Category Archives: Strategy & Scenarios

The Four Horsemen

Well I left the original title. But ended up with nine Horsemen of the Apocalypse. Some or all of these Horsemen are likely to drag us into a global depression.

1. Commercial real estate

Office occupancy across the country is down about 20% from pre-pandemic levels, but much more in the big cities, especially the Democrat-run ones where crime, homelessness and drugs make office workers unwilling to come downtown. Office buildings in big cities like San Francisco and New York are selling at small fractions of their previous purchase prices, and then re-entering the rental market at cut-rate prices.

Retail malls and big boxes have been suffering from online shopping and a glut of retail space. For places like France, Germany, the United Kingdom and Japan, average retail space is less than 5 square feet per person. In the U.S., that number is more than 23. This year is on track to be the worst year for retail bankruptcies since 2020, with strip-mall mainstays like Bed Bath & Beyond, Tuesday Morning, Party City and David’s Bridal all filing for bankruptcies. Notably Home Depot, Target, The Container Store all warning of negative trends. Shopping malls are seeing the same kind of drop in valuations as the heavily impacted office buildings.

2. Banks

A Hoover Institute report calculates that more than 2,315 US banks currently have assets worth less than their liabilities. The market value of their loan portfolios are $2 trillion lower than the book value. And remember this is before the fall of the asset values which is still to come. These banks are insolvent, even though their financial reporting may not disclose the fact due to “held to maturity” accounting rules.

(Egon von Greyerz on Twitter.)

Nervous bankers don’t want to take risks and so pull back on lending. The Senior Loan Officer Opinion Survey provides information on this tendency, otherwise known as a credit crunch. Quoting the Fed:

“In a set of special questions, the April SLOOS asked about banks’ reasons for changing standards or terms for loans across all loan categories over the first quarter. Overall, major net shares of banks reported that a less favorable or more uncertain economic outlook was an important reason for tightening, as well as reduced tolerance for risk, deterioration in customer collateral values, and concerns about banks’ funding costs and liquidity positions.”

3. Federal government

The Federal Government’s interest expense, on its $32 trillion in debt, now exceeds that of the former elephant in the room, military spending. Also, misleadingly, called “defense”. As of the first half of FY2023, The Federal government is spending 50% more than it takes in. An uncontrolled spiral is underway and will result in hyperinflation if not quickly brought under control.

4. Residential real estate

Recent years have seen an explosion of Short Term Rentals (STR) as Debt Service Coverage Ratio (DSCR) loans have made it easy for people with relatively little in the way of income or assets to acquire large numbers of properties to be deployed with AirBnB, VRBO and others.

You probably thought that, after the GFC, NINJA (No Income No Job or Assets) loans became unthinkable.  Well you thought wrong. They came back in as Debt Service Coverage Ratio (DSCR) loans. Basically a NINJA loan for the purchase of rental properties, DSCR loans enable real estate investors to get a loan because it takes into account cash flow from investment properties rather than pay stubs or W-2s, which many investors do not typically have. Lenders use DSCR to evaluate a borrower’s ability to make monthly loan payments. DSCR is simply the ratio of gross rental income to debt service expense, Needless to say, any hiccup in the income stream can turn quickly into default. DSCR requirements are typically 1.0 to 1.25, although some lenders will accept ratios as low as 0,75 with a 12-month cash buffer. Of course these loans are used to acquirte traditional rental properties, but the volume has been in STRs, This will not end well.

Large Investors – hedge funds and institutions – have been buying wholesale quantities of single family rental properties (SFRs), often buying whole developments from builders. Now they have started to sell, presumably as their financing is floating rate lines of credit rather than traditional mortgages. While the selling is subdued so far, it could become an avalanche.

Also see the China section

5. Consumer spending

Consumer spending will be negatively impacted by the increasing burden of debt service and layoffs.

Leading off is the end of student loan forbearance. This is no small matter with student loans now totaling $1.7 trillion, averaging $28,850 per borrower. Reportedly many borrowers have taken advantage of forbearance to add indebtedness for cars, vacations and a myriad of other purposes and will now be facing daunting monthly payment obligations. All of this will have a negative impact on consumer spending.

Consumer debt now amounts to about $4.8 trillion, bad enough, but the re-instatement of student loan repayment adds a sudden 35% to the burden.

This cycle, layoffs started with the highest paid workers. Elon Musk cut the workforce at Twitter by 75% and nothing much happened. The lights stayed on, development continued. Other “tech” bosses followed suit, tentatively. It became clear that some of these companies were basically adult daycare where little was demanded of employees. With generous severance plans, the hit to consumption has been muted so far but can be expected to build momentum, even as those still employed adopt more cautious approach to their spending plans. As noted above, retail businesses are signalling a downtrend in consumer spending. Fed Chair Powell has made it clear that he intends to keep hiking interest rates until the unemployment rate climbs significantly. This could easily snowball.

Res ipsa loquitur.

6. Inflation

See preceding post, “I Have To Laugh“.

7. Climate Initiatives

What a mess. Nothing damages an economy as much as an unreliable or intermittent energy supply. Widespread use of  wind and solar energy requires a complete re-engineering and replacement of the transmission grid, including use of batteries or other energy storage technologies. This will take decades and staggering costs. Governments trying to shortcut this process will cause economic havoc, as has already started in Europe. There is a better solution – nuclear – and a few enlightened governments may have consulted actual engineers and started down this path. But never underestimate the stupidity of governments pandering to vocal activists. And even if CO2 really is at fault (the historical record says it is a result, not a cause) the US is a drop in the global bucket.

Then there is the electric car fantasy. California has already had to ask electric car owners to suspend charging for fear of overloading the grid. Gas stations and tank trucks distribute enormous amounts of energy. The elcctricity industry is nowhere near able to generate or transmit this energy, but radical governments are calling for the elimination of gasoline and diesel powered vehicles. Way to cripple the economy, folks.

8. China

The Chinese housing bubble is collapsing as desperate speculators “want to cry without tears.” The government is attempting to prop up the market but it isn’t working. This is the largest asset class in the world and defaults will have worldwide impact, not only on foreign investment but also on Chinese trade with the rest of the world. China has propped up the global economy in the past. It now appears that it will drag it down.

9. Russia and Ukraine

Obviously the big risk here is continued escalation, possibly resulting in a nuclear Armageddon or, more likely, a land war in Europe. Again the stupidity of politicians make these outcomes a significant risk.

I Have To Laugh

Inflation numbers, like most economic data, are noisy in the short term and highly dependent on the weighting of the various components. That’s why we have both CPI and PCE, “headline” and “core” and even “supercore”. There are many other measures like “trimmed-mean”, “median”, “sticky” and so forth. The St. Louis Fed’s list of inflation charts – just the headings – runs to 30 pages. But financial commentators cannot resist the temptation to cherry-pick the data that supports their personal thesis and throw out the data that doesn’t (must be “transitory”) and declare imminent victory over inflation. Yes, the economy is quickly rotting from the inside. But there is no historical basis for believing that a recession will bring inflation down, at least without a financial crisis much bigger than the 2008 GFC. This is not to say that such a crisis won’t happen, but that is a separate matter from re-arranging the tea leaves to extract the desired prediction from the current data.

Credit John Hussman to use actual data and observe that the best predictor of inflation is… (drum roll) year over year inflation. But you don’t need to know that. All you need to know is that the Federal deficit for the first six months of FY2023 was $1.1 trillion. Federal revenue for the whole year is budgeted at $4.71 trillion. This means the Federal government is spending roughly 50% more than it takes in. That, ladies and gentlemen, is where inflation comes from. To make matters worse, its partner in crime, the Federal Reserve, is no longer converting that deficit into interest-free cash (QE) but is letting its Treasury portfolio roll off at maturity(QT). Now the Feds have to issue new interest-bearing debt, plus replace the existing debt as it matures. As of Q1, the interest bill alone was $929 billion, up 54% from the same quarter of 2022. Roughly half of all $32 trillion in federal debt matures in five years or less and must be re-issued at then-current rates.

I may laugh at the data manipulators, but this is a picture of a slow-motion train wreck where you and I are the passengers. The train driver sees no problem and is unwilling to even discuss applying the brakes, although brakeman Powell has started to turn the wheel. I am reminded of an incident that happened when I was in high school. I had a summer job working on a maintenance crew for a property developer. One morning I came in and the boss called me over “Grab your lunch and one of those folding chairs and come with me. You’ve got a watch, right?” “Yes,” I said and did as told. We drove out into the countryside and stopped by the side of the road. There was a buried concrete vault with steel doors on top, which we opened to reveal a large pipe and valve with an equally large wheel. You could hear a rushing noise. “This,” said the boss, “is a 36-inch water main. As you can hear, it is in use but we need to shut it down to do some work on it. Your job is to turn that wheel one quarter-turn every 15 minutes. If you turn it too fast that pipe is going to jump right out of the ground. Understood?” I acknowledged and he demonstrated and left, saying he would pick me up for quitting time. (IIRC I was being paid $0.80 an hour. but saved enough to buy my first car, a $1895 Mini Cooper with parental matching funds.)

Back to the subject. Powell is turning his wheel a quarter point at a time. Is he turning it too fast? We’ll only know if the financial system has a heart attack. Is he turning it too slow? According to Bloomberg, Venezuela is raising its interest rate to 97% on Monday. That’s what happens if he is too slow. When is quitting time?


Elementary, My Dear Watson

Borrowing short and lending long is catching up with banks that have forgotten (or never learned) the need to match maturities. This is banking 101. I can only assume that these banks had other things on their minds when they hired or promoted their executives. There is a shibboleth that says, roughly, those who do not study history are doomed to repeat it. The most recent history here is of course the failure of 32% of S&Ls between 1986 and 1995. And here we go again. Any properly managed bank could readily avoid or hedge interest rate risk and, fortunately, many seem to have done so. MBS, CLOs, CDOs, etc., the ways to offload are legion. Instead, managers chose to speculate. Unfortunately, stupidity is not a crime.

Edit: One can argue that rate increases played a role in the 2008 GFC, but in my view the main cause was poor credit quality leading to a vicious circle of defaults.

Powell On QE

Extract from the FOMC minutes 10/24/2012. Emphasis is mine:

MR. POWELL. Thank you, Mr. Chairman. So we have had Gary Cooper, the Most Interesting Man in the World, Bill Belichick, Woody Allen, and now Hamlet. [Laughter]

I support alternative B, to relieve the suspense. And as far as what is to be decided at the next meeting, it seems to me we should let it be decided at the next meeting. But I will say that if we have another good run of data, I think there would be a strong case to defer action. And I don’t see us as committed to act unless conditions warrant.

I have concerns about more purchases. As others have pointed out, the dealer community is now assuming close to a $4 trillion balance sheet and purchases through the first quarter of 2014. I admit that is a much stronger reaction than I anticipated, and I am uncomfortable with it for a couple of reasons.

First, the question, why stop at $4 trillion? The market in most cases will cheer us for doing more. It will never be enough for the market. Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated. And we will be able to tell ourselves that market function is not impaired and that inflation expectations are under control. What is to stop us, other than much faster economic growth, which it is probably not in our power to produce?

Second, I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.

My third concern—and others have touched on it as well—is the problems of exiting from a near $4 trillion balance sheet. We’ve got a set of principles from June 2011 and have done some work since then, but it just seems to me that we seem to be way too confident that exit can be managed smoothly. Markets can be much more dynamic than we appear to think.

Take selling—we are talking about selling all of these mortgage-backed securities. Right now, we are buying the market, effectively, and private capital will begin to leave that activity and find something else to do. So when it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. So there are a couple of ways to look at it. It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month. Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position. When you turn and say to the market, “I’ve got $1.2 trillion of these things,” it’s not just $20 billion a month— it’s the sight of the whole thing coming. And I think there is a pretty good chance that you could have quite a dynamic response in the market. And I would just say I want to understand that a lot better in the intermeeting period and leave it at that. Thank you very much, Mr. Chairman

After you’ve read this, do you think that Powell is in the least surprised by the consequences of raising rates? I don’t know what he will do, but I doubt that he will be deterred from whatever his strategy may be.

Bank Runs

Silvergate Capital, a bank known for its ties to the crypto industry, said yesterday that it would voluntarily liquidate. Today Silicon Valley Bank, known as close to the venture capital industry, was closed by California regulators. Both are somewhat special cases, so aren’t necessarily a sign of general distress.

However, it is fair to say that banks are pressured on both sides of their balance sheets. On the asset side, interest rate increases have caused securities portfolios to drop in value. On the liability side, short-term Treasury securities offer a safe and highly liquid alternative to bank deposits, forcing banks to either raise the interest that they pay or accept the loss of deposits needed for liquidity. So far most banks have chosen the latter, but it is a risky choice, as evidenced by Silicon Valley Bank, which was forced to sell its entire tradable securities portfolio at a significant loss in an attempt to shore up liquidity. This situation illustrates the two ways banks can fail – on the asset side, losses on loans and securities reduce the bank’s capital so that it cannot continue or, on the liability side, withdrawals deplete the bank’s liquidity – cash if you like – so that it is unable to meet the demands of depositors.

So far the impact on the broad stock market has been negligible, probably balanced between fear of a financial meltdown and confidence that a tremor in the banking system would force Powell to pivot. GLWT.

Edit: From an anonymous VC to a portfolio company CEO: “Our view is that this is a sector-wide issue. We’re advising founders not to use a bank right now. We’re pooling together our portcos’ capital and executing a large batch transaction for Starbucks gift cards. Starbucks is likely more stable than banks (they’re on every corner and everyone drinks coffee).

To cash out, we’ll just buy a bunch of those dipped madeleines they have near the checkout. Best case we make back 98 cents on the dollar. Worst case, we have a few million cookies that have a long shelf life.”

Of course the portfolio companies will never see that cash – the cookies won’t make it past the break room at the VC outfit.

Something’s Going To Break

From past experience, we can be pretty sure that the bear market doesn’t begin until the inverted yield curve returns to a positive slope. Usually this happens because of a major disruption in the financial markets. Here are some of the opportunities for breakage.

  • The average 30-year mortgage rate, as of today, is 7.13% according to Housing affordability has dropped to what Redfin deputy chief economist Taylor Marr calls the “lowest level in history.”
  • Office occupancy in major city centers is ranging from 40-60% as a result of WFH practices. Pressure on bricks-and-mortar retailers from online shopping continues to build. The overall US CMBS delinquency rate jumped 18 basis points in February to 3.12%. (The all-time high on this basis was 10.34% registered in July 2012. The COVID-19 high was 10.32% in June 2020.) . Giga-investor Blackstone just defaulted on $562 million of CMBS.
  • CPI/PCE inflation continues. While energy prices continue to be contained by withdrawals from the SPR, labor prices continue to increase. Fed chair Powell says that his primary measure of inflation is core PCE less housing, which implies a heavy weight on labor costs when evaluating inflation.
  • The Fed continues to raise short-term interest rates to reduce business activity and therefore reduce inflation. So far with little success. Financial markets are busily fighting the Fed’s attempts to tighten financial conditions. History says this does not end well.
  • There’s a war on, into which black hole the US continues to pump money and armaments. These will need to be replaced at great cost. Defense spending will be increased. The big risk is of further escalation, which could include the use of nuclear weapons.
  • The primary source of inflation is deficit spending by government. Half of the government’s debt has a maturity of less than five years. The Fed’s rate increases are quickly running up the government’s interest bill, which of course will increase the deficit – that’s how the black hole works. Interest is already nearly as large a budget item as defense spending.
  • China’s recovery from its draconian COVID policies is limping badly after a small initial surge. In addition, the US is actively hampering the development of technology in China and relations are a historic lows. There is a significant risk of another war, this time over Taiwan, where TSMC is the crown jewel of semiconductor manufacturing. All this means that China is unlikely to be the source of cheap manufactures goods that have helped quell inflation for the last twenty years or so.
  • The US stock markets remain highly overvalued and not investable as the flood of liquidity during the COVID era has supported speculation. The options market has grown to be larger than the equity market of which it is supposedly a derivative, leading to extreme gambling activities such as 0DTE options..

Get the idea?


Reportedly all stations in Russia have been ordered to carry Putin’s speech on Feb 21. Also it is reported that Russia intends to call a UN Security Council meeting on Feb 22 over the “sabotage” of the Nord Stream pipeline. Well-known thorn in the side of the US government Seymour Hersh has issued a detailed report alleging that the US Navy committed the sabotage.

Honne And Tatemae

There are many financial conditions indexes, but in general terms they represent the cost and availability of credit and equity financing, interpreted as relatively “tighter” or “loose, easy”. Markets were surprised that Powell appeared unconcerned that these indexes showed that financial conditions were more or less unchanged by the Fed’s rate and QT actions. His unconcern was interpreted as conceding that the bulls were right in believing that rates would soon come down.

My interpretation was that he simply didn’t think it was a problem. One of the Fed’s primary concerns is to keep financial markets functioning normally, and the indexes show that they are. However, it is important to remember that the Fed is very well informed. The Japanese have words for this, “honne” and “tatemae”. “Tatemae” is the outward appearance of conformance to society’s norms and rituals, while “Honne” is what is really going on behind the scenes. In this case, the “Tatemae” is the traditional information bureaucracy – the BLS, BEA, and even the Fed itself – and the ritual announcements of  lagged and often politicized estimates of economic data. The “Honne” is that the Fed uses all kinds of information services and is very much in touch with the high-frequency data that is gathered by state governments, industry associations and many other private services. The recent callout of the BLS by the Philly Fed shows that the Fed has little faith in the BLS. Powell knows that the economy is either on the verge of recession or already in one regardless of the NBER’s view. He knows that deflationary collapses are underway in markets like housing and used cars. He probably also expects that taking down inflation, as happened in the GFC, will likely require a severe correction in financial markets, probably worse than the GFC. But I am of the opinion that  he is willing to be wrong about that, so if markets are right to “look through” the recession to a return to low inflation he would be perfectly OK with that. He did warn that no rate reductions should be expected in 2023, nor would he back off prematurely, but this was widely ignored.

Edit: This morning’s employment report demonstrates the useless, erratic nature of the BLS data.


From the minutes of  the Fed’s 12/13-14 meeting:

Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.

Per Bloomberg, financial conditions are now back in pre-QT, super low rate – i.e. bubble – territory.

Fin Cond Index

This isn’t going to make Jerome Powell happy, is it? Could 0.50 be back on the table? Just to get the markets’ attention…


While a little of the massive cash pile that resulted from the Fed’s monetization of Treasury debt has been whittled away, there’s more than enough left to continue to encourage the manic speculation that we’ve seen in recent years. A week ago yesterday, Thursday, January 5, Bed Bath and Beyond (NYSE: BBBY), a past favorite of meme stock traders, told investors that ”there is substantial doubt about the Company’s ability to continue as a going concern.”

The stock closed that day about 30% lower, at $1.69. The following day, Friday, it closed another 23% lower, at $1.30 – fair enough for a company that had just issued a bankruptcy warning. But starting on Monday, the meme stock traders started a bull run and took BBBY along for the ride. On Thursday – yesterday –  the stock touched 5.87, a 350% gain from last Fridays’s close. Today, it closed at 3.66, a 180% gain from its low close and a 52% gain from its pre-news close.

This is not investing. This is the kind of speculative frenzy that is generally called “froth.” As in “frothing at the mouth” or “rabid.” “Froth” is at tops, not bottoms.

Edit: Just noticed that Bitcoin is back over $20K. Despite the continuous drumbeat of frauds, hacks, rug-pulls, SEC lawsuits, defaults, bankruptcies etc. Another sign of speculative fever.

Edit: I guess it is everywhere. “Lotto Madness” is back. Two months after a record-breaking $2 billion jackpot, another winning ticket, sold in Maine, is worth an estimated $1.35 billion. Odds of a jackpot-winning ticket: 1 in 302,575,350.