Another financial crisis is inevitable

by Charlie_East_West on November 19, 2013

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Five years after the 2008 financial crisis, one thing seems certain: we will eventually have another meltdown of the financial system. Why? Because we still haven’t fixed the problems that led to the last crisis. This meltdown may well come sooner than we think…

A friend of mine works in the City of London. He told me with great certainty that we should expect another financial crash in late 2014 or early 2015. In fact, many financial analysts are now whispering the unspeakable truth that the smart money in the City of London has begun the process of pulling out of the stock market due to unease about misplaced and dysfunctional mechanics within the current structures of both monetary and fiscal policy.

There are a number of reasons for this current unease:

1. Nothing has been fixed within our financial system
A root cause of the financial crisis was the dramatic rise of unregulated financial risks with huge and complex balance sheets composed of volatile assets and risky debt. Much of this system remains intact five years after the crisis, and is still relatively unregulated.

2. We repeating the same mistakes as before the 2008 crash
- The markets are going into a bubble. Crazily, George Osborne has opened the door towards a right to buy housing bubble just five years after the 2008 crash.
- Banks remain oversized and willing to risk it all. JP Morgan’s multi-billion losses in the London Whale, and current concerns on the Co-operative Bank show that the appetite for big risks in search of big profits remains insatiable.
- Derivative trading remains unregulated. What Warren Buffett famously called “financial weapons of mass destruction” continues to run amok across both Wall Street and the City of London.
- A lack of punishment in any financial skulduggery. Despite the continued financial abuses and trillions of dollars in lost wealth, not a single high-level executive of any financial firm has faced accountability in the form of criminal charges. This lack of accountability and punishment just allows the financial hucksters to continue with exploitation of the financial system into the future.

3. Interest Rates
The Bank of England have revised its projections about short term growth towards a more optimistic outlook. But, speculation is mounting that we may get gradual increases in interest rates by late 2014 or early 2015 – this in turn, will have a potentially devastating effect on the housing bubble as many homeowners will struggle to meet their own mortage payments.

4. Margin debt levels
Between November until May over the last 50 years, Market stocks traditionally overperform in what is called “The Halloween Effect” – It is expected to follow a predictable pattern again in 2013-2014. After which, around May 2014, as a way of self regulating both the markets and debt levels – the overall margin debt levels will rocket – as traders bet and borrow against their speculative investments. Many analysts already think that market debt is already worse than it was before the 2008 crash. So, when traders do decide to cash their own chips in – expect a quick crash.

5. The perfect storm
Combine all of the above and the clouds are gathering for a massive financial storm. Due to the perfect storm conditions of overinflated markets, market debt, house prices, accumulated debt from shaky mortages, household debt, continued bank debt, national debt and Eurozone instability – what we are going to see from May 2014 is the first signs of a huge market crash – the realisation of collective margin debt levels going sky high like they were in 2007, and with a potential sudden spike in interest rates, and a lack of market and government capital to solve the problem.

We are all being blindsided by the government-led rhetoric that the recovery is underway. This is a terrifying myth. We have a set of monetary and fiscal disasters waiting to happen – bundle all of these together and we get a financial crisis that will be potentially bigger than 2008. And, even more terrifyingly, is the lingering thought that how the hell will any new financial crash be bailed out by the government? It is perhaps this last consideration that gives economists, financial analysts, markets, the government, and households across the UK the greatest concern – it would lead to a complete loss of economic confidence, another deficit spike, a reduction in the UK credit rating, a forced spike in interest rates to pay for increased national debt levels, collapse in the wider economy and austerity that may be comparable to that seen in Greece.

So, another crash is likely to happen. As former US Treasury Secretary Henry Poulson recently stated “It’s a certainty. As long as we have markets, as long as we have banks, no matter what the regulatory system is, there will be flawed government policies. Those policies will create bubbles. They will manifest themselves in a financial system no matter how it’s structured and how it’s regulated.

Everyone has their heads in the sand over this. Nothing has changed since 2008. In fact, it has got worse – as the problems are worse. And, as such, when it all blows up again (which it will) – then the next financial meltdown will make 2008 look tiny by comparison.

Be afraid. Be very afraid.

{ 13 comments… read them below or add one }

George_East November 19, 2013 at 1:42 pm

I broadly agree that no lessons or at least insufficient lessons have been learned from 2008. The Osborne housing bubble is indeed one of the most cynical political manoeuvres ever by a Chancellor of the Exchequer – reckless in its consequences and gambling everything on it achieving enough of a feel good factor to bring the Tories victory in 2015, leaving the consequences of that bubble bursting until after 2015.
The other big issue I think is that the banks remain too big to fail. I have been saying throughout that the banks ought to have been broken up so that the systemic risk of one of them failing is removed.

I don’t think though that we are in a 2007 situation (yet) and I suspect that the timeline you suggest above is likely to be considerably longer. The prospects of a full blown financial crisis this side of the election, I think, are incredibly remote without some kind of external shock (collapse of the Euro/war with Iran etc):

1. The availability of credit is way more restricted than it was then;

2. Interest rates are rock bottom and are (in reality) likely to remain so for a good while yet. Carney has given himself wiggle room even if unemployment hits his 7% threshold. There won’t be a BoE move upwards I think until the Fed moves upwards and there is no immediate prospect of that (the ECB has just reduced its base rates remember);

3. Bank’s capital ratios are better (though not good enough) than they were in 2007-8.

Also even if there was a crash, it would be grim but we would not be in the same position of Greece. Its problems (like those of the rest of southern Europe) stem from not having its own currency and having to deal with improving its balance sheet by internal wage deflation, rather than letting the value of the currency fall and monetary expansion.

I think the much larger issue facing the British economy is a small recovery marked by a continued decline in real wages for the overwhelming majority. As Larry Summers recently remarked a permanent state of minor depression may be the new normal.

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Charlie_East_West November 19, 2013 at 1:58 pm

Lets work this out backwards – Britain would have an austerity programme similar to Greece, if the government had to act upon another deficit crisis which is prompted by another financial crash. In such a scenario – Interest rates will be forced to spike upwards if Britain has a credit rating crisis – which would be prompted by another financial crisis – which would be prompted by a stock market crash – which would be prompted by the worrying levels of market debt levels – which would be prompted by the unhealthy storing of toxic debts and a potential sub prime housing market – which would be prompted by Osborne’s right to buy scheme – which was prompted by a need to show some sort of economic growth at any cost – which was prompted by five years of little or no growth caused by austerity – which was prompted by the 2008 crash. And so it goes on…and on…and on….nothing changes.

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George_East November 19, 2013 at 3:51 pm

A credit rating crisis requires fears that the UK can’t pay its debts. The UK has its own currency with debts in its own currency. It is very difficult in such a situation to envisage how that happens. Remember Japan has a debt to GDP ratio of over 250% and has the lowest long term Treasury rates in the world.

Fears of a credit rating crisis are the very fears the right use to justify austerity. It was how Clegg tried to sell his change of mind on the economy. It was nonsense then and would be nonsense again.

You say that a credit rating crisis would be prompted by another financial crisis. But that is the exact opposite of what happened in 2008. We had a huge financial crisis but the safest long term debt in our history. A stock market crash and/or a financial collapse are likely to result in the same again – a flight to safety: government bonds.

As Paul Krugman has been rightly asking for 5 years now – how in macro economic terms does it even happen? Still no one has provided an answer to that question.

I don’t disagree with some of your analysis but I think on this point it just doesn’t work and it is the wrong thing to be afraid of.

Also and separately the credit rating agencies are full of shit. Both the US and France have been downgraded in recent years and the consequence for both has been a flight to government debt not a flight away from government debt.

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Charlie_East_West November 19, 2013 at 4:06 pm

I agree with your points about misplaced austerity – but, if UK plc are at somepoint forced to pay back their own interest at higher rates – then this will lead to one or possibly two outcomes – higher interest rates and more austerity.

Another financial crisis would suck our government into this vortex as it could lead to another spike in the deficit due to bail outs etc and set the wheels in motion towards even more austerity and interest rate hikes.

But – it is all speculation – both in terms of outcome and approach. My main thrust is this – we have a set of economic circumstances that are just papering over the cracks – and that can only ever mean one thing – financial crisis (Part II).

Tragically the government are still not operating in real terms of growth strategy. It is all about short termism hoodwinking growth based on another London/housing market bubble rather than developing industries that can compete and sell their outputs globally – this would involve certain industries being renationalised and run privately – as we both agree upon, and a stakeholder employee structure within such industries.

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David in London November 20, 2013 at 11:08 pm

I can’t say what’s changed since the 20th century but interest rates now appear not to be linked to the market. So they just keep them low to service the bankers and we all lose out, and they’re still making so much out of it it seems they can keep them down as long as they feel like it. It’s a nice trick but till they get busted we’re all losing out big time.

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Eddie Kaye November 19, 2013 at 5:14 pm

Being a total cynic, a late 2014 crash would debunk the Tory BS about how Labour ’caused’ the last one. Coupled with the fact that in 2008 Brown and Darling tried to stimulate our way our of it – Camoron and Gideon would try to cut our way out of it, put the final nail in the public sector coffin, and go into the 2015 election claiming they were making the ‘tough decisions’. Hopefully it will mean that election is fought on what it needs to be fought on – a need for a change in how things work. Merely changing the colour box more Thatcherism comes in is not the answer. A future crash would be the fourth of that rancid ideology’s 36 year tenure at the heart of oour political bubble – that bubble needs bursting!

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Charlie_East_West November 19, 2013 at 5:17 pm

Agree. Also – just look at the deficit since the Tories have been in power. It has rocketed.

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Julian November 20, 2013 at 2:32 pm

It will happen, they have been putting a sticking plaster on an infested gaping cut. The debt ratios of Governments and personal around the western world will mean there will be no recovery of any substance. Once the debts become unimaginable the crisis will begin.

My guess is the trigger will be the withdrawal of QE in the USA. This will cause rates associated with repayment to spiral.

This time there will be no saving the banks, it will get very messy indeed.

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Charlie_East_West November 20, 2013 at 11:14 pm

Julian – I agree. Eventually the whole model of paper money capitalism will collapse. There is just too much debt at every level. From the household to the corporate to the state.

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David in London November 20, 2013 at 10:57 pm

My economics is not at a level to analyse the details, but the main element is no one physically loses money during the crash, they have it redistributed to either governments, bankers, or the rare mortgage defaulter who isn’t repossessed. That’s why the system hasn’t changed, as they pulled off the perfect crime last time around and of course want another go. The governments are now told what to do for future favours, so every western country is run like the Mafia and should expect identical results with identical policies. Quantitative easing is the lowest form of market manipulation and skims a great percentage off most people’s incomes and the rest lose through the guaranteed inflation it causes by shifting investment from cash to commodities. Debasing a currency is still treason.

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Charlie_East_West November 20, 2013 at 11:13 pm

David – thanks for your comments. A really interesting angle. I share many of your concerns. I am also sceptical about the benefits of QE.

My main concern however, is the effect upon the wider economy in all of this. 1% will prosper regardless. 99% will pay a price somewhere down the line,

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In the know November 24, 2013 at 8:44 am

These debates interest me not because I am an economist but because I am keeping an eye on base rates because of my business. I am (perhaps the rare – I am not sure) example of someone who decided to respond to the low interest rates by taking my savings and investing in a new business start up – right in deepest part of the recession. Bit foolish because I required bank support – they said the right things and then pulled funding when it was required. But I struggled through (with many sleepless nights) and have emerged with a big debt and a profitable business – although I draw little from it, since I am trying to plough everything back in to reduce the debt burden before interest rates rise.

I read quite a bit saying that it is the bankers benefitting from low interest rates – I read much criticism of BoE and government policy (and I am certainly no coalition supporter) – but from my perspective (at the cutting edge of small business) the existing policy is working / has worked to some degree. A big hike in interest rates would hit my emerging business hard – a slow increase would appear to be the only sensible way forward.

What I have concluded though – is that the biggest failure in policy (from a small business perspective) was the attempt to get banks to lend. The banks ended up saying one thing and doing another (they lied continually) – saying it was business as usual and then pulling funding offers at the last minute. Lying like this was much worse than just being honest – it almost put me out of business (and home) and has crushed many existing and emerging businesses.

Sorry, if this appears a narrow view of this debate. But I thought that a bit of real experience (rather than theory) might be useful. I invested because of low interest rates (that was the idea – it worked for me), I employed well around 20 people in construction to set up my business just as construction was crashing, I injected almost a million into the economy mostly into the economy of my very small Northern Scottish village just as the sh*t hit the fan. I need interest rates to not jump while I recover from this investment (read debt) – a slow rise. Surely I am an example of some degree of successful BoE (and I hate to say it – government) policy in response to the crisis. Although admittedly, a success of the reaction to an emergency. We certainly do need some deeper and more systemic changes to avoid the emergency happening again – don’t expect that to come from the banking and financial sector!

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Charlie_East_West November 24, 2013 at 8:48 am

In the know – that is a brilliant personal critique of the situation.

You may be interested in my own story – which is similar in terms of running a business:-

http://www.allthatsleft.co.uk/2013/11/its-the-stupid-economy-stupid/

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