Wednesday, June 24, 2020

Let's play Jenga.... again... 12 years later


The classic "Jenga block" scene from the movie The Big Short, describing how the 2008 financial meltdown happened.  This scene is the best visual explanation of how debt, loans of one kind or another, are repackaged and sold, as "new" investments.  This simple metaphor of the Jenga block tower gets the basic idea across.  Since the Great Recession,mortgage backed securities and CDO's have been frowned upon.  So other forms of debt have been repackaged and sold in a very similar fashion.  Now lots of people aren't paying those loans back.  That's what makes the "Jenga tower" investments collapse.

In 2008, it was $1.3 trillion in subprime mortgage debt collapsing that brought the financial world to its knees, and sent something like 6 million homeowners running from their houses.  It's worse now.  MUCH WORSE.  According to this Forbes article from 6 days ago, more than 106 million different loans in the United States are not being paid back at the moment.  When people stop paying their loans, whether they just skip payments, or get into a deferment or forbearance program, money stops flowing into the bank or holder of the loans.  So the bank has less money to make their payments, and all these "assets," bundles of loans, aren't worth as much.  So the bank's financial position is less stable.  When enough people don't pay their loans, the investments made up of hundreds or thousands of loans, lose value, and that's when the Jenga towers collapse.

Right now, because of most people's paycheck to paycheck lifestyles, combined with 45 million people laid off and the Covid-19 shutdown, we have more people not paying their debts than at any time in history.  But it's not just one Jenga tower of subprime mortgages (which were home loans to sketchy people), like in 2007-2009.  We have several Jenga towers, with millions of people not paying their loans, that make up those Jenga towers.  That's what's on the verge of collapsing right now, a whole table full of Jenga towers.  And those towers are propping up the whole world's economy.

SLABS- Student Loan Asset Backed Securities- are basically the student loan version of the subprime mortgage bonds and CDO's in the clip above.  $1.3 trillion in subprime loans going bad triggered the financial collapse of 2008. There are roughly $1.6 trillion in student loans, making up the SLABS market right now.  A year ago, 40% of those loans weren't being paid on time, according to Nerdwallet.  It's safe to say a lot more student loans, making up those SLABS, aren't being paid now.  Why is there so much student loan debt these days?  Because investment banks have been making huge fees selling SLABS for 12 years.  They needed tons of loans to create them, so student loan money was easy to get.

To be fair, $1.3 trillion of these loans are "secured" by the U.S. government.  So what happens if those loans don't get paid.  Does the U.S. just eat that $1.3 trillion and write it off?  No one knows.  Yet.  One major difference between SLABS today, and the subprime bonds and CDO's in 2008, is that for every CDO and bond then, for every mortgage, there was a house that loan was for.  So the bank had a house to sell when the loan was foreclosed.  With student loans, the only collateral is the student's brain.  You can't foreclose a brain. 

CLO's- Collateralized Loan Obligations- This market is very similar to SLABS and CDO's, but it's made of of commercial (business) loans.  There are only about $700 billion ($.7 trillion) of these CLO's out there.  We all know how well America's businesses are doing right now, and how solid they are, to pay back all of these loans.  Another Jenga Tower.  Banks and insurance companies in the U.S. hold most of these investments, as far as anyone can tell.  So when these collapse, banks and insurance companies will be in in trouble.  Which ones?  We don't know.

CMBS- Commercial Mortgage Backed Securities- These are commercial (business) mortgages for commercial properties, repackaged, and sold as investments.  This is a little bitty Jenga tower, was a mere $96.7 billion last year (2019).  Who pays these mortgages?  Retail stores, mostly.  Ever hear of the Retail Apocalypse?  Yeah, those retail stores struggling and going belly up month after month, that's what this Jenga tower is based on.  Sounds solid to me.

And then there's the corporate bond market, another way that huge businesses raise money.  These days, companies that are damn near insolvent, like Boeing in March, sell billions of dollars in bonds, and then the Federal Reserve creates money from thin air, and buys those bonds, that Boeing knows it will never be able to pay off.  All the money The Fed creates out of thin air makes the dollars in your wallet or bank account worth less, which will lead to high inflation, at some point.  Maybe hyper-inflation.  This is how "zombie companies" are created, and that's a whole 'nother debt mess to be dealt with.

In any case, we have the three major Jenga Towers above, totaling somewhere around $2.4 trillion, and people and businesses not paying over 100 million different loans in the last two months.  That's nearly double the amount of debt that triggered the 2008 economic collapse, and a much greater number of people and businesses not paying that debt.  What could possibly go wrong?

Yeah, this is one reason I'm calling this a Great Depression when we're only a few months in.  After these bubbles pop, and they WILL pop, it will take years to sort the underlying mess out.  Things are going to get much crazier financially before they improve to any large degree. 

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