Two weeks ago I wrote a piece for Newsweek outlining potential troubles in the junk bond market. I pointed out that there is a strong possibility that enormous junk bond issuance is floating companies that otherwise would have gone bankrupt due to the lockdown measures. Here is that piece:
But that is not the only bubble on the horizon. The lockdowns and work-from-home appears to have driven investors pretty kooky because we also have what appears to be a major housing bubble inflating. I have outlined this in a piece I published today which can be read here:
If you add up the employment in the threatened sectors you get a range of anywhere between 8% and 10% of total employment in the United States. In contrast, during the 2008 crisis – which was almost wholly driven by a housing bubble – only around 5% of employment was under direct threat.
It is hard to come to any conclusion other than that, if I am right about the bubbles, the economy could be under more threat from a financial crisis-cum-deep recession than at any time since the Great Depression.
When you make a claim as large as this and you’re not a permadoomer, it’s usually good to ask the question: what would it take for me to be wrong? So far as I can tell we would need to assume the following for my thesis to be incorrect.
- The enormous increase in debt issuance by companies with balance sheets destroyed by the lockdowns highlighted by the BIS paper I cite is completely sustainable.
- Revenues are going to soar for these companies in the coming months and they will pay down all the excess debt.
- Further, the BIS stress test model – which is quite conservative and does not even assume another lockdown – would have to be totally wrong.
- With respect to the junk bond market itself, the current very narrow spreads we see – especially relative to forecast default rates – would have to be a permanent feature of reality; presumeably this would be due to some permanent Greenspan put-style arrangement implicitly promised by the Fed.
- Implicit in the last point is that the Fed can actually control junk bond spreads, even during a market meltdown or crisis.
- With respect to the housing market we would have to assume that the screaming valuations – which are just as high as in 2008 – are now a permanent feature of reality. These will either continue to expand indefinitely – rendering houses more and more expensive – or it would stabilise at its new high-level.
- The record levels of private sector residential investment growth is either sustainable or will not end with a bang but rather draw down slowly over time as we replenish the nation’s housing stock – the 2008-era lingo for this, now much derided, was ‘soft-landing’.
- MBS spreads, artificially lowered by the Fed buying up around 30% of the market, will remain suppressed allowing for the current levels of mortgage lending to continue; the record rates of growth of MBS issuance will either continue on or experience a soft-landing.
I think those are the assumptions you have to make to think that I am totally wrong about these bubbles. If you find them unreasonable – I do – then you have to conclude that we could be sailing into seriously choppy waters.