Doves Don’t Learn From History
A wise saying goes like this: “Those who do not remember history are condemned to repeat it.” So ask yourself: What is the fate of those who seem to have absolutely no recollection of events that happened just a few years ago?
We are nearing the end of 2014, and to the debt markets, it is almost as if the 2008 economic collapse never happened. It appears that borrowers and lenders are suffering from a severe case of collective amnesia. Yes, consumer debt levels took a slight breather in 2009-2010. But today, total consumer credit in the U.S. has risen by 22 percent over the past three years, and at this point 56 percent of all Americans have a subprime credit rating.
By the end of 2014, total U.S. credit card debt is expected to rise by $54.8 billion and average household credit card debt will surpass the $7,000 mark, reaching levels not witnessed since the end of 2010. Adding to these disturbing figures is student loan debt that is at a nationwide all-time record of $1.2 trillion, which is an 84 percent jump since the Great Recession of 2008. Almost 19 percent of student loan borrowers owe more than $50,000, according to a report published recently by the Federal Reserve. Only 6 percent of borrowers had that much debt in 2001. Student loan debt now outstrips credit card and auto loan debt in America. And speaking of auto loan debt, during the first quarter of this year, the size of the average vehicle loan soared to a new all-time record high of $27,612. Five years ago, that number was just $24,174.
The financial crisis of 2008 was born out of a romance between the US consumers’ insatiable desire to spend and financial institutions’ voracious desire to issue debt, which compelled them to lend money regardless of the other party’s ability to make payments. In 2008, this dysfunctional relationship ended badly and both parties swore each other off. But with the Fed in the background playing the violin, recent data shows these two lovebirds can’t stay away from each other.
Unfortunately, today’s mounting debt isn’t limited to the US consumer; Bank of America is forecasting about $110 billion of collateralized loan obligations for 2014, as volume is on pace for a record year. CLO’s are used to finance small and medium sized businesses. And CLO issuance in total is on pace to surpass the record $93 billion raised in the U.S. during 2007.
Adding fuel to the debt fire is the aggressively growing Junk bond market. Junk bond yields have fallen to the 5-6 percent range. This has caused fund managers, still insisting on a 10%+ return, to buy on leverage in order to increase the yield on their capital investment. Citigroup, displaying a pre-2008 mindset, has even calculated that leveraging junk bonds at 2.3X is a better trade than leveraging U.S. Treasuries at 8.1X.
All these data points prove that we, as a nation of borrowers, have learned nothing from 2008. In fact, things have gotten worse as our own Federal Government, lulled by record low interest rates, has massively stepped up its own passion for debt, taking Federal Debt levels up from $9.2 trillion, at the start of 2008, to $17.8 trillion today. But the tease is that with record low interest rates, they are actually paying less today to service that debt than they were 6 years ago.
This is in part because the Treasury insists on financing debt at the shortest duration possible. In fact, about 80 percent of the government’s $12.8 trillion publicly traded debt is financed with shorter-term Bills and Notes. And thanks to the Fed’s ZIRP and Treasury’s short-term thinking, the average interest rate on the government’s marketable debt was less than 2 percent last year. Compare that to the 6.6 percent level in January of 2000, when interest rates were still below their forty-year average.
It’s clear that simply reinforcing bad behavior of the past has left few to learn from previous transgressions. The past six years of record low interest rates, should have given borrowers a reprieve; an opportunity to refinance debt and get their financial house in order. Instead, it has predictably lured first the public, and now private sector borrowers to pile on more debt. Indeed, the aggregate level of U.S. debt now stands at a record $57 trillion! That figure is up nearly $7 trillion from the Great Recession.
Therefore, those investors who believe the Fed can seamlessly transition from 6 years of ZIRP and $3.7 trillion in QE should re-read the above data. An aggressive Fed will immediately cause our overleveraged and asset bubble-driven economy to collapse. It’s just a shame the Dole of Doves at the Fed never learned from previous mistakes — even those made just a few years ago.
This is why the Federal Reserve will not be raising rates anytime soon. And why Ms. Yellen kept the language in last week’s FOMC statement regarding, “considerable time” between the end of QE and the first rate hike.
Those investors piling into the U.S. dollar based on a hawkish Fed are making a big mistake. Our central bank wants to create an environment of perpetual inflation. And will not end its policy of providing negative real interest rates until thoroughly successful.
Since the Greenspan era, history has taught us that our dovish Fed exists to accommodate government borrowing. This truth is becoming more immutable as debt levels inexorably increase. Unfortunately, this codependent relationship has now caused the latest iteration of a stock market bubble to become the most dangerous of them all.