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Looking For The Next One: "All The Pieces Are Already In Position, Missing Now Only A Spark"
Submitted by Jeffrey Snider via Alhambra Investment Partners,
Looking For The Next One; Part 2, Finding Risk Rather Easily
As noted in Part 1, The Fed sees no risks of bubble trouble because they are looking at it all from the 2008 perspective. That is completely wrong-headed; if there is a “next one” it will have nothing to do with subprime mortgages, or even mortgages and real estate. By March 2007, the conventional estimate is that there were $1.3 trillion in subprime mortgages outstanding, all of which caused inordinate decay in liquidity and pricing through wholesale mechanisms that turned out to be disastrously self-feeding and often contradictory (as an example, tranche pricing through correlation trading where correlation estimates were based on CDS prices derived from liquidity in hedging demand which traced back to tranche pricing). Everyone seems to simply assume that the subprime problem ended in 2008, if only by crash.
That is true but only of mortgages. Deleveraging is myth as debt has still expanded, and greatly, just not in the same exact places. There are certainly auto and student loans that have exploded exponentially, especially in subprime categories, but if there is another credit bubble now, the third, it is undoubtedly corporate debt. The FOMC looks at corporate credit spreads being narrow and yields being low as a measure of its own success with QE, but that largely misses the real risks in such a condition – junk bonds are not meant to yield 5% or 6% because there is absolutely no cushion to that price!
A junk bond that yields 12%, as it had historically, offers some interest cushion to the pricing in principle – that was the whole point of junk bonds to begin with, the basic financial factor of risk/reward to be gainfully compensated by recognizing and pricing much higher credit risk. Thus, if a junk bond issuer were to start trending toward negative factors it wouldn’t necessarily offer a disruptive circumstance as prices typically were not exaggerated until the very end closer to default. A junk bond issued at 5.5% offers absolutely no cushion, and worse, the entire predicate position of junk bonds at 5.5% is endless liquidity which artificially caps default rates at historical lows, self-feeding the upward trend in prices (if the weakest companies can get financing easily, they don’t default where they may have before but that does nothing to change their business circumstance especially in a weak economy). In other words, the fact of the corporate debt bubble is that it will, in the end, push defaults together into a single event rather than allow them to be interspersed more organically. Worse, the more that artificial impediment to creative destruction seeps the less of a rebalance there is in pricing.
What good will a 5.5% yield be if defaults not only tick higher but do so in what looks like the snowball effect? That means the potential for selling is far, far higher under those circumstances than would ordinarily be the case where the Fed had not so intruded. Combine that with lack of liquidity systemically and the potential for disorder is enhanced beyond comprehension at this moment. Last month, Charter Communications floated three bond series of BB- junk, all priced with yields under 6%; May 2023 maturities with a worst yield of 5.125%; May 2025’s with a worst yield of 5.375%; and, May 2027’s with a worst yield of 5.875%. There isn’t even much “protection” or cushion in those prices if a recovery did actually show up and interest rates normalized, let alone systemic defaults finding general illiquidity.
The problem seems to be, not unlike the 2003-07 period, lack of visibility. It seems as if there is vague awareness more generally about a junk bond problem but that it is taken as a minor affair; the vast majority of the deluge in corporate debt in this “cycle” has been investment grade. But that was also true of the housing finance debacle – $6 or $7 trillion in mortgages (depending on the source) overall but “only” $1.3 trillion in subprime. As I tabulated last week, corporate debt issuance (gross) was around $4.2 trillion in the QE3 period (defined as 2012-14) while junk gross was “only” $975 billion of that.
Admittedly, this is a bit of mixed comparison, as gross issuance can often replace matured or outstanding debt or bonds, but I am just using the past three full calendar years on the corporate side. In some ways, that doesn’t even matter because these are all bonds that must be held somewhere by someone now (in other words, it is possible that a company may have issued a junk bond in 2012 and then floated a cheaper one in 2014 to retire the previous issue, meaning that there is some double counting in using gross issuance figures cumulatively, but given the short window here and the almost exponential increase in overall gross outstanding that is likely a limited occurrence).
Some might view that as entirely manageable, especially as being only three-quarters the size of subprime mortgages in 2007. The overall credit market has swung far higher, meaning proportions dedicated to the riskiest sector is actually smaller, and junk bonds are traded much more lively and openly; subprimes and their related structures were highly illiquid and thus pricing was limited to narrow gauges.
But that is not the extent of the corporate “subprime” problem, however, and it goes far greater to illiquidity and hidden regimes. In fact, leveraged loans may be the single largest problem in the corporate bubble universe under adverse conditions, even factoring any “gate” problems that will undoubtedly show up as corporate bond funds look to sell junk bonds if redemptions come in too hot. Leveraged loans are syndicated junk loans that are dispersed through the banking and financial system in almost exactly the same manner as MBS pieces were in the last bubble – and there is no real liquidity in them in which to offer robust and broad systemic pricing should it all go wrong.
I wish this were a small problem, but the fact is that leveraged loan gross in the QE3 period actually far, far outpaces even junk bonds – some $1.6 trillion!
And that’s not the fullest extent, either. We can add corporate debt CLO’s too, as even though not all are junk or of the leveraged loan type, they are essentially structured products with very low liquidity and open pricing just as dispersed throughout the financial system. That brings the total corporate bond bubble potential basis up to some $2.8 trillion!
Not only is that an immense total, even if gross, it has taken place in a manner totally unknown to financial history. We have no real idea how corporate bond prices will perform with bond funds and leveraged loan “products” scattered so far and wide, inside and outside of the banking system, and with a decaying eurodollar system to try to hold it all together. If there is another financial crisis, it will indeed look nothing like 2008 in its consistency, but the patterns are all already arranged.
All of this has taken place upon a foundation of illusion far too similar to the housing bubble – that economic growth would be sustained and robust, and that liquidity would be just as unfailing and dependable. That is the commonality among all asset bubbles, which the Yellen Doctrine asserts is unproblematic even where great financial imbalances are endemic; as they are assuredly now. That is a dangerous acceptance all its own, but for the Yellen Doctrine to survive, the flimsy bubble basis must as well. The herd is absolutely enormous and it will not take but a few to peel off toward the “sell” side to move prices into the snowball/stampede. The only reason that hasn’t happened yet is that the vast majority simply still don’t want to believe in any downside, especially one where the Fed got it all wrong; easy money is too much fun.
How does all this maintain itself if and when economic growth tends toward the worst case and liquidity is steadily revealed as beyond sickly already?
I don’t have the answers to that, obviously, but imagination being what it is this is not a pretty scenario. As stated at the outset, I wouldn’t even begin to venture a guess as the likelihood of it all going wrong other than to say it is much more realistic than is being talked about or even considered right now, and that a worst case at this point is really and truly a worst case. All the pieces are already in position, missing now only a spark. Maybe the Fed has more magic in its arsenal, but the eurodollar realities actually reveal that it never really did in the first place. There is now at least twice the leverage and still none of the financial cushion.
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One more poorly written article.
Yeah, I thought Greece was/is that spark... ???
What’s with the spark meme all of the sudden?
I thought the job was already farmed out to an African American swan.
Belated headline.
Greece Fire!!!
Watch out. It is easy to get burned, quite fluid, and not at all well contained.
We are burned....so burned. We are cooked. Crispy critters.
I wonder what hell Monday brings?
As for the amount of after hour aricles popping up on ZH on a Friday? I do not ever recollect a time like this.
Today's "strong" jobs report in perspective...all data via Fed's FRED. Data shows clearly there is no recovery.
http://econimica.blogspot.com/2015/06/jobs-day-ponderingperspectives-on.html
"Greece Fire!!!"
OH! OH! There're gonna throw water on it.
Peace bubble burst first?
Or, as Rickards would say the snowflake that starts the avalanche.
We are seeing radically tightening available supply. Protecting billions of dollars of derivatives bets in such thin physical market conditions is actually raising leverage to unsustainable levels. This is an interesting point we are at because these derivatives bets are now bifurcating the paper and the physical markets, and that’s a condition that’s impossible to maintain.
Unlike any fiat currencies that you can just print, gold’s spot market is anchored to a fractional reserve supply of bullion, where there’s some 500 – 600 tonnes of paper gold and some 5,000 tonnes of paper silver getting cleared amongst a daisy chain of LBMA bullion banks every single day. Obviously this creates a vast amount of synthetic supply that both influences and distorts the true supply/demand fundamentals. But it is the resulting physical deliverability that is now setting limitations on how far the paper price can be pushed lower. And this is a change from the past.
Now we have to remember that these massive bearish bets were accrued from a time when central banks could easily control the physical market. And it wasn’t anticipated that the physical market that they relied on to keep the scam going would migrate to Asia. And so these six insider bullion banks, which have the gold accounts at the Bank of England, they’ve lost control of the physical markets. This leaves only one viable option other than default — and that is to cash settle fractional reserve positions.
Physical demand has been exceeding supply for some years now, and the flywheel to supply borrowed central bank gold into the markets at a suppressed price is gone. It’s no longer there. (This is why Western) central banks no longer trust each other. They are demanding repatriation and no central bank is actually trusting any other central bank anymore. They want physical possession (of their gold).
So who is going to be lending physical gold into a marketplace in that kind of condition? They (Western central banks) are not doing it. So the inevitable bailout that’s going to leave unallocated gold holders completely cash-settled and on the sidelines as gold and silver prices gap up is coming.
- Andrew Maguire
^^^ Andrew MaGuire describing the gold and silver spark in a recent article. Didn't mean to use bold but that's how it saved the copy/paste fyi.
A Mossad paid troll junked you on the Gold angle.
Do not fret. Junks do not mean a thing when exposing the truth.
They need you invested in the Paper Ponzi. Be smart and opt out. Stop spending. Hilsenrath tipped their hand and let you know they are running low on liquidity.
Their game is almost over.
It is time to pull it on this Fraud Game and let them all get crushed by the paper house of cards.
Paper burns really well due to GREECE Fires.
Goodbye Bonds. Goodbye Stawks. Good riddance Derivatives Markets.
And it wasn’t anticipated that the physical market that they relied on to keep the scam going would migrate to Asia.
Next up, war w/China.
No. I believe that the GREECE FIRE will detonate the Financial Weapon of Mass Destruction, the Derivatives Market, first.
Even China will go down as a result of this detonation as their assets are WRC US Dollar based.
We are totally destroyed. There will be nothing to pay troops with over there. And China cannot grow enough crops. The Credit Freeze II will starve her of trade capital. The BRICS Bank is in no shape to facillitate World Trade as they have no Bond Markets.
If this happens rapidly, as rapid as I expect, then we will all be too weak to even begin to finance any sort of war.
Let the weapons decompose to rust.
I don't see any gaps up for at least a few years...
http://www.globaldeflationnews.com/gold-elliott-wave-update-for-week-end...
Do you mean something like this:
Regarding a "spark". That would do it.
The difference between a "bail in" happening here in the USA and Cyprus is "guns".
I mean can you imagine a bankster in a suit repeating the above story an armed to the teeth American population, many rednecks like me?
Fuck me!! I cannot WAIT! Bring it on banksters!
hairball
Guns are useless against nuclear bombs. The Federal Government has over 9000 nukes. Any locality that revolts against TPTB will be incinerated without compunction.
Good. How about Boulder, Colorado?
How about Rancho Bernardo, California where Romney's kids live? (Now they are really easy find...I am just TWENTY MONUTES AWAY. Mitt also lives in La Jolla.)
If the Federal Government nuked just one US community then that would be the last one nuked as it would disintegrate to outright Civil War.
Go crawl under a rock. They are going to keeeill you. You should cower and be frightened, pussy.
Yeah, but it takes just a few good soldiers with common sense to program a nuke's coordinates to hit DC.
Gosh! I hope those guards are carrying a LOT more firepower than I normally do or their wives will miss them greatly.
I prefer my charts "horizontal". I'm a candle man.
Greece defaulted on its spark.
The spark will be futures in island real estate. Fear not elite, we will have boats when the collapse happens.
Did someone say there was a spark? https://youtu.be/MFYSelW67fs
We haven't seen much in the way of junk defaults yet this cycle. I figure we must see a big uptick of defaults at least a year before the corporate debt bubble blows up - just like in 2007. We got plenty of time here. The subprime crap started blowing up about 18 months before the big banks got monkeyhammered in 2008.
Does anyone seriously believe that the megaTrillion dollar credit default
derivatives problem just disappeared into thin air??
How's this for a spark?
"Bank of America wins mortgage case"
The Supreme Court ruled Monday that Americans with second mortgages can’t void those loans by declaring bankruptcy.
It was a unanimous decision and one that reversed an appeals court ruling that allowed homeowners to seek relief on homes worth less than the amount owed on their first mortgage.
The ruling will have the largest impact in markets with a high number of homeowners considered to be “underwater” – owners who owe at least 25 per cent more than the value of their homes.
The markets that will feel the largest effect are Florida (which has almost 1.4 million properties “underwater”), California (almost 800,000), Illinois (just under 600,000), Ohio (over 400,000) and Texas (over 300,000).
The judge presiding over the case rejected the lawyer’s (who represented the two homeowners) case that the Bank of America had a “secured” claim on its loans regardless of the home price and mortgage value, according to the Financial Times.
“Under the debtors’ approach, if a court valued the collateral at one dollar more than the amount of a senior lien (debt), the debtor could not strip down a junior lien under Dewsnup, but if it valued the property at one dollar less, the debtor could strip off the entire junior lien,” wrote Justice Clarence Thomas. “Given the constantly shifting value of real property, this reading could lead to arbitrary results.”
http://www.mpamag.com/news/bank-of-america-wins-mortgage-case-22749.aspx
https://www.youtube.com/watch?v=AxOOoxfIvGI
Anatomy of a Bubble...
http://www.globaldeflationnews.com/anatomy-of-a-bubble-how-the-federal-r...
"If you visit Zero Hedge (or any other alternative news aggregator) each day, you’ll see an endless stream of articles from various talking heads complaining about the stupidity and incompetence of the Fed and how the Fed’s “too loose for too long” monetary policy will lead to our destruction. The globalists have had their controlled-opposition agents drumming “Blame the Fed” into the public mind for years now. And once the next crisis comes along, this drumbeat will become deafening."
http://redefininggod.com/
Yawn,,,,
The most dangerous spark is the one that may be obvious, as it is the one that creates the Domino effect on... Derivatives, the largest and most highly leveraged 'assets' in existence.