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A personal observation of the advent of AI (Artificial Intelligence) since my previous write-up in Feb: https://medium.com/@checkwoei/the-advent-of-ai-chatgpt-and-others-exploring-the-next-frontier-1bce9144aedf ChatGPT was only introduced to the world less than 5 months ago and the pace has accelerated exponentially in this short period. Many new inventive uses are being discovered and completed AI products are appearing on social media posts everywhere.

The genesis of an exponential rise in AI interest in recent times can be traced back to DeepMind’s AlphaGo defeat of the best Go player in the world in 2016. I highly recommend everyone to watch this documentary on youtube: https://youtu.be/WXuK6gekU1Y . It made everyone sit up and realize the potential of deep-reinforced learning. By 2017, China had declared that big data will be its new “oil” resource. It also kickstarted programs nationally to turbocharge its AI initiative since then.

While there is always the fear of jobs being lost to AI as machines take over, my takeaway is that we must learn to embrace and utilize AI in our daily lives. The alternative of ignoring it will be that we will be disadvantaged in our careers and be left behind. AI will improve our work effectiveness and free us to focus on higher value-added opportunities. Newer job opportunities will be created. While old jobs will become obsolete, many more new ones will appear. https://www.bnnbloomberg.ca/335-000-pay-for-ai-whisperer-jobs-appears-in-red-hot-market-1.1901850

At this point, I just like to share a bit of my learning journey and how I stumbled into AI. With the Skillsfuture government subsidies to help mid-career people pivot to growth areas like Tech, I started to embark on a new learning path in 2018. An old dog needed to learn new tricks to stay relevant. I wanted to reinvent myself while trying to pivot to a consultancy career at the same time. I was an ex-dark side banker looking to redeem myself with positive Jedi energies. Since then, I had completed various tech courses to educate myself. This includes a Diploma in Business Analytics, IBM’s SGUnited AI course, NUS’s Fintech program and various short courses that align with my goals.

The more I got into data analytics, big data, cloud computing and machine/deep/reinforced learning, the more convinced I am that this is the beginning of a brand new world where exponential growth is possible. The stars have finally lined up as computing power is now able to absorb and make sense of the huge amount of big data around us.

One area of interest that has progressed so rapidly within the last 18 months is the development and increased sophistication of deep fake image and video production. I remember doing a team project in 2021 for our IBM AI module on this topic. We were showcasing the fake Tom Cruise videos as an example of what was possible then. We used GAN (Generative Adversarial Network) and simple Python programming tied to public pre-trained datasets of less than 10k images to help spot and identify fake facial photos as a new account application security measure. Boy, they sure look crude and amateurish now compared to what one can do nowadays with a simple prompt and a click of a button.

Just look at the most popular generative AI applications like MidJourney and Stable Diffusion which can easily produce any realistic photo-like quality from anything you want via a few sentences. You have probably seen by now the video of the Pope wearing high-fashion Balenciaga outfits that fooled a lot of people. The originator did not need to draw well. He simply had to type words to prompt the generative AI to create realistic images.

With the combination of ChatGPT and these apps, the possibilities are limitless. One can prompt ChatGPT to fine-tune a detailed description to apply to the image-creating software to invent a photo-realistic art piece. We can also easily animate any person’s image to create a video of him/her speaking from any script we want.

Imagine what it will do to the advertising industry! There is no need to hire real people for new advertisements anymore. One can create personas who do not exist in real life to sell products without any fear of copyright violations. There are serious concerns that we will soon be seeing a bombardment of deep fake videos of well-known people hawking consumer products or spewing fake news.

There are also several new innovative ideas on how one can monetize all this new tech. An interesting suggestion was to develop online courses using ChatGPT to come up with full training modules and then create animated avatar lecturer videos to make the training interactive. The turnaround time would be hours instead of months thanks to the AI applications available now.

Another area of huge interest will be the medical field. AI data analytics is good at image detection and will be able to spot trends and patterns which the human eye is unable to. It was also used by banks to help spot fraud signals in credit cards where big data was available. For example, one can train the model on 10 million normal X-Ray images and separately train it on another 1 million images of positive cancer X-rays. Then when you show them new random X-rays, the trained neural network will be able to detect cancer with a high level of probability or indicate that it might happen in the future. https://www.nytimes.com/2023/03/05/technology/artificial-intelligence-breast-cancer-detection.html

To show how easy it is for a non-IT layman like me to do so, I used stable diffusion https://stablediffusionweb.com/#demo to create the following image below by typing a simple sentence: “Merge Joe Biden and Putin into one person, talking in Congress”. I can then prompt ChatGPT to do the following: “Imagine you are the presidents of the USA and Russia. Write a 300 words political speech on the following topic: To offer my sincere apologies to Ukraine and China for what we have done.”

I then use another freely available AI application to combine the face photo with the ChatGPT script to create a talking video. https://www.myheritage.com/deepstories/ The finished product will be of the imaginary person reading the whole speech like a normal human video with various facial expressions. The end-to-end process can be completed within 15 minutes. https://youtu.be/ZBSQZm7WrUs Fakes will get harder to detect as these AI tools improve exponentially in the near future.

The advent of AI is here and the possibilities are endless even as newer versions with bigger trained datasets are being rolled out within months. Let the games begin!

This is what traditional banks have been doing for hundreds of years: They collect deposits from mom-and-pop types of customers who normally use only one bank for all their financial needs. These funds are mostly CASA (Current Account, Savings Account) deposits and are relatively sticky, meaning that they do not leave the bank very easily and are normally dormant too.

Banks take advantage of this CASA by paying little or no interest. It is like a free loan to them! Just check your current/cheque accounts now. You are probably still getting zero interest even after the Fed’s aggressive rate hikes last year.

What do traditional banks do with all these “loyal” and sticky deposits then? They place them out to work to earn a higher yield to boost their profits. A measure of how well and profitable a bank is utilizing its duns is called NIM – Net Interest Margin, to measure the difference between a bank’s average cost of funds versus what it can earn. You will hear “borrow short term, lend long term” regularly in banking circles as a means of a bank’s funds management strategy. Banks seek to lend long-term to corporate and retail clients (eg. credit facilities, building/housing loans) while utilizing/borrowing short-term CASA funds or through the interbank overnight (O/N) markets.

In normal times, the interest rate curve is upwards sloping, meaning that short-tenor rates are lower than long-tenor ones. Banks will effectively “ride” the yield curve by placing out money long-term to earn higher rates and borrowing short. Yield curves may occasionally invert for countries in distress where short-term borrowing costs shoot up much higher as lenders demand a higher risk premium.

To effectively manage the various risks associated with the above-mentioned process, banks traditionally set up ALCO (Asset and Liabilities Committee) groups consisting of the CEO and senior members of the team like the Treasury head and the CFO. The ALCO normally have monthly meetings to review the bank’s portfolio to review various parameters like interest rates, foreign exchange, gapping and counterparty risks. Financial benchmark triggers are also put in place to be monitored and reported in a pre-meeting ALCO deck for members to review. The intention is to spot red flags in advance, prepare for possible black swan events and avoid them via proactive contingency planning.

Funds are also carefully bucketed and monitored by tenor, instrument and counterparty to avoid high-concentration risks on a particular area or tenor. Limits are usually set for each as benchmark trigger points for early warnings and red flags. This dynamic juggling of multiple balls in the air within an ALCO framework helps a bank avoid preventable disasters proactively.

There is a regulatory reserve ratio requirement that regulators set, requiring banks to keep funds in reserve and not to be lent out. To also prepare for a possible run on the bank due to unforeseen circumstances, banks also do create a cash buffer of sorts to backstop these situations. This conservative buffer of X number of months of cash flow needed is kept as cash in the bank at all times in preparation for a sudden run on the bank. Counterparty risks are also monitored religiously to ensure that it is not too heavily exposed to a few opposite counterparties in case one of them fails.

The recent bank failures have brought into question the viability of banks as an effective risk-mitigating mechanism to effectively provide funds management in the global banking system. SVB, Signature Bank, First Republic, Silvergate and Credit Suisse have exposed glaring flaws of the taken-for-granted banking processes which had worked so well before.

See my previous article below for a more detailed writeup on the recent bank failures: https://medium.com/@checkwoei/svbed-a-chaotic-week-and-more-to-come-d33311b74e12

There are preventable internal failed processes which can be identified. SVB’s ALCO was caught sleeping at the wheel during one of the most aggressive rate hike cycles in 2022. Gapping and counterparty risks were ignored. A comedy of errors coupled with a bank run forced regulators to seize the bank to avoid a full-blown banking contagion crisis. By the way, SVB didn’t even have a functioning Chief Risk Officer for most of 2022!

Is the concept of sticky CASA no more? In the current age of online banking and mobile usage, the transfer of funds takes seconds. There is no need to queue up at the bank branch to start a bank run anymore. Most people nowadays bank with more than one bank. Digital neo-banks make the adoption of a new bank account even easier. A serious bank run can now be staged in less than 24 hours with the help of social media. A bank may not be able to react fast enough to a tsunami of funds outflow to save itself from insolvency.

Perhaps in the near future, because of the speed and mobility of money thanks to technology, banks would have to institute lock-in periods for depositors like mutual funds. For example, allowing only 25% of a client’s money to be withdrawn immediately, 25% within a week and the balance a month later. This will provide some time buffer for banks to react and execute their emergency contingency liquidity plans more effectively.

A positively sloping interest rate yield curve is usually the case in a regular market environment. When the curve inverts, it is a warning red flag sign that should be taken seriously to readjust the portfolio for banks. The unusual 2022 aggressive rate hikes inverted the yield curve for months. Many banks had structured their portfolio to borrow short and lend long-term to ride the yield curve. This basic standard operating procedure is now in question.

Gapping issue – the time difference between your assets and liabilities. Bank depositors’ requirements to withdraw (liabilities) versus your assets parked in US Treasuries with maturities in a few years. Too much money rushing out the door while they are parked in longer-tenor assets resulted in a mismatch that became the ultimate stroke that broke the camel’s back for SVB.

A study estimates that all banks currently have about $650 Billion of unrealised mark-to-market (MTM) losses. This is a similar situation to what SVB had on their books due to its gapping/timing issue. These unrealised losses can now be “hidden” if they are placed in HTM (Hold Till Maturity) books where MTM is not required to hit their bottom line immediately. Should this accounting loophole be tightened for the sake of transparency? Maybe banks should set aside a fraction of the total MTM loss of their HTM books (eg 25% instead of zero currently).

Less discussed was another reason why the American banks failed. It was a few years in the making. The Dodd-Frank Act was enacted in 2010 because of the 2008 GFC. It required banks with assets of $50 Billion or more to submit regular stress test results to the regulators periodically. In 2018, the act was “successfully” changed after fierce bank lobbying to raise the threshold from $50 to $250 Billion.

Guess where SVB, Signature and First Republic were in asset size? They all had assets below the new threshold and were able to hide below the radar of regulators. Internal/ALCO management failure coupled with no requirement for external regulatory monitoring via stress testing resulted in shit hitting the fan a few years later. The 2018 changes to Dodd-Frank should be revoked to bring the threshold back to the original level of $50 Billion immediately to prevent mid-tier banks from having the same fate as SVB.

Fundamentally, banks need to re-evaluate the recent close-shave banking crisis and ask themselves if the old way of doing business has stopped working. The yield curve inversion may last much longer in anticipation of a coming recession and this will stress the portfolios even longer. Regulators have learned from the 2008 GFC to react and move swiftly this time to prevent contagion and avoid the domino effect.

Banking is about the confidence game. The speed of transactions has now moved into the nanoseconds of real-time transactions while banks are still using old and “tested” ways of monitoring risk every month. The reaction timing mismatch is glaring. Perhaps it is time now to fundamentally relook at how banking should be run in this new age digital world.

China is one of the oldest civilizations in the world, having a continuous recorded history of about 4,000 years. Other than the period of time when the Mongols took over China and started their global conquest, China had historically remained relatively peaceful and non-expansionist except for periodic short skirmishes with neighbouring countries like Vietnam, Korea and Japan.

A journalist who had worked in China for a number of years wrote a book about his experience and mentioned that China thinks in 100 years cycle. It believes that the country had reached rock bottom in 1940 and therefore its economy will peak in 2040. This could be why we frequently see many China statements stating 2040-2050 goals. We are less than 20 years from the Chinese belief that they would achieve peak influence and become a global superpower to reckon with soon.

China thinks in very long-term and strategic cycles. We will attempt to analyze its recent moves and the likely implications for the world in the near future in this article. They have been planting and formulating their overall plan and fine-tuning it even as America is constantly trying to box it into a corner to get Western support to slow down China’s development.

The speed at which China can move when it focuses its mind and energy on it has been proven again and again over the last 20 years. From buying bankrupt steel mills in the USA to disassembling them piece by piece. Then shipped them back home to reassemble the factory for local production in the early 2000s until it became a global steel exporter.

There are rumours that China was also helping Myanmar construct its new capital Naypyidaw which sprang out in the middle of nowhere in 2005. This was China’s first large-scale experiment to build a city from scratch. The experience helped it fine-tune and to perfect the infrastructure planning process to then build hundreds of new cities all over China.

The Chinese high-speed rail system started in 2008 and it now has the largest collection of bullet trains in the world with an impressive 40,000 km network within 15 years. In a span of 40 years, China has lifted almost 800 million of its citizens out of poverty through vast improvements in the standard of living with country-wide initiatives rolled out for the benefit of all.

My first visit to China was in 1990 to visit some relatives on the island of Hainan. By 2019 during my 4th visit, the place had been transformed with 2 high-speed rail lines running across the island. My 2018 study trip to Hangzhou also blew my mind with how advanced they have become with electronic money like Alipay and Wepay. The same goes for my business trips to Chengdu, Nanjing, Beijing and Shanghai over the years.

Naturally, its people have much to be proud of the accomplishments done in such a short time, within a generation. It is a rising star that is on track to become a global superpower. There is a hint of growing arrogance in their rhetoric at times but most of the Western world still does not want to acknowledge or respect its growing strengths and that frustrates China.

Instead, over the last few years, there is a blatant attempt to gang up against China to impede its rising status on the global stage rather than to come to the table to sort out the differences and disagreements. This has put China in a precarious position to defend and protect itself. Meanwhile, China’s politburo intellectuals began to plan for long-term strategic solutions. They are not swayed by short-term election cycles like the rest of the world. One perfect example is the “One Belt, One Road” initiative to win over the hearts of countries without colonization. There is no need to use a single bullet to flex their newfound economic might.

This leads us to the main topic of today – The Art of War China style and strategic moves ahead. There has been a number of brilliant China strategic developments in recent times that had been planned for a while and are only being executed now. These moves will lead to a new paradigm shift in the world economic balance. In Xi’s own words to Putin this week: There will be “Changes not seen in 100 years”.

After their victories in World War 2, the Americans have prided themselves as the protector of democracy. They frequently need to have the upper hand to ensure control. Since then, several needless and countless wars have been initiated and fought to help maintain military supremacy. Korea, Vietnam, Syria, Iran and Afghanistan to name a few.

Very often, sanctions work because America can hold a gun to the country’s head by denying access to the USD Swift system of payments, making it an instant international pariah. On top of that, the dollarization of its currency (eg. Oil Petrodollars and overseas Eurodollars) made it impossible for countries to escape the drug-like dependency on it. Many have to hoard USD for reserve requirements and to use their surpluses to buy even more US Treasury paper to fund the ever-growing US deficit black hole.

The systematic rise and blowing up of the American deficit with its endless money printing machine by the Fed in recent times had made many countries question why the rest of the world should continue to subsidize its excesses. Total US public debt has skyrocketed to more than $27 Trillion, almost doubling within a span of fewer than 10 years. The only available solution? To continue to raise the debt ceiling and hold the Senate/Congress to hostage situations via government shutdowns…

Another example of arrogance is the Ukraine war. The Western talking point that “you are either with us or you are against us” mentality has finally rubbed certain countries the wrong way. The BRICS countries are now pushing back. They are speaking out to chart their own paths and voice opposition to say that America does not hold a monopoly on the ideological truth it speaks of but has ulterior motives to support its military war machine. Fun fact: America has 750 overseas military bases in the world and quite a number surround China, which only has 5 globally.

America is also pushing China into the corner to halt its rise in many ways by targeting to slow down its economy. Attacks against TikTok and Huawei by a superpower against a single private company were previously unheard of before. They are becoming an American norm nowadays. It forced China during the pandemic to seriously consider if it should turn inwards into its own domestic economy to shield itself from the global economy as a way to reduce tension with America.

But the brand new grand China strategic plan has slowly been unveiled in recent months. It is the aim to de-dollarization the global economy. Leading the charge will be the RMB (Renminbi) aka CNY (Chinese Yuan). The actions and events speak for themselves.

China kick-started its CBDC (Central Bank Digital Currency) late last year in a number of provinces to introduce it to its citizens. It brokered a peace deal in the Middle East and aims to price oil in RMB soon. Xi’s recent meeting with Putin has resulted in a number of signed agreements which will further strengthen the use of RMB in global trade. There is a concerted move to get away from Petrodollars and the USD Swift system soon and many non-Western countries have agreed to follow suit.

In the next few weeks, China will likely begin to provide more details on the rollout plans to further internationalize the RMB. Many European and Asian countries are already paying tribute to China with visits to Beijing to hedge their bets as it reopens up post-pandemic. America is at its wit’s end and in a panic to try to further sabotage the plan. Destruction of the Nordstream pipeline to deny Europe of Russian oil and sending more troops to Taiwan to aggravate China further are some of the unintended consequences.

China’s rise to become a global superpower is inevitable. America has to contend that its number-one position for many years has now met a competitor that could dethrone it. Rather than fight it and put roadblocks in front, it should work with China for the good of the world to share the global stage and not just for its selfish interest alone. The move away from a US Dollar regime could be very bad for the US economy. Exciting times are ahead…

The recent bank run has claimed several scalps in the banking world and the biggest one was Credit Suisse (CS). After 166 years of operation, this prestigious name is no more. Its dramatic collapse happened within days after the SNB (Swiss National Bank) central bank forced UBS to take over CS at a fraction of the last traded share price plus including a lot of free backstops to the buyer.

UBS was the unwilling suitor that was dragged into the altar kicking and screaming in horror at the forced shotgun marriage to save its main competitor. The number one Swiss bank will now absorb the number two to form the biggest bank in the whole of Switzerland. Yes, the Swiss banking system is officially a monopoly now.

CS shareholders watch in despair that their beloved bank was sold for about CHF 76 cents from the last traded price of over CHF 2 dollars. UBS will convert CS shareholders to CHF 3 billion worth of UBS shares as a purchase price agreement. At its peak in 2007, CS was worth CHF 75 and now sold at CHF 0.76, a 99% drop.

The other bigger shocker was that the outstanding CHF 17 Billion of Additional Tier 1 (AT1) of Coco (Contingent Convertible) bonds were written down to zero value overnight. This was the first time that it had happened to the AT1 Coco bond industry which currently has a total value of USD 275 Billion in outstanding bonds globally.

AT1 Cocos bonds are bank capital securities that banks issue to contribute to the total capital required by regulators. Higher capital adequacy norms were imposed after the 2008 global financial crisis when several high-profile banks collapsed. AT1 was therefore created and issued by banks for additional capital to help absorb losses in an event of a collapse. This mitigates the need for a bailout from the regulators and instead requires AT1 bondholders to be the next in line to absorb the losses after all the shareholders are wiped out.

AT1 bonds are usually issued as perpetual bonds and are junior subordinated. They are classified as hybrid securities as they have features similar to bonds and equity (Convertible). The bonds do not have a maturity date and it is at the sole discretion of the bank to call back the bonds on their call date. AT1 bonds are therefore riskier than typical plain-vanilla bonds due to the subordination of the bond.

The credit ratings for AT1 bonds are also rated a few notches below the respective bank’s issuer ratings. This is due to the higher risk of investing in these bonds due to the respective clauses and its ‘hybrid’ nature between equity and bonds. Due to its higher risks, AT1 bonds are issued at a higher coupon in order to compensate investors for taking on more risk.

These AT1 bonds may result in a total write-off and become zero value for the investors when a trigger event happens. A trigger event, as defined in the document clauses, may be caused by a 1) contingency event OR a 2) viability event. When either of these events occurs, a partial or full write-off of AT1 bonds will be automatically triggered.

1)    A contingency event may be triggered when a bank’s capital adequacy ratio falls below a certain threshold. Typically, the threshold level where AT1 bonds are to be written off is when Common Equity Tier 1 (“CET1”) ratio falls below either 5.125% or 7.00% depending on the terms of the AT1.

2)    Meanwhile, a viability event is triggered when regulators deem that a write-down is necessary in order to prevent the bank from becoming insolvent or bankrupt.  A viability event can be triggered if measures to improve a bank’s capital adequacy are deemed inadequate by regulators to prevent insolvency or bankruptcy or when a bank receives support from the public sector to boost its capital adequacy.

When the UBS takeover of CS was being finalized, FINMA (Switzerland’s independent financial markets regulator) determined that a viability event had been triggered and hence CS’s AT1 clause was breached. The bonds were immediately written down to zero value.

The bondholders screamed murder because the assumption was that shareholders were supposed to be wiped out first before the AT1 bonds. Yet shareholders managed to get CHF 3 Billion of UBS shares from the buyer while the AT1 bondholders got nothing. The move shocked the whole AT1 industry as it had never happened before.

Of the total CHF 17 Billion outstanding CS AT1 bonds, most were denominated in USD except one. The exception was in SGD and supposedly had a size of about SGD 1 Billion. It looks like the SGD 1 billion tranches were mainly owned by Asian HNWI (High Net Worth Individuals) clients based in Singapore. I suspect that the CS Wealth management arm and most private banks may have marketed them to their clients as a relatively great investment with attractive yields.

This CS 5.625% Perpetual Corp (SGD) that was issued in 2019 probably had a yield of almost 9.75% in SGD in late 2022 as it had traded below par by then. Most investors would have assumed last year that it was unlikely that a global name like CS could go under that easily. Given that the minimum size for execution is SGD 200,000, it would have attracted a lot of private bank customers who are always on the lookout for higher yields. With a global banking name like CS paying almost 10% on a bond pre-2022 aggressive rate hikes, why not?

Imagine waking up the next day a few days ago to be told that your bond is now worthless, without the opportunity to be converted to equity while the shareholders were not wiped out first. Lawsuits should be flying fast and furious now. A lawyer friend of mine just mentioned that he has been experiencing all-nighters in the office for the last few days. This topic is probably top of mind for many HNWI customers looking to lawyer up.

I honestly don’t think that the bondholders stand a good chance of winning this debate as the SNB had already blessed the FINMA decision to completely write down this bond. It could be a long drawn out lawsuit that could take years of court battles to fight. Even if they win, the best case is that they will get CHF 3 Billion from the shareholders. This will be less than 20% of the bond principal notional (17 outstanding / 3 from UBS). The lawyer fees will also add up and eat into the recovered sum. They might have to give up and move on at some point in time.

https://www.bloomberg.com/news/articles/2023-03-23/could-credit-suisse-s-at1-bondholders-challenge-writeoff-in-court?utm_medium=email&utm_source=newsletter&utm_term=230324&utm_campaign=fixedincome&sref=TCJIUe33

Regulators have learnt an important lesson from the 2008 GFC. Bank shocks require quick preventive actions to proactively avoid contagion which could make the situation even worse in the end. The domino effect made the GFC even bigger as one after another bank was swallowed into the black hole. Regulators were headless chickens then and spent too much time debating on what to do next.

I for one do not think that we are in a worse situation now than in 2008. The leverage is much less and there is less toxic stuff now. Remember GFC’s CDO squared derivatives with exponential risk? Regulators are also reacting much earlier to stem the rising panic tide. There are rumbles and rumours of DB being the next victim as we head into the weekend… Let’s see what other surprises may hold for us next week.

Meanwhile, a number of opportunistic fund managers are buying other AT1 bonds due to the crazy market price dislocation as they see upside value. Another group is also grabbing AT2 (Tier 2) as they see an oversold situation as a safer alternative, to purchasing cheap and oversold bonds.

The financial world was in turmoil for the last 10 days as one bank after another fell off the chair in a domino effect. First, it was Silvergate, then Silicon Valley Bank (SVB) and First Republic Bank, followed by Signature Bank and then Credit Suisse.

Naysayers were predicting the Great Finance Crisis (GFC) of 2008 all over again while another camp insisted that things are much better this time around. Both were equally right in certain aspects we will dissect and explore them today.

The banking world has changed a lot in the last 15 years, fuelled by cheap borrowing costs and addiction to leverage to reap maximum profits in the fastest possible way. Predictions of an end to the party were persistently wrong as buying on any dips became the winning strategy.

The end finally came in 2022 as we emerged from a pandemic where even more money printing was required to support economies. The Ukraine war woke up the inflation monster and central banks finally had to act to hike interest rates aggressively within a matter of 12-15 months.

Into 2023, we are now seeing the aftermath of what the rate hikes have done to burst asset bubbles last year and uncover the ugly truths of leverage indigestion within the portfolios of financial institutions.

Technically, we are not as highly leveraged as in 2008 with the CDO derivatives voodoo black magic where even strippers can own 5 properties with no money down then. Watch “The Big Short” movie for quick enlightenment. This time around, it is more of traditional banking practices gone horribly wrong.

A normal bank usually attracts mom-and-pop depositors who are relatively sticky by offering CASA (Current Account and Savings Account) facilities. These funds are not volatile as clients normally bank with only one or two banks for all their needs, be it for loans, investment or credit card requirements.

The banks in turn set aside some of that as reserve requirements (around 10%) and tries to place out the rest to earn a higher yield. They pay the depositors a low-interest rate and pocket the rest as revenue. To be on the safe side, a big chunk of the 90% may be placed in longer-dated instruments that pay back the principal at par upon maturity. These include Treasury bills and bonds which are of the highest AAA rating.

This all went haywire when the Fed raised rates quickly in 2022. Bond prices have an inverse relationship with interest rates. If rates rise, bond prices will fall. There is a push for money to switch and reinvest in the newer bonds at higher rates of return and to get rid of the older lower-yielding ones. So if any bank were holding onto bonds purchased before 2022, their values will see a drop versus the current market values where they can sell them.

So SVB was stuck with a gapping problem. Its internet-savvy fintech depositors were not sticky as earlier thought and smelled danger last week (thanks to Peter Thiel’s rally call). They pulled out so fast that SVB had to sell its bonds portfolio at a mark-to-market loss. Otherwise, it could have held the bonds to maturity and gotten their funds back at par value without any principal loss.

The other stunning revelation was that SVB was operating without a CRO (Chief Risk Officer) for most of 2022!! The old one quit in Apr and hung around till Oct doing nothing while the new CRO joined in Dec. All banks normally have an ALCO (Asset and Liability committee) to monitor risks like interest rate exposures. So it seems that no one was red-flagging SVB’s interest rate risk during the greatest rate hike year of the century.

Most banks are in fact having the same gapping issue as SVB throughout 2022 with the rapid Fed rate hikes. Banks normally lend long-term and borrow short-term to “ride” the positive yield curve. But the curve has been inverted for some time and this tried and tested formula now results in a negative return. Worse still, the bonds in the portfolio are now trading below par. A report suggested that all banks probably now hold unrealized bond losses of at least $650 billion as a result. SVB had to crystalize about a $2 billion loss last week to pay depositors who were pulling out their funds as a bank run was formed.

The other irony occurred in Signature bank. One of its directors was Frank Barney, the architect of the Dodd-Frank Act. The Act was created after the 2008 GFC to strengthen the banking infrastructure with stress test scenarios which would have failed SVB for its interest rate exposures. This act was removed in 2018 by Trump as it was deemed that banks had reformed after 10 years LOL. Elizabeth Warren had strongly criticized the revoking of the Act in 2018 with no avail as the GOP was leaning towards less government intervention.

Funnily, for First Republic bank, it was the other big American banks that eventually came to its rescue. The too-big-to-fail banks decided late this week to cough up $30 billion to deposit into First Republic for at least 120 days to shore up the bank. Ironically, depositors were pulling out their funds to place in these bigger banks in a flight to safety! Yellen and Dimon managed to convince everyone that it is in their interest to re-deposit funds back to reduce the contagion bank run effect on the whole industry.

Credit Suisse was the next in line to get a backstop emergency loan from the Swiss National Bank (SNB). Its numerous losses and scandals have finally caught up to it. Even with a recent CHF 4 billion of new equity injection in Dec at a CHF 10 billion market capitalization, its market cap still fell below CHF 7 billion this week.

This week’s bank fiasco is not like 2008. Taxpayers’ monies were not used to bail out troubled banks. But thanks to technology, things now move at lightning speed. A bank run can happen in 24 hours via electronic transfers in real-time. The Fed is likely to only hike 25 bps next week instead of the expected 50 which Powell hinted about a week earlier.

The contagion effect should be minimized into next week assuming that there are no more new shocks. The regulators had surprisingly been extremely proactive in arresting the panic within days without bringing in the big cannons yet. The people will be braying for bankers’ blood to hang for their oversights this time as no one went to jail the last time during the 2008 GFC. Don’t hold your breath though 😉 …

Recently, I had a chance to revisit Hong Kong after more than 5 years. My last trip was in Feb 2017 for my previous banking job. My wife was also on a business trip this time and I tagged along for the free accommodation plus we decided to also add a weekend extension for a short vacation.

I had always found HK to be a fast-moving city with its citizens always on the move. They have a never say die attitude for life and believe that no one owes you a living except that you have to work hard to get what you want. The laissez-faire environment with minimum government intervention means that it was a great place to do business in. I wanted to see how HK has changed after COVID and the after-effects of the 2019 riots clampdowns.

For the first few days, I had the opportunity to roam around the city on my own to soak in the sights. I had also signed up for 2 walking tours to experience first-hand via the insights of local tour guides. It was enlightening and heartwarming to re-engage with the country again. My association with HK goes back many years with HK ex-colleagues and vacations with the family there.

My timing was also perfect as the government decided to suddenly remove all requirements for mask-wearing on the second day of our arrival. It was initially targeted to be phased in within the next few weeks but given that Macau had done it a day earlier, they decided to cut short the rollout of the relaxation of the restrictions. It felt odd for the locals to show their faces after more than 3 years of hiding behind face masks.

I started the vacation with an introductory walking tour in Central with a female guide and 3 other fellow travellers. She showed us a number of land renewal projects like the Central Market Building, Tai Kwun (Former Central Police Station Compound) and PMQ (historic site of the old Hollywood Road Police Married Quarters) as we walked around the Central business district.

As I understand Cantonese, I had a good conversation with the tour guide to understand the HK situation over the past few years and how it has affected their livelihoods there. Everyone was cautiously optimistic coming out of the lockdowns. Many are trying to come to terms that a slow return to normal is finally happening after almost 3+ years.

I also had good sunset drinks meet-up with an old schoolmate who had settled down in HK for 20+ years with his HK wife. He had also set up a successful accounting firm in the city. The pub he chose for our drinks was next to the Jockey club. The cool 16-18 degrees Celsius weather under the setting sun was a lovely setting for a few pints of Guinness.

The following day, I met my friend again at his office before going for lunch. I see the old electrified narrow HK tram cars moving through Hong Kong island as a nostalgic reminder of its past. Since I had nothing better to do, I decided to take the tram from one end of the city to the other and back. It was only HKD 3 per trip each way and it took me a total of 2.5 hours to enjoy the rich history of HK as a tourist on the upper deck of the double-decker tram bus to watch the world go by.

HK has many old buildings along the tram journey which remain untouchable as the crazy rise in real estate prices made it hard to acquire for redevelopment. Those that are lucky to have owned properties cling onto them as rental costs shoot up. Public housing is so difficult to obtain and the younger generation seems resigned to not being able to experience home ownership. New private rental units are also becoming smaller and 200+ square feet units are the norm now.

Over the next 2 days, I explored the Kowloon side to try to discover the real HK where most of the population put up at. I signed up for another walking tour on Friday which was called the “Dark Side of Kowloon”. The well-spoken guide brought us 4severalo a number of historical sites and the rich stories behind them. We visited the flower, aquarium fish and pet bird markets to understand the history of how they are created.

The final part of the 2 hours tour was the most unforgettable part. He explained about the terrible housing situation of the unseen and unheard population who are surviving below the poverty line. As an example, he highlighted that a citizen earning an average annual salary would need up to 30 years of his pay just to be able to afford to buy a new shoebox apartment at current prices.

We were ushered into an actual micro apartment in Kowloon to see whlike. It was basically a space formed from the segmentation of a dark and narrow upper floor of one of the old buildings. The room measured 10 by 10 feet wide without any windows. They managed to squeeze in a shower point and cooking area with a bed for a family to live within. The rental cost was about HKD 5,000 per month.

We often hear about coffin-like human cages being offered as a cheaper alternative. We were shown one such space which was just big enough for a single bed that the renter can put all his belongings within the coffin-like box cage and use a lock to secure his belongings. It was going for HKD 1,800 per month. Bed bugs are a constant problem in these cramped living quarters.

The government has historically been profit-driven and depends too much on land sales (>20%) for revenue. Too many people have been stuffed into these unlivable quarters in Kowloon that the real number is unknown. The government doesn’t have a solution to offer. Public housing is non-existent and the last thing they want to do is to have a proper consensus on this situation to discover that most are fire hazards waiting to happen with many safety issues. It is a hornet’s nest they prefer not to stir.

I have bittersweet memories of HK. It was the gateway to China and prospered for many years because the northern China Dragon had opened up in the 1980s. The false pretence of British-influenced democratic ideas before the 1997 handover to China had doomed a new generation to failure. This came to a head in the 2019 riots. Big brother has patiently waited for Covid to settle down before clamping down on the “traitors” to the motherland in 2022.

Chinese cities like Shanghai, Shenzhen and Guangzhou are now ready to steal the limelight away from HK. Its strategic value will continue to diminish over time as it continues to experience more brain drain in the ongoing China/USA tensions. Those that remain will continue to have a mixed sense of loyalty to HK or to China. Hopefully, there will be a push to increase public housing as it was and continue to be a big sore point for its citizens.

HK’s past glories seem to be impossible to relight again post-Covid given its current situation. It will require more governmental changes and willpower to help its citizens reposition for the future. I wish it the best of luck as the city starts to open up now.

Ukraine crossed the 1st anniversary of the Russian invasion this week. It was 12 months ago that a superpower attacked the country on the premise of liberating its citizens from Nazi control.

Since then, the war narrative has evolved while the world was severely affected just as it was getting out of the pandemic nightmare. Supply chains were disrupted and commodity prices surged. Sanctions were thrown at Russia and oil embargoes made things worse. Hedge funds made a ton of money in 2022 betting on the rise of raw material prices.

The Ukrainians fought back with everything but the kitchen sink. Their warrior history did not allow them to play dead and be trampled by the invaders. Putin’s expected walk-in-the-park lightning victory did not happen and multiple military generals changes later, we are still at a stalemate.

Initially, the West refused to send troops to help and hesitated to provide weapons for fear of escalating the tensions and provoking the Russian bear. That “supplying weapons” Rubicon line was crossed a few months later. NATO countries and America started to pour equipment into the country for Ukraine to defend itself against the invader.

Russia threatened the nuclear option repeatedly but had not pressed the button yet. We are now at the point where tanks and fighter jets are being sent over into Ukraine. The impasse going into winter seems to have hardened the resolves of both sides. They are dug in and aim to battle it out until the last man is standing.

Putin had initially proposed that Ukraine should stop its push to join NATO as a condition for a ceasefire. That made NATO and the EU even more determined to support the underdog against a bigger enemy. America contributed billions to date to arm and supply additional ammunition to the war effort.

There are 2 sides to the story and things are getting more complicated by the day. Russia claims that it is feeling threatened by the encroaching NATO countries circling them as more former Soviet Bloc countries signed up. Putin looks back to gaining the former glory of the USSR era before it collapsed in the 1990s.

The ease of the annexation of Crimea in 2014 by Russia emboldened Putin to try again in 2022 to capture more Ukrainian lands. The West and America had not done enough then and now realized that a stronger effort is required to push back the aggression.

India and China have steadfastly refused to condemn Russia for its actions, preferring to remain neutral. A non-Western cynic had even commented that Europe always thinks that its problems are the world’s problem, yet the world’s problems are not its problem. That thought process is coming back to haunt them as Asia superpowers refused to toe the line to join them now.

An Indian minister had insisted that it is the country’s right to do what is best for itself and not be dragged into other people’s problems. It continues to buy Russian oil as it is the cheapest. China still maintains that it will continue to have a strong relationship with Russia. It even proposed a plan to stop the war yesterday. The reaction to the proposal from the West was lukewarm as stopping the sanctions against Russia is a non-starter.

The overall winner? America. As more made-in-the-USA weapons are used and stockpiles are depleted everywhere, new orders are swelling up. The West has set up and positioned Ukraine to front the war against Russia by supplying it with seemingly endless weapons to fight back. Its citizens are suffering from daily bombardments that have destroyed its cities and created millions of refugees who have escaped to neighbouring countries to seek safety. American weapons manufacturers are very happy with the outcome as new orders are streaming in. The US deficit ceiling can just be increased further as the Fed prints more dollars to pump up its military machinery.

Unwittingly, Ukraine has become a pawn in America’s goal of maintaining its world leadership position. Rallying the Western world to fight for democracy and having Russia as the bogeyman spins a good narrative against Putin’s many years of warning NATO not to expand its borders. There is also the recent destruction of the Nordstream pipeline which some point to America as the culprit. The conspiracy theory was that it was done to deny Europe the ability to buy Russian oil. Why would Russia score an own goal to blow up the pipeline as most Western media sources are suggesting?

How will it all eventually end? The Western idealistic goal of defeating Russia is impossible unless we want to start World War 3. Just to kick them out of Ukraine requires endless tons of weapons and time. Lasting another year into this war is foolhardy. Russia needs its pound of flesh to retreat gracefully without its tail between its legs. Ukraine will need to surrender some territory to negotiate a meaningful peace settlement. Why not give up Donbas? It is pro-Russia and housed the rebels that were fighting Ukraine for a separate state. This may be a reasonable means to end this unnecessary war that has destroyed the country.

Meanwhile, we see a similar situation in Asia which the world had already forgotten that it still exists. No one hardly pays lip service to it anymore. Myanmar had a military coup a year earlier on 01 Feb 2021. Many of its citizens had been killed or imprisoned. The generals refused to negotiate and the country has since turned inwards into itself, having only open up to the world 11 years ago after 50 years of exile.

Foreign investors have gotten out of the country and sold out their onshore stakes. The country is now a pariah to the world and nobody wants to lift a finger to help. It is a forgotten topic as Ukraine news hogs the limelight. The tragedies of war are terrible but there is unequal treatment depending on the big-picture objective. Sad but true.

What is normal to us nowadays? After 3 years of Covid, anything before 2020 looks like a different world altogether. Youtube travel videos from 2019 and earlier cannot be used as a reference point anymore as many businesses may have stopped operating after years of lockdowns.

Are we nearing the levels we were at before the great shutdown of 2020? The initial collapse of supply chains and then the knee-jerk start-stop motions more than a year later had created choke points had taken time to unplug.

The final holdout for zero Covid (China) finally broke their walls down a few months ago. The rest of the world has progressively opened up more than a year after the first vaccines were rolled out in early 2021. Looking back, inflation was inevitable into 2022 as the global engine started to crank up again after country lockdowns had caused demand to collapse in 2020.

It was in hindsight that aggressive rate hikes had to happen last year which would lead to asset bubbles popping after many years of cheap borrowing costs since the 2008 GFC. It was a ticking timebomb that was waiting for a perfect storm to happen.

We are moving into a brave new world where Covid has permanently changed the way we work and think about life in general. Technology has allowed WFH (Work From Home) to happen and now a hybrid work life balance is possible. Digital nomads can work from any beach resort while moving around.

Every human being on earth had the chance to re-evaluate life again and assess our mortality as we face the deadly virus without knowing what will happen the next day. Humans are adaptable creatures but yet this once in a 100 years event shook us to our core.

And now we are slowly but surely returning back to normal. I can see revenge travelling picking up with still some cautious over hang of mask-wearing, just in case. Personally, I already had 5 shots of the vaccine to date (2 + 2 boosters + 1 bivalent) plus the flu and shingles ones too… I have never had Covid before but it may had been a mild infection which I did not notice.

The economy is at a crossroads junction and historical data cannot be used to determine the near future nowadays. While US interest rates are now reverting to the long term norm of 3-5% range and looking to touch a bit higher at the 5% level, it is good news for retirees who had to eat into their savings when rates stayed at almost zero for many years.

A paragraph from a Washington Post article probably provides a close enough reply to what we are seeing now:

“The most plausible explanation of all is that the pandemic and subsequent recovery were so unusual that the normal rules of economics don’t apply. Demand surged for everything from toaster ovens to used cars. Supply chains could not keep up. Prices spiked. Now, there’s a right-sizing. Goods inflation has come down for most items (even for eggs) as demand has subsided. The question is whether services inflation for travel, restaurants, entertainment, insurance and deliveries will follow.” https://www.washingtonpost.com/opinions/2023/02/10/economy-inflation-employment/

We are looking at the tail end of the inflation spike that started in Dec 2021 with the reopening of borders and the recovery of supply chains. The Ukraine war further turbocharged inflation fears as commodity prices shot up. There is still a few more rate hikes to go, but at a diminshing pace, in order to keep recession fears at bay.

Newer technological advances in AI (ChatGPT) and climate change innovative solutions should encourage inflation dampening measures as productivity jumps. On the other hand, if America gets its act together and push for a new infrastructure initiative for badly needed roads/bridges, high speed rail and new airports, that can spur inflationary upside pressures in the opposite direction. We have seen what it can do for countries like China and EU as demand for raw materials skyrocket. The opening of China is also a double edged sword as demand and production can pick up as material prices move higher.

Overall, we see a return to normal. But the new normal will differ from the old normal by a lot. The way things work historically will become obsolete and hybrid methods will have to be implemented. Cautious optimism rules for now, a departure from the gloom of recessionary fears just a few months ago. The wild card will be the ongoing Russia/Ukraine war. It is already a year and de-escalation is no where to be seen.

It is important that we look at the evolving macroeconomic picture from a top down approach to investing to further fine tuning of our existing portfolios. Cyclicals seems to have paused its rise and corrected a bit. Coming off from their peaks with big corrections in 2022, Tech stocks seems to have stabilized as they search for the next big thing. CBDC (Central Bank Digital Currencies) are likely to be launched this year as there is a concerted push to move away from USD dominance.