With nearly $620 billion in debts, it was the largest bankruptcy in history.
Now, a decade late – it appears the mainstream’s learned nothing. And many have forgotten the crisis that was 2008. . .
The banks are bigger and the damage of them crashing will be even greater this time around.
The elites – led by the Federal Reserve – have since 2008 told banks to continue lending and for consumers to continue borrowing. They did this by cranking interest rates down to zero (technically 0.25%). This allowed funds and ‘shadow banks’ to borrow huge amounts on margin.
It also kept commercial banks continually lending out loans. And at the end of the day if they lent out too much and didn’t have enough legal ‘reserves’ (deposits) to close, they’d simply ring up another bank (or the Fed) and borrow the amount needed.
“Hey BofA, we need $26 million.”
“Okay Citi, sounds good.”
Borrowing at near zero and lending out at higher rates was very lucrative. And basically, free money.
Banks can ultimately borrow from the Fed for 0.25% and lend out to the U.S. government for a solid 2-3% nominal return. Or even better, they’ll lend out to consumers who want a new house at a higher interest rate. Students that need debt for college. Auto loans. Or Emerging economies that need funding.
There’s more to it – and I’ll highlight it more in-depth in later articles. But aslong as interest rates are low, the game continues.
But the problem is – and just like before 2008 kicked off – short term interest rates are now rising.
All these banks that borrowed trillions from one-another and the Fed now have increasing debt servicing costs. Meanwhile the long end of the yield curves lowering, and many loans they’ve already lent out are locked in at a fixed rate. That $500,000 30-year mortgage that mom and dad refinanced will stay at 4.5%.
So as short term rates are rising, and long term rates are falling – that’s squeezing bank and other lending institutions margins. . .
It won’t be long until the yield curve inverts. Don’t know what I’m talking about? You can read more about that here – and why it’s preceded the last nine straight recessions.
All because of rising short term interest costs.
Putting it plainly, the higher short-term interest rates go up – the more fragile the entire system becomes.
History shows us that every time the Fed raises rates – there’s eventually a crisis.
Look for yourself.
This time won’t be any different – in fact, it will be far worse. . .
One huge reason is that the U.S. government’s borrowing at amounts that it hasn’t since the 2008 recession.
Now, during a recession, it’s permissible (thanks to John Maynard Keyne’s economic theories) for the government to pile on tons of debt.
But once the recession’s over, budget deficits need to contract again.
And that’s the farthest thing from what’s happening 10 years after 2008.
For instance, the fiscal year isn’t even finished yet (one more month to go) and the U.S. budget deficit is just shy of $900 billion.
That’s a 40% increase since last year. . .
President Trump’s tax cut plan and increased spending is causing deficits to swell.
And because of this, the Congressional Budget Office (CBO) has significantly raised their deficit projections over the 2018 – 2025 period. And the scary part is that they don’t even expect a single recession or slow down between now and then. These projections are assuming steady growth and a healthy economy.
They’re clearly not accounting for any margin of error here. . .
But just imagine how much the debt will be after another recession – when the U.S. will need to pile on even more debt. . .
While the government’s spending is out of control – especially at a time when the economy’s supposedly ‘healthy’ – the bigger problem is the cost of servicing all this debt.
Ignoring private consumer debt (which will be greatly affected by rising rates), the U.S. National Debt recently hit $21.3 trillion – with no signs of slowing down – and the interest payments due on all this debt is at a record high.
You can see that since the Federal Reserve began raising rates in December 2015, the cost of interest payments on the national debt has soared.
It just hit an all-time high of $538 billion per year. . .
Remember, the U.S. is taking in less tax revenue because of Trump’s tax cuts. So the Treasury will have to borrow new debt just to pay off maturing old debt and interest.
This is what Hyman Minsky – one of my favorite economists – called a ‘Ponzi’ scenario – when you need new debt to pay off old debt.
And if interest costs are this enormous from the Fed raising rates to just 2%, imagine how much it will cost if it goes to 3% or higher.
Short term interest costs will continue to rise over the near-term because of three reasons: higher inflation, Fed tightening, and the increased amount of debt needed by the Treasury.
Like I wrote above, the higher short-term rates go – the worse lenders will do. And if the lenders, like banks, can’t make profits – they’ll collapse under all that debt.
For the anniversary of Lehman Bros, I warn you – never forget the toll of too much debt and rising interest rates.
This has been the economic recipe for many problems throughout history – whether it’s corporations, governments or people. Borrowing huge amounts when rates are low and not being able to pay it all back as rates rise is fatal.
Because of all this, the financial system will continue becoming fragile – and sooner than later something will break.
The Financial Select Sector SPDR Fund (XLF) was unchanged in premarket trading Friday. Year-to-date, XLF has gained 0.80%, versus a 9.42% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Palisade Research.