Category: Politics

Blackrock Checked “No” on 93% of Environmental and Social Proxy Votes

Posted on by phoffman@channelchek.com

Blackrock’s Support for ESG May Have Been Unsustainable

Blackrock, a firm with a reputation for strongly supporting ESG resolutions, having voted yes on 47% of them in 2020, voted down 93% in the past year. The company provided the reasons for shunning 371 proposals out of 399 in its annual Stewardship Report released on August 23rd. With $9.4 trillion under management, investors pay attention to the investment manager. This gives it the power, whether it likes it or not, to create trends as others follow its lead. Should the company’s adjusted position on ESG be taken as something others want to mimic? The reasons given leave that in question.

BlackRock is the world’s largest asset manager. As such, the funds it manages own significant amounts of shares of a broad array of public companies. The Blackrock funds vote on important matters related to the underlying companies if a corporate resolution requires a shareholder vote. Think of the ETF or mutual fund as a trust, and the fund manager, Blackrock, gets to vote on behalf of the assets in the trust. Whereas if an investor owns individual shares of a company, they get to decide and vote themselves, either at a board meeting or more likely, through a proxy statement. Certainly, the amount of control over the decisions of corporations worldwide given to an asset manager of this size is immense.

Each year, the company files a report on its voting during the proxy season. It broke records by voting down 91% of all shareholder proposals and against 93% of those focused on environmental and social issues during the 2023 proxy year. The 7% of ESG proposals that BlackRock supported this year is down sharply from 2022, when BlackRock’s investment stewardship team supported 24% of such proposals, and from 2021, when it supported 47%.

BlackRock’s Investment Stewardship team, makes the voting decisions on both management and shareholder proposals on behalf of BlackRock’s clients. It said the large number of “NO” votes this year is partly related to a huge influx of shareholder proposals. These were described as “poor quality” by the BIS team, either because they were “lacking economic merit,” were “overly prescriptive” and “sought to micromanage a company’s strategy,” or were simply redundant, asking a company to do something it had already done, the Stewardship Report said.

BlackRock’s support for management proposals (not shareholder proposals), which accounted for more than 99% of the roughly 172,000 proposals voted on by BIS, remained high at 88%.

BlackRock’s trend of voting against shareholder proposals is largely in line with other fund managers. The median shareholder support for environmental and social proposals in the U.S. fell sharply from 25% in 2022 to just 15% in the 2023 proxy year.

The firm has backed away from ESG as a term if not a concept. The most recent CEO newsletter did not include the acronym at all, and during a June interview, CEO Larry Fink said he does not use the term, he gave this reason, “I’m not blaming one side or the other, but it has been totally weaponized,” Mr. Fink said. “In my last CEO letter, the phrase ESG was not uttered once, because it’s been unfortunately politicized and weaponized.” He now has a reluctance to have his firm associated with the term ESG after a wave of backlash from both sides of the political spectrum.

In December 2022, Florida’s chief financial officer announced that the state would pull $2 billion worth of assets managed by BlackRock, the largest such divestment by a state opposed to the asset manager’s environmental, social and corporate governance (ESG) policies. BlackRock also lost some of its business of oil rich Texas from its government pension funds because of its ESG policies. Louisiana and Missouri, have also taken steps to divest from BlackRock.

Although not specifically stated in the report, Blackrock fund managers still support the idea that good corporate citizenship could in turn, benefit shareholders. But they will no longer be out front as though ESG factors are the most important criteria. Earlier this month S&P Global Ratings decided it would not provide ESG ratings separate from its credit ratings. Instead, S&P will factor in all of the obligors’ business practices as it relates to risk of non-payment, and assign only a credit rating.

The term has become polarizing as differing political philosophies tend to stand together in support of ESG issues being taken into investment consideration, and other political leanings stand opposed to the not fully developed concept. This has hurt Blackrock.

Republican politicians have been probing Blackrock’s business dealings and asking conservative-leaning state pension funds to divest from the company, which they say has unfairly excluded the traditional energy sector.

On the other hand, environmental activists have lambasted Mr. Fink and his company for not doing enough to stop climate change, protesting in front of BlackRock’s headquarters and heckling senior executives at public speaking engagements. In June Blackrock began providing high-level security to protect Mr. Fink and others in management.

Take Away

When you put your money into most mutual funds, you give away the power that comes with voting on important matters to the underlying shares held by the trust of which you are a part owner. As mutual funds and ETFs have grown, more of the power to guide companies has been handed to the elite running asset management companies.

The growth in popularity in “sustainability” investing caused a rush from investors to these funds, which then needed to place assets in the limited number of companies in the segment. This caused a rise in the share prices of the companies and a rise in the popularity of the funds. Many investors were indifferent to ESG, but not indifferent to making money, they also jumped in. Companies quickly caught on and adjusted their logos to include leaves and the color green, altering some business practices.

While the leadership that Blackrock provides may signal the eventual demise of the term ESG, there has always been, and will always be an interest in putting your money where your heart is. The concept will live, but with Blackrock’s lead, the acronym may transform to something that is less political and less likely to cause protests outside of his home.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.wallstreetmojo.com/shareholder-resolution/

https://www.pionline.com/esg/blackrock-ceo-larry-fink-says-he-no-longer-uses-term-esg

https://www.ft.com/content/06fb1b85-56ba-48cd-b6f6-75f8b8eee7e1

https://www.reuters.com/business/finance/blackrock-continues-lowering-support-environmental-social-proposals-2023-08-23/

https://www.blackrock.com/corporate/insights/investment-stewardship

Candidate DeSantis’ Very Different Economic Vision

Posted on by phoffman@channelchek.com

DeSantis Thinks the Federal Reserve, Elitists, and China, Should all Have Less Power in Our Financial Lives

Federal Reserve Chairman Jerome Powell, appointed by President Trump, then reappointed by President Biden recently got a lot of attention from Florida governor and presidential hopeful Ron DeSantis – and it wasn’t the kind of attention someone in Powell’s position would welcome. This week, in his first big speech on the economy, DeSantis separated himself from the top candidates from each political party by vowing to “rein in” the Fed.

The platform DeSantis unveiled this week helps establish his position and puts a face on his campaign that is decidedly above the culture wars of other political campaigns. It also creates a clear difference in economic issues between himself and his party’s frontrunner, also from Florida, Donald Trump.

In a campaign speech in New Hampshire, DeSantis blamed the US central bank for high inflation, and its dipping a toe into social policy. He was also very critical of the Fed considering a digital dollar that would compete with private crypto, which the candidate does not oppose.

The overall tone as he began to lay out his economic agencda, was one of looking to curb the power of large corporations, limit ties to China, and stand against powerful elites. “We need to rein in the Federal Reserve. It is not designed or supposed to be an economic central planner. It is not supposed to be indulging in social justice or social engineering,” the governor said. He continued, “It’s got one job, maintaining stable prices, and it has departed from that with what it’s done over the past many years.”

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As statements that could be taken as a shot at the current Fed chairman, DeSantis said he would not likely support another term for Powell. “I will appoint a Chair of the Federal Reserve who understands the limited role that it has and focuses on making sure that prices are stable for American businesses and consumers, said DeSantis.

What seemed to be his biggest gripe with how the Federal Reserve has been run is with monetary policy. He believes that policy was kept too easy for too long after the financial crisis and pandemic. He believes this contributed to the high inflation, which forced a rapid tightening from policy makers.

The popular governor of the third most populace state, also railed against the Fed’s steps toward creating a central bank digital currency (CBDC), saying it was trying to crush financial liberty and seize more control over financial transactions.

“Why did they want this? They want to go to a cashless society. They want to eliminate cryptocurrency and they want all the transactions to go through this central bank digital currency,” DeSantis proclaimed.

The DeSantis economic vision, as described, was consistent with his reputation as Florida’s executive which is one that stands against the abuses of government power and big business. “We cannot have policy that kowtows to the largest corporations and Wall Street at the expense of small businesses and average Amerricans.” He continued, “There is a difference between a free-market economy, which we want, and corporatism in which the rules are jiggered to be able to help incumbent companies.”

He also expressed concern over loss of economic sovereignty sharply saying, “We have to restore the economic sovereignty of this country and take back control of our economy from China. This abusive relationship between two countries, must come to an end.”

Take Away

DeSantis is on the road, both showing he has an understanding of economics and unveiling a plan that is distinct from the top two candidates, both of which have already occupied the White House. DeSantis is being watched very closely by both political parties as he is a very popular governor with a lot of admiration and a large following. Florida remains a beneficiary of the large migration of businesses and families out of other states looking for a more innovative, fiscally responsible, less constricting place to live and do business.

Paul Hoffman

Managing Editor, Channelchek

Source

https://www.wmur.com/article/desantis-economic-plan-new-hampshire/44694804

https://www.ft.com/content/40cfecfb-e597-4bba-9ca6-a0fccb187184

Why the Fitch Downgrade is Better for Investors

Posted on by phoffman@channelchek.com

With a Longer Time Horizon, The US Credit Downgrade Helps the Market

Providing third-party research and analysis that then ranks an entity’s debt or equity outlook, including companies and sovereign nations, requires extremely high integrity. The mostly negative news headlines responding to the Fitch Ratings downgrade of the United States Long-Term issuance to AA+ from AAA is an indication of how much pressure analysts must be under to avoid issuing a downgrade. This is true whether the rating impacts the entire free world, or the stakeholders and their families of a small public company through company-sponsored research.

Most high-caliber analysts have built a model that gives them little room for pressure from the outside, either from the ranked entity, the investors, or even the financial media. It is undoubtedly easier to do nothing and cross your fingers as an analyst, but that doesn’t actually serve anyone well, including investors or the entity.

Background

In late May, while investors and other market watchers were trying to determine on which day in June the US Treasury would run out of money, Fitch, a securities rating service, placed a ratings watch on US debt which they had held at triple-A, the highest rating, indicating the lowest default risk for the issuer.

On July 31, the US Treasury unveiled an overview of its third-quarter debt issuance needs. At $1.007 trillion, it would be the largest third quarter on record. I have experience as an issuer ranked by Fitch and Moody’s while CIO of two funds that held a rating in order to meet specific investor guidelines.  Rating agencies are the first to be made aware of any changes being considered. So I suspect that Fitch, Moody’s, and S&P analysts were all aware of the details of what the Treasury planned and projected going forward. Moody’s downgraded the US back in 2011 from its lowest default risk rating. Its treatment back then was also not one of appreciation from the markets, investors, or the issuer.

This clip from the movie The Big Short attempts to show the movie-goer all the relevant pressures an analyst may be under, and why integrity is critical.

Thoughts on Ratings Move

Cathie Wood had a conversation on (Twitter) Spaces this morning with Pension & Investments’ Jennifer Ablan in an exclusive mid-year interview. Ms. Ablan asked Ms. Wood’s thoughts on the US downgrade. The Ark Invest founder didn’t hesitate to say that there is “a side that is happy to see it.” She went on to explain that it helps those managing the organization, in this case Washington, to do a better job. She explained that it  says, “legislature, let’s get your act together.” Wood, added “government spending is taxation.”

While Cathie Wood was discussing the most powerful nation in the world, the same concept should be applied to a company she holds, or you own that experiences a downgrade. It serves to help management discover weak areas they could pay more attention to and gives the investor the understanding and confidence that a third party is looking on and even consulting with management before they make any moves that may alter the rating.

Michael Kupinski, the Director of Research at Noble Capital Markets, is a veteran analyst that has undoubtedly had to ignore pressure from the outside and follow models he’s created to the path they help provide. Mr. Kupinski says, “Ratings and earnings revisions are a function of the dynamics of new, and, likely extreme, inputs on the investing continuum.” He then explained how all could benefit,  “Such revisions then present management a roadmap for the new baseline in expectations or for a course correction. As such, ratings provide a valuable currency to determine investment merits, set investment expectations, and for investors to determine risk,” said Michael Kupinski.

Take Away

Don’t shoot the messenger – instead, thank them.

A negative change in ratings, whether it be on debt issuance, equity issuance, or frankly ones own credit rating could serve to preserve something before it goes further down a bad path, and can be used as a guide to adjust and do better. While there was a lot of criticism for Fitch placing the USA on credit watch for a downgrade back in May, if they had not issued a downgrade as US Treasury issuance climbed even higher, it would cause investors to think that no one is paying attention. The outcome of not having another trusted set of eyes, on any security issuance, is weaker pricing.

Paul Hoffman

Managing Editor, Channelchek

Meet the top management and hear the compelling stories of less talked about opportunities, while mingling with analysts and knowledgeable investors at this year’s NobleCon19

Sources

Fitch US Downgrade Press Release

Cathie Wood Jennifer Ablan

Michael Kupinski

Will Uranium Prices Continue Rising?

Posted on by phoffman@channelchek.com
Image Credit: IAEA Imagebank

The Back Story on Why Uranium Investors Saw a Spike Up in Values

Nuclear energy now provides 10% of the world’s electricity. If a major supplier of uranium becomes unavailable, it could be very disruptive. For countries such as France that derives 68% of their electricity from nuclear power plants, it can become more than disruptive. This is why the coup in Niger, which provides 15% of of the uranium used in French power plants is generating so much concern.

Background

Over the past few days, a successful military coup in Niger has sparked concerns in the EU and especially in France regarding the potential ramifications on uranium imports crucial for powering the country’s nuclear plants. As a major supplier, Niger currently fulfills 15% of France’s uranium needs and holds a significant 20% share of the EU’s total uranium imports. French authorities, along with energy officials have been quick to address public concerns. While the short-term implications are minimal, long-term uranium requirements could become a challenge for France and other countries within the EU. The block of nations has already been engaged with efforts to reduce dependency on Russia, another prominent uranium supplier for European nuclear facilities.

France, is unusually reliant on nuclear power. Orano, the French state-controlled nuclear fuel producer, has maintained its operations in Niger despite the coup, with the company asserting its primary focus is on ensuring the safety of its employees in the region.

Existing uranium stocks are expected to sustain France’s uranium requirements for approximately two years. Therefore, the French government is confident that the current tensions in Niger will not immediately impact their uranium needs.

Long-Term Concerns for Europe’s Uranium Needs

While immediate disruptions seem improbable, Europe could face challenges in its uranium supply chain in the long run, particularly as the continent strives to diminish its reliance on Russian uranium. Niger, as the top uranium supplier to the EU in 2021, alongside Kazakhstan and Russia, play a critical role in sustaining Europe’s nuclear power sector.

Source: Koyfin

Uranium Investment Reactions

While it may seem cold to think of one’s investment portfolio when trouble befalls others, it is the flow of money in the capital markets that often helps allow for corrective actions that lessen the problem. The plot lines on the chart above represent Cameco (CCJ) a Canadian company that is one of the largest providers of uranium fuel. Energy Fuels (UUUU) which is the leading U.S. producer of uranium,  Sprott Uranium Miners (URNM) invests in an index designed to track the performance of companies that devote at least 50% of their assets to the uranium mining industry. The fourth plotline is the S&P 500.

The gap up after the news is unmistakable and suggests investors immediately expect reduced supply from the coup to cause current production to become more valuable as it meets unchanged demand.  

Take Away

The military coup in Niger has raised concerns that the supply of uranium to France and the EU may be disrupted. Officials have assured that short-term there is little need for concern, however there are still uncertainties in Europe’s as it was already reducing dependency on Russian uranium production. The evolving situation in Niger may influence the EU’s stance on sanctions against Russian uranium, and its long-term effects on the nuclear energy sector are still uncertain.

Investors may wish to look closer at energy stocks, including uranium producers as they determine whether or not the blip in stock price is the beginning of a trend or a reaction that may, in part, or fully unwind.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://world-nuclear.org/information-library/current-and-future-generation/nuclear-power-in-the-world-today.aspx#:~:text=Nuclear%20energy%20now%20provides%20about,of%20the%20total%20in%202020).

https://www.eia.gov/todayinenergy/detail.php?id=55259#:~:text=France%20has%20one%20of%20the,generation%20share%20in%20the%20world.

https://www.politico.eu/article/niger-coup-spark-concerns-france-uranium-dependency/

https://www.reuters.com/world/africa/pro-coup-protests-niger-west-african-leaders-meet-2023-07-30/

Could Bidenomics Better Build Your Portfolio?

Posted on by phoffman@channelchek.com
Image: WH.goc

Should You Invest Alongside Washington?

The White House, on Monday, June 26, launched an effort to refresh and even rebrand the administration’s economic policies. “Bidenomics” is the latest name given to the White House initiatives to invest in the country’s future. The unveiling of the latest spending plans includes $42.5 billion that will be spread to benefit all 50 states.

While the largest details of what Bidenomics is expected to entail will be presented in Chicago on Wednesday, some of the plans were unveiled on Monday. Spokespeople, including President Biden and Vice President Harris, laid out an “internet for all” plan in a public address.

The plan is to spend, on average, $750 million in each state in a bidding process for high-speed internet projects where there is none.

The overall thinking is that internet availability is viewed as a utility, much like the electrification of all communities.  

President Biden indicated Made in America would be integral to the plan. Pointing out thousands of miles of fiber optic cable will be built and laid as part of the project.

Other investment areas that may see added demand is commodities such as copper. The metal is a key element in cables, routers, and switches. As a result, the demand for copper could be expected increase as more and more people connect to the internet.

Fiber optic cables were specifically mentioned in the announcement; manufacturers of not just the cable, but connections, and companies that install the cable could potentially benefit from the $42.5 billion being spread, for coast-to-coast high-speed internet.

While the project is to be completed over the next six years, for each new household or business that gains internet access along the way, a potential new customer for many types of businesses goes online. Beneficiaries could include telecommunications, media, education, online retail, and of course big tech. As the internet has more steady users, these industries will all see increased demand for their services.

Take Away

Investing in companies that benefit from changes in government policies or spending is a common strategy that has helped many portfolios.

A big announcement on what to expect from the new Bidenomics was made on June 26; the country is promised an even greater announcement on June 28. Investors should note, the government does not build out these projects themselves; it engages private companies. At times the US government quickly becomes a large customer of these companies’, adding stability of revenue and significant profit to bottom lines. The President promised a Made in America approach to the contract process.

Paul Hoffman

Managing Editor, Channelchek

What is the Espionage Act? –  A Nuts and Bolts Description

Posted on by phoffman@channelchek.com

Understanding the US Espionage Act of 1917

This month marks the 106th anniversary of the Espionage Act. Enacted on June 15, 1917, just a couple of months after the United States entered WWI. While the Act is not specifically related to stocks and other investments, discussions of the Espionage Act may, at times, overtake the news and even distract market players or potentially drive market mood. So it is best to have an accurate understanding of the components. The Espionage Act is a federal law that criminalizes spying and other activities that could be harmful to US national security. The variations and intricacies involve spying for foreign governments, leaking classified information, obstructing selective service, and using the US Postal Service to promote interests counter to those of the USA.

The Espionage Act Sections

The Act has five main sections:

Section 792: This section prohibits gathering or transmitting defense information with the intent or reason to believe that the information may be used to the injury of the United States or to the advantage of any foreign nation.

Section 793: This section prohibits gathering or transmitting classified information with the intent or reason to believe that the information may be used to the injury of the United States or to the advantage of any foreign nation.

Section 794: This section prohibits delivering defense information to a foreign government or to a person who is not entitled to receive it.

Section 795: This section prohibits photographing or sketching defense installations without permission.

Section 798: This section prohibits disclosing classified information to unauthorized persons.

The Espionage Act Uses

The Espionage Act has been used to prosecute a wide range of offenses, including leaking information, recruiting spies, and creating disobedience among military ranks.  

Espionage: Espionage is the act of spying for a foreign government. Espionage can involve gathering or transmitting classified information, or it can involve recruiting or assisting spies.

Leaking Classified Information: Leaking classified information is the act of disclosing classified information to unauthorized persons. Leaking can be done intentionally or unintentionally.

Inciting insubordination in the military: Inciting insubordination in the military is the act or behavior of encouraging military personnel to disobey orders. This can be done by spreading rumors, making false statements, or even simply providing material support to those who are planning to disobey orders.

The Espionage Act is a powerful tool that can be used to protect national security. However, the law has also been criticized for its potential to infringe on First Amendment rights. The Espionage Act has been challenged in court on several occasions, the results have been mixed, but as it applies to first amendment rights during wartime, the courts typically sidewith the state.

Espionage is the practice of spying or using spies to obtain secret or confidential information from non-disclosed sources or divulging of the same without the permission of the holder of the information. – Oxford Dictionary

Additions and Amendments

Since 1917 the Act has seen additions and addendums. These include:

Sedition Act of 1918: The Sedition Act was passed as an amendment to the Espionage Act. It criminalized various forms of expression, including any spoken or written words that aimed to incite disloyalty or contempt towards the US government, the Constitution, or the flag. First Amendment challenges, during wartime have mostly failed. The Wilson administration made it against the act to use the US Post Office for any mailing that may violate te act – 74 newspapers had been denied mailing privileges

USA Patriot Act, 2001: Following the September 11 attacks, the USA PATRIOT Act expanded the scope of the Espionage Act by enhancing surveillance and investigative powers. It broadened the definition of “national defense” and allowed for more extensive monitoring of suspected espionage activities.

Take Away

The Espionage Act of 1917 prohibited obtaining information, recording pictures, or copying descriptions of any information relating to the national defense with intent or reason to believe that the information may be used for the injury of the United States or to the advantage of any foreign nation. Since 1917 there have been a couple of new amendments to the original law.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.mtsu.edu/first-amendment/article/1045/espionage-act-of-1917

https://constitutioncenter.org/the-constitution/historic-document-library/detail/espionage-act-of-1917-and-sedition-act-of-1918-1917-1918

How to Keep AI on the Right Path

Posted on by phoffman@channelchek.com

How Can Congress Regulate AI? Erect Guardrails, Ensure Accountability and Address Monopolistic Power

OpenAI CEO Sam Altman urged lawmakers to consider regulating AI during his Senate testimony on May 16, 2023. That recommendation raises the question of what comes next for Congress. The solutions Altman proposed – creating an AI regulatory agency and requiring licensing for companies – are interesting. But what the other experts on the same panel suggested is at least as important: requiring transparency on training data and establishing clear frameworks for AI-related risks.

Another point left unsaid was that, given the economics of building large-scale AI models, the industry may be witnessing the emergence of a new type of tech monopoly.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of Anjana Susarla, Professor of Information Systems, Michigan State University.

As a researcher who studies social media and artificial intelligence, I believe that Altman’s suggestions have highlighted important issues but don’t provide answers in and of themselves. Regulation would be helpful, but in what form? Licensing also makes sense, but for whom? And any effort to regulate the AI industry will need to account for the companies’ economic power and political sway.

An Agency to Regulate AI?

Lawmakers and policymakers across the world have already begun to address some of the issues raised in Altman’s testimony. The European Union’s AI Act is based on a risk model that assigns AI applications to three categories of risk: unacceptable, high risk, and low or minimal risk. This categorization recognizes that tools for social scoring by governments and automated tools for hiring pose different risks than those from the use of AI in spam filters, for example.

The U.S. National Institute of Standards and Technology likewise has an AI risk management framework that was created with extensive input from multiple stakeholders, including the U.S. Chamber of Commerce and the Federation of American Scientists, as well as other business and professional associations, technology companies and think tanks.

Federal agencies such as the Equal Employment Opportunity Commission and the Federal Trade Commission have already issued guidelines on some of the risks inherent in AI. The Consumer Product Safety Commission and other agencies have a role to play as well.

Rather than create a new agency that runs the risk of becoming compromised by the technology industry it’s meant to regulate, Congress can support private and public adoption of the NIST risk management framework and pass bills such as the Algorithmic Accountability Act. That would have the effect of imposing accountability, much as the Sarbanes-Oxley Act and other regulations transformed reporting requirements for companies. Congress can also adopt comprehensive laws around data privacy.

Regulating AI should involve collaboration among academia, industry, policy experts and international agencies. Experts have likened this approach to international organizations such as the European Organization for Nuclear Research, known as CERN, and the Intergovernmental Panel on Climate Change. The internet has been managed by nongovernmental bodies involving nonprofits, civil society, industry and policymakers, such as the Internet Corporation for Assigned Names and Numbers and the World Telecommunication Standardization Assembly. Those examples provide models for industry and policymakers today.

Licensing Auditors, Not Companies

Though OpenAI’s Altman suggested that companies could be licensed to release artificial intelligence technologies to the public, he clarified that he was referring to artificial general intelligence, meaning potential future AI systems with humanlike intelligence that could pose a threat to humanity. That would be akin to companies being licensed to handle other potentially dangerous technologies, like nuclear power. But licensing could have a role to play well before such a futuristic scenario comes to pass.

Algorithmic auditing would require credentialing, standards of practice and extensive training. Requiring accountability is not just a matter of licensing individuals but also requires companywide standards and practices.

Experts on AI fairness contend that issues of bias and fairness in AI cannot be addressed by technical methods alone but require more comprehensive risk mitigation practices such as adopting institutional review boards for AI. Institutional review boards in the medical field help uphold individual rights, for example.

Academic bodies and professional societies have likewise adopted standards for responsible use of AI, whether it is authorship standards for AI-generated text or standards for patient-mediated data sharing in medicine.

Strengthening existing statutes on consumer safety, privacy and protection while introducing norms of algorithmic accountability would help demystify complex AI systems. It’s also important to recognize that greater data accountability and transparency may impose new restrictions on organizations.

Scholars of data privacy and AI ethics have called for “technological due process” and frameworks to recognize harms of predictive processes. The widespread use of AI-enabled decision-making in such fields as employment, insurance and health care calls for licensing and audit requirements to ensure procedural fairness and privacy safeguards.

Requiring such accountability provisions, though, demands a robust debate among AI developers, policymakers and those who are affected by broad deployment of AI. In the absence of strong algorithmic accountability practices, the danger is narrow audits that promote the appearance of compliance.

AI Monopolies?

What was also missing in Altman’s testimony is the extent of investment required to train large-scale AI models, whether it is GPT-4, which is one of the foundations of ChatGPT, or text-to-image generator Stable Diffusion. Only a handful of companies, such as Google, Meta, Amazon and Microsoft, are responsible for developing the world’s largest language models.

Given the lack of transparency in the training data used by these companies, AI ethics experts Timnit Gebru, Emily Bender and others have warned that large-scale adoption of such technologies without corresponding oversight risks amplifying machine bias at a societal scale.

It is also important to acknowledge that the training data for tools such as ChatGPT includes the intellectual labor of a host of people such as Wikipedia contributors, bloggers and authors of digitized books. The economic benefits from these tools, however, accrue only to the technology corporations.

Proving technology firms’ monopoly power can be difficult, as the Department of Justice’s antitrust case against Microsoft demonstrated. I believe that the most feasible regulatory options for Congress to address potential algorithmic harms from AI may be to strengthen disclosure requirements for AI firms and users of AI alike, to urge comprehensive adoption of AI risk assessment frameworks, and to require processes that safeguard individual data rights and privacy.

Should Investors Expect Ongoing Monetary Policy Tightening Through 2023?

Posted on by phoffman@channelchek.com

Is the Fed Falling Behind on Slowing the Economy?

Is the Federal Reserve’s monetary policy losing out to inflationary pressures? While supply chain costs have long been taken out of the inflation forecast, demand pressures have been stronger than hoped for by the Fed. One area of demand is the labor markets. While the Federal Reserve has a dual mandate to keep prices stable and maximize employment, the shortage of workers is adding to demand-pull inflation as wages are a large input cost in a service economy. As employment remains strong, they have room to raise rates, but if strong employment is a significant cause of price pressures, they may decide to keep the increases coming.

Background

The number of new jobs unfilled increased last month as US job openings rose unexpectedly in April. The total job openings stood at 10.1 million. Make no mistake, the members of the Fed trying to steer this huge economic ship would like to see everyone working. However, with the Bureau of Labor Statistics (BLS) reporting “unemployed persons” at 5.7 million in April as compared to 10.1 million job openings, creates far more demand than there are people to fill the positions. Those with the right skills will find their worth has climbed as they get bid up by employers that are still financially better off hiring more expensive talent rather than doing without.

This causes wage inflation as these increased business costs work their way down into the final cost of goods and services we consume, as inflation.

Where We’re At

The 10.1 million job openings employers posted is an increase from the 9.7 million in the prior month. It is also the most since January 2023. In contrast, economists had expected vacancies to slip below 9.5 million. The increase and big miss by economists’ forecasting increases in job opportunities is a clear sign of strength in the nation’s labor market. This complicates Chair Jerome Powell’s position, along with other Fed members. 

It isn’t popular to try to crush demand for new employees, but rising consumer costs at more than twice the Fed’s target will be viewed as too much.

The Fed says that it is data driven, this data is unsettling for those hoping for a pause or pivot.


The Investment Climate

These numbers and other strong economic numbers that were reported in April, create some uncertainty for investors as most would prefer to see the Fed stimulating rather than tightening conditions.

But the market has been resilient, despite the Feds’ resolve. The Fed has raised its benchmark interest rate ten times in the last 14 months. Yet jobs remain unfilled, and the stock market has gained quite a bit of ground in 2023. The concern has been that the Fed may overdo it and cause a recession. While even the Fed Chair admitted this is a risk he is willing to take, he also added that it is easier to start a stalled economy than it is to reel one in and the inflation that goes along with expansion.

So the strong labor market (along with other recent data releases) provides room for the Fed to tighten as there are still nearly two jobs for every job seeker. Additional tightening will eventually have the effect of simmering inflation to a more tolerable temperature. If the Fed overdoes it on the brake pedal, according to Powell, he knows where the gas pedal is.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.bls.gov/news.release/pdf/empsit.pdf

Details of the United States Credit Watch and Downgrade Status

Posted on by phoffman@channelchek.com

Fitch Has Placed the United States and Some of its Debt on Credit Watch

What does it mean that rating agency Fitch has put the US debt on credit watch?

According to Fitch Ratings, a rating service that is one of the top three Nationally Recognized Statistical Rating Agencies (NRSRO), has placed the United States AAA Long-Term, Issuer Default Rating (IDR) on rating watch and at risk of a downgrade. The primary reason for the rating agency warning is the apparent standstill of negotiations related to the US borrowing limit along with the approaching day that the US may not be able to refinance the interest portion of approaching US Treasury Bills (T-Bills), US Treasury Notes (T-Notes), and US Treasury Bonds (T-Bonds).

Implications

When a top credit rating agency places a country’s debt on credit watch, it means that the agency is considering lowering that country’s credit rating if conditions remain unchanged or worsen. This would have a number of negative consequences for the country, and could negatively impact those that operate within its economy, this could include:

  • Higher interest rates on government borrowing
  • Higher rates on corporate debt priced off of US Treasuries
  • Higher mortgage rates spread to US Treasuries
  • A decline in the value of the country’s currency
  • Increased difficulty in attracting foreign investment

A downgrade of the US government credit rating below AAA would be a major event with far-reaching consequences above and beyond the immediate impacts bullet-pointed above.

Wording of the Fitch Ratings Warning

Rating agencies like Fitch, Moody’s, and S&P are private companies. Debt issuers pay to have their debt issues rated to provide investors with information and a framework of value. These rating agencies or NRSROs are somewhat akin to providers of equity research to stock market participants via company-sponsored research.

Some of the main categories listed by Fitch titled, KEY RATING DRIVERS, are “Debt Ceiling Brinkmanship”, “Debt Limit Reached”, “X-Date Approaching”, “Debt Default Rating Implication”, “Potential Post Default Ratings”, and “High and Rising Public Debt Burden”.

The concern with debt ceiling brinkmanship according to Fitch is the “increased political partisanship that is hindering reaching a resolution to raise or suspend the debt limit despite the fast-approaching x-date (when the U.S. Treasury exhausts its cash position and capacity for extraordinary measures without incurring new debt).”

Fitch’s warning indicates it still expects a resolution to the debt limit before the x-date. However, it believes risks have risen that the debt limit will not be raised or suspended before the x-date and that the government could begin to miss payments on some of its obligations.

Fitch pointed out that the US reached its $31.4 trillion debt ceiling on Jan. 19, 2023. While the US Treasury has taken what Janet Yellen called “extraordinary measures” she also expects the measures could be exhausted as early as June 1, 2023. The cash balance of the Treasury reached USD76.5 billion as of May 23, and sizeable payments are due June 1-2.

The x-date has been defined as the day the US can’t meet its obligations without borrowing above the current Congressional debt limit. Failure to reach a deal “to raise or suspend the debt limit by the x-date would be a negative signal of the broader governance and willingness of the U.S. to honor its obligations in a timely fashion,” Fitch warned. The rating agency indicated this “would be unlikely to be consistent with a ‘AAA’ rating”   

Fitch also addressed the 14th amendment discussions and other unconventional solutions, “avoiding default by non-conventional means such as minting a trillion-dollar coin or invoking the 14th amendment is unlikely to be consistent with a ‘AAA’ rating and could also be subject to legal challenges,” Fitch advised.

The debt default rating warning comes from basic understanding of the role of a rating agency. However, Fitch did offer an opinion on the likelihood. “We believe that failing to make full and timely payments on debt securities is less likely than reaching the x-date, and is a very low probability event.

If a default did occur, Fitch indicated it would be more than one level adjustment to some debt affected. Fitch’s sovereign rating criteria would lead it to downgrade the sovereign rating (IDR) to Restricted Default (RD). Actual affected securities would be downgraded to ‘D’. Additionally, other LT debt securities with payments due within 30 days could be expected to be downgraded to ‘CCC’, and ST T-Bills maturing within the following 30 days could be expected to be downgraded to ‘C’.

“Other debt securities with payments due beyond 30 days would likely be downgraded to the expected post-default rating of the IDR,” Fitch wrote.

The US has a high and rising public debt burden, according to the rating agency. It points out that government debt fell to 112.5% of GDP at year-end 2022 (compared to 36.1% for the ‘AAA’ median). It peaked during the pandemic at 122.3%. Fitch forecasts debt to increase to 117% by end-2024. Debt dynamics under the baseline Congressional Budget Office (CBO) assumptions project that the ratio of federal debt held by the public to GDP will approach 119% within a decade under the current policy setting, a rise of over 20 pp. Fitch also recognizes the added cost of financing, adding, “interest rates have risen significantly over the last year with the 10-year Treasury yield at close to 3.7% (compared to 2.8% a year ago).”

Take Away

The decision to put a country’s debt on credit watch is not made lightly. One company announcement such as this can have an impact felt across the globe. It’s important for them to get this right. NRSROs typically would only put a sovereign nation, especially the US, where its debt is often called “the risk free rate,” and the US dollar serves as fiat currency. Firch did this because they view it as responsible and in line with what securities analysts and the rating services they work for are expected to watch out for.

In the current case of the United States debt ratings, the main concern is the political gridlock in Washington, which has made it difficult to reach an agreement on raising the debt ceiling. If the debt ceiling is not raised, the United States will eventually run out of money to pay its bills, which would trigger a default. Fitch would be embarrassed (and arguably irresponsible) if they maintained a AAA rating just one week before the US Treasury Secretary indicated the nation couldn’t roll its debt.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.fitchratings.com/research/sovereigns/fitch-places-united-states-aaa-on-rating-watch-negative-24-05-2023

We May Soon Know if Yellen’s “Extraordinary Measures” are Extraordinary Enough

Posted on by phoffman@channelchek.com

The Pace of the U.S. Treasury Burn Rate Toward a $0.00 Balance

The US Treasury Department is nearing its last ounce of blood as it has been bleeding operating funds. All parties know that the debt ceiling has to be raised if the country is to avoid a financial catastrophe. Still, an impasse on debt ceiling negotiations continues. While the House of Representatives has passed a borrowing cap plan, it is not expected that the Senate would agree on the spending reductions, and President Biden made clear he would not sign it.

The markets, of course, have been paying attention, but for the most part, they have chosen to ignore the drama. Anyone that has been involved in the markets for a few years knows that in the past, there have been stop-gap measures or 11th hour decisions that have avoided a US debt default.

It is Getting Close

The US Treasury reported last Thursday that it had $57.3 billion in cash on hand. As with any ongoing entity, each week, it receives revenue and pays expenses. So the daily balance runoff fluctuates by different amounts each day. A snapshot is reported each Thursday along with other US financial data. The current pace, while not a precise rate to gauge the net burn rate, is useful.

The operating balance used to pay our bills as a nation has declined from $238.5 billion at the start of May, when tax collections helped boost balances. That’s a $181.2 billion decline over 18 days, or $10 billion per day. If the pace holds, the United States balance sheet reaches zero before the June 1 date previously estimated by US Treasury Secretary Janet Yellen.

Image: @GRDector (Twitter)

How are Officials Reacting?

The US reached its Congressionally imposed borrowing cap in January. Since then, there has been a cutting back on spending, as had been announced in January by Janet Yellen. The Treasury has since been operating under an “Extraordinary Measures” plan, reducing less than critical spending to pay obligations that can not be ignored without great consequence. This bandaid approach will go on and, at this point, can only be “fixed” if the debt ceiling is raised once again by Congress.

Treasury Secretary Janet Yellen has been clear in warning lawmakers that the Treasury’s ability to avoid default could end as soon as June 1. The nation has to increase its ability to legally borrow to make its payments while its obligations exceed its revenue.

Averting a June Crisis Without Congress

While most US citizens are aware of the mid-April individual tax date, corporate tax dates are quarterly. The next time most corporations pay their estimated taxes is June 15th. If Secretary Yellen can squeeze the Treasury balances until June 15th, she will no longer be driving on fumes – instead, she will have added a little more gas, not enough to get her to the next corporate tax date.  

Another thought depends on one’s interpretation of the 14th Amendment. This amendment of the US Constitution contains several provisions, one of which is Section 4. This section states that “the validity of the public debt of the United States, authorized by law… shall not be questioned.” While the exact interpretation of this provision is a matter of legal debate, it has been suggested that it could potentially provide a legal basis for the government to continue meeting its financial obligations, even if the debt ceiling is reached.

Some argue that the 14th Amendment could empower the President to bypass the debt ceiling and ensure that the government continues to pay its debts on time, based on the principle that the United States must honor its financial obligations.

Source: US Treasury (May 18, 2023)

Stalled Talks

Although the date of $zero balance is not far off if the President and Senate doesn’t agree to the House plan, or if the House is inflexible, negotiations have moved in fits and starts with Congressional leaders meeting on and off with each other and with the Executive branch.  

If the nation does default, it will unleash global economic and financial upheaval. The full consequences are not known since it’s never happened before. Those likely to see funds come to a crawl or be turned off are:

  • Interest on the debt: While the debt itself would continue to be serviced, a stringent austerity plan could potentially result in reduced payments towards interest on the national debt.
  • Government programs and agencies: Funding for discretionary programs, such as infrastructure projects, education initiatives, environmental programs, or research grants, could be reduced or eliminated.
  • Social welfare programs: Payments for social welfare programs, such as unemployment benefits, food assistance, housing subsidies, or healthcare subsidies, may be reduced or scaled back.
  • Defense spending: Military expenditures and defense contracts may face cuts, impacting payments to defense contractors and the procurement of military equipment and services.
  • Government salaries and benefits: Austerity measures could involve salary freezes, reductions, or furloughs for government employees, including civil servants, military personnel, or elected officials.
  • Infrastructure projects: Funding for infrastructure development and maintenance, including transportation systems, highways, bridges, and public facilities, may face reductions or delays.
  • Grants to states and local governments: Payments to states and local governments for various programs, such as education, healthcare, or community development, could be reduced.

The above are not set in stone, it’s important to note that the specific impacts of an austerity plan would depend on the policies and priorities set by the government, and different austerity measures are also a matter of negotiation.

While Yellen, the Congressional Budget Office, and multiple other forecasters think the $Zero date is likely during the first two weeks of June, it’s possible that the Treasury will have enough funds to carry it through the middle of the month, which would add more time.

However, as it looks now, the US Government is running on fumes; in the past, it has not allowed itself to completely run out of gas. If today’s situation follows past history, the markets will get scared a few more times before the US leaders agree and the country is back to business as usual.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://fiscaldata.treasury.gov/datasets/daily-treasury-statement/operating-cash-balance

https://home.treasury.gov/news/press-releases/jy1483

Trading With Artificial Intelligence – Benefits and Pitfalls

Posted on by phoffman@channelchek.com

ChatGPT-Powered Wall Street: The Benefits and Perils of Using Artificial Intelligence to Trade Stocks and Other Financial Instruments

Artificial Intelligence-powered tools, such as ChatGPT, have the potential to revolutionize the efficiency, effectiveness and speed of the work humans do.

And this is true in financial markets as much as in sectors like health care, manufacturing and pretty much every other aspect of our lives.

I’ve been researching financial markets and algorithmic trading for 14 years. While AI offers lots of benefits, the growing use of these technologies in financial markets also points to potential perils. A look at Wall Street’s past efforts to speed up trading by embracing computers and AI offers important lessons on the implications of using them for decision-making.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Pawan Jain, Assistant Professor of Finance, West Virginia University.

Program Trading Fuels Black Monday

In the early 1980s, fueled by advancements in technology and financial innovations such as derivatives, institutional investors began using computer programs to execute trades based on predefined rules and algorithms. This helped them complete large trades quickly and efficiently.

Back then, these algorithms were relatively simple and were primarily used for so-called index arbitrage, which involves trying to profit from discrepancies between the price of a stock index – like the S&P 500 – and that of the stocks it’s composed of.

As technology advanced and more data became available, this kind of program trading became increasingly sophisticated, with algorithms able to analyze complex market data and execute trades based on a wide range of factors. These program traders continued to grow in number on the largely unregulated trading freeways – on which over a trillion dollars worth of assets change hands every day – causing market volatility to increase dramatically.

Eventually this resulted in the massive stock market crash in 1987 known as Black Monday. The Dow Jones Industrial Average suffered what was at the time the biggest percentage drop in its history, and the pain spread throughout the globe.

In response, regulatory authorities implemented a number of measures to restrict the use of program trading, including circuit breakers that halt trading when there are significant market swings and other limits. But despite these measures, program trading continued to grow in popularity in the years following the crash.

HFT: Program Trading on Steroids

Fast forward 15 years, to 2002, when the New York Stock Exchange introduced a fully automated trading system. As a result, program traders gave way to more sophisticated automations with much more advanced technology: High-frequency trading.

HFT uses computer programs to analyze market data and execute trades at extremely high speeds. Unlike program traders that bought and sold baskets of securities over time to take advantage of an arbitrage opportunity – a difference in price of similar securities that can be exploited for profit – high-frequency traders use powerful computers and high-speed networks to analyze market data and execute trades at lightning-fast speeds. High-frequency traders can conduct trades in approximately one 64-millionth of a second, compared with the several seconds it took traders in the 1980s.

These trades are typically very short term in nature and may involve buying and selling the same security multiple times in a matter of nanoseconds. AI algorithms analyze large amounts of data in real time and identify patterns and trends that are not immediately apparent to human traders. This helps traders make better decisions and execute trades at a faster pace than would be possible manually.

Another important application of AI in HFT is natural language processing, which involves analyzing and interpreting human language data such as news articles and social media posts. By analyzing this data, traders can gain valuable insights into market sentiment and adjust their trading strategies accordingly.

Benefits of AI Trading

These AI-based, high-frequency traders operate very differently than people do.

The human brain is slow, inaccurate and forgetful. It is incapable of quick, high-precision, floating-point arithmetic needed for analyzing huge volumes of data for identifying trade signals. Computers are millions of times faster, with essentially infallible memory, perfect attention and limitless capability for analyzing large volumes of data in split milliseconds.

And, so, just like most technologies, HFT provides several benefits to stock markets.

These traders typically buy and sell assets at prices very close to the market price, which means they don’t charge investors high fees. This helps ensure that there are always buyers and sellers in the market, which in turn helps to stabilize prices and reduce the potential for sudden price swings.

High-frequency trading can also help to reduce the impact of market inefficiencies by quickly identifying and exploiting mispricing in the market. For example, HFT algorithms can detect when a particular stock is undervalued or overvalued and execute trades to take advantage of these discrepancies. By doing so, this kind of trading can help to correct market inefficiencies and ensure that assets are priced more accurately.

Stock exchanges used to be packed with traders buying and selling securities, as in this scene from 1983. Today’s trading floors are increasingly empty as AI-powered computers handle more and more of the work.

The Downsides

But speed and efficiency can also cause harm.

HFT algorithms can react so quickly to news events and other market signals that they can cause sudden spikes or drops in asset prices.

Additionally, HFT financial firms are able to use their speed and technology to gain an unfair advantage over other traders, further distorting market signals. The volatility created by these extremely sophisticated AI-powered trading beasts led to the so-called flash crash in May 2010, when stocks plunged and then recovered in a matter of minutes – erasing and then restoring about $1 trillion in market value.

Since then, volatile markets have become the new normal. In 2016 research, two co-authors and I found that volatility – a measure of how rapidly and unpredictably prices move up and down – increased significantly after the introduction of HFT.

The speed and efficiency with which high-frequency traders analyze the data mean that even a small change in market conditions can trigger a large number of trades, leading to sudden price swings and increased volatility.

In addition, research I published with several other colleagues in 2021 shows that most high-frequency traders use similar algorithms, which increases the risk of market failure. That’s because as the number of these traders increases in the marketplace, the similarity in these algorithms can lead to similar trading decisions.

This means that all of the high-frequency traders might trade on the same side of the market if their algorithms release similar trading signals. That is, they all might try to sell in case of negative news or buy in case of positive news. If there is no one to take the other side of the trade, markets can fail.

Enter ChatGPT

That brings us to a new world of ChatGPT-powered trading algorithms and similar programs. They could take the problem of too many traders on the same side of a deal and make it even worse.

In general, humans, left to their own devices, will tend to make a diverse range of decisions. But if everyone’s deriving their decisions from a similar artificial intelligence, this can limit the diversity of opinion.

Consider an extreme, nonfinancial situation in which everyone depends on ChatGPT to decide on the best computer to buy. Consumers are already very prone to herding behavior, in which they tend to buy the same products and models. For example, reviews on Yelp, Amazon and so on motivate consumers to pick among a few top choices.

Since decisions made by the generative AI-powered chatbot are based on past training data, there would be a similarity in the decisions suggested by the chatbot. It is highly likely that ChatGPT would suggest the same brand and model to everyone. This might take herding to a whole new level and could lead to shortages in certain products and service as well as severe price spikes.

This becomes more problematic when the AI making the decisions is informed by biased and incorrect information. AI algorithms can reinforce existing biases when systems are trained on biased, old or limited data sets. And ChatGPT and similar tools have been criticized for making factual errors.

In addition, since market crashes are relatively rare, there isn’t much data on them. Since generative AIs depend on data training to learn, their lack of knowledge about them could make them more likely to happen.

For now, at least, it seems most banks won’t be allowing their employees to take advantage of ChatGPT and similar tools. Citigroup, Bank of America, Goldman Sachs and several other lenders have already banned their use on trading-room floors, citing privacy concerns.

But I strongly believe banks will eventually embrace generative AI, once they resolve concerns they have with it. The potential gains are too significant to pass up – and there’s a risk of being left behind by rivals.

But the risks to financial markets, the global economy and everyone are also great, so I hope they tread carefully.

Is Your Bank Prepared for a US Debt Default?

Posted on by phoffman@channelchek.com

War Rooms and Bailouts: How Banks and the Fed are Preparing for a US Default – and the Chaos Expected to Follow

When you are the CEO responsible for a bank and all the related depositors and investors, you don’t take an “it’ll never happen” approach to the possibility of a U.S. debt default. The odds are it won’t happen, but if it does, being unprepared would be devastating. Banks of all sizes are getting their doomsday plans in place, and other industries are as well, but big banks, on many fronts would be most directly impacted. The following is an informative article on how banks are preparing. It’s authored by John W. Diamond the Director of the Center for Public Finance at the Baker Institute, Rice University, and republished with permission from The Conversation.  – Paul Hoffman, Managing Editor, Channelchek

Convening war rooms, planning speedy bailouts and raising house-on-fire alarm bells: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.

“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, said in a television interview.

The doomsday planning is a reaction to a lack of progress in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – another round of negotiations took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.

What happens if a default occurs is an open question, but economists – including me – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety would be further tarnished.

But how do you prepare for an event that many expect would trigger the worst global recession since the 1930s?

Preparing for Panic

Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s been convening a weekly war room to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the U.S. might run out of cash – nears.

Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad.

“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.

That’s when rational decision-making gives way to fear and irrationality. Markets overtaken by these emotions are chaotic and leave lasting economic scars.

Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the financial crisis in 2008 or the debt ceiling showdowns of 2011 and 2013.

One important way banks can prepare is by reducing exposure to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds.

The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was prompted primarily by a drop in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks at risk of failure as of March 2023.

Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy credit default swaps, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default is higher than that of Brazil, Greece and Mexico, all of which have defaulted multiple times and have much lower credit ratings.

But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default.

Keeping the Financial Plumbing Working

Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.

The Securities Industry and Financial Markets Association, for example, has been updating its playbook to dictate how players in the Treasurys market will communicate in case of a default.

And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans demanded the elimination of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash.

One of the biggest concerns Fed officials had at the time, according to a meeting transcript recently made public, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government issued just under $100 billion in notes and bonds to replace maturing debt and raise cash.

The risk is that there would be too few buyers at one of the government’s daily debt auctions – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt.

That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the government spent over $6 trillion on in 2022. This would be nothing short of apocalyptic if the Fed could not save the day.

To mitigate that risk, the Fed said it could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.

A Self-Imposed Catastrophe

Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit.

These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to rein in government spending. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, history shows they fail, as energy analyst Autumn Engebretson and I recently explained in a review of that episode.

That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.

Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.

In the Event of an Official U.S. Bankruptcy…

Posted on by phoffman@channelchek.com

Is a U.S. Default or Bankruptcy Possible – How Would that Work?

It seems no one is talking about what would happen if the U.S. defaulted on maturing debt, yet it is within the realm of possibilities. Also not impossible is the idea of the powerful country joining the list of sovereign nations that once declared bankruptcy and survived. A retired government employee with a passion for economic history wrote a timely piece on this subject. It was originally published on the Mises Institute website on  May 12, 2023. Channelchek has shared it here with permission.

The current known federal debt is $31.7 trillion, according to the website, U.S. Debt Clock, this is about $94,726 for every man, woman, and child who are citizens as of April 24, 2023. Can you write a check right now made payable to the United States Treasury for the known share of the federal debt of each member of your family after liquidating the assets you own?

A report released by the St. Louis Federal Reserve Branch on March 6, 2023, stated a similar figure for the total known federal debt of about $31.4 trillion as of December 31, 2022. The federal debt size is so great, it can never be repaid in its current form.

Some of us have been in or known families or businesses who had financial debt that could not be paid when adjustments like reducing expenses, increasing income, renegotiating loan repayments to lender(s), and selling assets to raise money for loan repayment were not enough. The reality is that they still could not pay the debt owed to the lender(s).

This leads to filing bankruptcy under federal bankruptcy laws overseen by a federal bankruptcy court.

Chapter 7 bankruptcy is a liquidation proceeding available to consumers and businesses. It allows for assets of a debtor that are not exempt from creditors to be collected and liquidated (turned to cash), and the proceeds distributed to creditors. A consumer debtor receives a complete discharge from debt under Chapter 7, except for certain debts that are prohibited from discharge by the Bankruptcy Code.

Chapter 11 bankruptcy provides a procedure by which an individual or a business can reorganize its debts while continuing to operate. The vast majority of Chapter 11 cases are filed by businesses. The debtor, often with participation from creditors, creates a plan of reorganization under which to repay part or all its debts.

These government entities have filed for Chapter 9 federal bankruptcy:

Orange County, California, in 1994 for about $1.7 billion

Jefferson County, Alabama, in 2011 for about $5 billion

The City of Detroit, Michigan, in 2013 for about $18 billion

The Commonwealth of Puerto Rico in 2017 for $72 billion

According to the United States Courts website:

The purpose of Chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.

Although similar to other Chapters in some respects, Chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors.

The bankruptcies of two counties, a major city, and a sovereign territory resulted in bondholders with financial losses not repaid in full as well as reforms enacted in each governmental entity. Each one emerged from bankruptcy, one hopes, humbled and better able to manage their finances.

The federal government’s best solution for bondholders, taxpayers, and other interested parties is to default, declare sovereign bankruptcy, and make the required changes to get the fiscal business in order. Default, as defined by Dictionary.com as a verb, is “to fail to meet financial obligations or to account properly for money in one’s care.”

Sovereign government defaults are not new in our lifetime with Argentina in 1989, 2001, 2014, and 2020; South Korea, Indonesia, and Thailand in 1997, known as the Asian flu; Greece in 2009; and Russia in 1998.

Possible Outcomes

Some outcomes from these defaults lead to sovereign government debt bond ratings being reduced by the private rating agencies, bondholders losing value on their holdings, debt repayments being renegotiated with lenders, many countries receiving loans with a repayment plan from the International Monetary Fund (IMF), reforms being required to nations’ entitlement programs, a number of government taxes being raised, their currency losing value on currency trading exchanges, price inflation becoming more of a reality to its citizens, and higher interest rates being offered on future government debt bond offerings.

Very few in the financial world are talking about any outcomes of a U.S. federal government debt default. One outcome from the 2011 near default was Standard & Poor’s lowering their AAA federal bond rating to AA+ where it has remained.

What organization would oversee the execution of a U.S. federal government debt default, and what authorization would they be given to deal with the situation? No suggestions are offered when its scale is numerically mind-numbing since the U.S. has used debt as its drug of choice to overdose on fiscal reality.

Some outcomes would include a lowered federal bond rating by the three private bond rating agencies, where the reality of higher interest rates being offered on newly issued federal debt cannot be ignored. Federal government spending cuts in some form will be required by the realities of economic law, which includes reducing the number of federal employees, abolishing federal agencies, reducing and reforming military budgets, selling federal government property, delegating federal programs to the states, and reforming the federal entitlement programs of Medicaid, Medicare, and Social Security. Federal government tax revenue to repay the known debt with interest will rise as a percentage of each year’s future federal budget.

One real impact from a federal government debt default would be that the U.S. dollar would no longer be the global reserve currency, with dollars in many national reserve banks coming back to the U.S. Holding dollars will be like holding a hot potato. Nations holding federal debt paper—like China ($859 billion), Great Britain ($668 billion), Japan ($1.11 trillion), and others as of the January 2023 numbers published by the U.S. Treasury—as well as many mutual funds and others will see their holdings reduced in value leading to a selling off of a magnitude one cannot imagine in scale and timing. Many mutual fund holders like retirees, city and state retirement systems, and 401(k) account holders will be impacted by this unfolding event.

The direction of an individual or business when they emerge from federal bankruptcy is hopefully humility—looking back with the perspective of mistakes made, learning from these mistakes, and moving forward with a focus to benefit their family and community.

However, cities, counties, and sovereign territories differ from individuals, families, and private businesses in emerging from federal bankruptcy. What the outcome of a federal government debt default will be is unknown. Yet its reality is before us.

About the Author:

Stephen Anderson is retired from state government service and is a graduate of The University of Texas at Austin. He currently lives in Texas. His passions are reading, writing, and helping friends and family understand economic history.