An Expert’s Guide To Investments, Inflation and Interest Rates in 2022….All Right Here!

An Expert’s Guide To Investments, Inflation and Interest Rates in 2022….All Right Here!

Lawrence (Larry) McDonald founder of The Bear Traps Report, noted economist, New York Times bestselling author and CNBC contributor joined us on Your Mortgage Matters! Larry is well-known for his expertise regarding investments across all asset classes, risk management and the economy in general.

With so much going on in the market today, we squeezed as much information from him as time would allow. He was a very gracious guest indulging us with answers to everything from Federal Reserve announcements, housing market projections, recommendations for investing opportunities, interest rates and more.

Once again, we deliver timely information that could make a difference in achieving your financial goals!
Jan 4
File…

Erika Christie changed the due date for this to-do

Lawrence (Larry) McDonald founder of The Bear Traps Report, noted economist, New York Times bestselling author and CNBC contributor joined us on Your Mortgage Matters! Larry is well-known for his expertise regarding investments across all asset classes, risk management and the economy in general.

With so much going on in the market today, we squeezed as much information from him as time would allow. He was a very gracious guest indulging us with answers to everything from Federal Reserve announcements, housing market projections, recommendations for investing opportunities, interest rates and more.

Once again, we deliver timely information that could make a difference in achieving your financial goals!
Jan 4
File…

Erika Christie changed the due date for this to-do

Michael Chabot
Hey guys, welcome back to another episode of Your Mortgage Matters brought to you by Angel Oak Home Loans. I’m your host Michael Chabot and we have an extremely rare and special guest today. I’m super excited about this one probably a little nervous to Larry McDonald, noted economist New York Times bestselling author, regular CNBC contributor, founder of the bear traps, reports and investment newsletter, former head of us macro strategy at society general and former VP of distressed debt and convertible securities at Lehman Brothers. He is the author of a colossal failure of common sense, co written with Patrick Robinson, an account of the events surrounding the financial crisis of 2007 to 2010. Details JPMorgan Chase’s purchase of Bear Stearns and the bankruptcy of Lehman Brothers, a New York Times bestseller for hardcover nonfiction featured in the academy award winning documentary inside job on Netflix. And this is impressive, ranked top 20 All Time books in finance by the CFA Institute. Larry, welcome to the show.

Larry McDonald
Thank you, Michael. Perfect, perfect introduction, my friend. Thank you. All right.

Michael Chabot
All right. So man, we have a lot to get to today. And we talked about a lot of it before we started. But in my research, I love this. So you kind of fell in love with the financial markets and learn stock picking in high school. And I think it’d be great for everybody to kind of hear about, you know, just a small little snippet of that to see who you are as a person and how you got into this, and then where your passion grew from there.

Larry McDonald
Well, my father, and my uncle had a brokerage firm. And it was in the 80s. And so that was a real bull market. That was incredible. And I remember my dad’s business doubling and tripling, in a very short period of time, and you know, we would sit around at dinner time and talking about socks. And, and I would, I learned about things like EBITDA, earnings before interest, taxes, depreciation and amortization. And over like, like in high school, college, talking to my dad about markets, and then I’ll never forget the summer of 87, the market was ripping, ripping, ripping and the rates were rates were pretty high. So interest rates started to compete with stocks. And all of a sudden, you know, that, that that crash, I’ll never forget, as the market was going down, my business was so busy that I was just out of high school, my dad had me pick up the phone and try to sell some intel or IBM or something like that. And I called the trader and I said, I need to sell X amount of shares of IBM. And he said, You know, I think he made the market like 8887, right? And I said, Well, my machine says it’s $110. And he says, we’ll sell it to you and machine them. Right, first experience of Mark. Wow, flowers later, I think the bid was like $60. It was that? Wow.

Michael Chabot
Wow. And so then from there, your first kind of big job in the market was I think, as we discussed, you joined Marilyn about 92. Is that right? Yes, yes. And then I know you said from there, you had you created a company and then sold it correct? Yes.

Larry McDonald
Okay. It’s called convert bond calm. It was the first website in the world to kind of showcase the convertible securities universe. And, wow, we were lucky enough to sell it to Morgan Stanley, in October of 1999. So, like, six months later, been worthless, but we were we hit we hit that bid, we hit that bid for sure.

Michael Chabot
Good for you guys. That’s awesome. And then from there, you joined Lehman in 2003 2004. That timeframe? Yes. Talk to us a little bit about before we get into all the heavy questions a little bit about what that experience was like at Lehman?

Larry McDonald
Well, it was it was a great organization. It was the culture was voted one of the best places to work in the Fortune 500. And you know, being there you always felt like you were kind of a little bit of an underdog because the larger investment banks or Citibank or Goldman’s your JP Morgan’s had a lot more capital. But it was an incredible team. You know, at Lehman, you kept your head down, you did your job, but if you didn’t he lost posts. In other words, over time, you can kind of see that the inner core of the company was very impressive and the people were great. But at the top, we started to see some real, you know, disturbing things in the kind of through the years and, and there was really a group of revolutionaries that one by one, we’re trying to stop the madness. And in each one of them eventually got pushed out of the firm.

Michael Chabot
Yeah. And I have some more questions a little bit later in the show about that, that experience and kind of what happened at the collapse. But before we get there, you know, our listeners, the biggest question that they have, and they’re so lucky to have you today, and as up as am I, is, where do you see financial markets heading into 2022?

Larry McDonald
Well, is this this two things going on there’s the economy is, is fairly strong, but you have a fiscal pullback of accommodation, that could be as high as $2 trillion. In other words, in the last two years, you did 3 trillion of deficit spending in 2020, then another three, 3 trillion this year. So that’s a tremendous amount of fiscal engine, that’s a fiscal engine of $6 trillion of deficit spending. And now you’re going to go, you’re gonna cut that down by potentially 2 trillion bucks this year, maybe. In other words, maybe we do a trillion trillion and a half. But if we do a trillion and a half deaths this year or trillion, then that’s a $2 trillion pullback. And that’s a lot for it. And I don’t care what your politics are. It’s just, I’m actually, I’m actually fairly conservative middle of the road. But unfortunately, when you when you deficit spend that much in the pullback in combination that fast, it’s a little dangerous. At the same time, the Fed is embarking on it right now, around the world, there’s been about 50 rate hikes. So I know you’re in the mortgage business as interest rates are very important. So the rest of the world hiking rates very aggressively against inflation. Now, the Feds been very patient this time around. In the Trump administration’s first year, they hiked rates four times. I mean, they were very aggressive. You know, obviously, the economy was in better shape, and there was no COVID company coming out of COVID. But here we are, the rest of the world is hiking rates aggressively, the Fed now has to catch up with the rest of the world in 2022. So you have a fiscal and monetary pullback that? You know, it’s probably going to upset the current growth path, which is fairly decent.

Michael Chabot
Yeah, I agree. And would you touch on something that we’re hearing a lot about, which is the great resignation? Would you mind? Sure,

Larry McDonald
Yeah, it’s important. The power of labor. So one of the things I talk about in our in our, in my book in our in our follow up book, is, you know, the power of labor is a big component in inflation. So the last 20 years, we’ve seen a regression, last 30 years of regression of a pullback in Labor’s power. And one of the things that Biden team that’s that is done, and Congress as well is they’ve, they’ve actually given more power to to to the employer, employer, I’m sorry, the employee versus the employer, in the sense that with the larger safety net, people don’t have to rush back into the labor force in that’s created more strikes. You’ve had dere, Kellogg, very, very big strikes that are highly unusual, and as well as Amazon, Walmart, and a lot of companies kind of paying up and competing for, for competition for labor. And that’s creating for the first time, very strong average hourly earnings inflation that corporations haven’t had to deal with. And so for the first time, corporations, you know, have to pay up a little bit. And so, profit margins haven’t been squeezed that much yet. But if labor stays as powerful as they are, that’s going to create some profit, squeeze probably next year.

Michael Chabot
Yeah. And that that brings up another question. I’m sorry, these are off my script. But I figure since I’ve got you here, I’d love to ask, you know, when, as we discussed earlier, you and I are around the same age, I think when we got our first jobs at a high school, we were probably are in high school, or probably making what three, four bucks an hour. That was minimum wage back then. And I see companies here, you know, where they’re advertising 1715 1720 bucks an hour for starting wages. And my question is, how do how does that translate into the economy? How to how do employers and companies continue to keep their profitability, their productivity or their profit margins intact? I know the answer, but I want to know kind of what your thoughts are and what you see moving forward into the future. Okay, so

Larry McDonald
yeah, so There’s definitely a competing mechanism out there where some of the big players have put forth, like highly unusual races. Amazon, for example, been very aggressive. And that forces everybody else up. Now that puts more hands in the pockets of, of the little guy, which is great. But inflation is up about 7%, year over year. So wages are going up, but the purchasing power of the average consumer is coming down too. So they’re really kind of offsetting each other right now. And it’s kind of a battle between wages and inflation. And I think overall, there’s a lot of pressure on the middle class here that I’m pretty uncomfortable with. And I think it’s fairly unstable. There’s a lot of inequality in the markets. And in so we’ve had the fiscal and monetary boosts, which is upwards of 11 trillion bucks, but it’s not really helping the little guy as much as it should.

Michael Chabot
Yeah. And I apologize, I rushed into it, because I was so excited to have you on the show. But let’s, I want to get back on script and tell us about bear traps, and how you offer a perspective across all asset classes.

Larry McDonald
Thank you for that. Well, it’s Michael, it’s really, it’s an institutional platform where hedge funds mutual funds and pension funds will work with us, we have a Bloomberg chat, that’s about 650 institutional investors in there, so you’re CIOs of your big funds. And we will put kind of interactive on the fly research commentary during the day. We have contributors in there. So it’s kind of like, you know, there’s no I in team, there’s a lot of incredible brainpower there were sharing ideas. In the old days, what we would do is we go to a stake in the Manhattan my wife and I and the kids would live in New York for 15 years. And we typically would go to one of the restaurants in you know, get have a nice room and have an ideas dinner once twice a month. And now we’re doing that kind of live in the chat. And so what we do for the retail investors, we recap, that discussion. And we recap. So it’s it’s a really a lens on a buy side conversation, and I think it helps smaller investor really understand what’s going on.

Michael Chabot
Yeah, I love that. I mean, you’re getting basically the top people giving the advice telling you what’s going on helping you understand the markets, because I think you would agree as technology. I don’t know, maybe maybe I’m wrong. But as technology grows, I feel like it gets more confusing instead of easier. I don’t know.

Larry McDonald
Oh, yeah, no question. I mean, it’s, I mean, in the old days, you get the research from your broker. And by the, by the time you got it, it was somewhat dated, depending on, you know, how, how, how well connected, your broker was within the different firms. Now, it’s Firehose every day. And you got to figure out like, we are we we help people figure out like, you know, what, what are the top five or 610 things to focus on each day to really get through all the noise?

Michael Chabot
So before I go to script I, well, I’m going to stay on script. I have a question I want to ask you, but I’ll get to it. I want to stay on script first. So because this is a great question, many advisors and investors praise what’s called the 21 Lehman risk indicators. Can you tell our audience what these are?

Larry McDonald
Well, we thank you, Michael, we developed them. Over a decade ago, in when Lehman was buckling, there were certain things that were happening. When I was on the trading floor, there was credit default swaps on the US banks. In other words, the cost to the cost of default protection on the US banks was higher than the Asian banks of the European banks. So there was a lot of like indicators like that, that were very telling about what was about to happen. And if you saw the movie, the big speech short, you know, they were, they were really on top of some of these indicators, like early payment defaults and things like that. People missing the first mortgage payment. So you look at the entire amount of mortgages issued in America. And then the percentage of firsts early payment defaults, was very low in like 2005, six, all of a sudden, 2007 it starts to explode higher. So those are the types of things that we’ve used in the past. Now we’re looking at other indicators around the world. We’re looking at Asian banks. So China’s been buckling a little bit this year with Evergrande. So we’re looking at Yes, you know, credit default swaps on standard charter, HSBC banks in the Asia region. And in world we’re also looking at not just the VIX, but the amount of people buying calls versus puts and what is the premium like there’s a lot of things credible excess speculation where I go back like 30 years it looking at this data. And it’s highly unusual where the markets at an all time high in the VIX is making is going up, you know that very unusual network. What that means is that people are normally people are paying up for options in down markets, so they want insurance. But here, it’s just like the late 90s. The speculative froth is so spectacular, that people are actually paying more for upside participation. It’s just an incredible, you know, risk indicator. The other, the other is the percentage of the stocks that are actually contributing. So the last like three months is the percentage of the socks. So the the index is like, if you look at the newspaper, The NASDAQ’s an all time high, s&p said all time high. But the average stock within the index is been really struggling. And so so there’s really two markets going on. Whereas next year, we think we could get a little bit of reverse of that where some of the smallest companies that have been struggling in the second half of the year, do better in whereas large caps that have been leading the way. Probably start to buckle.

Michael Chabot
See some pullback there? Yes. Yeah. That’s great stuff. Alright, so I wrote some notes. So for our listeners who may not understand some of the terminology, explained to them credit default swaps, and then just what the VIX is?

Larry McDonald
Sure, a credit default swap is, let’s just say you are a company that has exposure to the banks, you can buy insurance on one of the big banks with JP Morgan, Citibank, basically betting on their defaults. And it’s an insurance policy. So if they, if their credit, quality weakens, you can make 1020 You know, 30 times your money, depending on, you know, where you bought that insurance and where you bought that at default protection, the VIX is, is a measure of the equity markets, volatility, what people are paying for calls and puts. So think of the s&p 500. There’s a number of stocks in the s&p 500. There’s the index itself. And so people can buy calls on the index, and they can buy puts on the index. And there’s in the futures market, there’s a one month vix future, there’s a two month is a three month is a four all the way out to 810 months out 12 months out. And so the VIX basically calculates how much you know how much people are paying up, or it measures, you know, how much people are paying for that insurance. So, in normal bull markets, like 2000 678, you know, the VIX was 2006 and seven was very low. Whereas in this bull market, the VIX has been very high, even with the market at all time highs. And it just it just speaks to what we were talking about before. But it’s the I guess, so the VIX is it’s a volatility index measuring equity market volatility.

Michael Chabot
Great answers. Thank you for all right. And that that actually just leads us directly into my next question, which is, in a recent interview, you talked about why the rotation into commodities and value stocks, is this where you still see the best opportunities for investments?

Larry McDonald
Yes, exactly. What happens is when inflation becomes more sustainable, so the last 10 years, we’ve had inflation spikes, and then they’ve rolled over inflation spikes, and they roll over, and inflation isn’t very transitory. But when you have inflation, that that is sticky. growth stocks in say, and you’re already seeing this in the market, the big growth stocks are fine. But the tertiary players in growth, your software companies, your your innovation stocks, there’s so many growth stocks that are 1020 3040 70% off of their highs, because the the net present value of those future cash flows. So think of a company like Netflix, it produces cash flow over long periods of time, in the net present value of those cash flows is worth more in a deflationary environment. But if you have, if you have more search and inflation looking out three, four or five years, if you have more certainty of inflation, then those future cash flows are worth less. And so what happens throughout cycles is people want to own value stocks in that kind of environment, like the 70s and 80s. In even early 2000s, whereas in a market that that’s in a market like the last decade that was offering very certain details Are disinflation that’s when your growth stocks really, really do well. And so what’s happened is, we’ve had this long period of time, like over a decade where you’ve had Brexit and trade wars and COVID. And you’ve had all this pressure on deflation, more and more deflation, more certain deflation, to the point where, you know, in the front cover of BusinessWeek, six months ago, inflation is dead. Was the caption with a picture of a dying no dead dinosaur in so it what’s happened is all of that is put tremendous pressure on growth stocks, so everybody’s crowded in the same trade every every wealthy American owns Microsoft, Google, they own the same stocks Tesla. It’s really like eight or 10 stocks that all the wealth, I mean, literally $17 trillion. Michael 17 trillion is in the NASDAQ 100. That is absolutely terrifying. And I think what’s going to happen is not not forecasting a market crash. But we think with the highest conviction the next 18 months, you’re going to see 343 to four, maybe 5 trillion of that wealth, move into value stocks, you’re Intel’s re TNTs. Your Chevron’s in in Buffett bought one stock in the third quarter. It he didn’t buy anything else. He just bought chevron. So he’s, you know, Buffett’s built in that way.

Michael Chabot
Hmm. Interesting. That’s a lot 17 trillion. So do we. So a couple things. Number one, do you think we’re away from the word transitory now with inflation, right, that was that was kind of the buzzword there for a little bit? Well, it’s transitory while we’re getting back from COVID, from lockdowns from, you know, reopening of the economy and society. And then, I guess my question to you is, do you think that we’re right for a correction in the market?

Larry McDonald
For the indexes? Yes, but But for I think for like, other parts of the market, like think it cannabis stocks, they’re 70% off the highs. The biggest right now, there’s, it’s not legal to own these companies in a mutual fund. So there’s no passive money in there. There’s BlackRock and Vanguard have, you know, six $7 trillion, and they don’t have any money in certain in this sector, for example, cannabis, because we don’t have a safe banking. We don’t basically on the federal level, it’s hasn’t been decriminalized. So there’s certain sectors where, because the the Biden team won the House, the Senate and the White House, and so there was a very high expectation in the first second quarter of these names. Really, you know, getting a piece of legislation which would decriminalize on the federal level, because at the gift 32 plus state each State Attorney General’s that have already moved toward the criminal decriminalization. So we’re looking for sectors like that, that have really been beaten down another one is, you know, a Brazil and China equities have been destroyed this year because the Feds hiking rates you’ve got a whole bunch of things going on in in China around regulation and you know, they’re right now let me give you an incredible stat so right now you can fit close to seven Alibaba as in apple in that that number was one and a half of say within the last four years. So it’s seven it’s close. So you get you get Yeah, it’s I’m sorry it’s really really close to nine Excuse me. So Alibaba is worth three 350,000,000,320 and apples were 3 trillion so it’s it’s nine Alibaba has you can fit it that one apple was within the last five years that was like one and a half it so that that’s shows you the divergence between us tech in some of these international tech stocks.

Michael Chabot
Wow. And so you think there’ll be opportunities in those in those markets moving forward into the next year or the next few years?

Larry McDonald
Well, especially in the first half so we we look in the years where Michael and years where the s&p has had a good year, there’s a tremendous pressure on accountants all over America are calling up their their clients and saying, Give me a loser though. People are selling their tax loss, they’re selling their losers in the fourth quarter in here’s where the s&p is up a lot is much, much, much more pressure to do that. And so those types of stocks in the first half of the following year, do very, very well your entails your 18th ease. So a lot of those are value stocks that plays into we’re probably gonna have a really big rebalancing, like where the tax will loot tax loss losers of the fourth quarter become big winners in the first half of 2022.

Michael Chabot
Interesting. That’s great. All right. So what is the most common question you receive from risk managers familiar with your experience working at Lehman, and what do you tell them?

Larry McDonald
Okay, so the most common question, let’s say overall it has to do with management. And you know, how do we look at boards? Because management’s so key you look at, you look at the big stocks, and in the winners have had good management teams. And it Lehman, we had a weakness at the core of the upper management team. And so you want to look at how those, those CEOs, and how the boards are structured. So a board that is very, one of the things I talk about my book, a colossal failure of common sense is when the boards are structured like a boys club, when you have people on those boards that are really not the most safe, financial, financially savvy person where it’s a friend of the CEO. And so we look for things like that, we look for the amount of footnotes in the SEC filings, you know, the 10, Ks and the 10 Q’s, because when a company when a company is obfuscating the truth, there’s a lot of times and a lot of footnotes, it’s so we’re looking at management teams, were looking at how many CFOs, for example, you wanted very steady management team, when you have a lot of turnover at the top. It’s a very big warning sign. So Lehman had, I think, for CFOs, and for years right before the crash. So Lehman was definitely playing games there. And the other thing is, it’s just kind of a third tier indicator, but you want to look if companies are coming to the convertible bond market, we call it in my, in my book, The Last saloon. But the convertible bond market is, is a place where kind of the tertiary companies go to get financing and a company that is the company that is spending a lot of time in the convertible bond market is typically a warning sign, because that means that they’re having trouble financing themselves in other places. But those are, those are the questions we get on a regular basis. That’s what we’re looking for.

Michael Chabot
These, I You’re just blowing the roof off this I mean, such great answers so much knowledge. I’m trying I want to be mindful of your time. So I’m trying to keep my because I take notes during the interview, and I want to keep my questions and stay on script as much as possible. So I promise I won’t go over. So and I’m glad you talked about your book. And I want to talk about that next. So your book, a colossal failure of common sense has been a huge success. The details in the book, in my opinion, read like a fictional thriller with everything like greed and ruthlessness and relentlessness. Right? Arrogance, brilliance, except it was real, as we all know. So first, I would love to ask you is what what led you to write the book? And go ahead, I’ll let you answer that first.

Larry McDonald
Well, you know, it’s it’s the most rewarding part of it is because Patrick Mike, my good and my partner had written lone survivor with the Navy Seal, Marcus Luttrell. And he really didn’t know much about finance. So our objective was to create a book that could be read by your software engineer, your plumber, you know, somebody you’re smart, say is a smart gentleman or lady that runs a construction company, or maybe even a cleaning company. But in a business, people are smart, and students are smart, they work hard. So we wanted to really bring the unvarnished tale, what happened inside of Lehman, but also convey a lot of like Timeless Lessons in finance, in looking at boards and looking at all kinds of things that can help people manage money throughout a lifetime. It’s so the book is written in a way that anybody can read it. And in that was kind of our main objective was, a lot of times in finance. These books are dry toast, you know, they’re just, they’re written by journalists or whatever. And they they just written by people that that are talking to a very small audience, and we want it to really write it to a large, large audience.

Michael Chabot
Are you surprised by the success that it’s had?

Larry McDonald
Well, yeah, I am. I mean, it’s, I didn’t think the longevity, I’m shocked that like, oh, it’s still during the holidays. We’re getting a lot of sales. globally. It’s in 12 languages now. And we’re still getting, we’re still doing a lot of speeches make it definitely more make more money on the speaking tour than you do writing the book. So we just did an event in Dallas last two weeks ago. And we did an event in Zurich in the second quarter of last year. So we’re traveling around the world. We’re meeting with investors that have read the book, usually conferences. It’s great to give something back whereas when I was at Lehman was a group of traders and it was proprietary business, we were very small group in the last decade is allowed me to, you know, right now we have clients in probably 23 different countries and in doing the speeches around the world really is rewarding, working with a large group like that.

Michael Chabot
I love it. And what I love is that you’re using history and and the lessons from the past to move forward into the future, which hopefully, we won’t repeat, which is my next question. We still have people that are worried about another crisis that can occur again, they believe we’re in another housing bubble stock market bubble. My question to you is, why is today different? And why would a crisis like the last one not happen again?

Larry McDonald
Well, what happens, Michael, is there’s, with each crisis of the last 100 years, there’s a metamorphosis into an a different type of serpent, a different type of beast. It’s so like, think of the SNL crisis in the late 80s, you know, that was very specific to small banks. And then then all of a sudden, we run into the.com events, right, which was in long term capital, which was risk in hedge funds. And so it really inequities really had nothing to do with banking system. And then we come in to Lehman in the in the 2008 crisis, and that was a concentration of risk in the large bank. So that’s just a very different metamorphosis a serpent. One of the things that the crypto Kryptos, listen, crypto is, it’s gonna be it’s gonna be here for a long time, right? The problem is, is 15,000 currencies now? 15,000? There’s no question in my mind, this 15,000 currencies that there’s two and a half, three, two and a half trillion dollar market cap. And so out of those 15,000, there’s probably 150 currencies that will make it over the next decade. It’s very similar to the tech stocks in 1999. So you’re gonna have a probably a big flush there, that and the problem is this is this is what the Fed doesn’t understand. The Fed is full of academics, right. A Congress the same thing. The unintended consequences of Congress. You know, Steve mentioned, you know, Mr. Manchin, I should say the Senator mentioned, Joe Manchin, but it’s, you’re talking about pulling back a combination at the same time on the federal level at the fiscal side. And then at the same time, the Feds promising three rate hikes next year and a taper. So Right. One thing about crypto is and you could see it buckling now is it really is and this is the crazy thing about it. It depends on very loose financial conditions. So crypto will do very well with easy financial conditions. But when financial conditions start to tighten, if one big seller comes in and needs to sell, you know, a couple of 500, maybe $200 million worth of bitcoin, it’ll knock it down like 1010 15%. What happens is, the little guys get flushed out when that happens. It’s unfortunate, and I think in 10 years from now, crypto will be much more liquid and it will be much, it’ll be like more like gold could go gold’s biggest drawdown the last five years, the last 1010 years really like 18%. Whereas crypto since 2007. has had four drawdowns of set of 82% to 50%. Really like six six drawdowns in like, imagine if you’re like a small investor with 100,000 bucks, right? In, you’ve got like all your net worth in this in this crypto, and your $100,000 goes down to 20,000 and stays there for three, four months. It’s very difficult to sit there and whether it’s through that. The truth is the little guy will always get flushed out in the hole. The big guys are manipulating the market up and down a lot of times they’re they’re not you know, what we call in Wall Street, the stop losses where people get knocked out. And the big guys will drive it down, create capitulation selling bottom buy into that capitulation. In I think it’s it’s really you know, David versus Goliath. And it’s, it’s not a very even playing field right now. But I think that could contribute to some, some problems in the first half next year.

Michael Chabot
Yeah, I think you know, with in the in the mortgage industry, it’s still not crypto is still not accepted as a viable currency. A lot of people want to use crypto as a down payment on a home, you know, and it has to be converted. And so it’ll be interesting to see where that goes. And I’m glad you brought that up. And then I think just to kind of piggyback on what you what you said, and I’m sure you would agree that we have a lot of things in place. Now. You know, Dodd Frank and things in the mortgage industry. Would you agree this a question kind of statement question. Would you agree that it was a lot of the last financial crisis was the mortgage industry, right? Everybody was just drunk on success and profits and everything else and all the guidelines, all the things just went out the window on every level from the loan originator on the street all the way up to these big investment banks like Lehman, would you agree?

Larry McDonald
Yes. In other words, there was a you had too many people with speculative capital they’re owning. My friend, I have multiple friends that own 567 houses, and they had a little tiny sliver, sliver of equity in each one, they were flipping them. The good news is now we’ve had a decade of, you know, this is this is the house cycles work, where people were so scarred with Lehman in the financial crisis and mortgages, that we have a decade of renters, the baby boomers now are turning 85 to 87. Like the oldest ones. So think about the oldest Boomer is turning 80. So that’s a lot of wealth. It’s about it’s about 6060 to 70 trillion of wealth, it’s gonna be hidden from the baby boomers and the millennials. Call it college 68 trillion, for the baby boomers and the Gen X to the millennials now that millennials are hitting 42, the oldest Millennials hitting 42, this coming year. And so household formation, is the demographics that really pointing toward like this, why the builders are so strong here, because it’s a very good backdrop for for your industry, in the banks are cleaner. This this less funny lending that’s off the bank balance sheets the way it was before. Agreed, what are they what do they call these call over the counter lending, you know, but but, you know, like, we talked about the BNC, Lehman own BNC and Aurora mortgage, they were producing, like 10,000 loans a month, you know, and they weren’t. They were they were like, they were like, not really a bank. They were like a third party lender. And so right. So we’ve a lot of that’s been cleaned up. So naturally, I think you have a house, the supply of housing versus the demand over the next decade isn’t quite there. So you have a very good supply demand backdrop for housing, looking forward.

Michael Chabot
Agreed, which actually, I didn’t I didn’t plan this, but this parlays right into my next question. So we and you’ve touched on it. So all eyes lately have been on the Federal Reserve. They released their announcement on tapering, right, which was they’ve been buying bonds to help keep interest rates low. dialing back bond purchases, as we said, and, you know, where do you think this will be? So we talked about they’re going to they’re going to start to taper. They’re talking about interest rate hikes. And I’ll pause there and say, Larry, that most people, the average consumer thinks that when the Fed raises the overnight lending rate, that that automatically means mortgage rates go up. It doesn’t necessarily mean that you and I know that. But just talk about where do you think? What do you think the influence on mortgage interest rates will be near term long term and into the future?

Larry McDonald
Well, one important thing, Michael, is that in 2000, the last time the Fed was hiking, like 2016 1718, they did nine hikes in that last cycle. Plus they did quantitative tightening, which is complex, but they basically were reducing the bat fed balance sheet by the highest point at one point is 50 billion a month. So you could say there’s another five hikes there. So it was nine rate hikes plus quantitative tightening this cycle. The problem is, there’s an extra 30,000,000,000,020 to 30 trillion of debt globally. That’s below 2%. This time, so think about this more debt. Okay. Everybody knows there’s more debt because we issued a whole bunch of paper last year, the year before. Globally, everybody knows this more debt is a 20 $30 trillion and more debt. But more important than that, it’s the debt has been sold at like a 2% coupon. So what that means is, there’s not only more debt, but oh, there’s a huge pile of debt, upwards of 20 trillion that has less than 2% coupon on on it. So what that means is a 25 basis point rate hike today is equivalent to a 12, like a 1%. So like, or 100 basis point rate hike 20 years ago, because there’s so much more debt and the debt is like, because interest rates go up bond prices, interest rates go up bond prices down. So yep, like if the Fed raises rates 1% because of all that debt that’s out there. It’s such a low coupon. That’s what people don’t understand is that that’s why the Fed can’t aggressively hike this cycle. because there’s just so much more debt and a lower coupon. And so that could be good once again for the mortgage industry, because if you don’t have that, because that was one of the things that triggered the financial crisis, all oil spikes in 2007, eight, the global economy was ripping. Oil prices went from $50 a barrel in 2004 to 140. In 2008. It created an inflation. So all you had these mortgage resets, that Driggers the financial crisis, whereas this time around, the Fed is under tremendous pressure to to keep rates lower, because if rates were to go up by 2%, now, that’s the equivalent of like, almost eight or 9% move up in rates 20 years ago, in terms of damaging the economy, and pensions and all that. So the Fed is going to be forced to keep a lid on rates this cycle much more so than previous cycles.

Michael Chabot
Yeah, I think it’s, it’s going to really be a tug of war really, for them, it’s going to be such a tight line, because like you said, there’s so much more debt out there. Thankfully, I think the debt, you know, now is much better debt, I think, and maybe you would agree or disagree. You know, I we used to have a joke saying, you know, back in the early days, you fog a mirror, you get a loan now, you know, talking about mortgages, at least you have to prove that you can repay the debt, etc. I would think that would make that that debt that’s out there, at least on the mortgage side of it a little more secure. Now, we’re, we’re talking $30 trillion worth of debt worldwide, we’re not talking about just mortgages, right? We’re talking about credit card debt, car loans, etc. Is that correct?

Larry McDonald
It’s government debt. Like, right now there’s this 13 trillion of negative yielding bonds, most of those are in your room. And there was 17 trillion, maybe two months ago. So that’s come down. But it’s, that’s just those bonds are not below. They’re not 2%. Those are negative yielding bonds. So so there’s and then the US Treasury right now, the 10 years one, one, Spot four to one, spot, five in that range. It’s a that’s all the US 10 year treasuries are below the in all the municipal bonds, you know, California, New York, there’s a lot of bonds and been sold last, like two years at or below 2%. So it Yeah, it’s it’s mortgages. It’s corporates. Its its its sovereign debt. And, you know, this, this cycle is probably where we’re looking at your question before, we’re probably going to have like a sovereign debt problem like a, like a government. And that’s not the US. But globally, there’s been so many so much sovereign debt issued, that that’s, that’s probably one of the places where it’s different this cycle versus previous cycles where, yeah, it’s gonna be more on the sovereign side, the relative than versus the banks.

Michael Chabot
And that makes a lot of sense. And really what that does is that that ties the Feds hand, doesn’t it because typically, the best way they fight inflation is by raising interest rates. And so now it’s it’s real balancing act, right.

Larry McDonald
Yeah, exactly. They can’t, they can’t if they aggressively hike. They’ll throw us into depression, like recession very fast. Yeah. So they can’t like aggressively hike. And when Trump got in office, they hiked rates, you know, I think four times in that first year. So they did, and that was with no inflation. So think about this, like, think about there was no inflation during the like less than 2%. And they hiked rates four times. But Biden comes in and we have inflation, that’s 7%. And they haven’t hiked once. So it tells you it tells you the pressure. They’re under to keep rates low.

Michael Chabot
Yeah. And it goes back to I love, you know, history. And when Ronald Reagan took office, I think they raised rates, like over 600 basis points overnight. I know guys that were in the mortgage industry who said I went, I went home that night and interest rates were 9%. And I came back the next day and they were 14. Volker. Right. Exactly. And so you know, I mean, it’s interesting, because, and this is why I’m so excited to have you on the show, because nobody’s talking about what you just talked about, and why the feds are taking their time to do this because they really are in a in a very tight balancing act.

Larry McDonald
Yeah, it’s it’s one point the dollar is going to give way because if they if they if they try to stick about the rest of the world’s hike rates very aggressively this the previous cycle and the Lehman cycle 2010 to 20. The Fed was the first alpha male so they were hiking rates before everybody else. This time they’ve laid back and let Brazil’s hike rates like 400 basis points Russia, Indonesia, I mean, not so South Korea, I can easily Mexico 200 basis. This literally has been like 30 to 3540, maybe even 50 rate hikes globally, before the Fed this time. And so if the Fed is forced to stay down, eventually the dollar is going to come under some pressure.

Michael Chabot
Yeah. So I have a few more things before I let you go again, I want to I mean, we could go forever, but I want to be respectful of your time. You know, I was reading a recent blog post on your site, which there’s, I’ll put the show notes, guys, for those of you watching and listening, there is so much information there. Excuse me, I highly recommend it. But you talk about we, you know, you and I talked about this before we started but $11 trillion into the in for you know, and we have testing site issues in the United States, as far as COVID. We’re one of the most financially rich and technologically advanced societies in the world. And your blog talks about, you know, why we have lack of testing with all this money that we’ve pumped into the economy. So I’ll let you talk about that. And then one thing I found really interesting, which is it talked about buybacks, meaning stock buybacks are driving the stock prices higher, which I think is a really interesting thing that I’d love for you to talk about as well.

Larry McDonald
Yes. So Michael, we’ve done 11 trillion of fiscal and monetary think of the Think of the defibrillator is you know, you’ve got Yes, the patient was on the on the operating table, they took out the defibrillator is after after COVID. But boom, in 11 trillion in fiscal monetary. And we were sold by both the Trump and Biden teams that this was like, you know, COVID relief, if you really look do the math, I mean, there’s less than 300 billion I know, it doesn’t tell him but there’s less than 250 300 billion of pure COVID. The rest of it is a lot of, you know, this, this is money that went to the farmers is every single special interest group group. And is, as the old Obama team used to say, Rahm Emanuel, you know, he used to say, Never let a good crisis go to waste, you know, so what politicians typically do is they use a crisis to, to whip through legislation. And then what’s happened is part of that 11 trillion, over half of it was on the Fed and Treasury and, and basically, buying bonds buying corporate, so keeping interest rates really low for the corporations. The corporations sold trillions of dollars upwards near nearly two and a half. 3 trillion of corporate debt was sold over the last two years. And that has gone to buy back stock. And so the one of the reasons why the stock markets up so much, is that there’s been an incredible amount of buybacks. I mean, record numbers the last two years. And here’s another example of the unintended consequences. So the progressives on Capitol Hill, they see billionaires getting rich, they want to do something about it. They want a sound bite. You know, Elizabeth Warren wants that sound, a sound bite for the news. And so they want to create like a special tax on stock buybacks. And this is like, great, because it’s just like the one thing keeping the market up. And there’s been a couple things, but the one of the biggest factors that stock buybacks, so if you start taxing those, it makes corporations a lot more uncertain. And it creates more uncertainty in the market. And that could could could create a large problem for some of the big cap stocks, because it’s so if companies, companies may want to invest money, instead of buying back stock, that may be a good thing over the long haul. But if that bids, not there on the on the buyback side, that that that could be an unintended consequence that comes out of this, because we’re probably going to get, even though build back better failed. Democrats have a very small window between now and say, march 1 to pass something and I’m hearing from we have a live Bloomberg chat with like I said about 650 institutional investors in there. We’ve got some investors that are very close to the White House. We’ve got a team in Washington, ACG Analytics has been very helpful in I think it’s very clear the Democrats are going to like recreate bill back better to a smaller piece of legislation, where you’re going to get a you’re going to have some major impact on higher taxes for the Ultra Rich, higher corporate tax and potential tax on buybacks. And all this is going to come in the next two months, and it’s gonna have tremendous impact on asset prices next year.

Michael Chabot
Yeah, yeah, that’s great information. And funny note, you correct me if I’m wrong. I think Elon Musk saying he’s gonna pay 12 billion in tax this year. And I think I read somewhere that 12 billion runs the government for about 30 days or something crazy.

Larry McDonald
That’s an example like he reason why the markets acting a little funny here in the last month we’ve had the VIX has been ripping the market had a pretty big drawdown now it’s back But if you’re an ultra net worth person, you’re gonna sell some stuff this year in the fourth quarter, and then like he’s doing in that way, he has certainty over the tax code. Whereas if you wait till next year, then you’re potentially in your wealthy you potentially have a higher capital

Michael Chabot
gains tax. Yeah, I was gonna say there’s some changes coming to the capital gains taxes. Right, they affect especially the ultra wealthy.

Larry McDonald
Oh, yeah, they’re gonna pay a much higher tax. Yeah, for sure.

Michael Chabot
Yeah. All right. So just a couple more things before I let you go. And really what I want to focus on is, so let’s just quickly talk about the middle class, and what does this all mean to them? And where do you think it goes forward? For the middle class? The middle class really drives this country? Right?

Larry McDonald
Yeah, it’s tremendous inequality building, there’s pressures. We’ve seen social unrest where, you know, the the ultra wealthy have benefited from these programs and the the income level after tax and after inflation, for smaller families, for middle class families has come way down. And the percentage of the wealth from the middle class has come down about eight percentage points of the last 20 years. And a lot good chunk of that’s in the last two years. So in terms of the total net worth of Americans, that what the middle class had, their portion of that has come down about 8%, the amount of Americans on food stamps, has gone from 3.5 to three to 4% of the population in the 2000s. To now 14% of the population is on food stamps. And so, you know, now granted that they’ve expanded that food to be very, they’ve expanded the food stamp SNAP program to broaden it out. But at the end of the day, you have these tremendous pressures that are starting to build and it’s most likely going to transit. We already saw this with Trump, like, it’s not that it’s not that Trump was necessarily a good guy or anything, people were just fed up with the establishment. And so we’re probably going to have a voting bloc that the in 2024 2028, that looks for an outside solution, because because of this inequality debacle.

Michael Chabot
Yeah. And I mean, we’re facing higher fuel costs, right? So just to get tuned from your job cost more money, you’re seeing costs, higher costs in the supermarket for food, you know, it goes across the board, right? And we didn’t we didn’t talk about the word, but I’m going to the last question I want to ask you is so we laughed about this, before we started recording, which was stagflation. Right. And the reason I asked you is because so many people out on the street, they hear this word, and a lot of them don’t know what it means. We heard it a lot as kids because it was around when Jimmy Carter was president. Just talk about what that means. And do you think we’re headed towards that?

Larry McDonald
Well, the President tweeted yesterday about retail sales being up 8.6% year over year, but inflation’s up 7%. So even though the Retail Sales are up, 8.6, you can, you can make a good soundbite and it sounds good. But if inflation is up, 7% of retail sales are up 8.6 sales are only really up 1.6 slip, right. So so what’s happening is is that you have in right now, if you look at the 30 year Treasury versus the 20 year, something very strange has been happening in the yield curve of treasuries where the 30 year has been slightly below the 20 year. And if you look at the Euro dollar curve in terms of the amount of rate hikes that the market thinks that the Fed is going to be able to put forth, all that all your dollars. And all that means in English, is you can if there are measurements out there that tell you what people are betting on in terms of your total moderate hikes in the total amount of rate hikes, relative to what the Fed says they’re going to do is much lower. So what that tells you that there’s just inflation is already hiked rates for the Fed, inflation’s created these taxes that have sucked consumption powers out of the economy, in the ability of the Fed to do a three year hiking cycle with, you know, 10 rate hikes, the markets are telling you no way Jose, is that possible? So that means in 2022 to 24. You want to be invested in gold, silver emerging markets, like Brazil, China, those types of instruments that do well in a kind of a weaker dollar environment where the what if the Fed if the Fed has to shorten the hiking cycle shorter than previous times? That’s extremely bullish for gold? It’s like really?

Michael Chabot
Yeah. Well, Larry I’ve taken up enough of your time, sir, I could go on and on. You’ve been amazing. I just want to thank you so much. And guys, Larry’s on vacation right now doing this. So he’s been extremely generous with his time. Last question for is where can our listeners find you? Where can they get more information? And then we’ll put it in the show notes as well.

Larry McDonald
Okay, so thank you, Mike. It’s at convert bond on Twitter. And our website is the bear trap support.com. Inside Job as you said, the movie Inside Job is on Netflix. We played a nice part of that we helped develop that film, it won the Academy Award, so you can find us on Netflix and and then on Amazon, a colossal failure of common sense the inside story of Lehman Brothers, and I tell my wife, you know, once a month as a former Lehman trader, if we sell a million books, we’ll break even on our Lehman stock.

Michael Chabot
I love it. I love it. Well, Larry, again, beyond honored to have had you on the show and get the opportunity to interview you amazing information. I’m just really happy and thank you for your time, guys. This is Your Mortgage Matters. I’m your host, Michael Chabot, and we’ll be back again with an episode real soon. Thanks, Mike.

Larry McDonald
Let’s see at the top.