I asked my husband to give his opinion, as he does this for a living, but not on the debt side, on how we got here and what is happening, and he wrote a lot:
I have learned a few things that are kinda fundamental over time - the foremost of which is that with retail products, if you offer the general public one which is really good alongside one which is really bad, then there is some irrisistable force to choose the wrong one (plenty of mkt psychology discussion as to the why's of that exists). well, the last cycle has been no different in this regard, but sadly the asset in question was a crucial one. People hadn’t had access to the equity in their homes until like 10 years ago, there was a problem in that people were asset rich, yet (investible) asset poor. So the IBs provided people access to the equity in their houses, good. But, it went beyond the 10 or 15% that would have been fine, too 100 and 110% which was too much, and worse still, people took this money and (yep) bought more houses, compounding the issue by a factor function or two, and the banks on their side did the same... to the point where one person, one piece of collateral and one bank had like sextuple counted the same asset. So, this is called leverage and we all do it in order to try and get returns in excess of risk free. BUT a crazy and very capitalistic thing kicks in then --- greed. It is as irrefutable as Newtons gravity and other axioms, that risk and reward are tied together completely. Were banks kidding themselves that a AAA rated mortgage security could return 15% (say, 5 times risk free), were the general public kidding themselves that on a 100k annual income they could get 500k investment returns on 5mio worth of investment properties: YES. But it happened. You can’t make excess returns without taking excess risks – it is really, really simple. If you don’t think you are taking excess risk to earn twice the govt bond (risk free rate), then you simply don’t understand yet the risks you are taking. No exceptions.
So, the leverage thing is an issue, since if the 6x geared thing goes down by 1/4 then that is 1.25x the original asset. The thing that has exacerbated everything here is a very incorrect assumption of liquidity that others have touched on here. Most risk analysis suggests that if you have a portfolio of assets then a percentage might go bad. It ignores the systemic issues that can quickly arise, i.e., if one is bad, then aren’t they probably all bad. This happened in 2001 with tech names, and in 1998 with emerging market currencies. Well, the problem is that by and large all quantitative models we use throughout finance are based on variations of normal distributions. There is a bit of stuff that allows you to amend these for kutosis, and be a black swan, Nasim Taleb, kinda guy. But the average of both over a long enough period is basically a normal distribution anyway, so why bother. Most the of the statistical and risk management trades we put on at banks are mean reversion based strategies in one form or another - and so, hey presto, normal returns/normal distribution always wins. What we are bad as a humanity at is acknowledging when we are in a period of excess returns, and this denial of the truth can be supported by that most wonderful human characteristic - optimimism. It is what gives us the courage to say ITS DIFFERENT THIS TIME when clearly and demonstrably over the years - it isn’t.
So, where are we today --- paying the price for the fact that it was a one off event that everyone was allowed to spend their equity in their houses buying plasmas and large SUVs. This is a controversial perhaps, unpalatable certainly, truth --- low income earners are in a really difficult position to achieve above risk free returns for any lengthy period since they are unable to afford the big drawdowns that occur in the generally upward trajectory of asset values. (why upward - simply enough put its population growth).
What do i think is happening --- well, learned people in the business say that the debt super cycle is over. Simply put – it is not going to be acceptable going forward to say that you made your money by gearing up the assets you had, and on selling it. Remember the days when professions, and skills were valued - we are likely going back to that world again (since banks appear unlikely ever to allow us to gear up again, shareholders (incl governments) will dictate that.
So it would appear that a whole generation has gone and lost their collective assets (savings) and we are now in a position where that will have to be built up again. Difficulty is you can’t build savings without curtailing consumption. Now the biggest global consumer has this whole century been the USA, hence things like USD being the currency etc. I don’t subscribe in any way to their being emerging market decoupling, the planet has become economically smaller rather than bigger – the headline things you need to know are that the US consumes, and China constructs (and you can hang all the other theories off these. Hence if the US goes into a period of saving, then China goes into declining production, raw materials lose some value and so on and so forth.
Today – we have the Fed/Treasury tying really hard to offset this move to saving by proactively filling the gap and handing money to all and sundry, taking equity against this. This needs to be done. Couple of problems tho: if I gave you $1000 today, would you spend it, or put it in the bank because either you were scared you would lose your job, or you thought stuff was going to get cheaper and you could buy more with it in January? This is deflation, and it is what is spooking everyone. Or do you spend it? In which case problem solved.
So, S and P index – the global barometer of equity markets: well today it is around 900. Down from a high of 1500. Sounds pretty bad, but if you added up all the macro (economic) and micro (companies) issues then you would think it sounds like it ought to be 600 (no real science on this, but a lot of trough earnings arguments and the like suggest that this would be a cycle low point). I think that is true. What accounts for the 300 extra points right now is the huge and genuine unprecedented moves by Fed/Treasury. Previously, the mistakes they made were to be too laissez faire (eg, 1930s), and not move fast enough or far enough. This time they are desperately trying to get in front of the curve, and do something to fix what they think will happen in the worst case. The market seems to believe they have things on the right track, otherwise we would be at 600. Two paths from here – either they are wrong, and we have a big issue since they have wasted all this money (the deflation, or save at all costs, argument), or very limited upside, because we have a lot of the recovery in economies and assets priced in already – e.g., next year we believe things are on track, yet we have a market only back at 1000 or 1100.
I hope you aren’t offended that in all of this I don’t think I really have resorted to eco jargon often. You can put all these concepts into terms of GDP, GNP, Inflation, Current Accounts, Unemployment, M1/M2/M3, discount and rep rates, NTAs EBITDAs NPLs EPS and Price to Book --- but you end up with these basic concepts falling out. If I can expand on any of these, or actually describe some of them in the correct eco or micro terminology please let me know.
