'..In reality, the socialism of finance has annulled the capacity of markets to self-adjust and correct. Pressure just keeps building.''It's now been almost a decade of unprecedented monetary and fiscal stimulus - ten years of central bank command over the financial markets. Over time, markets became progressively less attentive to risk, including business cycle cyclicality, financial excess and instability. Bear markets and recessions had been prohibited. Basically, no amount of excess was concerning. And, importantly, the magical concoction of extremely low rates and extremely big deficit spending would ensure a corporate profits bonanza as far as the eye can see.
May 2 - Bloomberg (Shannon D. Harrington and Erik Schatzker): "Greg Lippmann, who helped design the trade against subprime mortgages that became known as the Big Short, says the next financial tremors will come from corporate debt. The former Deutsche Bank AG trader who now oversees about $3 billion at his LibreMax Capital LLC said… that corporate debt and equities will face the biggest pain when the next downturn comes. Investments linked to consumer debt, unlike the last crisis, will be relatively safe because companies have been the ones gorging the most on the ultra cheap interest rates during the past decade. 'If the first quarter's volatility is a harbinger of something bigger, I think that you're going to see a lot more trouble in the corporate market and the equity market than the structured products market,' Lippmann said on the sidelines of the Milken Institute Global Conference… 'The consumer is in much better shape than corporates. Consumers are less levered than they were pre-crisis. Corporates are more levered than they were pre-crisis, and I think structured products are not going to be the epicenter.'"
I also doubt that structured products will be at the epicenter of the next crisis. Subprime, mortgage Credit, and Wall Street Alchemy were the nexus for Financial Arbitrage Capitalism period excess. Government Finance Quasi Capitalism fundamentally altered the prevailing Financial Structure financing what is now one of the U.S. history's longest expansions.
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I would argue that the current Government Finance Quasi Capitalism stage has created much deeper and problematic financial and economic structural maladjustment. As has been said, "Capitalism without failure is like heaven without hell." A decade of aggressive policy activism worked its magic.
The old notion of one-decision stocks morphed into One-Decision Markets: Just buy and hold - your favorite equities or Credit index. Analysis Not Required. Central bankers will ensure the trajectory of stock prices remains up. The Fed's commitment to liquid and continuous markets has never been as rock solid. There will be no panic selling of stocks, and no destabilizing spike in market yields. And with rates at or near zero, there has never been such powerful incentives to buy risk assets (stocks, corporate Credit, EM, etc.). The perception of liquidity and safety ("Moneyness of Risk Assets") ensured a wall of liquidity would inundate funds holding equities, corporate bonds and EM securities. Amazingly, ETF assets grew almost 10-fold since 2008, in one of the history's most spectacular speculative financial flow episodes.
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Going back centuries, the "money market" has traditionally been at the financial crisis epicenter. From traditional bank runs to the 2008 run on Lehman's repurchase agreements, it's the panic liquidation of previously perceived safe and liquid instruments that can instantly spark illiquidity and crisis. Money has special attributes to be coveted and safeguarded. To purposely bestow the perception of moneyness upon risk assets - across asset classes on a global basis - is one of great transgressions in the history of central bank monetary management.
I would add that the proliferation of tantalizing new technologies makes this cycle all the more perilous. Massive prolonged speculative financial flows throughout a period of alluring technological innovation ensures malinvestment and deep structural impairment. Historical revisionism paints the 1920's as the "golden age of Capitalism," brought to a catastrophic conclusion by the Fed's negligent post-crash failure to inflate the money supply. In reality, it was a historic period of misperceptions - misperceptions as to the capabilities of Federal Reserve, Wall Street, financial innovation and technological advancement. It all came home to roost.
The "Roaring Twenties" episode was a confluence of colossal financial flows and historic technological development that ensured epic structural maladjustment and attendant latent fragilities. Unappreciated, especially late in the cycle, was the harsh reality that the finance fueling the boom was increasingly unsound, unstable and unsustainable. When speculative flows inevitably reversed, everything came tumbling down - everywhere.
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It's somewhat reminiscent of 1999, but on such a grander scale that the two periods are hardly comparable. The late-twenties is more pertinent: the proliferation of exciting technologies and innovation; lavishly over-liquefied securities markets; faith in policymakers and a general disregard for risk. In 1929, there was essentially no recognition of downside risk. A long boom had convinced about everyone that financial and economic underpinnings were sound. Similar to today, little attention was paid to the soundness of the finance underpinning the boom.
During the mortgage finance Bubble period, there was some recognition of how the system was "privatizing profits and socializing losses." And that's exactly how it played out during the crisis, with expensive bailouts, massive deficit spending and crazy central bank monetization. I would expect the next crisis to have disparate and more problematic dynamics.
At this point, an abrupt reversal of "retail" flows from the risk markets will pose a potentially greater systemic challenge than the previous crisis of confidence in structured finance. Not only have retail flows come to play a major financing role throughout corporate America, I would expect the sophisticated leveraged speculating community to move quickly to get ahead of ("front-run") outflows as they begin to materialize. Moreover, there are these gargantuan derivatives markets that are expected to function as an insurance marketplace. Rather quickly, liquidity will become a serious systemic issue across the securities and derivatives markets. Financial conditions might tighten dramatically almost overnight, abruptly interrupting plans for tens of thousands of negative cash-flow enterprises across the country - big and small. That's when Financial and Economic Structure will matter mightily.
A decade of Government Finance Quasi Capitalism has deeply engrained the view that enlightened central bankers and spendthrift governments have together tamed the business cycle. Bear markets and recessions were conveniently removed from the calculus. It's accepted as gospel that myriad risks have been fundamentally downgraded. In reality, the socialism of finance has annulled the capacity of markets to self-adjust and correct. Pressure just keeps building.
The upshot has been highly unstable Bubble flows - into the securities markets, intermediated through perceived safe and liquid investment vehicles into business enterprises on increasingly fragile footing - on an unprecedented scale. On a global basis (again with parallels to the 1920's), Bubble dynamics have ensured that financial and real resources have for years been poorly allocated, with maladjustment and imbalances now greatly in excess of those prior to the 2008 crisis.'
- Doug Noland,
The Old Roach Motel, May 5, 2018
Context(Story) – 2007 overlaps 2018 ‘..in the event of a financial crisis and economic downturn.’