The Next Financial Crisis will be Worse than the Last

This piece first appeared in Truthdig.

We’ve made it through 2017. The first-season installment of presidential Tweetville is ending where it began, on the Palm Beach, Fla., golf course of Mar-a-Lago. Though we are no longer privy to all the footage behind the big white truck, we do know that, given the doubling of its membership fees, others on the course will have higher stakes in the 2018 influence game.

The billionaire who ran on an anti-establishment platform went on a swamp-filling, deregulatory and inequality-producing tear, in the process creating the wealthiest Cabinet in modern United States history and expanding his own empire along the way. His offspring, Russia-related investigations aside, didn’t do too shabbily either. White House policy adviser Ivanka Trump’s brand opened a splashy new store in the lobby of Trump Tower in Manhattan, just in time for Christmas.

If you look at the stock and asset markets, as Donald Trump tends to do (and as Barack Obama did, too), you’d think all is fine with the world. The Dow Jones Industrial Average rose about 24 percent this year. The Dow Jones U.S. Real Estate Index rose 6.20 percent. The price of one Bitcoin rose about 1,646 percent.

On the flip side of that euphoria however, is the fact that the median wagerose just 2.4 percent and has remained effectively stagnant relative to inflation. And although the unemployment rate fell to a 17-year low of 4.1 percent, the labor force participation rate dropped to 62.7 percent, its lowest level in nearly four decades—particularly difficult for new entrants to the workforce, such as students graduating under a $1.3 trillion pile of unrepayable or very challenging student loan debt. (Not to worry though: Goldman Sachs is on that, promoting a way to profit from this debt by stuffing it into other assets and selling those off to investors, a la shades of the subprime mortgage crisis.)

Those of us living in the actual world without billionaire family pedigrees possess a healthy dose of skepticism over the “Make America Great Again” sect that believes Trump has transformed America “hugely,” for record-setting markets don’t imply economic stability, nor do 40 percent corporate tax cuts translate into 40 percent wage growth. We can march forward into 2018 carrying that knowledge with us.

But first, a recap. For the U.S. financial system, 2017 was marked by five main themes: The GOP’s “You All Just Got a Lot Richer” Corporate Tax Reduction Plan; Big Banks Still Bad; The Fed’s Minor Policy Shift; Debt; and Deregulators Appointed to Positions of Regulatory Authority.

Banks Are Still Big and Bad

The Big Six banks have paid billions of dollars in settlements for a variety of frauds committed before and since the 2007-2008 financial crisis, but that didn’t keep them from tallying up new fines in 2017. The nation’s largest bank, JPMorgan Chase, agreed to pay $53 million in fines for scamming African-American and Latino mortgage borrowers with disproportionately higher rates than for white borrowers. The Consumer Financial Protection Bureau fined Citigroup $28.8 million for not disclosing foreclosure-avoiding actions. Bank of America got fined $45 million for its foul treatment of a California couple trying to save their home.

But the Big Six bank that received the most attention in 2017, as it did in 2016, was Wells Fargo. The number of people affected by its fake-account creation scandal grew from 2 million reported in 2016 to about 3.5 million. That increase resulted in Wells Fargo expanding its associated class-action settlement to $142 million.

Wells Fargo was mired in smaller scandals, too. For instance, it charged 800,000 customers for auto insurance they didn’t need, raised mortgage rates for certain customers without properly disclosing it was going to, and made a bunch of unauthorized adjustments to people’s mortgages.

No Glass-Steagall Reinstatement, More Deregulation

The idea of reinstating the Glass-Steagall Act of 1933 featured in both the Democratic and the Republican National Committees’ platforms during the campaign season. But Trump’s treasury secretary, Steven Mnuchin, made it clear multiple times there would be no such push from the administration, arguing against doing so before senators including Elizabeth Warren and Bernie Sanders.

To emphasize his disdain for regulation and oversight, Mnuchin also pushed the Financial Stability Oversight Council, over which he presides, to vote 6 to 3 to rescind American International Group’s designation as posing a potential threat to the U.S. financial system. Thus, AIG will no longer be paying penance for its role at the epicenter of the last financial crisis by filing regular risk reports anymore. Federal Reserve Chair Janet Yellen also supported the move.

Consumer Financial Protection Bureau Bashing

In a major blow to citizen security, Richard Cordray, the Obama-appointed regulator, resigned as director of the Consumer Financial Protection Bureau in November.

During his six years at the helm of the CFPB, which the Dodd-Frank Act formed in 2011, the 1,600-person regulatory entity accomplished a lot. It has provided $11.9 billion in relief to consumers for enforcement actions affecting more than 29.1 million people, handled 1.2 million consumer complaints and garnered timely responses on concerns for 97 percent of consumers.

Still, Trump appointed White House budget director Mick Mulvaney to the post that Cordray vacated. Remember: Mulvaney as a congressman wasn’t a fan of protecting consumers. “I don’t like the fact that [the] CFPB exists,” he said. “I will be perfectly honest with you.”

Over at the Office of the Comptroller of the Currency (OCC), Joseph Otting, Mnuchin’s former partner in the takeover of IndyMac and subsequent flurry of foreclosures, was confirmed to the top position. In that spot, Otting will be able to help the Trump administration dial back more post-crisis bank regulations.

The Fed and Debt Bubbles

The Federal Reserve raised rates three times this year. With trepidation that more or larger hikes would cause a market meltdown (because cheap money has lifted banks and markets over the past decade), each time the Fed acted, it did so by the smallest sliver it could—25 basis points. All told, this brings the total rate hikes of 2017 to 75 basis points. The short-term interest rate now sits in a 1.25 percent to 1.5 percent range.

As part of its rate-hike-into-strength message, the Fed forecast that the job market and economy will further improve in 2018. Trump’s appointed Fed leader, Janet Yellen’s No. 2 man, Jerome Powell, will take stewardship of the Fed in February 2018. Policywise, he will do exactly what Yellen and Ben Bernanke did before him, given that’s how all his votes went—albeit while advocating less oversight of the big banks. That’s because cheap money turbo-boosts the stock market, and quick rate hikes can harm the bond markets.

The reality is that the Fed and the administration are scared that selling too many bonds back into the capital markets will result in broader sell-offs, which could lead to another credit squeeze and possible recession, not to mention losses for the big banks exposed to those corporations.

Zombie Companies

Fueled by cheap Fed money and low rates, the amount of outstanding corporate debt has nearly doubled from pre-crisis levels of $3.4 trillion to record levels of $6.4 trillion.

By Oct. 1, U.S. investment-grade corporate debt issuance had already surpassed $1 trillion—beating 2016’s pace by three weeks. The amount of speculative-grade (or junkier) corporate debt issued during the first three quarters of 2017 was 17 percent higher than over the same period in 2016. Altogether, that means that U.S. corporate issuance is set for another record year, as well as the sixth consecutive year of increased corporate debt issuance.

As history has shown us, all bubbles pop. Until then, certain companies are the equivalent of the living dead. The Bank of International Settlements (BIS), or central bank of global central banks, defines zombie firms as “firms that could not survive without a flow of cheap financing.” The latest BIS Quarterly Report labeled one of every 10 corporations in emerging (EME) and advanced countries as a “zombie.”

Corporate debt of nonfinancial U.S. companies as a percentage of GDP has surged before each of the last three recessions. This year, it reached 2007 pre-crisis levels. That didn’t end well last time. Plus, now, that debt has been powered by central banks the world over.

And whereas, in the past, companies used some of their debt to invest in real growth, this time corporate investment has remained relatively low. Instead, companies have been on a spree of buying their own stock, establishing a return to 2007-level stock buybacks.

Corporations and Taxes

Companies have taken advantage of cheap money to increase their debt and buy their own stock, even though Trump and the GOP peddled the notion that decreasing their tax rate by a whopping 40 percent would move them toward diverting their money from the stock and bond markets into jobs and wages.

The GOP tax bill cuts the corporate tax rate from 35 percent to 21 percent. Collectively, large U.S. companies only pay an average effective tax rate of 18 percent anyway. They only contribute 9 percent to the overall tax receiptsthe U.S. government receives each year.

Companies like General Electric haven’t paid any taxes in a decade. But more to the point, that tax cut is another form of cheap money giveaway. Even Jamie Dimon, chairman and CEO of JPMorgan Chase, concurred. He called the tax cut a “QE4” (another round of quantitative easing, added to the three rounds the Fed executed over the past decade to reach $4.41 trillion in credit).

Looking Ahead to 2018

As we enter the new year, consider this: All the Fed talk about “tapering” or reducing the size of its book, and even the 75 basis points of rate hikes, are a setup for the next act of the same play.

Since the Fed’s announcement that it was going to stop reinvesting the interest payments on the bonds it’s holding, the size of its book has been about the same. There’s always a mismatch between what the Fed says and what it does.

So despite its tapering talk, the Fed’s balance sheet is down a mere $10 billion (an equivalent of a rounding error) this year. Its book of assets remains at $4.41 trillion, a figure equivalent to 23 percent of U.S. GDP. Incoming Fed Chair Powell is more likely to keep supplying cheap money than withdrawing it from the markets in the instance of any wobbles.

What does that mean? Financially speaking, 2018 will be a precarious year of more bubbles inflated by cheap money, followed by a leakage that will begin with the bond or debt markets. The GOP tax cuts won’t technically kick in monetarily for corporations until after the year is over in 2019, but the anticipation of extra funds will fuel more buybacks. This will help to provide cover for any rate hikes the Fed implements, because it provides corporations the ability to boost their own share prices further.

Meanwhile, the Treasury Department, Federal Reserve and other smaller regulatory authorities in Washington will push for greater deregulation of the financial systems and banking industry on any level possible. If there is another financial crisis in 2018 or later, it will be worse than the last one because the system remains fundamentally unreformed, banks remain too big to fail and the Fed and other central banks continue to control the flow of funds to these banks (and through to the markets) by maintaining a cheap cost of funds.

Politically, no one in any position of the most power will do anything to fix any of this. It's up to us to push it.

Four Factors Behind Rising Volatility And How To Deal With Them

No one could have predicted the sheer scope of global monetary policy bolstering the private banking and trading system. Yet, here we were - ensconced in the seventh year of capital markets being buoyed by coordinated government and central bank strategies. It’s Keynesianism for Wall Street. The unprecedented nature of this international effort has provided an illusion of stability, albeit reliant on artificial stimulus to the private sector in the form of cheap money, tempered currency rates (except the dollar - so far) and multi-trillion dollar bond buying programs. It is the most expensive, blatant aid for major financial players ever conceived and executed. But the facade is fading. Even those sustaining this madness, like the IMF, are issuing warnings about increasing volatility.

We are repeatedly told these tactics benefit broader populations and economies. Yet by design, they encourage hoarding, or more crafty speculative behavior, on the part of big financial firms (in the guise of obeying slightly adjusted capital rules) and their corporate clients (that largely use cheap funds to buy their own stock.) While politicians, central banks and multinational government-funded entities opine on “remaining” structural weaknesses of certain individual countries, they congratulate themselves on having staved off more acute crises.  All without exhibiting the slightest bit of irony. 

When cheap funds stop flowing, and “hot” money shifts its attentions, as it invariably and inevitably does, volatility escalates as it is doing now. This usually signals a downturn, but not before nail-biting ups and downs in the process.

These four risk factors individually, or collectively, drive rapid price fluctuations. Individually, they fuel market volatility. Concurrently, they can wreak far greater havoc:

1. Central Bank Policies
2. Credit Default Risk
3. Geo-Political Maneuvering
4. Financial Industry Manipulation And Crime

Events that in isolation don’t impact markets severely can coalesce with more negative results. This is important to understand when prioritizing personal investment decisions. In this two-part report, I will outline driving forces behind today’s volatility and provide suggestions as to what you can do to protect yourself, and even thrive, going forward.

Take Central Banks First

Two weeks ago, stock and bond markets dipped when Federal Reserve Chair Janet Yellen announced, “equity market valuations at this point generally are quite high."  She admitted,  “There are potential dangers." She saw no bubble. The Fed continues to claim its policies have fostered sustainable - if slow – growth for the mainstream economy.

This wasn’t the first time Yellen has said as much. It won’t be the last. In November 2013, she saw no equity or real estate bubble, either. In July 2014, at an IMF lecture, she said the Fed wouldn’t raise rates just to burst bubbles, rather when the US has a healthy job market with stable prices.  She has assumed Ben Bernanke’s mantras in this regard.

Each time she speaks, the media enters interpretation overdrive and markets react similarly. They drop initially, then rebound to slightly lower levels than before. The pattern is becoming increasingly pronounced, though, as is the associated volatility.

Recent volatility spikes underscore the fragility of markets inhaling cheap money due to the global central bank policies that began with the US Federal Reserve, and spread to the European Central Bank, the Bank of Japan and the People’s Bank of China.  The IMF has recently stated that, despite rising volatility, a dose of “QE-Plus” may be needed.

Since the beginning of 2015, the stock market has fluctuated between new highs and turning negative for the year. Movements are mostly linked to the rate hike timing guessing game, amidst a roster of other commonly circulated “threats” from Grexit to erratic oil price behavior. Associated speculation is marked by lengthy media debates about what the word ‘patience’ means regarding Fed talk on rate hikes and smatterings of the realization that artificially stimulated markets don’t promote real long-term growth.

Growing Credit Risk

Yellen also mentioned "compression of spreads on high-yield debt, which certainly looks like a reach for yield type of behavior.” Obviously.  When high-grade debt interest rates are low, the only place to grab yield is in riskier securities. A credit bubble develops. This awareness has not been met with deterrent policy though, leaving the propensity of compressed spreads (and credit default spreads) to blow out (widen) from these levels.

The Fed’s goalposts on rate hikes keep changing. Globalization of low to negative interest rates and dampening of currency exchange rates relative to the dollar has helped keep US rate policy where it is, though the Fed doesn’t say this. The Fed’s zero-interest-rate and QE policy has propped markets, encouraged corporate share buybacks, caused yield seekers to buy riskier securities, and provided banks incentives to leverage it all.

Yellen isn’t wrong in her diagnosis; she’s just ignoring the Fed’s role in it. So is every other central bank and multinational entity. They offer liquidity crack and then wonder why junkies multiply. The Fed missed the last bubble and is missing this one. Meanwhile, the rate-hike guessing game increases market volatility.

From Geo-Politics to Manipulation

Excessive speculation also provokes volatility, especially as enacted by the major market players that control the narrative and the trading volume. This occurs with stocks, bonds, and commodities.  Often such moves rely on geo-political tensions as a cover.

When the US and its Euro-friends slapped economic sanctions on Russia over its actions in the Ukraine, the fallout was used to explain weaker market days.  Oil price drops were partially attributed to Middle East tensions, ostensibly because OPEC didn't agree to withhold production. They were also used to explain Russian economic weakness, allowing the Obama administration to gloat about the success of its sanctions.

Energy volatility, widely reported as oil price movements, can impair household budgets and the overall economy. When oil prices are elevated, associated household costs rise. When they drop, media stories about resultant layoffs can dampen markets and household investments in them. To the extent that prices are manipulated in either direction by financial players and not end-producers or users, they cause excessive volatility.

Big banks don’t care about any of this. They have the capital and global agility to leverage whatever situation arises. If Russia is weak, head to Latin America. If US hedge funds force Argentina into technical default, press Obama to lift sanctions and head to Cuba. It’s a merry-go-round of institutional speculation followed by volatility and decline.

Financial firms, including banks, hedge funds and less regulated players, exert tremendous power through leveraging capital, trading positions and public predictions. They can hype up prices to attract money into their market of choice and quickly reverse course, aided by a media eager to follow the story-du-jour for page-views or ratings.

The power of the large trading players to move prices remains vast. The Big Six US banks control 97% of all trading assets in the US banking system and 95% of all derivatives. Thirty Globally Systemically Important Banks (GSIB’s) control 40% of lending and 52% of assets worldwide. As volatility rises, ongoing concentration in these still-too-big-to-fail entities that can manipulate financial markets, produces triple digit stock market swings that capture headlines and stoke people’s fears.

Subsidization for the elite banking class can’t last forever. But it has already overstayed its welcome many times over, so predicting a specific end date is not easy (though I’m going with mid-2016, when the ECB will be done with this round of bond-buying.) In the interim, rising volatility signals an unraveling of current polices that can’t be ignored.

The uncertainty surrounding the inevitability, if not the exact timing, of multiple and possibly overlapping volatility drivers is itself a source of volatility. For the average person, these signs can be scary. Taking steps to avoid the circus as much as possible, such as extracting money from the markets, securing personal assets, and waiting out the swings, can be a source of emotional comfort and future financial stability.

(This Piece was Part 1 of a two-part piece marking the inauguration of my partnership on such topics with Peak Prosperity)

Why the Financial and Political System Failed and Stability Matters

The recent spike in global political-financial volatility that was temporarily soothed by European Central Bank (ECB) covered bond buying and Bank of Japan (BOJ) stimulus reveals another crack in the six-year-old throw-money-at-the-banks strategies of politicians and central bankers. The premise of using banks as credit portals to transport public funds from the government to citizens is as inefficient as it is not happening. The power elite may exude belabored moans about slow growth and rising inequality in speeches and press releases, but they continue to find ways to provide liquidity, sustenance and comfort to financial institutions, not to populations.

The very fact - that without excessive artificial stimulation or the promise of it - more hell breaks loose - is one that government heads neither admit, nor appear to discuss. But the truth is that the global financial system has already failed. Big banks have been propped up, and their capital bases rejuvenated, by various means of external intervention, not their own business models.

In late October, the Federal Reserve released its latest 2015 stress test scenarios. They don’t even exceed the parameters of what actually took place during the 2008-2009-crisis period. This makes them, though statistically viable, completely irrelevant in an inevitable full-scale meltdown of greater magnitude. This Sunday, the ECB announced that 25 banks failed their tests, none of which were the biggest banks (that received the most help). These tests are the equivalent of SAT exams for which students provide the questions and answers, and a few get thrown under the bus for cheating to make it all look legit. 

Regardless of the outcome of the next set of tests, it’s the very need for them that should be examined. If we had a more controllable, stable, accountable and transparent system (let alone one not in constant litigation and crime-committing mode) neither the pretense of well-thought-out stress tests making a difference in crisis preparation, nor the administering of them, would be necessary as a soothing tool. But we don’t. We have an unreformed (legally and morally) international banking system still laden with risk and losses, whose major players control more assets than ever before, with our help.  

The biggest banks, and the US and European markets, are now floating on more than $7 trillion of Fed and ECB intervention with little to show for it on the ground and more to come. To put that into perspective – consider that the top 100 global hedge funds manage about $1.5 trillion in assets. The Fed’s book has ballooned to $4.5 trillion and the ECB’s book stands at $2.7 trillion – a figure ECB President, Mario Draghi considers too low. Thus, to sustain the illusion of international systemic health, the Fed and the ECB are each, as well as collectively, larger than the top 100 global hedge funds combined. The BOJ has joined the fray wit its own path to QE. 

Providing ‘liquidity crack’ to the global financial system has required heightened international government and central bank coordination to maintain an illusion of stability, but not true stability. The definition of instability is this epic support network. It is more dangerous than in past financial crises precisely because of its size and level of political backing.

During the Panic of 1907, President Teddy Roosevelt’s Treasury Secretary, Cortelyou announced the first US bank bailout in the country’s history. Though not a member of the government, financier J.P. Morgan was chosen by Roosevelt to deploy $25 million from the Treasury. He and a team of associates decided which banks would live or die with this federal money and some private (or customers’) capital thrown in.

The Federal Reserve was established in 1913 to back the private banking system in advance from requiring future such government injections of capital. After World War I, a Laissez Faire policy toward finance and speculation, but not alcohol, marked the 1920s. before the financial system crumbled under the weight of its own recklessness again. So on October 24, 1929, the Big Six bankers convened at the Morgan Bank at noon (for 20 minutes) to form a plan to 'save' the ailing markets by injecting their own (well, their customer’s) capital.  It didn’t work. What transpired instead was the Great Depression.

After the Crash of 1929, markets rallied, and then lost 90% of their value. Liquidity froze. Credit for the masses was as unavailable, as was real money. The combined will of President FDR and the key bankers of the day worked to bolster people’s confidence in the system that had crushed them - by reforming it, by making the biggest banks smaller, by separating bet-taking arms from those in which people could store, and borrow money from, safely. Political and financial leaderships collaboratively ushered in the reform measures of the Glass-Steagall Act.  As I note in my most recent book, All the Presidents' Bankers, this Act was not merely a piece of legislation passed in spirited bi-partisan fashion, but it was also a means to stabilize a system for participants at the top, middle and bottom of it. Stability itself was the political and financial goal.

Through World War II, the Cold War, and Vietnam, and until the dissolution of the gold standard, the financial system remained fairly stable, with banks handling their own risks, which were separate from the funds of citizens. No capital injections or bailouts were required until the mid-1970s Penn Central debacle. But with the bailout floodgates reopened, big banks launched a frenzied drive for Middle East petro-dollar profits to use as capital for a hot new area of speculation, Third World loans.

By the 1980s, the Latin American Debt crisis resulted, and with it, the magnitude of federally backed bank bailouts based on Washington alliances, ballooned. When the 1994 Mexican Peso Crisis hit, bank losses were ‘handled’ by President Clinton’s Treasury Secretary (and former Goldman Sachs co-CEO) Robert Rubin and his Asst. Treasury Secretary, Larry Summers via congressionally approved aid.

Afterwards, the repeal of the Glass Steagall Act, the mega-merging of financial players, the explosion of the derivatives market, and the rise of global ‘competition’ amongst government supported gambling firms, lead to increase speculative complexity and instability, and the recent and ongoing 2008 financial crisis.  

By its actions, the US government (under both political parties) has chosen to embrace volatility rather than stability from a policy perspective, and has convinced governments in Europe to follow suit. Too big to fail has been replaced by bigger than ever.

Today, the Big Six US banks are mostly incarnations of the Big Six banks in 1929 with a few add-ons due to political relationships (notably that of Goldman Sachs, whose past partner, Sidney Weinberg struck up lasting relationships with FDR and other presidents.) 

We no longer have a private financial system responsible for its own risk, regardless of how it’s computed or supervised. We have a system whose risk is shouldered by the federal government and its central bank entities, and therefore, the people whose deposits seed that risk and whose taxes and futures sustain it.

We have a private financial system that routinely commits financial crimes against humanity with miniscule punishments, as approved by the government. We don’t even have a free market system based on the impossible notion of full transparency and opportunity, we have a publicly funded betting arena, where the largest players are the most politically connected and the most powerful politicians are enablers, contributors and supporters. We talk about wealth inequality but not this substantial power inequality that generates it. 

Today, neither the leadership in Washington, nor throughout Europe, has the foresight to consider what kind of real stress would happen when zero and negative interest rate and bond-buying policies truly run their course and wreak further havoc on their respective economies, because the very banks supported by them, will crush people, now in a weaker economic condition, more horrifically than before.

The political system that stumbles to sustain the illusion that economies can be built on rampant financial instability, has also failed us. Past presidents talked of a square deal, a new deal and a fair deal. It’s high time for a stability deal that prioritizes the real financial health of individuals over the false one of financial institutions.