- It's nearly the 10th anniversary of Jim Cramer's epic "they know nothing!" rant about bank illiquidity on CNBC, so we're looking at what's changed since then.
- It's not good.
- US corporate debt may be so high that it's a threat to global stability, according to the IMF.
- The UK has high unsecured consumer debt and high mortgage debt at the same time, the IMF and the Bank of England have warned.
- Europe's banks are threadbare, according to the IMF. On a net level, Italy, Portugal, and Spain have actually added non-performing loans to their books rather than worked them off.
- Since 2007, China has added $24 trillion in debt across its entire economy. The IMF believes China's banking system has developed "a structure potentially susceptible to rapid risk transmission and destabilizing liquidity events."
Almost a decade ago, former hedge fund manager Jim Cramer went on CNBC to talk about how the market had reacted to Bear Stearns' insistence that the investment bank was not in trouble.
Everyone who saw it remembers what happened next: One of the greatest TV meltdowns of all time.
In the moment, Cramer starts off as if nothing is wrong except for a mispriced stock. "The shorts have overdone the stock," he suggests at one point, play-acting an imaginary conversation between traders. "The Dow can rally," he shrugs.
But as Cramer moves onto the topic of former Fed chairman Ben Bernanke, he becomes suddenly angry. He cuts off co-host Erin Burnett mid-sentence.
He begins shouting that Bernanke ought to "open the darn fed window!" — the Fed's "discount window," which lets banks borrow short-term money to meet sudden liquidity problems. No bank willingly goes to the Fed window. It looks bad. But Cramer feels it is time.
Burnett tries to calm him down, sensing early, perhaps before viewers did, that Cramer is going off the rails.
"Cramer ..." she says quietly, her tone even.
But Cramer cuts her off. He isn't listening.
Then, he explodes.
"HE HAS NO IDEA HOW BAD IT IS OUT THERE! HE HAS NO IDEA!" Cramer yells. He bangs the desk in front of him with a fist. "I have talked to the heads of almost every single one of these firms in the last 72 hours and he has NO IDEA HOW BAD IT IS OUT THERE. NONE!"
Cramer is sweating. He goes red in the face. He is screaming.
Burnett is mortified.
"And Bill Poole [a member of the Federal Open Market Committee] has NO IDEA what it's like out there! My people have been in this game for 25 years. And they are losing their jobs! And these firms are going to go out of business and HE'S NUTS! THEY'RE NUTS! THEY KNOW NOTHING!"
By the end, Cramer is trying not to cry.
They both pause.
Burnett tries to wrestle some normality back into their conversation. They are on live TV and she looks genuinely afraid that Cramer has lost it.
Cramer starts up again. "This is a different kind of market and THE FED IS ASLEEP!"
It was a Howard Beale moment. A furious man, screaming into a silent storm that only he can see. It's one of the greatest moments ever captured on live TV news. And, as we found out over the next 12 months, Cramer's rage actually understated just how bad things were about to get.
This is what happened next.
In August 2007, the S&P 500 stood at 1,550. Sure, some banks had liquidity problems after taking on mortgage debt that had turned bad. But the market was correcting and would drop to 1,460 later that month. In the months after Cramer spoke, this happened:
Stocks more than halved from their peak in a jagged, yearlong collapse. Bear Stearns no longer exists — it was sold to JP Morgan for $10 a share (it had been worth $133.20). Unemployment in the UK doubled over the next few years to more than 8%. British people today are £6,000 poorer, on average, every year because of the economic drag caused by the great financial crisis. It was worse in the US, where unemployment peaked at 10% after the crash.
And then there's Greece. Unable to carry its deficits without private bank liquidity, Greece has been stuck in a recession that has been longer and deeper than the Great Depression was in the US last century. Unemployment there is still 26%.
And it was all because too much debt went bad, all at once.
Yet 10 years later, we are back where we started:
- The US has an elevated level of corporate debt today that is starting to worry banks at the global level. "Corporate credit fundamentals have started to weaken, creating conditions that have historically preceded a credit cycle downturn," the IMF said in its newest assessment of global financial stability, published last week.
- The UK has high unsecured consumer debt and high mortgage debt both at the same time. The IMF and the Bank of England have both expressed fears about a bumpy landing for those credit bubbles.
- Europe's banks are threadbare, according to the IMF. 85% of European banks have a return on equity (profit) level that is "weak" or "challenged," by the IMF's definition. The gross level of non-performing loans (NPLs) inside banks in Italy and Portugal hasn't changed since the peak, the IMF says. And on a net level, Ireland, Italy, Portugal, and Spain are all carrying a greater percentage of NPLs on their books now than they were at the previous peak, the IMF says. (Net NPLs are gross NPLs minus the banks' provision for NPLs, which gives you a measure of well banks handle bad debt.)
- China, since 2007, has added $24 trillion in debt across its entire economy. There is so much unpayable bad debt in China that the banking system is hiding it inside complicated credit products that have a higher risk of sudden defaults. The IMF says that system is "potentially susceptible to rapid risk transmission and destabilizing liquidity events."
This is the scary thing. Right now, as we trundle toward the 10th anniversary of the Cramer rant (August 3), the amount of sketchy debt being carried by the global finance system is again approaching a record peak.
In America alone, bad debt held by companies could reach $4 trillion, "or almost a quarter of corporate assets considered," according to the IMF. That debt "could undermine financial stability" if mishandled, the IMF says.
The percentage of "weak," "vulnerable" or "challenged" debt held as assets by US firms has almost arrived at the same level it was right before the 2008 crisis. Peaks in bad corporate debt crop up at the same time as recessions, as this IMF chart shows.
The average net leverage ratio of US firms has already equalled the 2007 peak and is testing the upward limit set before the 2000 crash.
The IMF's analysts have started to sound like Albert Edwards, the notoriously bearish analyst at Societe Generale:
"There has been a stronger reliance on debt financing as the credit cycle entered a mature phase. Corporate credit fundamentals have started to weaken, creating conditions that have historically preceded a credit cycle downturn.
"... In general, increased financial risk-taking is associated with pronounced leverage cycles that gradually build up and end abruptly in recessions, as for example in both 2001 and 2008."
In the UK, the IMF believes that mortgage debt in the booming property sector is a threat to the country's economic stability:
"The high leverage of some households could pose financial stability risks. The percentage of new mortgages at high LTI [loan to income] ratios above 4.5 remains well above pre-boom levels (i.e., circa 2000), as does the aggregate household DTI [debt to income] ratio, which has temporarily stopped declining and is higher than in most other G7 countries.
"... High leverage would amplify an economic slowdown, weigh on aggregate consumption, employment and could indirectly impinge upon financial stability."
The Bank of England has also sounded alarm bells about British consumer debt:
Bank of England
Which is high at the same time as mortgage debt (although still below the 2007 peak):Bank of England
It wouldn't be so bad if that debt was high-quality. But much of it is not. This is the IMF's chart of bad debt held by European banks. Italy, Spain, and Portugal have all added net bad debt over time, rather than working it off their books:
This is the IMF's summary of that data:
"Left unresolved, the combination of weak banks, lack of access to private capital, and large bad debt burdens impedes the scope for recovery and could reignite systemic risks."
As for China? Who knows.
The world's largest modern economy is also its fastest growing, and least transparent. The scale of its debt is staggering. Bond guru Bill Gross says the global economy today has more credit relative to GDP than in 2008. "In China, the ratio has more than doubled in the past decade to nearly 300 percent. Since 2007, China has added $24 trillion worth of debt to its collective balance sheet. Over the same period, the U.S. and Europe only added $12 trillion each," he told Reuters.
Chinese banks hide their illiquid credit inside products that look like savings accounts for consumers — and they pay a higher interest rate, of course — but are in fact just complicated interbank loans that may never be paid off. These are where the defaults are most likely to occur, according to the IMF:
"A possibly greater risk to stability may reside in the potential for defaults on widely-held 'shadow products' to trigger risk-aversion that results in the withdrawal of liquidity from short-tenor investments in high-risk borrowers. This risk is intensified by financial institutions’ own increasing reliance on short-term wholesale (including interbank) funding, a structure potentially susceptible to rapid risk transmission and destabilizing liquidity events."
A dark, poorly understood world
There is one last parallel between today and 10 years ago, when Cramer blew up.
At the time of Cramer's rant, few people actually understood why US banks were suddenly illiquid. It didn't make sense. Banks had loaned people money for houses. Even in bad times, people tend to pay their mortgages. If you don't make the payments you become homeless. Mortgages should have been more stable than other types of debt.
Of course, it wasn't that simple. The banks had buried those mortgages under layers of credit derivative complexity, adding leverage to the system, which magnified problems rather than balancing them. It was a dark, poorly understood world. That's why Cramer's anger took everyone by surprise. He had glimpsed something the rest of us had yet to see.
Today, we know there is a lot of debt out there, again. And we know that some of it is reaching peaks last seen in 2007. What we don't know is how much of it is in danger of suddenly blowing up. All we know is that the IMF and the Bank of England are concerned.
For those of you who don't remember how terrifying 2007 and 2008 were, here's a taste of what it feels like when you suddenly realise that things are going wrong faster than they can be put right: