This Is Another “Subprime” Waiting to Blow

By Bill Bonner, Chairman, Bonner & Partners:

Dow down 239 points yesterday – or 1.5% – after Japan posted its biggest one-day gain in seven years. This is getting interesting again. If it is just “volatility,” as Wall Street’s shills in the press maintain, it will probably pass soon. Everything will be okay. Back to routine imbecility before the end of the month.

But if these whipsaw movements are heralding a bear market, U.S. stock prices could be cut in half… or more. And they may not recover for 10 to 20 years. (Catch up on the details of our bear market forecast here.)

Bull or Bear?

Which is it? Bull or Bear? No one knows, of course. But it looks to us as though the whole shebang is getting ready to collapse. So far, the correction has trimmed $12.5 trillion off the value of global stock markets. There are a few reasons for stocks to go back up… and many reasons why they might want to go down further.

The 2008 global financial crisis was centered on mortgage debt. There was too much of it that couldn’t be repaid. When the value of the collateral – homes – headed down, the bubble popped.

Today, consumers have about the same amount of debt. But now the excesses are in auto loans and student debt. As you can see below, total auto loans stood at about $781 billion in 2007. Today, they’ve topped $1 trillion. And student loans have more than doubled over that time to $1.3 trillion.

091015 DRE Student and Auto Loan Debt Chart

Again, the collateral is falling in value. Used-car prices fall, as leases expire and more used cars hit the market. As for student debt, the “collateral” is the earning power of the person who borrowed the money.

And here’s a hint of what is happening to that. According to the Center for Immigration Studies, all of the net gains in jobs since 2007 have gone to immigrants – both legal and illegal. And the vast majority of those jobs have been gained in the hospitality industry – waiters, greeters, busboys, etc. (low-wage jobs).

That’s why student loan default rates are soaring. The “collateral” isn’t as good as lenders thought it was.

A Mountain of Maturing Debt

But today, we’re going to look at corporate debt, which has risen to $5.2 trillion from $3.2 trillion in 2007. As we’ve been reporting, C-suite cronies have been taking advantage of the Fed’s ultra-low rates to borrow money… buy back shares in their own companies… and pay themselves fat bonuses as the remaining shares go up in price.

(When corporations buy back shares, they cancel them. This automatically raises the earnings per share of the outstanding shares and increases their value.)

But that scam could be about to come to an end. Reports the Financial Times:

With a $4 trillion mountain of debt maturing over the next five years, corporate America’s reliance on cheap cash is about to get tested.U.S. corporate treasurers have rushed to lock in cheap borrowing costs in advance of the expected rate rise, refinancing more than $1 trillion each year between 2012 and 2014, according to Standard & Poor’s.

Tighter borrowing conditions will mark a turning point in the recent debt binge. Companies have had easy access to cash to write checks for multibillion-dollar takeovers, to fund buybacks and dividend strategies – all welcomed by investors as share prices rallied off 2009 lows.

But as rates turn higher, investors may see the flip side of cheap financing. Analysts warn companies will begin defaulting in greater numbers, particularly in the energy sector, which has found itself in the line of fire as commodity prices languish.

Rotting Fruit

You will hear from the talking heads that America’s corporate sector has never been in better shape. But like a peach, the fruit never looks better than just before the rot sets in. Here’s what really happened…

Thanks to a generous Fed, since the financial crisis hit, companies have been able to borrow at interest rates so low you need to get on your hands and knees to find them. And they used much of this borrowed money to boost their share prices via buybacks. Hey, presto! The trick is done right in front of our eyes.

Stock prices rise. And as stock prices rises, companies’ debt-to-equity ratios – which show how much debt they are using to finance growth relative to the value of their shareholders’ equity – improve. The companies may have more debt… but they have a higher share price to justify it.

When the mortgage debt bubble blew up in 2007, it was the weakest segment – subprime – that detonated first. It will be no different in the corporate sector. Here’s the FT again, on subprime corporate debt:

Moody’s and S&P warn that defaults are likely to increase in the coming years as interest rates rise, a concern echoed by bond funds such as Pimco. Analysts with S&P expect defaults among junk-rated U.S. companies to hit 2.9% by June 2016, nearly twice the rate in 2013.Moody’s list of companies rated B3 with a negative outlook or lower – its lowest rating rungs in the “speculative” space – eclipsed 200 for the first time since 2010 in July.

Corporate earnings have started to plateau this year. And share prices are no longer steadily rising as they have been since the last bear market bottomed in 2009. What happens when lenders are no longer willing to extend credit to corporations?

We know exactly what happens – because it happened twice before in this century. In the run-up to the 2000 and 2008 stock market peaks, stock prices rose, and the fruit looked juicier and juicier. Then credit collapsed, stock prices plunged, and things headed back to a more normal situation – until the feds got in on the act again.

Our advice: Eat the peach now. By Bill Bonner, Bonner & Partners

Alas, monetary policies will be “ineffective” in dealing with the next global issue, according to Investment Bank Natixis. Read… Global Economy Nearing a “Structural Recession”

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  15 comments for “This Is Another “Subprime” Waiting to Blow

  1. LG says:

    Dad “2009” : son you should get a student loan and go to school while jobs are hard to get . It’ll pay for your room, food and a new car.
    When you get a job you just pay it all back. Ok dad thanks.
    6 years later. Son you’ve been sitting on your ass for two years on my couch so go and get a job! Dad, there are no jobs in my degree, they were wiped out in 2009.
    The End

    • Nick says:

      I quit a semi-decent (barely) job in 2007 to go back and do a second masters . . . It took my almost 5 years to find a job in the field, and start getting my career on track. That was an awful time, it would have wiped me out and my family too if I hadn’t had the good fortune to marry a Thai woman with a nice place we could hole up in for a few years . . . it was worth it too, in the end, for my first degree was anthropology and the second public health. I would have borne any misery to not have to apply for jobs as an anthropologist the rest of my life . . .

  2. NotSoSure says:

    What’s not being asked here is what happens if it’s QE Infinity?

    • Sabbie says:

      They can’t do QE to infinity because that would require infinite faith, but as the system becomes more unstable, panic is likely to set in at some point. They have only the illusion of control.

    • Peepot says:

      It has to be QE to infinity. It is impossible to stop

  3. Brett says:

    QE to infinity, does that mean we all get really rich like the good people at GS busy doing Gods work?

  4. Bill H says:

    There is so much debt in every sector- student loans, housing, autos, government, pensions, etc – It is unfathomable to think that the Matrix that we currently live in could somehow survive anything but a complete write off. Anything short of that is folly. The banksters will fight tooth and nail to not allow that to happen because debt makes us their slaves. That leads us to the final question: when will the people start assembling the guillotines?

  5. Michael Boelens says:

    “Bankers are educated and trained in, but seldom deviate from the sound banking principles that have gotten us where we are today.” ~ Michael Boelens / Author: “Think and Think Again.”

    Oh, and where are we today? Living in fantasy world ….creating perceptions that have no real basis.

  6. Paulo says:

    I am about 1/2 through a very interesting book entitled: “Circle of Friends” by Charles Gasparino. The descriptor on the front of the book cover says: ” The massive federal crackdown on insider trading-and why the markets always work against the little guy”. I am currently at the point where they discuss the rise of Hedge Funds, and the actual manipulation of markets with inside information including the convenient buy and sell dates that have magically enriched a few. Martha Stewart has already been releasd from Fed-Club Cupcake and they are now circling the investigations around Steve Cohen from SAC Hedge Fund. I highly recommend this book. It is extremely interesting.

    The big contention in this book is the following question. (Indeed, the author comes right out and asks this several times): Why go after Insider Traders when the obvious criminals are those big Wall Street investment banks who are gaming the entire economy? So far it seems that political connections stop the investigations in their tracks. Often, the Hedge Funds and JP Morgans of the ‘Force’ quietly pay a fine and go back to their shady grubby ways. Like I said, fascinating.

    By the way, regular investors are scoffed and scorned at, including those financial advisor brokers who look after your retirement plans/dreams. I am 60 and now in the process of converting my few remaining RRSP (Canadian here) into a graduated income stream (RIF) to be re-deposited into simple term depsosits where my hard earned savings may or may not keep up to inflation, (Thanks ZIRP and Wall Street for screwing up even the interest income of the little people to enrich your bloated bellies).

    This whole system is a joke headed for a horrible reset in my opinion. I suspect plans are already afoot by the TBTF investor banks and their political minions to vacuum up what is left, (Oh yeah, bail-ins).

    Good thing my needs are few and my wants are even fewer. If they come for my house it would have to be an occupying army.

    I won’t have to tell you how it turns out. We are that close.


    • Petunia says:

      I have read all of Gasperino’s books. I find them more interesting for what they don’t say than what they do say. Please note that Eric Holder, the attorney general, was a banker’s lawyer, and put in charge of the Just Us Dept to make sure none of his clients would be prosecuted. Now he is back at his old firm cashing in on all his good work.

      BTW, I consider the Martha Stewart case a setup. Somebody wanted her company. What she was convicted of I saw almost daily.

    • Meg says:

      In a more spiritual note, I’m reading ‘The Harbinger’ and the ‘Mystery of the Shemitah”…from Jonathan Cahn and hoping God will take care of Wall Street… Just sooooo tired of working hard while ‘they’ get rich.

  7. We usually can get the What right, but the When remains unknown. It’s never paid to bet against America, or Canada for that matter; it won’t change soon. Go ahead, think it through – America hits the Reset button after a world panic and crash. Who wins, who looses, what does America do, what actually is the outcome, . . . and what have Warren’s actuaries been telling him for a long time?

  8. BradK says:

    My only observation about auto loans Vs. student loans is that an automobile is pretty much a necessity unless you live in an urban area and, unless wrecked or inoperable, will always have some value. If the loan for a newer car is defaulted the bank will simply repossess. And since auto prices are not nearly as elastic as home prices, were this bubble to burst, the damage would be nowhere near what we saw with housing. Or before that, with the dot com equities market and its irrational valuations.

    Student loans are altogether different. Here, the cost is increasing YOY at some multiple of the standard inflation (or in spite of a lack of) while the product being purchased (degree) is decreasing in value. As more and more middle class and professional positions are consolodated or sent overseas, the glut of degree holders (especially recent ones) either un or under employed and carrying high 5 to 6 figure loans is growing.

    Whether it unwinds slowly or gradually, this will not end well.

    • d says:

      Those easy student loans in useless degrees, are there for a reason, they are going to create another generation, perhaps 2, of employed, sort of, renters, how else will TBTJ keep all those overpriced properties tenanted.

      Then just before they fall down, around 40 years from now, they will sell them off in another, overpriced, wright to buy, sub prime scheme.

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