The great bubble of the current boom-bust cycle is not tech
stocks like in the late 1990s. Nor is it real estate like in the mid-2000s.
Rather ...The great asset bubble or our times is none other than bonds,
especially government bonds (also called sovereign bonds).
Not just bonds issued by countries on the brink of default
like Greece is this morning, but also bonds issued by countries that are
supposedly among the "strongest"!
This time around, it's the price of those bonds that has
blown up sky high to levels that are grossly overvalued. It's the bond market
that has been the most directly impacted by the Fed's massive injections of
printed money into the banking system.
And it's bonds all over the world that have been bid up by
other central banks in their desperate attempts to keep their governments
afloat and their interest rates down.
But the great bond bubble doesn't stop with government
bonds. When government bond prices are driven to nosebleed heights, all other
kinds of debt follows along — corporate bonds, municipal bonds, mortgage debts,
consumer debts and almost any kind of debt instrument imaginable.
Sure, bonds are different from stocks. But they obey the
same laws of supply and demand.
In the stock market, if there's a big enough buyer investing
hundreds of millions of dollars to aggressively bid for a company's shares, he
drives the price sky high. And conversely, on the day that huge buyer walks
away, the stock suffers a devastating crash.
The same is true for bonds. But instead of a big stock
investor, the buyer is the biggest of them all — the U.S. Federal Reserve.
Instead of investing hundreds of millions, it's investing
trillions. And, instead of buying stocks, the Fed buys bonds, especially
government bonds.
That's been the pattern we've seen — almost nonstop — since
2008. That's also been the pattern in every major foreign nation on the planet,
including the U.K., the European Union, Japan and even China. And that's why
sovereign debt is such a great bubble today — globally.
Indeed, the sovereign debt bubble is the most immediate,
most consistent and most dangerous consequence of the 2008 debt crisis.
So if you've forgotten — or have tried to forget — the true
severity of that debt crisis, it might be helpful to flash back to a few
memorable scenes from those days:
The scene of former Fed Chairman Alan Greenspan who, in
testimony before Congress, stated flatly that it was the worst crisis in 100 years.
The unforgettable image of former Treasury Secretary
Paulson, literally dropping to his knees before Congresswoman Pelosi, begging
for the billions he said were needed to prevent "a total Wall Street
meltdown."
An America in which 1 out of 7 homeowners were delinquent or
foreclosed on their mortgage; 4 out of 10 were upside down on their home
equity; nearly 5 out of 10 were among the millions of unemployed who were out
of work for over six months; and 7 out of 10 Americans were fearful of the future.
A government that rushed to bail out bankrupt banks, broken
brokerage firms, insolvent insurers, ailing auto manufacturers and any company
deemed "essential" to the economy.
And most shocking of all to anyone who understands the true
consequences, a Federal Reserve that has pumped trillions of dollars into the
government bond market, the mortgage market, the consumer credit market, and,
indirectly, every other debt or bond market on the planet.
We warned of these events before they happened. We named the
names of most large institutions that failed, also well in advance. But when
the crisis hit, we were not nearly as pessimistic.
We saw several silver linings in this crisis that most
others seemed to miss. But for the purpose of this article, suffice it to say
that the urgent measures that leaders sought so strenuously to justify now beg
equally urgent questions that I challenge them to answer:
Has the Federal Reserve run out of bullets? What happens
when a similar or worse crisis returns? Will America's leaders have the
political will and the financial resources to save the day again?
Yes, they prevented another great depression. Yes, they
saved the banks and helped drive stocks to new highs. But have they truly addressed the cause of the crisis?
Will they be forever able to bail out bankrupt corporations
like a General Motors, AIG and Bank of America? Can they again save smaller
bankrupt countries like Greece?
Sure, they can kick the can down the road. They can buy time
and postpone the day of reckoning. They can stimulate more stock market rallies
and some more economic recovery. They can certainly create new speculative
bubbles. But that's not the same as assuming responsibility for our future. It
doesn't resolve the next crisis and the one after that. It does little for you
and me, and even less for our children or theirs.
But the bigger question is: Who will bail out America?
No one can. No one will. Instead, ultimately, our government
will create a broader crisis impacting a wider segment of the population for a
longer period of time.
Indeed, even as the government sweeps piles of bad debts
under the carpet, it accumulates mountains of new debts — the biggest federal
deficits of all time.
This is why in recent years, we've seen a brand new crisis,
never before witnessed in modern times: Instead of merely corporations going
broke, we have seen entire countries that faced insolvency.
Greece was the first to get hit. Its federal accounting was
a mess; its spending, out of control; its deficits staggering. Suddenly, global
investors dumped old Greek bonds in their portfolios and went on a buyer's
strike for any new ones being issued. Portugal, Spain, Ireland, Italy and a
long line of East European countries also got smacked hard. Even the U.K. and
France were vulnerable to a similar onslaught.
Central bankers, finance ministers and top economists said
they were taken entirely by surprise. But again, the sequence of events was too
clear for anyone to have missed:
* In 2007, companies like Bear Sterns, Lehman Brothers,
Citigroup and Merrill Lynch had accumulated huge amounts of bad mortgages and
other toxic assets on their books.
* In 2008, when investors realized that the bad assets could
sink the companies' finances, they dumped their corporate bonds and stocks in
panic.
* Beginning in 2009, the governments of the U.S. and Western
Europe rescued the near-bankrupt banking giants, scooped up most of the toxic
assets and shifted them to their own books. So ...
* In the years that followed, whenever investors paid some
attention to how bad their finances really were, they dumped foreign government
bonds in panic.
To better understand why, let's remember how deeply and
thoroughly the government assumed ownership of the Debt Crisis of 2008 and of
nearly everything that has happened since.
The Greatest Government Rescue of All Time
We saw the first telltale warning of the debt crisis in
August 2007. Banks all over the world announced multibillion losses in subprime
mortgages. Investors recoiled in horror. And it looked like the world's
financial markets were about to collapse.
The nation's largest mortgage insurers, responsible for
protecting lenders and investors from mortgage defaults on millions of homes,
were ravaged by losses.
Municipal governments and public hospitals were slammed by
the failure of nearly 1,000 auctions for their bonds, causing their borrowing
costs to triple and quadruple.
Low-rated corporate bonds were being abandoned by investors,
their prices plunging to the lowest levels in history.
Hedge funds got hit as well, with one fund, CSO Partners,
losing so much money and suffering such a massive run on its assets that its
manager, Citigroup, was forced to shut it down.
And above all, major financial firms, at the epicenter of
the crisis, were being struck with losses that would soon exceed $500 billion.
The big question was no longer "Which big Wall Street
firm will post the worst losses?" It was "Which big firm will be the
first to go bankrupt?" The answer: Bear Stearns, one of the largest
investment banks in the world.
Again, the folks at the Fed intervened. Not only did they
finance a giant buyout for Bear Stearns, but, for the first time in history,
they also decided to lend hundreds of billions to any other major Wall Street
firm that needed the money. Again, the crisis subsided temporarily. Again, Wall
Street cheered, and the authorities won their battle.
But the war continued. Despite all the Fed's special lending
operations, another Wall Street firm — almost three times larger than Bear
Stearns — was going down. Its name: Lehman Brothers.
Over a single weekend in mid-September 2008, the Fed
chairman, the Treasury secretary, and other high officials huddled at the New
York Fed's offices in downtown Manhattan. They seriously considered bailing out
Lehman, but they ran into two serious hurdles:
First, Lehman's assets were too sick — so diseased, in fact,
even the federal government didn't want to touch them with a 10-foot pole. Nor
were there any private buyers remotely interested in a shotgun merger.
Second, foreshadowing the public rebellion that would later
bust onto the scene in the Tea Party movement, there was a new sentiment on
Wall Street that was previously unheard of: A small, but vocal, minority was
getting sick and tired of bailouts. "Let them fail," they said.
"Teach those bastards a lesson!" was the new rallying cry.
For the Fed chairman and Treasury secretary, it was the
long-dreaded day of reckoning. It was the fateful moment in history that
demanded a life-or-death decision regarding one of the biggest financial
institutions in the world — bigger than General Motors, Ford, and Chrysler put
together. Should they save it? Or should they let it fail? Their decision: to
do something they had never done before: They let Lehman fail.
"Here's what you're going to do," was the basic
message from the federal authorities to Lehman's highest officials.
"Tomorrow morning, you're going to take a trip downtown to the U.S.
Bankruptcy Court at One Bowling Green. You're going to file for Chapter 11.
Then you're going to fire your staff. And before the end of the day, you're
going to pack up your own boxes and clear out."
In both the Bear Stearns and Lehman failures, America's
largest banking conglomerate, JPMorgan Chase, promptly appeared on the scene
and swooped up the outstanding trades of the two companies, with the Fed acting
as a backstop. In both failures, the authorities played a role. But Lehman's
demise was unique because it was thrown into bankruptcy.
It was the financial earthquake that changed the world.
Until that day, nearly everyone assumed that giant firms
like Lehman were "too big to fail," that the government would always
step in to save them. That myth was shattered on the late summer weekend when
the U.S. government decided to abandon its long tradition of largesse and let
Lehman go under.
All over the world, bank lending froze. Borrowing costs went
through the roof. Global stock markets collapsed. Corporate bonds tanked. The
entire global banking system seemed like it was coming unglued.
"I guess we goofed!" were, in essence, the words
of admission heard at the Fed and Treasury. "Now, instead of just a
bailout for Lehman, what we're really going to need is the Mother of All
Bailouts — for the entire financial system."
The U.S. government promptly complied, delivering precisely
what they asked for — a $700 billion Troubled Asset Relief Program (TARP),
rushed through Congress and signed into law by President Bush in record time.
In addition, the U.S. government loaned, invested, or
committed ...
* $300 billion to nationalize the world's two largest
mortgage companies, Fannie Mae and Freddie Mac;
* Over $42 billion for the Big Three auto manufacturers;
* $29 billion for Bear Stearns, $150 billion for AIG, and
$350 billion for Citigroup;
* $300 billion for the Federal Housing Administration Rescue
Bill to refinance bad mortgages;
* $87 billion to pay back JPMorgan Chase for bad Lehman
Brothers trades;
* $200 billion in loans to banks under the Federal Reserve's
Term Auction Facility (TAF);
* $50 billion to support short-term corporate IOUs held by
money market mutual funds;
* $500 billion to rescue various credit markets;
* $620 billion for industrial nations, including the Bank of
Canada, Bank of England, Bank of Japan, National Bank of Denmark, European
Central Bank, Bank of Norway, Reserve Bank of Australia, Bank of Sweden, and
Swiss National Bank;
* $120 billion in aid for emerging markets, including the
central banks of Brazil, Mexico, South Korea, and Singapore;
* Trillions to guarantee the Federal Deposit Insurance
Corporation's (FDIC's) new, expanded bank deposit insurance coverage from
$100,000 to $250,000; plus ...
* Trillions more for other sweeping guarantees.
Grand total of money spent or promised as backstops: Over
$14 trillion.
Yes, with these trillions, the government was able to calm
the waters and restore credit markets. But the government could still not
dissuade average American families from taking matters into their own hands.
Those families could feel the dead weight of their mortgages
and credit cards. They feared for their jobs. And they abhorred piling on more
debt.
So in the years after the debt crisis, they decided to do
precisely the opposite. While most folks in Washington were still spending
taxpayer money like drunken sailors, households were waking up to the real
world and starting to cut their debts.
It was the natural, rational thing to do. But it was also
very unusual. Since World War II, the U.S. economy had been consistently fueled
and sustained by American households on a nonstop binge of borrowing and
spending.
Indeed, in almost every year since 1946, consumers had
borrowed more than in the prior year. Washington and Wall Street were happy:
The more consumers borrowed, the more they spent; and the more they spent, the
bigger the revenues at the nation's manufacturers and retailers.
In the years immediately following the debt crisis, however,
all that changed. American consumers not only borrowed less, but they also cut
back on prior borrowings — either because they defaulted or because they
voluntarily sought to restore their finances to avoid default.
Result: We witnessed the deepest decline in consumer credit
outstanding since the government began keeping records after World War II.
Was this good or bad?
The answer should have been obvious. If too much debt was a major cause
of the debt crisis, then it stood to reason that debt reduction was one of the
best solutions.
Nevertheless, Washington and Wall Street didn't see it that
way. All they seemed to care about was their own wallets. They knew that less
consumer borrowing meant less consumer spending. And they knew that less
spending meant lower sales, reduced profits for corporations and a sharp
decline in tax revenues for Uncle Sam.
So America's corporate and political leaders did everything
in their power to get consumers to borrow and spend like they used to.
Moreover, many Federal Reserve and Treasury officials were
deathly afraid of another big threat, which, in their view, loomed even larger
than debt reduction — deflation — declining prices.
If prices go down, they said, consumers will naturally wait
for still lower prices before buying homes, automobiles, appliances and more.
They'll spend even less.
Worse, they feared, consumers will see, with their own eyes,
that the purchasing power of their money is improving. So they'll be more
inclined to — God forbid! — salt it away. That, in turn, would reduce demand
and cause further price declines, creating a "vicious circle" of
sinking demand and sinking prices.
The fact that this process could help bring down the cost of
living and make life easier for average citizens — especially retirees — was
brushed aside. Instead, the authorities decided that this back-to-thrift trend
was actually dangerous and must be stopped dead in its tracks.
Ironically, this was also the rationale that the U.S.
Federal Reserve used to justify its greatest escapade of all, the focus of my
next article in this series, coming next Monday, July 6.
Good luck and God bless! Martin
The investment strategy and opinions expressed in this
article are those of the author's and do not necessarily reflect those of any
other editor at Weiss Research or the company as a whole.
"Source:
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