During one of the coronavirus task force briefings, an admiral came up and detailed how he was getting ventilators into the system. Much of the press was outraged when he detailed it out because the government was using a middle man that was profiting off it. The admiral’s response? “My job is not to invent a system. My job is to put volume in the system.”
Such is the realities of leadership in a time of crisis.
So. When the Fed went into ‘save everything mode,’ they did so with a desire to unfreeze credit markets and make sure markets functioned. Powell’s job was to put volume into the system.
That system now has volume. And plenty of it. Everyone is buying everyone else’s debt. Disney wants five billion for a year? Wells Fargo says ‘COUNT ME IN.’ Boeing is issuing bonds? ‘IT’S A RAID,’ says every person with access to debt markets. Delta can’t fly 10% capacity this quarter. People buy their debt like it’s the liftoff of the 747.
So the system now has ample volume going back and forth. Everyone’s leveraged to the tits in new debt. What could possibly go wrong?
30-50 million unemployed is what’s wrong.
Already high household debt continues to skyrocket as new income falls off a cliff is what’s wrong.
Reckless debt issuance and a borrowing system that never really reset after 2008-9 is what’s wrong.
In what will likely go down as the dumbest FOMO among smart money of all time, every major institution has tried its best to get in on every company’s debt offerings. But what happens if Delta sees just 30% of flying traffic in the third quarter? What if California and France refuse to open Disney’s parks until early July and shut them down again in September as precaution? And would anyone really be surprised if Boeing doesn’t get the 737 max off the ground until 2021?
These events have a decent probability of happening. And such companies as Delta and Boeing may not be able to service their debt at the end of 2020 if, say, we have to shut everything back down to prevent a second wave.
Not every bond holder is going to get screwed. But the rate of defaults on loans is going to be much higher than the laughable estimates JPM and Well’s have set cash aside for.
Let’s keep in mind: it wasn’t the Fed’s job to invent a new system. Its job was to keep the current system functioning.
So what is the system they’re pumping? The debt system. And all they’ve really done is re-inflate a debt bubble to a much bigger size than it was in February. And given the details released today by the Fed essentially announcing they’ll be buying HYG and LQD, this bubble is growing to hindenburg-sized levels.
With people putting their rent on credit cards, our system is just surviving right now. But what happens in wave two?
Boeing can’t pay its coupon as Delta withdraws all orders so it can attempt to service debt too big to pay itself. An empire like Disney looks at risk for shuttering. Restaurants are seen as germ lands by the average consumer and nobody goes dining in for several years. Housing construction companies simply cannot survive the epic demand and supply destruction with defaults on mortgages skyrocketing as well. Fannie and Freddie make 2008 look like a prelude to the real story. And the Fed may have to try and get out of HYG as companies in the ETF fail and they have to preserve tax payer dollars as per their legal obligation, which will only further feed the negative feedback loop.
At Buffet’s shareholder meeting saturday, he praised Powell’s speed to get credit markets functioning again. On top of that, he said March was the highest bond issuance month of all time, followed by April breaking that record.
But here’s what’s interesting in what he said: “We don’t know what the consequences of this will be.”
So perhaps we are somehow able to punt the debt bubble pop down the road by allowing all loans to defer for extended periods. Perhaps the US government is able to find some way to write off certain types of debt in a last resort effort to avoid economic catastrophe. They will certainly get creative as everyone becomes desperate. But in all likelihood, these kinds of ideas are untenable without resulting in extreme damage to other segments of the economy.
We are on the brink of the debt bubble collapse. And given a second wave, we will create a negative feedback loop that will slump the United States Markets for years.
I don’t believe we will have a 10 year great depression. We learned so much from that time period and we will use that knowledge to recover faster, and maybe even better. But like the civil war, world war one, and world war two: everyone thought at the beginning of each outbreak it was only going to last a few months. We think the same thing now about this crisis.
TL;DR: Often when you are operating in a paradigm you don’t realize the flaw of that paradigm until you are forced to shift into a new paradigm. The debt bubble paradigm is about to shift, but not before it pops.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.