The Demi-monde of Finance
By Sabine Saadeh Financial Trader/Writer
In the last week of February 2023, Credit Suisse released one of the most relevant publications; The Credit Suisse Global Investment Returns yearbook. It is a publication by renowned financial historians that have undergone a detailed study of the returns of equities, bonds, cash and currencies for 35 countries over a period of 123 years. With the bank now becoming part of UBS Group AG after 166 years of autonomous longstanding financial provision, I couldn’t help but wonder; what is it about animal spirits that make us humans completely forsake hard logic?
It is true that central banks were late at increasing interest rates, and that is a cause of the global banking crisis, but it is not the true cause. The underlying true cause, that is the red flag that has been ignored by regulators and banks for the past year, is the loose internal controls by all parties involved in the crisis, whether on the individual level or the corporate level or the banking level or the government level. I guess low cost money that has been available for more than a decade does make people forget to do their jobs!
Whatever happened to quarterly reports from banks that help investors assess the financial health of a financial institution? Why are there no basic investing objectives anymore? Just like how an individual investor has to have the prudence to monitor savings through SAFETY, INCOME and GROWTH, so should businesses, banks and governments.
A little glimpse of today’s demimonde of finance might help put things into perspective; the unrealized losses at the FDIC insured US banks exceeded $600 Billion at the end of 2022. This is before the loan losses incurred by banks. Now the higher rates not only affected the purchases of long-term securities with short-term bank deposits, but also real estate, non-essential consumer industries and highly leveraged companies. This means that even with regulators’ backstops, an environment of high inflation and low growth will make it very difficult for liquidity to flow back into the economy thus hindering eventual growth.
Stalemate is the enemy of any economy, not recession! Ignoring red flags that cause recessions do not make the problems disappear. In fact an increase in stagnation only leads to fueling a massive destructive bubble. Default rates globally have risen, reducing earnings and capital buffers, all because there was an economic policy of “look the other way!”
Another major red flag that is being ignored is that since the Great Recession in 2008, regulatory restrictions have shifted higher risk from traditional banks to the shadow banking system, which means institutions like insurance companies, pension funds and specialty financiers are dealing with complex lending and trading activities. The Bank of International Settlements estimates that almost half of the global financial sector was held by these non-bank financial institutions. With the rapid growth of shadow banking, where regulation is limited, “volatility laundering” is center stage. This means that the valuations differ tremendously between public and private markets, making regulated markets victims of “return manipulation.”
Going back to the Credit Suisse’s Investment Returns yearbook, global equities have returned an annualized return of 5%, bonds 1.7% and 0.4% for Treasury bills. That is hardly significant in comparison to the returns of hedge funds, but safe returns are low returns. In 2022, the private market reported a gain of 1.6% while public equities lost 22% of their value, a simple example of “return manipulation”. This drives investors to pay extra for illiquidity in private equity markets. A notion that is contrary to financial common sense but convenient for an individual investor to maintain a funding status, and private markets are usually able to report artificially higher returns. This reinstates “moral hazard” across global markets again, spreading vulnerability and volatility.
Now that financial weakness has spread to all parts of the economy, and yet inflation is still sticky, central banks ought to take a lead in handling the animal spirits abundant across all parts of the global economy otherwise the world will be stuck in the vicious circle of perpetual stagflation in a demimonde!