The Credit Cycle

I finally have my kitchen back, and now can devote more time to writing and consulting. I am still pushing another project, so my output here will probably be limited. I have taken another look at my bank primer project, and realised that I have too much content — I will need to trim back the theoretical wrangling texts that I previously wrote. With today’s article, I think I have covered most of the content I want to be in the book, although I might stick in some cursory analysis of a few different banks’ balance sheets. For example, I might compare some teeny-tiny American bank versus larger European or Canadian banks as a way of indicating the dispersal of what “banks” are. This article has only been lightly edited.

If the economy was in a stable equilibrium dominated by agents forecasting their cash flows out to infinity, defaults would be a random process – defaults would occur, but without a pattern to them. Default risk would be an insurable risk (i.e., could be managed by actuarial calculations like life insurance). However, the existence and popularity of the term “business cycle” indicates that the flows of commerce are cycle – and defaults follow the business cycle. During an expansion, banks do face a persistent relatively low level of defaults and delinquent loans, which does accord with being a random, insurable risk. The problem is recessions – which see a spike in defaults. Although it is possible for there to be a recession without a default spike (as discussed below), the “interesting” recessions are the ones with default spikes. The “really interesting” recessions are the ones where the banking system itself joins in on the default trend.

Primer: Introduction To Credit Spreads

After a hiatus resulting from various disturbances, I am back with another book manuscript section. I just reworked this section, and hopefully did not introduce major issues into it. However, I wanted to get this out before next week. Right now, my main concern in life is getting my kitchen sink back.

This section introduces credit spreads from a bond pricing perspective. Looking at bonds is not completely inappropriate, as banks do hold bonds in their liquidity portfolio. The illiquid loans on bank balance sheets can be analysed in the same way, albeit bankers might use different terminology.

Fed 50!

The Fed started what might develop into a rate cut campaign by reducing the target rate by 50 basis points. It looks like Chairman Powell has decided to take “Gradualism” behind the barn and put it out of its misery.

I have returned from an unplanned trip, caught some kind of virus, have a new consulting project, and half the main floor of my house is being refitted. As such, I have been even less on top of current economic events than usual. I am just putting this article up to let readers know that I am still around and thinking of them. My main concern is finishing off the next section of my banking manuscript. Once the dust (literally) settles on my house, I will take a look at the inflation manuscript.

Wholesale Payments Systems and Bank Reserves

Status update. I had to take an unplanned trip, while at the same time starting a new consulting project. I focussed on the project before I left, and I now have some time to do some writing while away from home. This is the latest instalment of my draft manuscript, which is a brief discussion of wholesale payments systems. I might beef up the discussions further. International payments is another variant topic, but I may shy away from opening that can of worms.

Wholesale payments systems are the glue that ties the banking system together. These systems allow banks to make monetary transfers to each other – either on their own account, or on the behalf of clients – quickly and more importantly, safely. The payments system allows bank clients to transfer money electronically to one another without worrying about the exact mechanism for the transfer.

Bank Credit Risk Management

This article is an unedited draft section from my banking manuscript. It finishes off the chapter on risk management.

The focus of this book is on how bank lending and liquidity flows interact with the wider economy. So long as credit losses remain at acceptable levels, they do not interrupt those flows. Given that the focus is elsewhere, this section will just offer a high-level perspective on how banks manage credit risk, without attempting to discuss what strategies individual banks use to analyse credit risk. Although this section will mainly refer to lending decisions, liquidity provision to capital markets participants also requires credit risk analysis.

Nothing Ever Happens

I realise that I have tempted fate with my article headline, but I am just referring to a current popular meme on Twitter (“nothing happens”). In this case, I am referring to the drop in panic with regards to the yen carry trade (and whatever else people were worrying about, like “repo pods”).

To repeat once again my monotonous point: financial crises generally need some form of credit event to make them interesting. Risk assets losing value will cause some leveraged players to blow up. (Pretty much any exciting market movement can ultimately be traced to one or more hedge funds shifting off this mortal coil.) Although a hedge fund blowing up will cause some credit concerns with its counterparties, in most cases there will be enough unscathed market participants to step into liquidations, and once the dust settles, people go back to whatever they were doing.

Sigh, Another UBI Study (Rant)

I have a need to rant as a result of recent discussion of yet another Universal Basic Income (UBI) study on Twitter. Rather than deal with the ugly political realities of a UBI, UBI proponents insist on doing studies on a tangential topic (how do people spend regular cash grants?).

I use a standard definition of a UBI where all living adult citizens receive a fixed monthly payment from the government. The idea is that the fixed monthly payment provides a guaranteed minimal standard of living without any other income sources needed.