Tuesday, March 22, 2016

Doug Kass Says: The End Is Nigh

On a more somber note, Doug Kass is predicting a financial crisis. As you know, he is not alone, but as the market recovers from its most recent swoon, the naysayers are becoming fewer and fewer.

Kass sees today’s market repeating what happened in 2008-2009. I recommend the entire article, but here are some excerpts:

During the U.S. housing boom that sparked the 2008-2009 meltdown, Wall Street blithely sliced and diced no- and low- documentation home loans into mortgage-backed securities. Investors ignored teaser rates and no-money-down adjustable-rate loans that were "dead at birth" and based on notion that home prices could never fall.

In time, these financial "weapons of mass destruction" received global acceptance and nearly bankrupted the world's banking system. That's not an exaggeration, but a fact. The whole thing was virtually a house of cards.

But memories are apparently short, as what's going on today is little different than what was happening then. All we have to do to see that is substitute the toxic "subslime" loans that were given to undeserving home buyers a decade ago with the record loans that financiers are giving to unworthy sovereigns and governments today.

Lenders were underwriting mortgages with little or no money down back in those days. And today, they're loaning money to bankrupt governments who are being paid to borrow money at negative interest rates.

Japan is the best example this, although certainly not the only one. The Asian nation's national debt currently tops 210% of gross domestic product, while the interest on Japan's massive government debt exceeds one-quarter of its tax revenues.

But thanks to the same kind of stupidity that prompted investors to buy housing derivatives a decade ago, Japan is still able to sell 10-year bonds that carry negative interest rates. In fact, the current mess is even worse in some ways than the last one because negative interest rates virtually guarantee that those who hold Japanese government bonds will lose money.

The size of today's bubble is also even larger than it was the last time around. There are more than $7 trillion of government bonds with negative interest rates out there, which vastly exceeds the size of the derivatives that nearly bankrupted the world's financial system nearly a decade ago. And this bubble grows larger and larger every day.

How are things today? Kass implies that things today are worse:

As bad as all of that was, consider what’s happening today:

* U.S. government debt totals about $19 trillion, or some $11 trillion more than it was in 2008.
* The Fed's balance sheet is approaching $5 trillion vs. $800 billion in 2008.
* Short-term interest rates are 0.25% compared to 4.5% back in the day. With interest rates at near-record lows, there's little opportunity for the Fed to further expand its balance sheet.
* The derivatives market is currently larger than $500 trillion vs. $182 trillion in 2008.
* Central-bank capital has dropped to 0.8% of assets from 4.5%.
* The size of the subprime bubble was $1.3 trillion, but the size of sovereign borrowing is $7 trillion today.
* Our government has to borrow money to simply pay interest, and monetary policy is hamstrung by near-zero interest rates.
* There are no more homeless people getting mortgages to buy homes, but there's a Danish sex therapist whose bank is paying her interest (instead of the other way around) on a loan that's financing her matchmaking Web site.

These numbers don't lie, and they'll have negative consequences in the fullness of time. Today's crisis is a lot more visible and much bigger than the derivative and subprime threats of a decade ago -- but importantly, the available policy responses are now far more limited.

As I said, it’s worth your trouble to read the whole thing.


Ares Olympus said...

Sure, I'll read the article in more detail later.

Kass: U.S. government debt totals about $19 trillion, or some $11 trillion more than it was in 2008.

The federal debt above does concern me, but less so than all the other forms of debt in the economy.

The reality is federal debt can be cleared almost by Executive order, if the President determines its in the interest of National security to do so, no different than Nixon shutting the gold window, and FDR ending public convertability to gold. I imagine the next crisis could cost us $30 trillion of new federal debt, and I have no evidence this crisis-bailout cycles we're in now can be reversed by any means.

In fact that's why I largely think we're beyond political solutions. All "honest" solutions to our financial predicament requires trillions of dollars of "phantom asset value" to disappear, and all our dreams of the future are lost. So its obvious that massive domino defaults of deflation will NEVER be accepted, and instead it will be inflation that "steals" our wealth, at least for those of us who are debt free and own assets.

And probably worse than inflation, war is a much more attractive way to destroy wealth, because an enemy has been imagined that threatens everything, so allows leaders to direct all aggression towards the enemies, and not towards the leaders who helped get us into this mess.

I don't know what a "reset" looks like, 2008 was sufficient wakeup call for me. Apparently February was a really good month for the markets, which to me sounds like anyone who didn't get out of the markets last year has "one last chance" to pull out before the real fall that's coming.

I can't see any downside to holding "cash" now. Whatever inflation is coming will be slower than asset deflation, and you have to believe there will be buying opportunities to bet after the next 20-80% "correction." 2016-2018 looks accurate to me but even if it takes another 5 years for the crash to happen, I'd still stick with cash, and debt-free productive assets I can touch.

Somehow I imagine Kass is another gold bug, and I admit if I had billion dollars sitting in the bank, I'd be willing to buy a few million of precious metals, and not care how much they're worth if I had to sell in a hurry, billionares can afford insurance assets that can drop in value by 90%, and still be 10% better than paper.

Ignatius Acton Chesterton OCD said...

One does not have to believe in limits. But they do exist. We have separated debt from the reality of market exchange... there is someone on the other end who is obligated to pay. So long as they believe in obligations. Once money realizes there are no obligations -- and therefore no trust -- the real pain settles in. The availability of money contracts system-wide. Money stops moving. Those are limits. Our political class no longer believes in limits. They buy votes with other peoples' money. Another reckoning is coming.