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$1.2T in risky corporate debt showing similar warning signs to subprime crisis (latimes.com)
465 points by lxm on Jan 21, 2019 | hide | past | favorite | 265 comments

At last year's World Economic Forum, there was a panel titled "The Next Financial Crisis", and while many different potential causes were considered, the most prominent one is definitely corporate debt, especially emerging market debt that is dollar-denominated. [0]

Much of the concern in markets right now seems to stem from the idea that as the Federal Reserve tightens credit, both through raising interest rates and through unwinding its previous QE programs, there will be a significant impact on companies that have borrowed at lower interest rates. Debt that is going to come due in the next few years is going to have to be refinanced, or is going to default.

If you're a country which borrowed in dollars, the tightening of US monetary policy will often lead to a change in exchange rates that makes it more expensive to pay back debt. Coupled with a global economic slowdown resulting from a trade war, and things start to look nasty wherever you look.

[0]: https://www.youtube.com/watch?v=1WOs6S0VrlA

Risk has already come off - I am seeing it in private equity. If you run a startup and burn cash, have your plan B ready to go when the shit hits the fan.


I remember when this was originally posted 10 years ago.

I've got mixed feelings about this. It's not 2008, and there's no reason to expect another 75-year economic event again. On the other hand, tech and VC investment has more than tripped since 2008.

"another 75-year economic event again"

How do we know it's a 75 year event? Because it happened once 75 years before? How often should it happen?

We can't honestly answer how often it's going to or should happen. We can't honestly assess these sort of risk patterns because we don't have models that take enough of the variables into account (or even could?)

Check out Taleb's Black Swan. His big thing is understanding what risks are measurable (very few), which have a bounded/estimable impact (still very few), and which are both unbounded and immeasurable or most of them.

>How do we know it's a 75 year event? Because it happened once 75 years before? How often should it happen? We can't honestly answer...

We do have models that take it into account.

Taleb's argument isn't that you can't model the market, it's that most people aren't using the appropriate models [0].

[0] https://en.wikipedia.org/wiki/Fat-tailed_distribution#Fat_ta...

Interesting. The gist seems to be that we model market events with normal distributions, which is consistent with what I've seen in other "natural" and/or emergent processes, and this underestimates risk, because the true distribution is fat tailed.

This came out in the same year as Taleb's Black Swan:



You can have a 75 year event in successive years - the UK village I live in once had two 250 year floods inside of 5 years.

>>You can have a 75 year event in successive years - the UK village I live in once had two 250 year floods inside of 5 years.

Yeah but at some point the "250 year flood" might need a new name, like every other year flood or something.

The 1987 market crash (October 19, 1987, single-day loss of 23% in the S&P 500 index) was a 25 standard-deviation event. Mind you, an 8 standard-deviation event is an event that should occur once every 3 trillion years. And 25 standard-deviation events are unfathomable given the age of the Universe.

Describing market moves in "standard-deviation events" does not really make sense. It is something for normal distributions and "random walks".

It has been known for a long time that his is not the case: https://www.amazon.com/Fractals-Scaling-Finance-1st-First/dp...

The conclusion is: due to faulty mathematics, far out of the money options are underpriced. Or, who Mandelbrot concluded, "investing on the stock market may be riskier than you think".

Not disagreeing with you, but would buying far out of the money options be a viable strategy if you wait long enough for the black swan event?

No, because timing.

But if you have a few bucks to spare and want to gamble you could buy far out of the money options for a downturn. VIX gets priced in, don't know how it looks currently.

Or you can gamble with "paper money" at Thinkorswim.

If you see a 25 standard deviation you are either

1. Incredibly lucky

2. Incredibly unlucky

3. Or don't have a standard distribution (but a fat tail distribution or Levi flight or whatever)

4. miscalculating

In principle yes. If far out of the money options are systemically underpriced then just buying a bunch and holding them should make money on average, by definition.

In practice there are a bunch of concerns. You have the gambler's ruin problem: even if your bets are positive expected value, it's very easy to go bankrupt. Since your fund makes all of its money from crises you have a bunch of counterparty risk along a risk of regulatory intervention etc.. Your fund will lose money in most years and it's very difficult for potential investors to know whether you're actually positioned to make money from a crisis or just wasting all their investment. See Keynes' line about sound bankers.

Taleb endorses and advises a fund that tries to bet on "black swans"; it's explicitly advertised as a fund that will lose 5% of its value every year in "normal years", but hopefully pay off in exceptional years. You can invest in it if you want. In theory it should work, but no-one will really know until after we have one of those exceptional years.

Nassim Taleb famously thought so, and made a killing in 2008 on this theory. But his fund does lose money in most years.

The trouble with this is that you need to have enough of a black swan to trigger the options but not enough that it prevents them paying out, e.g. due to counterparty risk or some kind of systemic collapse.

And "the market can stay irrational longer than you can stay solvent" - by definition this produces few, rare payouts.

Far better to employ the LTCM strategy and write a lot of out of the money options: https://en.wikipedia.org/wiki/Long-Term_Capital_Management

The trick is to do that with other people's money, on which you initially get huge returns. You can then collect large managment fees. The collapse takes out the fund, but it's an LLC so the staff get to keep their bonuses from previous years.

Generally not, because the price of the option is going to rise commensurate with the uncertainty of it being in the money.

It gets more and more difficult to accurately forecast that as uncertainty increases, which is why they're not priced as efficiently farther in the future. But since this is somewhat well known, you need to have some kind of edge to make it work - buying options haphazardly won't.

> The 1987 market crash (October 19, 1987, single-day loss of 23% in the S&P 500 index) was a 25 standard-deviation event.

Adding to this, the Swiss Franc revaluation in 2015 was called a 20 standard deviation event [0].

[0] https://www.ft.com/content/5a06ef16-b5e4-11e4-a577-00144feab...

Standard deviation only has meaning for a normal distribution.

In this context yes, especially since it assumes distributions are normal.

The strict statistical meaning of a standard deviation applies to any statistical distribution

I'd assume that statement presupposes a normal distribution. Is the stock market return normally distributed?

It's a power law distribution (Mandelbrot's work). That's why these numbers are outlandish.

Stock returns are modeled based on the assumption that they are lognormal.

Whether they really are is a different story.

What is the "75-year economic event" timeframe based on?

We now have "1000-year floods" five times in a year [1], is there good reason to think the economic predictions are more accurate than the climate ones?

[1] https://www.edf.org/blog/2016/09/01/we-just-had-five-1000-ye...

If there are at least 1000/5=200 floodplanes in the country it's not that surprising; and there are a lot more than 200 floodable areas.

I think you mean 5000 floodplains.

You're right, that was a silly mistake.

Houston had 500-year floods consecutively in 2015, 2016, and 2017. Oh and one in 2001. Must be a terrifically unlucky place.

That or the context in which such events were considered 500-year events has radically shifted in the last 100 and especially the last 50 years.

"500 year flood" just means that in any given year there's a 1/500 chance of it happening. In theory history has nothing to do with it.

In practice it's calculated with models that are tuned with historical data (among other things), so if you fail to notice some important changes and update your models you might be wildly off.

He's saying that they were 1/500 events previously, when the frequency was determined to be 1/500, but conditions have changed (climate, development, etc.) and they are no longer 1/500 events.

Which is kind of the point

Normally caused by non maintenance of flood channels and excessive building - that's what caused two 250 year floods in my village.

There are reasons to expect another such event again. First, those kind of shocks are not necessarily isolated, can happen in clusters. Second, the fundamental problems of 2008 were never fully solved, just transferred to govt/Fed balance sheets and pushed forward in time. It’s worth stress testing your current endeavors against a repeat.

>there's no reason to expect another 75-year economic event again

Because that so called 75-year economic event never really happened, or at least its full consequences, has been delayed by doctors injecting lots of adrenaline keeping it alive.

Japan, China, EU, and US has since printed unprecedented amount of money. A lot of people think there wont be another 2008, I would be happy if it was only 2008 recessions. I am worry it will end up like 1930 with Great Depression.

The post-08 tech boom is almost perfectly correlated to the rise of smartphones, which built a market for products like Facebook ads, Uber rides and the like. That too is a one-off event; we're at smartphone saturation these days.

Haven't banks also consolidated and gotten bigger?

Yes, but balance sheets of US banks have also improved fairly dramatically.

While I think a downturn may be in the cards, I don’t think another financial crisis is for the US.

China however...

I read The Road to Ruin last year. I don't know if it's viewed very credibly or not but the guy purports to have had a ringside seat to the 2008 GFC. That book reckons it's all about complexity theory and it's just becoming more and more complex and the next time it happens the complexity will be unparalleled and hence it is going to get hectic.

Now maybe that is just a way to sell books and it was a fun read, but I don't know.

I get the feeling we all know something is coming because it always has and it always will. Some suspect it's going to be catastrophic like never before. It's at least assumed it's going to hurt. We don't know when but it seems people are in agreement it's edging closer and closer and things are about to get really unfun for a while.

I just hope all the pain and misery happens to other people and I get through it unscathed. Totally going to take my share of the hurt most likely and that's OK I suppose. It's sort of fingers crossed at this point.

Financialization follows a cycle much like the hype cycle: something gets securitized, immense profits are made, people overextend and there's a crash, then it's reined in and becomes boring, and the next crash happens in something further out. If you read Liar's Poker, even in the '80s corporate equities were boring and all the action was in bonds. After the S&L crash, bonds were made boring (at least in the US for established companies) and the action moved to "emerging markets" and hot new IPOs. Asian crash of '97, dotcom crash of '99, these things get made boring and the action moves to mortgage securitization.

2008 crisis, mortgages get made boring, and the action now is in... well, if you can figure that out then there's a lot of money to be made. Car loans? Corporate loans? Foreign exchange? Commodities? I've seen all of those bandied about.

Your choices are “it will happen again”, or “it’s different this time”. Choose wisely!

> Risk has already come off

Are you able to elaborate on the derisking you've been seeing?

Angels pulling out last minute because they are worried about their stock portfolio. Investors withdrawing from a levered strategy because of the same concern.

Many companies are laying off right now...

Respectfully, that's not the sort of color I was hoping for. Instead, consider evidence of derisking as exhibited by recent moves in HY OAS [0].

[0] https://fred.stlouisfed.org/series/BAMLH0A0HYM2

Perhaps, but when it's industry-wide it's often a good leading indicator. My previous employer's only layoffs ever were in 2008, when one of their investors (I believe A16Z?) sat down the founders of their portfolio companies and told them to cut down, because the crunch was coming. These are companies whose management is in very close personal contact with the capital markets, and so often make decisions very quickly in response to what's going on there.

> Perhaps, but when it's industry-wide it's often a good leading indicator.

As far as I'm aware, employment data is considered a lagging indicator [0], as labor tends to be reasonably sticky.

> These are companies whose management is in very close personal contact with the capital markets, and so often make decisions very quickly in response to what's going on there.

I was fishing for other data, in part, because current data does not support the assertion that layoffs have accelerated [1][2]. In fact, initial claims data appears to be at -- or close to -- historical lows.

[0] https://www.thebalance.com/lagging-economic-indicators-list-...

[1] https://fred.stlouisfed.org/series/ICSA

[2] https://fred.stlouisfed.org/series/IC4WSA

Many companies are hiring right now. Some companies are hiring and laying off simultaneously.

One indicator is the number of large venture IPOs. I see Dell going public again, for instance, as an indicator of Michael Dell not wanting to carry the private concentration of assets as a risk any further.

> Are you able to elaborate on the derisking you've been seeing?

The giant amount of credit that was raised for LBOs during last 5 years of stocks rally.

A lot of those LBOs went sour.


Leveraged Buy Out. You use the value of the company you are acquiring to guarantee junk bonds that you sell to raise the money to buy the company.

Barbarians at the Gate is a popular book that goes into the details while telling the story of a large LBO.

Layoff, cost cutting.

Thinking about this reminded me of the line from the movie "The Big Short" where Michael Burry says one of the indicators of the coming crisis was an increase in the rate of fraud. Juxtapose that with what feels like an uptick in white collar fraud these past couple years. ie: Theranos, Fyre, 1MDB, numerous crypto token related scams.

That's interesting though i'm not sure that's the right kind of fraud. The fraud Bury was referring to was related to mortgage lending, both on the part of the borrowers (fraudulent documents supporting income, etc.) and on the part of the immediate lenders (the banks / lead generators for mortgages). The comparable type of fraud here would be businesses inflating their assets or income streams to acquire bank loans that they couldn't otherwise qualify for. It may be that that kind of fraud is on the rise, but I don't think the examples you cited (with the notable exception of 1MDB) are instances of it.

It's not causal, it's symptomatic. People tend take bigger risks, even criminal ones, when they have less to lose or less to gain. It's an interesting proxy for economic desperation.

That's an interesting perspective that I hadn't considered. I'm not sure if it's right though. You think it's symptomatic of desperation? I don't think of the lead-up to the 2007 financial crisis as a particularly desperate time for most people.

One interpretation is that for many who took on debt they couldn't support, it was a desperate attempt to continue a lifestyle that wasn't possible for them any more due to changes in both the global and local economies, aided by technology, which resulted in the reduced value of their labor.

Is it possible there is greater scrutiny during times of economic downturn leading to greatest discovery of fraud?

>>The fraud Bury was referring to was related to mortgage lending

To be frank, I guess the parent was talking about general fraud trends. It will be a little disingenuous to suggest the same set of events have to repeat for it be classified as fraud.

For eg, these days start ups with no way of turning in profits, but raising billions in debt could be suggested as a fraud eventually.

Burry refers to hard numbers - the rate of fraud was increasing. "What feels like an uptick" does not mean the rate has actually increased (I don't know if it has or not, but an uptick on reporting about fraud is not an actual uptick).

Fraud and scams are the second oldest profession. Nothing about theranos or fyre or crypto is unique to this time other than the social media-as-fuel component.

If you’re trying to say that corporate bonds are going to tank the economy, you’d need to find an increase in fraudulent issues. This is not the case—-the corporate bond market is highly regulated.

That is, if you trust the ratings agencies.

You don't have to trust the ratings agencies. You can look at the corporate balance sheets yourself.

Find me a recent issue that isn't properly priced considering the riskiness of the firm.

You lost me at “feels”. Need more than 4-5 anecdotes to determine if fraud is really upticking.

Accredited investors getting burned is not same as a national policy of grey zero loan restrictions, and the crypto was mostly retail investors using their Vegas money. You have to remember that it wasn't loan fraud that broke Wall Street's back in 2008, it was the the unregulated derivatives market of uncalculated risk... and that risk still exists today.


Theranos, from reading Bad Blood, seems to be fraudulent science with financial fraud as an inevitable effect. Also, it seems to be drawn out from 2011.

wasn't theranos fraud committed for much longer than a couple years?

Plus bad corporate paper is a highly-correlated procyclical problem, which will be extremely not-fun when the economy starts seriously slowing (especially since the government shot their fiscal stimulus arrow with the tax cuts and the Fed is still trying to get enough headroom to not have to worry about the “pushing on a string” problem they encountered in the ‘08 crash). Not going to be a fun year or two ahead.

Only about 15% of the deficit is from the tax cuts, the rest is over-spending.

100% of the deficit is from over-spending or from under-taxing depending on how you look at it...

two months into fiscal FY2019, medicare had taken in $34B and spent $129B

fiscal FY2019 CMMS spent $270B - a 24% increase YOY

therefore, it seems disingenuous to equate taxation with spending, there's just no way to arithmetically catch up.

edit: accidentally put medicaid instead of CMMS

What do you mean arithmetically? Simply increasing taxes to without attempting to reduce spending growth might not be a good long term strategy, but it not like the laws of arithmetic prevent it. Whether we could raise tax revenue 24% is different question than whether we should.

If you taxed at 100% and still had a deficit, then yes, it’s arithmetically inpossible. With higher taxes past a certain point revenue decreases, per the Laffler Curve.

Well sure, but we are nowhere near there. The 2018 deficit was less than 4% of gdp. https://www.usgovernmentdebt.us/federal_deficit_percent_gdp

The Laffer curve is not interesting when you are way on the left side of it.

That 4% is very deceptive. It gives the impression, that there is some room to stretch it. But is there? I mean, you're talking 4% of a situation where 100% is total heat death of all the participants in the economy. Where any amount gained in the system goes towards the deficit. This is bonkers.

Our ancestors would probably think that an economy that spends 97% of GDP on things unrelated to food production is bonkers, but here we are.

If high government debt was decreasing economic participation that would be cause for concern. But is there any reason to believe it is? Japan is running a much higher debt-to-GDP ratio and while people are (probably rightly) worried, the fact that nothing catastrophic has happened there yet suggests that there's at least that much slack available.

It's confusing to use the hypothetical of 100% in one sentence and in the next acknowledge that the optimal rate of taxation for maximising revenues is not at 100%.

The question is whether tax revenues could be raised by raising tax rates to the point that revenues exceeded current expenditure. Whether or not that is possible is uncertain.

I mean it's still $150 billion a year? Hell, even if the only work is corporate debt that could have gone into reducing the deficit directly?

If you're worried about overspending it seems weird to try and reduce the spending by.... reducing receipts. Just reduce spending!

I think you mean commercial paper.

This episode of Odd Lots entitled "Why the Eurodollar Might Be Ground Zero for De-Globalization" is a great listen:


I see that the podcast features Jeffrey Snider. You might be interested in his extensive series on Macro Voices [1] called Eurodollar University.

[1] https://www.macrovoices.com/edu (scroll to bottom)

> If you're a country which borrowed in dollars

All of Latin America, pretty much

> Much of the concern in markets right now seems to stem from the idea that as the Federal Reserve tightens credit

This became much less of a concern in late December, when Fed Chair Powell acquiesced to plummeting equities markets and declared a pause on rate hikes, emphasizing the data dependence and lack of a preset course for Fed policy. These statements signaled a shift in tone from the 'dots' published after FOMC, which indicated further hiking and a median expected neutral rate around 3% [0].

> both through raising interest rates

After Powell's comments, expectations for rate hikes have diminished. Looking at 30-Day Fed Funds Futures, you can see that the market is pricing in ~1 more rate hike before the Fed reverses course [1 - chart][2 - source data].

> unwinding its previous QE programs

It remains to be seen how aggressively the Fed will continue unwinding, but I'm curious how much balance sheet the Fed will actually be able to unwind. They've been rolling off ~50B in UST per month [3], starting from ~4.5T. For perspective, the Fed's balance sheet was ~800-900B prior to the GFC. There's reasonable concern that the Fed may not be able to reach pre-QE levels. The money stock appears to exhibit response to the Fed's balance shit reduction [4], which will not help foreign borrowers.

> Debt that is going to come due in the next few years is going to have to be refinanced, or is going to default.

It looks like loans have been refinanced such that the bulk of them mature in 2021 or later [5], giving issuers some breathing room for the time being.

[0] https://www.cnbc.com/2018/12/19/fed-dot-plot-december-2018.h...

[1] https://imgur.com/a/43Gt8si

[2] https://www.barchart.com/futures/quotes/ZQ*0/all-futures

[3] https://www.cnbc.com/2018/11/29/the-fed-is-still-tweaking-it...

[4] https://imgur.com/a/RA62s4e

[5] http://www.leveragedloan.com/us-leveraged-loan-maturity-wall...

This is true that many/most loans have already been refinanced. 2015-2017 europe was the hot bed for refinancing and anyone credit worthy has already done so. It's a good time for the fed to pull liquidity out of the system. If they do not then CLO hotbed would eventually just move to South America which is mainly risky energy companies.

Excessive debt has damaged Debenhams and killed some retailers in the UK.

Also changes in the deductibility of interest expense under the new tax law.

There isn't going to be any more tightening, sorry to say. The yield curve is flat out to 30 years. 5-year breakeven inflation has come down to 1.67%, way below the Fed target. Unless the Democrats rev up government spending again, which they can't until at least 2020, 2.5% is where this cycle peaks. So much for the secular bond bear market: the pattern of ever looser credit cycles remains.

I don't have econonic background but I understood why banks are allowed to print the money and give it to businesses. If amount of money is fixed, then this problem will go away on its own. Human nature is not relible and if allowed humans will overspend and subsequent default.

As Taleb puts it, executives at these companies don't have "skin in the game". Increasing shareholder value short-term is lucrative especially when their own compensations are tied to short-term stock value gain.

Another part is lack of progress in executive education. While engineering as a discipline have constantly improved by introspection. No such thing have happenned in business management area. It's all about maintaining the status quo and appearing in controls even when they are nowhere near it.

Banks don't print money. Federal Banks print the money, which basically means it's the government printing the money.

> If amount of money is fixed, then this problem will go away on its own.

There was a time when this in was in fact the case. It was known as The Gold Standard and it basically required governments to back up their currency with an equivalent amount of gold.

The Gold Standard ended when it was abandoned by the USA.

Basically the USA did start to print money and they didn't have the gold to backup that printing press.

https://en.wikipedia.org/wiki/Fractional-reserve_banking - yes banks print money (figuratively). They make loans and the money people receive on their accounts is money just created out of thin air.

> Banks don't print money. Federal Banks print the money, which basically means it's the government printing the money.

You are confusing two things about money creation: which entity decides to create the money, and which one carries the book-keeping entry that creates it.

In the US system, it is member banks that decide to create a loan. The money that is loaned is some combination of their own deposits, and money lent them by the Federal Reserve. The details of how much money they need to keep on deposit, how much is "their own", and how much the Fed provides are governed by FR rules.

So, it is indeed banks that make the individual decision to create money by giving a loan. The FR is merely the book-keeper for that decision and the rule-maker for how the system at large works.

Oh, and last, it is the US Treasury that actually prints currency. But we're all talking about the more abstract concept "money".

Banks don’t print physical money, that’s correct. But they do create new money when they lend money and I believe that’s what parent was referring to.

Banks don't literally print money but they do create it when they issue loans.

they do not create money, they are lending you someone else savings or money created by the federal reserve.

That isn’t how fractional reserve lending works. An example will probably help.

You walk into Friendly Neighborhood Bank and ask for a loan, and since they’re friendly they make the loan. Now, what does that mean? From your perspective you now have a liability (the loan) and an asset (money in a bank account). From the bank’s perspective, they now have an asset (the loan), a liability (your bank account), and an income stream (the interest payments).

The bank didn’t have to move any money around from the Fed or other people’s savings accounts to make this happen. They just entered the debits and credits into their system and boom the money appears in your account, just as good as any other money. They literally created it out of thin air.

> That isn’t how fractional reserve lending works.

I'm not sure which part of the GP you're disagreeing with.

Fractional reserve is exactly that banks lend out a fraction of the deposits that they take in (the rest is kept in reserve).

The only reason it looks like money is created is because people (and economists) think of 'money in their account' as real money, when in fact it's just a IOU from the bank to you (possibly guaranteed by the government).

If you think of money-in-your-account as actually a debt the bank owes you, then it becomes quite clear that banks don't create money any more than lending money to a friend creates money. And there is a sense in which it does - lending money to a friend results in your friend having money and you having an asset (an IOU from your friend) that you expect to be able to use at some point in the future, so there is a sense in which the sum total of wealth has increased by the value of the IOU.

According to wikipedia, Standard and Poors, and the Bank of England the view I give above is considered outdated and wrong. Oh well.




> Fractional reserve is exactly that banks lend out a fraction of the money that they take in

Isn't it a multiple instead of a fraction? Banks are required to keep in reserve a small percentage of the actual amount being lent, which means that they can lend a multiple of the money they take in.

Correct. In the US the required capital reserve is expressed in terms of daily net transaction amount. Wikipedia has a good breakdown[1], but for large banks the Fed requires 10% of NTA to be swept into the bank's Fed account overnight. There are also capitalization requirements for all banks, which are more stringent for nationally important "too big to fail" banks and bank-like entities.

What is “real money” in our current system?

For every debit there has to be a matching credit so nothing comes out of thin air.

If you go to your Friendly Neighbourhood Bank for a loan they are giving you their money, so you can then give that money on to someone else.

Now the bank is not so friendly that it gives you their money, instead they offer to lend you their money, on the proviso you pay it back in full and with interest.

For example lets say you want to buy a new car, so you go to the bank to get the loan.

The bank transfers the money to pay for the new car to the car dealership and you end up with a new car and a whole lot of debt.

> they are giving you their money

They create that money by crediting your checking account (their liability) and debiting your loan account (their asset).

But you missing one step where they credit your loan account by debiting their loan book account.

Also your loan account is not a bank asset, it is a bank liability.

It is money the bank might not get back.

That is incorrect, they only are required to own a fraction of the loans they give in assets. When a bank lends someone money, they create that money https://en.m.wikipedia.org/wiki/Money_creation.

The Central bank in your link is the Federal Bank.

Basically when retail banks need money they get it from the Central Bank through the Open Market Operation.

What happens is the retail banks offering up theirs bonds (which are assets), and the Central bank effectively buys (or sell) these bonds using a swap or repurchase agreement.

The retail banks then use that money to offer up loans to the public.

So the Central bank has the ability to print money by being prepared to buy up these bonds (using money that is effectively printed), but retail banks don't have that ability.

Retail banks and companies can do something similar by offering up their own bonds and selling them to investors, however should that organisation go broke the bonds take on junk status which basically means any investor that paid good money for them has lost the money.

For these transaction the money being used is real money.

When a bank lends you money the money lands in your bank account which means the bank can lend it out again. Even if you spend it, the money is going to land in someone else's bank account again. If we assume that 100% of the money is in the banking system without any potential for a bank run then in theory the bank could lend out an infinite amount of money.

This is not how the banking system works.

Banks, just like all institutions have to account for their money, hence the reason they employ accountants.

Those accountants all use the same accounting rules, rules that were in fact invented many centuries earlier by the monk, Luca Pacioli.

Those rules form the basis of double entry book keeping, which boils done to a very simple rule that for every credit there must be an equal debit.

What you are describing does not follow that rule because you are saying one credit can result in many other many other credits.

What you describe reads more like a pyramid scheme than a banking system.

Here's the best layman explanation by Bank of England of what is actually meant by "money" in the current economy[0]. Think it can be helpful for the discourse.

[0]: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

Well I must have hit some nerves. Getting up and down voted constantly.

This article is a bit misleading. The subprime crisis occurred because of the leverage on packaged debt that was held by big banks. Where by an original loan amount of say $1MM had an outstanding obligation perhaps 100x that.

The issue was that the banks held this debt, which means when there was an issue, they would become insolvent, which would lead to a financial crisis like the great depression, which is why government intervention was needed.

$1.2T of outstanding debt is high, however, not very relevant without knowing who the debt holders are. And as the article states, the primary big banks aren't overly exposed to this debt.

Additionally if the debt isn't leveraged on top of the outstanding loan amounts, again the damage from a potential crisis in this area will be very contained.

As the article states a lot of this exposure sits with private equity funds and hedge funds, which would result in very little impact to the average citizen if there were an issue.

In regards to the Michael Burry comments about fraud, that was specifically related to a bubble. That one of the surest signs of a bubble is out right and rampant fraud. This is critical because when a bubble occurs it means that mass hysteria sets over the general population as neighbors see people "dumber" than them making money. This leads to rampant speculation across the board, which then leads to bad actors committing fraud. They commit fraud because the incentives are high to make a quick buck.

A loosening of debt requirements, while a bad idea, doesn't qualify as fraud. There also isn't general speculation that is associated with a bubble, which was one of the main ingredients for the housing mortgage crash as well.

So while there maybe an issue here if defaults occur those issues will be very contained. There maybe some hit to the general financial markets, but nothing even remotely close to what occurred with the housing crisis.

This is basically the equivalent of saying that any debt that shows loosening guidelines and floating APR is the same thing as the housing crisis, which isn't accurate.

> That one of the surest signs of a bubble is out right and rampant fraud. This is critical because when a bubble occurs it means that mass hysteria sets over the general population as neighbors see people "dumber" than them making money. This leads to rampant speculation across the board, which then leads to bad actors committing fraud. They commit fraud because the incentives are high to make a quick buck.

That reads like a description of SV. Mass hysteria - check (eg. BTC, shitty startups)! "dumber" people making money - check! rampant speculation - check (eg. Uber IPO valuation of 120B, bay area shacks going for millions)! Actors committing fraud - check (eg. Theranos, Zenefits)!

So can we say that SV is in a bubble, maybe confined to the tech sector?

SV doesn't really fit the criteria of a bubble.

Bubbles gain steam by being accessible. The more people that get involved, the larger the bubble becomes. It isn't a ponzi scheme, but acts like one in many ways.

ICOs were well on their way to becoming a bubble, but being pegged to the price of cryptocurrencies, the bitcoin bubble popped before the ICO bubble really took off.

But if you look at the ICOs there was rampant fraud. Basically people writing white papers, with no real companies or products, and then raising millions of dollars. Very similar to the dot com bubble.

SV in and of itself creates a tremendous amount of value. Sure there are some spectacular failures, and some questionable investments, but overall there is value that is created. Without getting into any morality discussions, but purely looking at revenue, profitability, return to investors, companies like Uber, Facebook, Twitter, Airbnb, Tesla, and so forth have created tremendous shareholder value.

When you some a "stupid" app raise $5MM it really isn't much considering how much these other companies have raised, the revenue they generated and so forth.

So SV is definitely not a bubble per say. You could make the case that some valuations are inflated, but that is a sign of the macro market where SaaS companies are enjoying their largest revenue multiples ever, but if that corrects there will be a rest of perhaps 30-50% in market cap, but no where near total collapse.

Additionally these companies do have underlying products, services, benefits, and revenue.

You could say there is hype, over valuation, and so forth, but we aren't anywhere near bubble territory.

> Without getting into any morality discussions, but purely looking at revenue, profitability, return to investors, companies like Uber, Facebook, Twitter, Airbnb, Tesla, and so forth have created tremendous shareholder value.

Facebook yes, but how many of the others have paid any dividends to shareholders? Even these "success stories" seem to have valuations that are based mostly on speculation; plenty of investors have made money but they could have just been selling to "greater fools".

Bubbles are usually based on real anticipated value, that's what gets them started. The opportunity is there and a transformation is ocurring, but the investors in the bubble won't profit as they're too early or late or don't happen to invest in companies which survive.

e.g. South Sea Bubble, Railway mania, .com etc

The question then is, is this being repackaged and resold by the PE firms and the funds?

The repackaging and selling of debt isn't an issue in and of itself. During the housing crisis didn't start because the debt was being resold, that's actually a positive thing. It allows firms looking to invest to buy large blocks of an asset with a return from interest and a rating for risk.

The problem with the housing crisis was that the ratings agencies were committing fraud and so where the banks.

The ratings agencies were simply labeling too much risky debt as non risky.

While, the banks were committing their own fraud by taking less than triple AAA debt, packaging it together, and then saying that if you buy pools of B debts, because they are separate pools you are de-risking, so different B-rated debt pools should be rated as AAA because they are "de-risked".

So in this case as long as the ratings aren't fraudulent, the risk is properly stated and understood, then repackaging and selling is fine.

The second piece, which was really where the problem became "too big to fail" was that each one of these debt packages were doing resold through insurances 10 to 100x, so the total outstanding liability was not the original debt, but something like 100x the actual debt.

Again, if that isn't the case here, then any debt holders will just have to deal with whatever defaults occur, but if hey are PE and hedge fund firms that own half of that debt, this won't be felt across the broader economy.

no it's not.

The subprime crisis was precipitated by a lot of people taking out mortgages with either blatantly or coerced false income information in their mortgage applications on homes that had inflated values. Once home prices stopped going up as much and interest rates started increasing, these people were no longer able to make their mortgage payments.

Leveraged loans at 7x ebitda are still less leverage than someone taking out 90% LTV mortgage (90% LTV can be thought of as 9x leverage against your equity). Companies usually also have more flexibility to increase their income, or decrease their expenses compared to an average person. And mortgages have required amortization where as most levered loans to my knowledge are interest only.

All in all, unless a significant % of companies taking out levered loans are submitting fraudulent financial filings, this is nothing like the subprime crisis.

> The subprime crisis was precipitated by a lot of people taking out mortgages with either blatantly or coerced false income information in their mortgage applications on homes that had inflated values.

Whereas what, companies would never utilize non-standard accounting methods or falsified or exaggerated earnings reports or forecasts?

Sure companies will and can do that, there has been pretty good history of really large companies committing financial fraud. However, I don't think there ever has been systematic fraud in the US, unlike with subprime mortgages

When you just look at companies that fail, it ends up looking a lot like systematic fraud.

Also, it was not really single family home owners that defaulted in mass. Investors, even those with prime credit ratings, were much more likely to default than non-investors when prices fell.[8][9][10] https://en.wikipedia.org/wiki/Subprime_mortgage_crisis

People talk about subrime morgages as if they meant poor people. However, largely it was people buying up large numbers of homes and then strategically defaulting that caused the real damage.

Fraud was cited as a major factor contributing to the S&L crises. In companies it tends to be in the form of Control Fraud where insiders fleece the corporation.


You probably mean systemic fraud, because there has been plenty of systematic fraud.

The subprime mortgage crisis is in fact an excellent example of systemic fraud which happened in the US, fraud committed by ratings agencies (AAA CDOs) and banks (autosign). The system was corrupt, and probably still is - the incentives are all wrong.

Are you really sure there's no systematic fraud? The US is pretty corrupt as far as checks and balances on financial dealings goes, I wouldn't be surprised if this became another one of those "who could have known".

The bank's role is to verify that the provided information is valid.

Banks didn't care because they were going to sell off the mortgage and they didn't care about the underlying stability of the loan

>a lot of people taking out mortgages with either blatantly or coerced false income information

Money flowed freely b/c the mortgages didn't matter. It was the ability to bundle the mortgages and leverage them that fueled low-standards and drove much of the lending frenzy.

>The subprime crisis was precipitated by a lot of people taking out mortgages...these people were no longer able to make their mortgage payments

No. Again, mortgage debt alone was a mere fraction of the problem. Those loans were levered up many multiples through CDOs and other exotic instruments, which was the real problem.

In 2008 there was a lot of effort made to blame poor people/subprime debtors. But, it's been covered ad nauseam since then, so it's kind of surprising to hear someone still making those claims in 2019.

Let's also not forget the credit rating agencies' role: https://www.theguardian.com/business/2017/jan/14/moodys-864m...

The derivatives were created and rated on the assumption that the borrower's default rates were consistent with historical default rates. Of course that was not the case, and losses became multiples higher, and blew up derivatives that were highly levered. However, derivatives didn't cause the losses, borrowers defaulted!

Derivatives did cause the loses basically for what you said above.

>derivatives were created and rated on the assumption that the borrower's default rates were consistent with historical default rates.

The historical information was wrong because the issuer of the subprime loans hid bad loans given to people with thin credit histories.

Well, sure, we can play the chicken-and-egg game and posit that if they'd never defaulted, the house of cards would've remained standing.

But, that's the not the predominant issue for many reasons, some of which are embedded directly in your statements. For example:

>rated on the assumption that the borrower's default rates were consistent with historical default rates

Why would they be rated as such if the viability of the underlying mortgages was not, in aggregate, consistent with those that produced the historical rates?

That alone tells the story.

The derivatives drove the outsized lending which ballooned the number of riskier subprime mortgages in the first place. Then, the many layers of leverage just exacerbated the problem.

At the end of the day, increases in subprime loan defaults could have been weathered. The derivatives were responsible for turning a containable downturn into a full-blown crisis.

You're saying the same thing. If the underlying lone is precipitated by blatantly or coerced false income information then that was the problem. CDOs are simply derivatives that derived their value from those miss rated loans. So yes it was poor people, but it was also the people way to willing to give those people loans at rates way larger than they should of for financial instruments.

The people employed by the banks were complicit. It's that simple. If Jane Doe applies to buy a $1M home, and no one checks her credit and sees that she already has 3 other similar properties, whose fault is it? Passing the buck on due diligence is such a cop out. It's like a drug dealer justifying his actions; "Hey if I don't sell it to her, someone else will."

People who work in risk and compliance NEVER get promoted to the top because they are cost centers, and prevent other people in the company from getting that huge payoff.

Thats hard because you can easily blame that on consumer credit rating agencies like Equifax. Because their number doesn't weight length of credit repayment. So if you only have had any debt for 1-3 years you can have the same score as someone who has had debt for 10-30.

It was a cop out though. I think no one in the banks thought to challenge that. Now they do but previously they didn't

No. I'm not saying the same thing.

The definition of "EBITDA" keeps getting looser each year, so the true leverage is likely somewhat higher than you'd expect by just looking at the max leverage a credit agreement permits.

Also, most leveraged loans (i.e. institutional term B loans) require de minimis principal repayment in addition to interest (1%/year).

Any chance you have a comparison of EBITDA over the years? You've piqued my interest :P

Here's an article that describes the issue: https://www.reuters.com/article/us-ebitda-loans/adjusted-ebi...

This article describes some of the addbacks in more detail (scroll down to the section entitled "EBITDA add-backs and other adjustments"): https://www.hoganlovells.com/publications/the-evolving-ficti...

That's an eye opener for me. Thanks!

> 9x leverage against your equity

From where I'm from, physical collateral is valued more highly than paper collateral that can go to zero if such a companies earnings per share are already less than 0…

most companies also have hard assets, e.g. inventory, real estate, IP, equipment, etc. If you're ok with paying 15x P/E which is the average S&P P/E, then 7x leverage isn't so bad...

Although the companies with these levered loans are a lot smaller than S&P 500 companies.

Leverage agaisnt hard assets != leverage agaisnt equity (which you were talking about), and we're talking about individual companies P/E. Everyone cannot hold an index (if everyone does so, there is no incentive to weed out bad companies), some of which are good about not including neg eps companies in the P/E caluclation [0].

[0] https://www.marketwatch.com/story/heres-the-shocking-truth-a...

no it's not, and I know the two are different definitions. However, what I'm saying is that a 7x 1st lien leveraged loan against a company that is trading at 14x P/E is essential 50% the market value of the company. Of course, the hard assets of the company is probably a lot less than that.

> Although the companies with these levered loans are a lot smaller than S&P 500 companies.

Netflix isn't an S&P 500 company?

> no it's not.

It is easy to make fundamental predictions in finance. It is impossible to predict timings.

> Once home prices stopped going up as much and interest rates started increasing, these people were no longer able to make their mortgage payments.

When was the last time you looked at the Case–Shiller index?

> Companies usually also have more flexibility to increase their income, or decrease their expenses compared to an average person.

What actions do companies have available to them which consumers do not with regards to income or expense management??

For example, if you're GM and a lot of cars aren't selling you can shut down factories, repatriate assets, do stock buybacks, increase automation and more. If you're a person whose major asset is a house if you can't sell the house for enough to catch up on your debts or get a way better job. What can you do.

File for Chapter 11 bankruptcy. This gives the company some time to get things under control to pay off its creditors. Or if it's a GigaCorp like $GM, $F etc go complain to the politicians and hope they do something, although seeing how dysfunctional things are with parts of the US Government itself shut down, a good outcome is unlikely.


Public companies have the capability of selling treasury shares, and also diluting all shares and selling the newly minted shares

Public and also closely held companies also have the capability of offering new corporate loans on specific revenue streams

Finally, both public and closely held companies have a greater timeline. They issue 5-10 year loans in a good market and low interest environment, pay low amounts of interest for several years during a bad market, and then issuing new loans in a good market again.

And of course, bankruptcy not affecting the cash finances of any particular person in the company, or that individual's ability to acquire new credit. While the company entity itself takes the temporary reputational hit.

> The subprime crisis was precipitated by a lot of people taking out mortgages with either blatantly or coerced false income information in their mortgage applications on homes that had inflated values.

Yes but this was exacerbated because it wasn't as many people as what you said seems to suggest.

The investment banks were so highly leveraged on the collateralized debt that it only took 7% of the mortgage holders missing payments at once to bring down the whole financial system.

This suggests that the vast majority of people lying can actually be trusted to make payments, and would prefer to not be shut out of the credit system.

15 - 20% of subprime borrowers defaulted on their mortgages. That's a lot of people! Imagine, 1 in 5 of your neighbors defaulted and were foreclosed upon. This is not suppose to happen.


Thanks, yes thats a lot. I'll double down on what I wrote as the CDOs contained a mix of all borrowers of all levels of credit worthiness. It is likely we are agreeing on our stats, but I will concede that the subprime variant therefore can't be reliably trusted to make payments, just as the models predict.

A lot of the problem isn't in the debt as such, it is in the collateralization. When you bundle the debt and sell it on in slices with different risk profiles (i.e. separating out who gets paid first (least risky) to last (most risky) then it becomes really hard to understand how risky the debt slices are (which dictates how much they are worth).

People assume that the least risky debt (sometimes called super-senior) is worth its face value. The problem is that when things go wrong, investors lose confidence in the valuation of the debt. And suddenly a bank with say $1T of super-senior debt finds it is only worth $100B on the open market. And that means that the bank doesn't have the assets to back the loans it has made - so has to raise money by selling things. Selling things when you are in trouble is never a good idea, as you are forced to accept a discount. So you now have the market flooding with cheap assets (say securities), which then drops the value of the securities that other banks hold - which gives them problems in backing the loans they have made. Then they have to start selling.

And that's how a financial earthquake begins...

I run a small SAS company and consult for another medium sized O&G company. The amount of debt I am offered to take on every day is staggering. The O&G company recently took a $200k loan with little to no proof of income, collateral, or anything else. I know of some other small companies with MILLIONS in debt and absolutely 0 collateral to back it up. In the event of insolvency the lender will just soak the loss.

I work for a fintech company that is in the business of small/medium business credit and financing, and this is a very surprising thing to hear. My understanding is the majority of our customers are struggling to establish business credit and get decent financing, especially if they haven't been in business long and/or don't have high revenue streams.

Do the companies you mention have decent revenue, even if they also have debt?? Your situation is one many of our customers would love to be in.

Echo this. We have collateral, revenue, decent profit margins, and significant YOY growth (over 500%) and it's been difficult to get a loan or LOC due to how young we are. We finally got one for a small $10k LOC which is funny because our company credit card is many times larger than that. Gotta start somewhere though...

Struggling to get a 10k loan... like just as an individual that should be pretty easy for me to get at the drop of a hat.

Odd a business would struggle to get something that small.

A company can go under in two seconds with all the assets gone and the lenders will have to suck it up. An individual has to struggle with bankruptcy laws for a decade or more to get rid of the debt.

So if I've got 10k to loan, I'd rather loan it to some poor sucker that I then own, rather than to a business that might disappear tomorrow.

Yeah good point, businesses can effectively evaporate into nothing.

People, you can hassle them forever.

Kinda sad how that is.

> Odd a business would struggle to get something that small.

It being that small is part of the problem.

Your potential ROI for a 10k loan with anything resembling a normal rate is pretty small. There's not much money to be made, which means there's little incentive to take risks.

I should have thought of that as a relative founded a small local bank ages ago. They got bigger and he always talks about how they'd bring in a new loan executive dude and he'd be all "Oh man look at these tiny loans, these aren't cost effective."

And then they'd have to teach him that those tiny loans are how they grow / maintain their business with the local businesses, and farmers. They're small but doing things efficiently, safely (risk wise), but also quickly is how they gain the locals trust and loyalty.

Big banks show up and are all "naw we don't do that" and just don't catch on with the locals.

At least in the areas that their branches operate it has been effective for decades, the locals in those areas really like local banks, other places maybe not so much.

Often when it is that small, business owners will take out a personal loan because it is a lot easier.

I think it's mainly company age, these companies are both 10+ years old.

Is the debt on favorable terms or is it really high interest?

Obstetrics and Gynecology?

Oil and Gas

The O&G company has no assets(land, equipment, mineral rights, signed contracts, etc)?

The difference is that everybody knows that leveraged loans are risky. The mortgage crisis wasn't triggered by the fact that complex mortgage backed securities were risky, but by the fact that people thought they were pretty much risk free and were blindsided.

Whoever is determining credit worthiness needs to have skin in the game. This is what Dodd-Frank did. It required security bankers retain 5% of the overall risk of the security. Known as the Volcker Rule, it is now being rolled back: https://www.washingtonpost.com/business/economy/trump-signs-...

This is the key phrase in the story: "packaged into securities and sold to investors". This is exactly like the mortgage crisis. Back then banks knew many of the borrowers are not being truthful in their loan applications but lent to them any way (look up "liar loans"). Banks didn't care because they packaged these mortgages into securities and sold them to investors as "mortgage-backed securities", so defaults are someone else's problem. Banks are back at it again.

A public company is just packaged up its equity into securities and sold them to investors.

The mortgages of 2008 were to the real problems, the sudden lack of liquidity in the markets for trading them was. Sure, some mortgages were hurt, and the housing market went down, but the problems with those securities were illiquidity brought on by the difficulty in valuing the derivatives. Corporate debt is somewhat easier to price, because disclosure is better/easier.

Still. I am not rushing out to invest in these securities now...

> the problems with those securities were illiquidity brought on by the difficulty in valuing the derivatives

Can you please elaborate and/or provide a source? I’d like to learn more.

Timothy Geithner's book "Stress Test" does a great job of explaining this, IMO. The trouble with derivatives is that they are contractually bound to reflect some price that is locked to the price of a primary asset. If the derivatives are linked to the price of a security, which is in itself linked to a certain risk-bundle of assets (e.g. the AAA rated CDO with the most senior debt) then it was not exactly clear what happened to the derivative, because it wasn't clear whether people were going to make their payments on their mortgages, or whether the derivative counterparties could pay. The market responses was to try to sell all the derivatives, rather than wait to see what they'd be worth. Effectively, the liquidity which those derivatives and CDOs had prior to the crisis disappeared entirely, which meant that their true value fell much faster than it really should of since people were selling at a discount just to get them off their balance sheets.

The FED certainly still remembers the mortgage mess, considering they still hold some $1.6 trillion in mortgage backed securities on their books. One wonders what they will do when the next debt crisis hits. Will they take on another trillion in corporate debt? Clearly this can't go on forever, but there seems to be little political will to let credit markets normalize.

For me the whole situation is really scary.

That's the scary thing that makes it so difficult to argue invest in my opinion, in that really ever since the late 90s Asian financial crisis we've been on these huge boom/bust/boom/bust cycles, all fueled by the Fed encouraging people to take more risk to lessen the blow of the bust.

We've been on large boom and bust cycles since the 19th century at least. This isn't new.

And look where it got us in exchange: a new economy, the potential for AI and new medicine. Booms and busts don't matter in the grand scheme of things, so long as people remain productive and energy remains plentiful.

The economy is always in one of two states - recession, or people predicting that the next recession is just around the corner.

Here are two more things lurking behind the corner that can drastically effect the economy:

Inflation Deflation

Have also been reading about this [3-6]. With some believing the economy is slowing[1] (i.e., lower corp profits), and with the Fed believed to be pausing rate hikes[2] (i.e., no interest payment increases), I'm curious to see if this turns into a sizeable problem (i.e., quasi '08 bad)

[1] https://www.cnbc.com/2018/12/10/goldman-sachs-warns-of-a-sha...

[2] https://www.reuters.com/article/uk-global-forex/dollar-falte...

[3] https://www.zerohedge.com/news/2018-10-30/corporate-debt-bub...

[4] https://www.bloomberg.com/news/articles/2018-11-19/corporate...

[5] https://www.forbes.com/sites/jessecolombo/2018/08/29/the-u-s...

[6] https://seekingalpha.com/article/4225847-corporate-bond-mark...

People have been saying this since 2015. While the conditions for debt refinancing have certainly changed, it's not clear by any means that this is the sort of problem that would cause any sort of cascading recession all at once.

Peter Schiff and Ron Paul have been saying this since 2008. I used to believe them. I stopped when the fed ended QE and started raising rates despite Schiff's predictions.

Some might say the end of QE and the forced budget cuts due to the Tea Party shenanigans is the reason the predictions didn't come true...


I also find it amusing, in an ironic sort of way, how the Austrians get a bunch of flack for not accurately predicting future events when large parts of their economic theory is based upon not being able to predict future events.

There's a great saying... economists have predicted the last 7 of 5 recessions.

A more interesting question to ask is why we shifted from the student loan crisis to corporate debt as the very-definite-hiding-in-plain-sight cause of the impending crash.

My two cents:

(Full disclosure. Not an economist)

The great depression seemed to have ~5-8 primary causes to it. These causes came from many different directions and converged on a single year (or handful of years) in time. Since then, the recessions we've had have seemed to have occured due to a single or unitary primary cause. That is, they did not seem like the convergence of a multitude of quite distinct causes. A problem here is how fine a line you draw between separate causes. On one interpretation, there was a convergence of a multitude of causes leading up to 2008. The only thing I will say here is that the multitude of causes for 2008 seem much fewer in number and distinctness than 1929, and our present situation feels more similar - in that way - to 1929 than 2008.

Ray Dalio is saying our current situation most closely resembles 1937, and 2008 most closely resembled 1929.

It's really odd that he says that considering how different unemployment is today compared to 2008, where as in 1937 unemployment had consistently been bad starting back in 1929.

Interesting. I would very much love for him to be right.


[Insert healthiest year for American economy ever]

Source? I’d love to learn more

It's a very dry patch of grass waiting to be lit by something like a set of defaults in Asia which sets of a minor panic elsewhere.

There have been corporate defaults in Asia since 2015-2016. This looks more like a soft landing at this point, unless Powell decides to keep tightening. But all signs point to this rate-raising cycle being over, and in anticipation of that, financial conditions have already substantially eased just in the last couple of months.

The current financial system does not price taking care of the environment. Tragedy of the commons, air co2, oceans pollution. Further it is unstable there is always credit booms and busts in cyclical fashion. Further besides thrashing the planet it sends wealth from the middle class up to the top of the pyramid. I am curious why the middle class tolerates it? Could it be that most people do not understand the financial system?

I am sure that it is made deliberately complicated so that only those in the know can make money from it. I don't doubt that I could make money from it myself, but I don't have the time to learn all the intricacies of the system. Well that's my excuse.

I called this when we moved from basel 2->3 . It changed the reserve requirements to 0 for these type of loans.

Misleading. They show the amount that debt has increased, but they don't show how corporate assets have increased. If they did, you'd see that the wealth/debt ratio is NOT alarming.

When markets crash they tend to crash fast after seeming to be in a slow motion. I wonder what the kickoff will be?

If it’s this week it will go something like this:

1. People realize that they aren’t getting their tax returns because of the shutdown and it has an outsized effect because consumer savings rates are low. Market wobbles.

2. Treasury issues short term debt at high yields and long term debt at low yield yields Thursday, market crumbles Friday.

3. Fed meets next week to discuss the debt window and if they need to slow down QT or go back to QE. They don’t know. Market goes volatile.

4. Government shutdown ends at first sending stocks up. Then key economic data releases showing consumer spending is going to be weak because real wages were down.

Anyways, it’s more likely we’d have to see a couple of blue chips go bankrupt first like a big state utility company or a classic old American tech company.

Your first statement (People realize that they aren’t getting their tax returns because of the shutdown) is incorrect: https://www.bloomberg.com/news/articles/2019-01-07/irs-will-...

For awhile now I've been preaching my prediction which is:

When (not if) the market crashes again, it will happen MUCH faster than previous crashes due to increasing automated trading and general speed of news. Expect a flash crash within minutes instead of days. And, if there is a halt in trading it will crash even faster.

You have to take all these gloom and doom articles with a grain of salt. And take them as a reminder that all economic booms reverse. Yes, some are right. Yet, most are not. Question is which and when? We can't know and won't know until after the next financial disaster happens. Even as we go through one we won't know until months after it starts.

The last recession started at the end of 2007 yet we didn't really start feeling it until well into 2008.

Financial collapses are more like earthquakes. You never know when they will happen. But by the time they happen, it's too late to get ready so you better be ready to avoid a major disaster beforehand.

Beware financial analysis and economic forecasts. Confirmation bias is rampant.

"Leveraged loan", defined:


FT offers a more technical view of the phenomenon. Yesterday:


How would one go about shorting this debt?

You could short publicly-traded PE firms with unfavorable profiles, go after companies with bad current ratios and operational cashflow, or just short the market. Dangerous game, though — remember that the market can stay irrational longer than you can stay solvent.

"Being right early is the same as being wrong"

First, watch The Big Short and decide how you'll manage being on the right end of a winning bet with the incumbents doing everything they can to screw you out of payment.

Read the book - a couple of great scenes that weren't included in the movie.

Worth it for the bathtub scene.

Start a company and issue debt

Actually, this is my favorite answer, because it’s absolutely THE way to profit from terrible economic practices. Borrow money, and never give it back. That IS the correct way to come out a winner when it comes to operating stock ownership. Be the borrower.

Other people’s money, as they say. But can you spend that money as is on for example a Ferrari? Best bet would be to “invest” in something high risk where you either lose it or make so much you can pay off the loan and still be loaded.

Favorite saying: “ when you owe the bank $100,000, you have a problem. When you owe the bank $1,000,000,000, the bank has a problem”

Buy credit-default swaps on said debt. The swaps can even be found bundled conveniently in ETFs. Not recommended; good luck.

You can short or buy puts on high yield ETFs, such as HYG and there are probably some others. However, unless you know what you're doing, and have risk management, it's probably not advisable to hold longer duration short positions. The market may ultimately go down, but in the mean time, you'll be losing money and may not profit very much when it ultimately does go down.

The short squeeze in HYG over the past few weeks is insane, up nearly 6%. It had moved +/- 1% all year up until then. You’d have to hold through price moves like that.

Apparently high yield ETFs invest in junk bonds which are different then leveraged loans. For example, junk bonds are overseen by the SEC.

This debt can also be seen as a bet that there will be inflation.

Buy puts on $jnk, or try shorting it. Or you could take a look at corporate bond rate swaps.

Disclaimer: This is a terrible idea. Don't do it.

There are ETFs tracking corporate debt.

Short the companies with the most debt to earnings or some strategy along those lines.

Who profits off of people worrying about another economic crisis? I'm pretty knowledgeable on my local real estate market, and people are constantly telling me we're in a bubble (we're not) and it's all going to come crashing down this year (it won't). It seems very common these days for people with next to no economic expertise to be certain of a coming crash. I don't think it can be credited to everyone watching the Big Short.

Edit: Explanation because i'm getting downvoted. I live in Utah. Our prices have increased quite a bit in the past couple years. The first bit of increase was justified by the increase in high paying tech jobs, but then sellers got greedy. We're currently in a stalemate where nothing is selling because sellers want unrealistic prices. That's not a bubble, that's a market correction.

When prices reach a point where you can't pay your mortgage by renting out the property then you can pretty much guarantee that prices are on the (too) high side.

> ...but then sellers got greedy. We're currently in a stalemate where nothing is selling because sellers want unrealistic prices.

Technically...buyers make the market. Without a willing buyer it's all just wistful thinking.

The real question is if the prices are truly unrealistic or are they necessary to ensure the seller isn't losing money on the deal?

It was really interesting to watch. Prices kept going up until spring of 2018 when they crossed the threshold into too high territory. This is where we were kind of in a bubble because there were some willing buyers paying more than they could rent for. There weren't very many buyers that could afford those prices though, Salaries in Utah are historically lower than they would be in similar markets else where. If you're in Utah there's usually good reason to be stuck here. Religion, family, obsession with skiing, etc.

So now sellers are wanting the prices that houses sold for in the spring, but there just aren't enough buyers out there that can stomach that. And certainly not enough salaries out there that can stomach that.

> I'm pretty knowledgeable on my local real estate market, and people are constantly telling me we're in a bubble (we're not)

I don't know your real estate market, but real estate seems to be in a bubble basically world wide.

A bubble can easily predicted when looking backwards. Regarding the future: The Case–Shiller index does not make current US real estate prices look like a bargain.

Can you talk to the Case-Shiller index? I'm finding it somewhat difficult to understand.

I believe it should be going up (more people?), so how would you use it to argue US Real Estate prices are high?

Are these debt misclassified as AAA, I don’t think so because of what happened before at Moody’s, I think they changed some rules

No, they’re junk bonds, I.e. not investment grade.

does that mean VCSH (Short term investment grade debt) is a good or bad play?


Seems to be a similar theme: there is a ridiculous amount of money at the top that has nowhere to go and nothing to do but inflate debt and asset bubbles.

Most of the money the top dogs make is from selling overpriced assets to lower tier chumps :(

The irony and tragedy of modern capitalism.

Everyone wants to get paid, but no one wants to pay.

Since ones in power have more control, the top end up keep getting paid more, while the lower ends keep getting paid less.

One example would be equity firms.

They buy a firm with borrowed money, and in order to pay back the loan, interest on the loan, AND make a profit, they apply the expensive knowledge learned from fancy MBA schools (that charge bucks) and lower cost and increase profit. And lowering cost always means paying less to employees. And increasing profit means charging more.

Little do the super rich realize, that soon enough there will be no middle class to buy their stuff/services. And eventually the rich/superrich can only sell stuff to each other, while us peasants watch on smartphones from our slums using youtube service and enduring all the ads since we can't afford the $20/month to hide the ads...

Marriner Eccles, after whom the Federal Reserve building is named, said something very similar to your last paragraph. I need to dig up the quote.

Edit: Not the quote I was looking for, but maybe pithier: "The United States economy is like a poker game where the chips have become concentrated in fewer and fewer hands, and where the other fellows can stay in the game only by borrowing. When their credit runs out the game will stop." Beckoning Frontiers, Marriner Eccles

Edit: Here's the one I had in mind, written by Fed Chair Eccles in 1933:

"It is utterly impossible, as this country has demonstrated again and again, for the rich to save as much as they have been trying to save, and save anything that is worth saving. They can save idle factories and useless railroad coaches; they can save empty office buildings and closed banks; they can save paper evidences of foreign loans; but as a class they can not save anything that is worth saving, above and beyond the amount that is made profitable by the increase of consumer buying. It is for the interests of the well to do – to protect them from the results of their own folly – that we should take from them a sufficient amount of their surplus to enable consumers to consume and business to operate at a profit. This is not “soaking the rich”; it is saving the rich. Incidentally, it is the only way to assure them the serenity and security which they do not have at the present moment."

- https://www.nakedcapitalism.com/2011/09/marriner-eccles-on-t...

That quote reminds me of something Huey Long said not much after that (1935) after people were accusing his "Share our Wealth" program of being communist despite it having explicit protections for private property.

> "Communism? Hell no! ... This plan is the only defense this country's got against communism."

His was less of a "using poor people is helpful to the rich" argument than an "abusing the poor is going to create violent revolution", but both arguments stem from the same source. The cynic in me says that lines like these were easier to sell back when the idea of automating most of workforce wasn't quite so real. If the rich people of the future can get everything they need and want by owning technology - through patents, tech investments and physical technology for self-defense, why would they care if the rest of the country can play the poker game with them? If they have enough chips, why not just trade them among themselves forever? There will be nothing left to gain from letting other people buy-in significantly and there is no significant risk from refusing them.

I think Eccles refers to the 'violent revolution' argument with 'Incidentally, it is the only way to assure them the serenity and security which they do not have at the present moment.' I think (hopefully or cynically?) the answer to 'why would they care if the rest of the country can play the poker game with them?' is, to quote economist Mark Blyth, 'The Hamptons are not a defensible position.' IMO, it's a stable society that enables wealth, and wealth can't survive as an island in an unstable society.

> [...] they apply the expensive knowledge learned from fancy MBA schools (that charge bucks) and lower cost and increase profit. And lowering cost always means paying less to employees. And increasing profit means charging more.

A place I used to work brought in a new GM who, after nearly a year of attending meetings and taking notes without contributing anything of any perceivable value, made his grand proclamation of how he would build the company into a mega-profitable mega-corp:

He would reduce expenses (by screwing the employees).

And increase profit margins (by charging customers more).

And increase earnings (by making more sales).

Genius! No wonder he got paid the big bucks.

This, mind you, was at a company which built mining equipment. During the end of a massive slump in the ore market for the types of mines they serviced. At a time when the two major customers had both publicly announced 30%+ reductions in projected outlay for equipment.

And no, it didn't work.

That’s ice cold

If you like what I said, please click on subscribe, I mean, upvote my comment.


Buy Bitcoin then if this is your prognosis.

I think what’s really happening is social media is “going dark” in the wake of Facebook and Trump, and predictions that were previously possible, will now expire.

All of this ties into candidacy announcements for 2020 presidential elections, and people are doomsday prepping for that one, since the ground is going to shake no matter the outcome, this time around.

Nope, the economy goes in fairly predictable cycles and it doesn't care who's president.

Stocks are currently over valued: see Nobel prize winning economist's CAPE ratio.

I imagine economic bubbles are not independent. I wonder if this in sum with the student loan 'bubble' could make things worse than in part.

The article doesn’t mention who’s buying the debt. As long as it’s private investors using their own money, I don’t see a problem with this.

You'll recall the financial crisis in 2008, where many of us taxpayers paid massively to bail out these private investors using their own money.

The taxpayers made $96B on those loans [1]. The issue then was that everyone was buying those CDOs because they were AAA rated, things like the pension funds and the banks themselves. I'm saying that if only individual investors are buying the corporate debt, it's not a systematic risk.

[1] https://projects.propublica.org/bailout/

That's a fair point given the way I phrased my reply, but TARP is far from the extent of the cost of the financial crisis. The resulting market crash, credit crunch, unemployment all play a role in making this much more than a private issue. The fed estimated the cost to each American at $20-80K. [1] Also TARP could have very easily not made money, and bailouts are certainly not guaranteed to make money the next time around.

[1] https://www.nytimes.com/2014/01/22/business/economy/the-cost...

That's fair too, though it's easy to blame all of the recession on the subprime bubble bursting while I think it would have happened anyway, eventually. And I'm advocating for letting banks, funds and investors fail if they lose at the game of musical chairs. For this to work though they need to be kept separate from rest of the finance system and use their own money.

I'm agreed with you on that point. I wish we lived in that world and I think we should work harder to get there. As long as we don't, though, I'm resigned to recognizing the public costs of these private failures.

Oh, is that why college is free for everyone?

The public is put upon to absorb losses but is never issued the gains made.

And they call it "Quantitative Easing" wtf. Time to look past Capitalism and our Modern Feudal Lords.

Why do people always forget the 4.3T in Quantitative easing....

That's still an incorrect way to view it given that the fed still is holding on to around a trillion dollars worth of those CDOs, and one could argue this is a huge factor in why the median American home price is so much higher than it was before the 2008 crisis.

It's not, though. In real terms, house prices have barely risen.

"Altogether, accounting for both the TARP and the Fannie and Freddie bailout, $632B has gone out the door—invested, loaned, or paid out—while $390B has been returned."

It goes on to claim revenues that make up the difference in the stated amounts.

However, I don't see them say these figures are inflation-adjusted. 2018 dollars are roughly worth 83 cents in 2008 terms.

More importantly, those Propublica stats cover only TARP and the Fannie Mae / Freddie Mac bailouts. It counts the fake "profits" on the GM bailout[0] but not the losses on the losing end of the GM reorganization split[1], serving to bail out union pension plans.

[0] https://hubpages.com/politics/Obama-General-Motors-GM-Tarp-B...

[1] https://en.wikipedia.org/wiki/General_Motors_Chapter_11_reor...

It says right there on the page "$390B - Money returned to Treasury by bailed-out companies." It's not an outstanding amount.

Hence my writing "It goes on to claim revenues that make up the difference" in the first place.

Not really. Investors got wiped out in many of the 2008 cases. Some banks were given loans but that money didn’t go to investors, it all had to be paid back.

Indeed. I'm not saying the investors didn't have downside. Many did, and many of them lost everything (as they should have). But the public also bore a tremendous cost, and that makes the threat of another such crisis a public issue.

Additionally, if the public at large is losing then someone out there is winning and that entity will see these crisies as profit opportunities instead of disasters.

As a high schooler, I remember buying citi stock for $2.60 or something like that. Just an anecdote, but my teenage self just said, “come on. It’s still a bank!”

This kind of argument misunderstands what systemic risk mentioned in the article means. It's not the same as market or price risk.

When systemic risk is realized, those who took too much risk take with them much bigger number of people and businesses that had nothing to do with it. For example, you might not be able to withdraw your money, or completely profitable manufacturer can't get a operating loan to buy materials to make a products with high demand.

* https://en.wikipedia.org/wiki/Systemic_risk

* https://www.investopedia.com/terms/s/systemic-risk.asp

And then limited partners don't put money in to VC firms. And that guy who was taking $500K an year for twiddling JSONs at Netflix all of a sudden won't be able to pay mortgages on his $1.5 million home.

Guess what happens then.

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