Nouriel Roubini, the insightful economist who authors RGE Monitor has put together an article and argument that very clearly states the concerning features of the current asset/credit bubble when compared with the 90’s Long Term Capital Management bankruptcy and subsequent liquidity crisis. The reason it is so timely is that anyone with any longevity in the mortgage industry can be heard saying “we made it through the 90’s” as some sort of battle scar that somehow qualifies them as more likely to successfully navigate the crunch ahead than the rest of us. Roubini does an excellent job of showing why such an argument is foolish. The 90’s and this episode are dissimilar in many ways as outlined in this summary article in the Financial Times.
Roubini argues that the 90’s meltdown in housing and today are dissimilar because the 90’s meltdown was based solely on a lack of liquidity in the market. This cycle is based not only on illiquidity but also insolvency. And insolvency (the inability to repay outstanding debt) is the element that makes this cycle a bird of a different feather:
A liquidity problem occurs when a household, firm, country, etc is still solvent, but faces a sudden crisis, where a creditor is unwilling to refinance their claims for example. An insolvent debtor does not only face a liquidity problem, but could not pay the claims upon them over time, even if there were no liquidity problem. One, broadly, suggests sound fundamentals; the other very much not so.
LTCM, says Roubini, was mostly a liquidity crisis:
The US was growing then at 4% plus, the internet bubble had not burst yet, we were in the middle of the New Economy productivity boom, households were not financially stretched and corporations were not financially stretched with debt either.
Today we do not have only a liquidity crisis like in 1998; we also have a insolvency/debt crisis among a variety of borrowers that overborrowed excessively during the boom phase of the latest Minsky credit bubble.
The real factors at stake in this unfortunate situation are, says Roubini:
- You have hundreds of thousands of US households who are insolvent on their mortgages. And this is not just a subprime problem: the same reckless lending practices used in subprime.were used for near prime, Alt-A loans, hybrid prime ARMs, home equity loans, piggyback loans.
- You also have lots of insolvent mortgage lenders - not just the 60 plus subprime ones who have gone out of business - but also plenty of near prime and prime ones.
- You will also have - soon enough - plenty of insolvent home builders. Many small ones have gone out of business; now it is likely that some of the larger ones will follow in the next few months.
- We also have insolvent hedge funds and other funds exposed to subprime and other mortgages.
The fusion of these factors lack of liquidity and the real threat of insolvency are coming together in a perfect storm as Roubini concludes:
We are indeed at a Minsky Moment and this recent financial turmoil is the beginning of a much more serious and protracted US and global credit crunch. The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic - will not work; they will only postpone and exacerbate the eventual and unavoidable insolvencies.
As Aaron Krowne said in our recent podcast interview - “batten down the hatches.”
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[Source: Blown Mortgage]
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