Next Big Short

I tend to be earlier but it is better to be a bit earlier than late, agreed? Actually it is not really new about this topic as I have already started talking about it, but let me add a bit more information into a scary trend that we may likely face in a few years’ time.

If you haven’t watched film, “Big Short”, you may want to take a look. This is about a real life story about how Michael Burry, happened to be also a physician by training, made nearly $3 Billion during the financial crisis of 2007–2008 by shorting the subprime mortgage. This has become an epic short trading eternally engraved in the financial history. If you don’t know yet, Burry was also a few years earlier in setting up his big short that had costed him big paper loss and a huge outcry from his clients before the final crash came. After all, all looked very rosy and bright before 2007 for the real estate market. Even Bernanke famously testified that there was no crisis coming for the housing market at that time. Who needs to worry, right? I hope you do now together with me!

We are heading into a crisis that could be much more severe than the housing crisis and I think there is a high chance this may hit us within the next 5 years. I’m talking about the Corporate Debt (CD). Indeed, no one is talking about it, not mentioning any fear for it. After all, who cares when the borrowing interest is so low that almost any debt can be easily served? Probably not any more in the coming years!

So why I’m sounding so alarming? Well the sheer size of the CD up to now is mind-boggling and it is piling up even more as each day goes by. Similar to those days when the housing market was booming and mortgage could be easily obtained often with no immediate cost, who cared about how to repay the mortgage in the coming years. Corporations are doing exactly the same thing nowadays. Borrowing is too easy and cost is too low; who cares what may come next! Without knowing, they are already approaching the point that there is no return.   According to Wells Fargo Securities, corporations will need to refinance an estimated $4 trillion worth of bonds over the next five years. How much is that? It’s about two-thirds of all the outstanding debt for corporations or about one fourths of the US GDP! Now think about it. During the 2007-2008 housing crisis, the value of American subprime mortgage was estimated at $1.3 trillion as of Mar 2007, less than 1/3 of the total CD now. But it has already brought the whole financial world onto the edge of crash when interest rates started to move up, making a lot of mortgage owners not able to survive but defaulted. How much junk bonds in total now? Coincidentally also worth about $1.3 trillion. Junk bonds refer to those debt issued by the companies without a good credit rating (under the investment rating) and therefore are at high risk of default in general but especially so in an interest increasing environment. This is very similar to the subprime mortgage in nature. We can safely bet most of those junk bond companies will run into serious problems of refinancing and many of those even with good rating may also not be able to afford the increasing cost of their debt when the interest rate shoot high substantially. It is a general consensus that 4% of long term interest rate may trigger a lot of default. Ironically a fast growing and booming economy as we are seeing now may speed up the escalation of the interest rate. I don’t think it is far-fetched to see a 4% 10 year interest rate in the next few years. I’m even thinking we may see 5%+ rate in the not so long future. Then wait to see a tidy wave of corporate bankruptcy coming. It is nearly a perfect storm brewing although not many people are worried about it. On top of that, don’t forget we have historically high government debt piled up, plus historically high consumer debt (like student loans and credit card debts amounted to also trillions of dollars) stacked up. None of them can go easily when the interest rate shoot up. So mark my words: The next financial crisis will be the (non-housing) debt crisis. When it hits, it will make the housing crisis like walking on the beach!

Be Prepared!!