The Truss Debacle Signals the Financial Endgame is Upon Us
by Bob MacGuffie
While British Prime Minister Truss’s astonishingly rapid rise and fall is most certainly a personal tragedy and a national political embarrassment, it may also be the most portentous warning to the international economic system since the great credit freeze of August 2007. With comfortable hindsight, the tumult in the U.S. credit markets that summer has been recognized as a critical precipitating event to the international financial crisis which boiled over just one year later. The failures of Bear Stearns, Fannie, Freddie, and Lehman were attributed to the collapse of the sub-prime and mortgage markets in the summer of 2008. But the bell which tolled unmistakably one year earlier, was the bond and credit markets’ rampant liquidity crisis.
Unrecognized by far too many financial commentators is the criticality of credit to the western economies. Most every enterprise from small business to big business to governments to family households runs on the availability of credit. That’s not to imply most enterprises are over-leveraged. Clearly not – they simply, critically depend on credit to function. Federal Reserve Chair, Ben Bernanke was well aware of the potential for a credit crisis to implode the economy. He had watched as Alan Greenspan led the Fed to temporarily flood the markets with liquidity in the fall of 1987, staving off what could have been a very deep recession or depression. And as a student of the Great Depression, Bernanke would lead the way in ’08 with TARP, QE, and more, bringing the term “helicopter money” back into vogue. No one was going to accuse him of failing to ‘liquify’ the markets.
The purpose of the liquidity rush was to enable the credit and equity markets to do the painful readjusting and reallocation of capital, closing of ineffective enterprises, strengthening of investment portfolios and balance sheets – all the necessary to prepare the economy for the next expansion. The upshot of the ’87 crisis was the S&L implosion. The painful readjustment and restructuring of this financial market played out transparently over the following several years, without the need for inordinate financial injections after the stabilization of the initial crisis. The purging of the unhealthy enterprises set the stage for a significant economic expansion in the 1990s.
But the degree of readjustment and restructuring that Ben Bernanke saw on the horizon for the banking, insurance and other financial industries was more than Ben, and his friends leading many of those enterprises, could bear. As opposed to prior crisis aftermaths, virtually no financial services leader was sacked as a result of poor decision-making leading into the great crisis. There were layoffs and huge personnel dislocations, but that was for middle management and the worker bees – the captains remained at the helm. What was needed was accountability at the top, and a changing of the leadership guard. What we got was the Federal Reserve absorbing most of the impaired mortgages and other securities from the banks until they could again open their windows for lending. The Fed took on the bad debt, creating new reserves in the banks’ Fed accounts, by entering them as payables. This is the practice that’s commonly referred to as “printing money.”
The economic deceits continued into the ensuing years. The Fed significantly expanded the money supply by printing some $2 trillion in four rounds of so-called ‘quantitative easing,’ or QE, from 2008 to 2014, quadrupling its balance sheet to $4.5 trillion. Quick on the heels of the TARP bailout, this perfunctory absorption of bad debt and bad decisions from the shoulders of the bankers to the belly of the Federal Reserve, proved the maxim that the banks now were indeed “too big to fail.” But the Fed’s hubris in these years pushed the nation across a fateful financial Rubicon. At some $15 trillion and rising, the national debt was no longer financeable by the U.S. Treasury, except at inordinately low interest rates. At these debt levels, should rates normalize to five to seven percent, the interest carrying costs would make a shambles of the federal budget, crowding out other vital needs of the country. Now, no matter what, interest rates had to be kept under two percent for the indefinite future.
Much of the newly printed money made its way into the stock market, which after regaining its footing in 2009, began to move up to new highs as the decade progressed. Those outsized advances were then turbo-charged by the dual impact of low interest rates. Low yielding bonds coaxed more money into stocks… and at such low rates, borrowing to invest in stocks proved irresistible to far too many investors – and the band played on, with the Dow hitting new highs on a weekly basis. In an effort to cool the overheated stock market, Bernanke promised, or threatened, to taper, then end the QE. As he jawboned Wall Street, the mercurial moods of the traders drove the markets to convulsions on several occasions over the decade. But the underlying reality for the Fed was that interest rates must be managed no matter what it took. Commentators willing to speak this truth saw little time on business TV or in print. Their cynical side comment was we’re in ‘QE to infinity.’
With a rapidly growing national debt, the need to sell more and more bonds at each Treasury auction would naturally call for higher yields to attract enough investors. But, as noted, the Treasury could not finance its alarming debt load at higher rates. So, under various guises the Fed found a way to buy the debt of the U.S. Treasury, to maintain the necessary low interest rates. In recent years, whenever money exited the bond markets too swiftly, initiating a spike in rates, it seemed some magical force would swoop in and purchase enough bonds to stabilize the market. The same phenomenon maintained with swooping stock markets. The traders employing another cynical term, would say the ‘plunge-protection team’ was at work in the market, implying Fed-directed purchases by member banks.
Over the last half decade, the U.S. government has been sustained with annual trillion-dollar budget deficits financed with low-cost debt. Though never spoken by the ruling political and financial elite, they know this fraudulent scheme cannot go on forever – which brings us back to the ominous warning to western economies contained in Prime Minister Truss’s stunning rise and fall. In the midst of a languishing British economy, Ms. Truss entered office in early September intent on re-igniting the economy with a dose of Thatcher-styled tax cuts. But the program she advanced did not balance the tax cuts with the requisite spending restraints. Instead, the sweeping tax cuts were paired with hefty spending increases. Much of the new spending was designed to subsidize inflating energy prices, as the nation headed into winter. The tax cuts were to be followed later by deregulation measures, and at some unspecified point after that, government spending would be “examined.” It was quite clear – the tax cuts would be paid for not with spending cuts, but with debt. But the financial markets threw a fit, and simply rebelled at the program.
The British pound fell steeply against the dollar, leading to an increase in borrowing costs for both the government and British households. The firestorm and market turmoil led to the rapid replacement of the Chancellor of the Exchequer, a reversal of the entire economic program, and Truss’s resignation within about ten days. The more wistful observers read the episode as a market tantrum seeking a return to the days of consequence-free, easy money. But, a more sober analysis of the market reaction indicates the spontaneous rebirth of the ‘bond vigilantes.’ When a critical mass of these traders capitulate and sell, they can throw the markets into chaos, a loss of confidence in the markets, crashing bond prices, a credit freeze and other machinations which can simply lock the financial markets. The obvious illustration in our recent memory was when Treasury Secretary Paulson and Fed Chair Bernanke went to President Bush in October 2008 and said, if the banks do not receive the TARP bailout, that within 48 hours they will not be able to fund bank ATMs across the country. We don’t have to speculate on the national impact of ATMs being frozen for days, weeks, or significantly longer.
As noted above, U.S. financial markets have been supported by most of the crisis relief programs ever since the great recession. British financial markets illustrated to anyone watching that there IS a limit to the deficit, debt and money-printing subversion. The last time U.S. leadership looked over the economic abyss, they employed a rescue package of programs which currently remain in place supporting the economy. The Federal Reserve and the Biden Administration must now take the warning flare issued by the British bond and credit markets extremely seriously, and take the appropriate preventive measures still remaining. They have already broken the glass to extinguish the last fire, and we really don’t want to contemplate what might be in store for us should they proceed to ignite the most momentous economic conflagration.
Bob MacGuffie is co-author of the book ‘The Seventh Crisis – Why Millennials Must Re-establish Ordered Liberty,’ Seventh Crisis which examines and illuminates the historic crisis we currently endure.