Every Asset That Depends On Cheap, Abundant Credit (Housing, Bonds, Stocks) Is Doomed

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Four words: financialization, debtocracy, diminishing returns.

About a month ago I asked What If Stocks, Bonds and Housing All Go Down Together? (May 24, 2013). Why would such an outrageous thought even occur to me?
Four words: financialization, debtocracy, diminishing returns. The entire global economy, developed and developing nations alike, is now dependent on cheap, abundant credit for everything: for "growth," for asset inflation, and ultimately for central state deficit spending, which props up all the cartels, rentier arrangements, fiefdoms and armies of toadies, lackeys, apparatchiks and embezzlers that suck off the Status Quo.
I have long endeavored to explain the harsh reality of neofeudal, neocolonial financialization: Neofeudalism and the Neocolonial-Financialization Model (May 24, 2012) and the neofeudal debtocracy that depends on low yields (interest rates) to enable enormous deficit spending: Why Krugman and the Keynesians Are Lackeys for the Neofeudal Debtocracy (April 24, 2013).
The wheels fall off the entire financialized debtocracy wagon once yields rise.There's nothing mysterious about this:
1. As interest rates/yields rise, all the existing bonds paying next to nothing plummet in market value
2. As mortgage rates rise, there's nobody left who can afford Housing Bubble 2.0 prices, so home prices fall off a cliff
3. Once you can get 5+% yield on cash again, few people are willing to risk capital in the equities markets in the hopes that they can earn more than 5% yield before the next crash wipes out 40% of their equity
4. As asset classes decline, lenders are wary of loaning money against these assets; if the collateral for the loan (real estate, bonds, stocks, etc.) are in a waterfall decline, no sane lender will risk capital on a bet that the collateral will be sufficient to cover losses should the borrower default.
Let's take a look at four charts about housing and household net worth. For the middle class, the home remains the key asset, so housing and household net worth are correlated.
Here is a chart of mortgage rates since 1970. Rates were pushed to 17+% to snuff inflation in the early 1980s, and they've dropped over the past 30 years to historic lows: the rate for a fixed-rate 30-year conventional mortgage was about 3.5% a few weeks ago. It has now risen above 4%.
In the golden age of growth from 1991 to 2002, mortgages rates bounced between about 7% and 9%. The band from 1970 to 1979 was about 7.5% to 10%.
In other words, in eras of strong growth and low inflation, mortgage rates have been around 7% to 9%. So what happens to the monthly payments when the mortgage rate doubles from 4% to 8%? The payments double, too. And what happens to the price of houses when rates double? They fall to the point that households borrowing money at 7.5% - 8% can afford to buy a house, i.e. a price much lower than today's Housing Bubble 2.0 prices.
Here's mortgage debt. If mortgage debt had expanded at the previous rate, total debt would be closer to $5 trillion instead of $10 trillion.
You see what happens when debt becomes cheap and abundant: debt rises faster than wages or assets.
But hasn't household wealth increased mightily in the past decades? Here is a chart that plots the relationship of household net worth and total credit owed, i.e. debt:
Household wealth may be rising, but what this chart reveals is debt is rising even faster--that's why the line is declining. Put another way, every dollar of new debt is generating less and less wealth.
You might think that The Federal Reserve's policy of making credit cheap and abundant would goose people to consume and invest more money. Alas, the velocity of money is hitting historic lows: the Fed may be creating credit but people and enterprises aren't putting that money into circulation.
It's called diminishing returns: every dollar of debt creates interest payments, but it's no longer doing households or enterprises any good. The Fatal Disease of the Status Quo: Diminishing Returns (May 1, 2013).
That's why all asset classes that depend on cheap, abundant credit are doomed: once yields/rates rise, the valuations of those assets implode. And once valuations implode, there's not enough collateral left to support the loans used buy all those cheap-credit-inflated assets. So the financial system also implodes.

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Joe Sixpack's picture

Wow. The pro-taper crowd is in today at zerohedge. QE infinity! They have no other choice (even if it is not working).

Doubleguns's picture

Results will be the same. 

Herd Redirection Committee's picture

The price of everything you own = DOWN

The price of everything you need = UP

Pladizow's picture

Every crack head that needs crack is fucked!

Oh regional Indian's picture

Credit does not exist. There is only debt, masquerading as Credit, which we have been taught because it sounds better. To your credit etc.

It is a debt crisis and the other side of debt is not credit, but a counter-party/underlying asset.

Big switcheroo.

Too much liquidity and now everyone is drowning. From here to the FEd shutting off the tap is really near, 1929 redux.



gmrpeabody's picture

There will be no shutting off of the tap..., at least until we have no budget deficits.

zerozulu's picture

Nothing to worry about if you believed you are on your own.

Pinto Currency's picture


The question of what happens to the $100 trillion worldwide that sits in debt instruments has not been answered in this article.

As interest rates rise, defaults increase, and bonds lose value, bond holders are not just going to sit there.

Many bond holders will sell and buy assets of inate value driving up the price of those assets.

Energy, food production, precious metals, etc.

Panafrican Funktron Robot's picture


We are presently 1 hundreth of a percent away from IR swaps becoming a problem (2.5% on the 10 year).  

Herd Redirection Committee's picture

But betting on permanent low interest rates seemed such a good idea at the time!  Bernanke and Greenspan both told me they had my back!  /sarc

mjcOH1's picture

"Every crack head that needs crack is fucked!"

Wait until the inner-city residents get priced out of crack and embrace meth.

It's cut a swath through rural-poor-white America already. They're not as effectively plugged into the multi-generational welfare benefit system, and crack cost is beyond their capacity to steal in low population density areas.

Only a matter of time.

NoDebt's picture

That's the right comment.

What the article missed is the most debt-dependent thing on the face of the Earth- the Federal Government of the United States.

When that "asset class" blows up, you won't care about little things like stawks, bawnds or reel estate.  Because they will already have confiscated or taxed away most of those things from you.

new game's picture

The right action would be??? sell the mutha fucker, convert the cash to???

Hint: it is shiney and 1 lb is worth mucho. 50/50 $/G and wealthy renter/serf in disguise free to roam about.

One sold, one to go...

Diogenes's picture

Credit is a good thing to have, until you use it. Then it turns into debt which is a bad thing. I'm surprised this is so hard to figure out.

dark_matter's picture

Yeah, I always loved those "turn your equity into cash" commercials. Should have been "turn your equity into debt".

El Viejo's picture

That's why they won't stop.  Can't stop until the cure(QE) is worse than the disease. That's when drug addicts quit. When they look in the mirror and finally admit the long term pain is just simply not worth the short term high. It's true with drugs, money, food, sex, power etc. 

Is your life style sustainable??

NidStyles's picture

No life is truly sustainable, if it were there would be no such thing as death.

Seasmoke's picture

is that the cliffs notes version of the quote at the top of ZH

V in PA's picture

He said life style. Is your life style truly sustainable?

NoDebt's picture

Here's a visual for you:  Imagine a politician having that moment of clarity you just described.  Looking himself in the mirror one day and saying "My GOD, what are we doing?  What am I doing?"

Can't imagine it, can you?  And with good reason.  Because it will never happen.  They are all politicians, not leaders.  Leaders can see the big picture, politicians can't (and wouldn't even if they could).

Diogenes's picture

"Interest rates are still low aren't they? So what's the problem?"


Or: It's not the drugs that hurt. It's going without them that hurts.

fuu's picture

"Here's a visual for you:  Imagine a politician having that moment of clarity you just described.  Looking himself in the mirror one day and saying "My GOD, what are we doing?  What am I doing?"

I saw a little old guy from Texas when I read that.

Seasmoke's picture

i always want to think the Evan Bayh, had that mirror moment

Kirk2NCC1701's picture

Not that I disagree, but given all the spying going on, as someone pointed out in the last few days, TPTB get to all key politicians who have 'unacceptable' ideas or intentions.

Very few who were 'clean' and actually managed to get elected, get to be the voice of reason, the John the Baptist, around whom the Dissidents can gravitate.

They are happy to have a few of these, as they too serve a purpose and get to be 'branded' as an 'un-electable' brand, but they just don't want them to get too large a following, nor can they risk of having them assume any position of real power. IMO.

kridkrid's picture

Mine isn't. And I suspect not many people lead sustainable lives. Sustainable isn't living debt free, putting money away... even if you are stacking it. Our world runs on cheap energy and cheap credit/debt. I don't think many people can grasp just how intertwined it all is. Your life is only sustainable if you live off of the grid and are completely self sufficient. Even if you are growing your own food, living off of the land... if you go to a feed store for chicken feed, or are using fertilizer other than compost, you are still tied to the system. If you feel good about yourself because you run your own business... most of the people who buy your goods and services are collecting a paycheck from some corporation or government entity. Hard to say what things might look like when the wheels fall off.

zerozulu's picture

Some time doctor thinks this patient is not worth saving.

DoChenRollingBearing's picture

Every asset at risk of going down?  Uh, Canada is doing pretty well now, better than we in the USA are.  Resource rich Quebec included!  Yes, gold mining areas especially!

"Trip to Val d'Or, Quebec"  (Gold Valley...)


Thisson's picture

Canada is very vulnerable.  Much of their economy is dependent upon exporting raw materials to China, made into final goods for US consumers.  So yes their economy and housing prices has/have been booming, but that may not last as China's growth slows.  And Gold Miners (even in Val D'Or, like AEM) are starting to sweat as gold costs and gold prices converge, narrowing their margins.  If real interest rates continue to rise, that does not bode well for gold either.  I like gold a lot here, but if the reason for other assets declining is rising real rates, gold could suffer and decline in correlation with stocks and bonds.  It's real purchasing power may still do pretty well, but it's something to be thinking about.

Kirk2NCC1701's picture

Canada's Mfg industry got clobbered in this Recession/Depression, and they've down-shifted to the traditional primary industries.

The traditional model of being a branch-plant economy of the US has maxed out and shown its limits/weakness. Provincial governments are probably doing a better job than Ottawa, in creating the climate and infrastructure for Made in Canada industries.

And if/when such industries do evolve, they get culled by the US giants or politicians, lest they become too 'competitive'. E.g., Avro, Nortel, RIM.

cocoablini's picture

If inflation(money supply) is still falling even with 12 trillion in central bank injections then tapering will just drop us into a turbocharged deflation. Its preventing a total collapse, whether its being used badly or not. It should just go straight to consumers as tax breaks or freebies to juice spending but in the end the banks arenusing it to squat on.

TruthInSunshine's picture

Canada (which depends heavily on the U.S. - its largest trading partner) & its twin, Australia (which depends heavily on China, its largest trading partner), are both in a state of collective, cognitive denial that is large enough to be fairly deemed "epic."

It's not that I have some burning desire (or any desire) to see the Canadian & Australian economies fare poorly; it's just that basic arithmetic ultimately catches up with all deniers and pummels them into bloody submission & admission of the truth.

Herd Redirection Committee's picture

I told my dad two days ago "If there is a recovery under way, why has the US stock market rallied 45% in the last 2.5 years, and the TSX is up 3% over that time?  Don't they need natural resources if the return to growth is imminent?"

Enceladus's picture

If my reading of earlier post here are correct the reason this can't happen i.e. direct payments to the hoi polloi is that it will be used to pay off debts. Thereby reducing over all credit/debt and that can't be allowed to happen as it is used as collateral in an infinite loop of rehyoped dirivatives. So, pull all your money out and pay off all your debt and the system dies ;)

Panafrican Funktron Robot's picture

"but in the end the banks are using it to squat on."

Now consider the question of what the banks would like to have happen to those excess reserves, in terms of value.  Imagine the fire sale they could take advantage of.  

pods's picture

I prefer to call it BiWinning.

-Charlie Sheen

Winston Smith 2009's picture

The price of everything you own = DOWN

The price of everything you need = UP

Only if you need to use what will be the very scarce credit to buy it.  If you have cash, silver or gold, stuff will be very, very cheap!  That's how the smart money made out after the Great Depression, they bought huge quantities of productive assets at deflationary depression prices.  There will probably be a deflationary depression followed by inflation, so there will be a window of opportunity.

Citxmech's picture

"The price of everything you own = DOWN

The price of everything you need = UP"


Bingo!  "Bi-Flation" defined.

tarsubil's picture

Yes, qualitatively both will result in pain. No, quantitatively QE infinity will result in more pain.

NidStyles's picture

Some people can not understand the distinction, because they can not understand that there is no "we", as in "we" are not all in this together.

localsavage's picture

More like the people who passed basic math....

Midasking's picture

There will be no taper only more coin clipping.  Just my opinion but either way is going to be a disaster.  http://tinyurl.com/mem7o7x

steelhead23's picture

I'm not so much pro-taper as I am pro-sanity.  Look at those graphs, particularly implied velocity.  People aren't spending.  Wanna know why?  Many were stung during 2008, either lost money in the markets, or lost their job/house in the recession.  Easy credit is a lousy substitute for a good job - a paycheck beats a credit card each and every time.  QE has had very little effect on wages, which are low due to labor arbitrage.  If bond yields continue to rise, and I think they will, QE will become irrelevant, the market will crash.  A massive government-funded jobs program, combined with QE might have worked, at least temporarily, but the sequestration budget is certain to lead to recession.  That's right - RECESSION.

justinius1969's picture

One almighty cluster-fuck dead ahead..

thismarketisrigged's picture

today is prob the most volatility i have seen in a while. 


watching the banks on my level 2, the trades are insane, never seen this much consistent volatility in a long time.


it makes it more fun to watch that there all down 3 plus percent.