The Economy

Anecdotal, so take it for what it is worth. ... but when the extremely artificial liquidity from a variety of sources that is still keeping the global economic mess propped up for the moment runs out. ... I just don't see how we aren't going to have 1) a commercial real estate collapse, 2) the real banking crisis that we just got a prelude to, because there are hundreds upon hundreds of banks with portfolios of loans on buildings at sky high valuations that were the result of zero interest rate policy.

This video feels like bizarro world.

 

It's just not that complicated.



Zero interest rate policy and quantitative easing in the wake of the great financial crisis had banks loaning trillions of dollars for real estate purchases. Look at what happens to the line during the pandemic, when the Fed -- without people taking an interest or having a clue what they were doing -- began monetizing debt like there was no tomorrow. They were the world's worst hedge fund, buying up debt with no regard for credit worthiness or price. But unlike a hedge fund you might start, they could just create the money to buy that debt out of thin air.

The borrowing rates were so insanely and artificially low, and the lending standards were nil (the covenants on many loans are non existent) and that creates moral hazard. The Fed has had everyone's back, so when things blow up, the borrowers have been trained that they won't bear the costs, the cost will be pawned off on everyone else. And banks that couldn't operate profitably with a price-fixing czar putting a cap on what they could charge to lend, were forced to make loans that outside of that artificial environment look reckless. So we got a building boom. And a lot of borrowed money that was free in real terms was sloshing around as the Fed injected liquidity into the economy via lending. ... and it looked for things to speculate on, driving real estate prices higher. So the aggregate cost of those loans grew exponentially (what you see in the graph), and the amount of leverage underlying those loans rose. But no problem, because the Fed was engineering prosperity. ... all you needed to do was keeping rolling over your debt at zero cost forever.

But then because of the insane ramp up in debt monetization with the pandemic as an excuse, and the Federal government going on a spending spree to the tune of trillions of dollars, all of that monetary inflation spilled over into consumer prices. ... and the Fed very begrudgingly has felt forced to raise the cost of money. ... more than 500 basis points on their overnight rate. They haven't made much of a dent in their balance sheet (letting the debt they have bought expire without buying more debt to replace it). So the effect on interest rates has been muted. ... there is still a ton of liquidity propping up a lot of failed things.

But there have been cracks. In commercial real estate, you are seeing defaults tick up and valuations coming down. ... but the motherload of that debt still hasn't had to refinance. A wave of that is coming next year and the following year. And when that massive amount of debt needs to be rolled over. ... it's not free anymore (until the Fed does the cowardly thing it always does and tries to kick the can down the road, robbing more from the future to reward failure).

Now add in empty offices like in that video, and an economy that has softened a ton because of money suddenly having an actual cost for the first time in 15 years. And where does the revenue / cash flow stream for the owners of those buildings come from to service that greatly increased debt cost when they have to roll over their debt?

The ONLY thing that keeps an implosion from happening is if they can somehow inflate away the debt. ... bring interest rates back down to zero or negative. But that just will make the problem worse by kicking the can down the road, and unlike the period during the 2010s when they acted like they had created prosperity without a cost on the back of monetized debt. ... consumer price inflation is still swallowing up people in this country (the growth has slowed, but the dollars in people's pockets are buying less by the day) and if the Fed reverses course to prop up their bubble (including the commercial real estate bubble), inflation could take off in a "Shit, we turned ourselves into Zimbabwe" way.

I think they will choose runaway inflation over the economic misery, because it's a more hidden way to hurt people. So I expect a massive wave of more debt monetization is on the way. They will try to prop up failure all around us, plus, Congress needs them to monetize debt in order to keep deficit spending.

But whichever they choose -- let the bubbles pop or try to inflate away the problem -- we are all going to be serious losers for how out of control they got.

 

One thing I didn't cover in that post. ... that graph shows commercial real estate loans written by commercial banks. It doesn't include the shadow banking system which is huge. But just in terms of those banks. ... those loans are sitting on their balance sheets, and just like the banks that have gone into receivership as things have started to break with the Fed trying to tighten things up, the value of their commercial real estate loans has declined. On a marked to market basis. ... there are thousands of banks in this country that right now are under water. As in, if there were runs -- people tried to withrdraw their deposits -- they couldn't sell those loans to meet redemptions without huge losses and bank failures. Until the Fed caves (at least that is what markets are betting is going to happen), we are flirting with a debt and banking crisis right now that is much closer than the typical person understands. If the Fed really did what it had to do to try to deal with the consumer price inflation genie it unleashed. ... it would be catastrophic for the economy. As is, just with what they have actually done, banks are teetering.