One Bank Believes It Found The Identity Of Who Is “Propping Up The Bitcoin Market”

Back in May when the Chinese domination over Bitcoin was ending, we predicted that it would shift over to Japan, specifically, we said that “just as the Chinese bubble frenzy in bitcoin is fading, it may be replaced with a new one, in which thousands of Mrs. Watanabe traders shift their attention away from the FX market and toward digital currencies” and added that “If the transition is seamless, there is no telling just how far this particular bubble can grow.”

Judging by the exponential price surge in bitcoin in the subsequent period, we were clearly right on the latter, and now, according to a new analysis, we were also right on the former, because as Deutsche Bank reveals in a new report by Masao Muraki, “Japanese men in their 30s and 40s who are engaged in leveraged FX trading (or who used to trade but have stopped) are driving the cryptocurrency market” and who according to DB, happen to be more or less idiots, arguably because for the time being they are outperforming every other asset class… in history, to wit: “Japanese retail investors are less financially literate than their US peers across all age groups. Compared to the US, financial literacy is particularly poor among people 35-54 years of age. The poor literacy of Japanese retail investors also stands out beside UK and German investors.”

Ah yes, by contrast, the financial literacy of the world’s central-planners is off the charts. Look where that got us…

In any case, and without further ado, please meet the (rather boring) people who are propping up the Bitcoin market, at least according to Deutsche Bank.

Here are the details:

The identity of who is propping up the Bitcoin market

1. 40% of cryptocurrency trading is Japanese yen-denominated

An 11 December Nikkei report stated that 40% of cryptocurrency trading in Oct-Nov was yen-denominated. Japanese traders have reportedly come to account for nearly half of cryptocurrency trading since China started to shut down cryptocurrency exchanges, and this is said to be widely known among industry insiders (various estimates exist). This report shows that Japanese men in their 30s and 40s who are engaged in leveraged FX trading (or who used to trade but have stopped) are driving the cryptocurrency market.

2. The true face of investors engaged in leveraged FX trading

“Mrs. Watanabe” is a buzzword often used by US/European media and market participants to symbolize the typical Japanese retail investor who trades in FX. Following Abe and Kuroda, Watanabe may be the most famous Japanese name among market participants (although the purported creator of Bitcoin, Satoshi Nakamoto, is also famous). Japan accounts for a high 54% of global foreign exchange margin trading (leveraged FX trading) (source: Forex Magnate, 1Q2017), so Japanese retail investors are major players in FX markets. Data from GMO Click Securities which is the top company in its industry indicates that men hold 79% of FX trading accounts, and 63% of these men are aged 30-49 (as of end-September 2017; Figures 3-4). The typical Japanese leveraged FX trader is thus a man in his 30s or 40s and really ought to be called “Mr. Watanabe”.

As the speculative frenzy over cryptocurrency heightens, the spotlight is falling on the unique characteristics of Japanese retail investors. The Nikkei report mentioned above cited an example of a 38-year-old businessman who invested ¥8m ($70,000) in Bitcoin, including his bonus. The average household income of a 38-year-old is about ¥6.1m, the average savings are ¥5m, and the average borrowings are ¥8.8m. This report was also a topic of conversation among the managers of Japanese financial institutions that I visited this week.

3. Financial literacy

How much financial literacy do retail investors engage in leveraged FX/cryptocurrency trading possess? According to a survey by the Central Council for Financial Services Information (the Bank of Japan), Japanese retail investors are less financially literate than their US peers across all age groups (Figure 6). Compared to the US, financial literacy is particularly poor among people 35-54 years of age. The poor literacy of Japanese retail investors also stands out beside UK and German investors (Figure 7).

Before the FSA started applying pressure, the core investment products sold by banks and brokers were investment trusts with distribution yields above 10% (products with yields above 20% were particularly popular) that took compound risks and drew down principal (the typical purchase commission was above 3% and annual management fees were over 2%).

Figure 8 shows the top 3 reasons that Japanese retail investors engage in leveraged FX trading: 1) expectations of high returns, 2) they can easily invest in foreign currencies, and 3) many investors are earning profits. However Figure 9 shows that most investors say they quit leveraged FX trading because they did not do well (only 7.5% said they realized their profit goals).

More than a few Japanese investors positively value volatility. We have believed that “Japan is the Galapagos of asset management markets, pursuing its own path amid the long period of deflation. Japan’s investment style is typified by a combination of low-risk, low-return deposits and high-risk, high-return investments” (see our 11 December 2014 report, “Initiation: Securities firms confront changing “Galapagos market””).

4. Investors’ winning percentage and turnover

New investors continuously enter the leveraged FX trading market and repeat the metabolism of being forced out by a margin call due to sharp market changes. This results in a market with a tumultuous annual participant turnover.

Leveraged FX trading is essentially a zero-sum game. Japanese retail investors are playing this zero-sum game with institutional investors engaged in algorithmic trading. It would be very difficult for business men trading on their smartphones during lunch or after work to sustain their trade wins. In Figure 5, we equate increases in FX trading account margins with wins, and decreases with losses. Over the past 10 quarters, we estimate that wins to losses were basically even in six quarters, while significant losses dominated in four quarters.

5. From leveraged FX trading to leveraged cryptocurrency trading

We think that retail investors are shifting from leveraged FX trading to leveraged cryptocurrency trading. Firms such as the GMO Group and SBI Group are embracing the sense of urgency and starting to offer cryptocurrency trading services. Factor breakdown is difficult due to market variables, but leveraged FX trading has been sluggish since February 2017 (Figure 1).

Cryptocurrency has been trending up, so retail investors’ unrealized gains are also rising. With few investors leaving and a steady inflow of new investors, the investor pool has been expanding. We believe that investors participating in leveraged cryptocurrency trading are typically Japanese men in their 30s and 40s who are engaged in leveraged FX trading (or who used to trade but have stopped). We think that the pool of cryptocurrency investors not using leverage is even larger.

6. Margin call risk and fail risk

Leveraged cryptocurrency trading services are available in Japan. Some major FX brokers are using the same 25x leverage limit that applies to FX trading, but there are no direct rules in leveraged trading of cryptocurrency. During the Swiss franc shock in January 2015, many retail investors not only received margin calls but also incurred losses greater than their margin balances, because forced settlements couldn’t be implemented in a timely manner. This shows that investors can suffer losses which brokers end up booking as credit losses even with leveraged FX trading of developed-nation currencies. Authentication of Bitcoin settlements takes at least 10 minutes. The risk of incurring losses greater than margin is higher than in normal FX trading, due to high intraday volatility. As a result, we believe that brokers also face a higher risk of failure.

7. Unrealized gains are also virtual

The National Tax Agency recently indicated that profits generated by the sale or use of cryptocurrency are classified as miscellaneous income in principle and are required to be filed in income tax returns. We think that many investors are hesitant to realize profits because, combined with other sources of income, these profits would be subject to income tax (up to 45% tax rate) and residence tax (around 10%).

The progressive taxation system means that the tax rate rises in keeping with income for a single fiscal year (on a calendar year basis). For investors thinking of taking profit in the near term, a rational tax trade would be to sell some holdings this year and the rest next year. In contrast, investors hoping that profits will be taxed as capital gains in future (20% tax rate; but we cannot see any movement towards this) may put off realizing a profit.

8. Fair value of cryptocurrency

Cryptocurrency such as Bitcoin that have pure distributed systems do not have an underlying value like precious metals. Value is not guaranteed by an issuer because there is no issuer. The value of cryptocurrency is thus entirely based on the belief that it can be exchanged for goods or sovereign currencies (BoJ review of December 2015). While the valuation of exchange rates between legal tender and cryptocurrency should be the vital factor, it is retail investors (including “Mr. Watanabe”) who are currently carrying out price discovery.

With a broader range of investors set to enter the market in 2018 and an increase in the ways to hedge (short selling), we expect to see the market’s price discovery function being utilized. The CBOE Futures Exchange began offering Bitcoin futures trading on 10 December and the CME plans to start on the 18th (the US Futures Industry Association sent a critical letter to the Commodity Futures Trading Commission who self-certified new contracts for bitcoin futures products. The letter said that there has not been enough discussion on topics such as margin levels, transaction limits, stress tests, and settlement).

Rather than the cryptocurrency used for speculation, our focus is on the impact that distributed ledger technology (broadly defined as blockchain technology) can have on financial transactions and the business models of financial institutions. Furthermore, as speculation in cryptocurrency is growing to a scale that cannot be ignored, we plan to look more deeply into the potential impact on the market if the bubble should burst and the effect of concerns over this on regulations and monetary policy.

“What The Hell Is Going On?”: Trey Gowdy Absolutely Destroys Farcical Mueller Probe In Epic Monologue

 If there is any remaining doubt in your mind that Special Counsel Mueller’s probe is anything but a farcical, politically-motivated witch hunt, then you’ll be summarily relieved of those doubts after watching the following exchange from earlier this morning between Trey Gowdy (R-SC) and Deputy Attorney General Rod Rosenstein.

Presented with no further comment for your viewing pleasure…

Not A Bubble?

 Meet The Crypto Company – up almost 20,000% since inception in September…

To a market cap of over $12.6 billion…

Grant’s Interest Rate Observer drew the world’s attention to this ‘company’ yesterday…

Shares in over-the-counter name The Crypto Company, which listed in May and traded around $20 as recently as Dec 1st, have gone on a parabolic run in the last ten days – trading as high as $642.


That gives the Malibu, California-based business a market capitalization of $12.6 billion.


Valuing the Crupto Co. is somewhat difficult, as the only public filing on Edgar (the SEC website), is its securities offering document, in which it ticks the box “decline to disclose” under revenue range.


The company’s website does note that it’s in the business of providing “institutions and individuals direct exposure to the growth of global blockchain developments.”


And today it is down 75%.

FBI Deputy Director McCabe Told Agents To Lie About Benghazi Investigation, Says GOP Lawmaker

GOP lawmakers have come forward with new allegations of political bias or interference at the FBI – this time involving the 2012 Benghazi attack. John Solomon of The Hill reports that Rep. Ron Desantis (R-FL) recently interviewed a retired FBI supervisor who told him he was instructed by Deputy Director Andrew McCabe not to call the 2012 Benghazi attack an act of terrorism when distributing the FBI’s findings to the larger intelligence community – despite knowing exactly who conducted the attack.

The agent found the instruction concerning because his unit had gathered incontrovertible evidence showing a major al Qaeda figure had directed the attack and the information had already been briefed to President Obama, the lawmaker said. –The Hill

After the September 11, 2012 attack against U.S. government facilities in Benghazi, Libya, the Obama administration peddled a lie, telling the public that the attack was related to Muslims who had become enraged at an anti-Islam YouTube video, and not a planned act of terrorism – despite Hillary Clinton mailing Chelsea Clinton from her unsecured server the night of the attack to say exactly that.

Chelsea – using the pseudonym “Diane Reynolds” probably didn’t have the clearance to receive classified intelligence from her mother, the Secretary of State.

Two of our officers were killed in Benghazi by an Al Queda-like group: The Ambassador, whom I handpicked and a young communications officer on temporary duty w a wife and two young children. Very hard day and I fear more of the same tomorrow.” –Hillary Clinton to Chelsea Clinton

Wikileaks Clinton Email Archive #12136

And we now know FBI Deputy Director Andrew McCabe lied for the Obama administration in a clear, partisan violation of the FBI’s mandate to “detect and prosecute crimes against the United States,” not “lie for the President so as not to offend Islam.”

As Rep. DeSantis told The Hill: 

What operational reason would there be to issue an edict to agents telling themin the face of virtually conclusive evidence to the contrary, not to categorize the Benghazi attack as a result of terrorism? By placing the interests of the Obama administration over the public’s interests, the order is yet another data point highlighting the politicization of the FBI.”

DeSantis and other GOP lawmakers say they plan to question FBI Director Christopher Wray at a Thursday hearing in front of the House Judiciary Committee about claims of growing concern among certain FBI supervisors over political bias clouding decisions at the highest levels of the agency.

The case against the FBI for overt political bias couldn’t be more clear. Over the last week we’ve learned of veteran FBI investigator Peter Strzok’s dismissal for texting his mistress anti-Trump messages, which the DOJ is handing over to the House Intelligence Committee. We also learned yesterday that a second prosecutor on Robert Mueller’s Special Counsel, Andrew Weissmann, praised then-acting Attorney General Sally Yates after she refused to defend President Trump’s travel ban.

Fox News reports:

A top prosecutor who is now a deputy for Special Counsel Robert Muellers Russia probe praised then-acting attorney general Sally Yates after she was fired in January by President Trump for refusing to defend his controversial travel ban.


The email, obtained by Judicial Watch through a federal lawsuit, shows that on the night of Jan. 30, Andrew Weissmann wrote to Yates under the subject line, I am so proud.


He continued, And in awe. Thank you so much. All my deepest respects.


Judicial Watch President Tom Fitton called the new Weissmann document an astonishing and disturbing find.

“The data points we have regarding politicization are damning enough but appear all the more problematic when viewed against the backdrop of investigations whose ferocity seemed to depend on the target: the Clinton case was investigated with an eye towards how to exonerate her and her associateswhile the Russia investigation is being conducted using scorched earth tactics that seek to find anything to use against Trump associates,” DeSantis told The Hill.

DeSantis also said his FBI source pointed to an incident after Trump’s National Security Advisor Mike Flynn resigned over lying to Vice President Mike Pence over his contacts with Russia’s ambassador. An FBI executive is said to have made an inappropriate comment during a video teleconference indicating that the agency had a personal motive in investigating Flynn and ruining his career.

“The wildly divergent ways these investigations have been conducted appear to dovetail with the political bias that has been uncovered,” DeSantis said.

In response to the overt political bias at the FBI, the Inspector General’s office (OIG) has launched an investigation into Strzok and other officials connected to both the Clinton email investigation as well as the Trump-Russia investigation. Agent Peter Strzok who was removed for anti-Trump text messages ran both investigations, the latter Trump-Russia having been taking over by Robert Mueller’s probe which he was recently kicked off of.

Deputy Director Andrew McCabe, meanwhile, is directly under investigation by the OIG for potentially violating the Hatch Act or engaged in ethical conflicts pertaining to his wife’s run for the Virginia Senate in 2015 as a Democrat. She received $700,000 in campaign contributions tied to Virginia Governor Terry McAuliffe (D) – an ally of Hillary Clinton who was under FBI investigation at the time. The Hill reports that records show McCabe attended a March 2015 meeting with McAuliffe designed to secure the governor’s support of Jill McCabe’s candidacy.

Potential Hatch Act violation

As The Hill concludes:

McCabe has said he sought FBI legal advice on how to deal with his wife’s campaign. He nonetheless presided over the Clinton email case until just a few days before it was closed, when he unexpectedly recused himself.

Multiple Republican lawmakers said Wednesday they believe the email case was tainted by political favoritism and special treatment for the 2016 Democratic nominee and planned to press Wray about their concerns.

“We are here today calling for an investigation into FBI systems and procedures that have allowed special treatment and bias to run rampant,” Rep. Matt Gaetz (R-Fla.) said. “The law demands equal treatment for all, not ‘special’ treatment for some. There is a clear and consistent pattern of treating the Clinton investigation differently than other investigations.

Finally, An Honest Inflation Index – Guess What It Shows

Central bankers keep lamenting the fact that record low-interest rates and record high currency creation haven’t generated enough inflation (because remember, for these guys inflation is a good thing rather than a dangerous disease).

To which the sound money community keeps responding, “You’re looking in the wrong place! Include the prices of stocks, bonds and real estate in your models and you’ll see that inflation is high and rising.”

Well, it appears that someone at the Fed has finally decided to see what would happen if the CPI included those assets and surprise! the result is inflation of 3%, or half again as high as the Fed’s target rate.

New York Fed Inflation Gauge is Bad News for Bulls

(Bloomberg) – More than 20 years ago, former Fed Chairman Alan Greenspan asked an important question “what prices are important for the conduct of monetary policy?” The query was directly related to asset prices and whether their stability was essential for economic stability and good performance. No one has ever offered a coherent answer even though the recessions of 2001 and 2008-2009 were primarily due to a sharp correction in asset prices.A new underlying inflation gauge, or UIG, created by the staff of the New York Fed may finally provide the answer. Its broad-based measure of inflation includes consumer and producer prices, commodity prices and real and financial asset prices. The New York Fed staff concluded that the new inflation gauge detects cyclical turning points in underlying inflation and has a better track record than the consumer price series.

The latest reading shows inflation of almost 3 percent for the past 12 months, compared with 1.8 percent for the consumer price index and 1.8 percent for core consumer prices, which exclude food and energy. Since the broad-based UIG is advancing 100 basis points above CPI, it indicates that asset prices are large, persistent and reflect too easy monetary policy.

The UIG carries three important messages to policy makers: the obsessive fears of economy-wide inflation being too low is misguided; monetary stimulus in recent years was not needed; and, the path to normalizing official rates is too slow and the intended level is too low.

Harvard University professor Martin Feldstein stated in a recent Wall Street Journal commentary that “The combination of overpriced real estate and equities has left financial sector fragile and has put the entire economy at risk.” If policy makers do not heed his advice odds of another boom and bust asset cycle will be high — and this time they will not have the defense mechanisms they had after the equity and housing bubbles burst.

To summarize, a true measure of inflation – one that is highly correlated with the business cycle – is not only above the Fed’s target but accelerating.

Note on the above chart that both times this happened in the past a recession and bear market followed shortly.

The really frustrating part of this story is that had central banks viewed stocks, bonds, and real estate as part of the “cost of living” all along, the past three decades’ booms and busts might have been avoided because monetary policy would have tightened several years earlier, moderating each cycle’s volatility.

But it’s too late to moderate anything this time around. Asset prices have been allowed to soar to levels that put huge air pockets under them in the next downturn. Here’s a chart that illustrates both the repeating nature of today’s bubble and its immensity.

In other words, it is different this time — it’s much worse.

Nearly Insolvent Illinois Just Issued AAA-Rated Bonds Via This Shady Goldman Sachs Financing Structure

The state of Illinois is a financial disaster that will undoubtedly be forced into bankruptcy at some point in the future.  As we’ve pointed out multiple times over the past several months, the state faces a staggering $130 billion funding gap on its public pensions, a mountain of debt and $16.4 billion in accrued payables because they can’t even afford to pay their bills on a timely basis.  Here are just a couple of our recent posts on these topics:

  • Illinois Pension Funding Ratio Sinks To 37.6% As Unfunded Liabilities Surge To $130 Billion
  • Illinois Unpaid Vendor Backlog Hits A New Record At Over $16 Billion
  • The State Of Illinois Is “Past The Point Of No Return”

So what do you do when you’re effectively a junk-rated credit risk but you need to sell another bond deal to keep your ponzi scheme going a little longer?  Well, you turn to Goldman Sachs to help you engineer a shady corporate structure that supposedly gives new bondholders first dibs on sales tax revenue (i.e. you prime other unsecured bondholders)…which is just clever enough to fool the rating agencies into giving it a AAA-rating but, as analysts and investors point out, is unlikely to mean much of anything in a bankruptcy scenario.  Per the Wall Street Journal:

Yet the nation’s third-largest city is on the verge of selling as much as $3 billion in bonds at a triple-A rating, the latest twist in the tale of cash-strapped U.S. municipalities adopting Wall Street financial engineering in their struggle to raise money in the market.


Echoing methods adopted by Puerto Rico and New York, Chicago has created a new company to sell debt, offering a tempting pledge to investors: a dedicated first claim to the city’s sales-tax revenue.


In theory, that should make the debt as secure as U.S. Treasury bonds. But there is a catch: analysts and investors say in the scenario of a bankruptcy, it is difficult to predict whether owners of the new bonds would get paid back ahead of other creditors, pensioners or even police and emergency services workers.


The deal tests whether years of near-zero interest rates will send yield-starved investors into complex bond structures. And Chicago—with a school system that has teetered near bankruptcy and greater expenses than its revenues—could still face a funding gap down the line even if it manages to lower its borrowing costs, analysts say.


Thornburg’s Mr. Ryon said Chicago’s new entity doesn’t deserve separate credit ratings from the city’s other debt. “It’s a bit of smoke and mirrors,” he said.

Of course, anyone with half a brain should be able to realize that for Goldman’s structure to be effective it would necessarily mean that other outstanding Illinois bonds would have just been put in a subordinated position and should, therefore, be worthless.  That said, per the chart below, legacy ILS bondholders still seem to be pretty optimistic about their future recovery potential.

But while the jury is still out on whether this financing ponzi scheme will be effective at priming other bondholders or is truly nothing more than “smoke and mirrors” designed to fool the always gullible rating agencies, you can rest assured that other failing states like California will line up to take advantage of similar schemes in the near future…

Other cities and states will be watching Chicago’s bond sales. Illinois passed a special statute allowing the city to issue the bonds, and now other municipalities in the state can do the same.


States including California, Nebraska and Rhode Island have passed laws in recent years aimed at giving bondholders first claims on some taxes even if the issuer is in financial distress. Illinois and Michigan have also proposed similar laws.


Investors say municipalities with weaker financials will continue to try to woo bondholders with proposed safeguards, especially with the market rattled by Puerto Rico’s restructuring.


“The idea is to provide a little more reassurance to potential creditors that they’ve got first crack at the money,” said Glenn Weinstein, a Chicago attorney at Pugh, Jones & Johnson P.C., who has advised the city in the past.


At the same time, Mr. Weinstein said, “if you don’t have financial difficulties and your credit is good, you don’t need this.”

…all of which means that when the municipal ponzi scheme, with their $5 trillion in unfunded pension liabilities, finally goes bust it will be even worse than expected.

How “Ghost Collateral” And “Yin-Yang” Property Deals Will Collapse China’s Credit Bubble

 One lesson from the 2007-08 crisis was that the vast majority of financial market participants, never mind the general public, were unfamiliar with subprime mortgages until the crisis was underway. Even now, we doubt many have much understanding of repo, the divergence between LIBOR and Fed Funds from 9 August 2007 and Eurodollar liquidity. In a similar way, when China’s bubble bursts, we doubt the majority will be that familiar with “ghost collateral” and “yin-yang” property contracts either.

A second lesson from the 2007-08 crisis was that as the value of the collateral underpinning the vast amount of leverage declined, the surge in margin calls led to cascading waves of selling in a downward spiral.

A third lesson was that the practice of re-hypothecating the same subprime mortgage bonds more than once meant collateral supporting the most vulnerable part of the credit bubble was non-existent. It only became apparent with the falling prices and margin calls. Few people realized the bull market was built on such flimsy foundations, as long as prices kept rising.

A fourth lesson was that in order for the bubble to reach truly epic proportions, key financial institutions, especially banks, needed to conduct themselves in a negligent fashion and totally ignore increasing risks.

Each of these warning signs from the 2007-08 crisis exists in China’s property market now – and other parts of its financial system – bar one…falling prices leading to cascading waves of selling. However, as we’ll explain, we think it’s only a matter of months away now.

We should note that our thesis that China’s bubble would eventually be undermined by a “black hole” of insufficient collateral is one that we have been developing for several years. What we came to realize is that insufficient collateral is nothing more than normal business practice in the Chinese economy. It doesn’t matter whether it’s related to commodity-backed loans, property speculation or managing redemptions in the Wealth Management Products (WMPs) sector.

The first sign of this practice to received worldwide attention came to light in 2014 with the collateral fraud at China’s third largest port, Qingdao, which spread to another port, Penglai, before it suddenly got covered up stopped. Numerous borrowers were found to have pledged the same copper and steel inventory as collateral to obtain funding from various banks, including state-owned Citic Resources, as well as Citi, Standard Chartered, and others.

Not long after the scandal emerged, media attention began to wane, as commentators either assumed it was fixed or were distracted by other issues. However, it wasn’t fixed and we had a shocking reminder last month with the first major publicly announced loss. ED&F Man took an $80m hit after acting as a broker between Australia’s ANZ Bank and two Hong Kong-based trading companies in a sale-and-repurchase financing deal. The trade was backed by storage receipts for about $300 million of nickel stored in Glencore-owned warehouses in Asia. The problem was that the warehouse receipts were forged. As we said.

What is surprising is that it has taken over three years for the first serious hit from China’s “ghost collateral” to emerge. Or perhaps not: in a time of generally rising prices, few if any traders actually bother to check if their pledged collateral ever exists. The problem emerges when prices decline, which courtesy of China’s bubble machine, has so far not been an issue.

In June 2017, we discussed an article, “Ghost collateral’ haunts loans across China’s debt-laden banking system”, by our favorite Reuters reporter and forensic investigator of China’s collateral black hole, Engen Tham. Here are a few soundbites from Tham’s impressive piece.

One lawyer said he discovered that the same pile of steel was used to secure loans from 10 different lenders.

Most of the bankers said that kickbacks were prevalent, with loan officers turning a blind eye to the quality of collateral and knowingly accepting dubious and even fraudulent documents. Two of the bankers said they themselves had taken bribes to smooth the approval of loans.

Overall, 23 of the 30 bankers described the existence of ghost collateral as a serious problem and expected more instances to emerge as the Chinese economy slows. The bankers interviewed come from 13 banks in China, including some of the nation’s biggest lenders.

…fraudulent collateral is “a huge issue,” said Violet Ho, senior managing director and co-head of Greater China Investigations and Disputes Practice at Kroll, which conducts corporate investigations on the mainland. “Often you also see that the paperwork around collateral may be dodgy, and the bank loan officer knows, the intermediary knows, and the goods owner knows – so it’s essentially a Ponzi scheme.”


More than six months later and Egen Tham is back with a “special report” on loan fraud and missing collateral in China’s property market, “Hidden peril awaits China’s banks as property binge fuels mortgage fraud frenzy”. We strongly recommend the article as Tham goes into forensic detail as he examines specific legal disputes which act as a window on the broader Chinese property market.

Here is our summary.

Reuters discovered an epidemic of mortgage fraud in China’s property market from extensive research and interviews with buyers, sellers, real estate agents, loan agents (see below), bankers and lawyers from three major Chinese cities and four smaller ones.

Buyers habitually overvalue the cost of the house or property they are buying so they can borrow more funds which are typically channeled into the property market, e.g. buyers who have insufficient down payment or income. A mortgage banker at Shanghai Pudong Development Bank estimated that 20-30% of his clients borrowed the down payment from a third party.

Small banks and loan companies do not have the resources to monitor if money is borrowed to finance down payments on property deals. Reuters notes that short-term household loans increased by 243% to 1.6 trillion yuan in the first ten months of 2017.

There are up to three contacts for an individual property transaction – the legitimate one, one for the bank providing the loan which overstates the property’s value and one for the tax authorities. These are widely known as “yin-yang” contracts in which real and fake agreements operate side-by-side.

In these re-packaged loan arrangements, all parties, including the bank and the seller, can be complicit in the fraud. Tham provides detailed examples. Since “everybody is doing it”, the crimes go unpunished, even when the guilty admit them in court documents regarding related claims.

Reuters reports that it interviewed twelve estate agents who admitted to helping clients commit mortgage fraud. One salesperson at the E-House China agency said that about 50% of his clients engaged in mortgage fraud. Another real estate agent estimated that about 60% of Shanghai property deals involve “some kind of re-packaging”.

separate industry of loan agents has evolved which help property buyers to fraudulently secure mortgage loans. Real estate agents, and the banks themselves, introduce borrowers to the loan agents which keeps the criminal activity at “arm’s length”.

While many western websites are blocked by the Chinese authorities, discussions about securing a fraudulent mortgage, the price of fake documents and adverts from loan agents are prevalent on social media.

The motivation for mortgage fraud is the fear of missing out in the great Chinese property bubble. While official data showed that house prices rose 12.4% in 2016 (fastest since 2011), this understates reality. The state-controlled Chinese Academy of Social Sciences estimates that prices rose by an average of 42% in 33 major cities.

Reuters noted that property market insiders “see little prospects” of an end to mortgage fraud, even though the Chinese regulators have asked banks to stop over-valuations and “yin-yang” contracts. Even when evidence of fraud is specifically shown to a bank, it is likely to be ignored.

To add some color to our prose, here are a handful of soundbites from Tham’s article.

Almost all contracts for the sale of existing property in China have some “yin-yang” element, according to Denny Jiang, a former banker and recent home buyer in Beijing.

A Hong Kong property investor surnamed Fu, who declined to give his full name because he was admitting criminal behavior, told Reuters that 20,000 yuan (about $3,000) in a traditional red gift envelope was enough for a valuation company to inflate the price of the apartment he wanted to buy in Shenzhen by 40 percent. That increased the amount the bank was prepared to lend him by 1.26 million yuan.

While property prices in China continue to rise, mortgage fraud remains largely a hidden danger, much as subprime loans in the United States remained mostly out of sight ahead of the 2008 global financial crisis. The fear is that in a property correction, fraudulent mortgages would unravel, accelerating a collapse of housing prices in the world’s second biggest economy. This, in turn, would imperil China’s debt-laden financial system.

“It seems banks don’t consider the issue a serious one.”

We think the last two comments are particularly poignant, harking back to some of the key themes of the 2007-08 crisis. As we noted above, the one thing missing from China’s bubble is falling prices leading to cascading selling which exposes the “ghost collateral” in the financial system. As this chart from Bloomberg shows, the month-on-month growth in Chinese house prices has slowed dramatically from the heady levels of 2016, as Chinese authorities have increasingly tried to cool the bubble.

“Houses are for living in, not for speculation” as Xi Jinping stated at the recent Party Congress. Even though property sales have been slowing, The Standard reported the state’s CCTV said that the property sector’s three regulators, the PBoC, the Ministry of Housing and Urban-Rural Development and the Ministry of Land and Resources, remained committed to stepping up financial regulation and cracking down on speculation after a joint meeting in Wuhan last month.

The regulators said China would prevent funds from being illegally channelled into the property market, and ensure capital allocation between real estate and other industries was balanced. The three central government entities also told provinces to stick to their tightening measures and be consistent in policy, warning against lax regulation that could lead to big fluctuations in the market and a build-up in financial risks.

“(We) must not tolerate any thinking that we can sit back and relax,” the regulators said, according to CCTV. China will also improve its management of the land market and prevent cases of high land prices pushing up property prices.

In Deutsche Bank’s latest China macro presentation, “Risks to watch in next six months, part IV”, the bank explained why property prices will cool further and could be declining on a year-on-year basis by the middle of next year (the month-on-month decline would likely be apparent in early 2018). DB’s rationale is as follows. Leverage in the financial sector is slowing rapidly.

Financial deleveraging is a key factor behind rising interest rates…

…which will deflate China’s property bubble during 2018.

DB believes that unless the Chinese authorities rein back their deleveraging policies, H2 2018 could see the market slow rapidly…

…which assumes China’s central planners can fine tune a deflating bubble once it starts. We have our doubts.

An Angry Rudy Havenstein Lashes Out: “No, The Fed Is Not Populist”

Submitted by Rudy Havenstein

After years of seeing terrible market news and commentary, I’m pretty jaded, but when I saw the recent Marketwatch op-ed, “Janet Yellen’s true legacy is her focus on middle-class wages” (by Tim Mullaney), I thought such nonsense needed a response that went beyond 280 characters. (Half of Mullaney’s article is an anti-Trump rant, which is fine, and which I will ignore).

“If something is nonsense, you say it and say it loud.”
– Nassim Taleb

The article’s tagline, “Outgoing Federal Reserve chairwoman is a true populist, representing the interests of ordinary people”, reflects an Orwellian perversion of language that is so common today, a bizarro land where “inflation” is “growth”, “debt” is “wealth,” “QE” is “economic stimulus,” and “plutocracy” is “populism”.

 Janet Yellen heads what is arguably the most anti-populist entity on Earth. It’s a very strange world we live in, where the actions of the head of a private bank cartel are declared to be “populist” by countless econ professor cultists and their media acolytes, as average Americans stand in stunned amazement at the elites’ cluelessness.

So what is “populism”?  I asked Google, which hopefully excluded any Russian propaganda from the answer:

Ok, I don’t know about you, but reading that I immediately thought “That’s Janet Yellen.”  (I would prefer for this article to be about someone truly evil, like Alan Greenspan or Tim Geithner, as I’ve always thought of Yellen as more of a caretaker, a bit like Bruce Dern in Silent Running.)

This ridiculous idea of the Fed as “populist” is not a new phenomenon.  You have, for example, Canadian humor magazine Macleans back in 2014:

And none other than noted hairdresser Paul McCulley said this recently:

[You may remember Paul McCulley as the guy who said in 2002 (to cat afficianado Paul Krugman’s glee), “Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”  So how’d that work out for the average American? ]

Mullaney writes:

We hear a lot about populism these days, a political philosophy the dictionary says is about a party or faction “seeking to represent the interest of ordinary people.” And that’s what Yellen did as Fed chair….

Really? I suppose it’s fitting that a day after the Marketwatch propaganda dropped, the @FedHistory account tweeted this:

(As an aside, I ruined the #FedHistory hashtag for the Fed, but that’s another topic.)

Ok, so Aldrich…Aldrich…rings a bell. Oh yeah…

So who were these founding populists, “seeking to represent the interest of ordinary people,” who assembled on Jekyll Island?


Clearly these were the Joe Six-Packs of the day.

The “duck hunt” ruse was due to the incredible secrecy regarding the Federal Reserve’s formation:

Apparently the founders of the Fed weren’t committed to the “transparency” we have today, where, for example, Fed meeting transcripts are released after a 5-year lag, presumably to give the statutes of limitations time to expire. (Another canard is that the Fed is “independent”, which apparently it is from a corrupt, feckless Congress, but hardly from Citadel, Barclay’s, Pimco, Goldman, Citigroup, JPMorgan or Warburg Pincus, but I digress.)

So why such secrecy if these populists were just there to “represent the interest of ordinary people”?

Surely the public would have supported the two main reasons these men formed the Fed, to stifle competition and arrange for the socialization of bank losses?  I mean, to mandate price stability and stable employment?

Father of the Fed Paul Warburg tries to explain:

So, um…even a century ago the populace had “a deep feeling of fear and suspicion with regard to Wall Street’s power and ambitions.”  Maybe for good reason, then as now.   Upton Sinclair, in his 1927 novel “Oil!” (an inspiration for the film “There Will Be Blood”), happens to give a very good description of the Federal Reserve:

Clearly, Mullaney sees Janet as a different animal than the founders of her cartel:

“…she held interest rates low enough, for long enough, that consumers’ debt-service burdens reached 20-year lows while real household incomes recovered all of the ground lost in the recession and moved toward all-time highs.”

As is typical of Fed cheerleaders, all credit for any recovery goes to the Fed, and no blame for the preceding bubble and collapse.  The heroic arsonist helped put out the fire!  I will concede that Yellen’s Fed did oversee lowering rates to prehistoric levels, and also induced massive additional consumer borrowing.  The “debt burden”may be low now, but God help the poor debtors if rates ever return to anywhere close to average historical levels (not to scare you, but that’d be around a 5% Fed Funds Rate).   Of course, by then Yellen will be long gone, giving $500k speeches (inflation, you know), collecting her COLA-adjusted pensions and perhaps muddying the minds of another generation of Berkeley undergrads. She’ll be fine.

So yes, low rates are awesome, but while Citigroup (which should not existet al. may be able to borrow at 0%, still NO ZIRP FOR YOU!

As for real incomes, I do hope we can someday get back to Nixon-era levels.

To Marketwatch Tim, Janet Yellen is some sort of mythical figure, able to single-handedly create jobs, hike wages, and ameliorate the consumer debt burden.  This of course is nonsense.  First of all, look at Janet Yellen’s resume:

Other than perhaps some hiring at the Fed and the Berkeley econ department, it is hard to imagine any jobs that Ms. Yellen herself actually created.  Maybe she hired someone to garden her yard, and that’s commendable, but Yellen strangely believes that without formerly-tenured econ professors running things (to borrow from Jim Grant), the US economy would collapse:

“Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not.”
– Janet Yellen, 1999

This is a rather laughable statement coming from someone who won the 2010 NABE “Adam Smith Award”.  So how the heck did US unemployment drop to 5% in 1900 without a former Berkeley econ professor to guide it?  How did it even get as low as 4% in 1890 with no FOMC?  I guess it’s a mystery.

Speaking of Adam Smith, he described the folly of Janet’s position well in “The Wealth of Nations”:

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

Anyway, academia has been very good to Yellen, as her 2010 financial disclosure report shows.  This report shows, among many other things at the time, over $21,000 a month just in University of California pension income, “$500k-$1M” in her Heartland 500 Index fund IRA and a $50,000 “honorarium” from Chinese internet company Netease.  No doubt she can also look forward to many days of giving $250,000 speeches to those who most benefited from her largesse.  Having such a huge income (at least relative to the median US wage earner, who makes $30,557 a year) no doubt factors into Yellen’s fervent desire to spike the cost of living for the peasants.

Throwing in Janet’s $200k Fed salary, a very conservative estimate puts Yellen’s annual income in the top 99.9% of all Americans.  Quite literally, Janet Yellen is the 0.1%. (To be fair, the Fed pays its staff very well, which is  probably a side-effect of being able to create currency at will).

Yellen has served her 0.1% well.  Besides the Fed’s latest mandate, the booming S&P 500 index, and a 4.1% unemployment rate (which, if accurate, would mean Trump would never have been elected), Yellen oversees a nirvana where American wealth inequality is now at record levels on her watch, even worse than Russia or Iran(!!), with the top 1% now owning 38.5% of everything!  Yay!

A few more examples: The CEO-to-worker compensation ratio is at 224-to-1 in 2016, up from 22.5 back in 1973, millennials live with their parents at unprecedented historical levels (largely because Fed and government policies have made house prices far higher than they would otherwise be), and Americans are more burdened by student loan debt than ever.  I won’t even mention subprime auto delinquencies.  All this is in the 9th year of our incredible global synchronized recovery!  (What happens if there’s ever another recession, which of course there can’t be?)

Then there are the senior citizens who have been destroyed by ZIRP and inflation (which Yellen thinks is too low):

These seniors’ economic woes may explain why the elderly are the only demographic group with a rising labor force participation rate since 2000.  Would you like fries with that?

Meanwhile, the populist owners of the Federal Reserve are doing great

Moreoever, the Fed’s real claim to fame since 2009, the stock market’s “wealth effect” (also known as “trickle down”) is lost on the 70% of Americans who make less than $50k and are not benefitting from the Fed casino.

“There is absolutely no econometric evidence that there is a wealth effect except for a very slim slice of our highest wealth individuals.”
Lacy Hunt

(I will, out of kindness, refrain from mentioning that In the pre-Fed Panic of 1907, the Dow fell 48.5% from its all-time high, while in the Fed-mentored Panic of 2008-2009, the Dow fell 54.4%.)

Everything the Fed has done this century has been designed to get Americans into more debt, and most importantly to protect the (global) too-big-to-fail money-center banks. Everything else is secondary.  Just one example of this reality is when a “lightbulb went on” for Neil Barofsky, the Special Inspector General of the TARP:

There you have populist Yellen’s Fed in a nutshell: it’s all about the banks.  (Note that “Turbo” Tim Geithner, former tax scofflaw, NY Fed President during the height of TBTF bank fraud, AIG-creditor savior, US Treasury Secretary, and overall weasel, is now being rewarded as President of Warburg Pincus).

The Federal Reserve and Janet Yellen, despite the magical thinking of the Fed’s many media shills, are no more “populist” than JPMorgan Chase or Lloyd Blankfein.  If the Fed ever happens to help “the average American” through some action, it’s by accident, and there is plenty of evidence that the average American has not only not recovered from Great Depression II, but is actually worse off in real terms.  Time to wake up.

“Ever get the feeling you’ve been cheated?”
Johnny Rotten

US Household Debt Is Rising 60% Faster Than Wages, And One Rating Agency Is Worried

 In a report released today by DBRS titled “Consumer debt and debt burden”, the rating agency which is best known for keep Italian debt eligible for ECB monetization at the peak of the European banking crisis, looks at the latest Quarterly Report on Household Debt and Credit issued by the NY Fed (discussed here previously) which showed that consumer debt for the third quarter of 2017 was approximately $12.96 trillion, representing an increase of $116 billion over the second quarter of 2017. The debt level for the first three quarters of 2017 has continued to increase above the previous record debt level which was established in the third quarter of 2008 as shown in Exhibit 1 below.

DBRS also highlights that not only did total debt levels increase, but their composition changed as highlighted in Exhibit 2 below.

The good news: total mortgage debt has decreased since 2008, to $8.743 trillion from $9.29 trillion, but as of the third quarter of 2017, still accounts for 67.5% of overall consumer debt.

The bad news: since 2008, the growth in total debt has been attributable to the auto loan and student loan sectors. Auto loan debt has increased by 50% since 2008, to slightly over $1.2 trillion from approximately $800 billion. The most dramatic growth rate, as readers know well, has been in student loan debt which has grown by 122% since 2008, to $1.357 trillion from $611 billion.

But a bigger concern flagged by DBRS is that the growth in consumer debt is raising concerns when viewed in the context of the existing wage stagnation hampering the current economic environment. The rating agency cites a paper published in October 2017 by the Harvard Business Review which stated that the inflation-adjusted hourly wage has grown by only 0.2% per year since the mid-1970s and labor’s share of income has decreased to its current level of 57% from 65%.

Meanwhile, in the second quarter of 2017, wages were only 5.7% higher than they were a decade earlier. In comparison, the Federal Reserve Bank of New York/Equifax data shows that consumer debt growth over the same period was 9.3%.

In other words, the purchasing power of US households has been largely a function of rapidly rising debt, which over the past decade has risen 60% faster than wages.

There is another concern: while overall delinquency rates have stabilized in recent years, the one stubborn outlier remains student debt, where 90+ day delinquencies have risen to more than 10%.

This is a problem because as Bloomberg’s Lisa Abramowicz writes, considering that GOP tax overhaul may eliminate tax deductions on interest on student loans, this debt load could become even more onerous.

It’s not all bad news, however: as DBRS concedes, stabilizing delinquency trends imply that a tipping point has not yet been reached. There is also the suggestion that since there have been significant economic booms since the 1970s, during periods of persistent wage stagnation, the tolerance level for gaps in debt and earning power is quite large.

On the other hand, the rating agency also concedes that with consumer debt at all-time highs, and rising, as the debt/wage relationship seems to be entering a previously unobserved phase, “it seems prudent to closely monitor both components.”  This is a “red flag” for the economy because as Abramowicz concludes, “should unemployment rates rise at some point, this balance could fall out of whack, exacerbating any economic downturn.”

Of course, a variant perception on this threat is that once the economic fundamentals catch up with reality, and the US consumer is tapped out in a rising rate environment and crushed by the weight of $1.4 trillion in student loans, the Fed will promptly halt the current monetary tightening regime, and revert back to preserving the “wealth effect” with more ZIRP, QE and eventually NIRP. One look at the S&P confirms just how “worried” the market is about the current state of the economy…