Everything That Bubbles and Bitcoin Fixes It – Bitcoin Magazine
This is a recording of a recent Twitter Spaces conversation about broken credit markets, runaway inflation, and why we need to fix the current financial system.
Listen to the episode here:
Dylan LeClair: Over the last 40 years, it seems like the bubble, as this duration component unravels and as the long-dated risk-free rate goes much, much higher or has gone much higher, that the 60/40 portfolio pensions with that kind of LDI (responsibility-driven investment), where they used the long-dated bonds as collateral, it seems like that might be the breaking point.
Like maybe it happens in the US, maybe not. But if old treasuries are trading like shitcoins, there are some pretty big implications there in terms of how the overall financial system is constructed. So the question I propose is: While we haven’t really seen the credit risk at the corporate country or sovereign level, I think what will be very interesting is if central banks are allegedly reducing balance sheets, are allegedly going to continue to raise interest rates, when will the credit risk be quickly priced into relation to what we have already seen, which was the duration of relaxation?
Greg Foss: Great question. The short answer is that no one knows. The reality is that new issues repeat markets. And since there hasn’t really been any new issuance in the high-yield country, you could argue that the repricing hasn’t happened.
It’s secondary market trading, but if you come up with a big new issue – like let’s take this Twitter example. Twitter is not going to be sold on the secondary market. The $13 billion debt that Elon took on that was financed by the banks is going to stay on the bank’s portfolios, because if they had to sell it to the secondary market, the banks themselves would lose about half a billion dollars, that is. the yield that they proposed – pricing the debt to Elon and locking in a liability – is no longer a market rate, so they have to sell it down by at least 10 points, which they don’t want to do. Their charge to take that mark-to-market loss, so they’re going to keep it on the balance sheet and “hope” the market recovers. I mean, I’ve seen it before.
If you remember in 2007, there was a famous quote by Chuck Prince, CEO of Citibank, on today’s LBOs (leveraged buyouts). He says, “Well, when the music plays, you have to get up and dance.” Well, knucklehead Prince about three months later, really regretted that statement because Citibank was saddled with so much unsaleable paper.
That’s the situation with Twitter, which means they don’t force these bonds into the secondary market, which means the secondary market doesn’t have to reprice all kinds of CLOs (collateralized loan obligations) and leveraged products, but it’s going to dribble on that way, Dylan, it’s going to start dribbling that way.
It’s not a crisis like subprime, per se. It is a crisis of confidence. And the confidence is a slow bleed versus a subprime default or the recognition that structured products like the Lehman Brothers situation, or excuse me, it wasn’t Lehman, it was a Bear Stearns hedge fund that blew up on subprime mortgage debt. It was the canary in the coal mine that just started it all; it was the repricing of the secondary market in 2007. Where are we today? We are in a situation, as you mentioned, that the 60/40 portfolio has just been decimated. Back in 2007, the Fed was able to cut interest rates and bonds rose because yields were—if memory serves—exactly where they are today. There was room for the Fed to cut.
It didn’t trade at 1.25 or even 25 basis points, which is where the Fed has come from to today’s 3.25%. There was room for them to cut interest rates to provide a buffer; bond prices rise, yields fall, as everyone knows. There was a buffering effect there, but we don’t have that luxury right now.
As you mentioned, the 60/40 portfolio: worst performance in a hundred years. The NASDAQ has never been down double digits, while long bonds have been down double digits in the same quarter. Why? Well, the NASDAQ has only been around since the 1970s and long bonds have never lost double digits in the last 50 years. They have if you go way back to the depression, if I remember correctly.
The point is that the 60/40 portfolio has experienced the worst decline in probably close to a century. And Lyn Alden laid this out very well. As for a capital destruction figure, I think something like $92 trillion of wealth has been evaporated in the fight against inflation this cycle. Compare that to the 2008 time frame when only about $17 trillion in wealth had evaporated. We are talking orders of magnitude larger. We are talking about a US debt spiral where 130% national debt to GDP does not give you much room.
