10 Years After Bear Stearns, the U.S. Has Not Learned Anything About the Danger of Debt
As I write this, I am reminded that it’s the 10th anniversary since The Bear Stearns Companies, Inc. collapsed under its own debt. If you don’t remember it, it used to be a major investment bank.
Bear Stearns was one of the only banks to pay the ultimate price for the financial crisis its debt helped create, triggering the global recession that may even have been worse than the one that started in the 1930s with the October 1929 stock market crash.
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Naturally, as Wall Street hovers around its all-time highs, yet hesitating to return to the records set in January 2018, you’re probably asking yourself these debt-related questions.
Could Wall Street cave in again under the weight of overleveraged banks? Is the world heading toward another global recession?
A Wall Street trader might respond: Does Trump like his “beautiful” and “great” rockets?
It turns out the answer to those questions is a resounding “yes.”
Another Debt-Fueled Financial Crisis Lurks
Trump has modified the mechanisms that President Barack Obama approved in 2009 to try to control Wall Street excess—that is, excessive risk-taking by banks with their clients’ money.
The law that Obama approved is called the Dodd-Frank Wall Street Reform and Consumer Protection Act. All it does is regulate the amount of resources a bank must hold to compensate for any losses due to investment activity.
There’s no limit to such losses.
Thus, banks can go beyond their threshold, leaving shareholders and customers with the bill.
The regulatory restrictions may have generated a false sense of control. They may have allowed banks to get closer to the edge.
The banks’ limits are “generous” and just as everyone drives the speed limit on the highway at 75 miles per hour, all the banks are edging closer to the limit.
They are all overleveraged. And a debt crisis could erupt anytime.
It’s not just the banks’ fault. Like spoiled children, their insolent risk-taking was encouraged.
The U.S. government set a dangerous precedent in 2009, bailing out Wall Street. The banks may expect a similar treatment, should they (likely) get into trouble again.
But, how can the government bail them out one more time if the national debt is more than double what it was in 2008?
The U.S. Economy Has Less “Debt” Power
The United States is also losing its capacity to sell debt—feeding the U.S. economy and allowing it to run huge deficits.
Simply put, the United States will need to borrow, or sell even more debt, to keep going. But, politically, it’s doing everything to make it more difficult for foreign powers to “buy” this debt.
Favorable international relations are crucial to ensure goodwill from other countries. They’re also useful in keeping a certain stability, which allows growth and trade to continue.
These are essential factors for overall global growth.
The Dollar System Is Under Threat
So long as the United States has been the dominant power, it has been able to assure itself the ability to sell debt through the U.S. dollar “system.”
Until now, whenever the United States has needed money to pay for social programs and, more often, ballooning military bills, it simply prints more dollars.
It can do so, because it sells Treasury bonds to foreign governments. China and Japan are among the biggest holders of such treasuries or debt.
They need the dollars for financial transactions, which, especially in the case of commodities like oil and minerals, are conducted in dollars.
But, U.S. bonds are not as highly rated as others. The United States must keep the appearance of running a stable and responsible economy to uphold high credit ratings.
The lower the rating, the lower the confidence those investors have in the U.S. economy.
The higher the United States debt grows—and the Trump tax cuts will do just that—the more foreign debt buyers will demand as a guarantee. Just as the banks do to borrowers who have less than a stellar credit rating, foreign buyers demand greater bang for their risk in the form of higher interest rates.
As the U.S. economy stands now, there’s a definite “recessive” potential. More of the U.S. budget will have to go toward paying off the debt.
The effects are well known. Debt is what allowed Britain and France to take control of the finances of countries like Egypt and the Ottoman Empire in the 19th century. First, they sent budget controllers. Then they sent occupying armies to colonize these weakened and indebted lands.
Are Americans Ready to Experience a Taste of Greek Austerity?
All it will take for Americans to get a taste of the austerity that hit southern Europe—and Greece, in particular—after 2008 is a silly move.
As it happens, President Trump has already made that silly move. It’s a major blunder. He pulled the United States out of the Joint Comprehensive Plan of Action (JCPOA), also known as the Iran Deal.
The effects are draconian for Iran. They not only imply the return of heavy sanctions cutting off Iran from all banking and commerce with the United States, but they also apply sanctions to any foreign company doing business with Iran.
Iran is not a country that resource-hungry economic powers can ignore. Iran occupies a strategic geographical position, making it a natural and even cultural crossroads between the East and West. The country can boast an abundance of natural resources, including oil.
In fact, Iran is the world’s fourth-largest oil producer, also holding some of the world’s largest natural gas reserves. The country also has an educated and multi-skilled population.
In other words, many countries, from China and Japan to those in the European Union, want to do business with Iran.
Trump’s JCPOA decision will cause diplomatic hostilities. It will also force China to operate under the radar, as it were, buying oil and resources using yuan rather than dollars.
Europe may do the same. It has already agreed to buy Iranian oil in euros. (Source: “Europe To Pay Iran In Euros For Oil, Abandoning The Dollar,” International Business Times, May 16, 2018.)
Trump Has Accidentally Encouraged More European Unity
In fact, President Trump may just have pulled off what seemed unthinkable not long ago. He has shown Europe where to find the backbone it lost.
Under the new sanctions regime with Iran, Washington has given all countries and companies between three and six months’ time to terminate any business and contracts they may have had in Iran.
Naturally, the new sanctions also prohibit the stipulation of new contracts—in order to avoid the wrath of American sanctions—which fall under the extraterritorial principle.
The latter holds that the U.S. can sanction non-American companies that conduct business with countries the U.S. government has placed under embargo—if they have dealings with the United States or if they use dollars for transactions. (Source: “EU could impose blocking regulations if U.S. pulls out of Iran deal,” Reuters, February 8, 2018.)
Regardless of your understandable nationalistic instincts, it’s not beyond reason to expect the Europeans, the Chinese, and everyone else, to retaliate. Europe is trying to emerge from a massive economic recession. Iran was one of the countries that served many opportunities as well as cheaply produced oil.
The EU has already been forced to follow the U.S. sanctions against Russia. It has lost tens of billions in trade (conservative assessments estimate $100.0 billion).
The resumption of U.S. sanctions against Iran, and all their collateral restrictions, constitutes the proverbial straw on the camel’s back.
In practice, facing off an unruly Europe, Trump could punish European companies involved with Iran.
These include Mercedes Benz (building a plant there), Renault SA (EPA:RNO), Nissan Motor Co Ltd (OTCMKTS:NSANF), Airbus SE (EPA:AIR), Total SA (NYSE:TOT), and a host of others. Then they will have to choose: Trade with Iran or the United States. For the time being, the U.S. will win that battle.
But, for How Long?
Italy, the U.K., Germany, France, Belgium, Japan, and China are all involved in Iran—including their banks.
Many have accused Europe of being weak. But, Trump may have given it the spark and the need to come together under the guise of countering U.S. sanctions.
The history books of 2025 or 2030 might relate how the U.S.-European special relationship ended over Iran.
They might also speak of how Trump’s decision inflamed international tensions in general.
