Copyright 2014

From One Collateral Shortage to the Next


(Bloomberg) -- In 1863, with the US still reeling from a bloody civil war, a plan was launched in Washington to simultaneously fund its military loans and strengthen the nascent American banking system. We cannot maintain our nationality unless we establish a sound and stable financial system; and as the basis of it we must have a uniform national currency, Senator John Sherman urged at the time.

What followed was a program designed to replace the patchwork state rules that had for years allowed the countrys banks to sell their own private notes secured by loans or state bonds. Under the National Bank Acts of 1863 and 1864, banks could issue “national bank notes” that would be backed by the government, by depositing certain issues of US debt with the Treasury.

While the legislation helped fill federal coffers and became the basis for the Federal Reserve Act 40 years later, it arguably failed its second mandate as bank panics continued apace in the latter half of the 19th century. Instead of depositors demanding the return of private bank notes, they simply demanded national bank notes instead.

This nugget of US financial history comes courtesy of a new working paper from the Basel, Switzerland-based Bank for International Settlements. Its authors, famed economists Gary Gorton and Tyler Muir, argue that the National Banking Era bears an uncanny resemblance to more recent regulatory efforts to strengthen the global financial system in the aftermath of the 2008 crisis.

At issue is the systems tendency to manufacture safe securities in times when government-issued debt is in short supply. Prior to the financial crisis, for instance, Wall Streets securitization machine worked overtime to turn dodgy subprime home loans into triple-A rated securities. Not only did the resulting bonds satisfy the needs of a global savings glut desperate for investable assets, but the convenience of the securitized wrapper had the added benefit of turning the debt into suitable collateral for interbank loans in the vast repo market.

The story is told in the BIS chart below, in vivid black and white. It shows the steady decline of demand deposits backed by bank loans, and their subsequent replacement with privately-produced safe securities such as highly-rated asset- and mortgage-backed securities (ABS and MBS), asset-backed commercial paper (ABCP), and other ingredients of Wall Streets alphabet soup. In the late 19th century the need for such securities was made more urgent by the mounting scarcity of US government debt, the economists argue.

The creation of privately-produced safe debt is in part a response to a scarcity of government-produced safe debt, they write. The response to scarcity was not only increased private production of safe debt, but also increased mobility of the debt.

What happened next forms its own sizable chunk of US financial history. The repo market seized up in 2008, as concerns over the quality of the collateral underpinning short-term loans mounted during the collapse of the housing bubble. That culminated in the failure of Lehman Brothers, and the wider financial crisis.

Since then, regulators have embarked on an effort to strengthen the banking system through new rules requiring institutions to hold vast war chests of high-quality assets through the liquidity coverage ratio, or LCR, as well as new margin requirements for centrally-cleared derivatives trades.

In that sense, the LCR and its associated rules bear more than a little resemblance to the National Banking Era of more than 150 years ago, Gorton and Muir argue. 

It is likely that a system of immobile collateral that restricts certain forms of bank debt creation simply encourages other forms of bank debt to be created, they write. This is consistent with the growth in deposits during the National Banking Era. There is a remarkably strong correlation between Treasury supply and deposits. These new forms of bank debt are dangerous because they are typically not well understood or acknowledged, as deposits were not well understood in the National Banking Era and as shadow money (repo, ABCP etc.) were not understood until the recent crisis. In an effort to shore up one pillar of the financial system, regulators may inadvertently encourage a rerun of the same sort of behavior that help contribute to the 2008 crisis. New regulations do not address potential scarcities of safe debt. In fact, since the financial crisis, new regulations aim at returning to a financial system of immobile collateral.

The unanswered question here of course, is just what safe securities might be produced by a financial system faced with yet another collateral shortage.

Answers on a postcard to:

Centralbahnplatz 2

4051 Basel


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BBB reminds Service Members of targeted scams

HUNTSVILLE, Ala - While the nation is preparing to salute service members for their courage and sacrifice, scammers are looking for ways to take advantage of them as well as their family members.
Elizabeth Garcia with the Better Business Bureau talks to Steve Johnson about scams specifically targeting service members.

The High Priced Military Loans Scam - advertisements for loans that promise a guarantee, instant approval or no credit check will often come with hidden fees and extremely high interest rates. Remember that legitimate lenders will never guarantee a loan before you apply and loans that require an upfront fee are likely a scam.

The Veterans` Benefits Buyout Plans Scam - this buyout plan will offer a cash payment in exchange for a disabled veteran`s future benefits or pension payments. The cash amount is only about 30-40% of what the veteran is entitled to. These buyout plans can be structured in several different ways, so research thoroughly before signing anything over.

The Fake Rental Properties Scam - stolen photos of legitimate rental properties are used in advertisements that promise military discounts and other incentives. Service members will have to pay a fee via wire transfer for security payments or a key to the property - in the end they will receive nothing.

The Phony Jury Duty Summons Scam - a caller claims to work for the local court system and states that the service member did not show up for jury duty and now has a warrant out for their arrest. When the victim says they never got a summons, the caller will ask for a credit card number or Social Security number to clear up the matter.

The Misleading Car Sales Scam - websites posting classified ads will offer false discounts for military personnel or claim to be from soldiers who need to sell their vehicle fast since they have been deployed. Upfront fees will be required via wire transfer, or the vehicle will have problems after purchase.

The Expensive Life Insurance Policies Scam - members of the military are often the targets of high pressured sales tactics that offer unnecessary, expensive life insurance policies. Solicitors may make false statements regarding the benefits that these policies offer.

Call the BBB Military Line, the military arm of the Better Business Bureau. It provides free resources, such as financial literacy information, access to BBB services and scam alerts, and complaint and dispute resolution for all branches of the US military.

Beware of local scams targeting military families and veterans

WINSTON-SALEM, NC -- The Better Business Bureau of Northwest North Carolina is using the upcoming holiday as an opportunity to warn veterans and their families of potential scams targeting them.

A release from the BBB said, With focus deservedly on our nation's veterans and active-duty military, these men and women may also see increased attention from scammers.

Some examples include:

  • Impersonating a military or veteran charitys website and soliciting for donations.
  • Posing as the Veterans Administration (VA) to contact veterans about updating their credit card, bank or other financial records with the VA.
  • Charging service members for services they could get for free, such as military records.
  • Convincing veterans to transfer their assets into fraudulent investment schemes.
  • Offering guaranteed military loans that can have high interest rates and hidden fees.
  • Advertising housing online with military discounts and incentives, and then bilking service personnel out of security deposits.
  • Trying to sell products security systems to spouses of deployed military personnel by saying the service member ordered it to protect his or her family;
  • Selling stolen vehicles at low prices by claiming to be a soldier who needs to sell fast because hes been deployed.
  • Posing as government contractors recruiting veterans and then asking for a copy of the job applicants passport which can lead to identity theft.
  • Posing on online dating services as a lonely service member in a remote part of Iraq or Afghanistan, and then asking for money to be wired to a third party for some emergency.

BBB President and CEO. Brian Wright tells FOX8, Its disgraceful. Weve got the military that really stands for our freedom, and its unfortunate people are taking advantage of them.

FOX8 also talked to people at Veterans Helping Veterans Heal on North Glenn Avenue in Winston-Salem.

The organization offers a safe living space for at least two dozen veterans in the community. But its much more than a roof over their heads; the veterans there learn life skills while they recover from substance abuse or mental health issues.

VHVH Director of Operations Brian Hahne says the veterans they work with are already struggling to find stability and certainly dont need any additional hardships, such as being victimized by a scam artist.

Its a vulnerable population, he explained. Our veterans have served our country. I stress all the time- these guys have earned the opportunity to be part of this program by serving our country. And yet unfortunately there are scams out there targeting them as well.

The BBB encourages consumers to donate wisely this holiday in honor of veterans. Check Give.Org to make sure a group is legitimately collecting money for veterans and military-related causes.

Memorial Day weekend shoppers should also be cautious. Read the fine print and return policies, Wright emphasized, and when possible pay with a credit card so disputes will be easier later.

BBB: How to defend military families from financial threats

Americans pause to remember those who made the ultimate sacrifice for their nation on the last Monday of every May.

Memorial Day reminds us to be grateful for what so many service members have done for our country.

But even while many are reflecting on the heroism of those in uniform, there are those who are targeting service members and their families with scam attempts.

Here are some of the reasons why military members are frequently targeted by scammers:

? A steady and predictable paycheck is always a magnet for scammers, especially one that is guaranteed by the US government.

? Extended time away from home during deployments (and the mission focus required) can lead to giving less thought to daily personal financial matters.

? Financial strains can be aggravated by frequent family moves and stretched incomes. Scammers know that a family under financial pressure is more susceptible to "easy money" scams.

Watch for these scams

The Better Business Bureau warns military members and their families of these common scams frequently aimed at them:

? Veterans Administration imposters. By email or phone, someone will claim to be from the VA. They will want you to give them your credit card, bank or other financial information so that they may "update their records." The object is to steal the information from you that will then allow them to steal your money.

? "Instant approval" military loans. The offer may come with claims that there is no credit check and "all ranks approved." Such loans will probably have high interest rates, hidden fees or a demand for an up-front fee. Legitimate lenders will never require an up-front fee or offer loans with guaranteed pre-approval.

? Buyout plans for veteran benefits. Such schemes will actually pay you only 30 to 40 percent of the money you are entitled to.

? Unnecessarily expensive life insurance. There may be false promises of benefits. Remember that high-pressure sales tactics usually mean a rip-off.

? Military discount housing. Often requiring an up-front wire transfer or a fee, many of these offers will then give you nothing in return. They often tempt with fake photos of apartments or houses.

?  Military discount car sales. In return for a required up-front wire transfer, an inferior or stolen vehicle may be all that you get.

Protection advice

To keep scammers and rip-off artists at bay, always remember these tips:

? Up-front fees are bad news.

? Never wire money to someone you do not know.

? Get the total price. Watch out for misleading information.

? Don't give in to high-pressure sales tactics.

? Get everything in writing. Don't trust mere verbal promises.

? Check out the company with the BBB before agreeing to anything.

? Don't trust telemarketers or house calls. The VA does not use telemarketers or make house calls. Trust no one who claims they are from the VA without showing you proof.

Use the BBB's Military Line to find out about more issues and benefits for military families. Look over the Military Line Facebook Page for information that can help service members and their families.

2 Types of Stock I Never Plan to Buy

With such a horrific downfall, you might think that the industry is rife with deals, but I dont believe thats the case.

First and foremost, any investor in this industry is at the whim of the federal government. Thats because the tuition bills are paid largely through Title IV student loans. In fact, at many of these schools, Title IV loans -- when combined with military loans -- account for well over 75% of overall revenue.

Furthermore, the results from for-profit players are questionable at best. Though tighter regulation under the Obama administration has led healthier practices (ie, college counselors are no longer paid by commission on the number of students they bring in), for-profit students still have less favorable outcomes than their not-for-profit peers. They tend to drop out of school more regularly and have a tougher time finding a job even if they do graduate.

But perhaps the biggest threat is that what set for-profit schools apart -- online courses and flexible schedules -- is now becoming commonplace at traditional institutions of higher education. Because many of these institutions rely on state-run tax revenues and are not for profit, they offer far better tuition rates than for-profit rivals.

Add those factors together and you have a recipe for bad returns, even with these stocks having fallen so far from grace already.

Technology component makers

Im not against all technology stocks. In fact, tech stalwarts Alphabet, Baidu, and Facebook make up over one-third of my real-life holdings. Instead, I eschew investing in any technology company with the following three traits:

  1. It provides component parts that allow the guts of popular consumer devices, like smartphones, to run.
  2. A few customers account for a huge percentage of revenue.
  3. The moat is provided primarily through intellectual property rights.
  4. Valued at less than $5 billion, with less than $1 billion in cash.

There are lots of companies that fit this bill, the most well-known being companies like InvenSense (NYSE:INVN), Cirruc Logic (NASDAQ:CRUS), and Ambarella (NASDAQ:AMBA).