It was only 12 years ago when a sudden collapse of the housing market caused the fragile house of cards, a.k.a. the financial system, to implode in record time. Back in 2008, the general public was lead to believe that sub-prime mortgages were the culprit that shook the foundation of our entire financial system
I am not here to argue about what exactly caused the 2008 financial crisis, other than to point out that only 3% of the total secondary market in MBS was considered sub-prime at the time of the collapse. That percentage alone should be sufficient reason to question the mono-causality of the event.
Instead, let’s take a closer look at today’s collapse. More importantly, are there yet again similarities to be found with the 2008 financial crisis, and which cause will be attributed to the collapse of an entire economy and financial market?
The first and immediate answer will be that the sudden onset and rapid spread of COVID-19 is to blame for the current crisis. But is it? Let’s revisit the events of late February/early March.
The public was assured that this crisis was not a repeat of the 2008 financial crisis, that our banks were well capitalized, and our financial markets were functioning efficiently. Less than one week later, the Federal Reserve cut interest rates by 50 Bps in a surprise move.
Why? If markets were functioning normally, and banks were well capitalized, then why cut interest rates? Or, more importantly, which market segment needed a liquidity injection that was hidden from the public at large?
The simple answer to that question is the Corporate Bond market.
Since the 2008 financial crisis, many economists and Federal Reserve Board members had sent out warning signals about the ballooning of the corporate bondmarket as a result of our zero-interest monetary policy. By 2019, the entire corporate bondmarket, largely unsecured, increased to $16 trillion, of which 60% was made up of US companies.
That in itself should not be a real reason to raise “red flags”, if it were not that the majority of US companies borrowing cheap in this exclusive market are small energy companies, specifically shale-oil drilling companies, better known as “zombie companies”.
The definition of a “zombie company” is one that has no or little assets on its balance sheet, and barely generates enough revenue to pay the interest due on its loans, let alone any of the prinicipal. Such companies can only continue to operate in an economic expansion environment, steady or increasing oil prices, and low interest rates.
When the oil prices collapsed simultaneously with the COVID-19 outbreak and the subsequent lockdown, the only solution to the immediate lack of liquidity was a surprise move by the Fed. to lower interest rates by 50 Bp to increase liquidity into a secluded market. But the result was more than that. It signaled to the rest of the financial markets that there was a serious problem, even before anyone thought there was a problem. At least one that would negatively affect other financial markets from continuing to perform normally.
That simple and panic-driven intervention by the Fed. has now had serious consequences for the entire US financial system. We have now supplied each and every corner of our little “House of Cards” with $6 trillion. We have increased our national debt by $3 trillion in fiscal stimulus and we have yet again created a zero-interest policy for the foreseeable future, or at least until 2022.
In hindsight, this means that the US has sustained a zero-interest policy for the last 17 years out of 20 years since 2001. If you wish to know what the economic consequences are of a long-sustained zero-interest rate policy, just ask Japan. They still attempt to escape their 20 years of deflation.
The impact in the US is far bigger and greater that one can imagine. The initial 50Bp rate cut, and the subsequent rate cuts to zero, has allowed US-based zombie companies to continue to exist. One can argue that such is not necessarily a bad thing. But, consider this…
If I wish to save US companies, including the zombie ones, then one would at least expect that my liquidity injection, i.e. low to zero rates, would ultimately result in an improvement of solvency for said companies.
This is where the shoe no longer fits.
Those same zombie companies still continue to operate under the same liquidity rules while being unable to improve their solvency status or their balance sheet. Meaning, all of them are doomed to fail and collapse at the expense of healthy American energy companies.
In the meantime, Main Street America is struggling to access the same amount of liquidity and cheap borrowing, yet most of them have a balance sheet that was and is healthier than the above-mentioned zombie energy companies.
The question remains: who is America trying to save and why?
It is time to revisit the financial collapse. In 2008, we saved the automotive industry and the US banking industry. In 2020, we saved the American zombie energy companies.
When will we save the backbone of the American economy, i.e. small business owners…
