Below we look at drunk central banks and what this means for your money today and tomorrow, with a little reminder from yesterday.
2008: The Year Private Banks (and Free Markets) Lost Their Soul
Remember the $700 billion TARP bailout in the dark aftermath of the 2008 Great Financial Crisis?
There was tension in the air when Hank Paulson, former Goldman Sachs CIO turned Treasury Secretary, nervously stood beside the trigger-happy Fed Chairman, Ben Bernanke, and convinced Congress that emergency measures were needed to save the very financial system which they had just broken.
There was open talk of ATM’s being shut down and life as we knew it ending if DC didn’t step in immediately to save those poor banks overly exposed to a lot of sub-prime mortgage paper on their books.
Goldman Sachs was nervous too, as they had sold a lot of that toxic sub-prime crap (aka Mortgage Backed Securities—or “MBS”) to return-thirsty investors, pension funds and retail suckers.
These MBS instruments were levered debt instruments stacked in layers called “CDO’s” (collateralized debt obligations) which the math-challenged rating agencies had hitherto classified as A+ students despite their D- credit quality.
Aint those rating agencies something?
But at the same time Goldman was selling this D- MBS/CDO toilette paper to the world for fat fees, they were also insuring against their risk of loss with another fancy piece of paper called a Credit Default Swap, or “CDS.”
Goldman had been told by their revered insurer, AIG, that all was good in the event that their MBS toilet paper failed to work. The CDS would “insure” them.
In fact, a very clever AIG executive (insurance salesman) by the name of Joe Cassano was selling this CDS insurance with aplomb to Goldman and whomever else would buy it.
He made millions and millions and millions as an “honest broker” (oxymoron or just moron?) collecting insurance premiums for AIG and climbing the executive ladder.
Cassano was telling the world that the MBS would never fail, and thus he was collecting insurance premiums as if selling flood insurance to home owners in the desert.
In short: No risk, just lots of easy money for him and AIG. MBS would never fail, so why not take the premiums?
But here was the problem, a flood came to the desert and the MBS market failed in 2008. Remember?
When those same MBS/CDO products drowned in a flood of crappy credit loans, the great AIG had no money to pay out the insurance claims for the flood-soaked paper against whose losses it had previously “insured.”
Uh-oh for AIG, and thus uh-oh for a flood-damaged Goldman Sachs.
Ah, but no problem, former Godman executive Hank Paulson got you, the tax-payers, to bailout/” loan” AIG (and hence Goldman Sachs) to the tune of $85 billion.
Alas, the CDS exposure was saved, as were the banks.
Meanwhile, that same AIG executive who had previously brokered that worthless CDS insurance which rendered AIG temporarily broke, quietly limped off the seen with a $315 million exit bonus.
Aint Wall Street grand?
And Goldman Sachs, just inches from disaster in 2008 but for the AIG bailout, recovered just fine and within a year of the Great Financial Crisis of 2008 (which it helped create), was back to giving record-high bonuses to its executive staff.
Again, aint Wall Street grand?
And folks, that’s just one story among many during the great banking crisis of 2008.
Similar near-death experiences can be told for 12 out of 13 major banks at that time, including Morgan Stanley, Bank of America and Merrill Lynch, all of whom were equally levered, equally drowning in MBS exposure and, well, equally bailed out in some form or another.
Only Bear Sterns and Lehman Brothers were allowed to drown, and mostly because they (i.e. Dick Fuld and Jimmy Caine) were just too unpopular in the backroom meetings for the other bankers to toss a life vest.
Aint Wall Street cruel?
From Private Banks to Drunk Central Banks—More Soul-Crushing Insanity
But that was just one kind of Shakespearean tragi-comedy playing out at the private banks.
What was happening at our central bank, i.e. the Fed, then under the brilliant and now book-touring leadership of Ben Bernanke, was equally worthy of a crime novel sub-plot.
As the private bankers were drawing straws and divvying-out (as well as fattening up upon) bailout funds (after having just put the entire financial system on its knees), our Fed was engaging in some extraordinary maneuvers of its own.
In particular, Bernanke broke out the money printers and began printing hundreds of billions per quarter to backstop the markets (which he confused with the “economy”) in what would later become known as “QE 1.”
Bernanke, of course, assured us all in 2009 that QE1 was purely a temporary measure. An “emergency measure.”
But remember this: The Fed lies…
Bernanke also took interest rates to the zero-bound, allowing otherwise broke companies on the S&P, NASDAQ and DOW to borrow like teenagers with Dad’s Amex.
Aint the Fed generous?
But surely, the Wall Street crowd and public stock exchanges would not become addicted to printed money or zero-rate debt?
Again, we were assured in 2009 that such “forward guided accommodation” would not lead to an addiction.
After all, to just print money and inflate debt levels to the moon on cheap debt could not be seen as a full-time solution, for even the bankers (private or Federal) had to know that such policies were, well, pure “faking it.”
In short, there was no way the great capitalist bulwark known as Wall Street would ever become addicted to free money and unlimited debt binges from drunk central banks?
After all, this was the land of the free and free markets, not bailouts, addiction or Wall Street socialism.
Surely such open absurdity would only be provisional; surely natural price discovery, free markets and the American way of fair-play and fair markets would return, right?
Well, not so fast…
September 2008 to September 2020: From Shot-Glass to Full-On Addiction
You see, it’s now September of 2020, some 12 years since the Great Financial crisis of September, 2008 when all this “temporary” and “emergency” Fed-support began.
For years, I’ve been blunt in calling this sham of drunk central banks masquerading as “accommodation providers” for what it is, a Twilight Zone, a Danger Zone, Uncharted Territory, a rigged-to-fail charade etc.…
But whatever names you want give the foregoing (and seemingly unbelievable) set of facts, it is objectively clear that what began as an “emergency shot glass” of “accommodative” central banks and market “stimulus” can now be objectively diagnosed for what it clearly is: A drunk central bank “addiction.”
A Global Malady
What’s even more extraordinary is that this addiction to printed currencies and free debt is not limited to the US.
The reality of drunk central banks has gone global, from Italy to Australia, and from Germany to Japan, China to Canada (whose central bank is now buying government bonds, corporate bonds and commercial paper).
What a keg party, folks.
As of this writing, the major and drunk central banks of the world are now full-on binging, and as Bloomberg columnists, Simon Kennedy and Samuel Dodge described, “diving deeper into the unknown.”
Here in Europe, the ECB is “experimenting” (like the Bank of Japan) with more negative interest rates (which is a euphemism for a defaulting sovereign bond).
Down under in my dear Australia (as well as in New Zealand and India), its central bank is borrowing from the desperate playbook of Japan (and the US) to “control its yield curve,” which is just a euphemism for printing fake currencies to pay for their own bonds (and hence dampen yields).
Looking Ahead…Getting Drunk with the Fed?
As for looking forward, it is fairly safe to assume (via “forward guidance” from drunk central banks) that the stupid will just get stupider as more and more lose fiat currencies will be created out of thin air to pay for more and more unpayable debts and hence otherwise unwanted bonds.
This week the Fed, the Bank of Japan and the Bank of England will meet to discuss “policy.”
Gee, I wonder what they’ll do?
Given that the only two policy tools for drunk central banks are rate suppression and money printing, we can expect they will see every problem as a nail and begin a hammering away with more of the same two hammers.
Aint drunk central banks predictable?
As of the end of July, drunk central banks around the world had cut interest rates 164 times in 147 days and created over $8.5 trillion in new “stimulus” (i.e. addiction).
As for our own Fed, it’s balance sheet in January was $4 trillion; today the number has skyrocketed to $7 trillion, making the 2008 crisis (and nervous bailout) seem like a small hiccup as COVID provided a hidden pretext to bail out Wall Street, again and with far more “punch.”
Printed dollars and cheap debt are here to stay, and hence the market keg party is raging. No one seems to even be nervous anymore. It’s a full-on party.
According to JP Morgan, the average interest rate around the world is 1%, and for developed nations, this rate has dipped below zero for the first time in history.
Thus, if you’re looking for yield (i.e. return) in the bloated bond market, you’ll have to buy junk bonds, party till you drop and hope for the best.
And get ready for even more dumb, more fantasy, and more central bank can-kicking.
Portfolio Construction in a World of “Stimulus” Addiction
Well folks, there you have it—the New Abnormal.
Drunk central banks are in full-on binge mode and we are all waiting to see when (not if) the QE/Debt hangover will come, and how many investors (as well as currencies) will suffer a fatal overdose when inflation (if accurately reported) gets its last dark laugh over these melt-up markets.
Understandably, the foregoing circumstances may sicken you, but equally understandably, you may be saying to yourselves:
“Hey Matt—thanks for the horror story, but why not just ride this horrific stimulus wave—after all a fat pitch is a fat pitch, even if thrown by a drunken pitcher.”
We get this. Party on, right?
After all, markets love steroids. And as the saying goes: “Don’t fight the Fed.”
Our view, however, is fairly clear when it comes to this Fed: we don’t fully trust it.
We’ve chosen to tread lightly yet intelligently in this surreal period/party of financial addiction, for all the reasons referenced here and elsewhere.
By doing so, we’ve beaten the markets with none of the volatility of Q2.
Could we be wrong?
Could the addiction and drunk central banks and their binge party melt-up continue for years of more easy returns?
Should investors be all in, party on and risk on in a setting of central bank tequila shots, risk be damned?
Possibly. One can hope for the best. That’s entirely up to each of you.
Hope Is Not an Investment Plan
But as Tom always tells me, “hope is not an investment plan.”
That’s why we will manage risk rather than chase uncertain tops, and perhaps lag certain near-term rallies in markets dangerously over-valued and drunk on “accommodation.”
As we’ve learned in more than one extreme market boom-to-bust cycle, real money is made by: 1) not losing it and 2) by buying at bottoms not tops.
For now, the objective risks inherent to the current drunken market experiment are not worth the shaky rewards of more faith in binging.
It’s our opinion that going all-in in “diversified” stocks and bonds in traditional portfolios is akin to investing under the influence—i.e. a really bad idea.
Save the Champagne for Special Occasions, Not Investing
Over the weekend, my team won at the Medoc Polo Club Tournament and I later that evening I enjoyed lots of champagne without falling off the saddle once, a new personal best.
Of course, too much champagne lead to a helluva “morning after.” My old and aching body can still take such lumps, but not our portfolios.
Folks: Invest sober 😊 Leave the binging for a party, not your portfolio.
See you Thursday.
In the interim, stay informed, stay sane and stay safe.
Matt & Tom