This is a transcript of a Twitter Spaces conversation about broken credit markets, runaway inflation, and why we need to fix the current financial system.
Listen to the Episode Here:
Dylan LeClair: Over the last 40 years, as that term component has been depleted and that long-term risk-free rate has gone higher or higher, the 60/40 portfolio looks like a bubble with these kinds of pensions. LDI (liability-based investments) where they use long-term bonds as collateral, it looks like this is perhaps the tipping point.
It may or may not be in the US. But if long-dated Treasurys trade like shitcoins, there are pretty big implications for how the overall financial system is structured. So the question I propose is this: While we haven’t really seen credit risk at the corporate land or sovereign level, I think what’s really interesting is that central banks are supposedly reducing their balance sheets. If you continue to raise rates, credit risk is quickly becoming expensive compared to what we’ve seen, what time frame has been released?
Greg Foss: Great question. The short answer is that no one knows. The reality is that new releases make markets more expensive. And since there are no new releases in really high-yielding land, you could argue that repricing isn’t happening.
There is remarketing, but if you bring in a big new issue – let’s take this Twitter example. Twitter will not be resold. The 13 billion dollar debt that Ilo took on and financed by the banks will remain in the bank’s portfolio, because if they have to sell it to the secondary market, the banks themselves will lose about half a billion dollars, i.e. The return they’re offering – for Elon to price the debt and commit – is no longer the market return, so they’ll have to sell it at least 10 points lower, which they don’t want to do. Their load takes the loss to the market, so they keep it on their balance sheet and “hope” the market will go up again. I mean, I’ve seen it before.
If you remember back in 2007, a famous quote by Citibank CEO Chuck Prince was on LBOs (leveraged buyouts) of the day. He’s like, “Okay, you gotta get up and dance when the music comes on.” About three months later, Citibank regretted that statement because it was loaded with too much unmarketable paper.
That’s the situation at Twitter, which means they’re not forcing these bonds into the secondary market, which means the secondary market won’t have to revalue all kinds of CLOs and leveraged products, but it’s going to dribble that way, Dylan, dribble that way. will start to do.
This is not a subprime crisis. It’s a crisis of confidence. And trust is a slow bleed against a subprime default or the implementation of a structured product like the Lehman Brothers situation, or excuse me, it wasn’t Lehman, it was Bear Stearns, the hedge fund that blew up subprime mortgage debt. It was the canary in the coal mine that just started things off; it was a secondary market revaluation in 2007. Where are we today? We’re in a situation where, as you mentioned, the 60/40 portfolio has just been destroyed. Back in 2007, the Fed was able to lower interest rates and bonds rose because yields — if memory serves — were where they are today. There was room for Fed tapering.
It didn’t trade at 1.25 or even 25 basis points, which is where the Fed came in at its current 3.25%. There was room to cut rates to provide a buffer; bond prices go up, yields go down, everybody knows that. There used to be a buffering effect, but now we don’t have that luxury.
As you point out, the 60/40 portfolio: worst performance in a hundred years. The NASDAQ never fell into double digits, with long bonds down double digits in the same quarter. Why? Well, the NASDAQ has only been around since 1970, and long bonds have never lost double digits in the past 50 years. If I remember correctly, they are there if you go back to depression.
The point is that the 60/40 portfolio has probably suffered its worst decline in nearly a century. And Lyn Alden put it very well. In terms of capital destruction numbers, I think $92 trillion of wealth has evaporated in our fight against inflation over this period. Compare that to 2008, when only $17 trillion of wealth evaporated. We are talking about larger scale orders. We’re talking about the US debt spiral, where a 130% national debt-to-GDP ratio doesn’t leave you much room.