I worked with Doug Noland for nine years where he helped me manage the Prudent Bear Fund that achieved an excellent track record for the ten years ended 12/31/08. Doug and I would talk for hours about the credit bubbles as they evolved during both the 1999-2002 and 2006-2008 periods. Doug is an exceptional economist and strategist & he understands credit bubble dynamics better than anyone else in the world, in my opinion. He understood the credit extended by the GSE’s & for years he urged Fannie Mae & Freddie Mac to slow down their credit growth & predicted their eventual demise and the cataclysmic impact on financial markets. His weekly commentary was read by smart people on every continent. He’s a tireless worker who is brilliant in understanding credit and its impact on financial markets.
I’m linking to his Friday’s commentary to be found at:
I’ve paraphrased by excerpting from his excellent commentary but I’d urge you to read his entire missive and subscribe to his excellent weekly analyses at: http://creditbubblebulletin.blogspot.com
Weekly Commentary: Please Don’t Completely Destroy…
Aggressive monetary stimulus foments market distortions, while promoting risk-taking, leveraged speculation and latent risk intermediation dysfunction. Years of deranged finance ensured unprecedented economic imbalances and deep structural impairment. Today’s acute financial and economic fragility – and the risk of financial collapse – are directly traceable to years of negligent monetary management. I don’t see another Bubble on the horizon. Each reflationary Bubble must be greater in scope than the last. Mortgage finance was used for post-“tech” Bubble reflation. Policymakers unleashed the “global government finance Bubble” during post-mortgage finance Bubble reflation. Massive international inflation of central bank Credit and sovereign debt went to the heart of global finance – the very foundation of “money” and Credit. There is no greater Bubble waiting in the wings to reflate the collapsing one. We are instead left with desperate measures to expand central bank “money” and government borrowings that will surely appear absolutely reckless in hindsight.
Can’t a massive expansion of central bank credit (securities purchases, lending facilities, swap lines, etc.) now reflate the Bubble? I seriously doubt it. Risks associated with various strategies have been revealed. Leverage in its many forms has been, once again, shown to be a serious problem. Rather than the proverbial “100-year flood,” for the second time in less than twelve years the world is facing the worst financial crisis since the Great Depression. Burn me once, shame on you. Fool me twice…
Coming out of the previous crisis, the global economy had the benefit of a powerful “locomotive” of accelerating expansions in China and the emerging markets more generally. Importantly, post-Bubble reflationary measures came as those fledgling Bubbles were attaining powerful momentum. Beijing pushed through an unprecedented $600 billion stimulus package, while aggressive monetary policy stoked EM booms generally. Looking ahead, the global economy is without “locomotives.” It evolved into one massive global financial Bubble financing a precarious synchronized global economic expansion. And I believe speculative finance became a prevailing source of Global Bubble Finance. Here’s where I could be wrong. I seriously doubt this Bubble is revivable. The unwind will likely unfold over weeks and months. Extraordinary central bank measures will spur rallies and hopes for recovery. At times, it will appear that liquidity is returning. Yet the Bubble will not be reflated.
Confidence has been shattered. Faith that central banks have everything well under control has been broken. Myriad fallacies have been exposed. Central banks can’t guarantee liquid markets, especially in a Bubble-induced highly levered speculative environment. The entire derivatives universe has been operating on the specious assumption of liquid and continuous markets. The fantasy that contemporary central bank monetary management abrogates illiquidity and market discontinuity risks is being debunked. The mania in finance has, finally, run its course.
A Friday-evening ZeroHedge headline says it all: “Stocks Suffer Worst Week Since Lehman Despite Biggest Fed Bailout Ever.” In last week’s CBB, I wrote that we “saw more than a glimpse of what the beginning of financial collapse looks like”. This week’s sequel was how global financial collapse gains momentum – especially Wednesday. I watched the ’87 stock market crash on a Quotron machine. I’ve witnessed scores of bursting Bubbles and collapses – including bonds in ’94, Mexico ’95, SE Asia ‘97, Russia/LTCM in ’98, “tech” in 2000, 9/11, the spectacular 2008 collapse and 2012’s near melt-down. None of those previous crises were as alarming as current market dynamics. Bond markets also dislocated.
As the week unfolded, it was full-fledged financial crisis. It was difficult to keep track of the various emergency measures.
Despite it all, U.S. markets convulsed uncontrollably. U.S. equities were bludgeoned (S&P500 down 15.0% and Nasdaq falling 12.6%). Yet the more alarming developments were within the Credit market. Dislocation was deep and broad-based – Treasuries, investment-grade corporates, high-yield, municipal debt, MBS, commercial paper, CDOs and derivatives. A popular investment-grade corporate ETF (LQD) collapsed 13% in three sessions (Tuesday through Thursday). Perceived safe and liquid (“money-like”) instruments were crushed in a panic. ETF problems turned acute, as “investors” ran for the exits.
With Treasuries these days providing minimal upside, losses escalated for myriad levered strategies. The global leveraged speculating community is hemorrhaging. The derivatives complex is in chaos. Goldman Sachs Credit default swap (5-yr CDS) prices surged 66 to 223 bps, the high since the 2012 European crisis. Bank of America CDS jumped 63 to 199 bps; Citigroup 60 to 214 bps; Wells Fargo 59 to 192 bps; Morgan Stanley 57 to 211 bps; and JPMorgan 53 bps to 176 bps. Ominously, the big U.S. financial institutions were at the top of the global bank CDS leaderboard this week.
If financial collapse can be avoided, an altered financial world awaits. The old scheme doesn’t work any longer. The era of cheap money financing massive stock buybacks has ended. Leveraged speculation creating self-reinforcing liquidity abundance and asset inflation – over. Buy and hold and disregard risk has been discredited. Blindly plowing savings into perceived safe and liquid ETFs is a thing of the past. In the new financial landscape, can derivatives be trusted? How about the private equity Bubble? The age of endless cheap finance for virtually any borrower and equity issuer (irrespective of cash flow or earnings) has reached its conclusion.
Meanwhile, “helicopter money” has arrived. Seemingly outrageous on Monday, Senator Schumer’s proposal for a $750 billion stimulus package was small potatoes compared to spending plans contemplated by week’s end. Federal Reserve Assets surged $356 billion the past week to a record $4.668 TN. Fed Assets were up $907 billion over the past 28 weeks, as it becomes clear a $10 TN balance sheet will unfold more quickly than I have anticipated.
Today, “Helicopter Ben” looks fainthearted compared to what today’s central bankers are about to attempt. The experiment has gone terribly wrong, just as foolhardy bouts of inflationism have throughout history.
If they actually believe the massive inflation of central bank and government Credit will reflate markets and economies, they will be grievously disappointed. Government debt and central bank balance sheets have commenced what will be a frightening buildup. The inflationary consequences are today unclear. What is clear is it will be anything but confidence inspiring. The desperate inflation of perceive money-like Credit will not encourage the leverage speculating community to re-leverage. It will not entice burned investors back into perceived money-like ETFs. It will not stabilize currency markets. However, it does risk a bond market debacle.
History’s greatest Bubble is nearing the end of the line. It’s all left to central bank Credit and sovereign debt – the massive inflation of Credit at the very foundation of global finance. This experimental strategy is so fraught with peril that it is difficult to believe that risk will be disregarded – that things can somehow stabilize and return to normal. Confidence in central banks’ capacity to control global markets has been irreversibly damaged – and a long overdue market reassessment of the value of financial instruments has commenced.
Truth is stranger than fiction. The world’s weakened superpower cracks down, initiating a trade war with the aspiring superpower. Relations sour. Then, shortly after a watered-down compromise agreement is signed, a virus outbreak erupts in the aspiring country that leads to a global pandemic and major crisis in the superpower country. The aspiring nation’s dictatorial government, seeking a scapegoat to pacify its shaken populace, blames the superpower for the virus and its collapsing Bubble. The superpower government, in an election year, points blame at the aspiring nation’s government. Two strongmen leaders face off. The American Virus vs. the Chinese Virus, with consequences that are chilling to contemplate.