The Apotheosis Of Bubble Finance-----August 2007 Redux, Part 3


I have finished my book on the upheaval represented by the Trump candidacy and movement. It will be published soon, and is an exploration of how 30 years of Bubble Finance policies at the Fed, feckless interventions abroad and mushrooming Big government and debt at home have brought America to its current ruinous condition.

It also delves into the good and bad of the Trump campaign and platform and outlines a more consistent way forward based on free markets, fiscal rectitude, sound money, constitutional liberty, non-intervention abroad, minimalist government at home and decentralized political rule.

In order to complete the manuscript on a timely basis, I will not be doing daily posts for the next week or two. Instead, I will post excerpts from the book that crystalize its key themes and which also relate to the on-going gong show in the presidential campaigns and in the financial and economic arenas. Another of these is included below.

I am also working with my partners at Agora Financial on a new version of Contra Corner. More information on that will be coming soon.

Trumped Final

August 2007 Redux

......Nearly everywhere on the planet the giant financial bubbles created by the central banks during the last two decades are fracturing. 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 another 50%.

^SPX Chart

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 day traders’ 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 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, at the end of last summer’s melt-up rally, as we indicated earlier, the S&P 500 was trading at 25X LTM reported earnings

Moreover, the $87 per share reported for the period ending in June 2016 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 were 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.

The Baleful Legacy Of Bubbles Alan Greenspan

And that brings us back 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.

The same was true 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 third Bubble Finance crash of this century, 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 it at all!

“The 2000 bubble collapsed. We barely could see a change in economic activity. On October 19, 1987, the Dow Jones went down 23% in one day. You will not find the slightest indication of that collapse of that bubble in the GDP number – or in industrial production or anything else.

 So I think that you have to basically decide what is causing what. I think the major issue in the financial models has got to be to capture the bubble effect. Bubbles are essentially part of the fact that human nature is not wholly rational. And you can see it in the data very clearly.”

No you can’t.  As the astute student of 30 years of Bubble Finance, Doug Noland, recently observed:

 Had the Greenspan Fed not backstopped the markets and flooded the system with liquidity post the ’87 Crash, Credit would have tightened and bursting Bubble effects would have been readily apparent throughout the data. Instead, late-eighties (“decade of greed”) excess ensured spectacular Bubbles in junk debt, M&A and coastal real estate. It’s been serial Bubbles ever since.

Noland is completely correct. During the early part of the Bubble Finance era, the main street economy was goosed time and again by cheap credit, which induced household and business spending from the proceeds of steadily higher leverage.

But now the households of Flyover America are stranded at Peak Debt. Yet the Fed keeps hammering their real incomes via its specious 2% inflation target and their savings by its lunatic adherence to ZIRP.

Accordingly, and as we have previously demonstrated, the massive liquidity emissions of the Fed and other central banks never get beyond the canyons of Wall Street----- where they fuel ever more incendiary financial excesses and ever more traumatic crashes.

Now comes another.




David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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