Would it not be a hoot if we who expect the crash of industrial civilization, while we are staring intently at the usual suspects (peak oil, climate change, food shortages, grid failure, the San Andreas Fault) and waiting for one of them to start the avalanche, get sucker-punched by the Masters of the Universe? Would it not be excruciatingly funny if the very same people who almost burned the world alive in the first decade of this century managed not only to escape repercussions but to incinerate it in the second? The dial is moving from possible to likely as the ethically challenged whiz kids of Wall Street continue to play, unsupervised by adults, with the same matches in the same gasoline-soaked structure. Here’s what they’re doing, compared with what they did.
My house is my ATM: Back in the day, by which I mean ten years ago, people who owned houses were persuaded by financial jackals to treat their house as if it were an ATM, and take money out of it whenever they wanted. Housing prices would never go down, they were told, so they could always refinance. Today, investors who want a ten per cent return on their investment have been persuaded by financial jackals to treat houses as if they were ATMs, buying them cheaply (because ordinary people can’t afford them, or can’t get financing) for cash and renting them out.
Just as the jackals of old seemed really to believe that people who could not afford mortgages would be able to keep refinancing them, and that the music would never stop; so do today’s jackals seem to believe that being a landlord is a slam dunk. Gradually, they are learning that renters sometimes depart in the night; trash the houses that they don’t own; lose their jobs, or get sick, or have too many children; and far from being a slam dunk, landlordhood often sucks, financially. There are now signs that the smartest guys in this room are looking quietly but frantically for the exits, and when they find them — pop goes the bubble and the weasels.
As for real people in homes? Twenty per cent of American homeowners are under water (they owe more than their house is worth), and cannot refinance or sell. The number of people applying for mortgages with JPMorgan Chase and Citibank in the first quarter of 2014 was 70% lower than the number one year ago. The rate of home ownership in the country is at its lowest in 19 years. The lesson: when the institutions bail, there will be no one else to prop up the bubble.
From “No-doc loans” to “Covenant-Lite.” Back in the day, the jackals were handing out “liar” loans (containing unverified and untrue statements about qualifications of the applicant), “Ninja” loans (applicant has no income, no job, no assets), “No-doc” loans (applicant has no documentation of anything). The jackals didn’t care: if they were originators, they sold the loan as soon as they closed it, collecting all their fees and waving it goodbye. If they were conglomeraters, they bundled the loans, issued derivatives on them, and got them out the door, first collecting all their fees. No one gave much of a thought to where they would sit when the music stopped, as it always does.
Now, the action is in commercial lending, with the money flowing to subprime companies, not individuals. The loan flavour du jour is now “covenant-lite” loans, meaning loans made without the usual stipulation that the business use the proceeds for business, not to enrich the business owners. These loans are beloved by private equity firms that like to buy a company, mortgage all its assets, suck out the cash in fees and dividends, then let the company go into bankruptcy and screw the lenders. A record $238 billion worth of these puppies were issued in 2013, according to Reuters, and the pace is accelerating in 2014.
Never mind things, we want derivatives of things. What broke the back of the system in the 2009 era (the contraction actually began in the fall of 2005) was not just subprime debt and overvalued assets, it was the enormous bets placed on the system by institutions acting is if they were drunk in a casino. These bets are called derivatives. For example, slices and dices (called “tranches”) of securitized packages of looney-tunes loans, which constituted bets for the success of the Ponzi scheme; and credit default swaps, bogus insurance that constituted a bet against the success of the scheme. Back in the day, collapsing derivatives brought down some of the biggest players, and very nearly the world’s economy.
Today, the derivatives market is 20 per cent larger than it was just before the music stopped the last time. The International Bank of Settlements estimates that the notional value (notional value: that is, the value of all the bets if everyone won) of outstanding derivatives is $710 trillion, or 44 times the gross domestic product of the United States. If J.P. Morgan Chase, with total assets of $2 trillion, lost all its derivative gambles, it would owe the casino more than $70 trillion. In Vegas, that kind of loss would get you a one-way ride into the desert; on Wall Street, it gets you a bailout because you’re too big to fail.
Bottom line: as long as the Masters of the Universe are allowed to play their firehoses of money on whatever they deem to be the Next Big Thing (“It’s rental houses! No, wait, farmland! In Iowa! or Africa! No, check that, it’s fracking wells!), they will continue to blow up and deflate bubbles until they blow up the world. Where can I get a credit default swap to cover me for that?