In January of 2022, shortly after the Federal Reserve announced they were going to raise rates and halt QE to combat/adjust for inflation, a bitter reaction in the markets was seen. Stocks tumbled, marking the beginning of a downtrend that continues to this day.
A lesser-known effect is the collapse of CDO/CLO asset-backed securities issuance (US ABS Issuance). In fact, very few have taken notice of this, let alone the implications.
The present US and global economic situation and outlook are poor in the immediate term.
High and persistent inflation
High debt-GDP ratio
Shrinking real/inflation-adjusted GDP
Most know this. However, few believe we will enter a major recession or depression, and even less think the currency is in real jeopardy (not stagflation).
CDO/CLO ABS issuance levels may be a key indicator demonstrating that the situation is much worse than most understand, and why the house of cards that is the global financial system has begun tumbling.
To understand why, an objective understanding of the economic situation over the last 20 or so years is required.
Prior to 2008, we saw an over-securitization of collateral and dilution of asset-backed securities. The necessary volume of quality collateral sufficient to back the excessive and overinflated securities was inherently not there. Namely, in mortgage-backed securities.
To continue a rapid growth trajectory, once quality collateral ran out, securities were diluted and spliced with low-quality or effectively worthless junk. For example, AAA-rated was in fact, not AAA in terms of risk level and quality. The rating agencies were dishonest or not doing their job.
“Moody’s $864m penalty for ratings in run-up to 2008 financial crisis”
-The Guardian
By virtue of reality, this could not be sustained, and the GFC (Great Financial Crisis) occurred. After 2008, the Federal Reserve re-energized the economy by becoming the “buyer of last resort” through QE or Quantitative Easing.
The underlying problem remained, with the symptoms masked/delayed, for a period. By purchasing securities through QE, these poor ABS securities gained a new home. The balance sheet of the Federal Reserve. And by virtue of the fact that the Fed was a major buyer, other buyers participated.
Secondarily, it appears and is implied that the ratings are inflated. Implied, because when the Fed bails out nearly everything, and most involved are largely not held accountable, it can be inferred that the problem was not fixed. Especially in an environment that involves a buyer of last resort that simply “prints”.
Fundamentally, the problem was simply delayed because recessions and depressions serve as natural tools to weed out the bad from the good. In other words, fundamental price discovery. This price discovery is only possible in non-manipulated markets. There are two components, and the former permits the latter. Quantitative Easing. Inflated ratings.
To inspect the latter, a general snippet into the industry of a type of asset-backed security (ABS), mortgage-backed securities (MBS), we can look at the MBB AAA MBS ETF. The limited information on the bonds held within the security may provide insight or offer inferences as to whether these mortgage-backed securities are AAA.
Here, it is seen that sub 660 FICO score bonds compromise a certain portion of the MBB AAA ETF. Certainly, if this compromised a small percentage of the total security, it could still be considered true AAA.
However, according to Kirian Van Hest, the willingness to post scores of these levels, coupled with the incentive and permissibility by virtue of the presence of a massive buyer of last resort, the Fed, almost definitely means it is not in fact true AAA.
Here is an interview with Van Hest that goes more in-depth into the issue of asset-backed securities:
Mortgage Backed Securities Imploding Now Just Like 2008 | Deso
The decade that followed 2009 marked one of the strongest periods of growth in history.
With this in mind, we can go back to the more recent data. After the Federal Reserve said they would stop buying, CLO/CDO ABS issuances collapsed, and have largely continued to decline since then (indicated in yellow).
Without the Federal Reserve, other buyers have retreated. Meaning, that demand, other than the Fed, is reduced in the context of the discontinuation of the Fed as a buyer.
Here, simple supply and demand mechanics come in. Broadly speaking, ABS are over-diluted.
This is because of over-indebtedness, and inability to service debts, which is what gives ABS their value.
This is reflected in ETF which tracks the value of CLOs:
For good measure let’s look at the MBB AAA ETF (MBS iShares ETF MBB), further elucidating there’s a problem in the ABS market:
As of September 16th of 2022, this triple-rated mortgage-backed security ETF has hit all-time lows.
This is it. The party is over (…is what the markets appear to be indicating).
“The collateral underlying the financial instruments is finally going bust.”
-Kirian (Deso) Van Hest (Twitter: @desogames)
I credit Van Hest for the main theme of this article and suggest reading his work for a deep understanding of the present economic and monetary situation.
This being the case, hyperinflation of multiple major economies is possible, or as Kirian says, inevitable.
The main word of capital allocation strategy if this proves true? Precious metals. Mainly gold and silver.
What makes them a good investment? Simple supply and demand. In the context of a flow from synthetic assets (stocks, bonds, etc.), to tangible assets (commodities, etc.), the demand for gold would soar, meaning it is only reasonable to assume the purchasing power of these metals would significantly outpace inflation. Simply put, the perceived and actual value of having a physical value store is immense.
Consider this. In many instances of modern-day hyperinflation, the citizens switched to US dollars as a currency and safe haven.
“For years, the bolivar drifted toward irrelevancy as Venezuelans embraced the economic stability brought on by the widespread use of the U.S. dollar.”
-Bloomberg
This is a natural effect of being the global reserve currency. However, if the dollar itself ever becomes the “burning house”, gold, silver, and other precious metals may become a safe haven for a period.
