The Prehistoric Era of Volcker the Great vs. Bathtub Economics
When money market yields and the term structure of interest rates are not pegged by the Fed but cleared by the market balance between the supply of economic savings and the demand for borrowed funds, the profit in the carry trades is rapidly arbitraged away—as last demonstrated during the pre-historic era of Volcker the Great. So the way back home is clear: liberate interest rates from the destructive embrace of the FOMC and presently money markets would gyrate energetically and the global horde of carry-seekers would shrink to a corporals’ guard. Pimco’s mighty balance sheet would also end-up nowhere near $2 trillion gross, if it survived at all.
By contrast, as we approach the bursting of the third central banking bubble of this century, the fates have saddled the world with the most oblivious and therefore dangerous Keynesian Fed-head yet. Not only does Yellen not have the slightest clue that ZERO-COGS is a financial time-bomb, she is actually so invested in the archaic catechism of the 1960s New Economics that she mistakes today’s screaming malinvestments and economic deformations for “recovery.”
In that regard, the ballyhooed housing recovery in the former sub-prime disaster zones is not exactly all that. Instead, the housing price indices in Phoenix, Los Vegas, Sacramento, the Inland Empire and Florida went screaming higher in 2011-2013 due to speculator carry trades.
Stated differently, the 29-year olds in $5,000 suits riding into Scottsdale AZ on the back of John Deere lawnmowers are not there owing to their acumen as landlords of single-family, detached homes, nor do they bring competitively unique skills at managing crab-grass in the lawns, insect infestations in the trees and mold in the basement. What they bring is cheap funding for the carry. They will be gone as soon as housing prices stop climbing, which in many of these precincts has already happened.
Similarly, the auto sector has rebounded smartly, but the catalyst there is not hard to spot either—namely, the re-eruption of auto debt and especially of the sub-prime kind. The latter specie of dopey credit had almost been killed off by the financial crisis—when issuance plummeted by 90%, and properly so. After all, sub-prime “ride” loans had been mainly issued against rapidly depreciating used cars and down-market new vehicles at 115% loan-to-value ratios for seven year terms to borrowers living paycheck-to-paycheck, meaning that they had an excellent chance of defaulting if the Fed’s GDP levitation game failed and their temp jobs vanished.
All the forgoing transpired in 2008-2009, of course, but that is ancient credit market history that has now been forgiven and forgotten. Since those clarifying moments, sub-prime car loans have soared 10X—-rising from $2 billion to $22 billion last year, when issuance clocked in above the frenzied level of 2007. Sub-prime loans now fund a record 55% of used car loans and 30% of new car loans, but there’s more. The Wall Street meth labs have already produced a credit mutant called “deep sub-prime” which now account for one-in-eight car loans. Borrowers able to post a shot-gun or PlayStation as downpayment can get a loan even with credit scores below 580.
In short, even as real wage and salary incomes grew by less than 1% last year, new vehicle sales boomed by 25% during the last two years to nearly the pre-crisis level of 16 million units. The yawning disconnect between stagnant incomes and soaring car sales is readily explained, of course, by the usual suspect in our debt-besotted economy—namely, auto loans, which were up 25% since the post-crisis bottom and now at an all-time high.
This reversion to borrowing our way to prosperity also highlights the untoward pathways through which the Fed’s toxic medicine of cheap debt disperses through the body economic. Much of the dodgy auto paper now flowing out of dealer showrooms is not coming from Dodd-Frank disabled banks, but from non-banks like Exeter Finance and Santander Consumer USA that have a tell-tale capital structure. They are funded with a dollop of “private equity” from the likes of Blackstone and KKR and tons of junk bonds that have been voraciously devoured by yield hungry money managers who have been flushed out of safer fixed income investments by the monetary central planners in the Eccles building.
