David Stockman, Former White House Budget Director under President Reagan, is very worried that all of this Fed manipulation and mispriced financial risk in the system will cause the next crash. He was on Bloomberg TV today discussing his doomsday scenario with Betty Liu (watch it below or at Bloomberg.com). Here's how he thinks the Treasury bond bubble will pop via all the "repo'd bonds" outstanding (repurchase agreements 1, 2, 3). I'm not that familiar with the repo market.
"It's the greatest bond bubble in history. It's the most dangerous thing that has ever happened. And not just the Treasury, look at the junk bond market today. CCC rated debt is now trading under 6%. It's crazy. Nothing like that would've even been remotely thought of 4 or 5 years ago. So we have this huge recency bias. People don't even know anymore that they're heading to the end of the cliff...... When the bond bubble finally breaks because all the people who were front running the Fed and buying on repo Treasuries to take the spread between 2% on the yield and 10 basis points on their overnight carry. When they get any sense that the Fed is slowing down or (...), there will be panic selling because no one owns the bond. They're all renting it. It's a big arbitrage. It's the most dangerous thing that any central bank in history has ever done."
"My doomsday scenario is in the bond market. Once the yield starts going up, the price of all of these repo'd bonds starts falling, these fast money traders, they will sell. Who is going to buy? The Fed won't be in a position to buy because it's no longer in the quantitative easing business."
Timing is everything though. Look how JGB's (Japanese Government Bonds) have been at the zero bound (0%) for years. But, in a similar way, hedge fund manager Kyle Bass believes the JGB bubble will burst very soon (watch his University of Chicago presentation on "The Coming Crisis in Japan"). David Stockman was interviewed because he wrote a distressing article in the New York Times on March 30 (State-Wrecked: The Corruption of Capitalism in America). Here is his crash call and proof that the Fed hasn't really helped the real economy since 2000.
"Over the last 13 years, the stock market has twice crashed and touched off a recession: American households lost $5 trillion in the 2000 dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner or later — within a few years, I predict — this latest Wall Street bubble, inflated by an egregious flood of phony money from the Federal Reserve rather than real economic gains, will explode, too
Since the S.&P. 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the “bottom” 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans."
"When it bursts, there will be no new round of bailouts like the ones the banks got in 2008. Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth."
We are in distressed and volatile times. Or manipulated times. Good luck, and stay liquid.
Related Stockman posts on 9/27/2012:
David Stockman: This Market Isn't Real; FNMA MBS Spread Update (DistressedVolatility)
David Stockman's Core Criticism of Fed Policy (Interview on Capital Account) (DistressedVolatility)
Related posts/disses on the web:
Financing the Deficit (More Feldstein) (NYT)
Bond Bubble Brouhaha by Paul Krugman (dissing Martin Feldstein) (NYT)
When Interest Rates Rise by Martin Feldstein (Project Syndicate)
More Stockman by Paul Krugman (NYT)
Cranky Old Men by Paul Krugman (dissing David Stockman) (NYT)