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Double Bubble Trouble

Summary:
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: The Next Financial Crisis is Coming 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: Are We About to Repeat the 2008 Housing Crisis? 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

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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:

The Next Financial Crisis is Coming

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:

Are We About to Repeat the 2008 Housing Crisis?

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.

Philip Pilkington
Phillip Pilkington works in investment and has contributed to numerous online and print media outlets as a freelance economic journalist.

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