'..On top of exploding traditional deficits, taxpayers (more accurately, future generations) will be on the hook (again) for what will surely be massive recurring losses at the government-sponsored enterprises..''Conventional Wisdom is so often proved wrong. Thinking back over my career, it's amazing how many times what is believed true without a doubt in the markets turns out completely erroneous. There's no mystery behind this phenomenon. Responsibility lies foremost in flawed analytical frameworks. Fundamentally, bull market psychology rests on the basic premise that underlying fundamentals are sound - economic growth, earnings, inflation dynamics, new technologies, global trade, etc. No need to look further or dig any deeper.
When securities markets are strong (inflating), it's taken as a given that the financial system is robust. The problem, however, is that the underlying finance fueling the recent bull market has been patently unsound - and has been so for three decades of recurring boom and bust cycles.
A wise person said that it's not true that we don't learn from history. It's that our learning is dominated by recent history. It becomes too easy to ignore everything beyond the past few years. Over a relatively short time horizon, the previous bust cycle becomes ancient history. What matters for the markets - especially as the cycle evolves to the speculative phase - is the here and now. It's assumed that everyone acquired understanding and insight from the crisis experience - especially policymakers. They'll ensure there is no repeat; they have the tools and have amassed experience and comfort employing them. The previous crisis was a "100-year flood." Good not to have to ponder a recurrence for a few generations.
Conventional Wisdom will look especially foolish when this protracted cycle comes to its fateful conclusion. Not only was the mortgage finance Bubble not the proverbial "100-year flood," it set the stage for historic global government finance Bubble excesses. The real once-in-a-lifetime crisis lies in wait. Not only do we not learn from our mistakes, we instead seem to go out of our way to create bigger ones. This time much Bigger..
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Did we learn nothing? GSE Securities ended 2008 at a then record $8.167 TN. Remember all the talk of GSE reform - and possibly even winding down the (insolvent) behemoth agencies? Not going to happen. Outstanding GSE Securities did decline to $7.560 TN by the end 2012. Then a funny thing happened along the path of reformation: GSE Securities expanded $238 billion in 2013, $150 billion in 2014, $221 billion in 2015, $352 billion in 2016 and another $337 billion in 2017. It adds up to GSE growth of about $1.3 TN in five years, as the GSEs once again become willing boom-time instigators. It's worth adding that Fannie Mae increased "Total MBS and Other Guarantees" by about $23.5 billion during the first two months of 2018, with Freddie Mac's up $16.4 billion in three months.
For years, I argued that the thinly capitalized GSEs were destined for failure. It's not clear what I should be arguing these days. Their position is even more precarious, but no one could care less. The GSEs have become only bigger and have essentially no capital buffer - remitting earnings to their guardian, the U.S. Treasury. I suggest the ratings agencies ponder the trajectory of U.S. deficits in the event of a financial crisis and economic downturn. On top of exploding traditional deficits, taxpayers (more accurately, future generations) will be on the hook (again) for what will surely be massive recurring losses at the government-sponsored enterprises. A yield spike and the party marathon is over.'
- Doug Noland,
Conventional Wisdom, April 28, 2018
Context'Ten-years of ultra-loose global finance destroyed discipline - by borrowers and lenders alike.'