A decade ago, we saw a subprime mortgage debt crisis bleed into the rest of the markets. I think this time, the high-yield debt crisis will have the same result.
Sometime in the middle to late 2020s we will see a Great Reset that profoundly changes everything you know about money and investing.
Ten years into the ongoing laboratory experiment being conducted by the world’s central banks, everywhere you look there are multiple examples of the kind of lunacy those policies have fomented by reducing the cost of capital to virtually zero and forcing investors to take risks they would ordinarily avoid in order to find some kind of return.
I admire entrepreneurs who take risks and break new ground. They are the key to economic growth. Building a business is the single best and most effective way to create personal wealth. But it’s also true that most of those dreams are simply dreams and will never come true. A few who bet on them win big, but most lose some or all of their investment.
We’re seeing classic end-of-cycle behavior: throw caution to the wind and plunge capital into the market’s riskiest corners. This artificially-induced buying is propping up companies that would otherwise succumb to the fundamental forces arrayed against them.
Traditional loans generally have protective covenants built into the contract that protect the lender, including financial maintenance tests that measure the debt-service capabilities of the borrower. The issuance of covenant-lite loans means that debt is being issued to borrowers with less restrictions on collateral, payment terms, and level of income. Covenant-lite loans place less restrictions on the borrower in terms of requiring collateral and a certain level of income.
Last time around, the root problem was excessive residential real estate debt. Reckless lenders made unwise loans so unqualified borrowers could buy overpriced homes. These loans morphed into securities and derivatives and all blew up.
Our embrace of either crony capitalism or welfare statism is going to end very badly. Ideological positions have hardened to the point that compromise seems impossible.
Beginning with Greenspan, we have now had 30+ years of ever-looser monetary policy accompanied by lower rates. This created a series of asset bubbles whose demises wreaked economic havoc. Artificially low rates created the housing bubble, exacerbated by regulatory failure and reinforced by a morally bankrupt financial system. And with the system completely aflame, we asked the arsonist to put out the fire, with very few observers acknowledging the irony. Yes, we did indeed need the Federal Reserve to provide liquidity during the initial crisis. But after that, the Fed kept rates too low for too long, reinforcing the wealth and income disparities and creating new bubbles we will have to deal with in the not-too-distant future. This wasn’t a “beautiful deleveraging” as you call it. It was the ugly creation of bubbles and misallocation of capital. The Fed shouldn’t have blown these bubbles in the first place.
The simple conceit that 12 men and women sitting around the table can decide the most important price in the world (short-term interest rates) better than the market itself is beginning to wear thin. Keeping rates too low for too long in the current cycle brought massive capital misallocation. It resulted in the financialization of a significant part of the business world, in the US and elsewhere. The rules now reward management, not for generating revenue, but to drive up the price of the share price, thus making their options and stock grants more valuable.
Both parties in Congress are committed to more spending.
In a plunging market, you don’t sell what you want, you sell what you can.
A long line of businessmen and women seemingly have the gift to convince investors to buy unrated paper that is unsecured with no assets behind it. The problem is that unraveling dreams tend to be contagious. Investor psychology is fragile, so the collapse of one high-profile dream can bring lesser-known ones down, too. I think we’re approaching that point.
Ignoring problems rarely solves them. You need to deal with them—not just the effects, but the underlying causes, or else they usually get worse.
A decade ago, we saw a subprime mortgage debt crisis bleed into the rest of the markets. I think this time, the high-yield debt crisis will have the same result.