In last week's column, Banks versus the Fed, I reviewed the massive increase in U.S. treasury holdings by the largest banks, the money centers such as JPMorgan Chase & Co. (JPM), Bank of America Corporation (BAC), Wells Fargo & Company (WFC), and Citigroup Inc. (C), over the past year. I noted this was an indication that they are of the opinion that the Fed should not and will not raise rates this year.
The shift into treasuries by these four banks has helped to drive long-end treasury yields down. In the process, they forced most of the rest of the banking system to sell treasuries and move incrementally into riskier reserve securities not guaranteed by the U.S. government. This was mostly U.S. government-sponsored entities such as FNMA and FMAC.
The reason for this is the status of the money centers as being "too big to fail", which has resulted in them being designated as Globally Systemically Important Banks (G-SIBs), This designation has caused the cost of capital to these institutions to decline because they effectively have a backstop provided by the U.S. government and U.S. tax payer now.
The decline in cost of capital available to them has allowed them to profitably put carry trades on into U.S. treasuries. As this process has accelerated, it has forced the short-to- long spreads to compress to the extent that most other banks can no longer carry risk free trades into treasuries. They have had to sell their treasury holdings to the money centers and use the proceeds to buy riskier and thus higher-yielding securities.
The difference in cost of funds to the four largest versus the rest is profound. The average cost of borrowing for the four largest is .23% annually, with JP Morgan at .23%, Bank of America at .15%, Wells Fargo at .16%, and Citi at .57%.
Below them is another tier of G-SIBs provided this designation because of their global investment banking and international clearing services. This group is made up of The Bank of New York Mellon Corporation (BK), The Goldman Sachs Group, Inc. (GS), Morgan Stanley (MS), and State Street Corporation (STT).
Mellon and State Street, because of their clearing services have cost of capital even lower than the money centers at .06% and .11% respectively. Goldman and Morgan Stanley, even with their G-SIB status, have credit costs of .49% and .47% ,respectively.
Below the G-SIBs is another group of systemically-important financial institutions called the Domestic Systemically Important Banks (D-SIBs). This group in the U.S. is made up of 23 companies involved in national or super regional banking, insurance, and credit cards. This group also includes domestic branches of non-U.S.-based international banks.
The G-SIBs and D-SIBs have experienced a reduction in their cost of capital, allowing them to put carry trades on that the rest of the banking system can't.
The average cost of capital to the rest of the 6,500 banks in the U.S. is about .50%. There's a wide spread, but the germane point is that the systemically-important banks have had their cost of capital reduced by inclusion on these lists.
They are essentially now subsidized and given a backstop by the U.S. taxpayer. They are using the resulting financial benefit to them to reduce risk-taking behavior and productive loan making with the monetary support they receive and of which they are the first recipients.
The result is that the largest owners of capital are increasingly withdrawing their resources from productive enterprise. They are instead borrowing cheap monetary system capital from the federal government, supplied by the Fed, and arbitraging it by loaning the money back to the U.S. government's fiscal system. They do this through U.S. treasuries, agency debt and government-sponsored enterprise debt. This is as close to a free lunch for the wealthiest that can exist.
The result of this activity is that the real economy -- the private economy -- is having to work harder and is relying on the assets of the banks that are not considered systemically important in the process.
The impact is enormous. The G-SIBs alone account for about 43% of all bank assets. The D-SIBs account for about another 30%.
This is not just a U.S. issue, it is happening all over the world. As it is being implemented globally by the largest financial institutions, their largest non-bank customers -- both corporate and individual -- are benefitting from the public subsidies being provided. They are parking assets and putting arbitraged, or nearly so, carry trades on into their respective sovereign debts.
This is one of the reasons for the exceedingly low and even negative yields on sovereign debt in Europe and the trajectory for such by many of the world's largest corporate debt issuers.