The Coming Crash, Part 2: Band-Aid on a Bullet Wound

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The Coming Crash is a four-part series examining the 2008 Financial Crisis and current economic conditions. I am not a licensed financial expert. I’m not an economist. I’m just a guy trying to learn each day and share my thoughts with others. Consult your own financial adviser when deciding how to allocate your personal wealth.

“I had the most absurd nightmare. I was poor and no one liked me.” — Louis Winthorpe, Trading Places

Perhaps surprisingly, I actually believe the average person might already know that the “fixes” to the financial crisis haven’t done diddly. We saw it with Occupy Wall Street. We see it now with the call for Democratic Socialism; some even looking to drop “Democratic” from the “Socialism” all-together. I think political analysts who are honest with themselves can acknowledge that a large part of President Trump’s election night upset was from the economic angst of flyover country. People are dumb, but most of them know when things are not well.

Certainly some of the issues that caused the Financial Crisis of 2008 have been addressed. There are now more consumer protections in Adjustable Rate Mortgages – a rising interest rate environment shouldn’t lead to the same spike in mortgage defaults that we saw ten years ago. Lending requirements are different than they were during the housing bubble. But don’t be fooled. Many of the steps taken to right the ship could potentially lead to a very similar, if not worse, crisis down the line.

Quantitative Easing

QE, as it is also referred to. What is it? Put simply, it is dollar creation from the Federal Reserve. We could also call it base money expansion. The chart below shows just how drastic that base money expansion has been since 2008. Before the crisis, it took about 22 years to quadruple the base money in the system going back to 1986. It took just 5 years after the crisis to quintuple the base money in the system. If you’re not following why this matters, it means the purchasing power of your income has been decimated in the last decade.

Federal Funds Rate

During and following the crisis, the Federal Reserve took a hatchet to the Federal Funds Rate. As you can see from the chart below, the FFR was effectively nothing for close to 8 straight years. Something else the chart tells us is that the Fed typically starts lowering the rate right before it acknowledges a recession. It did so when the dot com bubble burst. It did so in 2007. This matters because when you keep interest rates artificially low, it is exceptionally easy for consumers to get credit. That could be with plastic or a home mortgage. We’ll explore this more in Part 3.

Private Profits, Public Loses

Despite offering up Lehman Brothers as the sacrificial lamb, the Federal Government largely took the position of bailing out failure with your tax dollars. Uncle Sam helped facilitate JP Morgan’s acquisition of Bear Stearns. Uncle Sam pumped billions of dollars of liquidity into the big banks. Uncle Sam bailed out AIG. Basically, the government did the exact opposite of what a free market advocate would recommend doing. So, while Uncle Sam was using tax revenue from your labor to bail out over-leveraged failures, he was simultaneously printing away the value of the currency that he forces you to transact in. Sound like a good deal? That is, of course, a rhetorical question.

Dodd-Frank

While I genuinely believe the intention was good on this legislation, Dodd-Frank was a failed attempt at post-crisis banking regulation. If the goal was to keep banks from becoming “too big to fail,” I fear the opposite has probably happened. In the chart below, you can see that long before congress tweaked financial regulations with a new bill, by 2014, community bank mergers were already ramping back up to 2007 levels. And it is well documented that Dodd-Frank was a bigger financial burden on smaller banks than it was on the big banks. And it was the big banks who were actually doing all the bad lending and derivative gambling. Since targeting the big banks was really the whole point, we can call this bill a failure.

Courtesy: Kansas City Federal Reserve

Government Spending

Throw out everything else: bank regulations, base money creation, easy credit – it’s all just part of the puzzle. To me, the biggest cloud of smoke that signals the economic fire is the government spending. This chart comes courtesy of Chris Hamilton of Econimica. Look at the spike in the debt compared to the real GDP growth after 2008.

Are you getting what this data is telling you? In the years since the crisis, federal debt has nearly doubled while Real GDP is up about 19%. Meaning, it is taking an unbelievable amount of government spending to get small growth in economic activity. Two theories can be made from this:

Theory 1: government spending is keeping the economy afloat. Which raises the question; did we ever actually get out of the recession?

Theory 2: government spending has completely cannibalized real economic activity.

Both of these theories could have some level of truth to them. At best, the federal government is wastefully spending. At worst, we never actually got out of the recession. Let that sink in. Tomorrow, Part 3. It’s going to continue to get ugly.

Disclaimer: Views and opinions expressed by Mike are not necessarily the views and opinions of CLNS Media. You can follow Mike on twitter @MikeFay34 and read his stock market technical analysis at faybomb.blogspot.com