Posts Tagged ‘banks’

Thinking of shorting Australian house price?

Tuesday, May 10th, 2011

Recently, we received an email from one of our readers:

Just wondering if you’d like to touch on possible investment ideas for hedging australian real estate?

I’ve had a look at puts on the banks before but the banks have mortgage insurance along with an implied guarentee from the gov so I was thinking that while their may be some correlation, it may not be as high as one would like when the chips are down.

As such any other possible hedging ideas would be appreciated, ideally it would have to be highly leveraged to act as a suitable hedge.

Looking at other places that suffered a debt/property collapse with a low housing supply may be a good place to start? (UK?)

Today, we will talk about this topic. We haven’t talked about Australian property for quite a long time. But you can read through our old archives and know where we stand on this topic. Also, please take note that nothing that is said in this blog should be construed as financial advice. Instead, we are just voicing out our ideas and suggestions for discussion and brainstorming. With that disclaimer, let’s dive into it.

It is no secret that Australian house price is heading for stagnation at best and a crash at worst. Even the most optimistic forecasts from the vested interests call for stagnation. Already, house prices in Perth have been falling for over a year already. There are reports of rising supply of homes for sale while at the same time, demand is weak and auction rates are weakening.

So, if you reckon Australia is heading for a house price bust, what are the ideas for shorting/hedging Australian house prices? Since there exists no financial instruments that can short Australian house prices directly, we can only do so indirectly through the side-effects of falling prices.

First, before we run off to take up short positions, it is helpful to envisage a few possible scenarios:

  1. Professor Steve Keen sees that we are facing a scenario whereby house prices fall 40 percent in nominal terms over a period of say, 15 years. That’s basically the Japanese scenario whereby the housing bubble deflate with a slow hiss. In this case, the fall in prices will be so slow (a few percent a year) that it becomes almost imperceptible.
  2. A rapid fall of say 10-15% followed by slow deflation.
  3. A big crash of say, 40-50% in a short period of time, say a couple of years.

In the first scenario, there is nothing much to short. The economy may be able to muddle through in stagnation for a very long time.

In the second scenario, the banks will suffer heavy losses but they will probably survive. The obvious idea is to short the bank shares. In this scenario, we can imagine consumer spendings will be depressed as well. Therefore, shorting retail related stocks is another idea. Property developers and builders will be shorting candidates as well. In this scenario, we imagine that the AUD will be weak as well, as the RBA will have to cut interest rates.

The third scenario will be the nightmare scenario. Such a precipitous fall in house prices will put the Australian banking system in serious trouble. For one, since property is the most popular collateral for lending in Australia, a house price crash will result in a credit crunch. As you can see what happened in the United States during the GFC, a credit crunch result will ultimately result in rising unemployment, which will in turn will feedback into a second round of effects into the economy through more mortgage debt defaults. If the entire banking and financial system falls into deep trouble, we will likely see an AUD currency crisis (see Will there be an AUD currency crisis?). In this scenario, we will not even bother to short Australian banking stocks. The financial and economic situation in Australia will be unpredictable and volatile. As we wrote in Protecting yourself against currency crisis.

Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF. If not, stock up some physical cash (both foreign and local), physical gold and silver (see our book, How to buy and invest in physical gold and silver) and supplies- these will tide you over while the sh*t is hitting the fan. For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).

Even if the AUD is to survive, we may witness rising interest rates as the RBA sought to defend the AUD from speculative sell-off.

Now, some people may ask, what if the Commonwealth government bail out the banks? Will that avert a crisis?

The problem with this question is that the word “bail out” is too vague. Does that question ask whether the government will bail out depositors? We imagine the government will do that. But does it mean that the government will bail out depositors and bank bond holders? Or even better still, will the government bails out depositors, bank bond holders and bank stock holders? Obviously, the more stakeholders the government bail out, the more expensive it is going to be. Will the government be able or willing to fork out that much?

With that, we turn to our readers. What are your thoughts and ideas?

Deleveraging in the Australian economy bites

Sunday, March 6th, 2011

If you read the newspaper headlines and billboard advertisements recently, you may notice something interesting (if not, strange) happening. National Australia Bank (NAB) announced that it is ‘breaking up’ with the rest of the banks in a new campaign. That immediately provoked reactions from the other banks, including Suncorp with its “breaking up” theme in a recent billboard advertisement.

Soon, bank investors are fretting about a price war among the banks, which means the race is on to the bottom for profits. As this news article reported,

Investors are becoming nervous about the prospect of a price war breaking out between the banks, with one major brokerage labelling the attacks a ?negative sum game?.

What on earth is happening?

Only as recently as four months, politicians were aiming their gun sights on the banks for ‘lack’ of competition, when Commonwealth Bank (CBA) initiated a rise in their mortgage rates that was almost twice the rate rise of the Reserve Bank (RBA). There were talk about building a “fifth pillar” in the banking system. Today, the banks seem to be starting a price war among themselves, in a race to the bottom.

Well, the reason is dead simple. To put it simply, banks are in the business of lending money. That’s their core business. As we wrote before in The dark side of rising bank profits,

One way to make more money is to increase lending.

Banks, as publicly listed companies in the stock exchange, are always under pressure to increase their profits year after year (i.e. seek growth). Heavens forbid that their profits ever fall! All hell breaks lose if that ever happens!

But there’s one big problem for them today- the savings rate of Australians have shot up to 10%, which is the highest since the early 1990s! That means that Australians are saving more money and repaying their debts. In other words, the Australian economy is now undergoing a deleveraging process. Consequently, it is becoming harder for the banks to make more money by lending more money. A very crude (and thus, inaccurate) analogy would be to compare the banks to dogs fighting among each other for a shrinking pie. As that article reported,

The infighting is an indirect result of the sluggish credit market, with banks under pressure to find growth, the report said.

What does this mean for the Australian economy?

As we explained in detail in Significant slowdown for Australia ahead?, deleveraging sucks away the aggregate demand from the economy. The first to get hit will be the retail sector that is related to discreditionary spending. The structural shift of Australian consumers from shopping in retail stores to shopping in the Internet is a symptom of deleveraging.

Given that the retail sector accounts for approximately 60% of the economy, continuation of this structural shift in consumer behaviour imply that more pain is in store for the retail sector.

Dumb politicians trying to push interest rates down

Thursday, December 2nd, 2010

In Australia, banks are very unpopular. They are seen by the public as greedy blood-suckers who are out there to rip the people off with fees and oppress them with debt repayments. Thus, when the Big 4 oligopolistic banks raised mortgage rates by up to twice the increase in rates by the Reserve Bank, there was an outcry by the heavily indebted majority.

As a result, politicians have to be seen to be doing ‘something’ to rein in the ‘greedy’ bankers. They have to engage in populism by coming up with policies to improve ‘competition’ in the banking sector in order to put downward ‘pressure’ on interest rates. But as we wrote two years ago in Support mortgage lenders to keep borrowers in indentured servitude?,

These economists do not understand the concept of competition. In the real economy, competition means utilising scarce resources in a more efficient way to produce more, create new products or make better products. But for the mortgage industry where the product is credit, how can the idea of ?competition? be applied when the product (money and credit) can be created limitlessly out of thin air by the government (central bank) and financial system?

If higher interest rates are that evil, why bother with difficult policies to put downward ‘pressure’ on interest rates? Why not legislate interest rates to zero? As we wrote in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

Think about this: if raising interest rates is ?bad? and cutting interest rates is ?good,? then why don?t the RBA set interest rates to zero, thereby putting the economy into a path of eternal boom (plus runaway inflation)? For those who think this is a good idea, then this article will set to let you understand why this is a bad idea.

Politicians are toying with the idea of introducing a fifth pillar to the banking system (in addition to the current Big 4) to increase ‘competition.’ But the fact that they are thinking about this shows that they are either dumb or extremely short-sighted. For example, as this article reported,

CREATING a ”fifth pillar” of banking through building societies and credit unions would require small players to almost triple their lending levels within four years, analysts say, raising questions over its impact on financial stability.

Australia’s housing debt is already equal to 82 per cent of gross domestic product, one of the highest proportions in the world. He said competition and financial stability had an ”inverse relationship,” a point demonstrated in recent years.

”There was no shortage of mortgage competition in the US and [Britain] between 2000 and 2007,” Mr Mott wrote.

Oh dear! Do we need to teach our politicians how to spell “SUB-PRIME?”

Furthermore, our Reserve Bank (RBA) had already explicitly said that they take into consideration the banks’ interest rates when they set their monetary policy. So, it follows that any downward pressure on mortgage rates will mean that the RBA has to increase interest rates even more.

If the idea of fifth pillar is not harmful enough, both side of politics are considering an even more insidious idea in to put downward ‘pressure’ on mortgage rates- they are considering allowing banks to issue covered bonds to make credit cheaper and more available.

Just what are covered bonds? Take a read at this news article,

Historically, regulators have banned banks from issuing [covered bonds] as they are at odds with legal requirements that depositors rank first in claiming bank assets if a bank fails – a cornerstone of the Australian banking system.

In other words, covered bond investors have a higher claim to the bank’s asset than depositors! Someone wrote of this idea as

The reason covered bonds are cheaper to issue is because they are stealing from the security enjoyed by depositors under existing banking laws. No complicated financial structuring… just straight-up queue jumping.

If the ban on covered bonds are lifted in Australia, how secure will depositors be when the government guarantee on deposits expires next year?

Now, with dumb politicians coming up with dumber and dumber populist policies, Australian investors should now be planning exit strategies for their risky cash at bank!

Credit problems in China

Sunday, August 8th, 2010

Last Friday, we asked our readers: Do you think China will crash soon? The results are pretty interesting. Almost 29% of you reckon that China will crash in a few years time. Almost the same number reckon that China will not crash as far as the eye can see. The rest are scattered throughout the other response. From what we can see, most of you do not think that China will crash anytime soon.

Today, we will talk about credit in China?s banking system.

In Western countries, central banks cannot force the private sector to borrow.  As we wrote in What makes monetary policy ?loose? or ?tight??,

To understand why, we have to remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

Apparently, this is not so in China. The Chinese government, which has greater administrative powers than Western governments, can force feed credit into the economy. The result: bad debts.

Professor Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management in Beijing, has concerns about the Chinese banking system. He wrote two articles detailing its weaknesses:

Chinese Banks At Risk, Part 1
Chinese Banks at Risk, Part 2

The question is, can there be a Western-style credit crisis in China?

Looming Black Swan that can bring the market back into panic

Thursday, August 6th, 2009

The Panic of 2008 ended in March 2009, when the S&P 500 fell to a low of 666 points. After that, the stock market, emboldened by optimism of “green shoots” of recovery, embarked on a powerful rally that was briefly interrupted by a small correction in June.

Today, the stock market is in an extremely technically overbought level. In lay-person’s speak, the stock market has arrived at a very bubbly level. This implies that the market is overdue for a trend reversal. But that does not necessary mean it is imminent because we have respect for this market rally.

For investors, what should they do?

If you have substantial long positions in the market, we believe this is the time to put on your hedges (e.g. long put options, short deep-in-the-money call options, stop losses, guaranteed stop losses, short CFDs on long positions, take some chips off the table, etc). For those who missed out on the March-June rally, Marc Faber advised at his latest market commentary that they should wait for a correction before entering the market.

What can possibly trigger a major correction? We looked high and low and found one possible Black Swan in one corner of the earth- Lithuania. In fact, this Black Swan may even trigger more than a correction- it can trigger another panic though it is hard to quantify how great that panic will be, given the propensity of the Fed to print money. As this news article reported,

Lithuania?s new president has admitted that her country could be forced to seek help from the International Monetary Fund if it fails in efforts to raise more money from foreign capital markets to prop up its teetering economy.

The fate of the Baltic economies is being watched across Europe amid fears that they could trigger devaluations and defaults in eastern and central Europe.

Sweden and other Nordic countries are especially sensitive because their banks expanded aggressively in the region and now face a rising tide of bad loans.

As the RBA’s most recent statement on yesterday’s interest rate decision said,

There is tentative evidence that the US economy is approaching a turning point, but conditions in Europe are still weakening.

The “green-shoots” can hardly be found in Eastern Europe (more generally, the “emerging” economies). Many European banks are highly leveraged to Eastern Europe.The following is the list of emerging market debt exposures of European nations:

Austria – 85% of GDP (Central & Eastern Europe)
Switzerland – 50% of GDP
Sweden – 25% of GDP
UK – 24% of GDP (mainly Asia)
Spain – 23% of GDP (mainly Latin America)

In contrast, the US amounted to only 4% of GDP.

Richard Karn wrote in his soon to be released book, Credit and Credibility,

Today, although the situation has improved in step with global equity markets, Western European bank exposure to Central and Eastern Europe alone exceeds $1.6 trillion.

The recent news of Lithuania can be a portent of more Black Swan contagion in Europe.

The following is the list of Central European refinancing needs in 2009 as a percentage of foreign exchange reserves:

Estonia – 346%
Latvia – 341%
Lithuania – 204%
Poland – 141%
Croatia – 136%
Bulgaria – 132%
Romania – 127%
Ukraine – 117%
Turkey – 110%
Hungary – 101%
Czech Republic – 89%
Kazakhstan – 82%
Russia – 34%

As Richard Karn continued,

Because the European central bank has not embraced quantitative easing and Western European banks have written down so little debt, especially compared with their US counterparts, a number of commentators contend the banking crisis has yet to fully hit Europe. Essentially, because European banks employed more leverage, they have less freedom to mark down debt, which makes them vulnerable in these conditions. In addition to the situation in Central and Eastern Europe, Western European banks face substantial US property losses they have yet to recognize, and are exposed to euro zone corporate debt to the tune of $11 trillion, equaling 95% of the combined economy, compared with US exposure of roughly 50%. If this were not enough, a significant portion of the Russian banking industry is under considerable stress, with $280 billion of a total $400 billion in debt to European banks being due in the next four years, and the issues regarding repayment and threats of non-payment that rattled markets regularly earlier in the year have yet to be resolved.

A contagion from Europe can easily trigger another global panic. That’s the reason why Kevin Rudd is not ready to declare “Mission Accomplished” for Australia with regards to the global recession (unlike the sheeps in the financial markets).

Watch this space.

What goes in the mind of the Rudd government as it extends FHOG?

Tuesday, June 2nd, 2009

As we all know, the Rudd government recently extended the increased First-Home-Owner-Grant (FHOG). The FHOG grant in itself is so controversial that even government advisers are questioning the wisdom of that scheme (see Rudd advisers criticise home buyers grant). Government propaganda hailed the FHOG as a means to help young Australians achieve the Great Australian Dream of home ‘ownership.’

Sadly, a lot of young people fell for that propaganda. One of the first tools of propaganda is to subtly twist the meanings of words.

For example, when a person borrows money to ‘buy’ a home, he/she do not really own that home in the first place. Instead, what happened was that the home ‘buyer’ had basically entered into a financial lease contract with the bank. The home ‘owner’ may have more freedom than a renter, but he/she has more responsibility in return. A large part of that responsibility includes financial accountability and trust to repay debts. There are many anecdotal reports that many first home ‘owners’ are not acting very responsibly.

There are also many applause that housing has never been more ‘affordable’ than before, due to record low interest rates. But the vested interests who gave the applause forget why interest rates are so low in the first place. The whole point of the RBA slashing interest rates is to reduce the debt servicing burdens of Australians (in the face of forecasted rising unemployment), not to encourage them to gouge on more debt. The FHOG, by its very nature, defeats this purpose by encouraging young Australians to go further into debt. Most worryingly, when interest rates are at record low, most of these first home owners are not hedging their gamble by fixing their mortgage rates. When the time comes for raising interest rates, many of these ‘affordable’ homes will become unaffordable.

Obviously, the Rudd government’s FHOG policy is a bad policy that will do more harm to Australia in the longer term. We are sure the government knows this. Yet, why did they go ahead with that foolhardy scheme, knowing that it is foolish in the first place?

Well, our theory (or rather, speculative guess) is that the real reason is not as stated in the propaganda (i.e. ‘helping’ young people achieve that ‘dream’). Instead, the true reason is to prop up (and if possible, blow a bigger price bubble) property prices for as long as possible, until China comes to rescue us. Why should property prices be artificially propped up? Let’s take a look at this chart:

Housing share of total private debt

As you can see, for the past 20 years, housing loans take up a larger and larger portion of the total private debt in Australia. At its peak in January 2005, housing accounts for 55.6% of debt. As in March 2009, it is slightly down to 53.1%.

At the same time, every mainstream economist are forecasting significant rise of unemployment rate. And as we said before in RBA committing logical errors regarding Australian household finance,

Given Australia?s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises. As unemployment rises (which all mainstream economists in the government and private sector are forecasting), it will eventually reach a critical mass of prime debts turning sub-prime. Once this critical mass is reached, the deterioration in the Australian economy will accelerate (see what?s happening in the US and UK today).

Rising unemployment will result in rising number of housing loans going bad. With housing loans taking up more than half of all debts in Australia, the sheer number of bad debts will threaten the stability of Australia’s banking system (bear in mind the amount of leverage in Australia’s banking system. See Small loan losses can wipe out banks). Unless…

What if the government succeeds in propping up the ‘value’ of the collaterals (homes) under-pinning the bad debts? In that case, the banks can take over the homes (and not liquidate in a distressed market), replace the bad debts in asset column of their balance sheets with homes with values that were artificially propped up (with the FHOG). We can imagine the Rudd government introducing some kind of scheme in which the banks rent the home back to the former home owner.

In addition, the government can implement another scheme to let the bank’s unemployed debtors to go on a repayment holiday (while interest payments get capitalised). That way, there wouldn’t be forced mortgagee sales to deflate house prices and coupled with FHOG to prop up the ‘value’ of homes, the accounting losses in the banks can perhaps be minimised?

Once the banking system goes down, the government will have to fork out up to AU$1 trillion in money (see Australian government?s contingent liability to exceed AU$1 trillion), which most likely mean Australia will have to print copious amount of money. Should that happen, the Australian dollar will be trashed and the government bonds will become junk bonds.

The question is, will this gamble succeed?

Small loan losses can wipe out banks

Thursday, April 30th, 2009

This week, Australian banks are confessing to profit downgrades. One of the chief reasons for reduced profit is the rise of bad debts. Also, banks are setting aside greater provisions for bad debts. That is, as we wrote before in Is a bank safe if it makes good profits?,

… banks will guess how much of its loans will default or be delinquent and apportion a small fraction of them as an expense. But until debt defaults really happen, a guess is just a guess.

Now, as you read the mainstream media, you may see positive spin being painted for the bad debt provisions by comparing their ‘miniscule’ size with the size of the entire loan portfolio. For example: “$1 billion of provisions for bad debt is only 1% of the entire loan portfolio.”

Well, small size (of bad debt provisions) can be very deceiving! Why?

Remember the concept of capital ratio that we introduced in Introduction to banking corporate accounting? Let’s say a bank is leveraged 25 times, it means they have a capital ratio of 4%. In this case, if 1% of their loans go bad, 25% of their equity are wiped out. If 4% of their loans go bad, the bank is completely wiped out and is insolvent.

Australian banks are more leveraged than their overseas peers, according to Brain Johnson, the former bank analyst of JP Morgan (see How safe are Australian banks?). So, a small proportion of loans going bad can have a more than proportionate impact on the bank’s balance sheet due to leverage.

Is a bank safe if it makes good profits?

Sunday, April 19th, 2009

The masses dislike the banks immensely. In Australia, we read news report that the banks’ profits were higher today compared to last year. The masses surmised that since their profits have increased, they must be doing well. In addition, some of those who are very optimistic about Australia’s banking sector will cite the increased profits as the basis to support their optimism.

So, just because a bank is making good (and rising) profits, does it mean it is safe? The short answer is “No!”

Remember what we said in Banking for dummies, we said that

At its very core, a bank borrows money at lower interest rates and lends them out at higher interest rates. Its borrowings are its liabilities while its lendings are its assets. When you deposit your money into the bank, your money is the bank?s liability but your asset. In accounting technicalities, your money goes into the bank?s balance sheet as an asset with a corresponding liability.

As we said earlier, a bank profits by taking a cut between its borrowing and lending interest rates. If it keeps too much deposit money in the ?vault,? it is money that is not put in productive use and thus, have a negative impact on its profits. On the other hand, lending money out entails risks of debt default.

Basically, all a bank has to do to increase its profits is to lend more money! This increase in profits is highly visible in the profit and loss statements. But what is much less visible is the increase in debt default risks of its loans. Typically, banks will guess how much of its loans will default or be delinquent and apportion a small fraction of them as an expense. But until debt defaults really happen, a guess is just a guess. If their guesses are wrong by a long shot, the result will be asset write-downs, which will result in unexpected losses.

Assuming that Australia is going to face a serious bout of debt deflation soon, we can imagine many of the banks’ guesses will be revealed as laughable underestimates. Even if the banks realise today that their guesses are way off from reality, we can imagine that they will be loathed to confess because that will imply huge profit downgrades.

The Australian government better warm up their monetary printing press to be ready for the activation of their bank deposit guarantees, just in case.

What will be the impact of government interventions on investing?

Thursday, January 29th, 2009

In our previous article (Are government interventions the first steps towards corruption & inefficiencies?), one of our readers asked,

… I have been wondering what the impact on government interventions will be for investing… What if one was to invest in Blue Chips, with the idea that they are ?too big to fail? (gov. intervention likely) and are therefore very safe?

He had brought a very good point.

Let’s say you have very strong reservations regarding investing in Australian banks (see How safe are Australian banks?). Based on your own assessment of the fundamentals, you make the decision not to invest in banks (if you are a trader, you may decide to short the banks). But then, you receive some tips from banking ‘insiders’ that the recent flight out of bank stocks is a fantastic buying opportunity. You are told that bank shares are so cheap that you will make a lot of money in a few years time if you buy them today. Naturally, you laughed at those ‘insiders.’

But they were right.

A few years later, they end up laughing at you instead. Let’s suppose that your fundamental analyses of the banks are correct. So, what went wrong?

Government intervention.

As we said before in Are government interventions the first steps towards corruption & inefficiencies?,

They [bailouts and rescues] are inherently unfair because the government will have to act as the judge and decide which businesses/industries should live and which ones should die. Unfairness, by its very nature, implies preferential treatment. What is the government?s basis for favouring one business/industry over the other?

So, in your case, the government bailed out the banks (which is happening right now in the US and UK) in such a way that shareholders are protected. If you are a trader, shorting the banks will lead to heavy losses.

From this example, you can see that when government intervenes, the market is no longer completely free. When the market is no longer completely free, it means that the rules change abruptly in the middle of the game. When that happens, those who ought to lose become winners and vice versa. Incompetency is rewarded and competency is punished (indirectly through taxes).

Imagine, what will happen if there’s a soccer match whereby the umpire is allowed to change the rules abruptly any time he wants? In such a world, it’s either that bribery will abound or no one wants to play the game. The same goes for the economy. A half-free market will discourage the capitalists and entrepreneurs and encourage cronyism, corruption and speculation.

That’s one of the reason why in such an environment, the Warren Buffett way is dead. That’s why Marc Faber said this is a traders’ market. It’s possible that we will see Warren Buffet’s long-term track record flounder in the years ahead.

Banks’ strategic behaviours unleashing waves of job cuts

Thursday, December 18th, 2008

Since the credit crisis first erupted 15 months ago, the problem was mainly confined to the financial side of the economy. Today, we are seeing signs of the crisis spreading to the real economy in far-flung countries like Australia. As Australian banks expected to sack staff reported,

Jobs are disappearing at the four major retail banks, and staff freezes have been ordered at investment banks and struggling fund management groups.

There are news reports that 10,000 banking jobs could go in the months ahead. While we will not be investigating the credibility of this number in this article, we will explore the concept of Game Theory using banking jobs as an example.

In essence, Game Theory is…

… a branch of applied mathematics that is used in the social sciences (most notably economics), biology, engineering, political science, international relations, computer science (mainly for artificial intelligence), and philosophy. Game theory attempts to mathematically capture behavior in strategic situations, in which an individual’s success in making choices depends on the choices of others.

In the banking jobs example, what if one of Australia’s major banks decide to cut staffs? What will be effect of this strategic decision on the other banks?

To put it simply, if XYZ bank restructures its business and cut, say 15% of its workforce, it will have a competitive advantage against the other banks in terms of costs. During hard economic times, people are tightening their belts and consumer spending will be down. Naturally, consumers will care less about product differentiations and care more on finding the cheapest bargains. Therefore, businesses that can lower their costs will have a price competitive advantage against their rivals. So, in this case, what will the rivals of XYZ banks do? They will follow XYZ’s lead of restructuring and cutting staffs.

That’s why in the months ahead, as the economy slows further, we will see waves of corporate restructures and staff cuts. Unfortunately, these actions by businesses will further depress the economy, which in turn will provoke the next wave of cost cuttings.