RPT MMC 2014 02 SB

SHADOW BANKING RE-EMERGENCE
New Acronyms & Vehicles, Same Game
Gordon T Long 2/18/2014
February 2014 Edition 1

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SHADOW BANKING RE-EMERGENCE

New Acronyms & Vehicles, Same Game
FEBRUARY MONTHLY MARKET COMMENTARY

MARKET OVERVIEW ................................................................................................................................................................................ 3 I- DEFINING CHARTS ............................................................................................................................................................................... 3 Era of Delusional Distortions & the Super Cycle Pivot b .................................................................................................................. 3 Defining Chart #1 - "Delusional Distortion" Expectations & the Log-Periodic Cycle .................................................................... 5 Defining Chart #2 - Finding the Longer Term Super Cycle Pivot b ............................................................................................. 6 Defining Chart #3 - The Big M and Super Cycle b ...................................................................................................................... 8 Defining Chart #4 - Short Term Small M Top Turmoil ................................................................................................................. 10 II- TARGETS ............................................................................................................................................................................................. 12 III- QUARTERLY KEY METRICS & ASSESSMENT UPDATE ....................................................................................................... 13 A - LONG TERM: Fundamentals ...................................................................................................................................................... 13 B - INTERMEDIATE TERM: Risk ..................................................................................................................................................... 15 C - SHORT TERM: Sentiment........................................................................................................................................................... 16 IV - MONTHLY RISK & PATTERNS ...................................................................................................................................................... 19 RISK ..................................................................................................................................................................................................... 19 PATTERNS.......................................................................................................................................................................................... 22 V - STUDIES ............................................................................................................................................................................................. 24 STUDY: Dotcom Level Euphoria ...................................................................................................................................................... 24 STUDY: Capital v Money: Liquidity v Credit .................................................................................................................................... 24 STUDY: Margin & Leverage .............................................................................................................................................................. 25 STUDY: DIVIDENDS & BUYBACKS................................................................................................................................................ 27 VI - TRIGGER$ ZONES ........................................................................................................................................................................... 29 VII - DRIVER$ & BIA$ .............................................................................................................................................................................. 30 VIII- GORD'S VIEWS & OPINIONS........................................................................................................................................................ 31 Economic Recoveries Don't Look Like This! ................................................................................................................................... 31 Falling Global GDP Growth Estimates ............................................................................................................................................. 32 The Intrinsic Enterprise Value ........................................................................................................................................................... 33 Forget Manipulated Government GDP, Look at the 2.5% Slowing Trade Volumes .............................................................. 33 Forward Earnings Estimates Seldom Look as Bleak as This........................................................................................................ 34 Eventually Earnings Will Matter ........................................................................................................................................................ 34 Divergence in Breadth Continues to Signal Heightened Risk ....................................................................................................... 35 Historic Levels of Euphoria ................................................................................................................................................................ 36 Historic Investor Intelligence Bull/Bear Ratio .................................................................................................................................. 36 Euphoria and Complacency Need Serious Consideration ............................................................................................................ 37 Even Goldman Can't Explain Away a 22% Excessive Exuberance ............................................................................................. 38 Based on the above, how can Multiple Expansions be Lifting the markets by 21%? ................................................................ 38 How Long Will Labor Tolerate this or Survive on Shrinking Disposable Income? ..................................................................... 39 Have a Look at the Market Deflated by QE ..................................................................................................................................... 39 In Case You Have Lost Your Perspective We Are Actually in a Bear Market ......................................................................... 40 Small Business is acutely Aware we are in a Bear Market! .......................................................................................................... 41 CRACK-UP BOOM after the near Term Consolidation We Still Expect new Highs ................................................................... 42 COMMENTARY SHADOW BANKING RE-EMERGENCE ................................................................................ 43 STEALTH SHADOW BANKING FLOWS .............................................................................................................................................. 43 FLOWS: LIQUIDITY, CREDIT & DEBT ........................................................................................................................................... 43 SHADOW BANKING CREDIT INTERMEDIATION PROCESS.................................................................................................... 44 THE FEDS $2.3 TRILLION EXCESS RESERVES ..................................................................................................................... 46 SAME GAME, NEW ACRONYMS The Acronyms in the Next Crisis ....................................................................................... 46 HOW IT NOW WORKS ...................................................................................................................................................................... 47 ARCHILLES HEEL: DURATION & COLLATERAL RISK .................................................................................................................... 62 DURATION .......................................................................................................................................................................................... 62 CONCLUSION .......................................................................................................................................................................................... 63

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MARKET OVERVIEW I- DEFINING CHARTS Era of Delusional Distortions & the Super Cycle Pivot b
The Currency and Inflation reporting distorts need to be continuously kept in perspective. Our view is that since December 1999 we have been in a SECULAR BEAR MARKET. Since 2002 we have been putting in an Expanded Flat CYCLICAL BULL MARKET which we expect to end in early 2015. NOMINAL VIEW Super Cycle b Is NOT Complete. Expected to Complete in Early 2015
REAL TERMS One way to consider the real actions of the market is to denominate the markets in hard assets or use inflation elements like the Producer Price Index versus the CPI.

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Most of the Elliott Wave practitioners had it right until the completion of the dotcom Bubble and the beginning of the current Secular Bear Market.
Though they all believe we are in a Secular Bear Market, the labeling since 2000 has been inaccurate.
The megaphone top which we have experienced is actually a distorted expanded flat 3-3-5 wave with the red line to the left being the final c wave of the 3-3-5 and counts as a 5 wave impulsive. When completed it will have put in Super Cycle Wave b

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Defining Chart #1 - "Delusional Distortion" Expectations & the Log-Periodic Cycle
We Are Here
Since the introduction of QE III (where price bars stop on the above graphic) we switched to the use of Dr Didier Sornettes Log-Periodic Cycle Model which has been exactly the right tool to use. It gave us an expected termination of January 14th, 2014 of the parabolic rise we were seeing in this particular leg.

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Defining Chart #2 - Finding the Longer Term Super Cycle Pivot b
We drew these exploded views below in December 2013 as we concluded the Log-Periodic Cycle and flet we would see a Small M top unfold WITHIN a larger M top.

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YET ANOTHER POSSIBILITY IF COORDINATED CENTRAL BANK ACTIONS ARE DELAYED THROUGH THE FIRST HALF OF 2014. Possibility of deeper "D3" if Central Bankers are slow to respond to the Collateral Copntagion.
POSSIBILITY OF AN EVEN LOWER BOTTOM

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Defining Chart #3 - The Big M and Super Cycle b

The following Weekly chart utilizes a combination of Technical Analysis and Macro Analysis to arrive at the likely Small M and Large M Tops from a Price, Time and Pattern perspective.
Small M
Large M
NOTE: There is a high probability that the M tops will be fractal patterns of the pattern we have seen since the 2000 market top.

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Please pay particular attention to the fact the chart below is a MONTHLY chart.
The 2 Std. Deviation Band on 12 MMA NEEDS TIME TO CURL

2-3 Months
Strong Signal of A FINAL PUSH HIGHER OCCURS BEFORE THE LONG TERM CORRECTION BEGINS.

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Defining Chart #4 - Short Term Small M Top Turmoil

We need time for the Death Cross (50 DMA Crosses 100 DMA Downward) To Develop We published the chart below showing the bounce we expected as part of the internal strength of the small M Top and the importance of waiting for the Death Cross (see: Don't Be Concerned - Yet! - 28 Jan 2014)
Below are our current expectations of the detail of the small M Top

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II- TARGETS We believe the markets have now put in a SHORT TERM TOP and will soon complete an INTERMEDIATE TERM Top. THE LIKELY ROAD MAP IN THE LONGER TERM
IT IS TIME TO TAKE RISK-OFF SHORT TERM > Go Net Neutral (Possible further movement has too high a RISK to merit being LONG) SHORT TERM LOW: Looking for a Near Term retest of the recent 1850 on the S&P 500 (Small M External Strength) before falling towards 1700 and the S&P 200 DMA by late October 2014. ** A LONG TERM TOP: ~ Looking for 1900 2015
- 1950 Top in Late Q4 2014 or Early Q1
(**ONLY If further Central Bank Liquidity Programs are continued as expected due to a GeoPolitical False Flag or a Monetary Crisis Development.)

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III- QUARTERLY KEY METRICS & ASSESSMENT UPDATE
Every quarter we look at the following in detail: LONG TERM INTERMEDIATE TERM SHORT TERM Below are the key takeaways: FUNDAMENTAL ANALYSIS RISK ASSESSMENT SENTIMENT
A - LONG TERM: Fundamentals
Latest Report December 4th, 2013 VALUATION METHODOLOGY Crestmont P/E Cyclical P/E 10 Q Ratio S&P Composite from its Regression Average From its Arithmetic Mean 79% 49% 53% 77% 64.5 From its Geometric Mean 91% 61% 59% 77% 72.0 Average 85.0 55.0 56.0 77.0 68.25

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1st HALF
THIS QUARTER
Pre-Crash

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FUNDAMENTALS
While we are told that QE was "easing" but tapering is not tightening, it is worth remembering that "conventional" balanced portfolios have performed dramatically worse when the Fed is not easing. However, what is more worrisome for the 60/40 crowd is the following chart as "excess" returns suggest a period of disappointing performance lies ahead. As we've asked before, is this as good as it gets?
B - INTERMEDIATE TERM: Risk

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CANARIES-RISK
C - SHORT TERM: Sentiment

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But it is not showing in Consumer Confidence and Sentiment We said last month to "Expect confidence to soon abruptly change and head lower with FEAR".
Consumer Confidence Collapses - Biggest Miss On Record

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SENTIMENT
Percentage Bears as Financial Repression Forces Risk Taking

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IV - MONTHLY RISK & PATTERNS
RISK
This level of complacency
Has BEGUN To Increase since US Budget Impasse
With Plummeting Economic Confidence

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And this Degree of Fragility and Instability

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With a Bond Market ready to reverse
Suggests a RISK-OFF short Term in US Equities

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PATTERNS
Should Offer Support for a Santa Claus Rally.
Ghost of 1929 Re-Appears - Pay Attention to the Signals

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1997 Peso Crisis Asian Crisis Intervention Run-ups

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V - STUDIES
STUDY: Dotcom Level Euphoria

Last stage is always when the public enters because it is afraid it will miss the increase.
STUDY: Capital v Money: Liquidity v Credit

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STUDY: Margin & Leverage

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This requires some sort of correction before extending much higher.

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STUDY: DIVIDENDS & BUYBACKS

CAPEX Has Been Replaced With Dividends & Buy-Backs. Top line growth is now being impacted as Free Cash flow noticeably weakens

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Debt funded Stock Buybacks have inflated the markets along with unfunded liability payments and bank lose reserve reversals.

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VI - TRIGGER$ ZONES

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VII - DRIVER$ & BIA$

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VIII- GORD'S VIEWS & OPINIONS
Economic Recoveries Don't Look Like This!

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Falling Global GDP Growth Estimates

NO ONE WANTS TO TALK ABOUT THIS? - The Reality of Global Growth Forecasts
... and they are ALWAYS too optimistic! With the exception of Western Europe, analysts have been lowering predictions for global GDP and across regions all year, suggesting a tough environment for 2014.

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The Intrinsic Enterprise Value

= Discounted Free Cash Flow = In Trouble
Forget Manipulated Government GDP, Look at the 2.5% Slowing Trade Volumes
This is a SERIOUS Problem!
The IMF keeps forecasting a pickup / turn around which just doesn't arrive!

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Forward Earnings Estimates Seldom Look as Bleak as This
IT APPEARS EARNINGS NO LONGER MATTER ... AT LEAST NO ONE IS TAKING ACTION - YET!
Eventually Earnings Will Matter

Stock Valuations are based on a Discounted Free Cash flow. EBITDA is Cash flow.
S&P 500 nominal price +15% from previous peak...

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Divergence in Breadth Continues to Signal Heightened Risk

The % of NYSE stocks above their 200-day moving averages has a strong bearish divergence similar to previous plunge-preceding divergences. This points to diminishing momentum for market breadth and preceded pullbacks in the range of 15%-20% in 2010 and 2011; increasing the risk for a US equity market pullback in 2014.
It would take a break below 60% for the % of NYSE stocks above 200-day MAs to provide a more dire warning for US equities.

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Historic Levels of Euphoria

The bull-bear index has now crossed the Rubicon into a euphoria mode that marked the turning point before the last 2 major corrections in the US equity market.
Shrugging that off... this has happened 15 times in the last 24 years with stocks falling 79% of the time in the following 3 months...
Historic Investor Intelligence Bull/Bear Ratio

The ratio of bulls to bears has never (that is ever) been higher according to Investor's Intelligence. There are now more than 4x more bulls than bears and even more concerning, the only time "bears" have been lower than the current 14.3% was in the spring of 1987...

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Euphoria and Complacency Need Serious Consideration

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Even Goldman Can't Explain Away a 22% Excessive Exuberance
+22% above Goldmans Risk, Macro, Valuation and Sovereign Models would suggest
Based on the above, how can Multiple Expansions be Lifting the markets by 21%?

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How Long Will Labor Tolerate this or Survive on Shrinking Disposable Income?
I was startled this US Thanksgiving to see the number of companies holding food contribution programs for THEIR EMPLOYEES!
Have a Look at the Market Deflated by QE

The chart shows the S&P 500 deflated by QE and it's breathtaking:

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In Case You Have Lost Your Perspective We Are Actually in a Bear Market
Market in REAL Terms - Inflation Adjusted by the PPI S&P 500

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Small Business is acutely Aware we are in a Bear Market!

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CRACK-UP BOOM after the near Term Consolidation We Still Expect new Highs
We Are Here!

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COMMENTARY SHADOW BANKING RE-EMERGENCE STEALTH SHADOW BANKING FLOWS
The $72 Trillion Global Shadow Banking System is now larger than the global regulated banking system according to the latest study by the Financial Stability Board (FSB). How could an unregulated and opaque industry, which is larger than the entire worlds GDP operate with such little attention? Even the FSB is not a government entity and operates under the auspices of an entity with a highly checkered and mysterious background - The Bank of International Settlements in Basel Switzerland. The FSB has had only two Chairmen since its inception who were able to see the full extent of the operations of this global industry: Mario Draghi who is now head of the European Central Bank (ECB) and Mark Carney who is now the Governor of the Bank of England (BOE). Even Ben Bernankes has written on the subject before being quickly catapulted to the Chairmanship of the Federal Reserve. For those who recall the details of the 2008 Financial Crisis then the fact that it was short term lending problems associated with Asset Backed Commercial Paper (ABCP) liquidity used to fund the Structures Investment Vehicles (SIV) that was the catalyst. It was this short term funding that was used to buy what is now euphemistically referred to as toxic waste (CDOs et al). Dodd-Frank has done absolutely nothing to change any of this despite the CCP (Central Counter Party) exchange, if it is ever implemented. What has changed is that the Shadow Banking System by necessity and with policy makers turning a blind eyed, morphed into something far more dangerous.
FLOWS: LIQUIDITY, CREDIT & DEBT

It seems everyone is fixated with the increase in the balance sheets of the central banks and how closely the match the increase in the in equity asset prices. There is very good reason for this and is why we have been doing the same for over 5 years now. However, the question is how is this liquidity being turned into Credit and Debt and what might change? Like we saw in 2008, when it changes it is abrupt and unexpected to those who have not understood the mechanics. So lets look at the mechanics and what might change

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SHADOW BANKING CREDIT INTERMEDIATION PROCESS

According to the New York Federal Reserves investigation: The shadow banking system is organized around securitization and wholesale funding. Loans, leases, and mortgages are securitized and thus become tradable instruments. Funding is conducted in capital markets through instruments such as commercial paper and repos. Savers hold money market balances instead of deposits with banks. Like traditional banks, shadow banks conduct financial intermediation. However, unlike in the traditional banking system, where credit intermediation is performed under one roof that of a bankin the shadow banking system it is performed through a chain of nonbank financial intermediaries in a multistep process. These steps entail the vertical slicing of traditional banks credit intermediation process and include 1) loan origination, 2) loan warehousing, 3) ABS issuance, 4) ABS warehousing, 5) ABS CDO issuance, 6) ABS intermediation, and 7) wholesale funding. The shadow banking system performs these steps of intermediation in a strict, sequential order. Each step is handled by a specific type of shadow bank and through a specific funding technique. Each of the seven steps of credit intermediation consists of a shadow banking activity, some of which is conducted by specialized shadow banking institutions while others by traditional financial intermediaries such as commercial banks or insurance companies. The seven steps of shadow bank intermediation are as follows: 1. Loan origination (such as auto loans and leases, non con-forming mortgages) is performed by finance companies that are funded through CP and medium-term notes 2. Loan warehousing is conducted by single- and multi-seller conduits and is funded through assetbacked commercial paper (ABCP).

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3. The pooling and structuring of loans into term asset-backed securities are conducted by brokerdealers ABS syndicate desks. 4. ABS warehousing is facilitated through trading books and is funded through repurchase agreements, total return swaps, or hybrid and repo conduits. 5. The pooling and structuring of ABS into CDOs are also conducted by broker-dealers ABS syndicate desks. 6. ABS intermediation is performed by limited-purpose finance companies, structured investment vehicles (SIVs), securities arbitrage conduits, and credit hedge funds, which are funded in a variety of ways including, for example, repos, ABCP, MTNs, bonds, and capital notes. 7. The funding of all of the above activities and entities is conducted in wholesale funding markets by funding providers such as regulated and unregulated money market intermediaries (for example, 2(a)-7 money market funds and enhanced cash funds, respectively) and direct money market investors (such as securities lenders). In addition to these cash investorswhich fund shadow banks through short-term repo, CP, and ABCP instrumentsfixed-income mutual funds, pension funds, and insurance companies fund shadow banks by investing in their longer-term MTNs and bonds.
Shadow credit intermediation performs an economic role similar to that of traditional banks credit intermediation. The shadow banking system decomposes the simple process of retail-depositfunded, hold-to-maturity lending conducted by banks into a more complex, wholesale-funded, securitization-based lending process. Through this intermediation process, the shadow banking system transforms risky, long-term loans (subprime mortgages, for example) into seemingly creditrisk-free, short-term, money-like instruments, ending in wholesale funding through stable net asset value shares issued by 2(a)-7 MMMFs that require daily liquidity. This crucial point is illustrated by the first and last links in the diagram, which depicts the asset and funding flows of the shadow banking systems credit intermediation process. The intermediation steps of the shadow banking system are illustrated in Table 2. Importantly, not all intermediation chains involve all seven steps, and some might involve even more.

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THE FEDS $2.3 TRILLION EXCESS RESERVES

If the above has left your head spinning then just notice one thing in the diagram above. Notice how repos are heavily involved in most of the Intermediation steps. The Feds balance sheet is being used though the repo process to fund the short term lending needs of the shadow banking system. The traditional banks as shown to the right are not lending and have excess reserves approximately equal to the increase in the Feds balance sheet. This is not a coincidence. The banks are using repos, collateral transformations and rehypothecation to fund the short term lending needs of the shadow banking system. Money Market Funds MMMF) are now buying credit enhanced repos versus ABCPs
SAME GAME, NEW ACRONYMS The Acronyms in the Next Crisis

2008 FINANCIAL CRISIS THE NEW GAME
NEW STRUCTURES
SIV Structured Investment Vehicles
=> SFV Structured Finance Vehicles -> REPO Repurchase Agreements COLLATERAL TRANSFORMATION
SHORT TERM BORROWING ABCP Asset Backed Commercial Paper CREDIT ENHANCEMENT CDS Credit Default Swaps AAA Ratings LONG TERM LENDING MBS Mortgage Backed Securities Mortgages
=>
=>
ABS Asset Backed Securities Sallie Mae - Student Loans Car Loans
SECURITIZATION RISK OFFLOAD
CDO => CLO Collateralized Debt Obligations Collateralized Loan Obligations CDS => SAFEHAVEN CLAUSE

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HOW IT NOW WORKS
The Achilles Heel of this unscrupulous and instable structure is twofold. 1- Duration 2- Impaired Collateral
DURATION
Banking and specifically Shadow Banking is today built on Borrowing Short and Lending Long. This practice leaves the system exposed to any short term disruptions in lending. The nature of the worlds geo-politics, global complexity and financial fragility leaves it only a matter of time before we face another financial crisis. IMPAIRED COLLLATERAL Additionally, due to a protracted period of Zero bound interest Monetary Malpractice, this has fostered mal-investment, mispricing of risk and the suspension of effective price discovery. All of these are fallout from the Moral Hazard and Unintended Consequences of flawed global monetary governance.

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CONCLUSION
We learned nothing from the financial crisis of 2008. The banks have only passed off their mistakes to the public through regulatory arbitrage and now once again are declaring record profits as the US sees it middle class gutted. Unfortunately, the US consumer which has been the engine of global growth and is now tapped out with the exception of the Student Loan and Car Loan growth now the dominate credit growth element pumping through the veins of the shadow banking conduit. This is insufficent. Expect the government to soon find new ways increase Shadow Banking Credit creation.

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SHADOW BANKING - $71T and Now Bigger than the Global Economy SIZING THE GLOBAL SHADOW BANKING SYSTEM FSB's Global Shadow Banking Monitoring Report 2013 11-14-13 BIS The main findings from the 2013 exercise are as follows: According to the macro mapping measure , based on Other Financial Intermediaries (OFIs), nonbank financial intermediation grew by $5 trillion in 2012 to reach $71 trillion. By absolute size, advanced economies remain the ones with the largest non-bank financial systems. Globally OFI assets represent on average about 24% of total financial assets, about half of banking system assets and 117% of GDP. These patterns have been relatively stable since the crisis. OFI assets grew by +8.1% in 2012, helped by a general increase in valuation of global financial markets while bank assets were relatively stable as valuation effects were counterbalanced by shrinking balance sheets. The global growth trend of OFI assets masks considerable differences across jurisdictions, with growth rates ranging from -11% in Spain to +42 % in China. Emerging market jurisdictions showed the most rapid increases in non-bank financial system assets. Four emerging market jurisdictions had 2012 growth rates for non-bank financial intermediation above 20%. However, this rapid growth is from a relatively small base. While the non-bank financial system may contribute to financial deepening in these jurisdictions, careful monitoring is still required to detect any increases in risk factors (e.g. maturity transformation or leverage) that could arise from the rapid expansion of credit provided by the nonbank sector. Among the OFI sub-sectors that showed the most rapid growth in 2012 are real estate investment trusts (REITs) and funds (+30 %), other investment funds (+16%) and hedge funds (+11%). Of note that the growth rate for hedge funds should be interpreted with caution as the FSB macromapping exercise significantly underestimates the size of the hedge fund sector. The results of the recent IOSCO hedge fund survey provide a more accurate picture of the size of the hedge fund sector but do not provide an estimate of its growth

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SHADOW BANKING: Why the Fed Can't Stop Fueling the Shadow Bank Why the Fed Can't Stop Fueling The Shadow Bank Kiting Machine 06-03-13 Bill Frezza via Menckenism blog Fractional reserve banking is unlike most other businesses. It's not just because its product is money. It's because banks can manufacture their product out of thin air. Traditional commercial banks essentially create money through a well understood and time honored pyramiding of loans. Depositors who understand that their deposits are thereby placed at risk choose their banks accordingly. Under the bygone rules of free market capitalism, only one thing kept banks from creating an infinite amount of money, and that was fear of failure. Failure occurs when depositors come to believe that their bank has lent out too much manufactured money to too many dodgy borrowers and may not be able to cover depositors withdrawals. When this happens, depositors rush to reclaim their money while there is still some left, leading to the banks collapse. Under free market capitalism, banks compete along a spectrum of risk and reward. Conservative banks offer a higher degree of safety by maintaining larger reserves, thereby manufacturing and lending out less money. Through word and deed they let depositors know that they lend to only the most creditworthy borrowers, who generally must post valuable collateral. These banks remain profitable because they successfully attract prudent depositors willing to accept lower rates of interest. Banks of a more speculative bent offer a lower degree of safety, maintaining smaller reserves to create and lend out more money. Seeking higher returns, they often lend to less creditworthy borrowers who may put up poor quality collateral or none at all. These banks attract risk-taking depositors looking for a higher rate of interest. They can be very profitable during periods of economic expansion but often fall into distress during economic downturns. Periodic bank failures remind depositors of the connection between risk and reward. When caveat emptor rules, smart depositors who pay attention make money and dumb depositors who don't lose theirs. Because the latter outcome is intolerable in a democracy, we have government-provided deposit insurance and other taxpayer-financed backstops that shield most depositors from the risk of loss. In theory banks pay premiums to fund this insurance. In practice these premiums are not risk-based. Banks are not penalized for making riskier loans, in turn often leaving the premiums too low to finance payouts. This creates a huge moral hazard, as it frees depositors to seek the highest return without regard for safety. Worse, it removes conservative banks competitive advantage. Under a government-guaranteed deposit insurance regime, conservative bankers who want to stay in business must take on more risk in order to pay the higher interest rates necessary to attract depositors. This often sets off a race to the bottom, which results in periodic banking crises.

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After each of these crises, politicians promise taxpayers that it will never happen again . And each time it does, the government creates a new set of labyrinthine regulations that attempt to mimic the business judgment of conservative bankers. Minimum reserve requirements are established, which normally become the maximum as there is little advantage in exceeding them. And both depositors and the bankers themselves become complacent about the banks investments because it is so easy to privatize gains and socialize losses. Banks also learn that competitive advantage can be obtained by either gaming the regulations or having cronies write them. As regulations get more intrusive and complex, politicians discover that they can be used to advance social policies, such as increasing home ownership among voters with poor credit, thereby increasing the risk on banks loan books. This mixed economic system is the one that replaced free market capitalism in hopes that it would prevent bank failures. Despite, and some even say because of, a regulatory regime that discouraged conservative banking and rewarded reckless mortgage lending, the banking system crashed again - in 2007-2008. What is not widely appreciated is that the ensuing government bailouts allowed an underlying shadow banking system to not only survive but grow even larger. It is called the shadow banking system because it operates outside most government-regulated banking laws. This is primarily because regulations and accounting standards havent caught up with the practices of these banks, which are relatively new and poorly understood. It was the seizing up of the commercial paper and repo markets that funds the shadow banking system that abruptly halted the flow of liquidity that kept the mortgage bubble propped up. This revealed the underlying insolvency of Fannie Mae, Freddie Mac, and many commercial banks stuffed with subprime mortgage securities accumulated under the mixed economic system described above. Powered by an exclusive club of primary reserve dealers, a group that once included high flyers like Lehman Brothers, MF Global, and Countrywide Securities, these shadow banks work hand in glove with the Federal Reserve to manufacture money by pyramiding loans atop the base money deposits held in their Federal Reserve accounts. To the frustration of Keynesians, and despite an unprecedented Quantitative Easing (QE) by the Federal Reserve, conventional commercial banks have broken with custom and have amassed almost $2 trillion in excess reserves they are reluctant to lend as they scramble to digest all the bad loans still on their books. So most of the money manufactured today is actually being created by the shadow banks. But shadow banks do not generally make commercial loans. Rather, they use the money they manufacture to fund proprietary trading operations in repos and derivatives.

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EMERGING WORLD: COLLATERAL TRANSFORMATIONS, REHYPOTHECATION & SFV's
It is critically important to distinguish the interconnectedness between banks and different types of shadow banking entities. Different shadow banking entities are associated with different risk factors such as credit intermediation, maturity transformation, and leverage.

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Excerpt below taken from: Why the Fed Can't Stop Fueling The Shadow Bank Kiting Machine Bill Frezza via Menckenism blog Where does the pyramiding come from if shadow banks arent making loans that get redeposited to fuel the cycle? Securities held as collateral by counterparties in a repo contract can be rehypothecated by the lender to obtain additional loans. (So can securities held in customer accounts, unless their brokerage agreements expressly prohibit it. This was an unwelcome discovery by MF Globals hapless clients, who saw their assets whooshed off to London where different brokerage rules allow such hypothecation.) Loans made against securities held as collateral can then be used to either buy more securities, which can be fed back into the repo market, or trade a bewildering array of complex synthetic derivatives. If this sounds like circular check kiting thats because it is, especially when you add in the issuance of commercial paper required to grease the wheels. The biggest difference is that an embezzler kiting checks does not have the support of a central bank providing steady injections of liquidity, beefing up balance sheets that create confidence in their debt instruments. How much of the original high quality collateral must shadow banks hold in reserve should some of their derivatives implode, as many did during the last crisis? Zero. By repeatedly spinning the wheel, the top 25 U.S. banks have piled up over $200 trillion in leveraged bets atop a thinning wedge of collateral, claims to which are spread across an opaque and complex chain of counterparties residing in multiple legal jurisdictions. These collateral claims are co-mingled with an estimated $400 trillion to $1.3 quadrillion in notional outstanding derivatives made by other banks around the world, altogether amounting to more than 20 times global GDP. Due to the fact that accounting standards have not kept up with these innovative practices, banks are not required to report the gross notional value of the outstanding derivative contracts on their books, only their net asset positions. These theoretical Value at Risk positions, which would only be netted out if all the contracts were unwound in an orderly manneras one might unwind a check kiting scheme before getting caughtcan only be realized in a liquidity crisis if the counterparty chains across which these contracts are hedged hold up. These counterparty chains froze in spectacular fashion during the last financial crisis. After the collapse of Lehman Brothers and with the insolvency of AIG looming, a chorus of politicians, bankers, and bureaucrats browbeat the government into delivering a system-wide bailout. As a result, many reckless banks and bankers that should have been driven out of the market are back doing business as usual. The largest banks learned that they need not worry about the possibility of bankruptcy. When the next crisis hits, all they have to do is shout systemic collapse and another bailout will appear. Being Too Big To Fail, they can maximize profits without having to hold reserves against

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the risk of counterparty failure, knowing that the taxpayer will always be there to make them whole. The solution is not more regulations, which will never keep up with the financial wizards whose lobbyists end up writing these rules anyway. In addition, trades can be made anywhere in the world, so to be effective the regulations would have to be global. As long as governments continue to prop up failing banks, regulation will always be inadequate to mitigate the moral hazard that accompanies bailouts. And, ironically, the added costs of regulatory compliance will make it harder still for smaller and more prudent banks to compete. True to form, Congress has not solved the TBTF problem but has actually made it worse, loading ever more regulations on commercial banks through Dodd-Frank. Meanwhile, taxpayer exposure to the banking system has grown even larger. Optimists believe that as long as everyone remains calm and keeps believing everything is fine, then everything will be. Central planning advocates hope that the kiting scheme can be unwound by extending banking regulations to cover the shadow banks while the Fed somehow weans them off of Quantitative Easing. Cynics believe that asking Washington to get the situation under control is a hopeless quest, especially since few Congressmen have a clue what is really going on. Meanwhile uncertainty hangs over the system since bankruptcy laws, which differ from country to country, have not kept up with hyper-hypothecation. Moreover, the governments handling of the auto bailout shows that investors cannot rely on existing bankruptcy law even when it speaks clearly on an issue. Therefore, no one really knows who will have first dibs on the collateral when the music stops. And just what are those high quality assets? Sovereign bonds and mortgage CDOs, which are themselves subject to precipitous losses. As the debate drags on and global economic conditions worsen, the growing pyramid is being kept afloat by the easy money policies of central banks too frightened to withdraw their support lest a stock market correction trigger a cascade of margin calls that brings down the whole systemmuch like last time. All this money creation has not yet generated much visible consumer price inflation. This is partly because official inflation measures are suspect but mostly because the bulk of the new money being created is flowing into financial assets and not the consumer economy. This has inflated asset bubbles to levels impossible to justify based on underlying economic conditions, in particular the stock market where investors have fled in search of yield. No one knows when the bubble will pop, but when it does a donnybrook is going to break out over that thin wedge of collateral whose ownership is spread across counterparties around the world, each looking for relief from their own judges, politicians, bureaucrats, and taxpayers. When that happens and the clamor for regulation, nationalization, confiscation, and demonization arises there is only one thing we can be sure of. The disaster will once again be blamed on a free market capitalism that has not existed in this country for over 100 years. SHADOW BANKING - NEW YORK FEDERAL RESERVE - The Definitive Work on Shadow Banking & The Financial Crisis Shadow banks are best thought along a spectrum. Each of the seven steps involved in the shadow credit intermediation process were performed by many different types of shadow banks, with varying asset mixes, funding strategies, amounts of capital and degrees of leverage.

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CLICK TO ENLARGE The Post-Crisis Backstop of the Shadow Banking System - Pozsar, Adrian, Ashcraft, Boesky (2010) Once private sector credit and liquidity put providers' ability to make good on their "promised" puts came into question, a run began on the shadow banking system. Central banks generally ignored the impairment of such important pillars of the shadow banking system as mortgage insurers or monoline insurers. Once the crisis gathered momentum, however, central banks became more engaged. The series of 13 liquidity facilities implemented by the Federal Reserve and the guarantee schemes of other government agencies essentially amount to a 360 backstop of the shadow banking system. The 13 facilities can be interpreted as functional backstops of the shadow credit intermediation process. Thus,
CPFF is a backstop of loan origination and warehousing; TALF is a backstop of ABS issuance; TSLF and Maiden Lane, LLC are backstops of th e system's securities w arehouses (broadly speaking); Maiden Lane III, LLC is a backstop of the credit puts sold by AIG-FP on AB S CDOs; TAF and FX sw aps are backstops of and facilitated the orderly "on-boarding" of formerly off-balance sheet ABS intermediaries (many of them run by European banks who found it hard to swap FX for dollars); and finally,
On the funding side,
PDCF is a backstop of the tri-party repo system (a "platform" where MMMFs (and other funds) fund broker-dealers and large hedge-funds) and the AMLF, MMIFF and Maiden Lane II, LLC are backstops of various forms of regulated and undregulated money market intermediaries. Furthermore, the Treasury Department's Temporary Guarantee Program of MMMFs was an additional form of backstop for money market intermediaries. This program, together with the FDIC's TLGP can be considered modern day equivalents of deposit insurance.
Only a few types of entities were not backstopped by the crisis, and some attempts to fix problems might have exacerbated the crisis . Examples include not backstopping the monolines early on in the crisis (this might have tamed the destructiveness of deleveraging) and the failed M-LEC which ultimately led to a demarcation line between bank-affiliated and standalone ABS intermediaries (such as LPFCs or credit hedge funds) as recipients and non-recipients of official liquidity. These entities failed too early on in the crisis to benefit from the liquidity facilities rolled out in the wake of the bankruptcy of Lehman Brothers, and their

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demise may well have accelerated and deepened the crisis, while also necessitating the creation of TALF to offset the shrinkage in balance sheet capacity for ABS from their demise.
CLICK TO ENLARGE These appendixes, which depict graphically the processes described in the article, offer a comprehensive look at the shadow banking system and its many components.
Map : The Shadow Banking System www.newyorkfed.org/research/economists/adrian/1306adri_map.pdf Appendix 1 : The Government-Sponsored Shadow Banking System www.newyorkfed.org/research/economists/adrian/1306adri_A1.pdf Appendix 2 : The Credit Intermediation Process of Bank Holding Companies www.newyorkfed.org/research/economists/adrian/1306adri_A2.pdf Appendix 3 : The Credit Intermediation Proc ess of Diversified Broker-Dealers www.newyorkfed.org/research/economists/adrian/1306adri_A3.pdf Appendix 4 : The Independent Specialists-Base d Credit Intermediation Process www.newyorkfed.org/research/economists/adrian/1306adri_A4.pdf Appendix 5 : The Independent Specialists-Base d Credit Intermediation Process www.newyorkfed.org/research/economists/adrian/1306adri_A5.pdf Appendix 6 : The Spectrum of Shadow Banks within a Spectrum of Shadow Credit Intermediation www.newyorkfed.org/research/economists/adrian/1306adri_A6.pdf Appendix 7 : The Pre-Crisis Backstop of the Sh adow Credit Intermediation Process www.newyorkfed.org/research/economists/adrian/1306adri_A7.pdf Appendix 8 : The Post-Crisis Backstop of the Shadow Banking System www.newyorkfed.org/research/economists/adrian/1306adri_A8.pdf

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SHADOW BANKING - Safe Harbor Privileges The roots of shadow banking 01-16-14 Enrico Perotti The shadow banking sector is an ill-defined financial segment that expands and contracts credit outside the regulatory perimeter.
It was critical in the build up and demise of the credit boom. Shadow banking operates outside the regulatory perimeter, It replicates the structure of banking in many ways. Even proper banks use them to avoid stricter capital requirements, Shadow banking assets at the time of the crisis had grown larger than the banking sector proper. While much reduced since 2008, in the US its size still exceeded bank assets in 2011. The rapid withdrawal of funding to this segment played a major role in the credit crunch of 2007-2008. As such, its prudential standards should be brought into alignment to avoid further regulatory arbitrage. The decision by the Basel committee in these days to accept a relaxed definition of the leverage ratio, for which banks lobbied fiercely, appears a serious setback.
Defining shadow banking by function By definition, shadow banking is not a precise category. In this column, I focus on financial intermediaries that take credit risk. Banks acquire illiquid risky assets, funding them with inexpensive, demandable debt.
Most investors prefer safe, short term and liquid assets, so banks can use cheap funding, by promising liquidity on demand. This is made credible by deposit insurance and access to central bank refinancing.
Confidence on immediacy ensures that demandable debt is routinely rolled over, thus supporting long-term lending and high leverage.1 As bank credit volume is constrained by capital ratios and deposit base, financial markets have thought of new ways to carry risky assets on inexpensive funding. Shadow banking requires creating a variant of demandable debt, credibly backed by a direct claim on liquidity. But the dominant funding channel is issuing collateralised financial credit, such as repos or derivative-based claims.2 This is the source of shadow banks very short-term, inexpensive funding source. How can these liabilities deliver investors credible liquidity upon demand? Jump the running queue: Superior bankruptcy rights Security-pledging (the collateral part of collateralised financial credit) grants access to easy and cheap funding thanks to the steady expansion in the EU and US of safe harbour status the socalled bankruptcy privileges for lenders secured on financial collateral. Critically, lenders in this collateralised financial credit transaction can immediately repossess and resell pledged collateral. They also escape most other bankruptcy restrictions such as cross default, netting, eve-of-bankruptcy and preference rules (see Perotti 2010).
These privileges ensure immediacy for their holders. Unfortunately, they do so by undermining orderly liquidation, the foundation of bankruptcy law.

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The consequences became visible upon Lehmanns default, when its massive stock of repo and derivative collateral was taken and resold within hours. This produced a shock wave of fire sales of ABS holdings by safe harbour lenders. While these lenders broke even,3 their rapid sales spread losses to all others, forcing public intervention. When the safe harbour provisions were massively expanded in a coordinated legislative push in the US and EU (Perotti 2011),4 they supported an extraordinary expansion of shadow banking credit and mortgage risk taking. The guaranteed ease of escape fed the final burst in maturity and liquidity mismatch in the 2004-2007 subprime boom, where credit standards fell through the floor. Borrowing securities to generate collateralised financial credit While shadow banks expanded with securitisation, they can also rely on the liquidity of assets they do not own. They do this by borrowing securities from insurers, pension and mutual funds, custodians, and collateral reinvestment programmes.5 In exchange, the beneficial (i.e. real) owners of such securities receive fees for lending the assets and they book these as yield enhancement. Borrowed securities are then pledged to repo lenders (the short name for credit grantors in a collateralized financial credit transaction) or posted as margins on derivative transactions. Experienced asset managers who lend securities in this way protect themselves via collateral swaps, i.e. a related transaction where the security borrower pledges collateral of lower liquidity. This socalled liquidity risk transformation chain (which transforms illiquid assets into short term credit) may have more links. The financial logic behind the liquidity risk transformation chain is clear. Security pledging activates the liquidity value of assets from long-term holders who do not need it. Such extraction of unused liquidity value may be seen as enhancing financial productivity. It certainly increase asset liquidity, and boosts securitisation. Yet this can be an illusory gain, flattering market depth in normal times, at the cost of greater illiquidity at times of distress. The repo lenders and security lenders typically require a more than one-to-one exchange to protect themselves against the possibility of the collateral losing value. These ratios are called haircuts since each $1 of collateral generates less than $1 of credit. Shadow banking runs: Rising haircuts A jump in market haircuts, and ultimately a refusal to roll over security loans or repos, is the classic shadow bank run.
As a security borrower cannot raise as much funding from its own illiquid assets, it is forced to deleverage fast or goes bust.
In both cases this triggers fire sales.
Once repo lenders seize collateral, they have all reasons to wish to sell fast.
First, they are not natural holders. Second, they do not suffer from a fire sale as long as the price drop is less than their haircut. Third, they are aware that others are repossessing similar collateral at the same time, so they have an incentive to front sell.
In addition, real money investors that lost their original holdings are likely to sell the repossessed, less liquid collateral.
First, they may wish to re-establish their portfolio profile. More critically, they legally need to sell within days to be able to claim any shortfall in bankruptcy court.
This leads to a dramatic acceleration of sales for assets originally committed to a long holding period.
While central banks are not in charge of shadow banks, they do come under pressure to stop fire sales and create outside liquidity. This completes the banking analogy. The safe harbour debate It is now evident that shadow banks need the safe harbour privileges to replicate banking. No financial innovation to secure escape from distress can match the proprietary rights granted by the safe harbour status, which ensure immediate access to sellable assets. Traditional unsecured

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lenders have taken notice, and now request more collateral, squeezing bank funding capacity and limiting future flexibility. Many attentive observers find such an unconditional assignment of superpriority to repo and derivative claimants excessive.6 Duffie and Skeel (2012) discuss in an excellent summary the merit of safe harbour. In their words: Safe harbours could potentially raise social costs through five channels: (1) lowering the incentives of counterparties to monitor the firm; (2) increasing the ability of, or incentive for, the firm to become too big to fail; (3) inefficient substitution away from more traditional forms of financing; (4) increasing the market impact of collateral fire sales; and (5) lowering the incentives of a distressed firm to file for bankruptcy in a timely manner. All these arguments demand attention. Repo lenders and derivative counterparties enjoy not just immediacy in default, but also reset margins daily. By construction, this produces a unique safe claim. Just as insured depositors, these claimants can afford to neglect credit risk, and perform no monitoring role. Collateral lending, by splitting up liquidity transformation, lengthens credit chains and expands the number of connections among intermediaries, contributing to systemic risk (Gai et al. 2011). What should happen to the safe harbour privileges? The main proposals aim at restricting eligibility. Tuckman (2010) suggested only cleared derivatives should enjoy the status. Duffie and Skeel argue it may be limited to appropriately liquid collateral (thus not ABS!) and only transparent uses (derivatives listed on proper clearing exchanges). In recent research (Perotti 2011), I suggest that claims be publicly registered (just as secured real credit is) as a precondition for safe harbour status. This will ensure proper disclosure, essential to macro prudential regulators, and avoids unauthorised or misunderstood (re)hypothecation. Investors who wish to claim superpriority in distress seek a scarce resource. They should be paying for the privilege, and for any risk externality it creates. In normal times, a low charge should be levied on registered claims. Charges should be adjusted countercyclically, lowered in difficult times, and raised when aggregate liquidity risk builds up, to brake an otherwise uncontrollable expansion. Other approaches involve limiting the stock of safe harbour claims directly (Stein 2012) by a cap and trade model, which a registry receiving fees could support. A critical issue is the treatment of collateral posted for central bank refinancing. For central banks to operate as ultimate liquidity providers, their claims should not be undermined. A specific privilege for eligible collateral is justified, as central banks are by definition not likely to create fire sales. Conclusions Thanks to the safe harbour rules, a shadow bank can hold risky illiquid assets and earn full risk premia with funding at the overnight repo rate. In what is essentially a synthetic bank, repo and collateral swap haircuts act as market-defined capital ratios. Liquidity transformation across states and entities has procyclical effects. It enhances credit and asset liquidity in normal or boom times, at the cost of accelerating fire sales in distress. While any reform to the shadow banking funding model should take into account its favourable effects on asset liquidity and credit in normal times, the associated contingent liquidity risk is not at present controllable (nor is it well measured!). There is an academic consensus that a balance has to be struck (Acharya et al. 2011; Brunnermeier et al. 2011; Gorton and Metrick 2010; Shin 2010). Appropriate tools are also necessary to align capital and risk incentives in banks and shadow banks (Haldane 2010). Security lending may also undermine Basel III liquidity (LCR) rules. At a time when all lenders seek security, questioning the logic of safe harbour provisions may seem unwise. Yet at the system level, it is simply impossible to promise security and liquidity to all. Uncertainty on the stock of pledged assets may create a self-reinforcing effect, feeding a frenzy among lenders to all seek ever-higher priority. This is already taking place, and is ultimately unsustainable at the individual and aggregate level.

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Finally, it is questionable whether the highest level of protection should be granted to collateralised lenders, and to shadow bank funding, over all other investors. For all these reasons, regulators and the wider society need to make an informed decision. References Acharya, Viral, Arvind Krishnamurthy, and Enrico Perotti (2011), A consensus view on liquidity risk, VoxEU.org, 14 September. Acharya, Viral and Sabri nc (2012), A proposal for the resolution of systemically important assets and liabilities: the case of the repo market, CEPR DP 8927, April. Brunnermeier, Markus, Gary Gorton, and Arvind Krishnamurthy (2011), Risk Topography, NBER Macroannual 2011. Duffie, Darrell and David Skeel (2012), A Dialogue on the Costs and Benefits of Automatic Stays for Derivatives and Repurchase Agreements, Stanford University, March. Haldane, Andrew (2010), The $100 Billion Question, Bank of England, March. Gai, Prasanna, Andrew Haldane, and Sujit Kapadia (2011), Complexity, Concentration and Contagion, Bank of England discussion paper. Gorton, Gary, and Andrew Metrick (2010), Regulating the Shadow Banking System, Brookings Papers on Economic Activity, (2):261-297. Perotti, Enrico (2010), Systemic liquidity risk and bankruptcy exceptions, VoxEU.org, 13 October. Perotti, Enrico (2011), Targeting the Systemic Effect of Bankruptcy Exceptions, CEPR Policy Insight No. 52 and Journal of International Banking and Financial Law (2011) Shin, Hyun Song (2010), Macroprudential Policies Beyond Basel III, Policy memo. Stein, Jeremy (2010), Monetary Policy as Financial-Stability Regulation, Quarterly Journal of Economics, 127(1):57-95. Tucker, Paul (2012), Shadow Banking: Thoughts for a Reform Agenda, Speech at the European Commission High Level Conference, 27 April, Brussels. Tuckman, Bruce (2010), Amending Safe Harbors to Reduce Systemic Risk in OTC Derivatives Markets, Centre for Financial Stability, New York.
1Historically, confidence was supported by high capital, reputation and limited competition. As competition increased and capital fell, central banks emergency liquidity transformation and deposit insurance allowed steadily higher credit and bank leverage. 2Trivially, shadow banks may also access bank credit lines (as SIVs did). 3The rest of the creditors had to wait years to get less than 20 cents on the dollar. 4Limited safe harbour status was granted as exceptions in the 1978 US Bankruptcy code, limited to Treasury repos and margins on futures exchanges for qualifying intermediaries. They were broadened progressively to include margins on OTC swaps. The massive changes took place in 2004, when any financial collateral pledged under repo or derivative contracts, whether OTC or listed, by any financial counterparty, came to enjoy the bankruptcy privileges (Perotti 2011). 5According to Poszar and Singh (2011): At the end of 2010.. about $5.8 trillion in off-balance sheet items of banks related to the mining and re-use of source collateral down from about $10 trillion at year end-2007. 6Creation of new proprietary rights is exceedingly rare. Limited liability is the last main case.

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ARCHILLES HEEL: DURATION & COLLATERAL RISK
DURATION

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CONCLUSION
The Shadow Banking System is almost completely unregulated. I. II. How can a $72 Trillion banking function which is larger than the highly regulated Banking System go unregulated? How can a $700 Trillion OTC, Off-Balance Sheet, Off-Shore, Unregulated SWAPS market go unregulated?
The global GDP is smaller than the Shadow Banking System and less than 10% of the SWAPS market. Until we can answer these questions we should conclude that risk is mispricing and price discovery for global financial markets is obscured!

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Gordon T Long Publisher & Editor

Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments. Copyright 2014 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or suggestions you receive from him.

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SHADOW BANKING RE-EMERGENCE

New Acronyms & Vehicles, Same Game

Gordon T Long 2/18/2014

February 2014 Edition 1

SHADOW BANKING RE-EMERGENCE

FEBRUARY MONTHLY MARKET COMMENTARY

February 2014 Edition 2

February 2014 Edition 3

February 2014 Edition 4

Defining Chart #1 - "Delusional Distortion" Expectations & the Log-Periodic Cycle

February 2014 Edition 5

Defining Chart #2 - Finding the Longer Term Super Cycle Pivot b

February 2014 Edition 6

POSSIBILITY OF AN EVEN LOWER BOTTOM

February 2014 Edition 7

Defining Chart #3 - The Big M and Super Cycle b

February 2014 Edition 8

The 2 Std. Deviation Band on 12 MMA NEEDS TIME TO CURL

February 2014 Edition 9

Defining Chart #4 - Short Term Small M Top Turmoil

February 2014 Edition 10

February 2014 Edition 11

- 1950 Top in Late Q4 2014 or Early Q1

February 2014 Edition 12

III- QUARTERLY KEY METRICS & ASSESSMENT UPDATE

A - LONG TERM: Fundamentals

February 2014 Edition 13

February 2014 Edition 14

B - INTERMEDIATE TERM: Risk

February 2014 Edition 15

C - SHORT TERM: Sentiment

February 2014 Edition 16

Consumer Confidence Collapses - Biggest Miss On Record

February 2014 Edition 17

February 2014 Edition 18

IV - MONTHLY RISK & PATTERNS

This level of complacency

Has BEGUN To Increase since US Budget Impasse

With Plummeting Economic Confidence

February 2014 Edition 19

And this Degree of Fragility and Instability

February 2014 Edition 20

With a Bond Market ready to reverse

Suggests a RISK-OFF short Term in US Equities

February 2014 Edition 21

Should Offer Support for a Santa Claus Rally.

Ghost of 1929 Re-Appears - Pay Attention to the Signals

February 2014 Edition 22

1997 Peso Crisis Asian Crisis Intervention Run-ups

February 2014 Edition 23

STUDY: Dotcom Level Euphoria

STUDY: Capital v Money: Liquidity v Credit

February 2014 Edition 24

STUDY: Margin & Leverage

February 2014 Edition 25

This requires some sort of correction before extending much higher.

February 2014 Edition 26

STUDY: DIVIDENDS & BUYBACKS

February 2014 Edition 27

February 2014 Edition 28

February 2014 Edition 29

VII - DRIVER$ & BIA$