Lenders, i.e. high-yield bond holders, will try to exit their positions all at once only to find a severe shortage of willing buyers.
The following week in Train Crash Preview, I listed the steps in which I think the crisis will unfold. They fall in four stages:
The Beginning of Woes: Something, possibly high-yield bonds, will set off a liquidity scramble. It will spread through the already-unstable financial system and trigger a broader credit crisis.
Lending Drought: Rising defaults will force banks to reduce lending, depriving previously stable businesses of working capital. This will reduce earnings and economic growth. The lower growth will turn into negative growth and we will enter recession.
Political Backlash: Concurrent with the above, employers will be automating jobs as they grow desperate to cut costs. Suffering workers—who are also voters—will force higher “safety net” spending and government debt will skyrocket. A populist backlash could lead to tax increases that prolong the recession.
The Great Reset: As this recession unfolds, the Fed and other central banks will abandon plans to reverse QE programs. I seriously think the Federal Reserve’s balance sheet assets could approach $20 trillion later in the next decade. But it won’t work because the world simply has too much debt. They will need to find some way to rationalize or “reset” the debt. Exactly how is hard to predict but it probably won’t be good for lenders, or for the holders of government promises like pensions and healthcare.
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