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The New New Big Short
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Last modified on 4/26/2020 4:27 PM by User.

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The New New Big Short

How I got here

My memory is fuzzy, but I thought I read a long-form article by Michael Lewis, then the movie, then the book.

I looked for the article, and found

-> https://www.bizjournals.com/boston/blog/bottom_line/2015/12/michael-lewis-big-short-conde-nast-portfolio.html

…but I don't think that was it.

I liked the movie, but I think you can't really understand the problem unless you carefully read the book. Its probably the most effective explanation of the complex failure that kneecapped our world economy.

From there, a conversation among my friends began: 

Can something like this happen again?

What is the next new new big short?

and why was it "big"?

The book looks at various key players, via the lens of people that saw it coming. It is by no means a complete list, but remember the obvious converse: Many people, that is hundreds of thousands of experts with hundreds of years of experience, paid hundreds of millions of dollars, collectively failed to see and react to "the big short".

How did that happen? The most common theme was that these were specialists in component of larger, complex economy. The vertical integration of their behavior combined with bad incentives, caused them to collectively run the ship off the cliff. Many of them probably understand the failure in retrospect, but could not see the future or react in the present.

The criteria would need to be: very large, systemic, and a viable trade. Boeing doesn't count, too small. Theranos, chump change.

What is the next (new new big) short?

The global economy is still vulnerable to large systemic failures, especially from large markets. My short list is the EU, China, and the US.

I picked the US simply because it is the largest, most interconnected, and it has the worst track record in this category.

In the US, the broadest economic risk is debt, and my limited thinking groups it into three types:

  • government
  • corporate
  • consumer

In the search for the big one, consumer debt is the riskiest, because the other two are more centrally affected by groups that have some policy and some sense of strategy, not to say they are prefect.

In US consumer debt the three largest / most-visible categories are:

  • college debt
  • medical debt
  • consumer debt

This being 2019 when the conversation, I couldn't think of any systemic way a lot of college debt or medical debt would lead to mass defaults, in a way that would do damage to the global economy. (I think it is easier today to come up with at least one scenario, which is mass, unplanned unemployment).

So looking at consumer debt: mortgage, credit cards, and auto debt are notable.

The old big short could repeat, but the clear trend line of younger adults way from home ownership makes that less likely than before.

Credit cards are the age-adjusted preferred financial vehicle, but at the end of the day, its hard to imagine credit card defaults taking down a bank, esp. in away that takes down the US economy. Basically, the banks are so good at taking consumer money up front, the interest-charges-on-balance is simply not systemically risky.

That leaves auto loans. This type of loan is already bad, and consistently getting worse:

  • Increased price of cars
  • Increased price of use of finance
  • Increased length of term
  • Increased sub-prime borrower segment
  • Increased interest rates concentrated in weakest borrowers.

What about the cars?

  • New sales growth is in more expensive, less fuel efficient cars.
  • Electric cars are expensive
  • Production of low-cost, fuel-efficient car models are decreasing

This is the pretty conventional, minimal future catastrophe scenario. Poor buyers can't make payments or buy new cars, so there are defaults, car repo, depressed sales, bad credit, personal bankruptcy, etc.

I'm not saying that is good, but that's the planned-bad.

Okay, so lets add a couple trends that I think are very important, especially when you are layering over failures that create larger systematic problems:

An intellectually-lazy, and morally bankrupt idea that subprime borrowers will pay the car ahead of their housing costs. In the great recession recovery, there's been a lot of talk about how this is true.

The assumption that new technology provides solutions that ensure payment, especially remote-disable technology. These systems might be tactically effective, but they are unlikely to be statistically safe. 

There are more, but the idea is to set you on the search for the metaphorical "bullet coming around the corner", that the "pros" or "experts" might overlook.

Here's the larger scenario. What if the price of oil goes up, either thru a price shock, or sustainably.

In the path we are on, this would be a catastrophe. Here's why:

People who are subprime and have cars have them because they are working and they need the car. (Who pays 25-33% on anything they don't need)

The cars are not an asset, about a 1/3 of the loans carry debt from the previous car, and they are at maximal terms already.

They are often working long hours, commuting long distances.

If there is gasoline hike they will be looking at: increased transport costs that are fixed, an inability to move closer (renters are credit checked now), an inability to buy new, more fuel efficient car, and an inability to buy a cheaper, used, fuel efficient car. Poor credit also means: no lease.

We could wake up one day with a sudden increase in the number of people who cannot effectively afford to go to work.