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NIRP Is Absolutely Crushing Big Parts Of The Finance World

Savers are the obvious victims of the past few years’ plunge in interest rates. But there are other casualties, including money market funds, which have no reason for existing if their yield is negative, and insurance companies, which price their policies on the assumption that they’ll earn good returns on their bond portfolios.

As bond yields plunge, the returns insurance companies can expect are also plunging, forcing them into huge write-offs and, soon, steep premium increases that will scare away customers. One big insurer just illustrated the spot in which the industry finds itself:

Lloyd’s of London Takes `Massive Hit’ From Low Investment Return

(Bloomberg) – Lloyd’s of London reported a 30 percent drop of full-year profit as the world’s largest insurance market was hurt by continued pressure on pricing and the lowest investment returns since at least 2001.

Earnings declined to 2.1 billion pounds ($3 billion) for 2015 as income from investments, primarily fixed income, sank 60 percent to 400 million pounds, according to the company’s annual report Wednesday. Weaker pricing in 2015 is expected to continue this year, it said.

“We’ve taken a double hit from reduced margins in underwriting and lower investment yield,” Chief Executive Officer Inga Beale said in an interview with Bloomberg Television Wednesday. “On the investment side we saw a dramatic reduction in 2015 that was a massive hit” to earnings.

Most of Lloyd’s 2015 earnings were generated when bond yields were a lot higher than they are today, so things will be much worse going forward. Here, for instance, is that now-famous chart of Japanese long-bond yields plunging from modestly positive to negative in the space of a few months.

Japan yield curve March 16

For an insurance company — or a pension fund (more about them in another post) — the only recourse is to adjust to this new reality by raising premiums and taking huge writedowns, as Lloyds just did. In such a harsh environment, weak players will fail and strong ones will suffer, but few will make the kind of money that justifies the effort.

And now on to the banks. If your business model is to borrow short-term at low rates and lend longer-term at higher rates, a flattening yield curve — which eliminates the difference between long and short rates — is an existential threat. But in recent years the big Wall Street banks have morphed from traditional lenders into hedge funds which make most of their money by trading increasingly-exotic financial instruments for their own accounts. And in a world of flattening yield curves and multi-industry credit crises, this kind of trading is suddenly a loser’s game.

Liquidity Death Spiral Traps Credit Suisse

(Bloomberg) – Credit Suisse just got caught up in the same liquidity death spiral that has claimed a growing number of debt funds.

Some of the bank’s traders increased holdings of distressed and other infrequently traded assets in recent months without telling some senior leaders, Credit Suisse CEO Tidjane Thiam said on Wednesday in a Bloomberg Television interview. This is bad on several levels. For one, it highlights some pretty poor risk management on the part of senior officers at the Swiss bank.

But perhaps more important from a market standpoint, it exposes a trap in the current credit market: Traders are getting increasingly punished for trying to sell unpopular debt at the wrong time. The result has been a growing number of hedge-fund failures, increasing risk aversion by Wall Street traders and further cutbacks at big banks.

This all simply reinforces the lack of trading in less-common bonds and loans. At best, this spiral is inconvenient, especially for mutual funds and exchange-traded funds that rely on being able to sell assets to meet daily redemptions. At worst, it could set the stage for another credit seizure given the right catalyst — perhaps a sudden, unexpected corporate default or two, or the implosion of a relatively big mutual fund.

To give a feeling for just how inactive parts of the market have become, consider this: About 40 percent of the bonds in the $1.4 trillion U.S. junk-debt market didn’t trade at all in the first two months of this year, according to data compiled from Finra’s Trace and Bloomberg. While corporate-debt trading has generally increased by volume this year, more of the activity is concentrated in a fewer number of bonds.

This has made it even harder for big banks to justify buying riskier bonds to make markets for their clients, the way they used to, because they could get stuck holding the bag. That’s what happened with Credit Suisse, apparently. The bank suffered $258 million of writedowns this year through March 11, and $495 million of losses in the fourth quarter, because of its holdings of distressed debt, leveraged loans and securitized products, including collateralized loan obligations, according to a Bloomberg News article by Donal Griffin and Richard Partington.

Credit Suisse is in a tough spot because it is trying to get out of its hard-to-trade assets at a bad time. It’s re-evaluating its business model under new leadership, higher capital requirements and the shadow of poor earnings.

But it’s certainly not alone in feeling the pain from a brutal and unforgiving period in debt markets. JPMorgan Chase, Bank of America and Goldman Sachs are expected to report disappointing trading revenues in the first three months of the year, and Jefferies already reported its train wreck of a quarter.

The upshot of all this paper carnage is that zero and negative interest rates are equal-opportunity destroyers, crushing the conservative strategies of insurance companies along with the idiotically aggressive practices of modern mega-banks. Virtually no area of finance will continue to function normally if rates stay at this level or — can’t wait to see this — go more deeply negative. And many niches will shrivel up and die.

We may, in short, be about to witness the market’s self-correcting mechanism in action.

19 thoughts on "NIRP Is Absolutely Crushing Big Parts Of The Finance World"

  1. To control the sheeple TPTB want to nationalize the banks. NIRP will expedite that process as banks fail and .gov swoops in to save the day.

  2. NIRP stands all forms of logic on its head. For example, the more money the banks lend the more money they’ll lose, the lower the interest rates are the more risky investments are perceived to be, and the best way to make/keep money is to not invest in anything, etc. The irony is that when everything implodes the CBs will be forced to raise rates!

    1. Central banks can not be forced to raise rates but they can be put in front of a choice:
      1) Destruction of the currency (no one will accept their currency
      2) Stop printing and allowing the interest rate to grow where the market want.

      If they wait until 1 start, 2 could not work anyway.

      1. True, but I was using the word “force” in the way the financial markets do, meaning that ‘logic would dictate’ or ‘unless you want to create or allow some other (bad) such-a-such a thing to happen’, etc.

        That said, they are already are in front of that choice and they’re wimping out. If they can’t make tough choices now, then when?

  3. ” — can’t wait to see this —” tsk, tsk. John, that’s just plain evil. I totally agree! Let’s see what reversion to the mean really looks like. 🙂

  4. The Central Banksters won’t be happy until it all lies in one smoldering ruinous heap of bad debt. Then they’ll blame the consumer for not spending enough …

    Long metal, long farmland, long dividend paying stocks, short of confidence in Monetary Mandarins.

    1. “long dividend paying stocks”? Better go short on that or get out entirely. Companies are slashing dividends right and left.

      1. No one can pick all winners, but I try to pick co’s that have long term ‘staying power’. Metals are my hedge against a mistake here.

  5. To start with if the banks and insurance companies get hurt badly it will be about time as the last time the taxpayers (all of us) had to bail them out so they could continue to rape us all for the rest of our lives. I say to bad so sad. Problem is they will get the government to bail them out again and leave us all with the bill Banks and insurance companies ARE the problem as the FED works for them! the created this mess and now they need to reap what they sow

    1. They will get bailed-IN this time, and depositors will get hit this time. These days, bank deposits are return-free risk!

  6. If you buy P.M.s over time you will at least build up real wealth. I’ve never been one to think a piece of paper is worth much money so have what you can use or barter with. Believe it or not this has been done for thousands of years. Hard to believe that people have been totally brought over to put faith in money instead of the one true place faith belongs. “God”

        1. That is too funny. I guess we deserve what we get as a country if so many of our people are that dense. Makes you wonder how quick you can brainwash someone?

          1. It’s a good illustration of how people think (or don’t think.)

            This guy has made tons of videos like this trying every which way to jog peoples’ minds but they don’t budge. I would think just the knowledge of what jewelry costs would make it a no-brainer, but no – even with women. There is one video where he’s trying to sell a 10 oz bar of silver for like a buck to a guy who had a couple of silver rings through his lip and just before the guy walked away Mark asked him how much he paid for his lip rings and the guy said about 150 bucks. It’s amazing.

  7. About 30 years ago, with a pencil and piece of paper (try this kids), I calculated if I could live off my projected Social Security Check, and the interest income on $1 Million. I assumed a “conservative” % rate (back then) of about 5%. That would have given me about $50,000 from the one million and then about $30,000 per year from Social InSecurity.

    Not bad. Kids gone, wife gone or dead (just joking).

    It is a good thing I soon started paying attention to the World. It is a good thing I realized I would most likely work till the day I die. Even if I had 5 Million, I would be in trouble today.

    Negative % is the Bankers way of saying we don’t need your worthless paper notes since we can print our own anytime., suckers…………………….

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