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2018-04-25 11:27 by Karl Denninger
in Market Musings , 190 references
[Comments enabled]  

This mornings stupid comes courtesy of a clownface with a nice bridge in the background -- the former Wells ****ed-You CEO.

The bridge goes nowhere.

The problem with markets today is that virtually everyone argues that corporations taking on lots of longer-term debt during the suppressed rate environment is good -- indeed, good bordering on God-like.


Go read this again.  The problem isn't with the "taking of the debt", it's what happens when rates rise -- or even refuse to fall further.  As I've repeatedly pointed out and in fact made a central point of my book Leveragesuch market distortions encourage and in fact almost mandate psychotic behavior by corporations and governments.

Specifically the only way to "keep up with the Joneses" is not to refinance your debt to a lower interest rate and enjoy the lower coupon payment but rather to add as much debt as you can while holding the coupon payment constant.  So if you borrowed $1 million with the rate of interest at 5% and the rate drops to 1% you will not take the opportunity to refinance the $1 million and pay 1/5th the coupon -- you will instead borrow another $4 million, which means your operating leverage is now 500% of what it was before.

This behavior inevitably bankrupts you -- doing that is both psychotic and criminally insane.

What caused the housing blowup was mass-attempts to do this by individuals, egged on by the banksters, Wall Street and the shiny new Mercedes that magically appeared in the driveway of your next-door neighbor.  Millions of Americans took their home, refinanced but instead of using that refinance to lower their payment they instead used it to extract as much more money as they could while holding the payment constant.  What they ignored was that their means of doing this was not long-term stable -- they were dependent on a rollover of the note that they took due to some "teaser rate" or feature that caused the coupon to reset.

When it reset and they weren't able to roll over the debt again on even-better terms they were instantly bankrupted as they had spent the money they borrowed, couldn't raise the difference to pay off the "extra" borrowing, and also couldn't afford the coupon at the higher rate.

A permutation of this is exactly what set off the Tech Crash.  I can tell you this with specificity because I saw it multiple times with vendors of various services and products.  The poster child from my time running an ISP was in the DSL marketplace where three separate firms came into my office trying to "partner" with us.  Every single one of them was building out their networks using cheap financing from Wall Street - most of it equity raises, but some in debt.  The problem with their model was that they were cash-flow negative and so eventually the price of the next equity or debt raise would go up instead of down and they were utterly reliant on being able to do the next one on comparable or better terms as they had no ability to redeem any of the outstanding rounds; the money was gone.  I threw all three of them out of my office because I knew that when they detonated the company that would get blamed when our customers lines went dead was MCSNet and that had a decent chance, if we had converted any material percentage of our customers to their services, of killing us at the same time.

When the market got a whiff of that "business model" being the only thing that kept these firms afloat they, and the market, both crashed.  All three of those firms ultimately blew up.

In 2008 when the market got a whiff of that being all that was powering the housing market it, and the market, both crashed.

Central Banks and our Federal Government, instead of allowing the market to clear that out in 2008 and 2009 promoted and explicitly supported more of it as a means of "rescuing" the economy.  That's what everyone did.  Literally everyone, from big business to small, from households (especially student loans and cars this time around) to governments that intentionally underfunded pensions and on top of doing that they sat back and allowed insanely illegal practices in the medical system that are driving those pension costs higher.  Never mind the pure insanity of allowing people to "game" pensions through things like "bonusing" in overtime or even double-dipping, resulting in them getting two or more pensions!

The limits of this game have been reached.  Trump knows ******n well what happens when you hit that wall as he nearly went personally bankrupt from doing it himself and several of his projects have blown up this way.  Those blow-ups almost always happen with very little warning although the eventual outcome is something you can determine years or even decades in advance because once you take on the debt and drive coupon as your means of "success" the outcome is certain.

We merely argue over when, not what.

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