- This week marks the 10th anniversary of the collapse of Bear Stearns, which proved to be the first domino of the banking system that fell.
- Economists aren’t sounding the alarm for another implosion of the global financial system.
- But in David Rosenberg’s view, belief that financial risks are low is a “myth.”
The worst financial crisis in modern history claimed its first victim during this week a decade ago.
Bear Stearns, an 85-year-old investment bank that was America’s fifth-largest at the time, failed to convince its shareholders that it had enough staying power to survive the housing collapse. Many of the mortgages taken by unqualified borrowers had been bundled into securities that Bear Stearns put together.
And so as more Americans struggled to make mortgage payments, putting these securities in jeopardy, Bear Stearns’ creditors began to panic. In a deal arranged by the Federal Reserve, JPMorgan acquired the firm for a tiny fraction of its market value.
You’d be hard-pressed to find an economist who’s speculating that another collapse of the financial system is imminent. At best, we could be looking at another economic crisis.
David Rosenberg, the chief economist at Gluskin Sheff, looks no further than where it all began a decade ago — in credit. This time, however, Rosenberg isn’t worried about housing.
“Watch investment-grade corporate and high-yield spreads very closely,” Rosenberg told Business Insider. “There is a bubble on business balance sheets.”
What Rosenberg calls a bubble, investors would describe as a hunt for yield. Investor appetite for returns wherever they may be found pushed the yields on the riskiest, most indebted companies to levels close to those most recently seen in 2006, before the latest financial crisis began to unfold.
But the credit market is starting to show cracks. Investors “haven’t learned how important it is to believe in mean reversion, and too many are lured into the herd-mentality camp,” Rosenberg said.
Bank of America Merrill Lynch data showed bond funds saw outflows of $14.1 billion during the week ended February 14, the fifth-largest redemption on record. About $11 billion of that came from high-yield funds, even after the market weathered the volatility that shook stocks and Treasurys in early February.
“I am also concerned about auto-loan and credit-card delinquencies, which are rising, and we haven’t even seen the unemployment rate start to rise just yet,” Rosenberg added. “Wait till that happens. This tells you the quality of the credit out there — very weak. In fact, almost half of the investment-grade corporate bond market is now rated BBB!”
A “BBB” rating is just two notches above junk.
Though more Americans struggle to make their car payments on time, there’s hardly any siren-blaring about a housing-style meltdown. In a recent note, however, Rosenberg argued it’s a “myth” that financial risks were modest.
“I think the White House has to be very careful not to deregulate so quickly when it comes to the financial sector, especially now as credit quality starts to erode,” he said.
“Remember — the financial setbacks that always occur amidst a Fed tightening cycle don’t have to include the banks,” Rosenberg said. “We had savings & loans companies in the 1980s, mortgage funds in the mid-1990s, a hedge fund (LTCM) in the late 1990s, for some examples.”
And so, the lesson for money managers here is that the time for reaching for the stars is over — at least for this cycle, Rosenberg said. He advises raising cash and reducing the beta or volatility of your portfolio.
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