Executive Summary

• The Fed's inability to recognize the true dynamics of the 2008 crisis has re-inflated a market bubble and unfairly rewarded the big banks
• More credit/liquidity cannot solve valuation/collateral crises. But that's exactly what central banks tried to do — creating today's "Everything Bubble"
• How the Crisis of 2018/2019 will differ from 2008
• Why this time, the Fed's fixes will be futile

If you have not yet read The FAANG-nary In The Coal Mine, available free to all readers, please click here to read it first. Note that this Part 2 is an updated version of a report first published in 2014.

In Part 1, we noted the eroding good options for investment capital in today's "Everything bubble" financial markets, as well as the dangerous risks that another 2008-style crisis is brewing. If markets are fractal, as argued by Benoit Mandelbrot, then we can anticipate more “once in a lifetime” crises than economists expect, and that such crises will be less predictable than expected.

In Part 2 of this report, we explain why the policies of the governments and central banks around the world that have boosted assets such as stocks, bonds and real estate to new bubble highs will cause a crisis that will be as damaging as 2008 — yet unfold quite differently, in ways the system is not prepared for.

Fighting the Wrong Battles

My primary thesis is this: the central banks’ initial response to the domino-like effect of subprime mortgages imploding was based on the assumption that the crisis of 2008 was a conventional liquidity crisis that could be resolved by making short-term credit (liquidity) available to temporarily stressed lenders and banks.

But when increasing liquidity failed most spectacularly to stop the meltdown, the Federal Reserve realized that the real problem was not a lack of liquidity but a collateral or valuation crisis: assets no longer had a market value to support the loans and derivatives that had been piled on the assets.  The collateral underlying a mountain of credit was impaired or even phantom.

This was a quite different problem than a lack of liquidity, i.e. the ability to roll over debt into new loans.