It doesn't matter if the banks crash again if the Fed will just bail everybody out again and push stock market inflation even higher than it is now. It's clearly unsustainable, but the question is, how and why will the bubble burst?
The author posits one option, of political intervention precluding another bailout. But the Federal Reserve is non-political precisely to shield it from attempted short-term political machinations. Congress will complain to the cameras and the Fed will go right back to "rescuing" the market.
No, the bottom will only well and truly drop out when there's significant capital flight - when the dearth of real investment opportunities relative to currency glut becomes so acute that capital leaves American borders in search of real return. But to where? And under which circumstances?
Think you nailed it. The thing is, in order for capital flight to be a risk there needs to be somewhere else of comparable size and upside opportunity to the US that doesn't rhyme with "China" and it sure as hell isn't Europe. So we're back to square one in which absolutely massive sums of money are chasing returns with nowhere else to put money than the same places it already is. It's madness on a global scale.
It's not that we don't see it, but we don't agree. I honestly don't have the energy to try to explain it here anymore -- the conversation always turns unpleasant, and I need a place on the Internet where I can avoid thinking about economics for a while.
Rationalizing the irrational tends to be unpleasant.
I think it's a complete fabrication that people are dependent on the financial system and that we need economic stability. People enjoy drama and they are able to recover from any economic failure. Even total failure.
Too big to fail is total BS. If a solar storm wiped out all records of bank accounts and all records of all financial holdings, the economy would quickly recover. The number of new opportunities that this would create would be unprecedented.
From the perspective of most people, the best feature of capitalism is not its ability to provide sustenance (even communism can do that), it's its ability to provide hope for something better... Unfortunately these days our modern version is not true capitalism, it's crony-capitalism and it doesn't yield much hope - You are given a place in society and the only way you can get something better is by doing something deeply unethical and then earning hush money from your corporate masters.
We are heading towards a dystopian surveillance capitalist future. Even if the economy crashes permanently and never recovers, that future doesn't look so bad compared to what would happen if we stay on course with current monetary policies.
i mean, globalism was always about helping capital find returms while hedging risk, under the guise of international trade being better for all than isolationism (but much better for capital than labor).
the core problem of hoarding wealth, as exhibited by the flight of capital to the US, is the inability of small groups of people to efficiently allocate capital, to have enough imagination and ingenuity to centrally-plan their allocations. it's literally anti-capitalist.
Can you give some guesses? I don't see any other place that would seem more attractive than the US. Every other place has its own problems whether it be lack of developed human capital, unstable government systems, etc. Maybe in the distant future if Mars transportation takes off that can be the next big thing?
Short of saying that a hyper inflation event in the US would probably break civilization and so allocating capital is irrelevant at that point, isn't the obvious answer Bitcoin or other crypto assets?
Yeah, until there’s a better market to invest in than the US or an attempt to dethrone the dollar as the reserve currency I don’t see anything changing no matter what the fed does with QE and bailouts.
> but the question is, how and why will the bubble burst?
I'd take the Black Swan approach. There are probably a dozen each unlikely events that could cause the bubble to pop but you're unlikely to actually predict which one will do it and when it will happen. Your optimal move is to assume something is going to happen at some point and just hedge yourself against that rather than try to predict. Taleb gets called an oracle but his entire philosophy is not to predict rare events that destabilize a system but just accept they will eventually happen and prepare accordingly
In this case having some portion of your net worth in BTC/Crypto seems like an obvious hedge
We never "righted" the system after 2008 (or 2001). We just kicked the can down the road, making the problem worse for ourselves when we eventually do finally lose control. Our system is 100% entirely dependent upon ARTIFICIALLY low interest rates driven by Central Banks. It's the only still keeping this zombie of an economy moving, and it's the entire world, not just the United States.
Central banks are doing everything in their power to keep interest rates low because if they were to tick up even a little bit, the whole house of cards will come toppling down. They can't do it forever and we're all just playing chicken with hyperinflation.
>Our system is 100% entirely dependent upon ARTIFICIALLY low interest rates
There is no such thing as "artificial" or "natural" rates of interest.
>Central banks are doing everything in their power to keep interest rates low because if they were to tick up even a little bit, the whole house of cards will come toppling down.
Why would, or should, they "tick up"? Capital is abundant. If rates were higher, things would be different, yes. But that is not the world we live in.
>It's the only still keeping this zombie of an economy moving, and it's the entire world
I love the idea that the entire global economy is fake, artificial and zombie-like, because it doesn't operate the way you think it should. A reasonable person would take a step back and question their premises and understanding.
>There is no such thing as "artificial" or "natural" rates of interest.
In a sense this is semantically correct, there is no one true interest rate, in a hypothetical pure market there are many rates for many different types of transactions.
But to say that wildly misses the point that the rates for all transactions are hugely skewed, all in the same direction, because a single player, who writes the laws, and prints the money, is putting enormous pressure on rates.
So yes, there is no objective one natural rate. But all rates right now are extremely artificially skewed.
> Why would, or should, they "tick up"? Capital is abundant.
Capital is abundant for the sole purpose of keeping rates low. You are confusing the causality here. If they weren't being suppressed, and actors were setting rates on a per transaction basis, then they would drastically tick up as many of the underlying entities economy wide have riskier default profiles than they have in the past. This isn't conspiratorial or speculative. This is widely understood to be true by mainstream economists, even those who support the rate suppression.
I just want to take a moment to note that capitalists are lobbying the central government over a difference of opinion about interest rates, asking the central planners to adjust The Number.
...And several Russian novelists burst out laughing in their graves.
It's artificial if the entity loaning you the money and setting the rate has no associated risk.
If I loan you money there's risk you won't be able to pay me back. So I decide what interest you would need to pay me for it to be worth it for me to take that risk. Lots of other people do that, and you get a "natural" rate of interest as you call it. Everyone offering you the loan has skin in the game.
But if the entity that prints the money says they'll loan you money, it doesn't matter to them if you can't pay it back. They set the money supply. If you don't pay back, they can take the value from everyone dealing in their money by printing more. This lack of risk allows them to undercut the rates of entities who would be taking on risk. Now you have an "artificially" low interest rate.
>I love the idea that the entire global economy is fake, artificial and zombie-like, because it doesn't operate the way you think it should. A reasonable person would take a step back and question their premises and understanding.
The new part is the expectation that governments will prop up companies during bad economies.
This is bewildering to anyone with a naive view that believes America is a purely capitalistic economy. Surely if a company prepares enough for the storms, it's worthy of surviving them. Running thin savings is now more risky, but it means more profit. That's fair.
From another perspective, it's economic innovation where unpredictable disasters don't kill huge companies or industries. This can be a good thing, but it's not really capitalism any more.
So the person taking a step back will ask, "How far will the government go to protect large companies? How large do you have to be to get this protection? How does all of this work?" This is what we can't answer.
This is where people (rationally) start to believe things are fake, because the country's leadership gets to decide what happens to companies during these times.
Now this company knows the government is likely to bail them out, what reason do they have to plan for the worst any more? This gets even more uncomfortable when they get bailouts for causing the disaster themselves.
The only companies the government is propping up are the airlines and small businesses by mainly paying for their payroll to keep people employed through the CARES act [0]. In what way is the government protecting large companies?
Exactly, it's protecting large airlines from going under. This means there's less risk here than if the government had not intervened. Any future pandemic will likely result in a similar response, therefore, airline stocks have reduced risk of becoming worthless.
At a basic level, if you removed all demand for airlines, you'd say "well, airlines don't look like a great investment". But now the demand matters less during disasters because demand isn't actually keeping the company alive as in most businesses.
This brings to mind Elon Musk and his many failed rockets. Normally a rocket failure is so expensive it has the potential to bankrupt even a rich company. In a pure capitalistic system investors would not risk suck long term goals as going to Mars, when it involves many rocket failures, and no profits.
But its in the national interest to push such research forward for the sake of humanity. So if state provides some welfare, or a cushion, to hedge such risky thing as building rockets, don't we all benefit. In a similar way to the way government grants pay for research at universities.
Its obviously a balance.
I live in Canada, a huge country. Its not profitable for any company to provide power to remote places with only a few inhabitants. Its only possible because the government mandates it, and the rest of us subsided it.
> Our system is 100% entirely dependent upon ARTIFICIALLY low interest rates driven by Central Banks.
It's the other way around: the entire reason why everything is so screwed is because of interest. It's an evil and exploitative practice that has destroyed so many people, only for a relative few to become wealthy. It's obvious today how this works out, but it's been going on for thousands of years, which is why it's banned in many religions, and for good reason.
It's a moral argument against the inherent exploitation involved in usury. No one denies the time value of money, it's about how to extract that value morally and ethically, and not at the expense of the needy.
What are you proposing as a solution? Is this a situation along the lines of “Democracy is the worst form of government, except for all the others”?
People with capital need an incentive to provide it to people without capital. You can argue reasonably that the distribution of capital isn’t “fair” but to argue there should be no interest charged seems irrational. Help me understand your position.
There are true risk sharing models that do not involve interest. For example, I want to start a business, instead of taking a interest-bearing loan, I have someone invest in my business in return for equity. This way, risk is shared by both (or more) of us. If the business fails, we both lost effort and money and time. If it succeeds, we both profit.
With lending money, there's usually a collateral involved. If the borrower defaults, then the lender simply comes after his property, taking more than what was originally lent, purely by the passing of time (which accrues interest).
When you read about student loans for instance, especially higher loans for people who go into law or med schools, how even after those people are employed and making good money, their outstanding amounts barely budge (or even accrue) even after a while. This is unjust, unfair, unethical, and exploitative.
A loan is when someone sells money. The interest is the profit to compensate for the risk. Is all profit, (including that derived from selling labour) to be thought of as theft?
Should everyone sell everything at cost to avoid "exploiting" others?
Selling money is unethical because of the inherent exploitation involved, by taking advantage of someone who is in need of it.
No one is saying not to make profit, just do it properly. You can rationalize interest as being compensated for risk, but it doesn't make any less exploitative. We have already seen how the economy keeps getting screwed, yet we don't learn.
When you're selling a good or a service, you're exchanging one type for another, usually hand-in-hand. You buy food, furniture, etc. in exchange for money. There's value in the thing you're selling in exchange for a certain amount of money (which also has value).
When you sell money for money, this equation breaks. You're exchanging $1 for a different amount in the future, taking advantage of the fact that the borrower cannot pay you in the present. This is what defines interest and usury.
It's easy to get bogged down in the details to legislate or rationalize a certain action. Take a step back and see the destruction that interest based lending has caused throughout history, and in the present.
If you are lending money at absurd rates because the borrower is desperate then we could call it exploitation, but this can happen in any transaction. All transactions are "taking advantage of the fact that the borrower cannot pay you in the present." If the person I'm selling food to already has enough food, why would he be buying more?
The difference with money seems rather to be that the value is created over time, where other transactions happen based on the current value of the things being exchanged. But given that we all die this doesn't strike me as morally wrong.
> If the person I'm selling food to already has enough food, why would he be buying more?
Food is perishable, and people like diversity in what they eat. Your example is an apples to oranges comparison. If he doesn't like what you offer, he'll go elsewhere.
> The difference with money seems rather to be that the value is created over time, where other transactions happen based on the current value of the things being exchanged.
Yes. Furthermore, when lending money to someone with interest, the lender gets what he put in and more, whereas say leasing a car out, he'll get it back, but it would have been consumed. This type of exchange doesn't happen with money.
> But given that we all die this doesn't strike me as morally wrong.
We can take that to it's conclusion and say nothing matters at all. People are out protesting against racial inequality, but we'll all die at the end, so it doesn't matter.
The increase in money lending us directly correlated with a vast increase in the standard of living for the average human.
Just because you buy a dollar rather than a shirt does not suddenly make you exploited. Imagine if everything debt is used for had to be bought in full. Very few people would own homes. Very few capital investment projects would be undertaken. Very few automobiles would be owned. Your life is far better because debt exists. There is no society where debt does not exist that is doing better than societies that allow debt.
> The increase in money lending us directly correlated with a vast increase in the standard of living for the average human.
You said it yourself, it's correlation, not causation. There are other factors that occurred in that time frame that increased the standard of living for people.
> Imagine if everything debt is used for had to be bought in full
That's how things were generally run back in the day, people saved up, then bought what they wanted. Also, people purchased on installments.
Your argument is basically that the ends justifies the means. That economic growth is the end goal, sell more cars, etc. so we need to put everyone in debt. We are already seeing the huge wealth gaps that exist in hyper capitalistic societies, due to no small part to running everything on interest and other immoral practices. I posit that if there were no interest, things would be more fair, and producers would have to reduce prices, making it easier for people to own stuff, compared to the inflation we see.
Generally, you don't get hyperinflation when asset prices fall.
If interest rates were to rise to normal levels, asset prices could fall 45%. It's hard to imagine anything but deflation.
Unless interest rates go to extreme negatives, you will not see another effect like the one we have already seen from interest rate manipulation. There's just not enough room for a big rate of change.
It would be completely separate if you had outrageous fiscal spending to try to prop up asset prices. Given that fiscal stimulus is much harder to pass than monetary, hyperinflation doesn't seem like the thing to worry about.
I argue that it's positive rates of interest that are artificial, not negative ones.
Traditionally if you had a large pile of gold and you wanted to protect it, you had to buy a safe to put it in and hire guards to keep the thieves out. The guard's salary is in essence a negative interest rate.
It was only the invention and adoption of fractional reserve banking that enabled positive interest rates.
I've long read about the following still being a problem (post-2009):
- CDOs (although a new generation of them have a new name/initialism)
- Frank/Dodd was partially rolled back
- The definition of bank size-classes was changed to reduce the regulatory burden over most regional banks that were previously more regulated
- No significant adverse event happened after Standard & Poors was identified as having significantly inaccurate ratings on CDO / mortgage bond
- moral hazard all over the financial sector, multiplied by large QE rounds
- shadow inventory of housing (not sure if this was sold off or if banks still hold lots of houses off the market)
- lots of private unicorns have opted not to try to go IPO, despite Wall Street records over the past few years
(edit: I converted the indented list to individual paragraphs)
But given these assumptions, are the US financial markets really that healthy? It still feels like we have a few asset bubbles, especially in the assets which QE propped up.
I'm not sure I agree with the terms you are using.
I get the difference between what is usually called a "bubble" and what is usually called "inflation", but I don't think you can accurately identify a bubble until it has already burst and you do it in retrospect.
"Fairly priced" is strange because every transaction is "fairly priced" in the moment (given the knowledge at the time), but may turn out to be "unfairly priced" if in retrospect it appears to be fraudulent.
It's a bubble if investors are irrationally speculating on the future value of the assets, relative to the dollar.
It's price inflation if investors are rationally speculating on the future value of the dollar, relative to the assets.
It is hard to conceive that the dollar is not going to depreciate as a result of monetary policy, or that the monetary policy is going to change. I consider the latter scenario to be more plausible.
> "Fairly priced" is strange because every transaction is "fairly priced" in the moment
To be clear, I'm saying that the price represents fair value.
The stock market used to be a way to raise capital for profitable business ideas. Now, private equity has enough capital, they don't need to raise money from the general public. We've been shutout of the good money, we only get to pick up the crumbs, if we're lucky. The only businesses that IPO now are sure money-losers.
> We've been shutout of the good money, we only get to pick up the crumbs
Yeah, I think my biggest complaint of the private market / public market is the accessibility gap and the face that the actual valuation of a private company is extremely skewed because there is such little public info for due diligence and the company is so rarely re-evaluated.
> The federal government stepped in to rescue the other big banks and forestall a panic. The intervention worked—though its success did not seem assured at the time—and the system righted itself. Of course, many Americans suffered as a result of the crash, losing homes, jobs, and wealth. An already troubling gap between America’s haves and have-nots grew wider still. Yet by March 2009, the economy was on the upswing, and the longest bull market in history had begun.
This paragraph is conceding a point that should not be conceded. The system did not right itself if many Americans lost homes, jobs, and wealth. 12 years later, not everyone has recovered from the 2008 collapse.
I suppose maybe it depends what "the system" refers to, exactly. If it's the same bankers who shape the financial system and the banks who all own part of the Federal Reserve which printed money to put price supports under their worst assets, then sure, "the system" "righted" "itself".
But in the end, there is no right or guarantee that every person will get a job, be able to keep a house, or will not lose wealth. And we should remember that about our future when reading this piece.
> But in the end, there is no right or guarantee that every person will get a job, be able to keep a house, or will not lose wealth.
That's true for most people, but it's simply not true for the wealthy in practice. The government did try to make an example of a few players in the 2008 collapse, but for the most part, the message sent by the handling of the 2008 crisis was that if you're a big enough company and you take a risk that doesn't pay off, the poor and middle class will be forced to subsidize your mistake.
What criteria should someone use to judge 'righted itself'? No event can ever be completely undone, merely compensated for. Many of the people who lost homes should never have bought them leading up to '08 - they only were able to because of unrealistic (and sometimes predatory) underwriting standards and financing that NEVER would have worked out, and blew up shortly thereafter once the people bankrolling it figured out what was going on.
The overall economy recovered, but of course it looked a bit different. It was 4-5 years later.
Mortgages should have been heavily renegotiated, bailout given to the home owners to pay back the mortgage in a bottom-up bailout. Let's throw in existing homeowners as well, who had made proper payments in the mix, so they get some benefit from the situation.
Instead lots of money handed over to banks to fix their books and toxic assets handed over to the .gov. Lots of people losing their homes and jobs, no one in the financial sector really seeing any jail time or penalty for their malfeasance. Much of the financial sector actually made off quite well during/after the crisis.
We're seeing it again with big businesses getting COVID bailouts, meanwhile politicians are wringing their hands that unemployment insurance benefits are "too high" and "main street" needs to get back to work. Make sure "main street" is held accountable and/or penalized, but it seems there are a lot of golden parachutes and soft landings for big business and the finance industries.
1. I don't think the system "righting itself" for all parties was ever a possibility. The capital to both pay the mortgages AND let the borrowers continue to own their houses simply did not exist.
2. You're looking at this from a perspective of blame. I recently took out a fairly large loan for a purchase myself, and even as a smart, educated person, it was difficult for me to find insight into what a reasonable monthly payment might be. Lenders have far more information than borrowers do. I think if we're going to place blame for the financial crisis, that blame has to be shared, but I think simply based on the information available to the parties involved, we have to place the blame primarily on the lenders, who have far more information and context than the borrowers do.
3. However, I think blame is fundamentally the wrong way to look at this. To me, the entire point of having an economy is to provide people with a better standard of living. If the economy ceases to perform that function, any intervention by the government should be geared toward causing it to perform that function again. Instead, the bailouts were aimed at improving a few myopic metrics, metrics which only benefitted the already wealthy. The problem isn't that the bailout didn't punish the right people: I'm not interested in punishment. The problem is that the bailout made America a worse place for almost everyone.
Meh, the article doesn't mention recovery rates. If a loan defaults it's not usual you are getting 0 back. Typically 30-40% is the assumed rate. That means if all the loans default then the top 30% of tranches shouldn't take a loss.
So now consider, most of the underlying loans have to default and the recovery rate has to be below battle tested assumptions before the top tiers get risky. This is very very unlikely to happen given the Fed and the US Govt. have done so much and are committed to do more to stave off a severe depression / recession. It's more like people were killing it buying the safer parts at distressed prices as over leveraged funds shed them on the back of margin calls in March.
Cov-lite loans are at the largest percentage of issuance of all-time. 30-40% with a complete lack of meaningful covenants in a lot of cases is wishful thinking.
Additionally, what's new about this cycle is tech companies being a massive percentage of issuance. What's the recovery value of a tech company with little to no real assets? Additionally, what's the recovery value of an energy company when oil has dropped as much as it has? Both of those sectors make up a huge portion of outstanding and will move the needle meaningfully even if other sectors are fine.
I probably agree with your overall point about the Fed and and govt but you really cannot use historical assumptions for recovery rates this cycle.
> We already know that a significant majority of the loans in CLOs have weak covenants that offer investors only minimal legal protection; in industry parlance, they are “cov lite.” The holders of leveraged loans will thus be fortunate to get pennies on the dollar as companies default—nothing close to the 70 cents that has been standard in the past.
The "haircut" on risky assets stops you leveraging it too much. I think it's about 5% for US treasury bonds. So for every 100 I want to finance I need to have 5 cash on hand. Itsuch higher for riskier assets and that keeps leverage down. Also when things start to get edgy banks demand a bigger haircut further reducing the available leverage forcing you to delever (e.g. March)
If you step through the arithmetic, you see that a 5% haircut can take you to 20x leverage. It's a geometric series.
That means that investors' internal risk limits are the binding constraint, not repo haircuts.
It's another way of saying that the financial sector sets its own leverage. Historically, that has not turned out well. It's why Dodd-Frank included a leverage rule for large banks.
> That means that investors' internal risk limits are the binding constraint, not repo haircuts.
While part of risk, expected return is a larger binding constraint in most cases over risk limits. I'm probably not going to lever up 20x for an tiny expected return. On the other hand, I may very well lever up 5-10x on something 50x more risky than treasuries if the 10yr is yielding 0.725%.
In practice most PM's have a VaR limit and a battery of dollar exposure limits, which are all set by the risk department.
There is some credible research which suggests that large financial institutions act as if they are optimizing mean return subject to a VaR constraint [1].
VaR is a fake number for way too many reasons to get into and anyone who paid attention to VaR these past few months would have lost a ridiculous amount of money. I only have experience working for hedge funds and how risk is managed greatly differs from fund/strategy/assets traded. Banks no doubt manage to VaR but banks also supposedly don't have prop trading desks anymore so they function much differently now.
The discussion seems to have shifted to argument for argument's sake.
But for the sake of argument: large bank VaR models affect hedge funds because hedge funds get their leverage through their prime brokers which are... large investment banks.
Aha. Is this how folks actually attain worthwhile rates of return on very low-return, low-risk investments?
[EDIT] well no that can't be it because it requires even more money coming in for those loans, which can't provide more expected return than the bonds they're buying or the whole thing would be pointless.
From an outsider living a long way from USA, for many years now I haven't understood how the financial instruments of USA work. It constantly looks like the country is merely printing more money to stay afloat.
If I printed some $100USD bills, took them to the bank and tried to deposit them, they would have no value. The consensus is that you aren't allowed to print money.
The United States Government prints money all the time. This money has value because there is a world-wide consensus that it has value.
The simple fact is that there is and has been (for many decades) no safer place to park vast sums of money than with the United States Government.
There are limits, though it's not clear what they are. If the US Government printed 330 billion trillion dollars, and gave a trillion to each US citizen, then the consensus would be instantly broken.
The US Government printing 'a trillion here, a trillion there', at this moment in history, is not materially damaging the global consensus. This confidence is relatively easy to measure: when the US creates more debt, are there buyers? The answer is and has been for many decades 'absolutely yes'.
I'm not trivializing this borrowing, and I'm not vilifying it. It is a unique tool that should be used wisely.
> The United States Government prints money all the time. This money has value because there is a world-wide consensus that it has value.
No the Government borrows against future taxes (consider that an accounts receivable), the borrowed money doesn’t have value because of consensus it has value because it is backed by future tax revenue.
If the government did as you say and borrowed a trillion per taxpayer the system would breakdown but not because of some “consensus” but because the account receivable (future taxes) is insufficient to payback the borrowed money.
It is rather astonishing that rational people continue to believe that there is enough future tax revenue to justify this. It's entering dotcom-boom territory, where even the most optimistic future profitability can't justify this level of backing.
Part of it, I imagine, is that the US government is likely to benefit from future tech booms, as it has in the past (despite tax shenanigans from the tech companies themselves). It gets a piece of stock market profits -- a stock market whose own levels are also currently out of keeping with rational revenue expectation.
It’s never getting paid back, there is so much number fudging to hide the reality of debt and guaranteed payments for future liabilities...we pretend we are $26T in debt (but when you add in the future liabilities We are over $148T in debt).
To your point being rational doesn’t really give insights into these issues, but talk to any government budget officer and the can give you a sobering reality of the situation.
I wouldn't expect to pay it back in the sense of reducing the debt to zero. A government is (nominally) eternal, and can continue to revolve its debt indefinitely. It doesn't retire or die the way a person does. As long as it pays its interest, it can just borrow again every time a debt comes due.
But it's not reasonable for that debt to grow without limit. It has to be able to pay the interest on the debt, for which it requires revenue. We take in only around $3T a year in total. That's still a large fraction of that $26T debt, but we're also supposed to pay our actual obligations out of that -- which at the moment are over $4T. Eventually the debt service is going to be larger than our revenue, and I just don't see investors being willing to just let that amount ride as new debt.
And yet people will loan us money for 10 years at well under 1% interest. That keeps the interest burden down -- and yet with the debt growing at over $1T per year it can't last forever.
Those seem like something someone with wealth might want to do. But for those without wealth... protests are pretty much the top of the short list of options they can take.
> No the Government borrows against future taxes (consider that an accounts receivable), the borrowed money doesn’t have value because of consensus it has value because it is backed by future tax revenue.
This is one of two reasons it has value.
As other comments mention, the other reason is because it's by far the leading global reserve currency. Which is to say it's an attractive mix of liquid, stable, and available, compared to alternatives.
Furthermore, there are certain commodities (e.g. oil), for which dollars are required.
As a result, other countries / parties may believe the dollar is overvalued, but they will still have to acquire them, at the market rate, to execute transactions.
As a result of that ongoing demand, the dollar will tend to be valued both on its future tax revenue value AND as a result of a substantial, continuous demand.
The current US federal debt is roughly 110% of GDP. In a few weeks, I'm going to borrow about 350% of my yearly income in the form of a home loan. I'm currently paying about 30% of my pre-tax income on rent, and this future mortgage will be about 22% of my pre-tax income, so on that basis alone it makes a lot of sense.
Less than 10% of the total federal budget goes into debt payments.
The absolute numbers don't really matter, but the percentages do. Trends also matter, as long as they're considered carefully.
One interesting thing about the federal government's debt is that it behaves very little like an individual's debt.
A pretty decent 10-year student loan right now is at 4% interest. And you generally have to pay it back with actual money that you earn.
A 10-year treasury note is at more like 1%, and nobody bats an eye at the government covering payments by issuing more notes. Meaning that, in effect, the US government is getting an indefinite interest-only loan at a pretty low rate.
Actual humans don't get to do that because of a sticky problem: eventually we age out of our money-earning years, and (hopefully some time later) we die. Lenders, understandably, have an interest in getting their money back before that happens. Or at least in getting to the point where the loan is collateralized by assets that are worth more than the loan's balance by the time that happens. And that's the ultimate reason why revolving debt gets worrisome: It's running down the clock.
The US government, on the other hand, is theoretically immortal. There's a risk that it might become insolvent at some point in the future, but there's not the same reason to worry about handling debt by endlessly revolving it, because there's no proverbial clock for it to run out.
This is all true and on target. Comparing US federal debt to personal debt beyond anything but the most surface level is inappropriate.
Another class of entities that have a kind of 'forever debt' are large corporations. In general, they never want to be debt free. As I said elsewhere, it's about the percentages and trends.
To be clear: even this comparison has weaknesses. Indeed, US federal debt truly has no direct parallels.
I'm fine with the US Government printing money when it makes sense to, such as during an economic downturn. However, since 2016, generally regressive federal tax policies without commensurate spending cuts during an economic boom have un-necessarily increased the national debt.
(To be clear: I don't think we should have been cutting social spending. But we definitely should not have been giving huge tax breaks to the most wealthy.)
Got it thanks. And you think that’s something to be concerned about because the ability to print money is reduced by every bill printed and thus should be used modestly / wisely?
I don't think anybody knows how much money the US can 'safely' print. My guess is that we can print quite a bit more, but who knows.
So to answer your question: it's likely that the future probability of safely printing money goes down as more money is printed, thus making that ability a scarce resource.
My intuition is that the federal government giving additional money to the wealthy (as it has done since 2016) is of less marginal value to society than retaining the future ability to print equivalent additional debt.
Where do dollars come from? Many observers say that the Federal Bureau of Engraving and Printing manufactures them. These manufactured dollars are then distributed to banks and through banks to other firms and to the public. They are manufactured in the quantities necessary for efficient settlement of loans and other financial instruments. In particular, attention is paid to current goals for purchase of "Treasury" notes. These instruments are also manufactured by the USA government.
Obviously, an individual human can't operate like this. The USA government can, and has for decades. Remember the Gospels' admonition to "render unto Caesar."
There is a lot of terminology, and the details are absurdly complicated, but the basic idea is simple:
* businesses make things and sell them
* businesses take loans as a way to have a base of money to operate with, because the costs associated to make things have to be paid before the revenue from selling them comes in, and sales may be cyclical, etc
* businesses pay interest on those loans. (Hopefully this interest rate is significantly less than their profit margin.)
* the issuers of the loans- usually banks- sell the rights to the interest payments of those loans. Why? When a bank makes a loan, it is exposed to the risk of the business failing- if it fails, the loan principal and interest payments are lost. banks don't want this kind of "all or nothing" risk (more below).
* people who buy those rights package those interest payment rights into legal structures that combine interest payment rights from a lot of businesses together
* parts of those melded interest payment legal structures are then sold, often sold back to banks, because now the risk, instead of being "all or nothing" is "diversified".
The same thing happens with mortgages- banks that issue mortgages sell the mortgages and then buy into structures that package the payment rights from many, many mortgages.
For every given institution/bank, the move to sell the specific asset and buy the diversified asset makes sense.
At a systemic level, when everyone is doing this, it becomes systemically risky.
What's happening now, because of the systemic risk, entities that hold these "diversified" assets are themselves selling them to the central bank, which is then absorbing the systemic risk. This article doesn't mention that bank holdings of cash are at all time highs.
In principle, this does not amount to "printing money to stay afloat"- though many will say in practice it does. In principle, it amounts to shifting systemic risk around.
It's weird that people think that it's different anywhere else. In fact, the situation in the US is, if anything, less serious than elsewhere. Especially Europe.
The ECB had to bail out quite a few banks, and several states have done the same. Even now the ECB is preparing new bailouts for European banks:
And when even the ECB thinks banks have behaved so appalingly they deserve to die (trust me this takes quite a bit of really, really bad behavior), the individual countries:
Simple...imagine an accounts receivable that you can borrow against, so when you are low on cash you can borrow money on the basis you will be able to pay in the future with the account receivables.
Only the US account receivable is taxes paid by taxpayers. So what happens is when the rich are in trouble they turn to the government and what the government does is says ok we will borrow against future taxes and just give it to you and typically those being bailed out are banks who turn around and take the taxpayers money and lend it back to the taxpayers. In short the taxpayers get screwed twice once being indebted to the government for future taxes and then again when they have to borrow their own debt from banks.
So imagine I’m your government and say look Bank needs money so I am going to give the bank $100 and you the taxpayers will have to pay that back. Bank gets the money and turns around and lends you $90 while keeping $10 as a fee earned and for lending you the $90 you will need to pay the bank back $100. You see now you need to pay $100 in future taxes to the government and $100 to the bank, so you are really out about $200 less the $90 loan.
>It constantly looks like the country is merely printing more money to stay afloat.
That's basically what's been happening since 2008. The main lesson the Economics profession learned from the Great Depression is that it's better to prevent a full-on depression by any means available than to let it occur and rebuild afterwards. Rebuilding after that level of economic destruction is long and arduous, better to preserve what you have. That's what the 2008 GFC would have caused (or worse) if not for extensive US govt and Fed preventative measures.
The modern means of doing that is for the government to deficit spend and for the central bank to pump the financial system full of cheap or free credit. Problem now is, nobody sees a way of unwinding the deficits and cheap credit without causing the depression they were trying to prevent.
Neither political party has the political will to balance the budget and be the cause of the resulting economic pain. Republicans convince themselves we can outgrow the deficits by cutting taxes, and Dems convince themselves that Modern Monetary Theory will spur growth and limit inflation enough to outgrow the deficits. The Fed tried early in the Trump admin to raise rates back to normality, and the market started crashing again, so they stopped. We're stuck.
It's the most consequential economic experiment since the US left gold standard, and nobody knows how it will turn out. Imho our best hope is for a gradual devaluation of the Dollar and a soft landing, avoiding a major shock. But under precarious circumstances like these, unpredictable shocks are a distinct, if not likely, possibility.
Bingo. Finance is just about allocating risk. When it goes wrong, it's either because 1) the risk taken was misunderstood, and/or 2) too much risk was taken.
Fraud falls into category 1 (as do many other things, like correlation of loan defaults), and leverage into category 2.
The mechanisms by which risk is allocated are generally quite simple.
I would say opaque rather than complex. The details of a CDS aren't complicated, nor is the Eurodollar system. But it can't be inspected from the outside, and even the Fed is reliant on running complex models in an attempt to model monetary policy impact.
Agreed, financial market structure is often intentionally obfuscated by incumbents. The worst public example is undocumented equity order types [1].
The Fed's monetary policy models are another story. If you drill down on the internal politics of the FOMC, you start to see the "research" as Kabuki theater which exists to justify whatever decision the big people upstairs want.
It is this political dynamic, rather than the reduced compensation, that deters most talented people from public service.
Idiotic article. First a CLO is essentially a portfolio of loans. You can call that gambling, and in a way, every financial risk is gambling, but it is the very job of a bank to take credit risk, and to lend.
Then, I don't know about Wells specifically, but it is possible that these CLOs may not even be external transactions, that the bank securitised its own loans so that it stands ready to post them to the central bank as collateral to get short term funding in exchange, if a liquidity crisis hits. If it is the case, it is actually a good thing.
The banking system is increadibly strong vs 2008, the amount of capital banks hold is a multiple of what they held in 2008, while having reduced the size of their balance sheets at the same time (ex Chinese banks). They hold huge amounts of liquid assets and have limits on how much short term funding they can rely on. In addition the introduction of bailin should protect tax payers in the case of a bank failure.
I would be much more worried about the financial impact of money printing. The amount of QE that the Fed has introduced is unprecedented, both in size and velocity, and they keep printing. And we are only at the begining of this downturn. This will massively distord the markets. And I don't believe it will not create inflation ultimately, which is a much bigger threat to savers than their bank credit risk.
Agree with a majority of this. US bank balance sheets are in a whole different universe than they were during the last crisis. CLOs are not only a minuscule portion of their holdings but they also hold a tiny percentage of outstanding CLOs.
Japanese co-op banks on the other hand have huge CLOs holdings and would be extremely exposed if these went sour.
> but it is the very job of a bank to take credit risk, and to lend.
This used to be true, but isn't. The job of the bank to is play the spread. They take 0% interest loans from the Fed, loan the money to you, and then resell the loan into the market (aka, your 401k). This is why the subprime mortgage crisis was a crisis. Banks had almost 0 risk. Just let the credit rating agencies stamp AAA on the CLO, push it into the state of California's pension fund as AAA securities, profit.
If any bank is not selling the loan, they're taking a completely unnecessary risk.
It will likely cause massive inflation but it may not cause much of an increase in CPI. I think economists ought to redefine inflation. CPI is not the same as inflation. CPI metrics have been thoroughly gamed decades ago and they're essentially meaningless.
Almost all of the monetary inflation these days shows up in the markets as inflated asset prices and does not show up in the CPI.
If you believe that bare sustenance of the working class is the only thing that matters, you could argue that this distinction is not significant... But growing wealth inequality is causing concentration of political power, distorting markets, regulating small businesses out of existence, creating useless corporate jobs, driving up rents, eroding privacy rights, eroding democracy, eroding freedom of speech, creating division (Milton Friedman even warned us about this in the 70s), encouraging unethical business practices (surveillance capitalism)... I think we're well beyond the point where we can sweep these problems under the carpet. They have become existential problems for society and they are caused by wealth inequality brought about by asset price inflation and accompanying stock buybacks (often paid for using interest-free printed credit from banks).
We live in a feudal society - But unfortunately for the plutocrats, they cannot use god's will as an excuse to justify their current position in society... The more time passes, the more people become aware of systematic cronyism, the more untenable the plutocrats' positions will be.
> I have a checking account and a home mortgage with Wells Fargo; I decided to see how heavily invested my bank is in CLOs. I had to dig deep into the footnotes of the bank’s most recent annual report, all the way to page 144... The total is $29.7 billion. It is a massive number. And it is inside the bank.
To put $29.7B that into context -- Table 4 of the most recent 10K says that Wells has ~1.7 trillion dollars of earning assets. Tables 1 & 2 indicate they hold around 180B of shareholder capital buffer.
Your appraisal seems fair... of the data you are working with.
But how many other financial instruments they own are tied up in CLOs on the books of other banks?
The whole point of The Big Short and Margin Call was that the banks aren't resilient, independent silos. When one bank shakes or falls, it can impact the neighboring bank which causes a domino effect. They all invest in slices of the things that the other banks invest in, they all do it with lots of leverage, and they all think they've hedged against the downside risk, but that still didn't prevent the 2008 collapse.
that's literally herding behavior, which is the loss of independence among market participants, so that risks start to align, rather than cancel each other out.
it's disgusting that we haven't learned anything from 2008.
To be fair, I think every financial instrument works this way (the transitive property of assets which own assets) all the time.
Having regulations which restrict which companies are allowed to trade specific classes of instruments/services (eg. Glass Steagall) helps mitigate this, but doesn't even approach eliminating it.
it does work that way far too often, and that's exactly the problem. financiers are no smarter than other kinds of market participants, and that's what this shows.
markets require relative participant independence for pricing and allocation to function properly, otherwise we get bubbles. and now, we get constant bailouts (of capital, not labor), so on top of that, there's no downside risk to provide any counterbalance. it's corrupt.
"Available data indicates that banks have the largest direct exposures to leveraged loans and CLOs. These exposures are concentrated among a limited number oflarge global banks and have a significant cross-border dimension.
... A number of non-bank investors are also exposed to leveraged loan and CLO markets. These include investment funds, insurance companies, pension funds, broker-dealers and holding companies.
... A comprehensive assessment of the system-wide implications of the exposures of financial institutions to leveraged loans and CLOs is challenging.
... These exposures are generally concentrated among a limited number of banks. These banks’ exposures to leveraged loans and CLOs, on a fully drawn basis, are significant relative to their capital adequacy ratios.
"Similar to other markets, the leveraged loan and CLO markets include direct and indirect forms of interconnectedness, both within and across borders. Direct interconnectedness arises from links in the intermediation chain, from origination and distribution of leveraged loans to securitisation by CLO manager.
... Through these direct links, shocks to the leveraged loan and CLO markets could transmit risks to financial intermediaries not directly exposed to such markets.
... Indirect interconnectedness can arise in the form of common exposures of banks and non-banks to leveraged loans and CLOs, and could provide an avenue for contagion among financial institutions."
"Similarly, vulnerabilities stemming from leveraged lending were increasing through mid-February 2020, as demand remained strong while credit standards stayed weak. Issuance came to a halt at the end of February, as investors became more cautious and attentive to volatility in financial markets...
Defaults on leveraged loans ticked up in February and March and are likely to continue to increase, with the specific contour highly dependent on the path of overall economic activity. Such developments would weaken the balance sheets of lenders, including CLOs that hold leveraged loans, and amplify the economic effects of COVID-19."
There would have to be a lot more insured CLOs to represent systemic risk. The total nominal amount of CLOs is just not great enough to cause a systemic collapse.
If you look at what the other guy said in this thread, taking WFC as an example, they have ~$2T in assets, and $27B in CLOs. They could lose every dollar in CLOs at once and the firm would still be fine.
There are certain smaller companies and brokers that deal in CLOs that would not be having a fun time if CLOs went belly up as a whole. The banking system would be fine. There is simply not enough of that paper out there to pose a systemic threat.
Having just read both Liar's Poker and Barbarians at the Gates, the concept of CLOs sounds awfully familiar.
Loaning money to high-risk companies? Bundling a whole bunch of said loans into securities? High returns despite the risk of a significant fraction of defaults? Sounds like the world has been here before.
If this was a B-flick, it might well be called the return (or revenge) of the junk bond monster.
This sounds entirely the same and this time the industry probably thought they were so clever because companies are likely still less risky than individual consumers and then oops Corona!
So what? There is only one game out there and its called printing money.
We have bad loans on the books? Oops, nothing we can do here and can't have so many foreclosed lower valued assets. Print.
If anyone looked at billionaire net worths, they would know that hyperinflation is rampant. The only reason it doesn't show up in the cost of Milk is because the peasants (we the people) fight for scraps and are willing to take smaller slice of the pie.
In other words, the Bernanke trick of inflating assets in 2008 did its job. It inflated assets and the size of the pie increased. But 90% of the participants still have a lower share of the pie.
How come no one is talking about the fact that a couple months ago our banks went from fractional reserve to zero reserve? If that doesn’t scream disaster is expected I don’t know what does. Literally anyone can form a banking org, get fdic insurance and print. money. out. of. thin. air.
If you aren’t doing it yourself already, maybe you should. I’m gonna try and maybe make a medium.com post about it.
> I ran my finger across the page to see the total for these investments, investments that Powell and Mnuchin have asserted are “outside the banking system.”
> The total is $29.7 billion. It is a massive number. And it is inside the bank.
What percentage of Wells Fargo's assets is that? It looks they they've 1.9 trillion in assets, so even they were worth nothing, would it have a material impact?
> The banks themselves may reveal that their CLO investments are larger than was previously understood. In fact, we’re already seeing this happen. On May 5, Wells Fargo disclosed $7.7 billion worth of CLOs in a different corner of its balance sheet than the $29.7 billion I’d found in its annual report.
America can afford to prop it up for as long as the dollar is in demand for international trade, and she will use her naval superiority to make sure of that
What part of the FEDs balance sheet [0] are you concerned about getting bailed out because it is pretty much entirely composed of the US government's own debt through US treasury securities and citizens homes through mortgage backed securities?
I'm saying the banks holding CLOs will get bailed out much in the same way as those holding mortgage-backed securities. I'd be concerned if this didn't happen.
> But the losses from CLOs, combined with losses from other troubled assets like those commercial-mortgage-backed securities, will lead to serious deficiencies in capital.
You're making a pretty brave assertion given what we saw in 2008. I now assume that the ratings are all skewed to be too optimistic, publicly acknowledged exposure is skewed to underreport, and our ability to see the actual damage that would be caused by a system-wide collapse in CLOs isn't clear because we don't know what each opaque silo is doing to multiply or hedge those CLOs (and neither does any individual silo).
Also, capital reserve requirements dry up very quickly when a panic starts to set in. The Federal Reserve saved us earlier this year and in 2008+, but there comes a point when it won't be as successful and investors may start to see other markets as being comparatively lower risk, especially after the official US debt will likely jump 20-50% this year alone and we never unrolled the $4.5trillion in QE, only added another $4trillion - $10trillion onto that.
If that's not sarcasm, help me understand why... I'm not a finance guy. The argument made by the author was roughly something like this:
- Capital requirements against the CLO's assume AAA ratings
- In 2008, we learned that AAA CDO traunches were really AAA (despite not containing a single AAA-rated loan) only when assumptions about (non-)correlation of defaults remained true -- ie real estate markets are local so not everyone defaults at the same time
- The problem with the AAA CDO ratings was that in a time of crisis, all the "good times" defaulting correlation assumptions go out the window and everyone defaults together. Now the magic of blending a bunch of BBB's, BB's, and B's into an AAA no longer works.
So if now we're repeating the same story -- a big shock ('rona) makes a whole bunch of previously uncorrelated loans default together -- then the argument goes that the capital requirements which assumed AAA ratings are insufficient.
Reserve requirements != capital requirements. Reserve requirements are vs deposits, capital requirements are vs balance sheet items. Big difference between the two.
The current economic system is fundamentally flawed. Unless someone has the courage to ban interest/usury, things will stay the way they are. We have known this for thousands of years now, but unfortunately greed and exploitation persists.
>But there’s another threat to the economy, too. It lurks on the balance sheets of the big banks, and it could be cataclysmic.
(10 paragraphs later)
>I ran my finger across the page to see the total for these investments, investments that Powell and Mnuchin have asserted are “outside the banking system.”
The total is $29.7 billion. It is a massive number. And it is inside the bank.
The author posits one option, of political intervention precluding another bailout. But the Federal Reserve is non-political precisely to shield it from attempted short-term political machinations. Congress will complain to the cameras and the Fed will go right back to "rescuing" the market.
No, the bottom will only well and truly drop out when there's significant capital flight - when the dearth of real investment opportunities relative to currency glut becomes so acute that capital leaves American borders in search of real return. But to where? And under which circumstances?