The financial crisis: a debt bubble

By jchaifetz

Retirement Income Network


My point is that we have not learned any lessons. Right now we are in a debt bubble.

The problem with bubbles is that when you are in one, you can’t see it. It’s easy to look back on the housing bubble and say, “How did we not realize it? It is so obvious now.”

How did we not realize that housing is not guaranteed to go up? How did we not realize that negative amortization interest only loans could cause problems? How did we not realize that no money down, liar loans could come back to bite us? How did we not realize that not everyone should be able to afford a $400,000 house?

I am as guilty as anyone. I currently own — and I use that term loosely — two condos in the Atlanta market. My point is that when you are in the bubble, it makes sense.

Right now, the world is in a crisis, although the average person wouldn’t know it. I think the average person believes that we had a financial crisis in 2008 and that we are in a slow recovery right now. Most people recognize that the market has been volatile recently, but it’s easy to brush off since it up almost 90 percent since the March 2009 lows.

I argue that we have had no recovery at all. In fact, the market is actually lower today than it was in 2009 (more on that in a minute). The Fed, European Central Bank and other central banks around the world have printed money and taken on more debt to solve the problem. Explain to me how you can solve a debt and over-leveraged crisis with more debt.

Most of us realize that it was in part the housing bubble as well as leveraged bets and credit default swaps that got us into this mess. We now have a massive national debt in this country. Currently, the debt is over $15 trillion dollars. That number is so big that the human brain cannot understand it.

We are solving a debt crisis with more debt. That’s like saying we should solve the housing crisis with more housing. The argument would go something like this:

“Sure, housing is in trouble, but if we build more houses now, we will put that whole sector back to work from the carpenter and electrician to the mortgage and real estate agent. The housing sector is such a big part of our economy that if we build more houses it will stimulate the entire economy. There will be more people with income who could then buy those houses. This will in turn make the housing market rebound and everything will go back to normal or better. “

As I am writing this, it almost sounds like a good idea, and if we were in 2007, we would probably all believe this. I know I would have given it some real thought.

However, now that we are on the outside of that bubble, we know that building more houses now is not a good idea. We have a glut of housing with more foreclosures coming — so the smart thing is to not build now. It’s so crystal clear that building high-rise condominium complexes would be a poor investment for anyone right now and that it would not solve the housing crisis.
My point is that we have not learned any lessons. Right now we are in a debt bubble. The bubble is being stroked by artificially low interest rates that cannot be contained forever. Every time there is a problem, we see the Fed, ECB, etc. step in and stimulate, whether it is by quantitative easing (printing money and creating debt), or lowering the fees and prices on dollar swaps.

We are building houses at the end of the housing market bubble and we are doing it at an exponential rate. What is going to happen when no one will buy our debt? We will have to raise interest rates to encourage new buyers. This will raise interest rates on borrowers and cause the whole system to crash.

Let me give you an example:

Tom just received his adjustable rate mortgage rate renewal on his variable mortgage. He was ecstatic to see his rate go from 5.875 percent to 3.25 percent. His payment is going down slightly, although now he is moving from interest only to principle and interest so the payment is about the same.

The good news is that he is at least beginning to pay down his mortgage. However, since he is $100,000 underwater, the $200 per month that he pays down is not going to help any time soon. Tom’s a sharp guy and would like to refinance, but he is too far underwater to do so. He figures he has no choice but to ride the storm out.

The real problem lies with what is Tom going to do when rates go the other way. What if he can no longer afford his own home when rates are at 5 percent, 6 percent, 7 percent or higher? He won’t be able to sell because he is underwater on his mortgage so he will be forced to foreclose. The problem is that Tom is not the only guy on the street with this problem.

I am getting a little off topic at this point, but I wanted to demonstrate how fragile a situation we are in right now. I mentioned earlier that I would get back to the fact that I believe that the market is actually lower now than it was in 2009. If we compare the S&P 500 in terms of ounces of gold we are below those lows. It would have taken .69 oz of gold to buy the S&P 500 in March 2009. Today we are right around .68 oz of gold.

Without going into a long debate on gold, the point is that the dollar is being devalued so much right now because we are printing money and creating more debt. It feels good to have the S&P 500 at a higher number; it’s too bad it doesn’t mean anything.

This does, however, fuel the bubble, because the idea is that if we print more money, the S&P 500 in nominal terms will go up which means people’s portfolios and bank accounts will go up. They will then feel richer, which means they will spend more money, thereby stimulating the economy and getting us going again the way we were over the last three decades.

Since we are currently in a debt bubble this idea seems grand. In fact, I almost believe it.

Whenever bubbles implode, and they always do, it becomes obvious that what we were doing did not make sense. We will ask similar questions as we did after the housing market. How did we not see this? How did we not realize that you could not fix a debt bubble with more debt? It’s so obvious now.

Now is the time to protect yourself.