milesfranklin.com / by Aug 29, 2016
The 2008 Great Financial Crisis came about because we began to hit “debt saturation” levels. The crisis was one of solvency but was attended to with added liquidity. Sovereign treasuries still had the ability to add debt to their balance sheets which was done in unprecedented amounts. Now, we are again bumping up against debt saturation levels as sovereign treasuries by and large have little room left to add more debt in efforts to reflate. The root problem of solvency was never addressed, only postponed to another day. That “day” seems to be in sight.
The Fed recently did a study concluding that a $4 trillion increase in their balance sheet should be enough to reverse a future recession. I would ask several questions: first, 2008 began as a downturn in real estate in the U.S. and quickly spread to financial asset prices and thus institutional balance sheets… In no way did it begin as “normal” recessions in the past have. It was not about inventory/sales until well into it. Why has the Fed come out with this study now? And why use average recessions as the potential boogeyman rather than the 2008 episode? I would equate their study to relating the response and protocol to treating a head cold and sore throat versus when the patient is prone to stroke and heart attack.
I have thought for quite some time, a good analogy for 2008 and the aftermath was like one giant “refinancing”. Think of it as a “cash out” on a home mortgage where money is taken out against equity yet the monthly payment didn’t go up because your interest rate went down. After closing, you feel pretty good because your payment did not go up and you have cash in hand to help you continue making payments. This is exactly what happened but we are again at a point where the monthly payments are starting to “bite” again. In technical terms, liquidity is again becoming very tight on a systemic basis.
So here we are again, in the same situation we had in 2007-2008. Too much debt with stretched valuation levels in equities and real estate …and stupid levels in the credit/bond markets as evidenced by “negative rates”. Central banks are again being forced to look at expanded QE while fiscal stimulus is again being eyed with one caveat …the Fed wants you to believe they are going to raise rates!