Here We Go Again: An August 2007 Redux via Mises
Nearly everywhere on the planet the giant financial bubbles created by the central banks during the last two decades are fracturing. The latest examples are the crashing bank stocks in Italy and elsewhere in Europe and the sudden trading suspensions by three UK commercial property funds.
If this is beginning to sound like August 2007 that’s because it is. And the denials from the casino operators are coming in just as thick and fast.
Back then, the perma-bulls were out in full force peddling what can be called the “one-off” bromide. That is, evidence of a brewing storm was spun as just a few isolated mistakes that had no bearing on the broad market trends because the “goldilocks” economy was purportedly rock solid.
Thus, the unexpected collapse of Countrywide Financial was blamed on the empire building excesses of the Orange Man (Angelo Mozillo) and the collapse of the Bear Stearns mortgage funds was purportedly owing to a lapse in supervision.
So it boiled down to an injunction of “nothing to see here”. Just move along and keep buying.
In fact, after reaching a peak of 1550 on July 18, 2007, the S&P 500 stumbled by about 9% during the August crisis, but the dip-buyers kept coming back in force on the one-off assurances of the sell-side “experts”. By October 9 the index was back up to the pre-crisis peak at 1565 and then drifted lower in sideways fashion until September 2008.
The bromides were false, of course. Upon the Lehman event the fractures exploded, and the hammer dropped on the stock market in violent fashion.
During the next 160 days, the S&P 500 plunged by a further 50%. Altogether, more than $10 trillion of market cap was ionized.
The supreme irony of the present moment is that the perma-bulls insist that there is no lesson to be learned from the Great Financial Crisis. That’s because the single greatest risk asset liquidation of modern times, it turns out, was also, purportedly, a one-off event.
It can’t happen again, we are assured. After all, the major causes have been rectified and 100-year floods don’t recur, anyway.
In that vein it is insisted that U.S. banks have all been fixed and now have “fortress” balance sheets. Likewise, the housing market has staged a healthy recovery, but remains lukewarm and stable without any signs of bubble excesses. And stock market PE multiples are purportedly within their historic range and fully warranted by current ultra-low interest rates.
This is complete daytraders’ nonsense, of course. During the past year, for example, the core CPI has increased by 2.20% while the 10-year treasury this morning penetrated its all-time low of 1.38%. The real yield is effectively negative 1%, and that’s ignoring taxes on interest payments.
The claim that you can capitalize the stock market at an unusually high PE multiple owing to ultra-low interest rates, therefore, implies that deep negative real rates are a permanent condition, and that governments will be able to destroy savers until the end of time.
The truth of the matter is that interest rates have nowhere to go in the longer-run except up, meaning that the current cap rates are just plain absurd. Indeed, after last’s week’s “bre-lief” rally the S&P 500 was trading at24.3X LTM reported earnings
Moreover, the $87 per share reported for the period ending in March was actually down by 18% from the $106 per share peak recorded in September 2014. So in the face of falling earnings and inexorably rising interest rates, the casino punters are being urged to close their eyes and buy the dip one more time.
And that’s not the half of it. This time is actually different, but not in a good way. Last time around the post-August 2007 dead-cat bounce was against $85 per share of S&P LTM earnings, meaning that on the eve of the 2008 crash the trailing multiple was only 18.4X.
That’s right. After the near-death experience of 2008-2009 and a recovery so halting and tepid as to literally scream-out that the main street economy is impaired and broken, the casino gamblers have dramatically upped the valuation ante yet again.
There is a reason for such reckless obduracy, however, that goes well beyond the propensity of Wall Street punters and robo-traders to stay at the tables until they see blood on the floor. Namely, their failure to understand that the current central banking regime of Bubble Finance inherently and inexorably generates financial boom and bust cycles that must, and always do, end in spectacular crashes.
Bubble Finance is based on the systematic falsification of financial prices. That’s the essence of ZIRP and NIRP.
It’s also the inherent result of massive QE bond-buying with central banks credits conjured from thin air. And it’s the purpose of the wealth effects doctrine and stock market puts. The latter are designed to inflate stock prices and net worths, thereby encouraging households to borrow (against rising collateral values) and spend on the expectation of permanently higher real wealth.
The trouble is, financial prices cannot be falsified indefinitely. At length, they become the subject of a pure confidence game and the risk of shocks and black swans that even the central banks are unable to off-set. Then the day of reckoning arrives in traumatic and violent aspect.
And that brings us to the father of Bubble Finance, former Fed Chairman Alan Greenspan. In a word, he systematically misused the power of the Fed to short-circuit every single attempt at old-fashion financial market corrections and bubble liquidations during his entire 19-year tenure in the Eccles Building.
That includes his inaugural panic in October 1987 when he flooded the market with liquidity after Black Monday. Worse still, he also sent the monetary gendarmes of the New York Fed out to demand that Wall Street houses trade with parties they knew to be insolvent and to prop up stock prices and other financial valuations that were wholly unwarranted by the fundamentals.
Greenspan went on to make a career of countermanding market forces and destroying the process of honest price discovery in the capital and money markets. Certainty, that’s what he did when he slashed interest rates in 1989-1990, and when he crushed the justified revolt of the bond vigilantes in 1994 with a renewed burst of money printing.
Ditto, when he bailed out Long-Term capital and goosed the stock market in the fall of 1998—-a maneuver that generated the speculator dotcom bubble and subsequent collapse.
And then he applied the coup de grace to what remained of honest price discovery on Wall Street. During the 30 months after December 2000, he slashed interest rates from 6.25% to 1.0% in a relentless flood of liquidity. The latter, in turn, ignited the most insane housing market bubble the world had ever seen.
During the second quarter of 2003, for example, as rates were brought down to a previously unheard of 1.0%, the financial system generated mortgage financings at upwards of a $5 trillion annual rate. Even a few years earlier, a $1 trillion rate of mortgage financing had been on the high side.
Needless to say, housing prices and housing finance costs were systematically and radically distorted. The crash of 2008-2009 was but the inexorable outcome of Greenspan’s policy of financial asset price falsification—–a policy that his successor, Bubbles Ben, doubled down upon when the brown stuff hit the fan.
So as we sit on the cusp of the next Bubble Finance crash, now comes Alan Greenspan to explain once again that he knows nothing about financial bubbles at all. According to the unrepentant ex-Maestro, it’s all due to the irrationalities of “human nature”.
Why, central banks have nothing to do with