Juggling Dynamite

Investment banks have been proving over the past 6 years, that when you can spend $2.7 billion on legal fees in a quarter you can get away with pretty much every crime and violation in the book.  Their proceeds of crime cash flow is so plentiful, that they can wrangle out of pretty much every breach with a cost-of-doing-business-payment to regulators or politicians.  The trouble is that eventually, it is bad for earnings; and that’s when shareholders finally get peeved and executives fall from grace.

Here is a prediction: Citigroup will go bust a third time and look to the taxpayers for a third bail out before this next down cycle completes.  The question is, when, oh when, will we the people, finally cut these corrupt institutions off from the public purse and push the investment banking arms back out to live and die on their own dime? See: Citigroup Expects $2.7 billion in fourth-quarter-legal-expenses.

“Citigroup Inc. said it would spend $2.7 billion to bolster its legal reserves, wiping out the bulk of its expected fourth-quarter profit and delivering a fresh setback in what was supposed to be a turnaround year.

The nation’s third-largest bank also said it would recognize $800 million in so-called repositioning costs, its largest cost-cutting tab since Chief Executive Michael Corbat took the reins two years ago.

The developments signal that the New York company is struggling to put its house in order amid deepening legal probes and uneven economic conditions that pressure profits in Citigroup’s global banking and trading businesses…

Citigroup was the only big bank to disclose major new expenses Tuesday. Top executives of Bank of America Corp. and Wells Fargo & Co. also presented at an investor conference hosted by Goldman Sachs Group Inc.”

For some important historical context see: The Untold Story of the Bailout of Citigroup

High yield bond prices historically trade in tandem with equity prices. Both are risky bets on the underlying corporations and market sentiment, at a given point in time. Contrary to the ‘long always’ prophets, the higher the price, the riskier and less attractive investments are to buy.

The chart below shows data from the St Louis Federal Reserve on the level of US Hi Yield spreads since 1996 (with Cory’s annotation) (ie., the extra yield that lower quality corporate bonds are paying holders when compared with similar dated government treasuries.)
Relevant is the fact that high yield spreads have gapped more than 5% above US Treasury yields, 4 times (pink boxes) in the past 18 years:  the Long Term Capital meltdown in 1998, the dot bomb implosion 2000-2003, the Great Financial Crisis  2007-2009, and the realization of a renewed global slowdown in 2011.  This fourth event spurred terrified central banks to throw every drop of liquidity and assurance they could muster at capital markets.  And as shown above, it worked for a while, as bond yields drifted lower again from late 2011 to mid- 2014.  Since then however, the trend is not encouraging.

Today back at 4.87%, high yield debt spreads are once more moving toward the 5% threshold that has marked the last 4 stock market shocks, when the revelation of capital loss woke deluded participants from complacent slumber.

The global theme continues to be that bad debts are compounding, particularly in previous ‘hot’ areas like energy companies, Venezuela and China, and this time around governments and central banks have insufficient reserves to back stop losses.

Slowing growth and plunging energy prices are putting pressure on heavily levered participants and priced for perfection assets.  Here is a direct video link.