2016-2018 Is Looking a Lot Like 2007-2008 to Me
It's said that we are what we repeatedly do. And here we go again, as 2016-2018 is looking a lot like 2007-2009 to me.
History has a delicious correlation to the past: It rarely repeats itself, but it often rhymes. What are the characteristics that "seem to rhyme" for the economy this time around? Let's run them down:
* The proliferation of debt.
* The broad ignorance of views.
* The naysayers who get dismissed.
Let's look this morning a each of these three factors in greater detail.
The Proliferation of Debt
"Growth based on debt is unsustainable, artificial."
-- Jose Manuel Barroso
Debt is the common denominator of most financial and economic crises. Nearly every meaningful speculative peak consists of the following conditions:
* Debt is cheap.
* Debt is plentiful.
* Abuses in the use of debt occur.
* A new buyer of a bubble-like asset class emerges.
These four conditions were certainly all in place during the tech-stock boom. Remember all of those day traders speculating in dot-com stocks?
We also saw them during the emergence of the 2006-2008 housing crisis. Remember all of those speculative investors buying homes?
And today, we can see them again with our current explosion of sovereign debt at a time of negative real interest rates.
The Broad Ignorance of Views
"I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms."
-- Former Federal Reserve Chairman Alan Greenspan
Although substantive signposts of an imminent crisis exist today, markets are ignoring them.
That's not surprising, as part of the reason why "ignorance is bliss" on Wall Street right now is that asset prices continue to rise and many of today's traders worship at that altar of price momentum.
Of course, that happened during the dot-com and housing booms -- and I believe it's happening again amid today's unprecedented expansion of government debt and acceptance of low or negative interest rates.
Recall that nine years ago, the Federal Reserve dismissed the notion that the subprime-mortgage problem would morph into a global weapon of financial destruction. Wall Street banks who marketed those crappy loans also certainly failed to warn investors (and ultimately paying almost $20 billion in fines over the next decade for their complacency).
Federal regulators likewise a blind eye to derivatives, while homebuilders (who benefited from the use of mortgage-backed securities) were clueless. Lastly, global financial institutions who packed their portfolios with derivatives clearly misunderstood the consequence of those instruments' proliferation.
Naysayers Get Dismissed
"New opinions are always suspected and usually opposed, without any other reason but because they are not already common."
-- John Locke
The final common denominator that exists with market meltdowns is that there are always a small group of observers who recognize the problem -- but who aren't heeded.
Alan Greenspan said in 2010 that when it came to the housing bubble, "everybody missed it: Academia, the Federal Reserve, all regulators."
But Scion Capital's Michael Burry, Emrys Partners' Steve Eisman, Paulson & Co.'s John Paulson, Shilling & Co.'s Gary Shilling and Euro Pacific Capital's Peter Schiff and others were naysayers during the housing boom. They were alarmed and generally positioned their portfolios accordingly, but Wall Street's consensus crowd dismissed them all.
Personally, I repeatedly warned on Real Money Pro and CNBC (mostly on The Kudlow Report) about the serious economic and investment ramifications I saw in both the period's housing speculation and the derivatives that Wall Street was merchandising. Eight to 10 years ago, I was writing columns with headlines like Housing's Headed to the Woodshed and Subprime Fungus Will Spread.
I'd also recommend that everyone carefully read Michael Burry's 2010 New York Timesop/ed piece entitled, I saw the Crisis Coming: Why Didn't the Fed? I think its warning applies to today's state of the affairs.
From my perch, the emerging picture of accumulating government debt makes no sense and has to come to an end. The numbers simply don't lie.
I'll discuss what I mean a little later today.
"When you combine ignorance and leverage, you get some pretty interesting results."
-- Warren Buffett
As I wrote in my opening missive, I fear that we'll soon see a repeat of the 2008-2009 financial crisis emerge in 2016-2018.
That's because I see a desperation of policy that rivals that of the Great Recession nearly a decade ago. Let's check things out:
Another House of Cards?
During the U.S. housing boom that sparked the 2008-2009 meltdown, Wall Street blithely sliced and diced no- and low- documentation home loans into mortgage-backed securities. Investors ignored teaser rates and no-money-down adjustable-rate loans that were "dead at birth" and based on notion that home prices could never fall.
In time, these financial "weapons of mass destruction" received global acceptance and nearly bankrupted the world's banking system. That's not an exaggeration, but a fact. The whole thing was virtually a house of cards.
But memories are apparently short, as what's going on today is little different than what was happening then. All we have to do to see that is substitute the toxic "subslime" loans that were given to undeserving home buyers a decade ago with the record loans that financiers are giving to unworthy sovereigns and governments today.
Lenders were underwriting mortgages with little or no money down back in those days. And today, they're loaning money to bankrupt governments who are being paid to borrow money at negative interest rates.
Japan is the best example this, although certainly not the only one. The Asian nation's national debt currently tops 210% of gross domestic product, while the interest on Japan's massive government debt exceeds one-quarter of its tax revenues.
But thanks to the same kind of stupidity that prompted investors to buy housing derivatives a decade ago, Japan is still able to sell 10-year bonds that carry negative interest rates. In fact, the current mess is even worse in some ways than the last one because negative interest rates virtually guarantee that those who hold Japanese government bonds will lose money.
The size of today's bubble is also even larger than it was the last time around. There are more than $7 trillion of government bonds with negative interest rates out there, which vastly exceeds the size of the derivatives that nearly bankrupted the world's financial system nearly a decade ago. And this bubble grows larger and larger every day.
Even in America, the situation is becoming ever more dangerous. Consider the fact that in 2008:
* U.S. government debt (as narrowly defined) stood about $8 trillion.
* The Federal Reserve's balance sheet was under $800 billion.
* 10-year Treasuries yielded approximating 4.5%, giving the Fed had some leeway to cut interest rates if necessary to fight a crisis or business downturn.
* The subprime-mortgage bubble peaked at about $1.3 trillion.
* Aggregate government debt was under $10 trillion.
* The derivatives market's notional value was $182 trillion.
* A homeless man named Johnny Moon was reportedly able to get some $600,000 of mortgages to speculate in the U.S. housing market.
As bad as all of that was, consider the facts today:
* U.S. government debt totals about $19 trillion, or some $11 trillion more than it was in 2008.
* The Fed's balance sheet is approaching $5 trillion vs. $800 billion in 2008.
* Short-term interest rates are 0.25% compared to 4.5% back in the day. With interest rates at near-record lows, there's little opportunity for the Fed to further expand its balance sheet.
* The derivatives market is currently larger than $500 trillion vs. $182 trillion in 2008.
* Central-bank capital has dropped to 0.8% of assets from 4.5%.
* The size of the subprime bubble was $1.3 trillion, but the size of sovereign borrowing is $7 trillion today.
* Our government has to borrow money to simply pay interest, and monetary policy is hamstrung by near-zero interest rates.
* There are no more homeless people getting mortgages to buy homes, but there's a Danish sex therapist whose bank is paying her interest (instead of the other way around) on a loan that's financing her matchmaking Web site.
These numbers don't lie, and they'll have negative consequences in the fullness of time. Today's crisis is a lot more visible and much bigger than the derivative and subprime threats of a decade ago -- but importantly, the available policy responses are now far more limited.
The Meltdown's Timing Is Uncertain
"This is the tragedy of almost every civilization -- that its soul is in its faith and seldom survives philosophy."
-- Will Durant
In 2006, the underlying belief was that U.S. home prices would never fall on a year-over-year basis -- a view that turned out to be wrong. A decade later, we're told that governments can simply print their way to prosperity and we can consume more than we produce because no amount of debt will deter economic growth. But I believe that's wrong, too.
When will today's potential crisis become a real one?
I believe it'll likely happen when global interest rates and inflationary expectations begin to move higher, or when currencies begin to behave like drunken college students on spring break in Ft. Lauderdale (causing global funding and servicing pressures).
Or perhaps it'll happen when:
* A totally unforeseen circumstance (or "black swan") suddenly produces a return to natural price discovery in our markets.
* Wealth and income inequality -- the byproduct of easy monetary policies -- cause social unrest.
* The quants bring this all to the end, just as they did in the October 1987 Wall Street crash.
* Confidence in our central bankers has a "Wizard of Oz" moment, in which the curtain gets pulled back and reveals that our monetary authorities aren't all-powerful gods, but regular human beings.
The Bottom Line
My concerns are no doubt early; they usually are. But I expect that rigging up the yellow flags (as I did vociferously in 2006-07) will turn out to be a profitable endeavor.
My advice: Stay tuned and be forewarned, because what's happening now in global capital markets makes little sense to many -- just as we saw a decade ago.
At the very best, I think stocks are overvalued. But at the very worse, I believe a new and debilitating crisis looms ahead.