Whatabout the Next Crash?

Now that we are First and Ten with the Biden administration and we learn that President Biden is at 50 percent mental capacity, let's talk about the real question.

What happens at the end of the current deficits and money printing?

There's a piece at American Spectator about this. Donald Devine quotes a bunch of experts that say there is nothing to worry about. Not yet. Then he makes his prediction:

My prediction is that Biden’s control of executive and legislative branches will produce a short economic boom in 2021, followed by a big bust in 2022 that takes down the whole progressive edifice with it.

One of the problems he sees is the modern "repo" market.

“In repo, broker-dealers, hedge funds and banks construct short-term transactions. You put up collateral — Treasury bills or sometimes less-pristine instruments — with an agreement to buy them back the next day or week for slightly more, and invest the proceeds in the interim.”

The question is: what happens when things turn South?

But eventually, iffy collateral sneaks into the system. That’s also fine, until markets hit an inevitable rough patch, like, say, March 2020. No one will take the junky stuff anymore, and everyone scrambles for good collateral. So there’s a mad dash, a brawl really, to buy Treasuries — like musical chairs with six to eight buyers eagerly eyeing one chair.

If this sounds too complicated, let me give you Walter Bagehot and his 1873 book Lombard Street: A Description of the Money Market. 

As I understand Bagehot -- he was the founding editor of the London Economist -- the credit system needs the following to work:

All loans must be properly collateralized so that the borrowed money can be recovered if the borrower defaults.

All borrowers must be able to service their loans.

If either of these things breaks down, then you got trouble, right here in River City. If both things break down you got nuclear Armageddon.

For instance, in the runup to the Crash of 2008 we had the US government encouraging low down-payment mortgage loans. See the problem? If there is a downturn in home prices then some of those low-down payment loans can't be liquidated if the borrower defaults.

Then, in addition, the US government was encouraging, even mandating, that lenders lend to borrowers -- such as minority borrowers -- with low credit ratings, i.e., borrowers with a higher than normal risk of not making the payments.

So when the Fed tightened up on credit in 2006 many borrowers with adjustable-rate loans couldn't make their payments and because their homes came on the market the price of homes went down and banks could not recover the principal when liquidating defaulted loans.

And so you get a credit crisis where traders in the system don't want to trade in securities with "iffy collateral."

Then you get a credit meltdown which, according to Bagehot, can only be stopped by a central bank, a "lender of last resort" buying up distressed loans. It can do this because the assumption is that the central bank has, as capital, the whole wealth of the nation to back it up. You can see how the central bank acting as "lender of last resort" solves the crisis. It buys up dodgy debt, and pays for it with newly printed money that people trust more than the dodgy debt. So the panic subsides.

Usually, however, the guy in charge of the central bank, being a mere ruling-class courtier, partially flubs the "lender of last resort" bit. So, in the Great Depression of 1929-33 the Federal Reserve did not bail out the Bank of United States when it failed in 1931, probably because it was a Jewish bank. In the Crash of 2008, Little Ben Bernanke decided in September that he did not have the authority to bail out Lehman Brothers. 

The incompetence of the courtiers means that the credit crisis goes on longer and is deeper than necessary and ordinary people get wiped out.

The question you may ask is whether in the next credit crisis the market will believe that the central bank can in fact act as lender of last resort, or whether the problem is so big that it is beyond the ability of the Fed or the IMF to turn bad debt into good debt.

Here's an interesting factoid. In the 2008 crash the US government had an actual $700 billion TARP bailout program to bail out the banks where is borrowed and spent actual money. But it "guaranteed" about $16 trillion in money market mutual funds.

I wonder if the whole bailout could have been done with a "guarantee." It would have been a whole lot cheaper.

But there is something else to worry about. It is "MMT," or Modern Monetary Theory. It is Keynesianism on steroids and supported by lefties like Bernie Sanders and AOC and says that pedal-to-the-metal with debt and spending is OK for government. At least for now.

The real question is: what do you do when the balloon goes up? Gold? Bitcoin? And whatabout any asset that is held in a financial institution that you access over the Internet? How hard would it be in a great crisis for the government to seize 23.2 percent of all assets at Fidelity and Vanguard? When everything is just a record in a database.