Chris Martenson Warns "Market Risks Today Are Higher than Ever"

Tyler Durden's picture

Submitted by Chris Martenson of Peak Prosperity,

After the shot across the bow in 2008, you might have expected that regulators and market participants would use the experience to change for the better, to become more prudent, and to reduce the sorts of risky behaviors that almost crashed the entire system.

Unfortunately, you'd be wrong.

LTCM and Moral Hazard

In 1998, there was a firm called Long-Term Capital Management (LTCM, as it is commonly referred to today), staffed by the best of the best, including one of the very top bond traders that Wall Street ever produced as well as two future Nobel laureates.

LTCM boasted of its use of complex models that were supposed to generate outsized returns while operating with a risk-minimizing profile that, mathematically, was only supposed to experience severe losses so infrequently that the periods between them would be measured in the thousands of years.

Unfortunately for LTCM, their models badly underestimated real risks, and their leverage was such that their original $1 billion in capital turned into total losses of $4.6 billion in a little over four years, nearly dragging down the entire financial system in the process.

While this experience has much to teach us in the way of market risk, hubris, and the dangers of leverage, it really needs to be understood in terms of the rise of moral hazard on Wall Street.  The main lesson that Wall Street seems to have learned from the LTCM disaster is that if the wipe-out was big enough, the Federal Reserve would swoop in and rescue things. 

Message received: Go big or go home.  Take on as much risk as possible, secure in the knowledge that if things got bad enough, the Fed would simply print up what was necessary to make all the players whole again, with perhaps one core player or institution thrown under the bus for the sake of appearances. 

Fast forward to 2008, and that exact experience was replicated perfectly, thereby reinforcing Wall Street's perception that it is best rewarded by chasing big risks and big returns. And if things didn't go as hoped, the good ol' Fed would always be there to push the Reset button.

Since nobody of consequence went to prison after the overt fraud and excesses of the housing bubble were revealed, and no bank had to give back a single penny of their ill-gotten and outlandish profits related to such behaviors, one does not have to be a genius to guess what happened next.

Banks took the taxpayer funds, paid themselves gigantic bonuses, and immediately began taking on huge new risks. I mean, why not?  If you had a rich uncle that promised to let you keep any gains from your trading portfolio but would absorb any losses you might incur, you'd soon be swinging for the fences like a pro.

Back to the Future

This is why today, instead of having been reduced, financial risks loom larger than ever. It's why the next downturn will be just as bad if not worse than the last one. Nothing has been learned, and nothing has been changed. The most basic of human behaviors, the tendency towards moral hazard (so well understood by the insurance industry) has been completely overlooked by the Fed.  Once again, that institution, entrusted with so much, has been exposed as being rather intellectually shallow, or at least devoid of common sense.

I'll leave you with this:  The very same Fed that could not and did not see that a housing bubble was forming is now equally complacent about corporate bond yields touching all-time record lows across the entire spectrum, right down to CCC junk that sits one skinny notch above default.  Stocks are for show, but bonds are for dough and with bonds now priced for perfection if not for something even better, there's no room for error. 

Even the slightest hiccup say, one brought about by a renewed global slump as is already underway in Europe and Japan will cause massive losses to bond portfolios, and we will, yet one more time, be reminded that indeed there is nothing new under the sun.  Central banks cannot print us all back to prosperity, and insolvency cannot be cured with liquidity. 

All that remains is to assign the losses to someone. And right now there are plenty of very well-connected and powerful individuals working feverishly to assure that those losses do not fall upon them.

That leaves you and me, otherwise known as 'taxpayers'. And 'bank account holders'. Oh, yeah and 'Muppets.'

Big Trouble Brewing

What the Fed, in cahoots with other central banks, has managed to engineer is a spectacular rise in the price of financial assets.  Stocks, bonds, and all of their associated brethren such as options, futures, and derivatives have all been magically elevated.

To put this into context, not only are stocks at nominal all-time highs, but bonds are too.  Bonds, however, are very different from stocks, and the fact that they are also at all-time highs should really be viewed with much more concern.

The bond market is enormous and dwarfs the equity markets by over 2 to 1, or 3 to 1 if you include non-securitized loans in the mix:


But just looking at traditional bonds, what we have here is a situation where over $100 trillion in bonds are now historically badly overpriced.  That's what “record territory” means to me, at any rate.  For every 1% loss on that portfolio, more than a trillion dollars will be lost.

While the value of stocks has to be carefully adjusted for inflation to determine if all-time highs have been reached (not yet, by the way), bonds are priced according to the yield they offer.  The higher the price, the lower the yield.  The yield of a bond is supposed to compensate you for the risks involved, which include inflation, default, and time.  

The worse the prospect, the higher inflation, and the longer the time to maturity the higher the yield will be.  So how important is it that bonds are now yielding record lows?  This is perhaps the single most important factor in the financial landscape right now, because it means either one of two things:  (1) the risks of default and inflation are at all time lows, or (2) bond buyers are not being adequately compensated for risk.

Here's the data for corporate bonds, but sovereign bonds are just as lofty, and the lack of yield in those securities explains the grasping for yield in corporate bonds:

Yield-to-worst in junk bond market hits record low

Mar 13, 2013


March 13 (IFR) - The yield-to-worst in the US high-yield bond market has fallen to a record low average of 5.56% this week, as investors flock to higher-yielding but riskier products.


With interest rates hovering around record lows, investors have found themselves rushing down the credit ladder in search of bonds offering more return - and more risk.


CCC rated bonds - the riskiest investments at the very bottom of the credit spectrum, just one notch above default level - have rallied the most.


"It's definitely risk-on behavior, where you are trying to get exposure to the most yield possible," said Drew Mogavero, head of US high-yield trading at Barclays.


"The safer segments of the market, BBs, have rallied to pretty low-yielding levels," he said. "So people are looking out to CCCs and other higher-yielding names."


Bond yields and prices move in opposite directions. As investor demand has driven up prices, yields have tumbled. Yield-to-worst indicates the lowest potential yield on a bond without the issuer defaulting.


Lower All Over


Broken down by ratings, the yield-to-worst on the Barclays Double B index is also at its lowest ever (4.24%), as is the level on the Triple C index (7.43%).


The only segment of the market that didn't close at a record low on Tuesday was the Single B index, which is 5.46% versus the record low of 5.39% set on January 24

Again, these are record lows as in never-before-in-all-of-time records.  To think that the Fed has all of this under control, that it can steer the consequences of an entire world of investment and speculation decisions to a normal and graceful ending, requires far more faith than I can muster.

The very idea that the worst-of-the-worst credit risks in the corporate world are now yielding less than 6% is even more absurd than anything that I observed during the height of the housing bubbles.  Even the tiniest hiccup will wipe out the holders of those bonds, leaving them with, at best, pennies on the dollar.

Let me be very clear here: What I see now in the bond market is at least an order of magnitude riskier than anything I saw in the housing bubble, and if/when it pops, the effects will be far, far worse.

In Part II: How to Survive the Mother of All Bubble Burstings: A Collapse of the Bond Market, we'll identify the most significant warning signals of market instability, including the growth in derivatives, the reemergence of synthetic CDOs, and the widespread overpricing of debt ranging from sovereign to junk securities. With these risks come huge implications for those with money in the financial markets.  What should we be doing to protect ourselves?  How do we avoid the next downturn?  What strategies make sense given what we know and where we are in this story?

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Irelevant's picture

Slovenia, next chip to fall.

MillionDollarBonus_'s picture

I always make sure I keep at least 30% of my portfolio in US treasuries. That way, if the market falls I have a reliable hedge, and I collect a risk free return every six months.

Abraxas's picture

I always make sure not to be one of the momentum crowd and to try to think long term.


Also you should get into Housing, Northern Telecom, Enron, Cyprus Banks, Some Greek bonds, Japanese Yen, The Euro..



in4mayshun's picture

FYI: when you're trying to insult someone by calling them a "moran," not to misspell moron.

q99x2's picture

If he intended to spell it  ...moron then then he would have written it as Milliondollarmoran_

I think he meant what he wrote.

Tapeworm's picture


 sorry, I am programming machine tools. One must always shout at them.

Demonoid's picture

Look up "moran" on Urban Dictionary, and you'll realize why you look pretty dumb here.

gmrpeabody's picture

You're all a bunch of maroons....

Irelevant's picture

Cyprus bonds are selling at a discount, maybe you are interested.

Rainman's picture

Fucking chimps could figure out the future better than you humans. No wonder you're all doomed.

Gromit's picture

Yes - and the discount on a 4 week million dollar T Bill will buy lunch at Subway!

Edit - just checked

Discount is up to .11%!

A miliion dollars now returns $85 per month!

Tapeworm's picture

That is a lot more than gold pays.

Monedas's picture

I always pay my taxes as early as I can .... and I always pay a little more than I owe .... that way I feel I am helping out .... and I sleep much better at night !       MillionDollarMonedas     1929         Comedy Jihad How'm I Driving 1 (800) FUCKYOU World Tour

Town Crier's picture

Only 30% in Treasuries? Shouldn't you double down on that? If only to show your allegiance to Dr Bernanke, your American hero? No? What's he gonna think?!

Wile-E-Coyote's picture

Burn it down, burn it to the ground.

Kirk2NCC1701's picture

"Slovenia, next chip to fall."

I think you're out on the limb with this one.  They, more than most EU contries, have decades of experience of being the only productive part of an otherwise socialist state (Yugoslavia).  If you know your history, the very reason they fought for and got independence, was to secede from the rest.  It took them 6 days, the Croats 2 years, and the Bosnians how many years and outside help?

While there was indeed some shooting going on, and the gun-folks here (I'm one) would love to hear that they got the Serbs out in some clever and ferocious battle, do you know how they did it?  They used their brains:  They turned off all the utilities to the militaty garrison (no water, no gas, no sewage and no electricity!), and told them to stay as long as you like.  They left (very quietly) a few days later.

So... Got facts & stats, or voicing opinion, hopes or fears?

Abraxas's picture

Your history consists of what the media spoon-fed you. Where are your facts and/or stats coming from? Looks like MSM to me.

Kirk2NCC1701's picture

Sorry, ROTFL. Nothing could be further from the truth. Was only few hrs car drive away (where I worked at the time), and had business contacts (that developed into friendships), to get a broad swath of info. So, no, no MSM was needed.

But back to the Real issue: Who's next in the EU? Yo no se, pero...

UK debt marsh's picture

Slovenia's debt:GDP is about 60%, but rises to 80% when State guarantees to State-owned companies and banks are included, so it's definitely on the list of possibles.

However a post-(next)-election Italy is a good bet, Spain is going backwards at pace, and then there is the dark horse, France.

French debt:GDP is 91%, their economic fundamentals and confidence is falling badly (PMIs below 45), and the government is a cross between a donkey and an ostrich.


The Invisible Foot's picture

Don't worry it's different this time. Fundamentals are sound, profits are soaring, and housing. DON'T FORGET ABOUT FUCKING HOUSING!!!   /sarc

localsavage's picture

My Realtor said it is a good time to buy.

NoDebt's picture

Mine too!  Hey, that can't be coincidence.  I think we got a legitimate trend here. 

Only problem is if I sell my house then I gotta go buy somebody else's overpriced pile of sticks.

Hey, wait a minute!......

Stuck on Zero's picture

We've got the same realtor.  He works for: Shaftem, Swindl, Conn, & Fleecem Ltd.


dark pools of soros's picture

I heard the same at the car dealership. Must be good times!

ebworthen's picture

Gawd what a recovery! 

Just ask around, everyone says things are as good as they were in 2005!

Party on! 

They can take 5% or 10% of our savings and retirement, it won't stop this juggernaut of an economy!

resurger's picture

What I see now in the bond market is at least an order of magnitude riskier than anything I saw in the housing bubble, and if/when it pops, the effects will be far, far worse.

Good luck in popping that cherry.

wake me up when the internet is offline, then we can talk about this bubble bursting

francis_sawyer's picture

Captain Obvious hour should come AFTER the 2nd or 3rd drink on a Friday...

Dr. Engali's picture

Give the guy a break. There's only some much screwed up crap you can write about. After you've been here for a while it's hard to touch on something new. I just hope we aren't talking about Cyprus for 3+ years like we were/are Greece. And I certainly hope we aren't Japan and talking this same crap 25 years from now.

Irelevant's picture

Well, we were just pushing the curve further in time. When it comes, the Seneca effect will be a bitch.

The Abstraction of Justice's picture

6 years of getting the end of times wrong teaches me not to cry wolf. 

NoDebt's picture

"I just hope we aren't talking about Cyprus for 3+ years like we were/are Greece."

Oh, crap.  You're........ probably right.  Up arrow for the comment's undeniable truthiness, down arrow for killing my Friday evening buzz.

jeebus's picture

One Bitcoin feeds 40 homeless people:


dick cheneys ghost's picture

Wow....Bitcoins are versatile

icanhasbailout's picture

Let them eat 10010101 10110010

El Viejo's picture

Are they made from soy??

The Abstraction of Justice's picture

I never donate to charties in which the employees earn more money than I do. Since I have retired this has given a great excuse never to donate to anything again. My next sacrifice will be in flesh in blood. Hopefully not my own. Oligarch hearts are what my God demands.

tbd108's picture

"Charity's fine, subscribe to mine, You've got to pick a pocket or two." Oliver.

Kirk2NCC1701's picture

Do 'Pros' accept bitcoin?  If it's not legal tender, then you just have some fun between consenting adults, right?  And all you're doing is, is swapping digital contact info, right?

"Hey there, wanna have some fun... play a video game together, get a private chat room?  I have a high rating from other Gamers.  I know a place nearby that's ideal for Gamers.  Collect tokens, use them to extend your... lifeforce."  You get the idea. 

Everything is 'clean' and on the up & up, it seems.  Just two people with a mutual interest in Gaming.  Nothing to see here Vice, move along.

EHM's picture

I didn't think you could eat bitcoins.

jeebus's picture

I didn't know you could eat gold or dollars either. Zerohedgers want a return to the barter system/ stone age. We can get rid of banks and still have the internet. That is bitcoin.

Eternal Complainer's picture

" Zerohedgers want a return to the barter system/ stone age"

ZH'ers just want to see central planners and all their criminal ilk fail horribly.
Then swift merciless justice meted out!

ebworthen's picture

Did you miss the ZH report earlier today about the U.S. Government going after BitCoin because it competes with the FED run Central Banking Ponzi?

Place your chips.

jeebus's picture

If you knew anything about bitcoin, you would know that the US government is powerless against bitcoin unless they want to turn the entire internet off. Considering that the internet is vital for banking, the stock market, basically the world at this point, I don't see it. But hey, I love all the skeptics. It's giving me more time to accumulate at this absurdly discounted price point. Paypal was worth $2 billion. Bitcoin is wayyy more useful than that. Most of you bitcoin skeptics are total clowns.

ebworthen's picture


I'm all for alternatives to Central Bank Ponzi's, I'm just throwing you a caution bone.

All they have to do is shut down some exchange servers and track the transactions (remember, the Internet started as a military network owned by the government).  I wouldn't put it past them to hack a few transactions and introduce enough doubt to debase the value.

I mean, some of the servers recently were running different versions and there were duplicated keys and invalid transactions amongst the supposedly "infallible" Bitcoin inftrastructure servers themselves.

I've heard all the religious zealotry about Bitcoin I can stomach - and the more I hear the frenetic diatribes about it's absolute and complete infallibility because it involves math (never mind electricity, completely monitored Internets, and someone somewhere running the exchange) the more I doubt it's longevity and validity.

If you want to put your faith in something on the Internet that could be turned off like a light switch go ahead, I wish you luck.