A Sign the Current System of Finance is in its Death Throes

Traditional banks could lose up to 60% of their profits to fintech firms over the next decade.

That’s not me saying that.

It’s according to a recent report from global consultancy firm McKinsey & Co.

But I’m not going to spend today trying to convince you of this fact.

By now you know I think the bank unbundling is a fait accompli. A done deal. And the only question you need to answer is: How can I profit?

But if you don’t agree with me on this, or you’re just bored with the whole thing, let me show you why you need to be watching the bank space carefully anyway.

Because last week, something really weird happened.

The last time it happened marked the beginnings of the GFC.

Let me explain…

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Why you need to watch the banking space

It’s often the most obscure corners of the finance world where the seeds of crises are born.

In the GFC it was the largely unheralded Collateralised Debt Obligation (CDO) space where the gremlins lay hidden.

The early tell was on 9 August 2007, when banking giant BNP Paribas announced it was going to stop dealing in the US mortgage debt market.

At this moment it became clear to everyone that trillions of dollars of dodgy derivatives were floating around. And because no one knew who held what, trust in the system evaporated.

The banks stopped doing business with each other. But it still took a year for the whole sorry story to unravel, culminating in the bankruptcy of Lehman Brothers and the panic of the aftermath.

So, did we get another early ‘tell’ last week? This time in something called the repo market in the US?

Perhaps…

What’s going on in the repo market?

The repurchase or ‘repo’ market is when banks lend to each other overnight.

It’s how banks with excess cash can lend to banks that need cash to settle accounts on a day to day basis.

And it should be the safest form of banking.

After all, if a bank can’t trust another bank for a night, then you have a big problem. Just like what happened in 2007.

The repo market is therefore just banks lending to other banks overnight at an interest rate called the overnight repo rate.

Because this is so safe, the interest rate on this is usually super low.

But look what happened last week on the chart:

Money Morning

Source: Trading Economics
[Click to open new window]

This is a yearly chart of the repo rate. As you can see, we just got a big spike. It rose from around 2% to almost 10%.

Make no mistake, this unusual event hurt.

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If you were a securities dealer or bank financing a $20 billion balance sheet and you had to deliver on rates at the 6%, 7% or 8% level, you got crushed’, said Tom di Galoma, a managing director at Seaport Global Holdings, in an interview with Market Watch.

Some tried to explain this event as a simple hiccup.

Pacific Investment Management Company said that soaring repo rates earlier this week can be tied to a culmination of events, including $35 billion of corporate tax payments and dealers needing an extra $20 billion in funding to settle recent U.S. Treasury issuance, which helped sap market liquidity.’

A simple issue of timing causing a cash shortfall?

Come off it!

Are they trying to say that the biggest banks in the world are so incompetent they can be blindsided by a known in advance tax bill!?

On second thoughts…

But seriously, surely not.

As is the usual case these days, the central bankers at the Federal Reserve rode to the rescue.

They injected US$23 billion in on Wednesday. And then another $53 billion and $73 billion over the course of the week.

Money created out of thin air to bail out the banks in their times of trouble.

Ahhh capitalism.

But the ‘socialists’ of the finance world did calm down and the repo rate fell back down to below 2% quick sharp.

It’s not over yet…

So, crisis averted then?

Maybe, maybe not…

The fact this even happened, that the ‘plumbing’ failed and the banks suddenly became very distrustful of each other, is something you should note carefully.

As always, it’s hard to work out what exactly it means in the moment.

All sorts of theories will come out. But let me ask you this…can you rely on the mainstream to tell you the real story?

This tweet probably sums it up best:

Money Morning

Source: Twitter
[Click to open new window]

My thinking?

Anytime something out of the ordinary like this happens, you have to be ready to act, as these things can escalate fast.

Don’t panic, but have an exit strategy up your sleeve and start doing your own diligence now.

Maybe it was a simple miscalculation in bank budgeting, maybe the central bankers have this under control, maybe there’s nothing to worry about…

But perhaps it’s the tip of a trillion-dollar iceberg.

Could it be a sign that big banks are struggling under the weight of a legacy of mistakes? Or a sign the current system of finance is in its death throes?

Whatever it is, watch this space carefully…

Good investing,

Ryan Dinse
Editor, Money Morning


Ryan Dinse is an Editor at Money Morning. He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur. With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle. Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.  


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