When the US House rejected the Wall Street bailout bill on September 29, 2008, I was hunched over in a swiveling, wooden bar stool with a Camel Turkish Gold burning between my right fore and middle fingers.
The vote was broadcast live on a dozen channels, but that wouldn’t have mattered if Mikey and Becca didn’t have cable. On that day, they did, but no thanks to them.
For most of the two years I knew the couple, their old Sony Trinitron sat on a particle board TV stand against the blank back wall of a dungeon-like living room on the bottom floor of a two-story townhouse. One day, the stand was gone, replaced by one of those cheap, plaster Corinthian column pedestals. “Looks good, right?,” Becca beamed. “Hobby Lobby. On sale.” I smiled. “Just like Tony.” She punched me jokingly in the shoulder. (In the HBO series, the TV in Tony Soprano’s bedroom sat on a similarly tacky decorative pedestal.)
Like everyone else in those days, the cable guy for Mikey and Becca’s building owed me a favor, so that old Trinitron had a few channels. They would have never splurged on cable of their own accord. I watched every, agonizing second of the House vote on the bailout bill.
There was a cream-colored couch with forest green stripes in the living room, but I never sat there. I never stayed long enough to get comfortable despite the couple’s well-meaning pretensions to hospitality. Instead, I usually perched on one of three bar stools situated around a weird-looking octagonal table within reach of the cocktail shaker set I bought them as a “gift.” (Truth be told, I bought everybody cocktail shaker sets back then, along with Tanqueray and Rose’s, so I could be sure that wherever I went, I could shake up a gimlet.)
“That’s that then,” I distinctly remember saying, as the House rejected the $700 billion package aimed at rescuing Wall Street and averting a depression. The vote was 228-205. I winced, dragged the Camel down to its patterned filter (the Turkish Golds had a distinctive filter design) and smushed it in an overflowing ashtray.
“That’s what?,” Mikey asked. He and Becca were staring blankly at the Trinitron with no conception whatsoever of what had just happened or why it mattered.
I expelled the cigarette smoke from my lungs in a half-exhale, half-sigh. “That’s the end.”
The Dow settled down 777 points that day. At the time, it was the biggest point decline in history.
The S&P fell 8.7%. “I honestly don’t even know where we go from here,” Dave Rovelli, then managing director of equity trading at Canaccord, told CNBC amid the despair.
“The problem is, out in the boondocks, people don’t realize what this means,” he added. “When they can’t get a loan at the bank, then they’ll figure it out.”
Rovelli was right. Mikey and Becca didn’t live “out in the boondocks,” but they were blissfully ignorant as to just how close to economic oblivion we all were that day. I didn’t bother to explain. My business there was done anyway.
I dumped three gin-soaked ice cubes in the sink, rinsed the glass out and found a place for it in the dishwasher, which was always full. I never knew whether the dishes were dirty or clean, and I’d stopped asking.
“I’ll check in with you guys in a week.”
“Roger that,” Mikey invariably said. I don’t remember exactly, but “Roger that” was his response to everything. It was his catchphrase. He didn’t understand that catchphrases were supposed to be unique.
“Watch the news tonight,” I told them. I knew they wouldn’t. I turned the bottom lock on my way out the door.
The bailout package eventually passed, of course. The ATMs never went dark, and although Rovelli’s “boondock” people would eventually come around to the reality that something had gone horribly awry, there were no soup lines, and the stores never ran out of milk.
One of the most curious things about the months around the meltdown was how generally oblivious so many of the folks who should have known what to expect seemed to be about the likely next steps once Armageddon was averted.
You needn’t have been particularly well-versed in the literature to know that Bernanke was a Depression aficionado, and you needn’t have been an economist to be vaguely familiar with the kinds of policy prescriptions he was destined to write (and keep writing until the patient was thoroughly addicted).
By September 2008, it had been so long since I had checked my account at Vanguard that I no longer remembered my username, let alone my password. I had to call them to get access, because I couldn’t remember the answers to my secret questions either, and the e-mail address attached to that account was long since dead. It was a “set it and forget it” account, and I had “set it” years (and years and years) previous.
But at that juncture, I could scarcely think of a better idea than to plow as much money as I could possibly spare into a balanced index fund. The writing was on the wall in terms of the policy response, and as far as the fate of the financial universe was concerned, we were either doomed or we weren’t, and there was really nothing in between. If we weren’t, it was the greatest buying opportunity I was ever going to see, and the series of simple transfers from one of my bank accounts to that idiot-proof Vanguard balanced index fund still count among some of the best “trades” I ever made.
More than a decade later, some of the biggest names in the business are busy declaring that the boom-bust cycle is over.
So said no less than Bridgewater Co-CIO Bob Prince in Davos on Wednesday. And he may be right. I explained why, at length, in “The Crucial Nuance Behind Bridgewater Co-CIO Bob Prince’s ‘Boom-Bust Cycle Is Over’ Declaration.”
But he may be wrong, too. In that linked post, I cited Deutsche Bank’s Aleksandar Kocic, who in 2017 suggested that it may not be possible for policymakers to emancipate markets – to lift martial law (if you will). “The Fed (and central banks in general) carries an implicit responsibility for orderly reemancipation of the markets, which makes stimulus unwind especially tricky”, he wrote. “The accommodation has been in place for a very long time, during which traditional transmission mechanisms have atrophied and investors’ mindset has changed in a way that has altered irreversibly their behavior, the market functioning and its dynamics.”
Recent notes from Kocic suggest that, for a variety of nuanced reasons, he generally agrees with the premise that the likelihood of booms and busts is diminishing in favor of an environment characterized by more or less of stagnation (see here and here). But it’s worth revisiting a few passages from another 2017 note in which he outlined the spiraling trajectory of volatility and leverage.
Consider the following passages from Kocic which will likely resonate with readers who cringed when Prince suggested the boom-bust cycle is no more (again, these are from a 2017 note):
However, the most interesting thing for us at the moment, is the question of what comes after each crisis, namely how is the recovery engineered and economy brought back on track. To be specific, let’s choose as the starting point 1999, the beginning of the internet bubble and follow (in the clockwise direction) the subsequent economic trajectory in the vol-leverage plane in the Figure below.
As the economy is heating up, volatility declines and leverage increases until the bubble bursts sometime in the late 2000. There is a volatile deleveraging for the next 2-3 years when low rates and expansion of the real estate market created conditions for the turnaround and beginning of another cycle. The only difference is that, this time around, the bubble was bigger and the limits were more extreme. Instead of being a periodic object (e.g. ellipse), the trajectory now becomes an outward spiral – in the second sweep, the leverage is higher and risk premia compression more extreme leading, naturally, to a deeper crisis and a need for an even more extreme measures of recovery.
The vestiges of crises past always linger – creative destruction isn’t a viable option in the modern world.
“On the Austrian analysis, recessions give a chance to re-allocate ‘mal-invested’ productive factors to efficient uses [and] they should therefore be allowed to run unhindered until they have done their work,” Robert Skidelsky writes, in Money and Government, before noting that “economists whose common sense had not been completely destroyed by their theories rejected the drastic cure of destroying the existing economy in order to rebuild it in the correct proportions.”
As Skidelsky alludes to, the idea of letting it all burn to the ground in order to ensure that every, last bit of misallocated capital is purged is, at best, implausible. At worst, it’s madness. But we should recognize that in the absence of that, future crises will be i) inextricably linked to their predecessors, and ii) likely more spectacular than those that came before. That second point (i.e. the idea that a defining feature of a fiat regime is a rolling boom-bust cycle that snowballs with each turn) means that policy responses will need to grow in magnitude over time to keep pace with ever larger busts. Eventually, the busts become so large that the policy responses required to combat them become caricatures of themselves that border on absurdity.
Some would suggest that’s the point we’re at now – the policy response is cartoonish, and easily meets the threshold for absurdity.
Writing more than two years ago, Kocic noted the following:
Spiraling leverage cannot continue indefinitely. At some point, the bubble becomes too big and cannot be subsumed by a bigger bubble – the damage of its burst would become irreparable. Therefore, when that moment comes the market faces a dilemma.
One of the choices is to persist in the above-mentioned “state of exception.” To wit:
We continue to operate in a regulated environment. Leverage is limited, but care is taken not to overconfine the system so we avoid the Japanese scenario. While this appears as a prudent approach to reality, it implies giving up all the ideas of unlimited growth, something that made US economy look better than the rest of the world. Compared to what we have seen before, this means settling for much less than this country is used to aspiring. Although a reasonable proposition, it is emotionally a difficult choice that is and will remain subject to substantial political manipulation. It is unlikely that populist narrative will not continue to challenge this choice.
As Kocic suggested, that is a decidedly unpalatable proposition – especially in the Trump era.
“Settling for less” is not at all consistent with Trump’s amorphous #MAGA promise. In fact, inherent in #MAGA is a certain deliberate ambiguity that implies an infinitely high bar – as Trump himself put it on the campaign trail in 2016, “you’re going to say Mr. President stop! It’s too much winning. And I’m going to say ‘no, we have to win more!’”
Fast forward three years and Trump continues to lament the forces he claims have kept the US economy from delivering emerging market-like growth. Just this week in Davos, for example, he blamed Boeing, hurricanes and, of course, monetary policy, for holding America back economically. Were it not for planes falling out the sky, strong winds, rain, floods and rate hikes, the US would be growing at 4%, the president said.
But if abandoning the dream of blistering growth is a proposition too hard to swallow (and if it would have been a bitter pill before, it’s been rendered even more so for large swaths of the American electorate thanks to Trump) we risk making decisions that catapult us from the lower left quadrant in Figure 14 shown above into the upper right quadrant. Here’s what Kocic said in 2017:
Flirting with high tail risk : Deregulation and deficit spending could result exactly due to abandoning the first path, as its direct challenge, under political pressure that American economy can restore its old status and resume its pace of the previous decades. This is a serious tail risk as it is playing against the backdrop of considerable overhang of the post-2008 one-side positioning. Central banks are massively short convexity in this scenario. Any inflationary maneuver, or anything that would be a bear steepener of the curve, could force disorderly unwind of the bond trade and reinforce the trend thus creating another crisis from which there could be no way out.
That might seem far-fetched at a time when the Fed and central banks in general are struggling to bring inflation up to target. Indeed, the disinflationary impulse is now so vexing that both the Fed and the ECB have embarked on wholesale rethinks of their policy frameworks. In 2020, it’s the lack of a bear steepener that’s disconcerting, as market participants fret that renewed bull flattening means faith in the reflation narrative which defined the fourth quarter is slipping.
And yet, through it all, the risk outlined in that last excerpted passage from Kocic has never truly gone away. An explosive bear steepening episode that forces a disorderly unwind of the still-entrenched “duration infatuation” in all its various manifestations would likely be highly destabilizing. As my good friend Kevin Muir points out whenever he gets the opportunity, inflation is the most underappreciated risk in the market today. And it’s always the one nobody sees coming that sparks the next crisis.
I can only hope that if Prince is wrong and the boom-bust cycle is not, in fact, dead, that I’ll be as sure-footed as I was in 2008. The trick then wasn’t so much being “smart” or hewing to some amorphous Buffett aphorism about being “greedy when others are fearful.” Rather, I viewed the situation as binary – either the world was ending or it wasn’t.
Sometime in the summer of 2014, I was standing in line at a shop in Grand Central with about 10 minutes to spare before I had to catch the Metro-North to the Tuckahoe station.
I got a text from Mikey, who had read something online that briefly quoted me. Also quoted in the same piece was one of the most famous hedge fund managers on the planet. Mikey doesn’t know what a “hedge fund” is, and there was no chance he understood the context of the article. But that didn’t matter. He saw my name and it made him feel like a vicarious “somebody.” And that was ironic because I felt the same way about that article – I was vicariously a “somebody” by virtue of being mentioned in the same piece as a name brand hedge fund legend.
I don’t remember the name of the shop in Grand Central, although I tried to look it up in the directory just now. It may have closed. They sold craft beer and small batch spirits.
I do remember what I was buying, though. It was a bottle of gin.