‘Once you’ve got too much debt in the economy … it’s incredibly difficult to get rid of it.’
Lord Adair Turner, Chairman of the Institute for New Economic Thinking
Humans, as a rule, are remarkably smart animals. And remarkably successful.
One of the traits that’s helped cinch this success is our ability to learn from both our own and our collective mistakes. Meaning we don’t need to make every mistake for ourselves. We can learn from others.
You don’t need to stick your hand in boiling water to know that’s a bad idea. Thankfully, someone else already made that mistake for us and passed on the news. And, unlike our animal cousins, you’re unlikely to step in front of a speeding car. You’ve been told what that outcome is. Not good.
We’re also quite adept at learning to do things that aren’t really natural. Like riding a bike, skiing or roller skating. The learning process in these cases can be a bit painful. But once you’ve got it down, you remember it for life. You won’t make the mistake of only hitting the front handbrake on your pushbike as you’re speeding downhill more than once.
So why is it that when it comes to the financial world, we’re so hell-bent on repeating our mistakes over and over again? All the while happily ignoring any advice and warnings to the contrary.
The US$3.2 billion snowflake that started the GFC avalanche
I bring this up for a reason. You see, 10 years ago today, on 22 June, 2007, the first cracks in the global financial system emerged. That’s when Bear Stearns’ highly speculative investments into the US housing market began to look more and more as if they’d stepped in front of a speeding car.
As The Sydney Morning Herald reports,
‘America’s then fifth-largest investment bank was among a number of Wall Street giants exposed to bad bets on the US subprime mortgage market.
‘Bear Stearns agreed to a plan for a $US3.2 billion ($4.2 billion) secured loan to its hedge funds under pressure from those bad debts.
‘But in the weeks after financial contagion followed, and, almost a year after the plan, JPMorgan Chase and the US government bailed out Bear Stearns.’
Not long after Bear Stearns received its taxpayer-funded bailout, word got out that Lehman Brothers, the fourth-largest investment bank in the US, had stepped in front of the same car. And Lehman was left to its own devices. Holding over $600 billion in assets, the bank filed for bankruptcy on 15 September, 2008. To this date, it remains the largest bankruptcy filing in US history.
You know what happened next. The contagion inexorably spread. Like any good contagion, it hit the weaker players first. But it wasn’t contained there. The financial crisis went global, and took down businesses and individual investors, strong and weak alike, to the tune of trillions of dollars.
If you were invested in the Aussie market, you undoubtedly recall exactly how painful the impact of the GFC was. The ASX 200 plunged from 6749 points on 12 October, 2007 down to 3145 points on 6 May, 2009. That’s a 54% loss in 19 months…one it has yet to recover.
And it was all caused by excessive borrowing by millions of individuals and businesses — only to discover they’d borrowed too much. (And yes, the widespread inept, and even corrupt, actions on the lenders’ side of the equation bear plenty of blame as well.)
As the smartest animals on the planet, you’d think that would be lesson learned. That 10 years on from the GFC would find the world on a fiscally responsible path. That governments, corporations and individuals would have paid down their debts to manageable levels, and have plenty of dry powder available to weather any minor downturns.
As a Markets & Money reader, I’m sure I don’t have to tell you that’s not the case. From The Sydney Morning Herald:
‘The Institute of International Finance (IIF) says global levels of debt held by households, governments, and non-financial corporates jumped by over $US70 trillion in the past decade to a record high of $US215 trillion, equating to 325 per cent of global GDP.’
To put that in perspective, it would take every person in the world performing the same work they did this past year for the next three years and three months to get out of this debt hole. But only if, during that time, every cent earned went to repaying the debt.
You don’t have to be a financial expert to see how that’s…erm…unlikely.
But speaking of financial experts, Lord Adair Turner is the Chairman of the Institute for New Economic Thinking. As quoted by Business Day, this is what he had to say:
‘“Once you’ve got too much debt in the economy … it’s incredibly difficult to get rid of it.
‘“If you say, ‘I’m going to write it off’, your banks go bankrupt … if you try get rid of it by people paying down that debt … the attempt to pay it back is what drives the economy into recession.”
‘To avoid that, interest rates then fall, and that simply encourages more borrowing, he says.’
More borrowing, eh?
That’s certainly the formula at work across the world. And nowhere is that more true than here in Australia. The latest figures show that the household debt to income ratio Down Under has hit an all-time high of 189%.
Now, I’m not trying to scare you. I imagine yesterday’s 1.6% plunge in the ASX 200 — seeing the index lose $27 billion of value — has you on edge already. But that doesn’t mean you should sell all your stocks and head for your bunker quite yet.
I expect the index will bounce back. And governments, businesses and individuals will manage to take on trillions of dollars more in debt.
Right up until they can’t.
Another widespread round of defaults is a virtual certainty. That may happen later this year, or it may be several years away yet. But it’s coming. And with the staggering build-up of debt continuing apace, the next GFC may well stand for Global Financial Catastrophe.
So what can you do? Simple. Use the brain billions of years of evolution have given you. Learn from the mistakes that you and others have made in the past.
Above all else, stay informed. Learn what you can do today to protect your hard-earned wealth before the next wave of defaults goes global. And know the warning signs to look for, so when the herd panics and starts to stampede for the exits, you’ll already be well out the door.
Find out exactly how you can do that, here.
For Markets & Money