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Worse than 2008?

Money and Markets: Investing Insights

Martin D. Weiss, Ph.D. | Monday, February 15, 2016 at 7:30 am

Legacy of 2008 debt crisis, first signs of 2016 debt crisis

Martin here with an urgent update on the 2016 debt crisis.

It’s a tornado. And it’s already here.

The twister’s violent funnel dips down from the dark clouds of the 2008 debt crisis, still hovering over the global economy.

Its precise path? Unpredictable.

Its next victims? To be determined.

But its presence is indisputable. And the damage to date is strikingly visible in multiple forms:

Swift collapses in global stocks, commodities and currencies. Swirling rumors of megabanks on the brink. Sudden disappearance of capital for high-yield bonds, IPOs and nearly every asset with a twinge of risk.

Shockingly, the tornado’s metrics — of breadth, volume and speed — are strikingly similar to those of the last debt crisis.

Only the names and places seem to have changed …

Instead of residential real estate, we have
a big bubble in commercial real estate.

About one decade ago, prior to the onset of the last real estate bust, a consortium of federal agencies — the Federal Reserve, the OCC and the FDIC — issued a CYA “guidance,” gently warning banks of excess risk-taking in their home mortgages. But beyond words, they did nothing about it.

Now, again, those same federal agencies have issued a CYA guidance, gently warning banks of risk-taking … but this time in the commercial real estate sector. And again, beyond words, they’re doing nothing about it.

But commercial real estate is a bubble of massive dimensions. Prices are 50-60% higher today in some locations and on some properties than we saw at the peak of the last bubble. Hot money, unable to find yield virtually anywhere else in the world, has gushed into so-called “trophy” markets like New York, Los Angeles and the District of Columbia, creating a construction frenzy of unprecedented dimensions.

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Residential towers almost as tall as the Empire State Building have shot up like sky-high monuments to the gods of greed.

Like the One57 tower, with 75 stories and a sorry saga of collapsing cranes, fire and the most expensive residence ever sold in New York history — $100 million for a two-floor penthouse.

Or like 432 Park Avenue, an 88-story residential tower soaring far above One57.

Instead of a massive pile-up of overrated
mortgage-backed securities polluting the world’s
investment markets, it’s a raft of overvalued
mergers and acquisitions.

Back in the two years prior to the 2008 debt crisis, the total volume of M&A activity in the U.S. was $3.3 trillion. Now, in the two years through year-end 2015, it’s around $4 trillion.

In his Safe Money Report, Mike Larson lists some of the mega-transactions that make prior merger booms seem puny by comparison: Pfizer’s (PFE) $160 billion offer for drugmaker Allergan (AGN) … Dow Chemical’s (DOW) $130 billion deal for DuPont (DD) … Anheuser-Busch InBev’s (BUD) $117 billion deal for SABMiller (SBMRY) … and oil giant Royal Dutch Shell’s (RDS.B) $81.5 billion play for BG Group (BRGYY).

Results so far: In most cases, stock investors have lost money, big money.

Instead of Lehman Brothers and U.S. banks, this
time it looks like it could be European megabanks
that might trigger a meltdown.

Larson asks: “Are credit markets warning of a Lehman-style crisis?” He immediately answers by showing precisely how Deutsche Bank — with $1.8 trillion in assets and the largest foreign-exchange division in the world — may be in trouble.

The telltale sign: The cost of insuring its debt has suddenly soared to a level that is reminiscent of the peaks reached during the 2008 debt crisis (see chart below).

2008-2016 debt crises deutche bank stock chart

He adds: “Things are getting so bad that Deutsche Bank had to issue a statement saying it can make certain debt payments in the coming two years. That was followed up by a memo to employees in which co-CEO John Cryan claimed the bank was ‘rock-solid.’ The mere fact the company felt compelled to say things are just peachy tells you they could be anything but.”

And a sharp bounce-back rally in Deutsche Bank shares this week changes nothing in its tailspin-downtrend from over $30.75 a share last October to less than $17 per share on Friday (see below).

deutche bank ag since february 2015

In many critical respects, little has
changed since the last debt crisis.

As I explained last week, at the end of 2007, between mortgages, credit cards and other consumer credit, U.S. households had $14.1 trillion in debt. Now, they again have $14.1 trillion in debt, according to the Fed’s latest tally.

Similarly, at year-end 2007, municipal governments had piled up a debt load of $2.8 trillion. Now, they’re up to $3 trillion.

Derivatives — the black core of the cumulonimbus debt-crisis cloud — are still here, and in larger quantities:

According to the U.S. Government Office of the Comptroller (OCC), on Dec. 31, 2007, just before the debt crisis struck, U.S. commercial banks held $165.6 trillion in derivatives.

Now, at their latest reckoning (9/31/15), those same commercial banks hold $192.2 trillion.

But here’s the big elephant
in the room: the government.

The government has fired all its biggest guns and exhausted all its ammunition to stimulate the economy, rescue banks and prevent a meltdown.

Hard to believe? Then just follow along with me as I review each of their weapons …

The first weapon that the government deployed in the wake of the debt crisis was the bank bailout — the Emergency Economic Stabilization Act of 2008, authorizing the U.S. Treasury Department to spend up to $700 billion to buy bad assets from failing banks and supply them with desperately needed cash.

The Treasury Department had some wiggle room to do this because the total interest-bearing debt burden of the federal government was only $6.1 trillion.

Today, the federal government’s debt burden is $14.5 trillion.

They’ve been there, done that. They no longer have the resources — nor the political mandate — to do it again.

The second weapon the government deployed was in the form of interest rates.

In 2007, the average Fed Funds rate for the year was 5.05%.

Last year, the average was just 0.26%.

That’s a whopping 95% reduction.

Clearly, that big gun has also been fired.

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And anyone who thinks the Fed truly has the option to lower interest rates below zero is in fantasyland. As we’ve proven repeatedly, the Europeans have tried it, and it backfired. The Japanese have just tried it, too, and it backfired even worse.

The third weapon the government tried was truckloads of cash that the Fed pumped into the banking system in exchange for bonds and securities of multiple stripes and colors.

Each time the Fed bought more securities, it stuffed them into its coffers. And each time, it bloated its balance sheet more and more.

Result: At year-end 2007, the Fed’s balance sheet was just $890 billion. Now it’s $4.5 trillion, quintuple its 2007 hoard.

They’re up to their ears in those assets, most of which never belonged on the Fed’s balance sheet in the first place.

And in this way, they’ve fired their biggest gun of all.

Abject Failure

One of the paramount goals of this gargantuan government weaponry was to at least stimulate some inflation. But alas, even that booby-prize goal was not achieved.

In 2007, the government’s index of consumer prices grew by 4.1% and its index of producer prices grew by 6.3% — a bit on the high side, but still something that folks in Washington today would gladly welcome.

By contrast, in 2015, the CPI grew by only 0.7% and producer prices actually fell by 1%, ushering in a new age of deflation.

It’s stark evidence that all the king’s horses and all the king’s men have been an abject failure.

One final word …

None of this means the world will fall apart in its entirety, or that it will all happen overnight. But it does mean you should invest with great caution.

Take advantage of inevitable stock market rallies to reduce your exposure to vulnerable companies.

Buy inverse ETFs designed to rise when the market declines — for portfolio protection and outright profit.

Wait for sharp and deep price declines before buying any asset — be it stocks, bonds or real estate.

When you do buy, focus exclusively on the highest possible quality you can find.

And above all, build oversized cash reserves for safety and for even better bargains still to come.

Good luck and God bless!