JP Morgan buys First Republic from FDIC
Over the weekend, the FDIC took over First Republic Bank (FRC) and immediately sold it to JP Morgan Chase (JPM) for $10.6bn. JPM will guarantee all deposits, and will promptly return $25bn cash to the private consortium of bank lenders. The FDIC will provide $50bn in 5-year fixed term funding, the terms of which are not disclosed.
We weren't aware that the FDIC had that much cash at hand to lend. Single family resi(dential) mortgages will receive 80% loss protection for 7 years. Commercial loans, including CRE will receive 80% coverage against losses for 5 years.
An average fair value loan mark is assumed 87% for the transaction ($22bn) – perhaps, a useful anchor for other banks' loan portfolios. Here is the presentation for the investor call hosted earlier today. A takeover by FDIC, shareholder and bondholder bearing losses, making uninsured depositors whole were in all our baseline scenarios. Post-sale guarantees and term funding were not things we knew to be in FDIC's remits. It only goes to show that there are only a few real experts on banking resolution.
Dimon calls sees end of banking turmoil
While JP Morgan CEO, Jamie Dimon's calls on oil prices and crypto are usually a good contra market indicator, on the banking stuff he's quite exceptional. Dimon believes the worst of the US banking turmoil is over. This is not a point of view we can ignore.
Stanley's Wilson still bearish
Mike Wilson at Morgan Stanley (MS) reiterates his bearish US equities call citing more hawkish Fed stance in the week ahead. Let's make this up as we go until we're eventually right. Meanwhile, MS economists expect a more dovish Fed tilt in the latter part of the year. The former is just an opinion without real data to support the view, the latter, is also an opinion backed by some data.
Shifting thesis, but still wrong
After 2 years of peddling a flawed general thesis on the relationship between stock prices and interest rates, some market pundits' have now swung to the other extreme in their views: monetary policy has no impact on stock prices. Also wrong as a general rule. Our jobs would be very difficult without these people. The theory on this topic is sound, their analysis is not. Market randomness gives a convenient excuse not to learn Finance 101.
Hussman on Phillips curves
Here's an example of a post where we may not entirely agree with the author's investment views, but nonetheless, the analysis is very good:
John P. Hussman
President, Hussman Investment Trust | April 2023
When one compares the claims that are regularly made about economics and finance with actual historical data, the only reasonable conclusion is that people seem more interested in having a common framework to describe their world than whether that framework is correct.
Although we agree with this general observation, our experience is one where top policymakers are cognizant of divergences between economic theory and reality. The rest may also be right for a while, even for the wrong reasons.
Here are a couple of interesting points from the article:
In the past, we've also highlighted the poor fit to the Phillips ‘curve' several prominent economists (including Paul Krugman) frequently publish to illustrate the relationship between the unemployment rate and core (PCE) inflation:
It's funny that Hussman chooses a straight horizontal line as the best fit to the data, like we did in regards to a NY Times blog post by Paul Krugman:
We arbitrarily chose a straight line, without presenting any countervailing economic theory, to demonstrate the lengths some folks go to square the circle.
Hussman elaborates further his point by revisiting Andrew Phillip‘s original paper which examined the historical relationship between the unemployment rate and real wage inflation:
Ah yes, that's a much better fit as a curve.
– The following chart is interesting, showing 12-year expected returns of a 60/30/10 portfolio consisting of (US) Equities, Treasury Bonds, and T-Bills, respectively:
Given returns on the fixed income assets in the portfolio are (mostly) known, deviations between actual and expected returns depend on how much faith one places in the Case-Shiller equity valuation framework. It's a useful guide, but is by no means a strong mean-reverting principle.
We all have our blind spots and biases, and Hussman is no exception. He may be at the opposite end of the spectrum to those that operate without any rigorous investment framework – placing a little too much faith in classical economic theories.
Flaws in Einstein's General Theory
Recent cosmological experiments have uncovered shortcomings in Einstein‘s General Theory of Relativity. Until a better alternative is found, it will remain the prevailing theory in Physics. And that is still likely many years away as it will require more observational data. By contrast, current discrepancies between theory and practice would imply that the field of economics is much closer to uncovering new groundbreaking theories.
There may be exciting times ahead for a young generation of economists.
– According to official FDIC filings, at the end of 2022, there was roughly $125bn money held by the FDIC to cover losses from insured deposits.
– A smart knowledgable person informs us that the $50bn 5-year term loan from the FDIC to JPM is made possible by a direct draw from (US) Treasury. i.e. an overdraft on the kitty money. Most likely, JPM issued a promissory note to the FDIC.
– Matt Levine (Bloomberg) provides a great overview of the JPM-FRC deal. He explains very well the (regulatory) rational for the $50bn loan.
– As we suggested in our previous update, the FDIC presented the most obvious place for some wiggle room on regulatory forbearance towards the broader banking system.
We just need one more step to make this financial engineering exercise complete. Perhaps the $50bn loan is pledged as collateral so JP Morgan covers Federal employees wages when the debt ceiling is reached?
Once upon a time it was about cracking down on banks exploiting regulatory loopholes.