2008 Redux

The crisis in 2008, while overly simplified, was an issue of bad real estate loans that led to over-commitments by financial institutions who insured those loans against default. Loans were made to developers and home buyers who had subpar credit and subpar balance sheets, but were justified because real estate prices could never fall. When the price of the asset fell, defaults rose and financial institutions felt the pain.

What are the chances that we’re going through this exact same process with commodities today?

Banks, in search of yield, lend to energy companies so that they can participate in the US energy revolution. The profitability of these companies are based on overly-optimistic oil price expectations and now that we’ve reached sub $50 oil defaults are rising rapidly.

Oil isn’t the only commodity falling however. Companies like Glencore are in massive trouble as commodity prices continue to fall, see the GSCI. As the wsj points out today, there is substantial risk for lending institutions that allowed Glencore to borrow money.

http://www.wsj.com/articles/glencore-oil-deals-could-bite-banks-1443989065

I’m sure there are fundamental reasons why this isn’t comparable, what are they? Why aren’t some of these new MLPs the equivalent to the start up real estate developers in '08?

What’s the solution outside of a commodity price rebound?

Is this more of an issue for private equity or are the major banks very exposed here? Obviously regulations should have created a more stable financial industry so the Lehman type event should be much harder to achieve.

This might be obvious, but I know very little about all of the above. Just curious to hear from someone who does.

there have been many commodity bear markets without a credit crunch or major recession.

wrt to MLPs, i’d expect consolidation to help make the sector more healthy but really the industry has a fairly steady revenue/earnings stream ex-debt and the size of the industry just isn’t enough to cause much calamity elsewhere. a few might go bankrupt but i’m sure most could raise equity to make themselves more sustainable.

wrt to the commodity collapse, as most large public players (e.g. BHP, Vale, Rio, Exxon, Conoco) have very healthy balance sheets and can operate in virtually any environment, there will be no major project shut-ins nor any “Lehman-like” default like some have suggested. if Glencore were to go down, BHP, Vale and Rio would pick off what they like and bondholders may take a minor loss but i wouldn’t expect some huge reverberation throughout the industry. also, there are many state-backed players in the commodity space which have a 50-100 year outlook so they are often willing to buy properties at what seem like excessive prices in this type of environment in order to secure good long-term projects. i do expect many small players to die in the commodities space but as the vast majority of the mining/oil industry’s production and market cap is in companies with virtually no risk of bankruptcy, i don’t expect other industries to be affected outside of reduced demand for financing and lower levels of employment growth.

I don’t really know, but I’m guessing that mortgage debt is much, much bigger than commodity related exposure in the context of the US economy. Total mortgage debt outstanding in the US is $13 trillion at the moment, and all major US banks have absolutely huge exposure to mortgage loans - probably in the order of hundred billions. So a decline in home prices of say, 20% is going to have dramatic repercussions in the financial system.

Commodities are important to the economy as well, but for the most part, the economic damage from the decline in commodity prices seems to be contained, and banks have large buffers to protect themselves from these comparatively small amount of defaults (small relative to real estate).

http://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm

Perfect, thank you both

The issue with mortgages was the leverage involved and how bad investment assumptions fed back into margin calls and the underlying and then into the economy as a whole. Although commodity futures can reach significant leverage ratios, the industry itself is likely not excessively levered (Lehman reached 30:1 leverage ratios) and perhaps can crash without enormous feedback into the rest of the economy.

Mortgages were in fact the largest security market in existence (larger than the stock market and the U.S. Treasury market). Energy is at best a portion of the stock market and the commercial bond market.

Finally, when housing prices crash and homeowners are underwater, they reign in their spending, potentially spiking a recession which can feed back into foreclosure and further falling home prices.

By contrast, when energy prices fall, consumers and businesses have more disposable income and/or profits.

So this may be bad for the energy industry, but it’s very imaginable that the damage will be contained therein.

I cover the commodities sector. Glencore is fine, there are a lot of major misconceptions floating around about their trading ops. The big players (except maybe the coal guys) are under strain but will ultimately be fine because they operate the best mines at the lowest points on the cost curves. Before they impload the small high yield players may go under or shutter high cost capacity. So there is a floor there. That being said, I wouldn’t be suprised to see major emerging market stress from producers in Africa and South America as well as the non-mining businesses that operate in those regions. China may also show significant signs of strain at points.

I guess I’m the only person not even remotely concerned about the commodity crash but deeply concerned about the continuing effects of QE. Rates needed to go up earlier this year if not last year. I don’t think we are going to have a crash but the Fed has created a huge dislocation in equities that is rampantly destroying / transfering capital to poor outcomes dotcom style. Commodities will recover. We need to let the economy get back on track and stop manipulating the market with monetary policy.

My outlook is we’re going to have a rotation between the IWO and IWN similar to what happened after 1999 when small cap value went into a multi-year bull market between 2001-2003. Yesterday may have been the first day of the rotation. Biotech and unprofitable “concept” tech stocks have another 80% to fall and there are some good value stocks laying around that will double or more when anyone bothers to notice them.

The market is still very broken but it’s getting rational. People think it’s broken because it’s down (down is good, wash this crap out) but the real brokenness is the dispersion and how imbalanced the sector valuations are right now. It’s possible we could have a market that is relatively flat while certain participants are virtually wiped out in a flat tape as the healthcare bubble pops.

No position in VRX but damn it’s fun to watch shitty “me too” investors get dominated on that one. Do a little work next time you clowns, starting with maybe even opening the 10-K and reading it. VRX is a microcosm for the stock market right now. The bull market for stupidity is over now.

You’re not the only person. Myself, many others, Bill Gross (repeatedly and vocally in his newsletters) and about a dozen major HF managers have all said the same thing regarding low rates.

^ Go Canada! home of the dying highfliers (e.g. Nortel, BlackBerry, Valeant). Are we ever going to build a company that is dominant and massive that doesn’t end in tears (that isn’t a bank)?

People talk about low rates, it’s the dispersion that no one is talking about. It doesn’t make sense to have stocks of real companies trading at decade lows with no solvency problems while garbage trades at a generational high. I haven’t seen anyone discussing this in the press and it is probably the biggest issue facing the market right now.

Sounds like a good time to be a value shop

Another big difference between the commodities route and the credit crisis was the implicit TBTF backing the banks had. That isn’t something that would be happening to commodities companies as if one failed the others would be fine to pick up the slack.

Due to regulatory concerns most of the banks shuttered or greately reduced the size of their commodities units so they aren’t having to worry as much as they may have it this occured 10 years ago. If credit disappears it makes MANY business very difficult to operate, if commodities prices go down, many businesses are helped (aside from plenty O&G and basic material companies)

I agree with this 100%. I’m starting to finally find some good value buys in several sectors. At the same time, I’m looking at other sectors wondering how these valuations can possibly be justified. If I had more free time to dig, I’m sure I could find even more opportunities.

In the final few years people were originating $500BB+ per year in subprime mortgages alone, and securtizing most of it. The article below says shale only took on $120BB in high yield debt over the last few years? Shrug, as others have said, more concerning are the US/UK/JP experimental monetary policies, and distortions they create.

“The latest slump in crude is rekindling concern that oil companies will struggle to service the $120 billion of high-yield, high-risk debt they took on in the past three years amid the U.S. shale boom.

http://www.bloomberg.com/news/articles/2015-03-17/energy-junk-bond-revival-cut-short-as-7-billion-lost-in-10-days

potential VRX fraud about to reverberate throughout the biotech sector? i bet bro is busy shorting the hell out of bios as i type.

geez. bro’s on fire these days. SKX indicating down 30% this morning.

As hacksaw as Citron is, their report looks real bad for VRX.