Implications of Delusion in Finance (English, 2023-02-19)

2023 got an interesting start! Sweden is now in the midst of an epic meltdown in the real estate sector. It is so grand that it has made politicians and their sponsors extremely nervous, to the point where they simply outright forbid the publication of near real time data on the housing crash. It is going down in history as the Ingo Crash (I just made this up, but since Stefan Ingves was on CNBC in January washing his hands like a reborn Pontius Pilate, in hindsight, it will probably be known by a similar eponym). I wonder if it is the sort of a panicky reaction in which the observer swiftly turns his head away from the scene of the accident, hoping that it will all go away, like an ostrich? Or maybe it is the latest victim of the “silence-all-free-speech-movement”?

Valueguard, who was in the business of publically tracking the development of housing prices, received an injunction by a local court to cease the monthly publishing of a real estate price index, which I have made prior use of here. To the uninitiated, this index is nothing more than a price index. But, if you belong to the enlightened ones, you know just how extremely dangerous this information can become, if it is wielded by “the enemy”. A back-of-the-envelope calculation shows that the Swedish banking sector, as relayed by the Swedish Banker’s Association, is composed of a few large banks with a rather small amount of equity. At the end of fiscal year 2021 the aggregate balance sheet comprised assets valued at 10 799 billion SEK (or 10.8 trillion SEK), whereas the lending to the real estate sector amounted to 5 026 billion SEK. Now, if we acknowledge, like Valueguard did, that the average price decline, year on year, in the housing sector amounts to some 12%, then it implies unrealized losses of approximately 600 billion SEK on the asset side. Sooner or later, they will have to be reflected on the bank balance sheets. When they do, they will wipe out the banks, because these losses surpass the equity declared to be 591 billion SEK. This is what any junior bank analyst would think, but then again, accounting has never really been about numbers; only political power. So, by restricting the access to current information, politicians are buying themselves time and it is a telltale sign that the battle of factions has begun. What are the likely forthcoming steps?

One obvious scenario is the recapitalization of the banking sector. This is the obvious short term ex-ante solution. These losses would have to be made whole, one to one, as the old ways of injecting a small amount of equity into a bank, thereby enabling a leverage of one SEK equity to 18 times the lending capacity, are gone. The banking sector is simply too large. So, expect placements in which share issuance of at least 600 billion SEK in the banking sector takes place in the coming years. Credible scenario? Not very. Especially not since the Valueguard price index shows that this is the end of the beginning (unlike the beginning of the end), and furter price declines are to come, coupled with a rise in inflation. Such a recapitalization would amount to more than half of the government budget. It does not strike me as a palatable political solution!

A familiar scenario would be the 1992 crisis, with a state bank nationalizing failing commercial banks and selling off bad assets at steep discounts, although I would not bet on it. The political class of the last decade(s) is now heavily indebted themselves with exposure to the real estate sector. There is a tiny conflict of interests, even though it would remain the morally sound thing to do. Let the state take over the banks and liquifiy bad assets! It has been done before, and we know how it works. The approach would obviously take some time, and a lot of illiquidity would ensue in the meantime. It is however a political process. Behind the scenes there are currently fervent, but low key, discussions taking place on who will (or pehaps deserves) to survive the coming deluge of defaults. Banks are not entities that exist outside a social context, quite the contrary! They facilitate business for some key group of industries, often owned by particular families. Swedish banks have very tight connections with French, UK and US banks; not Chinese nor Russian ones. Still, they remain tools of oligarchs (not all oligarchs are Russians)! Therefore, any negotiation that touches on the governance of banks make people extremely nervous, because these families stand to loose everything that they’ve built, not only during a lifetime, but perhaps even for generations!

When I taught Applied International Macroeconomics during the autumn semester of last year, I had time to read up on articles that supposedly are “on the scientific frontier”. It is revealing that the state of macroeconomics is in a complete mess after the Great Financial Crisis of 2008. One of the really interesting articles is the “Deviation from Covered Interest Rate Parity” by Du, Tepper, and Verdelhan in Journal of Finance from 2018. The Covered Interest Rate Parity is the idea that if capital can move freely, then by the use of currency forward markets, the interest rates in a domestic country should not deviate too much from foreign ones as market participants seek to exploit arbitrage opportunities. It’s a pillar of macro finance and the strand of literature that relies on no arbitrage assumptions. Well, you know what? Post the Libor scandal, this doesn’t hold anymore. Capital does no longer roam the globe in search for yield nor investments, probabaly because it was based on credit for far too long. Or, perhaps, as Borio, McCauley and McGuire claim in their article in the BIS Quarterly Review from December 2022:

FX swaps, forwards and currency swaps create forward dollar payment obligations that do not appear on balance sheets and are missing in standard debt statistics. Non-banks outside the United States owe as much as $25 trillion in such missing debt, up from $17 trillion in 2016. Non- US banks owe upwards of $35 trillion. Much of this debt is very short-term and the resulting rollover needs make for dollar funding squeezes. Policy responses to such squeezes include central bank swap lines that are set in a fog, with little information about the geographic distribution of the missing debt. 

If there is GDP of some 100 trillion USD, and 25 to 35 trillion USD goes “missing”, I’d say that’s a pretty big deal. The western financial world is in a complete dissarray as avowed by the scientific community. It is a total fricking mess!

So, it is no secret that Sweden is in a tight financial situation. If you are in a position of some power, the question on your mind likely revolves around possible trades to put on, like “what kind of bargain can I get for facilitating extension of credit to the imploding housing sector?” If credit is not extended, interest rates will go up and the external value of the SEK down, as international capital refuses to engage with Sweden. As interest rates go up, and wealth goes down, careers are obliterated (finance as a discipline can never really be separated from the people practicing it). So, the political ramifications of such a reversal in flow of funds are considerable, because they portend the reversal of the social classes in society. The housing millionnaries are bound to be demoted a step or two as valuations collapse. Paradoxically, the internal value of the currency might just improve in purchasing power as credit implodes, bringing forth an improvement of the relative clout of the poor have-nots; they don’t look as foolish for having averted the whole mess! The only one who is not really touched by any of this is the King of Sweden, clearly demonstrated by the envious, rancorous gossip in the press (how anyone still reads the garbage is beyond me). Now, perhaps you understand why there are some who vie for conflict, and preferably on a global scale? In this situation, just maybe, compensations will be had for political concessions?

Reading the news, I think that the general public can observe these imprudent tendencies to sell out the nation. If you are truly connected, you might avert complete personal disaster by facilitating entry into various political clubs. (Nato membership, anyone?) The pressure shows along other dimensions as well. Swedish business representatives voice concerns over the standing of the SEK, which is becoming an even more marginalized currency in international affairs; perphaps it is time to adopt the euro in order to better align onself with international interests? The last time we had this discussion in Sweden, it ended with a popular no-vote for the adoption of the Euro (and the murder of our foreign secretary, Anna Lind). So far, they are nothing more than news articles, which politicians skillfully navigate. Only the weak, or perhaps the mentally insane, will consider a trade along the lines of “what kind of bargain can I get for facilitating a betrayal of my country?”

It is tempting to project ones worries on outside foes, but the real struggle is occuring within the borders of this country, and the struggle is for ideas! It is a struggle to define how people think about problems, and who ultimately benefits. This struggle has been identified, and is becoming more and more clear over time. A reemergence of a new political amalgamation between moderates and conservatives (the latter from from both sides of the aisle) will likely remake Sweden from within, rooting out this sort of weird behavior of self deluding fearful denial. The enemy? Well, they are obviosly “the globalists” (whoever they are), who have completely and utterly penetrated the functioning of the government, either directly or implicitly. The coordinated global lock-down-and-mobile-phone-IDs-push during the Corona pandemic of 2020 clearly showed how far the coordination has gone, even in an easy going country like Sweden. The debacle revolving around the not-so-secret-mistresses-in-the-Swedish-Police/Armed-Forces in 2022 shows that the coordination is ongoing. Therefore, everything from national security issues, to migration policy, to excessively cheap real estate finance, to deluded “green energy”, are up for grabs in the coming renegotiation of the future.

My favourite topic of polemic discussion is the recurring reluctance to embrace nuclear energy as the energy of the future. Just when you think that people are finally making civilizational progress, concerns about nuclear energy are voiced. Just to put things into perspective: nuclear energy is the one power source that enables space travel, and has remained unbeknownst to mankind until the second world war. It is a huge technological progress, and only a complete idiot would claim otherwise. According to environmentalists, this is the power source that we should abolish in order to promote wind mills! Right. (Try traveling to Mars in a wind propelled rocket. I wish you all the best!)

At first glance, a lot of this delusional mismanagement looks like idiocy and corruption in government, but the older I get, the more I lean towards that it is nothing more than simple fear. Fear of loosing material wealth. Fear of being cast aside. Fear of World War III. Fear of not belonging to the group, which is a sort of a survival instinct. Besides, the game is now apparent, and in the open. These sort of games are played over the long term: decades, if not centuries. The prize is the soul of the country, and our future generations.

Game on!