The Market Collapse Investors Won't Expect
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The forces of inflation and deflation that we’ve talked about take a while to play out, but this market collapse could happen very suddenly and catch investors completely unaware.
Now, the thing is, we’ve come within hours or days of total global financial gridlock, total market collapse in the last 14 years. Everyone knows about 2008. People have a sense of that.
But it also happened in 1998 as a result of the Russia default and the collapse of hedge fund Long-Term Capital Management. At the time, I was involved with Long- Term Capital Management…I actually negotiated that bailout. I was in the room. I saw the $4 billion moved into our bank accounts to prop up the balance sheet. The money came from Wall Street. But there was a lot of give and take that almost didn’t happen and we were literally hours away from markets collapsing. We muddled through that. We kind of found the runways and got through.
But, people learned all the wrong lessons. Instead of banning derivatives and backing away from overleverage and putting a lid on banks, public policy did the opposite. We repealed Glass-Steagall, which allowed banks to act like hedge funds; we repealed Schwab’s regulation, which meant that you could do derivatives on anything. We repealed or increased broker dealer leverage from 15 to 1 to 30 to 1. The SCC did that in 2006 and the Boswell three capital requirements to allow greater bank leverage.
So, we said, game’s on. You can do whatever you want with as much leverage as you want and as much opaqueness as you want because of the use of derivatives. Is it any surprise that in 2008 we had another market collapse? Now, Bear Stearns goes down, Fannie goes down, Freddie goes down, Lehman goes down, AIG goes down – one by one the dominos were falling. We were days away.
Morgan Stanley would have been next, Goldman right behind it and then Citi then Bank of America and then J.P. Morgan — so all the dominos were falling. The government dropped a steel curtain between two of the dominos. They stopped it after Lehman and AIG so Morgan Stanley didn’t fall, but Morgan Stanley was days away from collapse.
So, the point is how much more are we going to stress the system? We almost collapsed in ’98, we almost collapsed in 2008. Three strikes you’re out.
The next market collapse is coming. You can see it coming because of the dynamics. The difference next time, it’s going to be bigger than the Fed. The Fed was able to bailout Long-Term Capital and the Fed was able to bailout Morgan Stanley and Goldman Sachs.
But the next time, it’s going to be bigger than the Fed. They’ve used up all their dry power; they’ve taken their balance sheet to $4 trillion. What are they going to do, take it to $8 trillion? How do you take the balance sheet that high to re-liquefy against the next collapse without destroying confidence in the dollar? You can’t do it.
So, that’s why the next crisis, they say it’s going to be three strikes, you’re out, and we’re not going to get another chance.
for The Daily Reckoning
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