Did Friday’s market plunge mark the start of the next crash?
Economic and market conditions are eerily like they were in late 2007/early 2008.
Remember back then? Everything was going great.
Home prices were soaring. Jobs were plentiful.
The great cultural marketing machine was busy proclaiming that a new era of permanent prosperity had dawned, thanks to the steady leadership of Alan Greenspan and later Ben Bernanke.
And only a small cadre of cranks, like me, was singing a different tune; warning instead that a painful reckoning in our financial system was approaching fast.
It’s fitting that I’m writing this on Groundhog Day, as to these veteran eyes, it sure has been looking a lot like late 2007/early 2008 lately…
The Fed’s ‘Reign Of Error’
Of course, the Great Financial Crisis arrived in late 2008, proving that the public’s faith in central bankers had been badly misplaced.
In reality, all Ben Bernanke did was to drop interest rates to 1%. This provided an unprecedented incentive for investors and institutions to borrow, igniting a massive housing bubble as well as outsized equity and bond gains.
It’s worth taking a moment to understand the mechanism the Federal Reserve used back then to lower interest rates (it’s different today). It did so by flooding the banking system with enough “liquidity” (i.e. electronically printed digital currency units) until all the banks felt comfortable lending or borrowing from each other at an average rate of 1%.
The knock-on effect of flooding the US banking system (and, really, the entire world) in this way created an echo bubble to replace the one created earlier during Alan Greenspan’s tenure (known as the Dot-Com Bubble, though ‘Sweep Account’ Bubble is more accurate in my opinion):
The above chart shows the Fed’s ‘reign of error’. It began with the deeply unfortunate sweeps program initiated at the end of 1994 (described below), proceeded to the echo bubble that itself broke in 2008 with even greater damage done, and all of which has led us to where we are today.
Note the twin panics of 2016 on the above chart.