Billowing risks in the global financial system are front and center once more as the world economy turns down and banks remain under-capitilized and recklessly levered. Same players, same factors, same crisis, redux. In the UK at least, some are pointing to “Brexit” as a scapegoat. In fact these macro conditions have been building to a breaking point over the past many years. See UK heading for financial crisis on grander scale than 2008, with ‘Bank of England asleep at the wheel’, new study:
The Bank of England’s annual stress tests of the UK’s banks, designed to ensure Britain’s lenders will not be at the heart of another destructive financial crisis, have been branded “worse than useless”, by a new report.
Kevin Dowd, professor of finance and economics at Durham University, argues in a paper published today by the Adam Smith Institute that the Bank’s tests, which model various adverse economic scenarios each year such as a major fall in UK house prices or a Chinese property crash, have a series of “fatal flaws” and that the central bank is “asleep at the wheel”.
“The purpose of the stress-testing programme should be to highlight the vulnerability of our banking system and the need to rebuild it. Instead, it has achieved the exact opposite, portraying a weak banking system as strong”.
Professor Dowd warns that the eurozone banking system is on the precipice of another crisis, which will also engulf the UK’s major lenders.
“Once contagion spreads from Italy to Germany and then to the UK, we will have a new banking crisis but on a much grander scale than 2007-08” he said.
US real GDP growth in the first six months of 2016 averaged just 1% annualized and inflation (CPI) was up only 1.1% from a year ago, nowhere near the 2% that the Federal Reserve targets. The peak of economic expansion is now well behind us for this cycle with the rate of growth slowing since 2014. At the same time, markets entered this downturn at some of the highest asset valuations in history.
This is a toxic combination for invested capital. This chart courtesy of Doug Short, reminds of stock market outcomes (market price declines) that have followed GDP downturns since 1929. Each time that equity valuations have entered the downturn more than 20% above their mean, market prices have returned -36 to -89% from peak to trough. Today 76% above the mean, equity valuations are worse than the peak of 1929 and second only to the all time fleeting 2001 tech top. Sober days lie ahead for those unaware, or in denial.