Recession or Great Recession?
People are worried because of what is called the "inverted yield curve" that there will be a recession.
What is an inverted yield curve? It means people will people want higher interest rates on shorter-term US bonds than longer-term. Which means that large investors view the US as more of a risk in the short-term.
I do not think this is a worthwhile metric right now. With inflation at 7 or 8% or more, then all rates are negative now anyway if bonds are less % than inflation.
BUT....I've heard some people even say we might have a Great Recession.
But let's see what actually caused the Great Recession.
It wasn't housing prices, for instance. Housing prices were already starting to recover in 2008 before things fell apart.
I wanted to break it down. Here's a timeline of the Great Recession as I see it.
What is an inverted yield curve? It means people will people want higher interest rates on shorter-term US bonds than longer-term. Which means that large investors view the US as more of a risk in the short-term.
I do not think this is a worthwhile metric right now. With inflation at 7 or 8% or more, then all rates are negative now anyway if bonds are less % than inflation.
BUT....I've heard some people even say we might have a Great Recession.
But let's see what actually caused the Great Recession.
It wasn't housing prices, for instance. Housing prices were already starting to recover in 2008 before things fell apart.
I wanted to break it down. Here's a timeline of the Great Recession as I see it.
1. 1994
2. 1995
3. Seemingly unrelated… 1998
4. 1999
5. 2000–2001
6. 2002–2006
7. 1999–2006
8. 2000–2006
9. 2000–2005
Note: The mathematical models hedge funds and banks were using never considered subprime borrowers. Hedge funds were borrowing at 1% and buying as many mortgage-backed securities as they could at 4%. Banks, funds, brokers… making money. People buying homes, homes going up in value…
As a result, the economy heated up. So the Fed started raising interest rates, from 1% to 5%. Now people who borrowed “interest-only” loans at 1% had to pay 5x more per month in payments. Subprimes started to default…
10. 2006–2007
11. 2006–2007
12. 2005–2007
Hedge funds got involved… They would SELL the credit default swaps). It was free money for the hedge funds since, up until then were, defaults basically zero if you sold a basket of diversified credit default swaps. This was a ton of free money for the hedge funds. But HUGE, HUGE leverage…
13. 2006
The hedge funds that were buying the insurance (John Paulson, Michael Burry) were losing money every month. Their long-term bet was that the system would collapse. John Paulson pitched me on his fund and I left his office thinking, “Holy fuck, we are screwed.”
Paulson only had one worry… He told me in 2006 (way before the top of the market) that he was afraid the banks would go out of business before he could get his money out. Two years later, this almost came true.
14. 2007–2008
15. 2007 (critical moment) - 2009
For 70 YEARS, banks had “marked to value.”
Example: Your house is worth $200,000. You know this because of the history of house sales in your area. You paid $170,000 a few years ago, etc. Normal house appreciation.
But what if your neighbors are getting divorced and fire-sell their house? They live next door to you and their house is exactly like yours. They sell for $125,000 but you think, “No big deal. That was a weird situation.” That’s “mark to value.”
“Mark to market” turns it upside down… It forces you to use the last comparable house sale and NOW that’s what your house is worth: $125,000. Not $200,000. You don’t care because you know it will bounce back. And banks are now more transparent. Good intentions again…
But a bank that switches from “mark to value” to “mark to market” — RIGHT IN THE MIDDLE OF SUBPRIME DEFAULTS — it suddenly has to mark down its entire portfolio. Still, not quite a disaster yet. BUT… what if the banks borrowed too much?
If a bank or fund used 100:1 leverage, then even if 1% down (caused by the defaults ,plus some manipulation) will wipe out an entire trillion-dollar bank (Lehman Brothers) or insurance company (AIG) or dozens of hedge funds and basically every bank on Wall Street.
Lehman Brothers collapsed. Lehman was one of the only banks that didn’t help in the bailout of the highly leveraged Long-Term Capital Management hedge fund (LTCM) in 1998. The decision-maker, Treas Secy Hank Paulson, former CEO of Goldman Sachs, had a 10-year grudge.
One day later… Paulson saved Merrill Lynch by arranging a sweetheart deal with Bank of America.
Because of FASB 157, nobody could lend to the banks anymore (they had to mark their assets to less than zero)… which meant banks couldn’t loan to companies to make payroll….
The American system collapsed. The Great Recession began. Nobody could get cash into the system. Paulson arranged TARP (semi-nationalizing the banks) and the bailout (same as now — exact same playbook). But some important notes…
November 2007, when FASB 157 passed, was the top of the stock market. Mark to market was the law in the early 20th century but outlawed by FDR in 1938, which probably led to the end of the Great Depression as banks were able to lend more. So how did Recession end?
In early 2009, FASB 157 was a huge debate. On March 12, Congress met to discuss, and eventually new rules were passed to allow “mark to value” again. On March 9, the market started going straight up, until February 2020 (coronavirus)… similar to the Great Depression.
From 1938–2007, because of “mark to value,” there was no depression. Without TARP, and then the bank bailout in early 2009, then the repeat of FASB 157, we would’ve had a depression.
BUT “mark to value” is often called “mark to myth.” Who benefited? And who is benefiting now?
John Paulson turned $100 million into $6 BILLION (I wish I had invested when he asked me to).
Bill Ackman turned a $27 million investment last month into $2.6 BILLION. He went on CNBC saying the world was going to hell. He sold his investment right after. BUT…
16. The point is....
Blame mortgage brokers for convincing subprime borrowers to buy houses? Blame banks for lending the money? Blame hedge funds for manipulating the market of MBS? Blame Bush for not seeing this coming? Blame Paulson for the bailouts?
The point is….
Government, leaders, voters often have the best intentions but don’t realize consequences that could come years later. Watch out for student loans and watch out for future bubbles in this bailout. There WILL be a crisis two to five years down the road created by current good intentions.
I’m not sure why I did this. I wanted to show how, when you connect the dots, something complicated can be presented in a simple fashion. I also wanted to underline future unknowns in what is happening now by looking at the past. AND see if Twitter is a good place to “teach.” THANKS!
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