The Era of Bubble Finance

Submitted by William Bonner, Chairman – Bonner & Partners

Debt Curse

NEW YORK – “Not a bad view. That’s the mayor’s house right beneath us.”

We were on the 16th floor of a new apartment building, looking out over the East River. With us was President Reagan’s former budget advisor and Wall Street veteran David Stockman – a man who has been closer to the Bubble Epoch than almost anyone.

The Dow rose 183 points on Wednesday – or just over 1% – after starting the day in the red.

SALOMON_3142495bWilliam Salomon in Salomon Bros. & Hutzler’s trading room in 1965. Salomon Bros. sold the first ever mortgage-backed bond on Wall Street in the 1980s

Photo credit: Arthur Brower / The New York Times

“I was there at the creation,” said David.

“After leaving government, I went to Salomon Brothers in the late 1980s. We were just starting to put together packages of mortgage-backed debt.”

Bubble finance has taken many shapes and sizes. Mortgage-backed derivatives. Private equity. Junk bonds. Student debt. Subprime auto loans. Stock buybacks. This debt was a curse to most Americans. But it blessed Manhattan.

The weekend’s Financial Times included real estate listings from New York City. There was a penthouse apartment for sale on the Upper East Side for $60 million. Luxury digs on the West Side were going for $30 million… another for $16 million.

You don’t make that kind of money parking cars… or making them. So, if you want to buy one of these places, you almost have to work in finance. Most people have no idea how the financial world works. They think investments go up or down and you make money depending on your luck or your skill – just like any other game. They don’t know the game is rigged.

Central banks make credit available to the big banks at preferential rates. The banks then earn a fat “spread” by making loans to government, industry, and households. They make money lending… and then, they make money again by packaging and selling the debt to investors, pension funds, and insurance companies.

Everything is fine until the credit cycle turns down. Then marginal debtors can’t pay and marginal (sub-prime or junk) debt loses value. Stocks and real estate go down, too. Everybody loses money. And everyone wants the Fed to “do something.” What can it do? Make credit even cheaper!

JNKYo Fedheads! It’s that time again! Cheaper credit needed! Liquidity junkies are out there dying of thirst! – click to enlarge.

 

Bubble Finance

Stockman was present at the creation of the whole Bubble Epoch. In 1981, President Reagan appointed him to be his first budget director. Four years later, he quit in disgust.

“Funny, isn’t it? I was alarmed by a national debt of $900 billion. Yesterday, it went over $19 trillion. And nobody cared.”

President Nixon made the Bubble Epoch possible by going off the gold standard in 1971. No “golden anchor”: no limit on how much money and credit you could create. But the Bubble Epoch didn’t really begin until 10 years later under “The Gipper.”

 

Regan, Reagan and StockmanThen budget director David Stockman (right) skeptically eyes treasury secretary Don Regan and the Gipper

Photo credit: Dennis Cook / AP

 

Stockman battled the big spenders in the Republican Party – and lost. After he was out of the way, Reagan ran some of the biggest deficits ever. Soon, debt was out of control everywhere – in government, industry, and private consumption.

“We must be nearing the end of this,” said Stockman. “I expect the whole world economy to plunge into deflation and recession.”

 

Federal DebtTotal federal debt – when you can print unlimited amounts of money, anything is possible, right? It will never end! Just ask John Law… – click to enlarge.

 

Charts by: StockCharts, St. Louis Federal Reserve Research

 

Chart and image captions by PT