The Financial System Is Becoming Increasingly Unstable

Bloomberg posted an article this morning describing the Collateralized Loan Obligation market as “Wall Street’s Billionaire Machine.”  But I seem to recall that the CLO market was one of the financial nuclear bombs that blew up and triggered the financial system de facto collapse in 2008.  Well, it’s back – with a vengeance.  Of course the taxpayers were  once again sold a bill of goods never delivered when it was promised that the Dodd-Frank farce legislation would “protect” the system from the re-development of these financial weapons of mass destruction…

Bank stocks are in a bear market now and there’s a reason for that. Many of you have probably seen leveraged loan ETF charts that look like this:

The chart above shows an ETF operated by Blackstone that invests in senior secured leveraged loans. Typically these loans fund private equity leveraged buyouts. But any highly leveraged company with a junk bond credit rating is a Wall Street candidate for this type of loan.

What you’re seeing in the chart above is the beginning of an investor stampede out of this asset class. This asset flourishes in the type of money environment – Central Bank money printing and interest rate intervention – that has existed for the last 10 years. The loans carry a higher rate of interest than an investment grade corporate bank loan. This appeals to pensions and insurance companies, which need to find the highest risk-adjusted interest bearing investments possible. I like to call these: “c’mon in the water is fine” loans. These are the type of loans that get magically transformed in to CLO’s – like lead into gold – at least the for Wall Street scammers who do the transforming.

As I’ve mentioned previously, credit market investors tend to be more risk-averse than  equity players. They also scrutinize financial fundamentals more closely. To this end, bank debt investors are the most conservative. They also get to see the non-public financials of the companies to which they lend. That chart above reflects the onset of fear of in the leveraged bank debt market. It means that these investors likely have been seeing negative trends in corporate financials develop.

When I showed that chart to a colleague of mine earlier this week, his response was: “it looks like parts of the stressed financial system are breaking at the same time – dominoes are falling.” He was referencing the leveraged loan, investment grade and high yield debt markets. The latter two had been showing signs of breaking down well before the leveraged loan market started to crater. Investors have been pulling pulling billions out of all three segments of the credit market. The deteriorating financial condition of corporate America is spreading its wings. This is part of the reason the volatility in the stock market has ramped up recently.

Bank stocks are in a bear market and bank liquidity is drying up – There’s a massive liquidity crisis developing and the chart of SRLN reflects that. The sell-off in the housing stocks – down over 30% since the end of January foreshadowed this, just like the sell-off in homebuilders preceded the onset of the last financial crisis. This time it will be worse. This crisis is beyond the banking crisis 10 years ago. It’s everything. You do not want to be a creditor or own stocks going forward.

Looks like the Spanish philosopher, George Santayana, was correct:  We did not learn from the past and now we’re condemned to repeat it.

6 thoughts on “The Financial System Is Becoming Increasingly Unstable

  1. Of course, what’s reported and what is actually true make for an ever bigger detonation. Fraud is the business model of America and elsewhere, around the globe these days. Who says crime doesn’t pay? Just ask Elon.

  2. Dave, seems like the bear is officially confirmed here in the equities markets. What are your general thoughts on the inverse ETF’s ( QID, SQQQ, SDOW, SDS)on all leveraged levels? Going 1-2x here? Sell the rallies I’m hoping for a big bounce to find an entry on the inverse. Also been loading up on miners post august smash, can’t wait for that sector to turn around.
    cheers

    1. I don’t like ETFs, especially leveraged ETFs. The triple levered ETFs lose 10% of their value per month
      from the time premium decay of the derivatives used to create the leverage

  3. Dave, I think that the idiots in charge just sent a signal.
    I know that being a contrarian is not how the general public
    thinks. You have to be a bit abstract to be able to construct
    a more macro view. I ask what does this article convey to you ?
    It seems like the economy is going down like the Titanic and these
    guy’s are grabbing all the life boats while they can.

    https://www.zerohedge.com/news/2018-12-23/plunge-protector-mnuchin-reportedly-called-bank-ceos-calm-markets-ahead-monday-open

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