Debt Is Again The Big Short

The world has amassed enormous debt.

Global debt now amounts to more than 317% of global gross domestic product.   What’s more, #global debt rose to a record $233 trillion in the third quarter of 2017.  This was more than $16 trillion higher from end-2016.  In the U.S., the federal government is now over $20 trillion in debt.

Meanwhile, private non-financial sector debt hit all-time highs in Canada, France, Hong Kong, South Korea, Switzerland and Turkey.  

The enormous debt pile could end up acting as a brake on central banks plans to raise interest rates.  Higher interest rates would inhibit the debt servicing capacity of highly indebted firms and governments.

Undoubtedly, many sectors of the economy have shown strong growth.  In particular, the #energy industry, both U.S. domestic and foreign producers, have benefited from higher energy prices.  Furthermore, the environment for oil companies is dramatically improving.  There are signs that the energy market is rebalancing.  Crude futures have rallied to multi-year highs.  The main driver has been a supply cut from the major oil producing group OPEC and its allied partners.  OPEC began to restrain output in January of last year.  And the production cuts are scheduled to continue throughout 2018.

Even so, the level of debt has begun to raise concerns.  One of those concerned voices is Larry Summers, former Treasury Secretary under President Bill Clinton.  “Yes, we are growing at a reasonably rapid rate.  However, it’s taking unsustainable fiscal deficits to drive us to that point.”  “It’s taking unsustainable increases in credit to drive us to that point. It’s taking unsustainable increases in asset prices. You can always generate a sugar high. The real problem for us is not achieving growth, but achieving sustained, healthy growth with a financial environment that’s sustainable.”

Corporate debt

Some observers have already begun to speculate about where the next “Big Short” will occur.

One prominent observer is Greg Lippmann.  He is the former Deutsche Bank AG trader who now oversees about $3 billion at his LibreMax Capital LLC.  Lippmann was made famous by the book and movie The Big Short.  Lippmann believes that the next financial tremors will come from corporate debt.  “The first quarter’s volatility is a harbinger of something bigger.  I think that you’re going to see a lot more trouble in the corporate market and the equity market than the structured products market.” “The consumer is in much better shape than corporates.  Consumers are less levered than they were pre-crisis. Corporates are more levered than they were pre-crisis.  Furthermore, I think structured products are not going to be the epicenter.”  “The next recession may not be imminent.  However, it is on the horizon.  It will be less severe but longer than the global financial crisis of 2008 and 2009. It’s likely to be more akin to 2000 through 2002.”

Commercial Real Estate

Others believe that commercial real estate is vulnerable.  But this time, hedge funds (along with Deutsche Bank and Morgan Stanley) aren’t targeting subprime mortgages—they’re going after #commercial real estate.  It’s no secret retailers and malls have been struggling for years.

Student Loans

Others believe that #student loans will cause the next fiscal crisis.  Fortune believes that student loans will cause an “economic crisis the likes of  which this generation has never  experienced.”  “The higher education bubble (one-sixth of the U.S. economy) will likely burst with the force of all previous catastrophes combined—a shock wave so sudden, so large, that it gathers the full force of the savings and loan, insurance, energy, tech, and mortgage crashes, creating a blockbuster-level perfect storm.”

Maybe Fortune has overstated the problem; maybe not.  In any event there seems to be a growing consensus that the mountains of debt that have been accumulated by the public and private sectors have grown so large that they have begun to inhibit growth and are casting a pall over the economy.

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