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The Whaley Report: Bad life decisions

The silent majesty of a Fall morn. The clean, cool, chill of October air. The rhythmic pounding of corn filled bags on plywood boards. And an entire population of college kids, liquored up by 10am. God, I love college football season! Whenever I go to a college football game, it brings back fond memories. College is where you go to grow and mature and let’s be honest, very little growth occurs without making bad life decisions.

No, I’m not talking about the irreparable kind that keeps you from getting legitimate employment or that requires you to notify the local authorities when you move.

I’m talking about the bad life decisions that lead to you moving your RA’s dorm room outside into the quad and replicate it exactly. After the fact, you find out that his Dad is a bigwig with the IRS, and the parents of the kids involved get audited.

Sitting there, tipping a Solo cup back, I couldn’t help but think about the college that central bankers have forced all of us to attend. They promised us growth but all we’ve received is a never-ending parade of bad life decisions.

The difficulty with bad decisions is that they have an uncanny way of looking like really, really good decisions at that moment. Like putting your beer on the back deck while it snows to use mother nature as a cooler. It’s only after a six-pack and the next foot of snow fall that you realize your short-sightedness. Central banks are forcing individuals and institutions to make decisions that look really good, given the current state of policy, but could wind up burying the entire financial system once it’s all said and done.

And so what of this growth goal of Central banks? They haven’t delivered. US growth is at the lowest point in three years and has been sliding for six consecutive quarters. China’s growth rate is the same as it was during the Financial Crisis, and those paltry numbers are made up by the government. Japan’s “growth” spends most of its time in contraction and the Eurozone’s growth peaked five years ago. All of the central banking shenanigans haven’t delivered sustainable growth, but it has delivered something else.

The International Monetary Fund (IMF) recently came out with its assessment on the state of financial stability and what these guys are saying is downright scary.

As it turns out, 0% interest rates for close to a decade wreaks havoc on a bank’s ability to make money. Who knew?! Weak banking profitability has two profound impacts, one current and one future.

Currently, weak profitability means that banks have a harder time building up capital to brace against economic shocks and it leaves less money for them to lend. The poster child for this issue is Deutsche Bank but they aren’t alone. We are seeing this capital building problem all over the globe, in both emerging and developed countries.

The future consequence of abnormal central banking policies is where things get real interesting, and downright ugly if you’re a bank. According to the IMF, 25% of banks in developed economies, representing $12T in assets, would be “vulnerable during a rosy economic environment marked by faster economic activity, rising interest rates and declining defaults.” What the heck?! Central banks have bastardized capital markets to the point that if the world entered the ideal environment for banks to profit, then a quarter of the world’s banks would “remain weaken and face significant structural challenges.”

That’s right kids, we live in a world where banks are having trouble making money in a low growth, low interest rate environment and if the world ever finds its way back to economic prosperity, banks won’t be able to operate in that environment either. Well, what environment is left? Banks are between a rock and a hard place and it has led to bad life decisions. Banks are walking further and further out on the risk curve because they can’t make any money.

JP Morgan is extending credit to consumers who redefine the term “sub-prime.” Jamie Dimon, and other bank CEOs are managing career risk by lending money to people who have a Slim Shady chance of paying it back. In June, Bank of America-Merrill Lynch paid a $415MM fines for using customer cash to generate trading profits. Over the last six years, these guys held up to $58B per day of customer deposits in a trading account for the firm’s benefit. Yeah, that really happened. Talk about bad life decisions. Like driving eight hours in a blizzard across three states to see a girl. Although she was a solid “8”, 19-year-old you doesn’t realize that you shouldn’t risk your life, not even for a “10.” Not to mention, who in their right mind would drive across West Virginia in the dark?!

The truly scary part of this IMF study is that it was completed before the onslaught of negative rates. I can’t even imagine the deplorable systemic ramifications of multiple years of rates being pushed deeper and deeper into the ground. This goes well beyond banks being able to make a dollar. These banks are counterparties to each other and to many other institutions. A couple of weeks ago, I wrote about the counterparty risk that Deutsche Bank’s current circumstance is causing. Now, increase that risk exponentially and you start to get a picture of what happens if the IMF is right.

The bottom line is that a world with improved growth prospects might be the catalyst for the next crisis!

There’s no question that bad decisions are a part of life and they are certainly part of investing. But when bad decisions are widespread and occurring at the institutional level, those decisions put the whole system at risk. No, I can’t tell you when these bad decisions will lead to the next major market disruption. But I can alert you to the real dangers lurking in markets that others are overlooking. Most individual investors are stacking up bad decisions that won’t reveal themselves until it’s too late. James Garfield said “things don’t turn up in this world until somebody turns them up.” I’m here to turn things up and help you minimize bad decisions. Being aware of developments that no one else is discussing, like the bigger picture impact of bank profitability, is the difference between bad decisions that lead to regret and good investment decisions that allow you to sidestep danger.

Landon Whaley

Landon Whaley is the Founder and CEO of Whaley Capital Group. Mr. Whaley launched Whaley Capital Group in the aftermath of the 2008 Financial Crisis because he wanted to provide real value and a unique client experience in an otherwise highly commoditized industry. Whaley Capital Group delivers on this mission by following a rigorous investment strategy that is committed to a global macro-style of investing, while simultaneously providing a world-class, boutique-style client experience. You can contact Landon at: landon@whaleycapitalgroup.com