Posts By: Western Wall Street
Banks sell 2.4 billion NIS of mortgages to Institutional buyers – Are we setting ourselves up for another subprime crisis?
The cooperation between Israel’s banks and Institutional investors is not new; these two industries have held hands on many occasions and in various fields of activity, effectively blocking out competition from abroad.
Over the past few months this collaboration has strengthened with the purchase of 2.4b shekels worth of mortgages by institutions. Some of us will reminisce how this trend was one of the major features behind the subprime crisis of 2008. When banks assume that they are not entering a long term loan contract with their borrower, they automatically take higher lending risks. Although currently the banks are cautious and highly regulated, if this trend of developing a secondary market continues, as expected, we will embark on a long slippery slope towards a fall. And since the blind buyers of these products are our hard working citizens pension plans, this fall will affect us all.
Why is this happening? Why now?
The reason is that the product currently suits both sides of this equation. Banks have long ceased to profit from mortgages. The main income used to be from the government mortgages which do longer exist. The meager spreads on mortgage is money not well spent for banks, which have turned mortgages into loss leaders in order to gain the client by means of giving a mortgage. Thus we saw mortgage banks merge into their parent companies, and borrowers practically forced to transfer banking activity. By giving, and then selling the loan, the bank keeps “the fat” and releases the commitment.
Once the regulator raised equity ratios on mortgage portfolios, this portfolio became more cumbersome for the bank, encouraging selling out.
The Institutions need shekel based fixed income product to meet and hedge obligations. In this everlasting low interest environment, they turned to income producing properties, bringing yields down by 2% in 3 years. Finding themselves overexposed to real estate, they turn to any sort of product which provides cash-flow. Although the returns of mortgage portfolios are low in Israel, the risk is equally low and there is a diverse set of borrowers reducing risk.
Where will it go? I expect the banks to sell another 12b NIS by the end of 2016; Brexit has set back any sign of recovery in European economies, promising a continued spell of low interest. This is turn keeps the demand high for Israeli real estate, and the ongoing demand for new mortgages will need to be met. No bank can afford to stop providing mortgages, and so the old will be sold to make room for the new.
This short term solution should be replaced by a long term one. The banking market in general, and mortgage market in particular, needs new players. To-date, the regulator has made it virtually impossible for overseas financial institutions to enter the retail market. Maybe, with the assistance of online platforms and P2P type platforms, the Israeli public will benefit from a competitive market, reducing prices and coercing the banking industry to provide the service that customers deserve. The alternative, a repeat of 2008, is far less enticing.
The tax collector must love poor people; he’s creating so many of them.
Benjamin Franklin, in his letter to Jean-Baptiste Leroy, stated that “In this world nothing can be said to be certain, except death and taxes.” Will Rogers added that at least death does not get worse every time that congress meets.
The first known system of taxation was in Ancient Egypt around 3000–2800 BC in the first dynasty of the Old Kingdom. The earliest and most widespread form of taxation was the corvée and tithe. The corvée was forced labor provided to the state by peasants too poor to pay other forms of taxation, labor in ancient Egyptian being a synonym for taxes.
Megilat Esther, which is read in the synagogue on Purim, is full of intriguing narratives and is a web of a plot which unravels into an almost fairy tale like happy ending, with the death of the bad guy and the emergence of the unlikely proletariat to hero. Interestingly though, within the described events of the Jews being able to retaliate against their enemies, one verse repeats itself over and over again “they did not plunder or help themselves to the spoils of their battles”. The constant repetition of these verses is highly questionable and it seems that the text is definitely stressing, even overplaying, this fact.
Shortly after, out the blue, another extraordinary fact is pointed out. The king levied a tax on his empire. This may well coincide with the known taxes levied by the Persian King Darius, as the first regulated and sustainable tax system known in history, based on levels of production. This would make it the first system which turned taxes from being a measure of cruelty by a ruthless leader, to a social tariff aimed at increasing social equality.
The verse seems very out of place and context. We are not told anything about Achashverosh’s internal or external policies, his military methods or even his manner of ruling the nations of his empire. Why are we told of his tax policy?
Maybe one question answers the other. The story of Megillat Esther is about ruthless leaders with no sense of human rights who see murder, homicide and plunder as an acceptable way of instilling fear into their subjects, and exerting power as method of rule. Later this concept would become known as social Darwinism – the survival of the fittest. They are not the exception, this is the acceptable manner of rule of the region and period. In our story the Jews are the victims, but assumedly there are many such stories with other minorities.
The events of Megillat Esther are not just a one-time event. They changed the course of economic history and manner of rule. The Jews never plundered or enriched themselves after overpowering their enemies. That was not their goal at all, they just wanted to defend themselves. At the same time, they passed on the message that society does not have to plagued by constant power struggles and needless killings, with aim to enrich oneself and seek further dominance. A new social system was initiated, which gives individual equality and rights, and protects the vulnerable from the callous and ruthless. It empowers the weak and reduces the power of the strong.
It is called taxation.
No-one, barring governments and accountants, likes taxes. However, when cursedly filling out IRS or Inland Revenue documents and paying taxes, maybe the memory that the alternative to the tax system is far worse will make this woe a little less painful.
Although the majority of Israelis still view the banking system as monopolistic at worst, oligopolistic at best, The Bank of Israel really does try to create an illusion of competition between the banks.
Different moves have included prevented the take-overs of smaller banks, assisting in changing over standard orders and taking the pension funds and certain capital market activities out of bank hands.
The latest invention is the Bank I.D card – known as the “Teudat Zeut Bankai”. This is a full run down of accounts and activities to be provided by each bank to the customer on the 28th of February, in order to allow easy comparison between banks’ charges, interest rates and credit ratings.
Is this document of value or should it be discarded like most of the surplus paperwork there banking system insists on supplying its consumers?
For customers who have one bank account, like the majority of the country, apart from cause frustration about the amount the bank charges, there is little to be gained by studying this report. People are unlikely to compare between friends or post this to Facebook to get shares, likes and comments. If you run more than one account, then by all means, compare and contrast. It is even worth going into the more expensive bank to ask reduce fees, but I fear the response will be more frustration and few will actually follow through.
This report does provide, however, a useful vessel for any customers who are credit-consumers. The majority of banks have recently instigated credit scores for their customers. These are based on algorithms which rely on very routine criteria. Part of these criteria are on the running of the account; this is fairly generic. There is however an emphasis on the constancy of What is this “Teudat Zeut Bankai” – Bank I.D Card? Is it “good for the Jews”?
At the end of the 1970’s, most of London’s double-decker busses were newly equipped for one person operations, making redundant the vast work-force known as “bus conductors”. This period was plagued by constant strikes of London transport workers, but more importantly, by a vociferous public debate about the social repercussions of machines replacing people.
Little were the disputants to know that this was a tiny stream in what was to become a flood of positions and professions slowly made irrelevant by growing technologies, which in turn created new types of jobs and vocations. There are very few professions which can truly say or believe that they are immune from redundancies due to technological reforms.
The current trend of FinTech – Financial Technologies – is giant in its vastness and diversity. Around 5,000 FinTech start-ups are attacking almost every angle of the conventional banking and financial world and biting at the flesh of their income sources. The catalyst of this trend was the financial crisis of 2008 and the subsequent credit crunch, which sent the market to search for new sources of finance. The shortage of credit paired with a low interest rate environment for investors provided perfect conditions for the growth of peer to peer (P2P) lending, improving the situations of both sides of the equation. Hereafter, the road to the FinTech eruption was short.
Does FinTech mark the end of the banking industry? Many would hope that this is the case; public sympathy with this industry is justifiably not high. FinTechs aim to find the banks’ most profitable sources of activities and replace them. The expectation is that banking profits will be reduced, over the next decade by up to 40%. However, there are several key reasons why banks will remain a central part of the economies, despite this boom in competition:
- The banks themselves spotted or sensed this change at a fairly early stage. Many banks are themselves heavily involved in FinTech – Citibank probably a leader in this field – and they will still protect their core business.
- The majority of FinTech’s, however revolutionary they may be, are reliant on the banks for success, and need to tie in to the banks’ infrastructure to make their product function. Even the firmly rooted P2P industry has to use a bank as a clearing agency.
- The FinTechs tend to choose areas which are not regulated or the regulations are less stringent. Many areas will remain highly regulated and, although burdensome, these will remain in the hands of the banks which have the systems to deal with the regulators.
- Many changes require legislation and changes in regulations. The high tech industry works on a two-year cycle; these changes can take five or six. Few start-ups have the ability to breathe that long without oxygen.
The FinTech industry has to be collective and strategically calculated to beat the Goliath of the banking industries. A full bodied attack will lead to self-destruction as many of the companies are creating similar products, and will be more focused on competing with each other than fighting the giant. Groups should continue to bite at the banks heals relentlessly, wearing out the beast over ten rounds rather than going for a knock-out blow.
“Only when the tide goes out do you discover who’s been swimming naked.” Warren Buffet
2016 started with a sharp downturn in world markets, and for many portfolio owners, and managers, it would be gratifying just to return to where we started off.
Will the market will correct itself, or will it continue in its decline? To try to analyze whether the market will continue to fall, we have to solve the mystery of whether we are on the verge of an economic or financial crisis.
Two of the properties which previously existed on the eve of financial crises do not exist today.
Firstly, the interest rates. Towards the crises in 2008 and 2001 US interest rate was around 5%. We are not in that position today, and, even if the Fed will raise interest rates once or twice more this year the rates are far from the levels pre 2001 and 2008 financial crunches. Today, investors do not have the privilege to flee the equity markets to higher interest rates in the market bond.
Secondly, there is no world recession. China’s growth is lower than expectations and probably has not grown 6.9%, as according to official figures. Previous crises were accompanied by recessions in the world. True, today there are economists who argue that the US will slip into recession in 2017, however, the vital signs of the US economy are still positive.
Causing further instability are the Chinese efforts to stabilize the situation. The Chinese are doing this by way of government intervention. Although the intentions are good, markets in general respond negatively to the notion the governments can intervene with market forces, especially in the aggressive way that the Chinese government intervenes.
However, even if we are not on the verge of an economic or a financial crisis, there are signs which hint to vulnerability in the markets. It always comes from the same place – leverage. For the past seven years, companies have generously leveraged at very reasonable prices, have developed their business and cared for their shareholders through generous dividends and buy-back. Now, when there is heavy pressure on the revenue line of those companies and lower global growth, companies will have to work primarily to serve the creditors. This is the main reason why some overpriced stocks will take a dent in the metalwork.
There will be cases of insolvency and lack of cash flow to service the debt, raising the prospects for an increase in bankruptcies. The most obvious examples of this are the world’s metals companies. These companies are borrowing in bonds to develop more mines, when they thought that demand for metals from China will only increase. In reality, China requires less raw materials, after years of rapid industrialization, and there is no country in the world which is replacing China in demanding these products. The result is that metals prices crash and revenues go down sharply. The combination of these factors will conclude, inevitably, in companies that will not be able to serve their debt.
Another industry which will cause the market to continue to be volatile is the energy market. Morgan Stanley has said oil could fall to $20 a barrel while Standard Chartered has predicted an even bigger slide, to as low as $10. Standard said: “Given that no fundamental relationship is currently driving the oil market towards any equilibrium, prices are being moved almost entirely by financial flows caused by fluctuations in other asset prices, including the US dollar and equity markets.
The Israeli share market should stand out with relatively moderate declines. 30% of our index is in global pharmaceutical, which is a defensive industry in terms of risk and leverage. The corporate leverage in Israel is lower than most western countries and the currency remains stable.