Gilty Finking

BlackRock's liabilities, the Bank of England's pivot and the folly of fake rates...

(Source: Getty Images)

Bill Bonner, reckoning today from Baltimore, Maryland...

Yes, dear reader, it’s a YODO world now. Investors are realizing that when they are dead, they are dead forever. No Fed voodoo to raise them from the grave.

And it’s the first time for most of them. No chance to practice. No opportunity to learn.

And so, the mood was glum at the end of last week. The jobs report on Thursday showed a stronger employment market than expected. Investors figured the odds of a Fed U-turn had gone down. They sold stocks. MarketWatch:

While markets have not yet morphed into an actual state of alarm, an increasingly dark sentiment is starting to brew behind the scenes.

Nikko Asset Management’s John Vail said a “short but scary” global recession is likely to be ahead. Ben Emons of Medley Global Advisors said Wednesday’s decision by major oil producers to cut production, starting next month, has the potential to turn into a prolonged stretch of higher inflation and big market swings. And volatility expert Harley Bassman said stocks could drop as much as 20% from where they are now — a magnitude similar to the single-day decline that took place during 1987’s “Black Monday” scare.

As the Fed raises rates, they become more ‘normal’ than they’ve been for many years. But ‘normal’ terrifies investors. It makes them realize how weird things have gotten and that they may have to back up before they can go forward. That is, they may have to give up their Bubble Era profits and admit that much of what they believed was either a lie or a delusion.

Disorderly Fashion

You don’t get real money from a printing press.

Credit from the central bank is not the same as money that has been earned and saved.

And there are limits to what assets are worth… and how much debt you can support.

And prices go down as well as up.

And fake interest rates – zero! – do far more harm than good.

And a group of hacks at the Fed can’t really improve a $24 trillion economy.

That would be normal. But when you’ve been living in a dreamworld, a return to normal can be brutal.  

So far, the decline in stocks and bonds has been orderly. There has been selling, but no panic selling. Today, we wonder when it will become disorderly.

All over the world, from the largest institutions – such as Larry Fink’s BlackRock – to the smallest minimum-wage household, normal interest rates squeeze the space between income and outgo. For many, the space disappears completely… and then outgo exceeds income. And as our old friend Sid Taylor, a defense budget analyst, used to say: “When your outflow exceeds your income your upkeep is your downfall.”  

The Bank of England ‘pivoted’ when it realized what ‘normal’ would do to the gilt (UK government bond) market. These are, by the way, the safest investments in the UK. They’re not NFTs or cryptos. England is not going to default. Gilts are not going to disappear.  

But you can still lose a lot of money in government bonds. And that’s what Britain’s pension and insurance giants were doing when the BoE (Bank of England) saved them.  

Lessons Unlearned

Imagine that you are running a giant pension company. You have billions in assets.  But you have billions in liabilities too. People are going to retire; you have to make sure they have the money they were promised.

You invest safely, prudently… careful not to lose money. This is money that absolutely, positively has to be there when it is needed.  

Trouble is, you based your projections on “normal’ interest rates. At 4% interest, you had it made. Your assets would earn enough to cover upcoming payouts. But at zero interest rates? You had to innovate.

Along comes Larry Fink. He tells you not to worry. You can use his “liability-driven investing” strategy (LDI). In the last major market hoop-de-doo, in 2008, Larry lost $100 million for First Boston in mortgage backed securities. But now, he’s learned his lesson, or so he says.

You don’t want to gamble with pension savings. But what else can you do? And Larry makes it sound… well… almost scientific. He shows you some neat charts and graphs. The idea is simple enough. If you need 4% interest, and your investments are only earning 1%... you borrow 3 times your assets in order to end up with 4 times as much yield.

Larry wears a nice suit. He says he cares deeply about the environment, social justice and enlightened corporate governance. And he makes it sound so easy.

And soon, your pension fund has borrowed billions of dollars and Larry’s LDI funds have more than $1 trillion in assets. But wouldn’t you know it? Just when you thought things might work out, UK bond yields went up (bond prices went down). Gilts were the collateral behind the billions the funds had borrowed. When they went down, pension funds got margin calls and had to sell their gilts to make payments to their creditors – further impairing the value of their collateral.  

Panic Early, Beat the Rush

That was the situation on the 29th of September. The bond market was becoming disorderly. Larry Fink’s LDI empire of debt was tottering. If it toppled over… it could bring down the whole system.  

Such is the wacky world created by the ultra-low interest rates. Nothing is safe.  Stocks are down. Bonds are down. Even gold, though flat for the year, is down $300 since March.      

When asset prices go down, lenders and investors – and all their tricked-up speculations – get into trouble. Because the assets of the latter are the collateral of the former. So, it was that the UK approached its moment of clarity and normalcy… and wanted nothing to do with it.

Meanwhile, over on this side of the Atlantic… Larry Fink has his headquarters in New York. US pension funds have made similar bets, trying to make up for a lack of yield by taking bigger gambles. Corporations, meanwhile, borrowed more than at any time in history, in order to disguise weak earnings and bid up their share prices. And even the federal government begins to teeter under the weight of $31 trillion in debt. It soon faces interest payments of $1 trillion per year.

Something’s gonna give. Then investors, standing in line patiently now, will begin to push and shove… and rush the exits.

Regards,

Bill Bonner