The Day the “Coming Doom Loop” Went Loopy

In just a single day last week, The Daily Doom ran three stories, hot in the financial headlines, from three different authors that prominently featured the term “doom loop.” I guess The Daily Doom was an aptly chosen name for the news we have today.

Now, maybe that all started with Nobel Laureate Nouriel Roubini speaking about his latest book, featured on my site, wherein “Dr. Doom” talks a lot about a doom loop — the kind of burden we’re destined to keep repeatin like Sisyphus pushing his rock up the hill. Only our rock is a snowball that gets bigger every time it rolls back down on us.

However, none of the other two authors even mentions Roubini. So, it could equally be that doom is just in the air. Each author, in fact, wrote about a different but related downward spirals, arriving at the same conclusion: The US economy and global economy are now in an inevitable downward spiral from which there is no possible extraction. It is the latter point that is most concerning and on which they all agree.

That conclusion has been a major theme on my own site for years: we would enter multiple downward spirals together that were all inevitable because they were baked in from years and years of extremely low interest rates coupled with years of massive money printing and debt pileups for which none of the central banks of this world have ever had any workable end game for breaking the low-interest dependency they were creating.

We have now entered multiple vortices with the crashing of stocks, safe-haven Treasury bonds, cryptocurrencies, banks and housing all going down the drain together. So, as the world’s central banks try now to back out of their quantitative easing to kill the inflation they finally fueled, they are crash everything! That was always where this was headed.

To explain how and why, let me start with Nouriel Roubini in his own words:

Roubini’s Rubik’s cube

In January 2022, when yields on US ten-year Treasury bonds were still roughly 1% and those on German Bonds were -0.5%, I warned that inflation would be bad for both stocks and bonds.

Higher inflation would lead to higher bond yields, which in turn would hurt stocks as the discount factor for dividends rose.

EABW News

As did I, though I started warning back in 2020 that inflation would rise as a result of the pandemic recovery solutions being applied by Fed and feds in consort back then until it would force the Fed to tighten, which would be bad for both stocks (for the same reason Roubini gives) and bonds. But, let’s let the maestro continue.

But, at the same time, higher yields on “safe” bonds would imply a fall in their price, too, owing to the inverse relationship between yields and bond prices.

This basic principle – known as “duration risk” – seems to have been lost on many bankers, fixed-income investors, and bank regulators.

As rising inflation in 2022 led to higher bond yields, ten-year Treasuries lost more value (-20%) than the S&P 500 (-15%), and anyone with long-duration fixed-income assets denominated in dollars or euros was left holding the bag.

That, I had laid out as an inevitable part of Great Everything Bubble Bust on the basis that Fed quantitative tightening would drive up yields on bonds as the Fed stopped soaking them up. So, everyone could have seen this coming as inevitable cause and effect. Inexcusably, then, the very people causing the problem — the Fed — did not see it coming and did not properly regulate banks to make certain all banks saw it coming and prepared for it in advance.

That part is nearly as incomprehensible as it is inexcusable. Thus …

The consequences for these investors have been severe. By the end of 2022, US banks’ unrealized losses on securities had reached $620 billion, about 28% of their total capital ($2.2 trillion).

In fact, judging by the quality of their capital, most US banks are technically near insolvency, and hundreds are already fully insolvent.

Another problem has affected banks during this time of bank runs that I did not even think of, but it should have been easy to foresee as well, especially for bankers who work with this kind of thing every day:

The current, apparently persistent flight of uninsured – and even insured – deposits is probably being driven as much by depositors’ pursuit of higher returns as by their concerns about the safety of their deposits.

Naturally, as the yields rose on bonds (prices fell) depositors would, at some point, start to realize they could make more money on their savings by storing them all in US Treasuries, held risk-free to maturity, clipping coupons to collect the interest, than they could in banks that offered almost no interest. It became time for banks to pay the piper for all those years of zero interest.

Actually, what I didn’t see was that banks would be so incredibly greedy, they would not raise their interest on deposits as interest rates rose everywhere else. It wasn’t until recently that I started wondering why interest on my own bank deposits was not rising when interest on the banks’ loans was. At that point, I started thinking about moving my money, but I still didn’t realize this was a systemic problem everyone was experiencing from their banks. So, of course, deposits started to pour out of banks once Treasuries paid enough to make it worth the limitations of switching to something less liquid than cash in the bank.

In short, after being a non-factor for the last 15 years – ever since policy and short-term interest rates fell to near-zero following the 2008 global financial crisis – the interest-rate sensitivity of deposits has returned to the fore. Banks assumed a highly foreseeable duration risk because they wanted to fatten their net-interest margins.

Banks, in other words, hurt themselves by being so greedy that to maintain the nice profit margins they had been growing fat on, they lost a lot of depositors who were finally sick of getting no interest on the money THEY loan to banks.

To add insult to injury, regulators did not even subject banks to stress tests to see how they would fare in a scenario of sharply rising interest rates.

That part was beyond dumb; so, it certainly didn’t have to happen. One must concluded the regulators were either outright stupid or they wanted banks to collapse. I mean the level of stupidity involved in not foreseeing this would happen when you are a person who works in the bond and banking industry everyday is almost inconceivable.

With that part now already in play, we get to Roubini’s doom loop:

Now that this house of cards is collapsing, the credit crunch caused by today’s banking stress will create a harder landing for the real economy, owing to the key role that regional banks play in financing small and medium-size enterprises and households. Central banks therefore face not just a dilemma but a trilemma.

But the increase in long-term rates is also leading to massive losses for creditors holding long-duration assets.

So, the economic crash created by banks tightening credit due to the peril they brought on themselves with the flight of deposits to better causes, will loop back as defaults to create more peril for the banks. On top of that, as we’ve now seen, they are stuck holding massive amounts of long-term bonds with very low yields as reserves in a market where new bonds of the same duration offer much higher yields. So, if they have to sell them to make good on those fleeing deposits, they must do so at considerable loss as we saw with SVB and others.

As I have long warned, central banks confronting this trilemma will likely wimp out (by curtailing monetary-policy normalization) to avoid a self-reinforcing economic and financial meltdown, and the stage will be set for a de-anchoring of inflation expectations over time….

A severe recession is the only thing that can temper price and wage inflation, but it will make the debt crisis more severe, and that in turn will feed back into an even deeper economic downturn.

Since liquidity support cannot prevent this systemic doom loop, everyone should be preparing for the coming stagflationary debt crisis.

And that is what I have long been saying this present tightening phase would devolve into — a severe stagflationary recession. It’s reinforcing to have someone of Roubini’s stature confirming what I believe ad have been saying.

Russell Napier – The Toronto Star

Napier talks about a more future-forward doom loop that will change how banking happens in the future, not just break banks, in an article titled “Banking crisis leaves an over-leveraged world flirting with a ‘doom-loop’.”

What does he mean by a “doom loop?”

Recent government and central bank interventions to shore up failing commercial banking systems — sparked by rising interest rates — has created a whole new politicized credit system….

What is important about the growing banking crisis, however, is how it is being tackled by central banks and governments. Their reaction to the distress will be the key driver for the path of economic growth, inflation and also returns for savers for many years to come….

Intervention to prevent fallout from high interest rates on economic activity and financial stability … may reduce the risk of a severe recession and banking crisis — but it’s not free….

[For example:] For decades, savers have favoured holding wealth in Switzerland for many reasons, not all of them good, such as tax evasion. However the good reasons for holding wealth in Switzerland were that the country was fairly unindebted, had a strong banking system and abided by the rule of law. By allowing the country, particularly its banking system, to become dangerously large, and debt in the Swiss private sector to reach elevated levels, Switzerland has now lost all the key characteristics which made it a happy home for many of the worlds’ savers….

The message the intervention in Switzerland should send to investors is that there are no limits to how far the government will go, assisted by central banks, to prevent the failure of commercial banks. 

Toronto Star

I would qualify that last statement to say there are no apparently limits to how far governments and central banks will go to prevent the failures of ultra-large commercial banks, which has caused those banks to grow vastly larger since their early too-big-to-fail days. The result of such deep government involvement, of course, is that banks lose independence, and they are going to be more likely to do the government’s bidding down the road; but also the conglomerating intervention that we’ve just seen all over again sets the stage for the next larger cycle (loop) back to an even more perilous bailout situation because the powers that be made those banks even more systemically critical.

Without perhaps realizing it, government reaction to financial stability issues is pushing their economies along the continuum from market economies towards command economies. Each intervention leads to greater government influence in directing the flow of bank credit and the time will come when it also impacts how savings are allocated.

The banks and governments, in other words, become more interdependent — banks for rescues when the low interest rates cause problems for the banks as they just did when rates had to be raised because of the inflation they were creating, and governments for a return to low interest rates to refinance the debts they piled up from those bailouts.

Countries found themselves in a so-called ‘doom-loop’ in which falling government bond prices and higher interest rates exacerbated the financial crises.

The doom loop in this situation is the catch-22 for sovereign debt where the more you keep rates low to keep sovereign debts affordable for governments that have already overextended themselves in massive rescue efforts for years, the more you entice the reckless business behavior comes from easy money and that ultimately leads to situations the governments have to bail out again (like SVB) as people reach for yield and pile on cheap debt to get there.

You also entice governments to take on more debt by lulling them into believing they can afford it, but those rates won’t stay affordable because inflation will come into the picture and force rates to rise. Down the road, that means the governments have even more banks to bail out and more resulting economic problems to rescue but have less capacity to do it without driving their own interest rates up. That is what we saw in Europe during the Great Recession in Grexit and Spexit and Italeave. Such is the way when you are solving debt crises by piling on more debt as we did in 2008, 2020, and are now at great risk of doing again.

Should a similar result now befall governments springing to underwrite the risks to their financial systems, then a similar rise in bond yields and a similar ‘doom-loop’ could result. As governments take on more debt to solve all their problems, the cost of their credit starts to rise, creating problems for the government, itself. At that stage governments tend to turn to their financial institutions and force them to buy government bonds at the low yields which they can afford

And there you start down the path toward hyperinflation by monetizing government debts.

Financial Times sees ill times for financiers of commercial real estate

Rana Foroohar points in the Financial Times to another kind of doom loop that could evolve in the murkier recesses of finance — shadow banking, particularly as commercial real estate is now rapidly falling in value. CR is one area where shadow banks are big players (financial institutions that are not banks so they do not have FDIC protection or many of the other rescue taps that banks have). These would include hedge funds that invested heavily in real estate.

If you asked a few months ago where the next financial crisis might emanate from, most people probably wouldn’t have said regional banking. Rather, they might have guessed at the shadow banking sector, which has grown dramatically since the global financial crisis of 2008. It remains far less regulated than the traditional banking sector….

Consider, for example, the trouble brewing in commercial property loans, and private equity real estate funds. This is where the shadow bank and small bank stories meet. Small banks hold 70 per cent of all commercial real estate loans, the growth of which has more than tripled since 2021. Following the easing of Dodd-Frank rules for community banks, smaller financial institutions have also invested more in riskier assets owned by private equity and hedge funds (as have other institutions looking for better returns, including pension funds).

Small bank funding to commercial real estate is now tightening. This, along with interest rate rises, is putting downward pressure on commercial property values, which are now below pre-pandemic levels. That will curtail capital flows, derail investments and put pressure in turn on private equity funds with loans that are maturing, or which need equity injections….

This means asset managers may be forced to go to investors for more capital (which will be a tough negotiation at the moment) or sell property out of their portfolio to cover loans….

This has the feel of a doom loop to me…. It’s safe to say that the combination of falling values, higher rates and a credit crunch is going to mean we’ll probably see some high-profile defaults. Perhaps more importantly, I think we are about to see a curtain pulled up on what private equity and the global asset management business in general has been up to over the past few years….

This month, political economist Brett Christophers will publish a book titled Our Lives in Their Portfolios: Why Asset Managers Own the World. He believes we’ve moved from financialised capitalism to something more insidious — an asset manager society in which the titans of finance own “essential physical systems and frameworks” — the homes in which we live, the buildings where we work, the power systems that light our cities and the hospices in which we die.

Financial Times

Empires will unravel. That, you see, is the thing about loops of dependency on years of low interest: you break the loop by raising interest, and a lot of entities that have become precariously dependent on that low interest fall apart. That drives the cost of credit up further throughout an entire industry or government due to perceived rising risks in the industry, affecting all players, causing more things to fall apart.

Simon Black sees red

With all of these feedback loops amplifying the noise and troubles buried in overly indebted institutions during times when interest is rising and values of assets like stocks, bonds, and real estate are all falling everywhere, Simon Black questions how anyone can think the banking crisis is over. (So do I!)

If you’ve ever heard a feedback loop in an audio system, you know things can amplify to an ear-piercing scream in a very short time … as we saw when Silicon Valley Bank just popped up out of the woodwork. The next thing we knew — and with equal alacrity — the long beleaguered behemoth Credit Suisse crashed through its own floor, and the two banks were not even related, except for that factor just described where a problem in an industry can suddenly make eyes look up and become alarmed at other problems so that panics set in.

Black thinks that, right now, people are too calm. They’ve gone back to sleep already and are doing nothing truly serious against the perps. (I agree.)

Every time there’s a major crisis, Congressmen book a committee meeting to express their shock and outrage [for the public]. They pass new laws to prevent a future crisis. Then their new laws fail to work properly, so they hold another public hearing to express more outrage.

[Thus,] The Senate Banking Committee summoned key officials from the Federal Reserve, FDIC, and US Treasury Department. And the tone was quite angry.

Sovereign Man

I would say it was not angry enough, but carry on….

Senators were flummoxed that their thousands of pages of banking legislation had once again failed to provide adequate protection to the US financial system. And they were looking for someone to blame.

Most absurd was how the officials in the hot seat (who, again, represent the primary bank supervisors in the United States) managed to avoid any culpability whatsoever.

Which is exactly where I say the senators were not angry enough. The banksters got away with a lot of blame shifting for their own lack of oversight:

They acknowledged that they had advanced knowledge of the banks’ problems.

They acknowledged they should have done something about it. They acknowledged they had the tools and authority to do something about it.

Yet they did absolutely nothing… and somehow ended up being praised as gusty and courageous.

It’s natural to blame the bank executives for making such idiotic decisions with their customers’ money. But culpability is not mutually exclusive. It’s not either/or. And the regulators had a major role to play in this crisis.

Not only did they escape culpability at yesterday’s hearing, but the regulators even managed to pat themselves on the back for their swift and decisive response to the crisis.

That’s certainly how I saw it. The Fed and FDIC and Treasury all got off with a mild tongue lashing with dollops of lavish praise for now, and everyone went back to playing Doom Loop, creating bigger loops for the bigger banks to play with, which they did by promising infinite insurance to their depositors.

They also all with nauseating repetition reassured the entire nation through this senate grandstanding opportunity that “our banking system is strong and resilient,” yet all presented absolutely no evidence to support that claim. Nor was any evidence demanded by the senators. Why? One possibility is the connections mentioned above where banks and governments become interdependent on each other for low interest rates. Or they all know as much about regulating banks as my dog knows about performing brain surgery. Of course, there are more nefarious possibilities like good old-fashioned graft.

Originally, their assertion that banks were strong was based on banks being loaded with reserves. We all know how that proved not to be true once they had to rely on their reserves and found them essentially as useful as waterlogged wood for a fire. No one even thought to ask why the $2-trillion in reverse repos were not re-reversed everywhere to put cash back into reserves or to inquire about how the huge devaluation in commercial real estate is diminishing bank collateral, should loans default … and what is being done about that. More defaults in CR will raise the sense of risk throughout the industry, drying up willingness to extend credit, which will raise rates more for those who must have credit — DOOM LOOP!

The “systemic risk exception” they talked about turned out to mean all rescue efforts go to those with high systemic risk in order to syphon more deposits from small, solid banks over to those systemically gargantuan banks in order to raise the level of systemic risk in the next cycle — DOOM LOOP!

We never learn.

Closing the loop

As Lance Roberts points out,

Banking Crisis Is How It Starts, Recession Is How It Ends

As the Fed tightens monetary policy, a banking crisis is historically the first evidence that something was breaking.

Real Investment Advice

It is interesting to note how predictably and routinely the nation’s worst busts time out with the Fed’s raising of interest rates:

There are those rinse-and-repeat cycles. As you can see, the Fed has already raised rates as much as in this cycle it ever does in any of these cycles before it causes major breakage and a recession and has to start sending interest back down in order to prime up the next rebuilding cycle. This time, however, high inflation forces them to keep raising. Can anyone say …

“DOOM LOOP!”