Bill Gross warns about Fed’s cheap-money schemes
SAN LUIS OBISPO, Calif. (MarketWatch) — Bill Gross predicting a “Credit Supernova.” Yes, that’s what the “Bond King” sees dead ahead. He knows, his firm has $2 trillion at risk of collapsing into the “Black Hole” coming after the Credit Supernova, when the Federal Reserve cheap money finally explodes in America’s face, brings down the economy, again.
Gross’s Credit Supernova metaphor is the explosive headline on his latest Pimco newsletter. So what’s a supernova? Jump over to the Space.com’s parallel universe where you’ll discover a supernova happens when a “blindingly bright star bursts into view in a corner of the night sky ... burns like a ... brilliant point of light.”
A supernova is “the explosion of a star that has reached the end of its life ... Supernovas can briefly outshine entire galaxies and radiate more energy than our sun will in its entire lifetime.”
Yes, a supernova is the “explosion of a star that has reached the end of its life.”
“End of its life?” Is America’s star economy burning out? Sure sounds like it: Gross is doing more than just hinting with his Credit Supernova metaphor. He’s predicting the collapse of the American economy and global financial markets, far worse than the 2008 Wall Street bank credit collapse, worse than the 2000 dot-com crash.
As the folks over at Business Insider put it: “Investment banks have morphed markets with ‘Ponzi Finance.’ And time is almost up.”
Fed’s Ponzi scheme: Credit expansion killing economic growth
Business Insider’s Matthew Boesler summarized Gross’s rather cryptic metaphor this way: Gross’s newsletter “tackles the relationship between credit expansion and real growth” where under Bernanke the Fed’s cheap-money bubble makes our monetary problems get bigger as the Fed keeps kicking them down the road.
So the Fed’s “Ponzi Finance” must run its printing presses full blast to pump more and more credit into the economy “just to cover increasingly burdensome interest payments, with accelerating inflation the end result.”
The problem is huge: Bernanke’s Ponzi Finance is self-sabotaging. Endless cheap money upsets the balance between credit expansion and real economic growth, resulting in diminishing returns: “Each additional dollar of credit seems to create less and less heat. In the 1980s, it took four dollars of new credit to generate $1 of real GDP. Over the last decade, it has taken $10, and since 2006, $20 to produce the same result.” Bad news.
Yes, Wall Street and central banks worldwide are the engine driving Bernanke’s Ponzi scheme straight into a Credit Supernova bubble. Why? Because in the past generation more and more of the Fed’s new credit was channeled into market speculation, distorting the balance between markets and the real economy.
“Investment banking, which only a decade ago promoted small-business development and transition to public markets, now is dominated by leveraged speculation and the Ponzi Finance.”
Gross warns: As a result, “our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic — it is running out of energy and time. When does money run out of time? The countdown begins when investable assets pose too much risk for too little return; when lenders desert credit markets for other alternatives such as cash or real assets,” a trend that’s already accelerating as more and more investors wise up to Wall Street’s dangerous Ponzi Finance, anticipating that a Credit Supernova will soon bring down Bernanke’s totally mismanaged monetary system, probably in 2013, months before his scheduled retirement.
After Credit Supernova will banks see the light ... or stay blinded?
Alan Blinder is familiar to Wall Street Journal readers and investors. The former vice chair of the Federal Reserve just published “After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead.” His recent New York Times op-ed piece is a perfect playbook of what’s coming after Wall Street’s Credit Supernova explodes.
Blinder opens by quoting Hegel: “What experience and history teaches us is that people and governments have never learned anything from history.” But then Blinder adds, “actually, I think people do learn. The problem is that they forget, sometimes amazingly quickly. That seems to be happening today, even though recovery from the economic debacle of 2008-9 is far from complete. Evidence of this forgetting is everywhere.”
His list of Wall Street’s mental blocks is all too familiar. They are blind, in denial. So Blinder “encapsulates what we must remember about the financial crisis into 10 financial commandments, all of which were brazenly violated in the years leading up to the crisis.”
Imagine his frustration, like Moses coming down from the mountain, seeing the people partying, honoring false idols, the golden calf of profits. Wall Street did the same, forgot in 2000, forgot again in 2008, went back to the same old tricks.
Hopefully the next time, Blinder’s 10 Commandments will be enacted after the Credit Supernova explodes and awakens everyone across Wall Street, Washington, Corporate America and Main Street’s 95 million investors. Maybe even re-enact Glass Steagall.
So here’s an edited, paraphrased version of Binder’s new 10 commandments:
1. Remember that people forget, too much, too fast
Tim Geithner: “There was no memory of extreme crisis, no memory of what can happen when a nation allows huge amounts of risk to build up.” Blinder: “When the good times roll, investors expect them to roll indefinitely. When bubbles burst, they are always surprised.”
2. Never rely on self-regulation
“Self-regulation of financial markets is a cruel oxymoron. We need zookeepers to watch over the animals.” Blinder’s typically great imagery. Dodd-Frank Act “reforms are still being phased in” but “the industry (here and abroad) is fighting them tooth and nail.”
3. More protection for shareholders
“In the years before the crisis, too many directors forgot those responsibilities, and both their companies and the broader public suffered from the malign neglect.”
4. Elevate risk management
More disclosure: “When it comes to risk-taking, what you don’t know can hurt you.” CEOs let insiders “ride roughshod over risk managers, tipping the balance toward greed.”
5. Use less leverage with increased capital requirements
“Overborrowing was one of the chief foundations of the house of cards that collapsed so violently in 2008. Overpaid investment ‘geniuses’ used leverage to manufacture extraordinary returns out of ordinary investments.” Bigger returns trigger bigger risks.
6. Keep it simple, stupid
“Modern finance profits from complexity, because befuddled customers are more profitable ones.” But as “Paul A. Volcker, the former Fed chairman, once said, the ATM was the only beneficial financial innovation ... Who needs credit default swaps on collateralized debt obligations?” Yes, the Wall Street casino loves dumb gamblers.
7. Standardize derivatives, trade them openly on exchanges
Make derivatives “transparent, well collateralized, traded in liquid markets by well-capitalized counterparties and sensibly regulated, derivatives can help investors hedge risks ... opaque over-the-counter derivatives.” Unfortunately the “industry is pushing to keep more derivatives trading out of the sunshine.”
8. Keep all deals on the balance sheet
Banks put too many “important financial activities off their balance sheets to hide how much leverage they had. But the joke was on them.” Dodd-Frank is crystal clear: “Capital requirements shall take into account any off-balance-sheet activities of the company.” No wonder Wall Street hates it.
9. Fix perverse excessive compensation
“Offering traders monumental rewards for success, but a mere slap on the wrist for failure, encourages them to take excessive risks.” Investors want “claw-backs” for when huge gains turn into losses. If banks don’t do it, “the heavy hand of government” will.
10. More protection for consumers
Blinder ends with his biblical analogy of the Ten Commandments intact: “The meek won’t inherit their fair share of the earth if they are constantly being fleeced. What we learned in the crisis is that failure to protect unsophisticated consumers from financial predators can undermine the whole economy. That surprising lesson mustn’t be forgotten. The Consumer Financial Protection Bureau should institutionalize it.”
Unfortunately even Binder doubts his 10 commandments will ever become the law of the land. Maybe if the Bernanke Credit Supernova ignites the world in a giant fireball bringing down the global economy and financial markets. Maybe that Credit Supernova will finally wake us up.
Fat chance, we’re all just human. And humans will forget again, right? Remember how quickly we forgot Hegel’s warning: “What experience and history teaches us is that people and governments have never learned anything from history.” Never? Never.
Paul B. Farrell is a MarketWatch columnist based in San Louis Obispo, Calif. Follow him on Twitter @MKTWFarrell.
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