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  • Family Offices Could Teach UK Banks A Thing Or Two About Uncapped Bonuses

    Family Offices Could Teach UK Banks A Thing Or Two About Uncapped Bonuses

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    As the UK’s mini budget, second mini budget and upcoming full budget come under fire from all directions, there is one thing that everyone is talking about and that is bankers bonuses.

    Despite tax reductions being reversed, another chancellor being removed from Cabinet and a two-year energy cap, being uncapped, one thing staying firmly on the agenda is the decision to reverse a regulatory cap on bonuses in the UK banking sector and the rest of the Kingdom is questioning why.

    While the UK tries to answer that question, we explore how uncapped bonuses already work in Family Offices and the lessons that could be learned for banks once passed.

    The move was proposed by former chancellor Kwasi Kwarteng in a bid to make London more attractive for global banks and for workers amid what is being widely described as a talent shortage. It is also thought to offer more long-term incentives to critical banking professionals, something Family Offices know a thing or two about.

    Family Offices are not regulated, therefore, nor is their compensation. This allows some Family Office professionals to walk away with extraordinary amounts of wealth every year and in return, it keeps Family Offices alive.

    82% of Family Office Executives receive a performance bonus. While this will differ from Family Office to Family Office, there is no regulatory cap in place and based on our annual research, we have found the average Chief Investment Officer receives 31% – 50% of their salary as a bonus in the UK while in the US, this often sits at the 100% mark. For Chief Executive Officers and Managing Directors, this figure sits between 51% and 75% of annual salary. This means CIOs often walk away with more than $792,000 in the US while CEOs in the UK earn around $612,500 a year.

    These figures might not appear to be as high as those you see in Investment Banks today but in Family Offices, money isn’t everything. Despite boasting some of the world’s greatest wealth, working for a Family Office is very rarely about the compensation you receive. While compensation must be benchmarked and standardised and is very rarely low, it is often more about being able to make a greater impact – working in an intimate team with unlimited liquidity to achieve a shared long-term objective.

    Working in a Family Office also offers unrivalled security which we saw following the pandemic when Investment Bankers pulled 100-hour weeks in an attempt to claw back any hope of a bonus in a time broadly referred to as ‘bonus backlash’ while Family Office Professionals walked away with 100% if not 200% of their annual salary as bonus season closed a successful year for Family Offices.

    This is also not to say the average figures given above are representative of every Family Office. We work with a Family Office where the Chief Investment Officer receives a basic salary of over £2M a year without any additional bonus or incentive. He has a very meritocratic bonus structure in place to reward his entire team.

    He said: “Our bonus structure is simple. It is not dependent on the success of an individual asset class nor does it differ based on the liquid/ illiquid nature of the asset. Each employee is able to take home 100-200% of their salary as a bonus each year, dependent on the upside return and their own personal performance. We say it is discretionary as we frequently boost the figures to ensure they walk away with more than the matrix suggests. This year every single employee has walked away with 150-200% of their annual salary and we believe it is this ‘share the pot’ mentality which has awarded us a loyal and motivated team.”

    Ultimately, uncapped bonuses are used to motivate, engage and embed critical professionals into the Family Office but they are not used in isolation. The most important instrument, and one that banks can learn from, is a Long-Term Incentive Plan (LTIP
    TIP
    ) and how above any type of traditional bonus, when implemented effectively can engage staff, align interests and incentivise them to stay within your organisation for as long as they can – something Family Offices require to survive and something that would banks could benefit from. One of the reasons in fact cited by Kwarteng to push ahead with this move as high-base salaries and low-bonuses are creating a churn of workers and driving up costs for British banks.

    LTIPs were traditionally delivered in the form of a performance share but have evolved in the world of Family Offices to incorporate a whole host of rewards including Carried Interest, Stock Options, Co-Investing Opportunities, Forgivable Loans and Matched Investment. Professionals with longer term reward structures are most content and driven to succeed within their Family Office and according to a recent Agreus survey, believe that LTIPs are far more important than any monetary annual compensation as it helps them to feel valued.

    LTIPs also proved to be particularly useful during the pandemic when a variety of factors made rewarding bonuses alone extremely difficult.

    COVID-19 alongside the push to IPOs in some of the emerging markets, a new generation of wealth, a focus on ESG and a heightened awareness of digital assets such as cryptocurrency have all forced Family Offices to further diversify. While making the Investment Space a whole lot more interesting, it further complicated how Family Offices reward Investment Professionals, especially when it comes to bonuses.

    Family Office Investment Professionals broadly led by Chief Investment Officers are responsible for a broad range of assets under management. Each of these assets necessitate a unique set of requirements from the length of time, commitment and contribution involved, the skill set and specialism required and the level of risk it calls for. They also carry unique factors impacting level of return and ability to measure that return from holding period yields, inflation and interest to demand and economic growth. Each asset class also requires a different benchmark, which as we now know is more than half of the time based on different indexes, industries, regions and countries.

    All of these idiosyncrasies make valuing assets an individual and laborious task but awarding a bonus based on those valuations is near impossible and has only been exacerbated by the move to further diversify as well as recent Investment hiring trends.

    All of the above have further complicated the conversation around bonuses and as a result, Family Offices adopted three new rules during the pandemic. These include:

    1) The move to increase discretionary bonuses based on overall fund performance

    2) An introduction of LTIPs for critical members of staff, not just on the investment side of the business

    3) An emphasis placed on preserving as well as generating wealth

    While banks cannot follow the exact guidelines set out by Family Offices, so long as they embed LTIPs and uncapped bonuses with clear and correlating key performance indicators, they can use this reward structure to engage and retain staff while creating a successful and meritocratic organisational culture which is inherently more competitive and guarantees every employee is striving to reach the same goal.

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    Paul Westall, Contributor

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  • Bank of America tops estimates on better-than-expected bond trading, higher interest rates

    Bank of America tops estimates on better-than-expected bond trading, higher interest rates

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    Bank Of America CEO Brian Moynihan is interviewed by Jack Otter during “Barron’s Roundtable” at Fox Business Network Studios on January 09, 2020 in New York City.

    John Lamparski | Getty Images

    Bank of America said Monday that quarterly profit and revenue topped expectations on better-than-expected fixed income trading and gains in interest income, thanks to choppy markets and rising rates

    Here’s what the company reported compared with what analysts were expecting, based on Refinitiv data:

    • Earnings per share: 81 cents vs. 77 cents expected
    • Revenue: $24.61 billion adjusted vs. $23.57 billion expected

    Bank of America said in a release that third-quarter profit fell 8% to $7.1 billion, or 81 cents a share, as the company booked a $898 million provision for credit losses in the quarter. Revenue net of interest expense jumped to $24.61 billion, on a non-GAAP basis.

    Shares of the bank rose 6.1%.

    Bank of America, led by CEO Brian Moynihan, was supposed to be one of the main beneficiaries of the Federal Reserve’s rate-boosting campaign. That is playing out, as lenders including Bank of America, JPMorgan Chase and Wells Fargo are producing more revenue as rates rise, allowing them to generate more profit from their core activities of taking in deposits and making loans.

    “Our U.S. consumer clients remained resilient with strong, although slower growing, spending levels and still maintained elevated deposit amounts,” Moynihan said in the release. “Across the bank, we grew loans by 12% over the last year as we delivered the financial resources to support our clients.”

    Net interest income at the bank jumped 24% to $13.87 billion in the quarter, topping the $13.6 billion StreetAccount estimate, thanks to higher rates in the quarter and an expanding book of loans.

    Net interest margin, a key profitability metric for bank investors, widened to 2.06% from 1.86% in the second quarter of this year, edging out analysts’ estimate of 2.00%.

    Fixed income trading revenue surged 27% from a year earlier to $2.6 billion, handily exceeding the $2.24 billion estimate. That more than offset equities revenue that dropped 4% to $1.5 billion, below the $1.61 billion estimate.

    Like its Wall Street rivals, investment banking revenue posted a steep decline, falling about 46% to $1.2 billion, slightly exceeding the $1.13 billion estimate.

    Of note, the bank’s evolving provision for credit losses showed the company was beginning to factor in a more harsh economic outlook.

    While Bank of America released $1.1 billion in reserves in the year-earlier period, in the third quarter the firm had to build reserves by $378 million. That, in addition to a 12% increase in net charge-offs for bad loans to $520 million in the quarter, accounted for the $898 million provision.

    Analysts have said that they want to see bank executives factor in the possibility of an impending recession before investors return to the beaten-down sector. Bank of America shares hit a new 52-week low last week and have fallen 29% this year through Friday, worse than the 26% decline of the KBW Bank Index.

    Last week, JPMorgan and Wells Fargo topped expectations for third-quarter profit and revenue by generating better-than-expected interest income. Citigroup also beat analysts’ estimates, and Morgan Stanley missed as choppy markets took a toll on its investment management business.

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  • Mastercard To Help Banks Offer Bitcoin And Crypto Trading

    Mastercard To Help Banks Offer Bitcoin And Crypto Trading

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    Mastercard is set to announce plans today for a program to help institutions offer bitcoin and cryptocurrency trading, CNBC reported.

    Mastercard will work with Paxos to “bridge” the gap between banks and will manage the security and regulatory compliance, two big reasons many banks have stated for avoiding bitcoin and cryptocurrency.

    “There’s a lot of consumers out there that are really interested in this, and intrigued by crypto, but would feel a lot more confident if those services were offered by their financial institutions,” said Jorn Lambert, Mastercard’s chief digital officer.

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    Nik Hoffman

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  • Bank of America Reports Earnings Monday. What Wall Street Is Watching.

    Bank of America Reports Earnings Monday. What Wall Street Is Watching.

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    Bank of America Reports Earnings Monday. What Wall Street Is Watching.

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  • Truss’ jittery Tories blame Bank chief over market meltdown

    Truss’ jittery Tories blame Bank chief over market meltdown

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    As Britain’s central bank boss, tasked with managing inflation and setting interest rates, Andrew Bailey likes targets. Now he is one.

    Markets are dumping U.K. assets amid chaotic policymaking from Liz Truss’ new government — but Bailey’s rocky stewardship of the Bank of England is getting a growing share of the blame. His harshest critics include some of Truss’ most senior Conservative Party colleagues.

    At stake are home loans for 2 million households coming due for renewal amid cripplingly high interest rates in the next two years and the viability of pension funds managing more than £1 trillion worth of assets. Failure to quell a “fire sale” of U.K. bonds and currency risks a financial meltdown that could spread far beyond British shores.

    The current bond market pressure began after U.K. Chancellor Kwasi Kwarteng announced a vast package of unfunded tax cuts, stoking investors’ fears about the long-term sustainability of the government’s debt. 

    The dramatic selloff of government bonds sparked a panic at U.K. pension funds, which couldn’t handle the price falls, and has huge knock-on impacts for mortgage rates and borrowing costs.

    The political fallout has so far landed on Truss’ government’s shoulders — prompting U-turns on key policies as opinion polls showed cratering support.

    Yet before the U.K.’s self-inflicted turmoil, Bailey was feeling political pressure over the central bank’s handling of double-digit inflation and the rising cost of living that comes with it. 

    While No. 10 refuses to be drawn on the Bank’s decisions, Business Secretary Jacob Rees-Mogg suggested a failure to raise interest rates quickly was at the root of the turmoil in financial markets.

    He dismissed it as “commentary” to draw a direct link between the government’s mini-budget and concerns over the U.K.’s financial stability that led to emergency intervention from the Bank, adding that pension funds’ “high-risk” activities had played a role.

    “It could just as easily be the fact that the day before, the Bank of England did not raise interest rates by as much as the Federal Reserve did,” he told the BBC’s Today program. 

    In another apparent swipe at the Bank, Rees-Mogg added: “The pound and other currencies have been falling against the dollar because interest rates in the U.S. have been rising faster than they have in other markets.”

    In the immediate aftermath of Kwarteng’s disastrous mini-budget, the Bank seemed to be in command of the situation when it stepped in to calm the pension fund crisis and refused to be pushed into an early interest rate rise by markets. But two further interventions this week and confusion over stark comments from Bailey himself risk undermining that impression.

    The governor on Tuesday issued a rare ultimatum to beleaguered pension funds struggling to meet cash calls in the government bond market. “You’ve got three days left now. You’ve got to get this done,” he warned at an event in Washington.

    The bank has effectively bailed out pension funds since the U.K. government’s mini-budget roiled the markets. The bond-buying intervention is intended to offer temporary relief and give the affected funds time to raise enough cash to handle historic surges in yields.

    Bailey’s message appeared to be aimed at upping the pressure on funds to sell assets in time rather than expecting an extension beyond Friday’s deadline. “We will be out by the end of this week,” he said.

    Yet the remarks seemed to backfire instantly, sparking a sharp fall in the pound, although it has since recovered.

    U.K. government borrowing costs also increased again on Wednesday, with the yield on 30-year gilts moving above 5 percent — the level that first sparked the bank’s intervention — before dropping back after the Bank used its firepower to buy £4.4 billion of gilts.

    Financial market experts think the governor’s comments were a mistake that will force the bank into following the government’s recent U-turns. 

    Mike Howell of CrossBorder Capital described Bailey’s words as the “shortest suicide note in history,” and said the governor will have to change course. 

    “Andrew Bailey’s insistence that emergency support will end on Friday is an unsustainable position that we expect to be reversed quickly,” said Oxford Economics chief economist Innes McFee.

    If the Bank loses credibility, its ability to rescue the economy from market disruption will be severely hampered. Increasingly costly interventions will yield ever more limited results if investors lose faith in the U.K.’s most important financial institution.

    Before Bailey’s comments on Tuesday, one markets strategist said the Bank could “test the water” by stopping the program on Friday and then restarting if necessary — but that would be risky because it’s unclear how much yields would have to rise before triggering the same problems at pension funds.

    “While a very able central banker, he has spent most of his career outside the BoE’s monetary policy and markets areas,” said EFG Bank chief economist Stefan Gerlach, previously a central banker himself.

    “He is not the best fit for the job, given the nature of the problems the Bank is facing now. His communications missteps over the last year were damaging,” he said, pointing to Bailey’s confusing guidance on interest rates. “It’s like the fire brigade saying ‘you have to have your fire before Friday because then we are heading home.’”

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  • Liz Truss panics as markets keep plunging

    Liz Truss panics as markets keep plunging

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    LONDON — Try as she might, Liz Truss just can’t calm the markets.

    Despite reversing her plan to cut tax for the highest earners, bringing forward a more detailed budget statement by almost a month and halting the appointment of a controversial senior civil servant to oversee the Treasury, the Bank of England was again forced to step in to try to stabilize market turbulence. 

    Insiders pointed to the surprise appointment of James Bowler to the Treasury top job, passing over Antonia Romeo, who it was widely briefed had got the role, as a sign of No. 10’s anxiety.

    “The PM is panicking and reaching for almost anything that she can do to calm the situation. She was so burnt by the fallout from mini-budget that anything that seemed bold, she now wants to massively trim back,” said a senior Whitehall official.

    Treasury officials say that Chancellor Kwasi Kwarteng’s tone in the past week has become markedly more conciliatory as he tries to steady the buffs. 

    But in spite of these U-turns, the current market unease may be out of the government’s hands. 

    The so-called mini budget came at a particularly fragile time for the economy, caused by high inflation and the Bank of England’s attempts to end a policy that saw it buy up huge quantities of government debt, originally an attempt to stabilize the economy in the wake of the 2008 financial crisis.

    Kwarteng’s tax cuts, presented without any detail about how they would be funded, spooked the markets, triggering a crisis at U.K. pension funds because the huge spike in yields forced them to bonds — but that then forced prices down further.

    The Bank of England intervened with a £65 billion check book to give pension funds more time to raise cash and stop the so-called doom loop taking hold. Governor Andrew Bailey said Tuesday the Bank’s emergency support will definitely end Friday, prompting fears this may not be enough time.

    The resulting crisis leaves Britain’s new prime minister with an intensifying political problem, as support ebbs away the longer it takes to tame the markets. 

    Jill Rutter, senior fellow at the Institute for Government and former Treasury official, said: “Paradoxically, having said they were the people to take on the Treasury orthodoxy, they are now walking on such thin ice that they are complete prisoners of the most orthodox orthodoxy.”

    Staying alive

    The race is now on for Kwarteng and his Treasury team to come up with a way to restore credibility by the end of October, when he is due to explain how the tax cuts will be paid for. 

    “It’s really difficult to see how you can have a vaguely deliverable plan to bring that back under control,” said the IfG’s Rutter, who pointed out that trying to find money from one-off events such as asset sales would not help the underlying fiscal position. 

    “If you’ve still got a pension fund problem with collateral issues, what [the government] give you on the 31st will probably not be that relevant, because you’ll still be dealing with a bigger problem,” said one markets strategist, speaking of condition of anonymity.

    “If you as a government have somewhat stabilized [pension funds] … the currency is going to react based on how [the market] views the overall fiscal long-term sustainability.”

    But the government’s dented reputation will be hard to rebuild. “If the root cause is fiscal policy, then the issue probably isn’t going to go away until the markets’ concerns over fiscal policy have eased,” said Paul Dales, chief UK economist at Capital Economics.

    “That makes the chancellor’s medium-term fiscal plan on 31 October a very big event for the gilt market, the pound and the Bank of England. Our feeling is that the chancellor will have to work very hard indeed to convince the markets that his fiscal plans are sustainable.”

    Ministers originally said their plan for £43 billion in tax cuts would be funded by borrowing and economic growth, but experts now warn it will require reductions in public spending. 

    The Institute for Fiscal Studies think tank predicted the chancellor would need to spend £60 billion less by 2026-2027, while the International Monetary Fund released a report calculating that high prices will last longer in the U.K. than many other major economies..

    Ahead of the mini-budget, the Resolution Foundation’s Torsten Bell spelled out why this could have a lasting effect. “The big picture in a world where interest rates are rising and inflation is high, is that you don’t want to be seen as the one country that everyone decides is a bad bet.”

    “Showing how serious you are is important,” he added. “If we are really arguing that our growth strategy is to borrow lots more and then that will pay for itself then they [the markets] don’t believe that.”

    One government official speculated that in order to fill the hole in public finances and make the numbers add up Truss and Kwarteng would be forced to U-turn on further aspects of their mini-budget, such as the decision to cancel a planned corporation tax rise. 

    In the meantime, it’s not just the markets that remain unconvinced by Truss’ and Kwarteng’s approach. 

    At the chancellor’s debut session of Treasury questions in the Commons Tuesday, senior Tory MPs queued up to openly cast aspersion on his strategy. 

    Former Cabinet minister Julian Smith asked for reassurance that tax cuts “will not be balanced on the backs of the poorest people in the country” — normally an attack line reserved for opposition MPs. 

    Treasury committee Chairman Mel Stride warned that if Kwarteng did not seek buy-in from fellow MPs on the next fiscal statement it would upset the markets again.

    The PM’s spokesman reiterated Tuesday that Truss is “committed to the growth measures set out by the chancellor” and “the fundamentals of the U.K. economy remain strong.”

    While that statement continues to be tested, so will the position of the prime minister and her chancellor. 

    Annabelle Dickson contributed reporting.

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  • Jamie Dimon says UK government deserves benefit of the doubt after sparking market turmoil

    Jamie Dimon says UK government deserves benefit of the doubt after sparking market turmoil

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    Jamie Dimon, chairman and chief executive officer of JPMorgan Chase & Co. says the new U.K. government should be “given the benefit of the doubt.”

    Al Drago | Bloomberg | Getty Images

    JPMorgan Chase CEO Jamie Dimon said new governments “always have issues” and U.K. Prime Minister Liz Truss should be “given the benefit of the doubt” following a turbulent first month in office.

    “It’ll take time to execute the policies and kind of drive growth and what’s important … [but] there’s a lot of things the U.K. has going for it and proper strategies to get it growing faster … then it can accomplish some of the other objectives it wants to accomplish too,” Dimon told CNBC’s Julianna Tatelbaum on Monday, speaking at the JPM Techstars conference in London.

    “I would like to see the new prime minister, the new chancellor, be successful,” he said.

    Dimon’s comments come after a rocky few weeks for Truss’s administration. Finance Minister Kwasi Kwarteng announced a raft of fiscal measures in a “mini-budget” on Sept. 23, including unfunded cuts to income tax and canceling a planned increase in corporation tax.

    Sterling plummeted and yields on U.K. government bonds, or “gilts,” were sent through the roof and have yet to return to their pre-announcement levels.

    The government then opted to reverse the decision to abolish the highest income tax bracket — a 45% rate for those earning more than £150,000 — just 10 days later.

    ‘Every government should be focusing on growth’

    Growth should be an objective for every nation, according to JPMorgan’s Dimon.

    “I think every government should be focusing on growth — I would love to hear that out of their mouth every time a president or prime minister speaks,” Dimon said.

    “Growth comes from proper tax policies, from proper investment policies, consistency of law … being attractive to foreign investment, being attractive to companies and having strategy around industries,” he said.

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  • Global crypto markets face tougher rules under G20 plan

    Global crypto markets face tougher rules under G20 plan

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    Crypto’s Wild West era may be coming to an end.

    According to the Financial Stability Board (FSB), a global financial standard-setter, most of the cryptocurrency market should be subject to the same tough rulebook that governs traditional finance.

    The FSB, which was born in the wake of the 2008 financial meltdown to stave off further shocks, will propose the plan to rein in crypto to finance ministers and central bankers from the Group of 20 industrialized countries gathering in Washington next week, the plan’s chief architect, Steven Maijoor, told POLITICO.

    “A lot of the activities in crypto assets and crypto assets markets resemble activities in the traditional financial system and therefore we take the approach: Same activity, same risk, same regulation,” Maijoor, who sits on the Dutch central bank’s governing board and oversees banking supervision, said in Prague in early September.

    The move is set to put major crypto trading platforms on red alert, coming as the U.S. Securities and Exchange Commission seeks to impose securities regulation on cryptocurrencies and as the EU prepares its own rules for digital markets.

    More broadly, the FSB’s work on digital assets is likely to act as a cold shower for crypto currencies that seek to expand their services without complying with regulations.

    Regulators fear the lack of investor safeguards could see volatility in cryptocurrency markets spilling over into the traditional finance sector, as banks and money managers venture into the market.

    Some $2 trillion of the market’s value has evaporated since its highs of November last year, triggering corporate collapses and exposing scams that left millions of crypto investors penniless. Risks within the crypto markets are still contained. But that could quickly change and threats could spill over to financial markets from various channels, according to the European Securities and Markets Authority.

    Maijoor will present G20 policymakers with draft recommendations that he’s been developing with a team of global regulators within the FSB since April with the view of securing financial stability as crypto goes mainstream. Countries around the world will need to decide whether new rules are needed for novel arrivals within the crypto market, such as digital wallets. The rest should be captured by new or existing financial rules.

    “This is not only related to securities,” said the 58-year-old, who used to lead the EU’s securities regulator before getting a job at De Nederlandsche Bank. “There are also already some crypto activities that are captured by anti-money laundering laws and regulations and we can observe that also, in that case, there is non-compliant behavior.”

    The example of companies skirting around dirty money safeguards is an easy one for the Dutchman to give. His central bank in late April fined the world’s biggest crypto exchange, Binance, €3 million for offering services to Dutch citizens without having cleared the required Dutch safeguards against dirty money — gaining a competitive advantage against its rivals. Binance objected to the fine in June.

    The Financial Stability Oversight Council, chaired by U.S. Treasury Secretary Janet Yellen, said the crypto industry needs to be brought to heel in several areas | Alex Wong/Getty Images

    Ministers and governors will also get updated recommendations on how to regulate global stablecoins, digital tokens that are tied to national currency or a reserve of financial products to keep their value steady. The stablecoin update is separate from the crypto recommendations and came in response to Facebook’s failed bid to introduce a virtual currency for some 2.9 billion social media users around the world.

    Maijoor’s work will be subject to consultation, so companies and countries will be able to suggest changes to what will become the global blueprint for supervising the market.

    Locking horns

    The recommendations could embolden U.S. banking and markets regulators, which are increasingly taking the position that digital asset trading platforms and brokerages should follow existing regulations.

    The Financial Stability Oversight Council, which is chaired by U.S. Treasury Secretary Janet Yellen and counts SEC Chair Gary Gensler and the heads of other federal agencies among its members, on Monday released a report that identified several areas where the crypto industry needs to be brought to heel. 

    “Crypto cannot exist outside of our public policy frameworks. That’s regardless of what [Bitcoin’s pseudonymous creator] Satoshi Nakamoto might have initially thought, or what market participants might say today,” Gensler said during Monday’s FSOC meeting. 

    Ripple and Coinbase, both major crypto exchanges that have locked horns with Gensler, will be hoping for a different outcome that involves new rules.

    Coinbase has argued that crypto assets are more akin to commodities and that the SEC classifying them as securities is like putting a straitjacket on how the market could develop, especially considering those rules were developed in the 1930s. The Commodity Futures Trading Commission would be a far better fit, according to the exchange.

    “I think it is reasonable to assume that none of the authors who drafted these securities statutes from the 1930s … did so while thinking of a day when a decentralized, cryptographically-based, automated financial instrument would be adopted en masse by millions of people in the United States and around the world,” Coinbase’s chief policy officer, Faryar Shirzad, wrote in a blog in July.

    Sam Sutton contributed reporting from New York.

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  • ‘The Fed is breaking things’ – Here’s what has Wall Street on edge as risks rise around the world

    ‘The Fed is breaking things’ – Here’s what has Wall Street on edge as risks rise around the world

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    Jerome Powell, chairman of the US Federal Reserve, during a Fed Listens event in Washington, D.C., US, on Friday, Sept. 23, 2022.

    Al Drago | Bloomberg | Getty Images

    As the Federal Reserve ramps up efforts to tame inflation, sending the dollar surging and bonds and stocks into a tailspin, concern is rising that the central bank’s campaign will have unintended and potentially dire consequences.

    Markets entered a perilous new phase in the past week, one in which statistically unusual moves across asset classes are becoming commonplace. The stock selloff gets most of the headlines, but it is in the gyrations and interplay of the far bigger global markets for currencies and bonds where trouble is brewing, according to Wall Street veterans.

    After being criticized for being slow to recognize inflation, the Fed has embarked on its most aggressive series of rate hikes since the 1980s. From near-zero in March, the Fed has pushed its benchmark rate to a target of at least 3%. At the same time, the plan to unwind its $8.8 trillion balance sheet in a process called “quantitative tightening,” or QT — allowing proceeds from securities the Fed has on its books to roll off each month instead of being reinvested — has removed the largest buyer of Treasurys and mortgage securities from the marketplace.  

    “The Fed is breaking things,” said Benjamin Dunn, a former hedge fund chief risk officer who now runs consultancy Alpha Theory Advisors. “There’s really nothing historical you can point to for what’s going on in markets today; we are seeing multiple standard deviation moves in things like the Swedish krona, in Treasurys, in oil, in silver, like every other day. These aren’t healthy moves.”

    Dollar’s warning

    For now, it is the once-in-a-generation rise in the dollar that has captivated market observers. Global investors are flocking to higher-yielding U.S. assets thanks to the Fed’s actions, and the dollar has gained in strength while rival currencies wilt, pushing the ICE Dollar Index to the best year since its inception in 1985.

    “Such U.S. dollar strength has historically led to some kind of financial or economic crisis,” Morgan Stanley chief equity strategist Michael Wilson said Monday in a note. Past peaks in the dollar have coincided with the the Mexican debt crisis of the early 1990s, the U.S. tech stock bubble of the late 90s, the housing mania that preceded the 2008 financial crisis and the 2012 sovereign debt crisis, according to the investment bank.

    The dollar is helping to destabilize overseas economies because it increases inflationary pressures outside the U.S., Barclays global head of FX and emerging markets strategy Themistoklis Fiotakis said Thursday in a note.

    The “Fed is now in overdrive and this is supercharging the dollar in a way which, to us at least, was hard to envisage” earlier, he wrote. “Markets may be underestimating the inflationary effect of a rising dollar on the rest of the world.”

    It is against that strong dollar backdrop that the Bank of England was forced to prop up the market for its sovereign debt on Wednesday. Investors had been dumping U.K. assets in force starting last week after the government unveiled plans to stimulate its economy, moves that run counter to fighting inflation.

    The U.K. episode, which made the Bank of England the buyer of last resort for its own debt, could be just the first intervention a central bank is forced to take in coming months.

    Repo fears

    There are two broad categories of concern right now: Surging volatility in what are supposed to be the safest fixed income instruments in the world could disrupt the financial system’s plumbing, according to Mark Connors, the former Credit Suisse global head of risk advisory who joined Canadian digital assets firm 3iQ in May.

    Since Treasurys are backed by the full faith and credit of the U.S. government and are used as collateral in overnight funding markets, their decline in price and resulting higher yields could gum up the smooth functioning of those markets, he said.

    Problems in the repo market occurred most recently in September 2019, when the Fed was forced to inject billions of dollars to calm down the repo market, an essential short-term funding mechanism for banks, corporations and governments.

    “The Fed may have to stabilize the price of Treasurys here; we’re getting close,” said Connors, a market participant for more than 30 years. “What’s happening may require them to step in and provide emergency funding.”

    Doing so will likely force the Fed to put a halt to its quantitative tightening program ahead of schedule, just as the Bank of England did, according to Connors. While that would confuse the Fed’s messaging that it’s acting tough on inflation, the central bank will have no choice, he said.

    `Expect a tsunami’

    The second worry is that whipsawing markets will expose weak hands among asset managers, hedge funds or other players who may have been overleveraged or took unwise risks. While a blow-up could be contained, it’s possible that margin calls and forced liquidations could further roil markets.

    “When you have the dollar spike, expect a tsunami,” Connors said. “Money floods one area and leaves other assets; there’s a knock-on effect there.”

    The rising correlation among assets in recent weeks reminds Dunn, the ex-risk officer, of the period right before the 2008 financial crisis, when currency bets imploded, he said. Carry trades, which involve borrowing at low rates and reinvesting in higher-yielding instruments, often with the help of leverage, have a history of blow ups.

    “The Fed and all the central bank actions are creating the backdrop for a pretty sizable carry unwind right now,” Dunn said.

    The stronger dollar also has other impacts: It makes wide swaths of dollar-denominated bonds issued by non-U.S. players harder to repay, which could pressure emerging markets already struggling with inflation. And other nations could offload U.S. securities in a bid to defend their currencies, exacerbating moves in Treasurys.

    So-called zombie companies that have managed to stay afloat because of the low interest rate environment of the past 15 years will likely face a “reckoning” of defaults as they struggle to tap more expensive debt, according to Deutsche Bank strategist Tim Wessel.

    Wessel, a former New York Fed employee, said that he also believes it’s likely that the Fed will need to halt its QT program. That could happen if funding rates spike, but also if the banking industry’s reserves decline too much for the regulator’s comfort, he said.

    Fear of the unknown

    Still, just as no one anticipated that an obscure pension fund trade would ignite a cascade of selling that cratered British bonds, it is the unknowns that are most concerning, says Wessel. The Fed is “learning in real time” how markets will react as it attempts to rein in the support its given since the 2008 crisis, he said.

    “The real worry is that you don’t know where to look for these risks,” Wessel said. “That’s one of the points of tightening financial conditions; it’s that people that got over-extended ultimately pay the price.”

    Ironically, it is the reforms that came out of the last global crisis that have made markets more fragile. Trading across asset classes is thinner and easier to disrupt after U.S. regulators forced banks to pull back from proprietary trading activities, a dynamic that JPMorgan Chase CEO Jamie Dimon has repeatedly warned about.

    Regulators did that because banks took on excessive risk before the 2008 crisis, assuming that ultimately they’d be bailed out. While the reforms pushed risk out of banks, which are far safer today, it has made central banks take on much more of the burden of keeping markets afloat.

    With the possible exception of troubled European firms like Credit Suisse, investors and analysts said there is confidence that most banks will be able to withstand market turmoil ahead.

    What is becoming more apparent, however, is that it will be difficult for the U.S. — and other major economies — to wean themselves off the extraordinary support the Fed has given it in the past 15 years. It’s a world that Allianz economic advisor Mohamed El-Erian derisively referred to as a “la-la land” of central bank influence.

    “The problem with all this is that it’s their own policies that created the fragility, their own policies that created the dislocations and now we’re relying on their policies to address the dislocations,” Peter Boockvar of Bleakley Financial Group said. “It’s all quite a messed-up world.”

    Correction: An earlier version misstated the process of quantitative tightening.

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  • Cramer: JPMorgan’s ‘excellent’ earnings mean nothing to the market

    Cramer: JPMorgan’s ‘excellent’ earnings mean nothing to the market

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    Squawk on the Street

    CNBC’s Jim Cramer and the ‘Squawk on the Street’ team break down JPMorgan Chase’s latest earnings report.

    03:35

    Wed, Oct 13 202110:13 AM EDT

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