Infestation
Doug Nolan
I’ll resort to technical jargon: “Terminal Phase Excess” is fertile breeding ground – a veritable cloning factory – for cockroaches.
Before we delve into bugs and larvae currently gnawing away at the Bubble’s periphery, a brief jaunt down memory lane.
From economist (and actor) Ben Stein’s August 12, 2007, New York Times op-ed, “A Market Crisis Disconnected From Reality” - which articulated the conventional view following the June subprime eruption.
“The total mortgage market in the United States is roughly $10.4 trillion.
Of that, a little over 13%, or about $1.35 trillion, is subprime - certainly a large sum.
Of this, nearly 14% is delinquent, meaning late in payment or in foreclosure.
Of this amount, about 5% is actually in foreclosure, or about $67 billion.
Of this amount, according to my friends in real estate, at least about half will be recovered in foreclosure.
So now we are down to losses of about $33 billion to $34 billion.
The rate of loss in subprime mortgages keeps climbing.
In time, perhaps it will double, maybe back to $67 billion…
But by the metrics of a large economy, it is nothing.
The total wealth of the United States is about $70 trillion.
The value of the stocks listed in the United States is very roughly $15 trillion to $20 trillion.
The bond market is even larger…
My point is this: I don’t know where the bottom is on subprime.
I don’t know how bad the problems are at Bear.
Yet I do know that the market reactions are wildly out of proportion to the real problems that have been revealed or even hinted at…
This economy is extremely strong. Profits are superb.
The world economy is exploding with growth…
Some smart, brave people will make a fortune buying in these days, and then we’ll all wonder what the scare was about.”
“Terminal phases” tend to be as confounding as they are enthralling.
Things appear robust.
Late-cycle loose financial conditions ensure boom-sustaining Credit excess.
Booming debt bolsters corporate earnings, incomes and economic activity, as ever-inflating stock and asset prices crystallize the perception of boundless wealth and bright prospects (“permanently high plateau”).
For a bit, Ben Stein and the risk-dismissive bullish narrative appeared well-founded.
The S&P500 reached a record 1,576 intraday on October 11, 2007.
It’s worth noting that Q3 2007 saw Corporate Bonds (from the Fed’s Z.1) expand a then record $471 billion and Total Mortgages grow a strong $302 billion, as Credit boom momentum at the “Core” initially spurned cataclysmic “Periphery” developments.
But I’m getting somewhat ahead of the game.
There is yet no cataclysm, though it was another week that suggests the clock is ticking.
Friday’s 1.7% rally reduced the week’s losses for the KBW Regional Bank Index in half.
Zions 5.8% Friday rally cut its week’s loss to 5.1%, with Western Alliance Bancorp’s 3.1% recovery reducing losses to 3.3%.
Despite Friday’s gains, the Nasdaq Financial and Insurance indices closed the week down 1.9% and 3.6%.
The Nasdaq Financial Index ended Thursday at the lowest close since June 27th, with the Nasdaq Insurance Index trading Thursday to lows since April 9th.
October 16 – Bloomberg (Yizhu Wang):
“Shares of two regional US banks tumbled Thursday after the companies said they were the victims of fraud on loans to funds that invest in distressed commercial mortgages, fueling concern that more cracks are emerging in the credit markets.
Zions Bancorp sank 13% after it disclosed a $50 million charge-off for a loan underwritten by its wholly-owned subsidiary, California Bank & Trust, in San Diego.
And Western Alliance Bancorp tumbled almost 11% after it said it made loans to the same borrowers.”
October 16 – Bloomberg (Yizhu Wang):
“Relative to the collapse of First Brands Group and Tricolor Holdings, the hits disclosed by regional lenders Zions Bancorp and Western Alliance Bancorp seemed small — a figure in the tens of millions, not billions.
Still, the back-to-back reveal of loan fraud renewed the simmering debate on Wall Street about whether the era of freewheeling capital is about to cause a comeuppance for banks and non-banks alike.
In the case of Zions and Western Alliance, the alleged culprits were the same: investment funds tied to Andrew Stupin and Gerald Marcil, among other parties, borrowed the funds to finance their purchase of distressed commercial mortgage loans.”
October 14 – Bloomberg (Sridhar Natarajan):
“Investors spooked by the implosion of auto lender Tricolor Holdings and car-parts supplier First Brands Group got little reassurance Tuesday from the head of the biggest US bank.
‘My antenna goes up when things like that happen,’ Jamie Dimon, JPMorgan… chief executive officer, said…
‘I probably shouldn’t say this, but when you see one cockroach, there are probably more.
Everyone should be forewarned on this one.’
The pair of bankruptcies were a shock for the credit markets, where companies have been borrowing at a record pace while handing investors outsized returns.”
Bubbles can run, but they can’t hide.
There’s no cure, certainly not from looser monetary policy, government interventions/bailouts, and Wall Street promotion and chicanery.
Prolonging Bubbles promotes myriad excess, including fraudulent activities.
With so much “money” sloshing around the system, the prospect of making quick millions and, for this cycle, billions, becomes irresistible.
If you are not a risk-taker, you’re a loser.
And with loan officers, investment bankers, fin-tech operators, hedge fund managers, and countless financiers making so bloody much money, scores of even good-intentioned borrowers will push the limits of growth and leverage.
When conditions tighten, fear of crushed dreams and financial ruin will see many resort to deceit - and begin the sad transformation to crookedness.
As for recent Cockroach sightings, the good news is they’re little critters, annoying, but, at least outwardly, not overly alarming.
The bad news: these youngsters have much more imposing relatives – legions of grown-up roaches still gorging on the steroid of loose conditions - still propagating systemic infestation.
October 14 – Financial Times (Joshua Franklin and Akila Quinio):
“Goldman Sachs, JPMorgan Chase and Citigroup have reported bumper profits across their Wall Street divisions, even as they warned that investor exuberance risked driving a recent runup in financial markets into bubble territory.
The three banks reported quarterly earnings… that comfortably beat analysts’ estimates… JPMorgan’s net income increased by 12% from the same quarter a year earlier to $14.3bn, while at Goldman — the bank whose business is most heavily geared towards investment banking and trading — net earnings rose 37% to $4.1bn.
Citi’s net income increased by 18% to $3.5bn.
Revenues from investment banking and trading increased by at least 12% at all three banks in a sign that Wall Street’s much-anticipated revival under the Trump administration is finally starting to materialise.”
October 14 – Wall Street Journal (AnnaMaria Andriotis, Alexander Saeedy and Ben Glickman):
“Wall Street is firing on all cylinders.
Dealmaking, trading and corporate lending are gaining steam and fueling profits at the nation’s biggest banks, with Goldman Sachs, JPMorgan…, Citigroup and Wells Fargo all beating third-quarter profit and revenue forecasts.
Goldman is now on pace for its best year ever in its main investment-banking and markets division.
JPMorgan is on track to make over $50 billion in annual profit for the second year in a row.
BlackRock is sitting on a record $13.5 trillion in assets under management…
Record high stock markets fueled increased trading and borrowing by hedge funds and others to buy even more securities.
President Trump’s policymaking is adding volatility that keeps traders eager to move…
Financing activity is surging, with mergers on the rise.
Then there are the massive investments in the rise of artificial intelligence, building out data centers and other infrastructure.”
October 14 – Bloomberg (Silla Brush):
“BlackRock Inc. pulled in $205 billion of client money in the third quarter as the world’s largest fund manager expanded its footprint in private credit and alternative assets.
Investors added $153 billion on a net basis to stock, bond and other exchange-traded funds — which topped $5 trillion for the first time — reflecting the massive growth of the products this year…
Net flows to long-term investment funds were $171 billion…
‘I believe the scale of the opportunity ahead for BlackRock, our clients and shareholders far exceeds what we’ve ever seen before,’ Chief Executive Officer Larry Fink said…”
October 14 – Wall Street Journal (Jack Pitcher):
“The world’s biggest money manager just shattered its own record.
BlackRock ended the third quarter with $13.46 trillion in assets under management, up 17% from a year ago…
At an investor conference in June, BlackRock executives outlined plans to become a do-everything money manager and set an ambitious target of raising $400 billion for their private-market funds by 2030.”
October 16 – Bloomberg (Paige Smith):
“Charles Schwab Corp. reported third-quarter earnings that beat estimates as the firm benefited from a surge in retail investing activity.
The firm reported $134.4 billion in total net new assets, a 48% increase from a year earlier…
Daily average revenue trades grew 30% to $7.42 trillion…”
Hoping to eventually move on, but I’m compelled to reiterate the Fed’s error in cutting rates a year ago despite perilously loose conditions and financial excess.
The upshot: Q3 “Terminal Phase” worst-case scenario – booming lending, “subprime” financing, securitizing, leveraging, speculating, risk-transferring, cheating, and swindling – all right into deteriorating fundamentals and a fateful Credit cycle downturn.
Classic.
Epic.
“Hangover” will not do justice.
October 16 – Bloomberg (Annika Inampudi):
“Goldman Sachs… President John Waldron said there’s been an explosion in the growth of credit over the past decade — and that the fallout if things go south won’t be pretty.
The executive pointed to the roughly $5 trillion of borrowings extended across high-yield bonds, leveraged loans and private credit — with the latter driving most of the growth.
‘We’ve had an explosion of credit extension, mostly in private credit — some in the banking system, but mostly in private credit over the last decade,’ Waldron said Thursday during a panel at a Semafor event…
‘We may, and probably will have some defaults there, and it’s not going to be pretty when it happens.’”
October 17 – Financial Times (Eric Platt, Kate Duguid and Amelia Pollard):
“Investors in the $2tn leveraged loan market have warned that the abrupt collapse of First Brands Group is an early sign of trouble for a market where hasty deals and hurried due diligence have become commonplace.
First Brands was among the largest issuers of loans bought by collateralised loan obligations, investment vehicles that buy up small slices of hundreds of individual corporate loans.
CLOs have become popular with insurers and other big investors who bet that by spreading their lending across many different companies they are protected from the pain of defaults in one or two businesses.
But the rapid bankruptcy of First Brands… has raised concerns over the rapid growth of the CLO market, which has provided almost unquenchable demand for the leveraged loans that private equity firms often use to finance their acquisition sprees.
Some fund managers worry that a spate of CLO losses could cause Wall Street’s securitisation machine to sputter.
‘Inside credit markets for more than a year, there has been a grudging recognition that there was and is a series of credit problems that could be substantial and could be dangerous to the overall economy,’ said Andrew Milgram, chief investment officer of Marblegate Asset Management, a distressed-debt investor.”
To be clear, the global government Finance Bubble puts mortgage finance Bubble excess to shame.
The inflation in “Core” government sovereign debt and central bank Credit is unparalleled.
In more pressing analysis, the current cycle’s “subprime” “Periphery” so dwarfs previous cycle excesses to the point of making high-risking mortgage lending almost appear systemically inconsequential.
Hard to believe, but 17 years have passed since “the great financial crisis.”
Memories have long ago faded.
Years of zero (and near to it) rates spurred extraordinary financial innovation and development.
Financial structure evolved with the proliferation of new age avenues for lending – fintech, brokerage accounts, crypto, buy now pay later, etc.
In particular, booms in leveraged lending and “private Credit” fundamentally eased Credit Availability for high-risk borrowers – for financing business development, M&A, household spending and just about everything.
Borrower and lender alike, most individuals at the forefront of today’s financial boom have scant recollection of 2008.
It’s the old codgers on roach watch.
There will always be clever – even inventive - twists and spins.
But high-risk lending remains high-risk lending.
Given time, old derided “subprime” will be transformed into new, enhanced, upgraded, modernized, sophisticated, but still “subprime” – no matter how much the enterprising proponents of new age finance apply heavy eyeliner, eyelash extensions, and Hermès lipstick to disguise the porker.
There is no revoking the Credit Cycle.
We’re in the throes of a high-risk lending boom without precedent.
A historic multi-decade Credit Bubble culminated with a most protracted period of “Terminal Phase” excess.
Thousands of businesses and enterprises have for too long feasted from the trough of easy Credit Availability and liquidity overabundance.
For many, negative cash-flow operations and bloated balance sheets create acute vulnerability to abrupt tightening of financial conditions.
The happenings of Tricolor, First Brands, Zions, and Western Alliance have triggered a tightening of Credit conditions.
Ominously, Credit issues were already surfacing despite loose conditions and booming finance.
October 17 – Bloomberg (Miguel Ambriz and Keith Naughton):
“Car loans have gone from the safest consumer credit products to among the riskiest over the last 15 years as delinquencies rose more than 50%, driven by soaring car prices and rising interest rates, a new study shows.
Consumers across all income categories are struggling to make monthly car payments, according to VantageScore, a credit-scoring company.
Auto loans were once a safe haven, with drivers prioritizing payments on their transportation above other debts, but delinquencies on car loans have jumped since 2010.”
The VIX Index traded to 28.99 in early Friday trading, the high since April 24th – before reversing sharply lower to close the week at 20.78.
Friday’s markets recovery made things look less bad.
After losing 5% and 3.7% the previous week, the KBW Bank and Broker/Dealer indices recovered only 1% and 0.9% this week.
Following last week’s 36 bps widening, High Yield spreads to Treasuries this week narrowed 11 bps.
High Yield CDS declined seven bps after surging 21 bps.
Notably, Leveraged Loan market recovery was MIA, with prices down another seven cents to 96.46 – closing Wednesday (96.35) at a five-month low.
With Credit blowups pressuring markets, we’ll now see the typical dynamic where news/analysis follows market direction.
Festering issues will belatedly garner some attention.
And they’ll be burning the midnight oil at the ratings agencies.
October 16 – Bloomberg (Rene Ismail and Kat Hidalgo):
“The private credit industry’s claims of market-beating, stress-free returns are ‘illusory,’ a group of academics say, adding fuel to the fire in a week that already saw executives fend off broadsides from the likes of Jamie Dimon.
Academics from Johns Hopkins University and University of California, Irvine, argue that direct lenders offer investors marginal returns compared with more transparent and widely-traded leveraged loans — and less in some cases.
In research… in the Journal of Private Markets Investing, they contend that the asset class produces limited alpha, or extra compensation over market benchmarks.
‘Private credit performance is both lacking in alpha as well as a timely return of capital,’ Jeffrey Hooke, one of the authors… said...
‘The two main marketing points of the industry seem to be illusory.’
Their critique comes at a sensitive time for the market.”
October 12 – Financial Times (Lee Harris):
“Rating agency S&P has warned of risks from the complexity and lack of disclosure in the private credit market, as US insurers push into the fast-growing asset class.
‘There’s just a lot less transparency’ about private credit assets, said Carmi Margalit, S&P’s head of North American life insurance.
The agency estimates that $530bn, or about 23%, of life insurers’ corporate bond holdings were issued through private placements…
Of these, about $218bn had a ‘private letter’ credit rating, confidential scores available only to the issuer and some investors.
The private credit market provides trillions of dollars of loans to companies…
The US life insurance industry, which has more than $8tn of invested assets and manages retirement savings for millions of people, has been among the biggest investors.
The industry’s private credit holdings also include $71bn of structured finance bonds with private letter ratings, according to S&P.”
This week corroborated analysis of a Credit cycle at a critical juncture.
But it’s a safe bet that the colossal financial apparatus that has mushroomed over this long cycle will put up one hell of a fight.
Wall Street, the banking system, fintech, and “private Credit” are all geared up to continue bankrolling the boom.
And there’s this AI thing – histories blackest of financial black holes.
On the one hand, the staggering scope of the AI arms race buildout ensures endless Credit demand – borrowing with the potential to keep the high-risk leveraged lending and “private Credit” wheels turning.
On the other hand, I can’t imagine a more perilous late-cycle Credit dynamic than funding a multi-trillion dollar global AI arms race.
So long as the mania holds, markets can pretend this is a sound Credit dynamic.
But this perceived robust AI Credit boom mutates to a problematic subprime debacle as soon as financial conditions tighten, speculators head for the exits, and liquidity evaporates.
To that end, there are clear and present potential catalysts.
October 14 – Wall Street Journal (Lingling Wei and Gavin Bade):
“In its trade standoff with Washington, Beijing thinks it has found America’s Achilles’ heel: President Trump’s fixation on the stock market.
China’s leader, Xi Jinping, is betting that the U.S. economy can’t absorb a prolonged trade conflict with the world’s second-largest economy, according to people close to Beijing’s decision-making.
China is holding a firm line because of its conviction, the people said, that an escalating trade war will tank markets, as it did in April after Trump announced his Liberation Day tariffs, prompting Beijing to hit back.
China expects that the prospect of another market meltdown ultimately will force Trump to negotiate at an expected summit with Xi late this month, the people said.”
October 14 – Telegraph (Hans van Leeuwen):
“The world’s investors, executives, policymakers and politicians all now keep an eye on the Truth Social account @realDonaldTrump…
Now there’s another habit they might need to cultivate: watching the announcements from China’s ministry of commerce.
The ministry’s initially low-key announcement last week of new regulations on Chinese rare earth exports has sent shock waves through the West…
‘This is a completely new dawn.
This no longer has anything to do with trade.
We’ve morphed from a trade war into a grey-zone operation,’ says James Kynge, a China watcher at think tank Chatham House.
‘It’s a complete step change in China’s leverage and China’s ability to coerce not only the US, but every other country in the West, if it chooses to do so.
The evidence of the past suggests that Beijing may well use this leverage.
And then we’re into a whole different world.’”
The administration’s China trade war commentary has been dizzying.
President Trump:
“Don’t worry about China, it will all be fine!
Highly respected President Xi just had a bad moment.”
“I think we’re going to be fine with China.
I have a great relationship with President Xi.
He’s a very tough man, a very smart man.
He’s a great leader for their country.
He’s a great leader.”
“The USA wants to help China, not hurt it.”
The Sunday/Monday conciliatory fest was of the now ordinary market-pleasing TACO variety.
Not only were equities needing a boost, but the crypto Bubble was suddenly faltering.
I also suspect the President didn’t want a sinking stock market to detract from his Gaza ceasefire and trip to Israel.
Conciliatory, however, had faded by midweek.
“US Blasts China as ‘Unreliable’ as Trade Tensions Mount.”
“Bessent Says China ‘Can’t be Trusted’ as Trade Fight Escalates.”
“Bessent Calls China Trade Negotiator ‘Unhinged’ Wolf Warrior.
“Bessent Says China Trade Negotiator ‘Very Disrespectful,’ ‘Unhinged’”
“Scott Bessent Slams China: ‘They Want to Pull Everybody Else Down With them.”’
“Bessent Urges World Bank to End Support for China.”
“Bessent Says U.S. Supports Tariff on China for Buying Russian Oil – If Europe Also Acts.”
Come Friday (crypto under more pressure), the tone had changed again.
“Trump Says Threatened High Tariffs on China ‘Not Sustainable.’”
“US-China Trade Talks Seen Next Week as Trump Plays Down Tariffs.”
“Bessent to Meet China’s Vice-Premier in Bid to Solve Rare Earths Spat.”
It was intriguing that Secretary Bessent, who has had a couple well-publicized rage incidents (Elon and Pulte), complained about a “very disrespectful” and “unhinged” Chinese trade minister.
Beijing surely has by now deeply researched psychological profiles for senior U.S. officials, most notably the President and Treasury Secretary.
It just seems the Chinese are carefully executing a sophisticated and comprehensive strategy.
There will be ebbs and flows – the trade war will heat up and temperatures will be brought back down.
There will be some compromises, but the Chinese appear well dug in.
Unless the Trump administration backs down, Beijing is prepared to “fight to the end.”
They see the U.S. as vulnerable, and Trump lacking the fortitude to withstand market, economic, and political pain.
Meanwhile, President Trump just doesn’t at this juncture seem of the frame of mind to easily give in to Chinese demands.
The risk of major trade war escalation should not be dismissed.
With today’s confluence of cracks in Credit, fledgling risk aversion, and trade war friction, the possibility of deleveraging is back in the discussion.
Major market dislocations in segments of the equities market (i.e., heavily shorted stocks) and in the precious metals are likely harbingers of bigger things to come.
And my thoughts return to colossal “basis trade” leverage, a key unappreciated source of global liquidity excess.
One of these days…
October 16 – Bloomberg (Masaki Kondo):
“Hedge funds in the Cayman Islands held more Treasuries at end-2024 than US official data show, with their ownership likely to be $1.4 trillion higher than reported, according to researchers at the Federal Reserve.
The funds’ holdings had increased by $1 trillion since 2022 to reach $1.85 trillion by end-December, the researchers including Daniel Barth and Daniel Beltran wrote...
A report from the Department of the Treasury put the funds’ ownership at $423 billion.
The Fed researchers said their figures showed the Cayman Islands is the largest foreign owner of US government securities, ranking ahead of China, Japan and the UK.
The discrepancy in the data likely arose because the official data did not fully pick up transactions linked to the so-called basis trades, where hedge funds short Treasury futures and buy Treasury securities to profit from the difference in their prices...
Hedge funds finance these trades by borrowing in the repurchase-agreement market and pledging the purchased securities as collateral...
It may be difficult to track ownership of securities after they are exchanged as collateral.”
And a final ponderable…
October 13 – New York Times (Andrew Ross Sorkin):
“Back in the 1920s, Charles Mitchell — the swaggering head of National City Bank, the forerunner to Citigroup — had a ritual.
He would take his bond salesmen to lunch at the Bankers Club, perched atop the Equitable Building at 120 Broadway, and point to the city below, stretched out in miniature.
‘There are six million people with incomes that aggregate thousands of millions of dollars,’ he’d say.
‘They are just waiting for someone to come to tell them what to do with their savings.
Take a good look, eat a good lunch and then go down and tell them.’
For Mitchell, finance and the new instruments of wealth — stocks, margin loans, investment trusts and even exotic foreign bonds — were not to be hidden away but promoted like any other product.
‘It has always seemed to me that there is, and always has been, too much mystery connected with banking,’ he liked to say.
He wasn’t alone in preaching the gospel of access.”
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