The Next Financial Crisis

[Swammerdami]

I think Loren and I have very similar views here; it's my word choices that have him disagreeing!

The credit crisis of 2008 was the most dangerous world-wide financial crisis since the the Great Depression. It was caused by a housing price bubble, and by financial shenanigans pursued in the name of "hyper-efficiency" but which led to large-scale gambling: Big Wall Street Traders were buying million-dollar sports-cars by squeezing an extra 0.01% here and there, oblivious of real-world implications and with criminal cooperation from rating agencies. They eventually cost trillions to the real economy.

Disagree. I think the primary cause of the collapse was that we ignored the lesson we learned in 1929 about limiting margin ratios....
Unfortunately, we did not learn our lesson in 2008 and did basically nothing to curtail the exotic forms of borrowing. The same instability still exists. It's like the snow pack on the mountain--if it's unstable enough sooner or later the avalanche will be triggered. The nature of the trigger is unimportant, the underlying instability is what caused it.

I'm not sure why you say you "disagree" with me. My "hyper-efficiency" and "gambling" referred directly to excessive leverage. By the way, there are hyper-efficiencies other than excessive leverage that also pose risks to stability; high-frequency trading is one example.

But do not underestimate the sheer criminality that contributed to the crisis. The fancy new "investments" required good ratings from Moody's et al, but the favorable ratings were a corrupt joke. It is unethical for Wall St. salesman to exaggerate the way used-car dealers do, but many were well aware of financial flimsiness.

It's hard to prosecute Wall St. criminality. Passing new regulations after the fact is like Whack-a-Mole: New loopholes will be found. I think a very small tax on financial transactions would eliminate some of the useless hyper-efficiency and associated instability.

I disagree because I think the main issue was the instability caused by the excessive leverage rather than the gambling etc.

The guys playing with fire got burnt. I don't care. I care that the system was so unstable that the fire propagated far beyond them.

And instability is not the same thing as hyper efficiency.

I don't like long cascades of rejoindering, but this is all much too confused for me to ignore. My guess is that the word "gambling" has some special "shady" connotation to Loren; otherwise the link between "excessive leverage" and "gambling" would be unquestioned.

And Loren's "instability is not the same thing as hyper efficiency" is even more baffling. Loren, Do you think the phrase "A and associated B" implies that "A and B are the same thing"? I'd offer specific examples of A and B to demonstrate the absurdity of your conclusion, but I think you should do that so we can be sure we're on the same page.

If you want to know the difference between "efficiency" and my "hyper-efficiency", or want examples of the ASSOCIATION between hyper-efficiency and instability I'll oblige, but first let's make sure we're speaking the same dialect!

 

[Harry Bosch]

It's hard to prosecute Wall St. criminality. Passing new regulations after the fact is like Whack-a-Mole: New loopholes will be found. I think a very small tax on financial transactions would eliminate some of the useless^* hyper-efficiency and associated instability.

I agree with your small tax on financial transactions. And I also agree with Loren about too much margin.

But to actually fix bubbles from appearing again both of you are missing the point IMO. That has to require unfettered consequences that normally should happen with capitalism but did not happen when government restored investment firms that should have paid a price. So rather than pass more regulation and laws, why can't government just let the people that cause the mess go out of business like they should? For example, why did Bear Sterns really need to be bailed out? And if they really did need to be bailed out for the public good,....why did the US government allow them NOT to be broken up into smaller pieces afterwards? Why was there no penalty for leaders of those financial institutions? Let those institutions go bankrupt like they should and/or temporarily nationalize them until financial stability is achieved again. But do not ever ever bail them out without consequence. That is how capitalism normally works.

I agree that malefactors should pay a heavy price, but Bear Stearns is a poor example for two reasons:
(1) The Bear Stearns shareholders DID pay a heavy price: They were offered $2 per share for stock that had recently been priced at $130+. (The $2 price was upped to $10 or such through litigation, but that litigation had nothing to do with government.) The "bail-out" was that JPM assumed Bear Stearns obligations — but without making that paper good, insolvency would have spread like a virus. (The US Treasury came up with several billion but that was to entice JPM, not to help Bear Stearns' owners.)
(2) Bear Stearns was itself a VICTIM; they failed because they were pursuing the same over-rated paper that had hypnotized so many.

And anyway, should passive shareholders be punished for mischief by executives? (Yes, they should be and are punished. But it's unfortunate that the active swindlers do not pay the heavy price. Many of the active swindlers from 2007-2008 are now happily retired with many millions.) It's too bad that big-time white-collar crime goes unpunished, but prosecution is very difficult.

I know of no easy remedies, other than the small transaction tax I already mentioned. It is unfortunate that the brightest young people are incentivized to go to work on Wall St. for millions of dollars, when they could be doctors, scientists or teachers who are doing something useful for society.

Of course passive investors shouldn't be prosecuted for crimes committed by someone. In our system, only the people who directly commit the crime or who know of it can get prosecuted (unless your name is Trump). You wouldn't want to go after the CIO of a company if the CFO cooked the books right? Unless the CIO know of it or was part of it. The real issue is that white collar crimes are difficult to identify, and difficult to prosecute against criminals who often have great representation.

 

[ZiprHead]

What will be the major causes of the next financial crisis?

Too much corporate debt on office space in the big cities. COVID has shown us that workers can be anywhere now, so why do firms need to pay high rent prices in the cities? Corporations that are also going to have more difficulty with their expenses after paying more incremental interest on their debt. A lot more of that kind of real estate vacant on the market and could trigger something worse. And then there could also be a huge sucking sound when ordinary workers in the big cities realize how overpriced their homes are and start moving out en mass. Those small homes are going to be worth a lot less when it is learned that the jobs don't need to be in the big cities anymore.

That's your idea of the next major financial crisis???

 

[RVonse]

It's hard to prosecute Wall St. criminality. Passing new regulations after the fact is like Whack-a-Mole: New loopholes will be found. I think a very small tax on financial transactions would eliminate some of the useless^* hyper-efficiency and associated instability.

I agree with your small tax on financial transactions. And I also agree with Loren about too much margin.

But to actually fix bubbles from appearing again both of you are missing the point IMO. That has to require unfettered consequences that normally should happen with capitalism but did not happen when government restored investment firms that should have paid a price. So rather than pass more regulation and laws, why can't government just let the people that cause the mess go out of business like they should? For example, why did Bear Sterns really need to be bailed out? And if they really did need to be bailed out for the public good,....why did the US government allow them NOT to be broken up into smaller pieces afterwards? Why was there no penalty for leaders of those financial institutions? Let those institutions go bankrupt like they should and/or temporarily nationalize them until financial stability is achieved again. But do not ever ever bail them out without consequence. That is how capitalism normally works.

I agree that malefactors should pay a heavy price, but Bear Stearns is a poor example for two reasons:
(1) The Bear Stearns shareholders DID pay a heavy price: They were offered $2 per share for stock that had recently been priced at $130+. (The $2 price was upped to $10 or such through litigation, but that litigation had nothing to do with government.) The "bail-out" was that JPM assumed Bear Stearns obligations — but without making that paper good, insolvency would have spread like a virus. (The US Treasury came up with several billion but that was to entice JPM, not to help Bear Stearns' owners.)
(2) Bear Stearns was itself a VICTIM; they failed because they were pursuing the same over-rated paper that had hypnotized so many.

And anyway, should passive shareholders be punished for mischief by executives? (Yes, they should be and are punished. But it's unfortunate that the active swindlers do not pay the heavy price. Many of the active swindlers from 2007-2008 are now happily retired with many millions.) It's too bad that big-time white-collar crime goes unpunished, but prosecution is very difficult.

I know of no easy remedies, other than the small transaction tax I already mentioned. It is unfortunate that the brightest young people are incentivized to go to work on Wall St. for millions of dollars, when they could be doctors, scientists or teachers who are doing something useful for society.

Of course passive investors shouldn't be prosecuted for crimes committed by someone. In our system, only the people who directly commit the crime or who know of it can get prosecuted (unless your name is Trump). You wouldn't want to go after the CIO of a company if the CFO cooked the books right? Unless the CIO know of it or was part of it. The real issue is that white collar crimes are difficult to identify, and difficult to prosecute against criminals who often have great representation.

The passive investors should not go to jail. But they should be allowed to lose all their investment since they were ignorant to leave their money with firms who had criminals running them. That way sooner or later the honest leaders will be the only ones trusted to invest in.

 

[RVonse]

What will be the major causes of the next financial crisis?

Too much corporate debt on office space in the big cities. COVID has shown us that workers can be anywhere now, so why do firms need to pay high rent prices in the cities? Corporations that are also going to have more difficulty with their expenses after paying more incremental interest on their debt. A lot more of that kind of real estate vacant on the market and could trigger something worse. And then there could also be a huge sucking sound when ordinary workers in the big cities realize how overpriced their homes are and start moving out en mass. Those small homes are going to be worth a lot less when it is learned that the jobs don't need to be in the big cities anymore.

That's your idea of the next major financial crisis???

I did not say it was my idea of the next major financial crisis. I said this could trigger breaking the bubble of the next financial crisis. The bubble is there and something will prick it. This is my best guess.

Read what Swammerdami wrote in bold again.

 

[Harry Bosch]

It's hard to prosecute Wall St. criminality. Passing new regulations after the fact is like Whack-a-Mole: New loopholes will be found. I think a very small tax on financial transactions would eliminate some of the useless^* hyper-efficiency and associated instability.

I agree with your small tax on financial transactions. And I also agree with Loren about too much margin.

But to actually fix bubbles from appearing again both of you are missing the point IMO. That has to require unfettered consequences that normally should happen with capitalism but did not happen when government restored investment firms that should have paid a price. So rather than pass more regulation and laws, why can't government just let the people that cause the mess go out of business like they should? For example, why did Bear Sterns really need to be bailed out? And if they really did need to be bailed out for the public good,....why did the US government allow them NOT to be broken up into smaller pieces afterwards? Why was there no penalty for leaders of those financial institutions? Let those institutions go bankrupt like they should and/or temporarily nationalize them until financial stability is achieved again. But do not ever ever bail them out without consequence. That is how capitalism normally works.

I agree that malefactors should pay a heavy price, but Bear Stearns is a poor example for two reasons:
(1) The Bear Stearns shareholders DID pay a heavy price: They were offered $2 per share for stock that had recently been priced at $130+. (The $2 price was upped to $10 or such through litigation, but that litigation had nothing to do with government.) The "bail-out" was that JPM assumed Bear Stearns obligations — but without making that paper good, insolvency would have spread like a virus. (The US Treasury came up with several billion but that was to entice JPM, not to help Bear Stearns' owners.)
(2) Bear Stearns was itself a VICTIM; they failed because they were pursuing the same over-rated paper that had hypnotized so many.

And anyway, should passive shareholders be punished for mischief by executives? (Yes, they should be and are punished. But it's unfortunate that the active swindlers do not pay the heavy price. Many of the active swindlers from 2007-2008 are now happily retired with many millions.) It's too bad that big-time white-collar crime goes unpunished, but prosecution is very difficult.

I know of no easy remedies, other than the small transaction tax I already mentioned. It is unfortunate that the brightest young people are incentivized to go to work on Wall St. for millions of dollars, when they could be doctors, scientists or teachers who are doing something useful for society.

Of course passive investors shouldn't be prosecuted for crimes committed by someone. In our system, only the people who directly commit the crime or who know of it can get prosecuted (unless your name is Trump). You wouldn't want to go after the CIO of a company if the CFO cooked the books right? Unless the CIO know of it or was part of it. The real issue is that white collar crimes are difficult to identify, and difficult to prosecute against criminals who often have great representation.

The passive investors should not go to jail. But they should be allowed to lose all their investment since they were ignorant to leave their money with firms who had criminals running them. That way sooner or later the honest leaders will be the only ones trusted to invest in.

Well, they did, didn't they? I don't recall investors being bailed out. There were several banks in my area that completely collapsed. Shares went to zero.

 

[RVonse]

There was some punishment but what happened to the "too big to fail" companies like AIG and Goldman Sachs? Did they really fail and are they still too big to fail? Is BOA still too big to fail? If so, why weren't they allowed to disolve and/or be spit into smaller banks they were before 2008?

 

[Loren Pechtel]

And anyway, should passive shareholders be punished for mischief by executives? (Yes, they should be and are punished. But it's unfortunate that the active swindlers do not pay the heavy price. Many of the active swindlers from 2007-2008 are now happily retired with many millions.) It's too bad that big-time white-collar crime goes unpunished, but prosecution is very difficult.

I know of no easy remedies, other than the small transaction tax I already mentioned. It is unfortunate that the brightest young people are incentivized to go to work on Wall St. for millions of dollars, when they could be doctors, scientists or teachers who are doing something useful for society.

I don't see how a transaction tax will stop the scammers.

I favor a different approach: For any company with an actively traded stock limit income to $1m/yr. Beyond that convert the compensation to shares, paid out at the rate of $1m of current shares per year. While any such pending shares exist they may not engage in any short sales or the like of that company's stock. The idea is to tie their income to the long term prospects of the company. No pumping it up and exercising their options before the long term consequences show up.

 

[Loren Pechtel]

I think Loren and I have very similar views here; it's my word choices that have him disagreeing!

I disagree because I think the main issue was the instability caused by the excessive leverage rather than the gambling etc.

The guys playing with fire got burnt. I don't care. I care that the system was so unstable that the fire propagated far beyond them.

And instability is not the same thing as hyper efficiency.

I don't like long cascades of rejoindering, but this is all much too confused for me to ignore. My guess is that the word "gambling" has some special "shady" connotation to Loren; otherwise the link between "excessive leverage" and "gambling" would be unquestioned.

And Loren's "instability is not the same thing as hyper efficiency" is even more baffling. Loren, Do you think the phrase "A and associated B" implies that "A and B are the same thing"? I'd offer specific examples of A and B to demonstrate the absurdity of your conclusion, but I think you should do that so we can be sure we're on the same page.

If you want to know the difference between "efficiency" and my "hyper-efficiency", or want examples of the ASSOCIATION between hyper-efficiency and instability I'll oblige, but first let's make sure we're speaking the same dialect!

Why are you equating efficiency with leverage?

 

[Loren Pechtel]

The passive investors should not go to jail. But they should be allowed to lose all their investment since they were ignorant to leave their money with firms who had criminals running them. That way sooner or later the honest leaders will be the only ones trusted to invest in.

Didn't they lose basically all their investment?

 

[Loren Pechtel]

There was some punishment but what happened to the "too big to fail" companies like AIG and Goldman Sachs? Did they really fail and are they still too big to fail? Is BOA still too big to fail? If so, why weren't they allowed to disolve and/or be spit into smaller banks they were before 2008?

Companies can continue to exist with the shareholders getting wiped out.

 

[Swammerdami]

What will be the major causes of the next financial crisis?

Too much corporate debt on office space in the big cities. COVID has shown us that workers can be anywhere now, so why do firms need to pay high rent prices in the cities? Corporations that are also going to have more difficulty with their expenses after paying more incremental interest on their debt. A lot more of that kind of real estate vacant on the market and could trigger something worse. And then there could also be a huge sucking sound when ordinary workers in the big cities realize how overpriced their homes are and start moving out en mass. Those small homes are going to be worth a lot less when it is learned that the jobs don't need to be in the big cities anymore.

I was reminded of RVonse's possibly prescient post when I read this article.

Today San Francisco has what is perhaps the most deserted major downtown in America. On any given week, office buildings are at about 40 percent of their prepandemic occupancy, while the vacancy rate has jumped to 24 percent from 5 percent since 2019. Occupancy of the city’s offices is roughly 7 percentage points below that of those in the average major American city, according to Kastle, the building security firm.
More ominous for the city is that its downtown business district — the bedrock of its economy and tax base — revolves around a technology industry that is uniquely equipped and enthusiastic about letting workers stay home indefinitely.
. . .
“Imagine a forest where an entire species suddenly disappears,” said Tracy Hadden Loh, a fellow at the Brookings Institution who studies urban real estate. “It disrupts the whole ecosystem and produces a lot of chaos. The same thing is happening in downtowns.”

I've been reading that billionaires are buying lots of farmland to diversify their asset base. Perhaps there's a good reason they prefer farmland over city buildings.

 

[Swammerdami]

This good video discusses risks to global financial markets of rising interest rates. As central banks stomp on their brake pedal, they need to keep stomping the gas pedal as well to dodge traps.

A rising tide floats all boats….. only when the tide goes out do you discover who's been swimming naked.

This quote might describe a fun sex party. Perhaps more apt would be "When central banks tighten the oxygen supply, weaker swimmers choke and drown."

 

[lpetrich]

We are not yet facing any one killer bubble, but the U.S. is facing several which combined potentially are a problem.

4 Economic Bubbles Growing In the United States

Although the market indices have been hitting record highs, there are structural problems that continue to build in the United States economy that may severely impact customer spending and corporate earnings in the next several years. This article (updated for 2019) will outline four bubbles...

www.lynalden.com

The four bubbles:

1. Student loan debt
2. Per capita healthcare costs
3. Unfunded state pension liabilities
4. Federal debt