red and blue light streaks
The Financial Times reported Friday morning that the big banks that Wall Street is betting on are failing in private credit markets. It's something that New Republic writer Logan McMillen is sounding the alarm about because it is the same thing that happened in the 2007 and 2008 global economic collapse.
This week, the Federal Reserve likely freaked out economic experts when it demanded the largest banks "detail their exposure to the opaque, multitrillion-dollar private credit market," said McMillen. "Then, almost simultaneously, word broke that some of those same banks are imminently launching a credit default swap index with S&P Global, targeting that same market."
McMillen cautioned that the U.S.'s macroeconomic program is quickly falling apart under the stress of President Donald Trump's war against Iran, the closure of the Strait of Hormuz and the rise in inflation.
It comes as the "U.S. Treasury is now desperately trying to finance a $1.9 trillion deficit without a large pool of captive foreign buyers. Trump "failed to prepare" for the crisis. A former Trump strategist told CNN last month that the president thought Iran would be just as easy as Venezuela was.
Nate Swanson, a former Trump staffer and current senior fellow and director of the Iran Strategy Project at The Atlantic Council, assumes that Trump thought the whole operation would be easy and he'd be successful
Trump was coming off a "win" from his June strikes and from capturing Venezuelan leader Nicolás Maduro. In the past, Trump was able to kill Iranian military officer Qasem Soleimani "with virtually no repercussions," said Swanson.
Trump has done nothing to prepare for the closure of the Strait of Hormuz, and worse, he's done nothing to protect the U.S. economy from the ensuing disaster after the bombing began.
"China is dumping U.S. Treasuries at a rate not seen since the Global Financial Crisis, while stalwart buyers like Japan are seeing their bond yield rates creep up to their highest levels in 27 years," said McMillen, explaining it isn't healthy for the macroeconomy.
What happens this weekend might mark a shift that will be felt for at least a year or more "in the form of a liquidity crisis."
"The Fed’s request that major banks detail their exposure to the private credit market should terrify risk assessors. When macroeconomists picked through the rubble of 2008, many landed on the conclusion that there had been a catastrophic mispricing of risk," McMillen said.
Credit rating agencies continued to claim that toxic subprime mortgages were somehow AAA-rated. Regulators in 2008 at the very least knew where the underlying assests were, McMillen explained. That isn't happening with the $2 trillion private credit market. It's a black box hidden in "regulatory shadows to facilitate high-risk corporate loans that traditional banks were forced to abandon after the passage of Dodd-Frank."
A major indicator of danger comes from a March Politico report revealing that investors are pulling their money after a "string of blow-ups." At the same time, the world of artificial intelligence has posed a risk to some software companies. So, investors are growing so worried that they're pulling their money out to such an extreme that they hit withdrawal limits.
Those limits on withdrawals "from many of these private funds tell us there’s a bank run taking place behind the velvet ropes, in the VIP section," cautioned McMillen.
So, Wall Street is offering a product for another possible crash. In 2008, "credit default swaps" played a significant role in the collapse of the housing market. Now they're being introduced into the $2 trillion market at a time when there is a "liquidity crisis." It's also happening as the Federal Reserve admits it doesn't understand what's going on and has asked banks to detail their exposure to the private credit market. McMillen described it as a kind of "mirror maze of transactions for regulators to navigate."
For about 12 to 18 months in 2007, a small handful of mortgage defaults proved capable of triggering a cascade of multibillion-dollar payouts across the globe." These were after the ABX index (Asset-Backed Securities Index) was created. It was a kind of "synthetic collateralized debt obligation market" that ultimately reached $5 trillion in value. It was just one kind of "credit-default swaps.) Investors were then able to make bets on those investments"without ever owning the underlying asset."
It ultimately led to "a small handful of mortgage defaults ... triggering a cascade of multibillion-dollar payouts across the globe," said McMillen.
Now, the same thing might happen again, only with the private credit market that handles $2 trillion in corporate debt.
"Wall Street is once again seeding flammable barrels of fictitious capital in the financial sector, virtually guaranteeing that if the underlying loans bomb, the blast radius will be much larger than the asset class itself," wrote McMillen.
In 2008, "there was still an 'adult' in the room," he explained. Now, the U.S. is a mess fiscally, and when it comes to foreign relationships, the president isn't winning a lot of friends. Back then, McMillen said that the U.S. had a "clean-enough balance sheet" to navigate the losses and keep things moving.
"Today, U.S. government debt is equal to 122 percent–124 percent of annual gross domestic product," he cautioned. "In the past, this was manageable because the petrodollar paradigm forced the rest of the world to buy U.S. Treasuries. But with the Carter Doctrine scuppered, the Strait of Hormuz closed, and the State Department weaponizing the SWIFT system through sanctions, those once-captive buyers are finally beginning to abandon the U.S. dollar."
It means the U.S. "will be backed into a corner with only a few viable exits." It means the banks would have to be bailed out for the second time in 20 years to prevent a global collapse. The American dollar and credit outlook would be the casualty while everyday people are forced into an "austerity crisis."
"When the domestic economy faced the last crisis of this magnitude, in the late 1970s, Fed Chairman Paul Volcker hiked interest rates, intentionally triggering a recession that broke the back of organized labor. The “Volcker shock” served as the founding act of the bipartisan neoliberal consensus, establishing a macroeconomic and foreign policy paradigm where the U.S. offshored its industrial base and policed maritime shipping lanes in exchange for cheap imports," explained McMillen.
In March, AlterNet wrote about one of Trump's big plans: opening these risky investment markets to anyone who wants to participate using their retirement funds. Now there is a fear that doing so could push markets teetering on the brink over the cliff.
"The Labor Department is planning to roll out a long-awaited proposal that would offer workers invested in retirement products like 401(k)s access to the so-called private markets — a class of highly coveted but risky investments that have historically been walled off from the masses," Politico explained last month.