“Enjoy it while it lasts”
-Sir Alan Greenspan, June 13, 2007,after suggesting “the global liquidity boom, which he dates back to the end of the Cold War, is nearing its end.”
“The fragile five” appears with rising frequency in the financial columns. This warning to stand aside, much as the “Asian contagion,” in 1997, is bound to boomerang on Wall Street since Wall Street will keep selling as long as demand exists. At that time, U.S. investment banks were distributing sub-prime, Thai auto-loan securitizations to Greenwich. The hedge funds leveraged such securities into a Fed-led, Wall Street bailout in October 1998. The question of whether the Long-Term Capital Management (LTCM) rescue party should be considered a bailout was answered conclusively in Alan Greenspan’s Age of Turbulence scrapbook: “[A]n orderly liquidation of [LTCM] was by no stretch of the imagination a bailout.” Greenspan’s assertions of blamelessness when he is guilty-as-charged are the foundation for his fortune.
He has also profited handsomely from being wrong. This may seem a strange causality, and, in fact, a distinction should be made. Greenspan has been wrong because his public statements have already been vetted and approved by every hack, Wall Street economist. “Wall Street economist,” is a shorthand substitute for myriad establishment totems who earn their living by saying what the majority wants to believe.
This makes the bewilderment of the Bernanke Fed in June 2007 all the more, er, bewildering. (“The ‘expected impact from weaker housing…may flare in the future, today – in the words of Ben Bernanke – it is contained.'” – July 18 2007, MarketWatch)
In January 2014, Simple Ben is about to leave us, no wiser after seven more years as Federal Reserve chairman. Sounding more askew than ever at his December 18, 2013, press conference, the future civil-service pension recipient spoke as directly and honestly as we have come to expect: “[T]here are concerns about effects on asset prices, although I would have to say that’s another thing that future monetary economists will want to be looking at very carefully.”
The fragile five – Brazil, India, Indonesia, South Africa, and Turkey – are suffering from investment outflows. As risk trades head home (to the Upper East Side and Mayfair), possible contagion through U.S. markets rivals the startling array of market upheavals that were widely expected on June 13, 2007.
A bucket filled with reports of doomed credit excesses sits beside this desk. To condense, and also to offer ammo when the academic bureaucrats sit before Senate panels and mumble “We had no warning,” I follow with newspaper articles by a single newspaper, the Financial Times, and by a single reporter, Tracy Alloway. The pre-2007 activities were described in Panderer to Power with a similar intent: to show anyone with even a nodding acquaintance with credit and leverage the credit bubble was doomed, long before 2007. By 2004 (in fact, much earlier), the collapse of Fannie Mae, the corruption of mortgage lending, the criminal actions that inflated the credit bubble, were already obvious (and footnoted in Panderer to Power, for any ambitious district attorney.)
In the December 11, 2013, Financial Times, Tracy Alloway warned: “The global search for yield has spurred some of the loosest lending conditions in credit markets since before the crisis, the Bank for International Settlements has warned.” The BIS, the central banker’s central bank, also issued a barrage of warnings before 2007. On December 14, Alloway was again on her soapbox: “Central banks have flooded the financial system with cash, driving investors to park their money in higher-yielding securities and largely obfuscating the true state of underlying markets.” She then referred to the same BIS report: “In an era of cheap and easy money, investors are encouraged to buy bonds from troubled companies and thereby suppress the default rate.” Who can forget: “House prices never go down?” Once again, central bankers have laid 312,000 traps for unsuspecting grannies who were enticed from their interest-bearing (roughly: 0.4%) CD or passbook savings account because they had to eat.
“Surge in Boom-Era Debt is Signal for Overheating,” was the title of an October 19, 2013, Alloway scolding: “Five years of the Federal Reserve’s ultra-low interest rates have made the market for loans to highly indebted companies white-hot in recent years as investors clamour for the higher yielding assets and corpora[tions] rush to finance old debt.” Here we see the consequence of low rates to both investors and to investment-grade, corporate bond issuers. Businesses run for-profit are losing sales to failed competitors [sic] kept in motion by Ben Bernanke’s nationalization decisions.
Kicking off the new year (January 1) Alloway’s title prophesized: “2014 Outlook: Sugar High.” She reported from a tea at the New York Athletic Club where “waiters bearing trays of cookies fanned out among the bankers and investors,” as Leonard Tannenbaum, chief executive of Fifth Street Management sounded like Tracy Alloway: “I believe there’s another cycle coming. So have a cookie. I want you to enjoy the sugar high – while it lasts.”
The columnist, along with co-author Michael Mackenzie, picked up where Tannenbaum left off: “Issuance of syndicated leveraged loans – those made to companies that already carry high debt loads – reached $535.2 billion in 2013. That is just shy of the $604.2billion sold in 2007, at the height of the last credit bubble. Meanwhile, loans that come with fewer protections for lenders, known as “covenant-lite,” accounted for almost 60 per cent of loans sold in 2013, compared with a 25 per cent share in 2007. Sales of “payment-in-kind” notes, which give borrowers an option to repay lenders with more debt reached $11.5 billion in 2012 [2013? – FJS] – a post-crisis high.”
The Alloway & Mackenzie team quoted Russ Koesterich, chief investment strategist at BlackRock: “There are no bargains in fixed income. [Not true. There are pockets of mispriced bonds, probably too small for BlackRock. – FJS] We have seen a return to a lot of the practices that made people nervous in 2007 such as PIKs and cov-lite.” Alloway & Mackenzie went on to write “‘junk,’ or high-yield, bonds surged to a record in 2013 as companies rushed to refinance and investors snapped up the resulting assets. Issuance of junk bonds rated ‘triple C’ – the lowest designation – jumped to $15.3 billion, surpassing the pre-crisis peak.”
The preceding articles are a sampling, without introducing the stories written by other Financial Timesreporters, such as Vivianne Rodriques. The practical lessons to be understood include: (1) a 0.4% yielding CD may be just the place to wait now, (2) no government (or aligned) official is worth listening to on these points, (3) the closer we get to the credit collapse, official pronouncements will grow more reassuring, and (4) when the stock market started falling after mid-2007, it went down by 50%. The Fed bailed out the stock market. This time, the Fed is the credit most vulnerable to collapse.
Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and “The Coming Collapse of the Municipal Bond Market” (Aucontrarian.com, 2009)