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Fed Now and The Crossroads to a Global Digital Payments Economy

The Biggest Upgrade to the US Financial Payment Rails Since SWIFT

The biggest upgrade to the payment rails of the US financial industry - since the SWIFT system was introduced in 1973 - is going to be unveiled in July 2023. The system known as FED NOW will enable instant payments that take seconds to complete and can occur 24/7, 365 days a year, all with integrated clearing functionality allowing financial institutions to deliver end-to-end instant payment services to their customers. This means the recipient of funds will have immediate availability and access to utilize these funds. To put this in perspective ACH transfers typically take anywhere from one to three business days to complete, domestic wire transfers can take 24+ hours to complete and international wire transfers can take up to a week to complete. Fed Now will not replace the Automated Clearing House Network (ACH) - at least not anytime soon - and is expected to complement ACH services. However, the writing is clearly on the wall as Fed Now grows its track-record, adoption, sophistication, and capacity.

Instant payments are digital payments which have the capacity to be "programmable" and generate rich data. What is rich data? Rich data is the process of compiling data to determine when and where a person is most likely to buy something, as opposed to relying on trend forecasts. Rich Data is used to predict consumer behavior. While this may sound like a godsend to businesses of all types as well as the Federal Reserve and other agencies who rely on financial data for forecasting and decision making, this "potential to invade privacy" will simultaneously cause consumers to sound the "alarm". Who wants their every transaction to be trackable?

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The Three Interests Shaping The Economy

THE THREE INTERESTS SHAPING THE ECONOMY

Self Interest, Government Interest & The Inverted Yield Curve Interest

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AI, The Singularity & Quantum Leap Beyond

In this article we are going to discuss the evolution of AI, its origins and development to here and where it may be heading. Many books have been written on the subject, so this is going to be a short but hopefully informative and abbreviated history to here and a peak into the beyond. We will continue to write about the evolution of AI in our blog and bi-monthly newsletter and build upon this article.

The Singularity

We are entering a period of technological accelerated change over the next 3-20 years, the likes of which has never been experienced by humankind. Some technologists have identified or labelled the culminating point to which this accelerated change will lead as "The Singularity" which can be viewed as the "end of the beginning" after which the singularity epoch of human history begins. What exactly is "The Singularity"? The “Singularity” is a projected future point in time when exponential developments in computer (artificial) intelligence and computational power result in the most dramatic and irreversible change in human history. The origins of the term lie in physics where "The Singularity" is described “as a point at which a function takes an infinite value, especially in space-time when matter is infinitely dense, as at the center of a black hole. “The emphasis in this sentence is "takes an infinite value".

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The Credit Squeeze, Banking Crisis & Resulting Economic Headwinds

The impact of the banking crisis is still unfolding despite assurances from the Federal Reserve and the Big Banks that the banking system remains strong and resilient. With over 100 banks in similar situations as SVB the mismanagement of "duration" risk is clearly widespread among many regional banks. In addition to the current "risks" that have the headlights focused on them are the significant commercial paper "risk" that regional banks hold and will need to be refinanced in the coming years. These are valued in the trillions of dollars. A significant portion of this debt was financed when interest rates were around zero. As this debt rolls over and needs to be refinanced there is a high probability this will occur in a market with higher than zero interest rates, lower property values and less liquidity in the short term, due to the banking failures and call for tighter regulation of regional banks.

COVID accelerated a comprehensive change in employee remote work arrangements. While the trend has generally moved towards a hybrid approach of remote and in-office work arrangements, companies are down-sizing their office space requirements as they consolidate use with shared employee spaces. This trend will impact demand for commercial office space. The commercial real estate market is struggling as a result. Before the pandemic, office space occupancy was close to 95% whereas last December it was at 47%.. Lower rental income equates to declining values. An office building in San Francisco for example that sold for $397 million in 2019 was on the market in December 2022 for $155 million.

Regional banks carry significant risk exposure to commercial paper and commercial real estate companies that are in a market downturn and this will be or should be a forward looking concern to investors and depositors. Columbia Property Trust’s default on a $1.7 billion floating-rate loan, and Brookfield Asset Management’s default on $750+ million in debt in Los Angeles are early warning signs. Commercial real estate leases can span several years so it will take approximately a couple of years for this to unfold during which millions of leases will expire. Companies renegotiating their leases will have the upper hand. They may lease less space or no space attall. Either way, this trend will impact the value of commercial real-estate if rental occupancy and rates decline. This in turn will impact the value of commercial loans on regional banks books and impact their capital ratios.

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Navigating The SVB Collapse and The 2023 Global Banking Crisis

This week's news has been dominated by the crisis in banking and the second biggest banking failure in US history. If one had to point to the root of the current global banking crisis, it would be the "mismanagement of risk", fuelled by a significant dose of depositor and investor fear. This is the common denominator at all the banks that were and still are most impacted.

Silicon Valley Bank did not adequately hedge it's treasury bond and mortgage backed securities portfolio which had been purchased during the zero interest 2020-2021 environment, leaving it with significant growing unrealized losses as interest rates rose. Under normal banking and economic conditions this would not have been a significant risk. However under significant stress and difficult economic conditions with depositors withdrawing significant funds, the bank could be exposed to having to raise funds to meet withdrawal demands and in order to do that it would have to sell its bonds and mortgage backed securities at a significant loss.

Banks are meant to be in the business of managing risk and mitigating for exactly these types of scenarios. Instead of hedging that risk one must assume that it considered that risk to be an outlier. In either case, one would be right in questioning the judgement of management. As depositors withdrew funds, SVB had to sell its portfolio of bonds and mortgage backed securities for a loss of approximately $1.8bn. When SVB announced this fact to the market - a market that was already on edge - along with the need to raise additional capital, large Silicon Valley VC's began pulling their funds out of the bank which combined with dire messaging amplified through the megaphone of Twitter turned into a stampede. Over $40 billion dollars was withdrawn in 3 days causing the second largest banking failure in US history and new management - that is, the FDIC - to step in.

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