Lax risk management, an incurious Federal Reserve, credit rating agency shopping, greed and garden-variety stupidity. Welcome to what could be the next great financial crisis.
I keep waiting for the bottom to fall out and am reminded of J.K. Galbraith:
"Only in the financial world is there such an efficient design for concealing what, with the passage of time, will be revealed as self- and general delusion."
"In a speculative boom, the tide of money covers a multitude of sins. When the tide goes out, the sins are there for all to see."
I was too young to have observed how the massive inflation of the 1970s started, but I wonder if the only choice now is between severe inflation and severe economic contraction. I'm convinced it's one or the other. Adding to all the peril you wrote about are things like cryptocurrency -- a damn shady sector.
"the only choice now is between severe inflation and severe economic contraction. I'm convinced it's one or the other"
Agreed. The retirement cohorts need to brace themselves to see their pensions go poof 90's-Russia style. Of course, they'll be blamed for their own demise, in the idiotic fights whipped up between the so-called "generations".
I concur that policy makers have to choose between those two unpleasant options, but this unavoidable outcome is the entire argument against intervening in the free market. We can only blame ourselves and try to delay the inevitable.
Without going into this too specifically I will say that those of us in the industry have been pointing out the insane amount of debt PC companies have had to raise with capital inflows. Just look at the “investment grade bonds” with the highest yields on offer right now - top of the list are all private credit. When you borrow to lever there is NO room for negative outcomes…. Negative outcomes ALWAYS happen at some point in the cycle and then poof.
As long as there are no taxpayer-funded bailouts, it's simple caveat emptor. Once the government bailouts arrive, then we're all invested in private credit (Rich Helppie's warnings notwithstanding).
More voo-doo economics. I don’t pretend to really understand everything going on. But my bullshit meter is pegging out. Or maybe I am just too old to understand “modern” economics.
Though concerned a little by the banks’ lending to them, let’s not forget that the Fed has provided them a LOT of liquidity by paying them interest on their overnight funds - a historical anomaly - while printing money like crazy during QE2 and Covid, and should be able to sustain some losses better than 2008. And that was an issue more with trading firms than banks. My bigger concern is the insurance companies. If they are placing a significant portion of their capital into these funds, the risk of losses is enormous and can remain well-hidden until a collapse. And sorry, insurance examiners are even weaker than bank examiners when analyzing risks.
I can make this relatively simple, not that anyone in charge cares, because they make out great from The Grift(tm). But for the rest of us---
John Maynard Keynes was a very smart economist. He did not get everything right in his "General Theory...", but his mistakes were more on the political side than on the economics. More specifically, he argued that the roughest edges of an economic downturn could be ameliortaed by a mix of government fiscal and monetary policies, in the case of massive deflation, but pumping more money into tehe conomy through government deficits and supportive central bank policies to let those deficits translate into more money in circulation. Conversely, whenthe economy is runnning "hot," the government should run surpluses, abetted by teh central bank, to soak up excess money and avoid inflating teh currency. (Parenthetically, common usage gets it mostly wrong, confusing price increases with "inflation." Inflation means increasing teh amount of money in the c=economy, which will usually lead to increased prices if carried on too far or too long... but prices of particular things can rise for other reasons, too.
Keynes never promised that teh economy could be managed smoothly, forever, and no more business cycles. he just argued that in a case of extreme deflation (the Great Depression), government could and should take actions to counter that deflation so teheconomy could get back on its feet. And, once that happened, teh government could reel all that back in, and while things would be balanced over the long run, adjustments could be made from time to time to smooth out teh wildest swings.
Some decades ago, it became obvious that the government would not take fiscal actions to rein in inflation, because such actions (budget cuts and tax increases) are unpopular in the short term. So, we threw out at least half ofthe tools to implement Keynes' theory, and are left with only monetary policy, which is a VERY blunt instrument. So, when inflation begins to heat up, we tighten the money supply and make credit more difficult--essentially, strangle the whole economy. And when deflation threatens, we pump money and ease credit to grow the money supply. Wer overheat the whole economy rather than address the specific industries or areas that are problems. Those are the only tools we use. And we are very reluctant to do the tightening bit, because, like fiscal belt tightening (budget cuts and tax increases), it, too, is unpopular, and the asset markets, esp. stocks and bonds and related options markets, respond negatively.
So, for decades we have been in a long-term ratchet where we increase liquidity whenever problems seem likely to arise, but when prospects look better we never tighten enough to "soak up" all that money and credit we just created. That is why price increases are perennial, and the Fed has given up on its mandate for a stable currency, redefining 2% annual "infation" (really, 2% annual ovrall price increases) as its goal. Which is ridiculous under any rational system, at 2% prices double every generation, but given all the above, is the best they can hope for.
The point of all this being that all that created money and credit has to go somewhere, in search of yield (investment returns). And, there are only so many good ideas and companies and assets out there, and not enough to satisfy the artificially enlarged demand for investment returns.
So, you get money chasing weak investments--really, speculations-- and in that environment, people will commit all sorts of imprudent and even fraudulent acts to get at that money. So, a market break and financial crisis every 10-20 years, as asset prices get bid out of line with what they can return, and then the crash when the Fed touches the brakes (for fear of inflationary price increases) and everyone realizes that at current asset prices, they will not get the return on investment that they planned on.
So, fraud is built into the system, as excess money looks for returns, and imprudent people and fraudsters pretend to offer for sale assets to meet all that demand. And teh "investors" look teh other way because what choice do they have? The money has to be invested somewhere!
QED. As Charlie Munger said, "Show me the incentives and I will show you the outcome." The incentives lead to asset prices being unsustainably high due to unreasonable optimism and large doses of fraud, and the outcome is a cycle of "hot" markets followed by bankruptcies and market crashes when the optimism and fraud is revealed.
In a recent interview, Joe Manchin recommended term limits for Congress. This is the only way that budget cuts (and less likely tax cuts) can get done.
I wrote about this in August as part of a column about defined contribution retirement funds being exposed to private equity. Details how the leverage upon leverage can lead to disaster.
“You’re not paid to do due diligence in this market.”
Oh wait, same phrase true for institutional doctors in the Covid era.(instead rational analysis was punished re masking, social distancing, lockdowns, early treatment, vaxxing a rapidly mutating respiratory virus with a non-immunizing vaccine, mandates, etc).
I wonder if the author has any examples of full fledged systemic financial crisis not involving banks. Banks are inherently unstable as they fund themselves with demand deposits that came walk out the door anytime. While losses in PC could be significant, and the losses would hit pension funds hard that have funded PC funds, it it’s hard to see a systemic financial crisis occurring unless banks are funding a significant part of private credit capital precisely because PC capital is locked up in closed end funds. Do you have any data supporting the proposition that banks are significantly funding PC? If so, you have a legitimate point and I would join your concern. While the Executive Life debacle was very bad for policy holders - exacerbated by poor regulators in CA who gave away a sizable amounts of the recovery to Apollo against the advice of his financial advisors- it did not create a systemic crisis.
I know that Moody's recently reported commercial banks have about $300 billion in loans to private credit, Wells leading the way. There's a link to the First Brands story we ran a couple weeks ago. Additionally, I believe that commercial banks have provided the funding leverage for middle market private equity....and that is probably very signficant. I'll see if I can find that data.
That was my general thinking reading this article. Which I thought made a lot of good points. This kind of fraud and poor decision making is unfortunately nothing new but it is not systematic.
It’s all bubbles these days. It’s not just the financial system. The education system, the medical system, the electrical grid; you name it. All teetering on the edge. Even the military is a bubble: we don’t have enough missiles, our tanks are about 50 years old, and just look at the B-52…first flown in 1952!
The only question now is which bubble is going to start all the others popping.
Money is the biggest fraud ever conjured up. It makes the invisible man in the sky mythology seem like objective science. ALL, repeat, ALL money is created, conjured up out of nothing and is Faith/indoctrination based. When you borrow money from the bank, even the biggest Bank, you're borrowing what they don't have "even the reserve is conjured up" and you get bank credit instantly conjured on the banks computer as a credit and a debit which is effectively money. The last American POTUS that had some control over the Banks was Andrew Jackson. The system needs to taken down and replaced with a "Public central bank system" like in China where the people's government controls the money, unlike the west where the financial systems control the ostensibly democratic "actually engineered consent" governments. Good luck with that. This time it might be a bail in, not a bail out.
When the Federal Reserve Board Members are more concerned with enriching themselves and scamming the system they're supposed to be shepherding, how can it not implode?
"The game plan was to make your money, move on to the next deal, feign ignorance when it all blows up, get a bailout, and LET OTHERS PAY THE PRICE."
Didn't read further yet, but the part in all caps above guarantees it will happen again.
If Trump really wants a legacy as a populist, he'll stop this before it happens, or at worst let it happen with FISA judges and Gitmo cells waiting for every person with this mindset.
One quibble- you are conflating S&P global’s middle market credit universe (which by definition are big enough credit users to merit the attention of S&P credit analysts, with the entire middle market company space.
It’s line asking a bar owner to opine on the drinking habits of the average American. They can only talk about the average bar drinker. They can’t tell us if the bar drinker is representative of the average American.
The quip about not being paid for diligence is scary, and it reflects oversupply of credit. Excess liquidity creates sloppiness.
Back in 2007 it seemed credit card loans were good risks because borrowers paid them off, but the reason they were able to pay them off was that someone else gave them a new card and incented them to move balances. Plentiful liquidity can impersonate solvency….until new liquidity stops and we see who can actually generate cash flow to pay off existing debts rather than relying on new debt to pay off old debt.
The public was not too happy with the massive bailout to Wall Street in 2008 and senior executives being immune to prosecution for criminal fraud. Imagine the reaction this time around. Maybe this time we will see some cities partially burn.
I keep waiting for the bottom to fall out and am reminded of J.K. Galbraith:
"Only in the financial world is there such an efficient design for concealing what, with the passage of time, will be revealed as self- and general delusion."
"In a speculative boom, the tide of money covers a multitude of sins. When the tide goes out, the sins are there for all to see."
I was too young to have observed how the massive inflation of the 1970s started, but I wonder if the only choice now is between severe inflation and severe economic contraction. I'm convinced it's one or the other. Adding to all the peril you wrote about are things like cryptocurrency -- a damn shady sector.
"the only choice now is between severe inflation and severe economic contraction. I'm convinced it's one or the other"
Agreed. The retirement cohorts need to brace themselves to see their pensions go poof 90's-Russia style. Of course, they'll be blamed for their own demise, in the idiotic fights whipped up between the so-called "generations".
I concur that policy makers have to choose between those two unpleasant options, but this unavoidable outcome is the entire argument against intervening in the free market. We can only blame ourselves and try to delay the inevitable.
Without going into this too specifically I will say that those of us in the industry have been pointing out the insane amount of debt PC companies have had to raise with capital inflows. Just look at the “investment grade bonds” with the highest yields on offer right now - top of the list are all private credit. When you borrow to lever there is NO room for negative outcomes…. Negative outcomes ALWAYS happen at some point in the cycle and then poof.
As long as there are no taxpayer-funded bailouts, it's simple caveat emptor. Once the government bailouts arrive, then we're all invested in private credit (Rich Helppie's warnings notwithstanding).
There will always be taxpayer funded bailouts funded by the middle class taxpayer because nobody gives a rip about them. Especially Congress.
More voo-doo economics. I don’t pretend to really understand everything going on. But my bullshit meter is pegging out. Or maybe I am just too old to understand “modern” economics.
Though concerned a little by the banks’ lending to them, let’s not forget that the Fed has provided them a LOT of liquidity by paying them interest on their overnight funds - a historical anomaly - while printing money like crazy during QE2 and Covid, and should be able to sustain some losses better than 2008. And that was an issue more with trading firms than banks. My bigger concern is the insurance companies. If they are placing a significant portion of their capital into these funds, the risk of losses is enormous and can remain well-hidden until a collapse. And sorry, insurance examiners are even weaker than bank examiners when analyzing risks.
I can make this relatively simple, not that anyone in charge cares, because they make out great from The Grift(tm). But for the rest of us---
John Maynard Keynes was a very smart economist. He did not get everything right in his "General Theory...", but his mistakes were more on the political side than on the economics. More specifically, he argued that the roughest edges of an economic downturn could be ameliortaed by a mix of government fiscal and monetary policies, in the case of massive deflation, but pumping more money into tehe conomy through government deficits and supportive central bank policies to let those deficits translate into more money in circulation. Conversely, whenthe economy is runnning "hot," the government should run surpluses, abetted by teh central bank, to soak up excess money and avoid inflating teh currency. (Parenthetically, common usage gets it mostly wrong, confusing price increases with "inflation." Inflation means increasing teh amount of money in the c=economy, which will usually lead to increased prices if carried on too far or too long... but prices of particular things can rise for other reasons, too.
Keynes never promised that teh economy could be managed smoothly, forever, and no more business cycles. he just argued that in a case of extreme deflation (the Great Depression), government could and should take actions to counter that deflation so teheconomy could get back on its feet. And, once that happened, teh government could reel all that back in, and while things would be balanced over the long run, adjustments could be made from time to time to smooth out teh wildest swings.
Some decades ago, it became obvious that the government would not take fiscal actions to rein in inflation, because such actions (budget cuts and tax increases) are unpopular in the short term. So, we threw out at least half ofthe tools to implement Keynes' theory, and are left with only monetary policy, which is a VERY blunt instrument. So, when inflation begins to heat up, we tighten the money supply and make credit more difficult--essentially, strangle the whole economy. And when deflation threatens, we pump money and ease credit to grow the money supply. Wer overheat the whole economy rather than address the specific industries or areas that are problems. Those are the only tools we use. And we are very reluctant to do the tightening bit, because, like fiscal belt tightening (budget cuts and tax increases), it, too, is unpopular, and the asset markets, esp. stocks and bonds and related options markets, respond negatively.
So, for decades we have been in a long-term ratchet where we increase liquidity whenever problems seem likely to arise, but when prospects look better we never tighten enough to "soak up" all that money and credit we just created. That is why price increases are perennial, and the Fed has given up on its mandate for a stable currency, redefining 2% annual "infation" (really, 2% annual ovrall price increases) as its goal. Which is ridiculous under any rational system, at 2% prices double every generation, but given all the above, is the best they can hope for.
The point of all this being that all that created money and credit has to go somewhere, in search of yield (investment returns). And, there are only so many good ideas and companies and assets out there, and not enough to satisfy the artificially enlarged demand for investment returns.
So, you get money chasing weak investments--really, speculations-- and in that environment, people will commit all sorts of imprudent and even fraudulent acts to get at that money. So, a market break and financial crisis every 10-20 years, as asset prices get bid out of line with what they can return, and then the crash when the Fed touches the brakes (for fear of inflationary price increases) and everyone realizes that at current asset prices, they will not get the return on investment that they planned on.
So, fraud is built into the system, as excess money looks for returns, and imprudent people and fraudsters pretend to offer for sale assets to meet all that demand. And teh "investors" look teh other way because what choice do they have? The money has to be invested somewhere!
QED. As Charlie Munger said, "Show me the incentives and I will show you the outcome." The incentives lead to asset prices being unsustainably high due to unreasonable optimism and large doses of fraud, and the outcome is a cycle of "hot" markets followed by bankruptcies and market crashes when the optimism and fraud is revealed.
In a recent interview, Joe Manchin recommended term limits for Congress. This is the only way that budget cuts (and less likely tax cuts) can get done.
I wrote about this in August as part of a column about defined contribution retirement funds being exposed to private equity. Details how the leverage upon leverage can lead to disaster.
Here is a link if anyone interested
https://open.substack.com/pub/thecommonbridge/p/private-equity-is-no-place-for-average?r=er71k&utm_medium=ios
“You’re not paid to do due diligence in this market.”
Oh wait, same phrase true for institutional doctors in the Covid era.(instead rational analysis was punished re masking, social distancing, lockdowns, early treatment, vaxxing a rapidly mutating respiratory virus with a non-immunizing vaccine, mandates, etc).
I wonder if the author has any examples of full fledged systemic financial crisis not involving banks. Banks are inherently unstable as they fund themselves with demand deposits that came walk out the door anytime. While losses in PC could be significant, and the losses would hit pension funds hard that have funded PC funds, it it’s hard to see a systemic financial crisis occurring unless banks are funding a significant part of private credit capital precisely because PC capital is locked up in closed end funds. Do you have any data supporting the proposition that banks are significantly funding PC? If so, you have a legitimate point and I would join your concern. While the Executive Life debacle was very bad for policy holders - exacerbated by poor regulators in CA who gave away a sizable amounts of the recovery to Apollo against the advice of his financial advisors- it did not create a systemic crisis.
I know that Moody's recently reported commercial banks have about $300 billion in loans to private credit, Wells leading the way. There's a link to the First Brands story we ran a couple weeks ago. Additionally, I believe that commercial banks have provided the funding leverage for middle market private equity....and that is probably very signficant. I'll see if I can find that data.
That was my general thinking reading this article. Which I thought made a lot of good points. This kind of fraud and poor decision making is unfortunately nothing new but it is not systematic.
Corrections are no fun but necessary
If engineers built bridges, like economists manage capital, would we would have any left standing?
It’s all bubbles these days. It’s not just the financial system. The education system, the medical system, the electrical grid; you name it. All teetering on the edge. Even the military is a bubble: we don’t have enough missiles, our tanks are about 50 years old, and just look at the B-52…first flown in 1952!
The only question now is which bubble is going to start all the others popping.
Money is the biggest fraud ever conjured up. It makes the invisible man in the sky mythology seem like objective science. ALL, repeat, ALL money is created, conjured up out of nothing and is Faith/indoctrination based. When you borrow money from the bank, even the biggest Bank, you're borrowing what they don't have "even the reserve is conjured up" and you get bank credit instantly conjured on the banks computer as a credit and a debit which is effectively money. The last American POTUS that had some control over the Banks was Andrew Jackson. The system needs to taken down and replaced with a "Public central bank system" like in China where the people's government controls the money, unlike the west where the financial systems control the ostensibly democratic "actually engineered consent" governments. Good luck with that. This time it might be a bail in, not a bail out.
When the Federal Reserve Board Members are more concerned with enriching themselves and scamming the system they're supposed to be shepherding, how can it not implode?
"The game plan was to make your money, move on to the next deal, feign ignorance when it all blows up, get a bailout, and LET OTHERS PAY THE PRICE."
Didn't read further yet, but the part in all caps above guarantees it will happen again.
If Trump really wants a legacy as a populist, he'll stop this before it happens, or at worst let it happen with FISA judges and Gitmo cells waiting for every person with this mindset.
One quibble- you are conflating S&P global’s middle market credit universe (which by definition are big enough credit users to merit the attention of S&P credit analysts, with the entire middle market company space.
It’s line asking a bar owner to opine on the drinking habits of the average American. They can only talk about the average bar drinker. They can’t tell us if the bar drinker is representative of the average American.
The quip about not being paid for diligence is scary, and it reflects oversupply of credit. Excess liquidity creates sloppiness.
Back in 2007 it seemed credit card loans were good risks because borrowers paid them off, but the reason they were able to pay them off was that someone else gave them a new card and incented them to move balances. Plentiful liquidity can impersonate solvency….until new liquidity stops and we see who can actually generate cash flow to pay off existing debts rather than relying on new debt to pay off old debt.
The public was not too happy with the massive bailout to Wall Street in 2008 and senior executives being immune to prosecution for criminal fraud. Imagine the reaction this time around. Maybe this time we will see some cities partially burn.