: paying back such high rates. What's your sense of just
Speaker 1: how significant that credit risk is and whether it's accurately
Speaker 1: reflected and where the market is right now.
Speaker 6: Yeah, one thing that we've seen is the credit spreads
Speaker 6: really haven't blown out in the way that you would
Speaker 6: anticipate given what's going on in the market. So we
Speaker 6: do think that there's some risk of widening where I
Speaker 6: think the bank loan sector certainly is vulnerable. Private credit.
Speaker 6: We don't know what's happening there because they don't mark
Speaker 6: the market, but I have to think that there's some
Speaker 6: bad loans there that are having to be restructured, and
Speaker 6: the high yield spreads have been much to than I
Speaker 6: would have anticipated at this stage of the game.
Speaker 1: Just very specifically, after SVB happened and now First Republic,
Speaker 1: some people were saying they were going to come in
Speaker 1: and buy bank bonds that had gotten beaten up because
Speaker 1: particularly for regional banks, that there was still value there.
Speaker 1: Gerard Cassidy of RBC put this out, where JP Morgan
Speaker 1: is not assuming First Republic's corporate debt or preferred stock,
Speaker 1: does this raise another risk, another layer of risk that
Speaker 1: makes that proposition perhaps less valuable than some people were
Speaker 1: arguing initially.
Speaker 6: Yeah, you've seen bond holders and equity holders and preferred
Speaker 6: holders get washed out in these deals. So I think
Speaker 6: you have to be pretty selective when you're looking at
Speaker 6: the banking sector now in terms of the bonds. You know, again,
Speaker 6: I think they're good bonds and they're not so good bonds,
Speaker 6: and maybe there's some opportunities there, but I do think
Speaker 6: you have to be really selective.
Speaker 2: Kathy, I've asked this question a few times, so I'm
Speaker 2: going to ask it again. It's a little bit unfair
Speaker 2: of me. So you can take as much time to
Speaker 2: think about it if you want. The risk that sham
Speaker 2: and pound runs now for months, In fact, for the
Speaker 2: linelast twelve months, we've been talking about the risk of
Speaker 2: him becoming Burns. Is the bigger risk now that he
Speaker 2: becomes treche and hikes at the most inappropriate time?
Speaker 5: Just think that's thrue. Why do you come down on
Speaker 5: that one right now? Is it Burns or Treesche? What's
Speaker 5: the big risk for him?
Speaker 6: I think it's Treche And have all along I thought
Speaker 6: that this FED was moving too fast and ignoring some
Speaker 6: of the lags between tightening monetary policy and what impact
Speaker 6: it has on the economy and on the financial system.
Speaker 6: And we've seen a lot of stress in the financial
Speaker 6: system in various ways even before this, and so I
Speaker 6: think the risk is greater that they moved too far
Speaker 6: too fast, as they have then having the Arthur Burns
Speaker 6: problem of having to tighten down the road. I don't
Speaker 6: think this is a repeat of the sixties and seventies.
Speaker 6: It's a very different economic environment.
Speaker 2: Would you go as far as saying you don't think
Speaker 2: the inflation story is as sticky as some people might
Speaker 2: say it is.
Speaker 6: Yeah, I do. I think we've seen the good prices
Speaker 6: come all the way back down. I mean, oil prices
Speaker 6: are lower than they were pre pandemics, so we've seen
Speaker 6: the supply side come back. And when you look at
Speaker 6: your balance sheets on consumer side, are good people spend
Speaker 6: money because they have jobs. But it doesn't look to
Speaker 6: me like that it's necessarily a big push and inflation.
Speaker 6: We still have aging population, we still have demographic drag,
Speaker 6: we still have a lot of savings globally, so I'm
Speaker 6: not sure that we need to move as fast as.
Speaker 5: They have moved.
Speaker 2: Kathy, good to see you. I can't believe it's been
Speaker 2: like three years plus, but it has been. I don't
Speaker 2: know where that time's gone. Kathy Jones a chance swap.
Speaker 2: Thank you very much joining us on Somebody's headlines. Mara
Speaker 2: Rodriguez Va Darrez, managing principal at mr V Associates. Maara,
Speaker 2: wonderful to catch up with you again. Just working through
Speaker 2: this together over the last few weeks. It's been a
Speaker 2: pleasure for all of us here on the show. Can
Speaker 2: I just get to that headline from Jamie Diamond that
Speaker 2: on banking faiblures this is getting near the end of it.
Speaker 2: Do you get this sense that this is anywhe near
Speaker 2: the end of it?
Speaker 7: Respectfully, I'm not sure that I agree.
Speaker 8: What is not idiosyncratic here is we're discovering that, unfortunately,
Speaker 8: a lot of these banks are not very good at
Speaker 8: interest rate risks and liquidity measurements, which really is what
Speaker 8: should be astonishing. This is the basics of banking, and
Speaker 8: as long as the European Central Bank, the Bank of England,
Speaker 8: and of course the Federal Reserve continued to raise rates,
Speaker 8: I'm afraid that this turnoil may not.
Speaker 1: Be over yet. Marie, do you think that the regulators
Speaker 1: models effectively account for interest rate risk given that they
Speaker 1: were not able to get ahead of some of these cases,
Speaker 1: You know.
Speaker 7: They actually do.
Speaker 8: And one of the things that has really come out
Speaker 8: since Friday with the Federal Reserve reports as well as
Speaker 8: the FDIC reports, is that a lot of problems, for
Speaker 8: example with Silicon Valley Bank and Signature, we're actually identified
Speaker 8: by the regular The problem was the enforcement and there
Speaker 8: have long been many, many requirements for banks to measure
Speaker 8: interest rate risks. The problem is Unfortunately, with every new
Speaker 8: crop of risk managers and lenders, they always think that
Speaker 8: this time is going to be different. They don't pay
Speaker 8: attention to the history that interest rates go down and
Speaker 8: they also go up, and you need to constantly be
Speaker 8: testing your asset liability measurements, all your different kinds of
Speaker 8: models for interest rates going up and down. So this
Speaker 8: idea that people have been caught by surprise they didn't
Speaker 8: realize that interest.
Speaker 7: Rates could go up, is really truly astounding.
Speaker 1: One thing that Jamie Diamond did say was that there
Speaker 1: would probably be some reduction in lending on the heels
Speaker 1: of their acquisition of this bank A First Republic. What's
Speaker 1: your sense of how many smaller banks are going to
Speaker 1: get a wired, how much lending is going to get
Speaker 1: taken out of the system if there are more potential
Speaker 1: incidents just like this.
Speaker 8: Yeah, I am worried about some of the smaller banks,
Speaker 8: even some of the community banks, some of the smaller
Speaker 8: regional banks. It's hard to compete with the incredible advantages
Speaker 8: that a JP Morgan, Bank of America City Bank have.
Speaker 8: These are globally systemically important banks. It's not just their size,
Speaker 8: it's just the diversity of the different businesses that we have,
Speaker 8: and here we are twenty twenty three, and it almost feels,
Speaker 8: at least from the history books, that we're kind of
Speaker 8: back to eighteen ninety five with JP Morgan rescuing the
Speaker 8: American government in nineteen thirteen when JP Morgan was rescuing banks,
Speaker 8: that kind of bank has become incredibly powerful, so it
Speaker 8: now has incredible exposure to operational risk. What kinds of
Speaker 8: skeletons are going to come out with this acquisition of
Speaker 8: First Republic.
Speaker 7: We really need to keep an eye on those.
Speaker 2: Kinds of things. Joked about thirty minutes ago that Washington,
Speaker 2: DC was still asleep, wasn't awake yet and hadn't seen
Speaker 2: this deal. Then she messaged me a moment ago and said,
Speaker 2: it looks like people are waking up. Senator Warren on
Speaker 2: Twitter in the last I think twenty minutes said this,
Speaker 2: The failure of First Republic Bank shows how deregulation has
Speaker 2: made the two big to fail problem even worse. A
Speaker 2: poorly supervised bank has been snapped up by an even
Speaker 2: bigger bank. Congress needs to make major reforms to fix
Speaker 2: a broken banking system. Mara, what's broken about it and
Speaker 2: what kind of follow through follow up are you expecting
Speaker 2: after this stress of the last couple of months or so.
Speaker 8: Well, one thing that has definitely broken is that after
Speaker 8: all the time that legislators and various lobbyists spent with
Speaker 8: Dodd Frank, there's a good portion of Title one that
Speaker 8: was actually got it where banks the size of Silicon
Speaker 8: Valley or First Republic were no longer considered systomachly important.
Speaker 8: That's incredibly incorrect, as we've seen this, and it has
Speaker 8: very signific and repercussions to the entire financial industry as
Speaker 8: well as to main street.
Speaker 7: Think of all those people who are now getting hurt and.
Speaker 8: Are going to be losing their jobs every time that
Speaker 8: one of these banks fails. So you need to declare
Speaker 8: these banks systemically important. That then means that they would
Speaker 8: get enhanced supervision. They would have to do a better
Speaker 8: job of measuring liquidity risks, especially doing simulations of periods
Speaker 8: of stress, which is what they should have been doing
Speaker 8: all along. And so there is an element of truth
Speaker 8: that there is deregulation. However, you also need to provide
Speaker 8: the examiners and all the different.
Speaker 7: Kinds of supervisors with resources.
Speaker 8: They don't have enough in terms of manpower in terms
Speaker 8: of human resources, and they also need more resources in
Speaker 8: terms of technology to be able to better detect when
Speaker 8: some of these risks are percolating with the banks, and
Speaker 8: you need to fire executives and high level risk managers
Speaker 8: when they don't do their jobs, and they there definitely
Speaker 8: need to be clawbacks. All these executives are walking away
Speaker 8: with millions, and what about everybody else at the bank
Speaker 8: and in the surrounding community that is going to lose
Speaker 8: their job?
Speaker 5: What about firing regulates us.
Speaker 8: That's right if indeed there's a good post mortem and
Speaker 8: we discover that there are any kind of professional in
Speaker 8: the various state as well as the national regulatory entities
Speaker 8: that aren't doing their job, they need to be fired.
Speaker 8: And part of the problem is the tone at the.
Speaker 7: Top, the way that things were.
Speaker 8: You know, let's face it, President former President Trump made
Speaker 8: terrible appointments. The tone of the top then filters down
Speaker 8: and it very much became both to offsite and on
Speaker 8: site examiners to have hands off and to almost be
Speaker 8: friendly with the banks. That's not what we want. We
Speaker 8: want examiners, both on site and the offside supervisors to
Speaker 8: be empowered to not only talk about what the problems
Speaker 8: are at the banks, but then you need enforcement. All
Speaker 8: of the treasure trove of documents that was released on
Speaker 8: Friday shows that those examiners were on top of things.
Speaker 7: It was the enforcement that completely lacks.
Speaker 5: Sadly, was Chairman Powell a terrible appointment.
Speaker 7: I had? That's a very interesting question.
Speaker 8: I think one thing that I think that he has
Speaker 8: done a very very good job in very difficult circumstances
Speaker 8: with monetary policy. That is where his background is, where
Speaker 8: his expertise is. His background is not in bank regulation,
Speaker 8: bank supervision, bank examination. These are interrelated, but they are
Speaker 8: different things. I think that somebody like lyel Brainard should
Speaker 8: have been appointed to head the banks earlier during the
Speaker 8: Trump administration. When I say head the banks, I mean
Speaker 8: the bank supervisory part. Obviously, I think that mister Barr
Speaker 8: has been a good appointment, but he.
Speaker 7: Barely got there.
Speaker 8: So there's a lot of different parts to the Federal Reserve,
Speaker 8: and Miss Chair Powell's background is not in supervision and examination.
Speaker 8: Former Chair Tarula was fantastic, Unfortunately he never got the
Speaker 8: official designation. So there are some talented people there, but
Speaker 8: they were not put to head bank supervision when they
Speaker 8: should have under the previous administration. And those things take
Speaker 8: time and they're all surfacing now, so there definitely has
Speaker 8: to be a serious post bortem about what needs to
Speaker 8: be done about both state as well as the national agencies.
Speaker 2: Mar thank you, Mara Rodriguez Viadarus. There of MRV associates
Speaker 2: going into key week, the Fed on Wednesday, payrolls Friday,
Speaker 2: Apple earnings on Thursday. We've got to start with the
Speaker 2: banking sector in America. Lori Cavacina joins US now head
Speaker 2: of Usacuity Strategy at RBC Capital Markets. Lorii does that
Speaker 2: deal over the weekend put this issue to bed, Well, let's.
Speaker 7: Hope, John.
Speaker 9: I mean, we've been watching the KBW Bank index performance
Speaker 9: very closely. We think it's become as important of a
Speaker 9: sentiment barometer as anything else.
Speaker 10: That you can look at these days.
Speaker 9: And I think when we go back to the financial crisis,
Speaker 9: when we go back to the tech bubble, we look
Speaker 9: at things like world Com, Bear, Lihman, and Ron. What
Speaker 9: we know is that the problem children in any crisis
Speaker 9: have to settle down before the market can can settle
Speaker 9: down itself. And I think that if you look at
Speaker 9: that index, that bank's index, it's been trying to stabilize.
Speaker 9: It's remarkable the resilience that we've seen. We know that
Speaker 9: earnings revision trends and small cap financials, which is a
Speaker 9: good proxy for regional banks, have been absolutely smoked. And
Speaker 9: that's something else that you know, we really need to
Speaker 9: see happen in here before I think the market can
Speaker 9: be content with the idea that the pain is out
Speaker 9: of the way. So time will tell, John, But I
Speaker 9: do like what I'm seeing.
Speaker 10: In the data.
Speaker 5: SVB failed.
Speaker 2: In March, the equity market rallied First Republic was essentially
Speaker 2: going under. In April, the equity market rallied Laurie. Can
Speaker 2: you make sense of that? The fact that we seem
Speaker 2: to have left behind the KBW bank index and the
Speaker 2: broader s and P five hundred has carried on grinding higher.
Speaker 10: Well, there's another child.
Speaker 9: That the market's paying attention to, not just its problem
Speaker 9: child of the regional banks, but it's you know, sort
Speaker 9: of oldest, you know, stellar child, the text sector, and
Speaker 9: the earnings there I think are in a recovery process.
Speaker 9: If you look at the rate of upward divisions, another
Speaker 9: good proxy for earning sentiment It got absolutely smoked last
Speaker 9: year for the T I MT space broadly, and it's
Speaker 9: actually in recovery mode this year. We're seeing things get
Speaker 9: less bad. We've even seen the tech sector briefly in
Speaker 9: our upward revision territory, and frankly, John, that is just
Speaker 9: the child that.
Speaker 10: Matters more to the market right now.
Speaker 9: It's it's just bigger in terms of its market cap representation.
Speaker 9: So the structure of the S and P five hundred
Speaker 9: is in such a way today and this is very
Speaker 9: different from what we've seen in the past. But if
Speaker 9: tech is behaving well, it also pre traded the pause
Speaker 9: essentially and is looking ahead to rate cuts. We can debate,
Speaker 9: you know, whether or not that's going to actually happen,
Speaker 9: but basically, the recovery, the improving trends, and the positive
Speaker 9: interest rate dynamics for the tech sector have been enough.
Speaker 1: Well it's not just the tech side sector though, Laurie,
Speaker 1: as you know, you've been tracking the earnings and even
Speaker 1: in some of the consumer discretionary areas, you've seen consumers
Speaker 1: absorb higher prices. They have absorbed going around the world
Speaker 1: traveling as much as they possibly can. At what point
Speaker 1: does the fact that even these bank failures that we're
Speaker 1: talking about not tighten credit enough to really do the
Speaker 1: work for the FED, and that comes in as a
Speaker 1: potential surprise for markets this week.
Speaker 9: Well, look, I do think that the FED is likely
Speaker 9: to go ahead and hike later this week. That's basically
Speaker 9: priced into market. I think for the FED to not
Speaker 9: do it at this point in time would spook the
Speaker 9: markets more than helping it. But I think that you
Speaker 9: have to always go back to the reasons why the
Speaker 9: FED is doing what it's doing. And if the FED
Speaker 9: is saying, Okay, we can go ahead and hike one
Speaker 9: more time, we think this is a relatively contained implosion.
Speaker 10: We think that the economy is strong enough to go
Speaker 10: ahead and do that. That is a vote of confidence
Speaker 10: for the here and now. Now.
Speaker 9: I do agree with you that we're seeing a tighter
Speaker 9: lending environment coming up.
Speaker 10: I was listening to.
Speaker 9: Bloomberg earlier this morning and liked what I heard one
Speaker 9: of the analysts saying about, you know, this doesn't really
Speaker 9: seem like it's a cliff. It seems like it's something
Speaker 9: that's going to come in, you know, in terms of
Speaker 9: drill and drabs over the longer term. I think we
Speaker 9: have to go back and ask what is sort of
Speaker 9: the state of the consumer balance sheets coming into all this,
Speaker 9: And I think the resiliency that you're seeing in terms
Speaker 9: of that consumer spending speaks to the fact that so
Speaker 9: much of a mess was cleaned up during COVID from
Speaker 9: all the stimulus programs and all the time that people
Speaker 9: were forced to spend at home, and that strength is
Speaker 9: now coming in and it's an asset and a buffer
Speaker 9: for this economy, and it's showing up in those consumer
Speaker 9: earnings results.
Speaker 1: Is the best way to play this in large cap
Speaker 1: companies and not necessarily the Russell two thousand. It's more
Speaker 1: exposed to other banks that, as Charlie Munger said over
Speaker 1: the weekend, could be laden with some of these other
Speaker 1: bad loans, or at least to underpriced loans based on
Speaker 1: where interstrates currently are.
Speaker 9: I think, you know, we go back to these crises
Speaker 9: that we saw in the past. If you go back
Speaker 9: and look at, you know, sort of the big growth
Speaker 9: stocks back in the tech bubble, it took a very
Speaker 9: very long time for this to become a leadership berry again.
Speaker 9: And you can say the same things about the banks
Speaker 9: coming out of the financial crisis.
Speaker 10: So I think it's right to have some caution there.
Speaker 9: We've moved to a neutral on the financials and say
Speaker 9: that in small cap as well, they're cheap at who
Speaker 9: the heck knows how cheap they actually are. I do
Speaker 9: think outside of the financials in small cap you can
Speaker 9: find interesting things to play.
Speaker 10: On a recovery thesis.
Speaker 9: Small cap consumer discretionary the sector looks extraordinarily cheap right
Speaker 9: now and should benefit from kind of a recovery going
Speaker 9: into twenty twenty four.
Speaker 10: The same fundamental.
Speaker 9: Tailwinds that we would see in the big CAF names,
Speaker 9: but the large cap consumer discretionary stocks are actually extraordinarily
Speaker 9: expensive right now, so we think there's a better risk
Speaker 9: reward in those small cap consumer names.
Speaker 10: I do, though, think Lisa, as long.
Speaker 9: As markets are kind of jitterate, and as long as
Speaker 9: markets are focused on, you know, kind of getting ready
Speaker 9: for FED cuts down the road, I do think that
Speaker 9: tech is going to have some tailwinds now. We are
Speaker 9: watching the positioning there very very closely. The nastaf futures
Speaker 9: are starting to get elevated. When that breaks, when that peaks,
Speaker 9: it's going to take down the tech stocks for a
Speaker 9: little bit. It's going to impact the broader SMP five
Speaker 9: hundred as well. But for now, I think the earnings
Speaker 9: trends are good. I think the FED trajectory in terms
Speaker 9: of where the market expects to go is good. So
Speaker 9: I think you can be selective in small cap, but
Speaker 9: I do think that the tech space and big cap
Speaker 9: should do pretty well.
Speaker 2: Laurie, you're not verish. I just want to be upfront
Speaker 2: about that. You're really not. You've been constructive in some
Speaker 2: ways in many ways over the last few months, Laurie.
Speaker 2: How hard is it to convince someone to take money
Speaker 2: out of money market funds and put it in the
Speaker 2: equity market.
Speaker 9: I think that it depends on what part of the
Speaker 9: market you're talking about, the time horizon you're giving investors,
Speaker 9: and the.
Speaker 10: Purposes that it's supposed to achieve.
Speaker 9: So one of the things we've been talking a lot
Speaker 9: about lately is the energy sector, which has really really
Speaker 9: nice divid in yields, balance sheets that have been cleaned up.
Speaker 9: It's been kind of an orphan sector for the last
Speaker 9: few years. It's come back over the last year or so,
Speaker 9: especially with rush of Ukraine in the spotlight.
Speaker 10: That's a pretty easy.
Speaker 9: Conversation to have with investors right now, even though there
Speaker 9: are some shorter term concerns.
Speaker 10: About oil prices.
Speaker 9: I do think at the end of the day, one
Speaker 9: of the things we see retail investors do is come
Speaker 9: into the S and P five hundred for yield opportunities.
Speaker 10: And even though the growth sector.
Speaker 9: The growth part of the market is zigging and zagging
Speaker 9: right now in terms of all the strength we're seeing
Speaker 9: on earnings, there's some really interesting yield opportunities if you
Speaker 9: look in other sectors.
Speaker 10: Those aren't tough conversations to have.
Speaker 2: Frankly, Lurie, thanks for paminas LERI cavistd that of MBC
Speaker 2: Capital Markets.
Speaker 1: Joining us now to really give a sense of what
Speaker 1: the risk reward is for a federal reserve, the balance
Speaker 1: of risks at a time of inflation that is coming
Speaker 1: down but still incredibly high. Joseph Lavornia, a chief US
Speaker 1: economist at SMBC Nico Securities, Joe, wonderful that you're joining
Speaker 1: us here on set. I'm wondering, from just a high
Speaker 1: level perspective, what is the impact on the economy from
Speaker 1: failures of banks that have left the biggest banks in
Speaker 1: America assuming the smaller ones even bigger and not going
Speaker 1: to fill in some of the lending.
Speaker 11: There are two key things, Lisa. Number one, this problem
Speaker 11: resides with the Federal Reserve. Management issues exist in banks,
Speaker 11: no question, But this FED raised rates much more than
Speaker 11: the guidance suggested.
Speaker 5: They put those rates way above.
Speaker 11: Where the markets suggested last summer. They were supposed to
Speaker 11: be based on the version of the yield curve and
Speaker 11: the banking system. The lending system doesn't work when you
Speaker 11: have a higher short rate versus the longer rate. Yield
Speaker 11: curve not just as a predictor of recession, but causes recessions.
Speaker 11: And the sad thing is the FED is going to
Speaker 11: now regulate these smaller medium sized banks when it was
Speaker 11: FED policy itself that caused this crisis. That's number one.
Speaker 11: Number two, given the tightening and lending standards we saw
Speaker 11: in January before this SVB Signature Bank First Republic situation,
Speaker 11: Rose banks were already tightening lending standards small medium in
Speaker 11: large banks at the fastest pace since previous recessions. So
Speaker 11: I can imagine that when we get the data a
Speaker 11: week from today, on Monday May eighth, at two, it's
Speaker 11: going to show further tightening and lending standards and that
Speaker 11: is unambiguously bad for the economy.
Speaker 1: So you just said a number of things that I
Speaker 1: want to dig into, and I'll get to the FEDS
Speaker 1: and sort of how quickly they raised rates in just
Speaker 1: a minute. But if you're saying that they raised rates
Speaker 1: so quickly that the banking model did not work, then
Speaker 1: what kind of follow on effect do you expect in
Speaker 1: other regional banks Even though a lot of people say
Speaker 1: they have been fortified, they have raised capital, they have
Speaker 1: addressed some of the issues.
Speaker 5: Well, that may be true. So there's two issues early.
Speaker 11: So one is systemic, like how many other banks perhaps
Speaker 11: are behind the banks that have had troubles, and we
Speaker 11: don't know the answer to that. The FED is backstop
Speaker 11: these banks through these various lending programs. The issue, though,
Speaker 11: is will these banks make loans and extend credit that
Speaker 11: to me is unlikely to happen. In other words, they're
Speaker 11: going to call in deposits or call in loans, try
Speaker 11: to raise deposits, revolving lines of credit won't be extended.
Speaker 11: That's bad for growth. So whether there is another systemic
Speaker 11: issue because of let's say bank mismanagement, we'll call it
Speaker 11: with quotes, is a sort of irrelevant in the sense
Speaker 11: that what the FED has already done from a monetary
Speaker 11: policy transmission mechanism is they've they've basically killed credit and
Speaker 11: money and lending create.
Speaker 1: So you don't think that it was the issue of
Speaker 1: Randy Quarrels for not necessarily enforcing some of the regulatory
Speaker 1: oversights that the FED flagged at specific banks that have
Speaker 1: run into trouble.
Speaker 11: No, I mean, that's just political cover. I mean, if
Speaker 11: you looked at the bond market through April of last year,
Speaker 11: was the middle part, the longer part of the curve.
Speaker 11: Those were bond market returns at that point were the
Speaker 11: worst returns you had in measured history. So the market
Speaker 11: was not People did not expect the FED to keep
Speaker 11: going in seventy fives, and it was after that first
Speaker 11: seventy five when the yeal curve inverted and the FED
Speaker 11: stupidly ignored it.
Speaker 1: Okay, but then what would you say to people who
Speaker 1: point to the actual economic data that's coming in. It's
Speaker 1: been stronger than expected. Consumers keep spending. There has been
Speaker 1: ongoing credit creation. This morning, we have ten different issuers
Speaker 1: ready to sell corporate debt even though rates have risen
Speaker 1: so much. What would you say to people, say, the
Speaker 1: economy has proven it is resilient and it has been
Speaker 1: able to withstand this, and then someone actually, it hasn't
Speaker 1: driven inflation down enough.
Speaker 11: Inflation's lagging, inflation's coming down. If you look at the
Speaker 11: tree of the CPI, the upswing in the downswing has
Speaker 11: been identical in this cycle. Their pockets of the economy
Speaker 11: that are strong. We had the same debate Lisa back
Speaker 11: in eight. I remember vivil I wrote a piece on this.
Speaker 11: You look on eight we had people debating if we'd
Speaker 11: entered recession. The economy grew over two percent in the
Speaker 11: second quarter of two thousand and eight and what turned
Speaker 11: out to be the deepest recession since the thirty So
Speaker 11: the fact that the data are all in alignment is normal.
Speaker 11: We had where housings in recession, manufacturings in recession, inflation's
Speaker 11: coming down. Core CPI will be sticky. Rents are a
Speaker 11: big piece, but we know the housings weakening. What is
Speaker 11: so wrong and just waiting and seeing what happens for
Speaker 11: this spillover, if any in the rest of the economy.
Speaker 11: If that could have done that numerous times over the
Speaker 11: past year.
Speaker 1: Well, they've gotten it wrong. Though they've got gotten it
Speaker 1: totally right, and they got the transitory concept wrong as well,
Speaker 1: and that some people would argue, including muhammadl Aaria, that
Speaker 1: that was the reason for how rapidly they rose real
Speaker 1: they raised rates. So yes, perhaps they did raise them
Speaker 1: too quickly, but that was the least worst option after
Speaker 1: not raising them for as long as they did. So
Speaker 1: what would you say to that? I mean, was the
Speaker 1: first misstep in the real misstep not raising them back
Speaker 1: in the summer yea twenty twenty.
Speaker 11: Absolutely J. Powell channeled his inner poll voker when he
Speaker 11: wanted to be reappointed. So you're absolutely right, and Muhammed's
Speaker 11: right about that. However, you don't correct one mistake by
Speaker 11: making another mistake. And I could imagine the people who
Speaker 11: have been arguing the Fed to raise rates, who have
Speaker 11: got to get inflation down. What happens, least hypothetically, we
Speaker 11: go into recession this year, as I believe will happen,
Speaker 11: and we're in next year presidential election year. What kind
Speaker 11: of political pressure is the FED going to take? Because
Speaker 11: it doesn't matter who's arguing, is one side is going
Speaker 11: to be happy they're cutting or not cutting or whatever
Speaker 11: it might be. So the FED has really put a
Speaker 11: huge bull's eye on its back, and it could have
Speaker 11: been prevented. And part of the problem is that to
Speaker 11: Fed all these meetings, it's all this unanimity.
Speaker 5: There should be debate.
Speaker 11: Economists don't agree in anything, except for those at the FED.
Speaker 1: This is something that people are expecting. Well here perhaps
Speaker 1: more of going forward. But right now, given where we are,
Speaker 1: given how quickly they've raised rates, what is the bigger
Speaker 1: risk if they pause at this point? Is that the
Speaker 1: right course of action?
Speaker 11: Is it justation at a point where people are concerned that.
Speaker 1: They're going to reignite some of the credit creation.
Speaker 11: Inflation is easy to handle your raise rates. The FED
Speaker 11: should have paused a while ago. The FED will be
Speaker 11: cutting and should be cutting break even inflation, the yield curve,
Speaker 11: the dollar, commodity prices, none of these things have been
Speaker 11: suggesting for the last six or seven months. There's really
Speaker 11: any sort of inflation problem. Not that inflation's not needs
Speaker 11: to come down, it will, but the FED should stop
Speaker 11: this crazy policy of tightening, and they should continue with
Speaker 11: the balance sheet, but they should cut on the rates.
Speaker 1: That should people are expecting. The market is pricing in
Speaker 1: a twenty five basis point rate hike at Wednesday's meeting.
Speaker 1: Based on that rate hiking cycle, based on what you're
Speaker 1: seeing in the fundamental economy, what do you think will
Speaker 1: be the outcome for the US economy.
Speaker 11: Recession by third quarter of this year. I mean, the
Speaker 11: thing is, you look at the index leny indicators in
Speaker 11: the six period of peak twenty one months before the
Speaker 11: economy peaked, that would put an economy peak this year
Speaker 11: in September. We're down almost eight percent over the past
Speaker 11: twelve months. Virtue, All the indicators are declining. The EIL
Speaker 11: curvistil inverted. You mentioned the bank lending. That tightening is
Speaker 11: still working itself through the economy. Why in the role
Speaker 11: of your raising rates, you're actually making the problem worse
Speaker 11: because you're lifting money market rates, which is encouraging to
Speaker 11: record deposit flight. It's like, I don't understand what these
Speaker 11: people don't see it. It's kind of like remember in
Speaker 11: Zulander with Will Ferrell that you know we got to
Speaker 11: a piano key necktie, like the Fed you those short rates,
Speaker 11: So those bill rates are up at five percent plus
Speaker 11: you've put them there?
Speaker 5: What are you doing?
Speaker 1: Never thought that i'd hear Zulander cited as a model
Speaker 1: for FED policy. Joseph Lavornia of SMBC Group, thank you
Speaker 1: so much for being with us. Subscribe to the Bloomberg
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Speaker 1: for listening. I'm Lisa Abramowitz, and this is bloomberg
Speaker 10: S