U.S. CREDIT CRISIS, 2020
Fun fact: If the U.S. economy continues to expand into July of 2019, it will have achieved the longest period of economic growth in the country’s history.
Now let’s talk about the expanding debt bubble. Just look at the graph above. That’s federal, corporate, student, home, and credit card debt, all at all-time highs, in an economic period where debt should be curtailed.
What will kick off the credit crisis?
A leading factor could likely be student debt, which has risen exponentially since 2010. Note that the market for student debt popping alone won’t do much. I’m referring to student loans mitigating the buying power of individuals, reducing corporate revenues and causing the barrage of corporate debt recently issued (at ridiculous valuations, mind you) to be deemed junk. Student debt, credit card debt, healthcare costs, and stagnant wages are all creating a scenario where the average person’s buying power decreases, and that’s what will turn corporate bonds toxic.
Quietly flying under everyone’s radar are the subprime auto loans. For the last 10 years or so, the vast majority of new cars have been sold on PCP, then to be sold on to banks in the same way that mortgage CDOs were prior to ’08. When interest rates go up, one of the first debts most likely to default will be the payments on the brand new BMW.
U.S. healthcare costs, by the way, are the highest of any First World country, and will only increase. In fact, healthcare spending is projected to outpace GDP growth by 1.2%, reaching nearly 20% of the total GDP by 2025. The deeper issue here is that a growing portion of this spending is “out-of-pocket”, meaning more and more smaller bills that fall below deductibles (or simply aren’t covered by the insurance company) are borne by the consumer. Such costs increased by 11% in 2017, leaving many Americans with less disposable income “very concerned” about their ability to keep up with future medical expenses. With the uninsured rate slowly on the rise, one can only assume this trend will continue. If it does, and the problem is allowed to fester, it could lead us to the tipping point where consumer spending begins to decline, impacting corporations, which will finally buckle under the weight of their massive debt.
Another potential trigger will probably be structured products of some kind — perhaps CLOs? Dodd-Frank regulations were relaxed when Trump stepped in, and now CLO funds have no legal obligation to hold a percentage of the product they sell. CLOs are now on track for a record breaking year — possibly over $150 billion! In other words, the size of the structured products market is likely in the trillions again, and the Fed raising rates so quickly isn’t helping.
Housing is already showing the signs. You can see a shock erupting in Seattle markets as inventories pile up, and homes are no longer closing well above listing price, but below. The San Francisco Bay Area, Dallas and other hot markets may be getting the same treatment pretty soon, which could end up leaving homebuilders with higher losses and possible bankruptcy. See, it turns out most of the leveraged loans going into the CLO issuance are tied to startups and companies with bad balance sheets like fintech, homebuilders, commercial real estate developers, and REITs. A slowdown in these sectors will tank those CLOs. Starting to see the pattern?
Now, with all that being said, large-scale defaults in the tech sector are not an absolute certainty, thanks to Chinese, Saudi, and Japanese inflows, but at the moment it does seem like foreign investors are less willing to buy treasuries. Reducing exposure? The October scare might have opened their eyes, and if those loans can’t get rolled over, then just like when the originators of home loans couldn’t secure financing in 2007, the economy will start to collapse. Yes, the corporate debt bubble is a mirror of the subprime mortgage bubble. Corporate valuations are growing recklessly, and companies keep issuing new debt to refinance and buyback more shares, further propping up those valuations. And just for the record, people who think a company like, say, McDonalds is “too big to fail”, despite tripling its debt in 5 years while revenues have been stagnant/declining, are mad. Leverage is like cocaine. Once stocks tumble, pensions will follow, and they’ll all beg the federal government for help. Because the U.S. never learns from its mistakes, the gov’t will bail out pension funds and further worsen the deficit (compounded by the 2017 tax bill), thus hurting treasuries.
Will it rival ‘08? I think so, if only because in one fell swoop, this event will most likely bankrupt several U.S. companies and leave many with “junk” credit ratings. The worst of this crisis will not be limited to insurance companies and banks, as it was in ‘08.
What securities/investments would be useful in navigating it? Credit default swaps on corporate bonds, obviously. Notice how outlandish Elon was acting when Tesla’s bond yields were volatile? You could tell he was sweating. Insurance-linked securities such as catastrophe bonds would add even greater diversity.
I’m a trader. I generally look at charts, not underlying fundamentals, but what’s going on all around us simply cannot be ignored. Just like in ’08, the signs of systemic risk are now everywhere you look, waiting for pretty much anyone to connect the dots.
I am not a registered financial professional, THIS IS NOT FINANCIAL ADVICE.
