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The causes of the next crash are clearly visible

In hindsight it is extraordinary that the warning signs of the 2008-9 crash were almost universally missed, largely because the hoped-for fantasy of bull markets continuing uninterrupted blinds investors to the nature of the capitalism they’re riding on. But lessons are rarely learnt, and the signals of over-exuberance and over-reach are apparent again today, with the same blind eye failing to register them.

Most obviously of all, excessively leveraged loans to private equity have now reached dangerous levels. More than a third of leveraged loans this year have lent more than 6 times earnings before interest, tax, depreciation and amortisation, which is only slightly below the proportion at the peak of the 2007 credit bubble. Bank exuberance is shown by loans with less lender protection than usual. The proportion of these ‘covenant light’ loans is now above 60%, the highest ever.

Second, the junk bond market is booming, and last year was the best for risky payment-in-kind bonds since 2008. Third, the boom in flotations is now running at a pace not seen since the dotcom bubble burst more than a decade ago. The quality of the protection now being offered to shareholders has fallen drastically in the most-sought-after sectors of biotechnology and dotcoms. The Alibaba offering, the biggest IPO ever in the US, received overwhelming demand from investors who were palmed off with shares that give them no say at all in how the company is run or who it is run by. This kind of exuberant stampede is often the forerunner of the later crash.

Fourth, the current wave of takeovers looks notoriously similar to 2000 and 2007, and again these takeovers are largely financed by debt. Fifth, companies are borrowing to buy-back their own shares on an unprecedented scale, similar to the period up to June 2007 when the credit crunch began. Sixth, big losses almost always come when the market is over-priced. On the basis of the multiple of price to estimated operating earnings, shares are now more expensive today than in 2007 or 1987.

The forward price-earnings ratio has been more expensive only during the dotcom bubble and its aftermath. And seventh, when the US Federal Reserve stops supporting the market by by buying bonds next month and prepares to end the longest period of low interest rates in history, there is a real risk of higher market volatility than usual which could turn dangerous.

All of this exposes what little re-regulation has been put in place since the crash 6 years ago and how inadequately the banking system, let alone hedge funds, private equity and the shadow banking system, have been reconstructed. But it’s not as though we haven’t this time been warned.

2 Comments

  1. Shirley Knott says:

    The Nasty Party setting us up for another economic tumble then, hoping their false recovery lasts until the next election.
    Meanwhile, Austerity! Austerity! We’re all in this together! “We” and “ours” get to CHOSE while we CHEWS on the poor and low paid – so seems to be Osborne’s message.

    1. Robert says:

      It’s pretty much labour as well that’s an issue really.

      Miliband is all about austerity nothing about growth because growth will cost borrowed money, so while the world tried to heal it’s self after the boom, bang, explosion, we must put up with two parties so badly run the leaders of one cannot even mention immigration or the economy at conference .

      The fact is the Tories can only attack the bottom, while labour does not want to talk about anyone except the hard working.

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