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  • Writer's pictureMike V.

Weekend Newsletter 9.22.18

"An investment in knowledge pays the best interest” - Ben Franklin

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Reuters: Too big to Compete

Wall Street’s top banking regulator sued the federal government to void its decision to award national bank charters to online lenders and payment companies, saying it was unconstitutional. Maria Vullo, superintendent of New York’s Department of Financial Services, called the July 31 decision by the Office of the Comptroller of the Currency (OCC) to let financial technology companies, or fintech firms, obtain charters “lawless, ill-conceived, and destabilizing of financial markets.” She said New York could best regulate those markets. OCC spokesman Bryan Hubbard said in an email that the regulator, part of the U.S. Department of Treasury, would vigorously defend its authority to grant national charters to qualified companies “engaged in the business of banking.” Fintech firms have long pushed for national bank charters to let them operate nationwide without needing licenses in every state, a process they say can impede growth and boost costs. Treasury Secretary Steven Mnuchin has said easing regulation of newer financial companies can “encourage financial ingenuity to foster the nation’s vibrant financial services and technology sectors.”

CNBC: Tesla

Former General Motors Vice Chairman Bob Lutz suggested that Tesla's shares, will soon spiral to $0 because "the jaws are tightening, and I think in another year or two we'll see a movie called 'Who Killed Tesla,' a conspiracy movie starring Leonardo DiCaprio." Lutz argued “Tesla will never make money on the Model 3 because the cost is way too high. He's got 9,000 people in that assembly plant producing less than 150,000 cars a year. The whole thing just doesn't compute. It's an automobile company that is headed for the graveyard."

Bloomberg: $250 Trillion in Debt: The World’s Post-Lehman Legacy

In many ways, all the talk about global central banks beginning a “great unwind” of their extraordinary monetary stimulus is positively quaint. After all, how can officials from the Federal Reserve to the Bank of Japan even pretend to know how to reverse what they’ve done over the past decade? I’m speaking specifically about propping up financial markets with easy money and allowing the world’s debt burden to balloon to almost $250 trillion. They kept interest rates at or below zero for an extended period — probably too long, if they’re being honest with themselves — and used bond-buying programs to further suppress sovereign yields, punishing savers and promoting consumption and risk-taking. Global debt has ballooned over the past two decades: from $84 trillion at the turn of the century, to $173 trillion at the time of the 2008 financial crisis, to $250 trillion a decade after Lehman Brothers Holdings Inc.’s collapse.

Not everyone is piling up debt. Thanks to post-crisis regulations, financial corporations have become healthier and more resilient to another shock. Over the past decade, they’ve increased their debt by just $3 trillion, leaving their debt-to-GDP ratio as low as it has been in recent memory. But other companies have picked up the slack, taking advantage of rock-bottom interest rates to take on increasingly high amounts of leverage to buy back shares and pay higher dividends with selling debt. Some $27 trillion of borrowing later, the obligations are almost as large as the world’s GDP.

Households across the globe appear to be in a similar position as they were 10 years ago. As a percentage of GDP, the debt has barely changed. But it depends where you look. Household have accumulated $6.5 trillion of debt, up from $757 billion in 2008. Now, 10 years after the collapse of Lehman Brothers, we’re seeing the results of the grandest central-bank experiment in history. On the surface, it looks like mission accomplished. But dig a little deeper, and you’ll find that this road has been paved with debt, debt and more debt — and that it’s a one-way street. Let’s start with the $15.3 trillion U.S. Government bond market, the world’s biggest bond market. Remarkably, it has tripled in size since August 2008. For context, in the prior 10-year period, it grew by “only” $1.5 trillion, even amid the beginning of the Iraq War. The totality of U.S. federal debt now makes up more than 100 percent of America’s GDP. This isn’t a uniquely American problem. Across the globe, government debt has soared over the past decade. While individuals and financial institutions have been busy getting their houses in order after the crisis, many large governments leaned on their captive buyer base — central banks — to binge on debt and pull forward economic growth.

The fact that central banks suppressed interest rates also encouraged non-financial companies to tap the bond markets early and often. Sometimes those proceeds were put to productive uses, but often the corporations merely purchased their own shares, boosting the stock value. Now, this isn’t solely a developed-market story, either. Emerging-market debt levels are much higher than they were 10 years ago, with yield-starved investors clamoring for dollar-denominated debt from places like Turkey and Brazil. Of course, those nations are now coming under pressure as the Fed raises interest rates, boosting the dollar and making it costlier for companies in those countries to repay their obligations. But it’s worth noting that China’s debt levels have exploded in the post-Lehman era. China is now saddled with almost $40 trillion of debt, compared with less than $30 trillion for all other emerging markets combined. In 2008, the group had $16 trillion of debt, while China only carried $7 trillion. The world’s second-largest economy is now coming to terms with rising corporate defaults. No one knows whether the leverage across the financial system is sustainable — only that it’s different from 2008. Back then, some individuals overextended themselves by taking on mortgages they had little hope of repaying. This time, companies are pushing the envelope as far as they can, accepting weaker credit ratings in an effort to maximize profits. Sovereign governments, meanwhile, are in uncharted territory. While they can effectively print money with the help of central banks, no one is quite sure what happens when a global superpower like Japan reaches a debt-to-GDP ratio of 224 percent. Confronted with an aging population and promises of a social safety net, there’s no easy solution for how to counteract this trend. With the recession nine years in the rear-view mirror, this would typically be the time to pay off debt, not add to it. Because of that, the fretting about the Fed’s current balance-sheet runoff plan is almost comical. There’s simply too much debt in the system and no clear path to truly paying it off. Not even central bank officials are pretending they’ll shed all their holdings — estimates fluctuate around ending at $2.5 trillion. This is the post-Lehman legacy. To pull the global economy back from the brink, governments borrowed heavily from the future. That either portends pain ahead, through austerity measures or tax increases, or it signals that central-bank meddling will become a permanent fixture of 21st century financial markets.

FT: Bullish US stocks leave rest of the world trailing

The autumn worry is over the growing gulf in the performance of Wall Street and the rest of the world. Nordea Asset Management describes this as an equity bull market “firing on one cylinder”. Analysts’ one-year forward earnings estimates show growing optimism about US equities but a very different outlook for China and emerging markets. The dollar nightmare is just getting bigger for EM, we have built bad habits.” In the long run, the divergence between the US and the rest of world creates “an unstable equilibrium that ultimately has to close”, Mr Bahrke added. He expects the reduction in the gap will come from a pullback in US strength rather than a rise and emerging markets. So, US strength will peak when the tax cut benefits fade. But that is for next year. “For now, US equities might continue to outperform,” Nordea said.

Michael Vissotski & Michael Mazzola


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