Trouble Ahead, Trouble Behind

“Taxman”

 Song by The Beatles

“Dear Mr. Jones”

Song by Counting Crows

IT’S JUST MATH AND HISTORY, A Simplified Attempt to a Complicated Story

“Trouble”

Song by Little Feat

The Financial eco-system is extremely complex and is constantly changing. Recently, the media reported on the bankruptcy of Silicon Valley Bank. This came out of left field; in a day, the epicenter of venture capital became history, and it will take time to truly understand the repercussions. The public tends to think of the health of the economy through the eyes of the stock market, but the less understood debt markets are forecasting a different outcome. I am attempting to tell a complex story by integrating established history, back of the napkin math and some current day common sense to shed light on the future. To help make the this a bit more entertaining and possibly comprehendible, I’ve integrated songs from bands, including a couple with a double entendre such as The Dead, Disturbed, Los Straitjackets, Nick Lowe, Talking Heads, Dire Straits, The Vapors, U2, Blood Sweet and Tears, The Who and Ten Years After. Go to troubleaheadtroublebehind.com to view an interactive website where you can hear the actual music soundtrack that accompanies this story.

The genesis of this effort was to help me personally think through the impact and speed of the Silicon Valley Bank collapse. In short, Silicon Valley Bank had a demand from depositors for $42B on a Thursday and was insolvent the next day. They were forced to sell their portfolio of liquid securities that were supposedly held to maturity for a real loss of $15B. This was almost their entire real tangible equity plus the FDIC will lose up to $20B in the liquidation process. The $2 trillion venture capital industry could see portfolio markdowns of 25% to 30%, a “haircut” of possibly $500 billion, owing the Silicon Valley Bank debacle. “After the failure of SVB, we expect greater valuation scrutiny and disclosure, especially as a large chunk of ‘fiduciary’ capital from pension funds has flowed into these markets and unlike endowments and family offices, there are no avenues to extend and pretend. There are enough zombie companies with frothy valuations that need restructuring, price discovery and of course re-tooling of their business models to a world of tighter credit, subdued revenue, and higher rates,” according to Bloomberg Intelligence analyst, Gaurav Patankar. A real time example, Twitter set a valuation of $20B for its stock option program, less than 50% of its purchase price and I was told from the head of a major VC firm they took a 40% write down.

A recent  article, in the Financial Times, by Abbey Joseph Cohen draws an interesting parallel to the collapse of SVB to Bank of the United States (“BUS”) in 1930, then the largest bank in the country. Both provided niche services that were not widely understood at the time how they effected the economy; SVB to Venture Capital and BUS to immigrants. According to the article, the BUS bankruptcy is widely believed to have been a major catalyst in turning the 1929 recession into the far more serious Great Depression. We won’t be able to quantify the true impact of this moment for years to come.

The following excerpt from an interview with the CEO of UniCredit causes me great concern; Banking shocks in the United States and Switzerland are “relatively localized,” but profound macro changes presage an uncertain future, said UniCredit CEO Andrea Orcel, a former head of UBS’s investment bank. Inflation, geopolitics, and the resetting of value chains are happening in parallel. “It’s almost inevitable something bad will happen and governments won’t have a playbook because our playbook is for past crises.” 

The best we can do is look at history and current events to help us formulate a personal game plan.

Historical Context

The Spanish Flu, Roaring 20’s, Prohibition and The Great Depression

 The Spanish Flu, Prohibition, the Roaring 20s, and the Great Depression were interconnected events that occurred in the early 20th century that made a significant and lasting impact on society and the economy of the United States. While each event had its unique causes and consequences, they were all interrelated and influenced one another in many ways.

The Spanish Flu

The Spanish Flu, also known as the 1918 Influenza Pandemic, was a global pandemic that lasted from January 1918 to December 1920. The pandemic infected approximately 500 million people worldwide, with an estimated 50 million deaths. The United States was one of the countries hit hardest by the Spanish Flu, and that global pandemic had significant effects on the country's economy, healthcare system, and society as a whole. The pandemic also had a significant impact on the economy, with many businesses forced to close due to high rates of absenteeism among employees. The government implemented measures such as mandatory quarantines and business closures in an attempt to slow the spread of the disease, but these measures had a negative impact on the economy. The pandemic was also a contributing factor to the economic depression that followed in the 1920s. In addition to its effects on healthcare and the economy, the Spanish Flu also had social and cultural impacts. The pandemic led to widespread fear and panic, and people were advised to wear masks and avoid crowds. Schools and universities were closed, and many public events were canceled, including parades, festivals, and sporting events.

Prohibition

Prohibition in the United States refers to the period from 1920 to 1933 when the manufacture, sale, and transportation of alcoholic beverages was prohibited by the Eighteenth Amendment to the U.S. Constitution. At the time, many supporters of prohibition believed that it was a moral issue, and that alcohol consumption was a threat to individual and societal morality. Prohibition was seen as a way to promote temperance and moral behavior, and to reduce crime and social problems associated with alcohol use. However, prohibition ultimately failed to achieve these goals, and instead led to a rise in organized crime and corruption. Many people continued to drink despite the ban, and bootlegging and speakeasies became widespread. Prohibition was eventually repealed with the passage of the 21st Amendment in 1933. In terms of morality, the prohibition era is often seen as a moralistic and idealistic period in American history, with advocates of prohibition presenting themselves as champions of virtue and righteousness. However, the failure of prohibition and the associated rise in crime and corruption also served as a cautionary tale about the dangers of trying to impose morality through legislation.

The Roaring 20’s

The Roaring Twenties was a decade of rapid expansion of the U.S. economy, driven by new technologies, mass production techniques, and the growth of consumer culture. This economic boom led to increased disposable income for many Americans, a flourishing middle class, and a surge in consumer spending. The stock market experienced a remarkable period of growth, with share prices soaring and investor optimism at an all-time high. This boom ultimately culminated in the Wall Street Crash of 1929, a devastating historical milestone that marked the beginning of the Great Depression. The 1920s were also marked by rapid technological progress, with innovations such as automobiles, radio, motion pictures, and household appliances transforming daily life for millions of people. These advancements enabled greater mobility, connectivity, and access to information and entertainment. The 1920s were a period of considerable social change, with women gaining greater freedom and independence following the ratification of the 19th Amendment, which granted them the right to vote. Additionally, the decade saw the rise of the flapper subculture, which challenged traditional gender roles and embraced a more liberated lifestyle. The Roaring Twenties were a golden age for arts and entertainment including the advent of "talking" motion pictures.

The Great Depression      

The Great Depression (1929–1939) was an economic shock that impacted most countries across the world. It was an extended period of economic depression that became evident after a major fall in stock prices in the United States. It was the longest, deepest, and most widespread depression of the 20th century. Between 1929 and 1932, worldwide gross domestic product fell by an estimated 15%. By comparison, worldwide GDP fell by less than 1% from 2008 to 2009 during the Great Recession. The negative effects lasted until the beginning of World War 2.

What were the major causes of the Great Depression?

According to David Wheelock of the St. Louis Fed, among the suggested causes of the Great Depression were the following reasons: stock market crash of 1929; the collapse of world trade due to the Smoot-Hawley Tariff; government policies; bank failures and panics; and the collapse of the money supply. 

The Stock Market Crash of 1929

The stock market crash of 1929, also called the Great Crash was a sharp decline in U.S. stock market values. The panic began on Black Monday (October 28), with the market closing down 12.8% and continued again the next day, Black Tuesday (October 29), with the Dow lower by another 12%. Over a two-month period the Dow went from 381 to 198 on Black Tuesday, a 48% decline. The Dow rallied to 300 in May 1930, but then rapidly declined and did not surpass its previous highs for 25 years. The Great Crash culminated with a period of rampant speculation fueled by stocks purchased with margin loans, tightening of credit by the Federal Reserve, the proliferation of holding companies and investment trusts (which tended to create debt), a multitude of large bank loans that could not be liquidated, and an economic recession that had begun earlier in the summer.

Bank Failures and Panics

At nearly the same time, widespread bank failures and panics resulted in a crisis of confidence among depositors with over 9,000 banks failing. In the years leading up to the Depression, many banks were overextended and had made risky loans to speculators in the stock market. When the stock market crashed in 1929, many of these loans became worthless, and banks were left with large losses. As the value of the banks' assets declined, depositors began to lose confidence in the safety of their deposits and began to withdraw their money en masse. The panic of bank runs was exacerbated by the fact that many banks had invested heavily in the stock market, leaving them vulnerable to losses when the market crashed. Additionally, the lack of a strong regulatory framework for banks meant that there was little oversight or protection for depositors, and many banks were allowed to operate without sufficient reserves or capital. As the bank runs continued, more and more banks failed, exacerbating the crisis, and causing further panic among depositors. The failures of small, local banks had a ripple effect, leading to the failure of larger banks and the contraction of credit and lending throughout the economy. The failure of banks also had a devastating impact on businesses, which were unable to secure credit to finance operations or invest in growth.

The Collapse of World Trade and Smoot-Hawley Tariff

The Smoot–Hawley Tariff Act of 1930 was a Republican party sponsored law that implemented protectionist trade policies in the United States and raised U.S. tariffs on over 20,000 imported goods. The official title, An Act to Provide Revenue, to regulate commerce with foreign countries, to encourage the industries of the United States, to protect American labor, and for other purpose. The Act prompted retaliatory tariffs by America's trading partners significantly reducing both exports and imports. Economic historians believe that the Act worsened the effects of the Great Depression. Government Policy and Collapse of the money supply.

The Glass-Steagall Act (“GSA”) was created during the great depression to separate commercial and investment banking and barred banks from owning insurers. Its purpose was to keep things small to prevent systemic risk.

According to the St. Louis Federal Reserve Bank, The Great Depression was not a failure of capitalism or of markets, but rather a result of misguided government policies, specifically, the Federal Reserve allowing the money stock to collapse as panics engulfed the banking system.

Interconnectivity

The interconnectivity of these events is significant. The Spanish flu pandemic contributed to the rise of prohibition, as many people believed that alcohol consumption contributed to the spread of the virus. Prohibition, in turn, contributed to the rise of organized crime and corruption, which had a significant impact on the economy and society. The Great Depression, which was caused by a combination of factors including the stock market crash and overproduction, was worsened by the policies of governments, which initially pursued policies of austerity and balanced budget These interconnected events that had a significant impact on society and the economy of the United States. While each event had its unique causes and consequences, they were interrelated and influenced each other in many ways. The lessons learned from these events continue to shape the way we think about public health, economics, and social policy.

Parallels to The Spanish Flu, Roaring 20’s, Prohibition and The Great Depression

 “100 Years”

Song by Five for Fighting

How Our Past Informs the Present, and Perhaps the Future

The Collapse of World Trade and Donald Trump

“Back in the U.S.S.R.”

Song by The Beatles

Russia and China are being driven together as the chasm with the West deepens. Gone are the days of globalization, causing shortages and inflation. The U.S. has added tariffs to numerous goods coming from China and other trading partners and vice versa. China is becoming a formidable foe engaging in political, military, financial and technological war. Donald Trump’s “Make America Great Again” seems like similar policy to the Smoot-Hawley act. The world order is being reset in front of our very eyes. China is challenging the US dominance in diplomacy in the Middle East, brokering diplomatic relations between Iran and Saudi Arabia. Vladimir Putin has spent the past week or so releasing plans to put tactical nuclear weapons in Belarus, disregarding critical treaty obligations requiring notice of nuclear missile tests, and the call up of more than 100,000 new troops for his war on Ukraine. The world is split on the war in Ukraine. Could this be the beginning of something even more severe?

“Sunday Bloody Sunday”

Song by U2

Donald Trump is potentially a visionary predicting death and destruction, but maybe it’s to the financial markets and his wealth. Donald Trump is the first former president to face criminal charges. Trump called the indictment “political persecution.” This is unprecedented. Trump has been fingerprinted and had his mugshot taken like any criminal. After this, everything (except perhaps a long, litigious road to a trial or two) remains uncertain. Trump has previously predicted “death and destruction” should he be indicted. His history of causing mayhem is a proven fact. He gathered his troops in Washington D.C. to try and stop Congress from certifying the Presidential election that removed him from office. The aftermath was also unprecedented. His mob broke into Congress and several Americans died and dozens more were injured. His indictment thrusts our divided nation into a new chapter of chaos.

Government Policy and Collapse of the Money Supply.

“(I Love the Sound of) Breaking Glass”

Song by Los Straitjackets and Nick Lowe

The Depression era Glass-Steagall Act was repealed in 1999. This began an unprecedented consolidation of financial institutions that created massive complex organizations that are challenging to manage. This has reintroduced systemic risks that are now upon us. Former management of Credit Suisse believe that its merger with First Boston changed its culture and risk tolerance resulting in its demise.

“Once in a Lifetime”

Song by Talking Heads

C3 Teachers believes that the Federal Reserve was to blame for the Great Recession because it created the conditions for a housing bubble that led to the economic downturn. They were also instrumental in perpetuating the crisis by not doing enough to stop it. The National Multifamily Housing Council states that the cost of home ownership has surged 71% over the past three years or over 20% per year compared to average annual rent growth of 6.3% over the same period. The rent-to-buy spread hasn’t been this wide since its peak in 2006. Could this be the prelude of an encore performance?

“Drop It Like It's Hot”

Song by Snoop Dogg

The Dodd–Frank Wall Street Reform and Consumer Protection Act, commonly referred to as Dodd–Frank, is a United States federal law that was enacted on July 21, 2010. The law overhauled financial regulation in the aftermath of the Great Recession. It restricts the emergency lending (or bailout) authority of the Federal Reserve by prohibiting lending to an individual entity and lending to insolvent firms. This limits the playbook used to save the economy in 2008. The FDIC can now only implicitly guarantee bank deposits over $250,000 and not explicitly guarantee them. This means that as the government tries to calm the public, they can only implicitly guarantee deposits after a bank becomes insolvent. It is still possible that if a bank fails uninsured depositors may not be covered.

“Free Fallin'”

Song by Tom Petty and the Heartbreakers

Torsten Slok, Chief US economist at Apollo Group, says there’s been a dramatic removal of money from U.S. banks: Further, that removal has been almost entirely from relatively small banks, with the money flowing in part to the larger institutions that — thanks to the more conservative regulation forced on them after the Global Financial Crisis of 2008 — are obliged to hold more capital, and who also tend to hold a smaller proportion of their liabilities in uninsured deposits. Money flow to money market funds: according to the Investment Company Institute, the total assets of such funds have now topped $5 trillion for the first time.

Nothing like this has happened since deposit insurance was introduced in the 1930s. That was when the U.S. decided it had had enough of bank runs, and the creation of the Federal Deposit Insurance Corp. largely eliminated them. London’s Longview Economics Ltd. states that this is the first time that money supply growth has gone negative on a year-on-year basis, in the deposit insurance era. So, this is an extreme and novel situation to the extent that the current post-Depression system has never been subjected to this test before. It’s been subjected to other tests, of solvency, most critically in 2008, but not to a crisis concerning deposits. The chance that a run on deposits is allowed to turn into an all-out disaster analogous to the crash of the early 1930s is minimal.

However, a broader government guarantee will necessarily mean tighter regulation, less risk-taking, and lower profitability. Shareholders were wiped out at Silicon Valley Bank and Signature Bank even as deposits were guaranteed. So, while this still appears to be “only” a liquidity issue, the confluence of technology and the emergence from an extreme low-rate regime make this a test that the system has never had to endure. This could result in a bigger problem than deposits, the creation of credit. Without cheap reliable funding, more government regulation and a higher cost of capital, banks will be reluctant to lend or even worse the desire to renew loans. The reduction of leverage will bring down the value of assets, limit growth and reduce profitability.

The parallel of holding companies and investment trusts of the Great Crash: Are they today’s Shadow Banks?

“Like A Rolling Stone”

Song by Bob Dylan

Assets held by financial institutions without a banking license increased from $100 trillion in 2008 to almost $250 trillion today, according to the Financial Stability Board. They will be putting “nonbank financial intermediation” back on the table as a priority for 2023, according to a statement from the Treasury Department. Fund managers are also concerned. A systemic credit event poses the biggest threat to global markets, and the most likely source of one is US shadow banking, according to a survey of investors published last week by Bank of America Corp. The concern is that private equity firms and others were allowed to load up on cheap loans as banking regulations tightened after the global financial crisis, without enough oversight into how the debt could be interconnected. The systemic risk is that if the shadow banks run into trouble the ultimate trouble will reside in the bank that provided leverage to the fund.

The parallel of The Spanish Flu and Covid 19

“Hey 19”

Song by Steely Dan

The World Health Organization (WHO) declared Covid-19 a pandemic on March 11, 2020. The United States experienced several waves of infection, with the number of cases and deaths peaking at various times throughout 2020 and 2021. Its impact on the U.S. economy, lead to widespread job losses, business closures, and a decrease in GDP. The pandemic-induced recession resulted in millions of Americans losing their jobs, particularly in sectors such as travel, hospitality, and retail. The pandemic has had far-reaching social consequences, affecting mental health, education, and the overall well-being of millions of Americans. The lockdowns and social distancing measures have led to increased rates of anxiety, depression, and substance abuse, while the shift to remote learning has exacerbated existing educational disparities. The cost of the COVID-19 pandemic in the United States is difficult to quantify precisely, as it includes direct government spending, economic losses, and other indirect costs. The relief packages enacted by the government amount to over $5 trillion in federal spending, with additional costs associated with unemployment benefits, healthcare spending, and indirect costs such as increased mental health issues and long-term health consequences for COVID-19 survivors. Did the stimulus package equal to 25% of U.S. national debt just prolong the inevitable?

The parallel of Prohibition and the overturning of Roe vs Wade and Morality

“Twilight Zone”

Song by Golden Earring

The overturning of Roe v. Wade represents a significant moment in American history, raising questions about the moral and legal foundations of abortion rights in the United States. Ongoing struggles for gender equality, including the fight for equal pay and reproductive rights, continue to shape the social landscape. The Black Lives Matter movement, LGBTQ+ rights movement, and other mainstream social justice efforts have gained prominence in recent years. Additionally, environmental concerns have become a front-and-center  issue, driving broad social and economic efforts to address climate change and promote sustainable practices. In time, the complex relationship between morality, law, and society, as well as the challenges that arise when attempting to legislate morality will have unintended consequences.

The parallel to the Roaring Twenties

“The Lion Sleeps Tonight”

Song by The Tokens

We have experienced a period of economic growth, rapid technological advancements, and significant social change. E-commerce and digital technology have driven consumerism to new heights, transforming the way people shop and consume goods. The stock market has experienced remarkable growth, with tech companies playing a significant role in the market's overall performance. The Internet, smartphones, and other digital technologies have transformed communication, work, and leisure activities. Online streaming platforms and social media have reshaped the entertainment industry and the way people consume content. Advances in renewable energy technologies and electric vehicles are driving a shift toward sustainable energy and transportation solutions. Today, we must be mindful of the potential consequences of wealth disparities and technological disruptions on society, as well as the urgency of addressing climate change and promoting social justice.

History’s interconnectivity with today

“Don’t Look Back”

Song by Boston

The COVID-19 pandemic placed immense pressure on the economy leading to unprecedented government interventions. Long-term implications from that remain to be seen. There are currently significant moral and social debates, on issues such as abortion, LGBTQ+ rights, and gun control. In recent years, we have experienced rapid technological innovations in fields such as artificial intelligence, renewable energy, and digital communication that can lead to unforeseen consequences. The Great Depression was triggered by the stock market crash and was exacerbated by factors such as income inequality, protectionist trade policies, and an unstable banking system. While we have not experienced a crisis of this magnitude in recent times, the tremors, and shocks of the 2008 financial crisis and the COVID-19 pandemic served as reminders to all of us of the many vulnerabilities in our global economic system. Issues such as income inequality, unsustainable debt levels, and climate change are front and center.

Now consider that in 1929 corporate profits reached an all-time high of 9% of GDP, a level not achieved again until this current moment in time.

“Minute by Minute”

Song by The Doobie Brothers

Citigroup, Inc.’s Chief Executive Officer Jane Fraser said mobile apps and consumer’s ability to move millions of dollars with a few clicks of a button mark a sea change for how bankers manage, and regulators respond to the risk of bank runs. Runs have long been attributed to “contagions” of fear and information, but now there’s digital virality. “Instant communications and social media propagate panic in new ways,” wrote Todd Baker, a senior fellow at Columbia University. “The banking system wasn’t and isn’t prepared for this type of accelerated bank run.”

Other Stock Market Crashes and Parallels

“Won’t Get Fooled Again”

Song by The Who

The Crash of 1987

“Bubble”

Song by Imagine Dragon

The stock market crash of 1987, also known as Black Monday, occurred on October 19, 1987, when the Dow Jones Industrial Average (DJIA) fell 22.6% in a single day. This sudden and drastic decline was the largest one-day percentage drop in the history of the DJIA. The crash was triggered by a variety of factors, including rising interest rates, global trade imbalances, and computerized trading strategies that exacerbated market volatility.

The consequences of Black Monday were severe and far-reaching, with markets around the world experiencing significant declines. In response to the crash, central banks and regulators took various measures to stabilize markets, such as injecting liquidity and implementing new regulations to curb speculative trading. The crash served as a wake-up call for investors, regulators, and policymakers, highlighting the need for effective risk management and oversight in financial markets.

The Lost Decade: Lessons from Japan’s Real Estate Crisis(Barry Nielson)

“Turning Japanese”

Song by The Vapors

Japan's equity and real estate bubbles burst starting in the fall of 1989. Equity values plunged 60% from late 1989 to August 1992, while land values dropped throughout the 1990s, falling an incredible 70% by 2001. As a result, from 1991 to 2003, the Japanese economy, as measured by GDP, grew only 1.14% annually, well below that of other industrialized nations. From 1991 through 2001, Japan experienced a period of economic stagnation and price deflation known as "Japan's Lost Decade." While the Japanese economy outgrew this period, it did so at a much slower pace than other industrialized nations. During this period, the Japanese economy suffered from both a credit crunch and a liquidity trap.

The Bank of Japan (BOJ) put the brakes on the money supply in the late 1980s, which may have contributed to the bursting of the equity bubble. As equity values fell, the BOJ continued to raise interest rates because it remained concerned with still-appreciating real estate values. Higher interest rates contributed to the end of rising land prices, but they also pushed the overall economy into a downward spiral. In 1991, as equity and land prices fell, the BOJ dramatically reversed course and cut interest rates. But it was too late, a liquidity trap had already been set, and a credit crunch was setting in.

When a central bank injects money into the financial system, banks are left with more money on hand but also must be willing to lend that money out. As Japan suffered from a credit crunch in the 1990s, Japanese banks were slow to take losses. Even though public funds were made available to banks to restructure their balance sheets, they failed to do so because of the fear of the stigma associated with revealing long-concealed losses and the fear of losing control to foreign investors.

The Asian Crisis of 1997(International Monetary Fund (IMF))

“Heat of the Moment”

Song by Asia

For the three decades before Asia's financial crisis, Indonesia, Korea, Malaysia, and Thailand had an impressive record of economic performance - fast growth, low inflation, macroeconomic stability and strong fiscal positions, high saving rates, open economies, and thriving export sectors. The underlying causes of the Asian crisis have been clearly identified as: substantial foreign funds became available at relatively low interest rates, as investors in search of new opportunities shifted massive amounts of capital, stock and real estate prices shot up initially, so the region attracted even more funds, the countries' exchange rate regimes encouraged dollar-denominated debt, and exports were weak.

It is clear, with the benefit of hindsight, that this situation was "just a big accident waiting to happen"; the only question was what would trigger it. Once the crisis broke out in Thailand in July 1997, the Asian countries were all vulnerable. And the markets overreacted. The thinking was that if this could happen in Thailand, it was bound to happen in other Asian countries. Creditors withdrew funds from the region, and the crisis spread.

The Dot-com bubble

“1999”

Song by Prince

The Dot-com bubble saw a five-fold increase and then the collapse of the Nasdaq Index during the period 1995 to 2000. The technology and Dotcom dominated index climbed from under 1,000 to climax at 5,048.62 on March 10, 2000. The crash that followed saw the index tumble to 1,139.90 on Oct. 4, 2002, a 76.81% fall. By the end of 2001, most Dot-com stocks went bust. Even the share prices of blue-chip technology stocks like Cisco, Intel, and Oracle lost more than 80% of their value. It would take 15 years for the Nasdaq to regain its peak, which it did on April 24, 2015. During this period of decline, the Fed was aggressively easing rates and liquidity.

The Great Recession

“The Sound of Silence”

Song by Disturbed

In 2008, the U.S. began to experience the impacts of the greatest economic downturn since the Great Depression. This period of economic contraction actually began in 2007, but it became a full-blown crisis in March 2008 when Bear Stearns began experiencing liquidity issues. Later that year, two investment banks became insolvent – Bear Stearns and Lehman Brothers. In the week after Lehman Brothers declared bankruptcy on Monday, Sept.15, 2008, the U.S. Stock Market somehow managed to close slightly higher than it had started. This was not in any way a reliable indicator of what was to come. After that, the S&P 500 went on to fall 46% before hitting bottom almost six months later.

The failures of Silicon Valley Bank, Signature Bank, Credit Suisse, and First Republic in critical condition, could this be the latest Lehman moment and we just don’t realize it yet?

“Born in the U.S.A.”

Song by Bruce Springsteen

The banks and economies that sustained the longest lingering damage were in Europe, not the U.S. The risks are considerable that the biggest hurt could again be sustained outside the U.S. Banks have grown steadily less important domestically as companies and individuals have increasingly raised finance from markets. Banks’ power as the ultimate financial intermediaries remains much greater in Europe, and also in the most powerful economies of Asia. This means that trouble for banks in the Eurozone and the UK, makes any crisis harder to quell, and especially in China could create far greater economic damage. The Institute of International Finance shows that as of 2019, bank lending to the private sector was equivalent to gross domestic product in the Eurozone, but barely half of GDP in the U.S. Apart from China, note that the UK also has particularly elevated exposure to its banking system, and that Japan is more bank-dependent than the Eurozone.

“Take the Money and Run”

Song by Steve Miller Band

Easy monetary policy under former Japan central bank - Governor Haruhiko Kuroda unleashed a $3.4 trillion firehose of cash on the investment world. Now the stage is set for a possible policy reversal under his successor, Kazuo Ueda. The stakes are enormous: Japanese investors are the biggest foreign holders of U.S. treasuries and own everything from Brazilian debt to European power stations. The flow reversal is already under way.

America has long been a safe haven to invest for much of the world. Could our days be numbered?

Remember, historically, all great empires have eventually fallen from grace.

What Does Real Cost of Capital Mean?

“Money For Nothing”

Song by: Dire Straits

As reality sets in from the last month of financial disasters, credit availability is becoming increasingly limited. Without credit the economy contracts and pandemonium becomes the new reality. After experiencing a decade plus of a government subsidized cost of capital, we must now prepare for one with a market rate or potentially worse a premium that could be expensive.

Assume for this exercise that the home represents an investment of any long-term asset. If you purchased a $500,000 home two years ago and invested 20% or $100,000 and borrowed $400,000 at 2.5% your annual payment would be $18,960. However, if you were to purchase the same home today, your annual payment at the average mortgage rate of 6.97% would be $31,836. To keep the same mortgage payment of $18,960, you could only borrow $240,000 and purchase a $340,000 home, which is only 68% of what you could afford two years ago. If you needed to sell the house today, your $100,000 investment is worthless. The loan on the 2.5% mortgage is valued significantly below par. If the current house is worth $340,000, the lender loses $60,000 of the $400,000, a 15% loss. The change in interest rate makes your investment worthless and your lender would lose 15% of the amount of the loan.

U.S. banks with assets above $25 billion have $2.5 trillion invested in liquid securities held to maturity. At the end of 2022 if the securities had to be liquidated, they would have a realized loss of $620B or a loss of 24% of their value. The combination of surging interest rates, high investment losses and heavy deposit outflows is new for most investors and executives in the banking industry. To many this feels like uncharted territory. “I have covered this industry for 20 years plus and I have never seen anything like this,” said Ania Aldrich, an investment principal at Cambiar Investors. “In all the stress testing we have done for at least the largest banks have never stressed for anything like this.” First Republic Bank estimated its $137 billion portfolio of home mortgages would be worth about $19 billion less than their carrying value if sold off, according to its annual report. I’m not sure how to calculate the expected cost of capital. The only thing I can deduce from all this is that it should be significantly more expensive than the market is forecasting. My opinion is that it takes time for all the realities to filter through the system, but a sudden shock can accelerate it. If you triangulate these factors, it is hard to imagine that the banking system has much tangible equity.

Debt Markets vs. Equity Market

“Simple Man”

Song by Lynyrd Skynyrd

The media portrays the stock markets as the gage for the health of the economy. Stocks/equity are traded on platforms that are easy to access and understand because they represent ownership in a company. The bond/debt market is three times the size of the equity markets. The debt markets are harder to comprehend because the market is very fragmented, opaque, each product is unique and not universally traded on exchanges. The concept is simple to understand, they only care about the ability of the borrower to timely pay principal and interest. Equity markets are more complex, they have to make numerous predictions about the future to determine today’s value. The debt markets tend to forecast the future of the economy faster than the stock market. Look at the chart of the S&P 500 and the Nasdaq 100, vs HYG and JNK. It is a chart of popular equity indexes vs popular debt indexes. During the Great Recession they traded in unison. Today the equity indexes are trading at a substantial premium to the debt indexes. This could be an early warning sign that the equity markets need to decline in value to be fairly valued.

Crypto Currency; Could this be the next Tulip Mania?

“Tiptoe Through the Tulips”

 Song by Tiny Tim

Tulip mania was a period during the Dutch Golden Age (1634-1637) when trading tulip bulbs was all the rage. People were leveraging up to trade bulbs. The profits in tulips helped to create a culture of mania and risk-taking. Many individuals suddenly became rich, and society believed that this would last forever. In February 1637, the market crashed. It is generally considered to have been the first recorded asset bubble in history. The term "tulip mania" is now often used metaphorically to refer to any large economic bubble when asset prices deviate from intrinsic values.

I must confess that I don’t thoroughly understand crypto. Then again, I’m not sure anyone truly understands its full complexity and risks. The field is nascent, unregulated, and ripe for fraud. The U.S. Securities & Exchange Commission (SEC) and the largest trading exchange, Coinbase, are headed for a legal showdown that could be devasting for crypto if they lose. Crypto produced the 60th richest person in the world, Samuel Benjamin Bankman-Fried, a man who is perhaps a modern-day tulip trader? He had a net worth of $26 billion as of last year. Today in 2023 he is worth nothing and faces up to 100 plus years in jail. There were a lot of sophisticated institutions and investors that believed in him and his company, FTX, that were annihilated.

Neither tulips nor crypto were systemic risks to the overall economy but represented the current risk-on mentality of society in the moment.

What does all this mean? History is not on our side and there are many eerie parallels.

“Every Picture Tells a Story”

Song by Rod Stewart

Low interest rates have created an inflated asset basis that is limiting mobility for both people and financial institutions. I don’t think central banks and the government can bail out the economy. They’ve already used unprecedented measures to battle the Great Recession and the COVID-19 pandemic, creating the last decade of underpriced capital and inflation. There could be a bad crowding out in the debt and equity markets as liquidity dries up just as the need increases. In my opinion, the unraveling is just beginning and could be more prolonged than anticipated.

“I'd Love to Change the World”

Song by Ten Years After

Is the next financial calamity hiding in plain sight? Man prepares to prevent past mistakes, but evolution finds a way to evade them. You can only plug the holes in the dike for so long before the dam bursts. The evolution of the Internet and technological advancement has created complexity, fragmentation, efficiency and has accelerated time periods. “Risks to the outlook are heavily skewed to the downside, with the chances of a hard landing having risen sharply,” the IMF said. The World Bank is warning of a “lost decade” ahead for global growth, as the war in Ukraine, the Covid-19 pandemic and high inflation compound existing structural challenges. To me the real issue with Silicon Valley Bank is the speed upon which a catastrophe can occur. This has parallels to another historical event, Black Monday, the Dow Jones Industrial Average (DJIA) lost 22.6% of its value in a single day, the largest one-day percentage decline in history. History always repeats itself but takes on a new name and format, it is just a matter of when and how.

“Spinning Wheel”

Song by Blood, Sweat & Tears

What goes up must come down

Spinnin' wheel got to go 'round

Talkin' 'bout your troubles it's a cryin' sin

Ride a painted pony let the spinnin' wheel spin

You got no money and you got no home

Spinnin' wheel all alone

Talkin' 'bout your troubles and you, you never learn.

In these uncertain times, it's important to remember that what goes up must come down, just like the spinning wheel in Blood, Sweat & Tears' famous song. The cycles of events we go through in life are reflected in this metaphor, and we must prepare for the ups and downs of the economy.

“Casey Jones”

Song by Grateful Dead

Trouble with you

Is the trouble with me

Got two good eyes

But we still don't see

Come round the bend

You know it's the end

Driving that train

High on cocaine

Casey Jones you better Watch your speed

Trouble ahead Trouble behind

And you know that notion Just crossed my mind

Very Truly Yours,

Gary Veloric

“Sympathy For The Devil”

Song by The Rolling Stones

A/K/A The Red Stripe Plane Group

The Veloric Center for Entrepreneurship at American University coming October 2023.

P.S.: “We Didn’t Start the Fire”

Song by Billy Joel

Billy Joel's 1989 classic tune "We Didn't Start the Fire" is considered by many to be a musical lesson in modern American history with over 100 historical references. Its lyrics are a chronological list of people, events, and issues from the first 40 years of Billy Joel's life, beginning in 1949. The song was spawned out of a conversation that Joel had with Sean Lennon in the studio. Sean was with a friend who told Joel that it was a “terrible time” to be a young person. Joel was on the eve of his 40th birthday, and he told the despairing youth that things weren't much brighter when he was 21 either according to faroutmagazine.co.uk.

We didn't start the fire

It was always burning, since the world's been turning

We didn't start the fire

No, we didn't light it, but we tried to fight it.

Interest rates down interest rates up

Money supply up money supply near all-time Lowe

The Fed lowers the Fed raises

Commodities crash then resurrect

Credit spreads tight than widen

Credit plentiful now anemic

Deflation then inflation

Tulips blossom into Cryptos

Extended periods of prosperity and 10 years to recover

Bank of the United States 1930 Silicon Valley Bank 2023

It’s my money and I want it now - 877-CASH-NOW!

Dear Mr. Jones…Trouble…American Pie

Once in a Lifetime…Back in the U.S.S.R…. Believin

Sunday Bloody Sunday…(I Love the Sound of) Breaking Glass

The Weight…Free Fallin'…Like A Rolling Stone…Crash

Won’t Get Fooled Again…Turning Japanese…Heat of the Moment…Bubble

The Sound of Silence…Born in the U.S.A…I’d love to Change the World

Take the Money and Run…Money For Nothing…Simple Man

Tiptoe Through the Tulips…Every Picture Tells a Story…We Didn’t Start the Fire

Spinning Wheel…Casey Jones…Sympathy For The Devil…J.G. Wentworth

What else do I have to say?

We didn't start the fire

It was always burning, since the world's been turning

We didn't start the fire

No, we didn't light it, but we tried to fight it

The Black Crows…Little Feat…Don McClean

The Talking Heads…The Beatles…Marcel

U2… Straightjackets…Nick Lowe

The Band…Tom Petty…Bob Dylan…Dave Mathews

The Who…The Vapors…Asia Imagine Dragon

Disturbed…Bruce Springsteen…Ten Years After

The Steve Miller Band…Dire Straights… Lynyrd Skynyrd

Tiny Tim…Rod Stewart…Billy Joel

Blood Sweat and Tears…The Dead…The Rolling Stones

Rock and roller, cola wars, they can't take it anymore

We didn't start the fire

It was always burning, since the world's been turning

We didn't start the fire

But when we are gone

It will still burn on, and on, and on, and on, and on, and on, and on, and on