Norinchukin Bank made headlines with its announcement that it is selling $63 billion in bonds. This will primarily be US Treasuries and ECB debt.
This, naturally, brings out the usual calls about the collapse of the dollar and how the Debt level of the United States is scaring away investors. Actually, this is nothing of the sort.
As we usually discuss, viewpoints of this nature lead to more erroneous conclusions. Repeatedly, the reality of the US Dollar is clear. If it is destroyed, it is not because it is too weak but, rather, too strong.
It is the impact on emerging markets that will determine the future of the dollar.
Therefore, if the selling by Norinchukin isn't about the credit of the US (and EU), then what it is?
Norinchunkin Bank Losing Money
When we look under the hood, we see how losses are the bank are mounting. They are triple what they expected.
This is another thing that is loaded with misdirection, at least for the average viewer.
The entire situation boils down to the carry trade. All of this revolves around the bank's trading practices. This is a bank that relies exclusively from profits generated on its assets.
Which brings us to the primary problem.
The fact that interest rates increased mean the carry trade was more expensive. This is because the cost of money goes up, turning a potential profit to a loss.
Since the Fed has shown no indication of lowering rates, the bank is well aware that it things will not turn around anytime soon.
In other words, the bank is having to bail on these positions in order to stem the losses.
The fact that USD interest rates shot up so quickly has a major impact as more than half the portfolio is more than half USD.
Borrowing In USD Requires A Better Return
Norinchukin is forced to reach for a better return due to higher USD rates.
This means the bank is going to turn to commercial paper. It is going to take on more risk for a better return, providing the buffer between what it costs to borrow the money.
Of course, we will have to see if this is a smart strategy long term as we can see how this could cause larger problems down the road. I guess this is one of the "kick the can" moments.
Unfortunately, this is not the only bank facing this situation.
The company is far from alone in facing paper losses on bond holdings. US banks had $516.5 billion of unrealized losses in their securities portfolio at the end of March, according to regulators. Bank of America Corp., the second-biggest US bank, had more than $100 billion of such losses, and its low-yielding bond portfolio has limited its profit gains as rates rose.
We could see many other banks following a similar trend . There is no way to keep accruing these losses without doing something to offset it.
Norinchukin has more than 30% of its holdings in assets that are 5-10 years. Depending on when they were issues, the could be at very low rates.
It is easy to see how a loss on this trade is occurring.
Operate At A Different Level
We all must always remember that banks operate at a level that is different from the rest of us.
This is especially true for investment banks.
I often discuss the Repo market and Eurodollar system. That is an example of a bank generated system that few of us understand and none of us are invited to. It was made by bankers, for bankers.
Over the decades, they erected different layers on top, further complicating matters. To be honest, there are only a handful around the world who fully understand all that is taking place. In other words, people like Jamie Dimon are simply on an alternate tier.
Banks are major traders. There is no separation, at least in the US, between commercial and investment banks. Here we see massive fallout as the trading arms often create problems.
This is the case for Norinchunkin. It is an investment bank along the lines of Goldman Sachs who makes money of its portfolio.
Here we see the problem with banking these days. Everything is transactional. In a world of transactional banking , there are profits and losses. That is the problem. Many want to blame fractional lending but with reserves at the Fed over $3 trillion, it shows this isnt the problem.
The same story is repeated throughout the world. The fact these banks operate in a transactional manner means we have systemic risk as we are seeing with Norinchukin.
For now, the problem will be alleviated by simply selling the bonds they have and moving into commercial paper.
This will suffice, until the next crisis.