The Fed: Long Term Parking by Salient Partners
|Anthony ‘Tony’ Soprano:|
And I don’t want to hear about the freaking economy, either! Sil, break it down for ’em. What two businesses have traditionally been recession-proof since time immemorial?
Certain aspects of show business … and our thing.
– The Sopranos, “For All Debts Public and Private” (Season 4, Episode 1, 2002)
There’s a great scene in the 4th season of The Sopranos where Tony is upbraiding his crew for their lack of “production”, particularly in the traditionally lucrative field of loan sharking. The recession is no excuse, says Tony, for failing to make money from “our thing” – organized crime. It’s a great scene because of the language, the routinization of a decidedly non-routine business. You can easily imagine Tony and Silvio as the CEO and CFO of a regional bank in 2002, exhorting their loan officers to get out there and drum up some business.
Like the Soprano Family in 2002, the problem with the US economy in 2014 is not that there is too much private debt being created, but too little. The danger for US markets is not that there is some private debt bubble about to burst, but that markets have become disconnected from the natural cycle of debt and growth, a cycle which remains decidedly anemic.
I think it’s this disconnectedness that fundamental investors feel about this market – the “alienation”, as Marx would put it – that pushes otherwise sober market observers to wring their hands about this debt bubble and that debt bubble, this looming apocalypse and that looming apocalypse. Most recently, the media alarm bells have been about a “complacency bubble”, where low implied volatility levels for the market in and of themselves somehow create the potential for a big market drop. Even the occasional Fed governor has gotten into the act, claiming in their best Capt. Renault voice that they are shocked … shocked! … that markets are so blasé about world events. Please. This was the plan all along, explicitly laid out by Bernanke et al, that monetary policy would force everyone to buy riskier assets then they would otherwise prefer, inflating all financial asset prices and bridging the gap between the market everyone wanted and the real economy we actually had. This is not market complacency born of animal spirits and a “what, me worry?” attitude. This is market complacency born of an intentional (and incredibly successful) government plan to mold investor behavior. As a result, the current market complacency does not mean the same thing as prior periods of market complacency. And that makes all the difference in the world.
I’ve written here, here and here about why the whole “Minsky Moment” notion – which has come to be something of a rallying cry for those pointing to the dangers supposedly inherent in this market – is entirely misplaced. The Minsky-lite idea that “stability creates instability” may be in vogue, but really it’s just a vague tautology. Yes, I will stipulate that stability does not last forever. Thanks. Terribly keen insight. No, if you take Minsky’s ideas seriously you have to focus on private debt bubbles, and right now there are none in the US. Maybe there are in China, and I’m particularly interested in learning how far down the rabbit hole this commodity rehypothecation story goes. But in the US? Nope.
But what about the $1 trillion student debt burden, Ben? What about the historically high levels of auto loan debt and corporate debt? Here’s the answer: a high level of private debt does not necessarily create a debt bubble.
First, debt in an absolute sense is never a problem. The problem, as Tony Soprano would be happy to explain to you as he cracks a baseball bat across your knees, arises when your debt obligation outstrips your ability to pay it back. This problem does not exist for households or corporations in the US.
Here’s a chart from Fed data showing household debt service obligations as a percentage of disposable income. Debt servicing has not been this easy for American households since the Fed started compiling the data in 1980.
For corporations, here’s a chart from Bloomberg data showing the ratio of net debt (debt minus cash) to EBITDA (earnings before interest, taxes, depreciation, and amortization) for the S&P 500. This is a very standard measure of liquidity and leverage, and today’s ratio of 1.37 is less than one-third what it was before the Great Recession. The cold hard fact is that US corporate balance sheets have not been this strong or less levered in more than 20 years.
Second, a market bubble can only exist in the form of market securities. If debt is not securitized it never reaches the public market and does not create a bubble. Here’s a chart from SIFMA data showing asset-backed securitization issuance (auto loans, student loans, credit cards, equipment loans, etc.) for the past 20 years through 2013. ABS issuance last year was not even equal to what it was in 2000, and is more than $100 billion below its peaks in the go-go years of 2005-2007. Sorry, no bubble here.
Third, even if a high level of poorly underwritten private debt manages to find a high degree of securitization – I’m looking at you, student debt – a bubble can’t exist if the private debts are backstopped by public debt. This was the magic of the Temporary Liquidity Guarantee Program (TLGP), which for my money was the single most important program – far more than QE 1 – in preventing the world from imploding after Lehman’s bankruptcy. If the FDIC had not placed the full faith and credit of the United States behind the future issuance of private unsecured debt of FDIC-insured bank holding companies in November 2008, I have no doubt that the entire financial system would have collapsed for lack of liquidity. I mean, why do you think Goldman Sachs and Morgan Stanley became ordinary banks? Do you think they wanted to come under the thumb of Sheila Bair? No, the TLGP was the difference between life and death for Goldman Sachs and Morgan Stanley, as there is no way on God’s green earth that they would have been able to fund themselves given their highly levered balance sheet without a US government guarantee on their unsecured debt. So they chose life, which for Goldman Sachs amounted to about $30 billion in new funding. For GE Capital it was about $90 billion. How nice it must be to be too big to fail, and how infuriating it is to hear Lloyd Blankfein and crew claim today that Goldman Sachs was just fine