The Everything Bubble
How years of irresponsible mismanagement have put the American economy at risk
By Willie Costa and Vinh Vuong
The American economy has been twisted into a perverted mockery of the natural order, the consequences of which have spawned the slow rot of speculative insanity that is turning the most powerful economic engine in history into a shambling, zombified husk of what was once rationality. George Romero’s 1978 classic, Dawn of the Dead (and its 2004 remake), had a line that’s apropos the current situation: “When there is no more room in hell, the dead will walk the earth.” Specifically, that the sins of commission (and omission) can only be out of sight and out of mind for so long before their consequences are inexorably visited upon those who commit them. But the problem with karma is that its aim is less than precise, and the (in)actions of the few tend to adversely affect the multitude.
But while the laws of gravity and finance agree that what goes up must eventually come down, the laws of common sense would advise against standing near the point of impact.
Welcome to the “everything bubble,” a correlated and wholly avoidable impact caused by the atrocious monetary policy of the Federal Reserve that has directly affected prices across most asset classes, including equities, housing, bonds, commodities, and even exotic derivative instruments.
First Things First, The Trump Tariffs: A Misguided Solution That Exacerbates the “Everything Bubble”
While protectionist policies like the Trump-era tariffs may seem like an assertive attempt to correct long-standing trade imbalances, in reality, they do little to address the structural issues plaguing the U.S. economy. Instead of fixing the root causes of our economic vulnerability, these tariffs threaten to accelerate the unraveling of what we have termed the “everything bubble” — a massive and unsustainable inflation of asset prices across equities, bonds, housing, and even alternative markets like crypto.
The United States is the number two exporter in the world and the number one consumer. Our strength lies not only in what we produce but in the immense demand generated by American consumers. Trade deficits, while often vilified, are not inherently problematic in this context. They reflect our consumption patterns and the strength of the dollar as a global reserve currency. The more urgent concerns lie not in trade deficits, but in poor monetary policy decisions and reckless fiscal expansion.
The Federal Reserve, for over a decade, fueled asset bubbles through historically low interest rates and quantitative easing, creating massive distortions in capital allocation. Rather than enabling sustainable growth, the Fed’s policies encouraged excessive risk-taking, corporate stock buybacks, and rampant speculation. When paired with Congress’s unchecked deficit spending and ballooning national debt, the result is a fragile financial ecosystem teetering on the edge.
Tariffs, in this context, serve as a blunt instrument. They raise prices on imported goods, fueling inflation and harming consumers — especially the middle and working classes. At the same time, they strain international trade relationships and introduce further uncertainty into global markets. These outcomes may marginally benefit a few domestic producers in the short term, but they do nothing to repair the macroeconomic imbalances driving the current crisis.
Instead of tariffs and trade wars, we need serious reforms: disciplined fiscal policy, a responsible and transparent Federal Reserve, and strategic investments in innovation, education, and domestic production capacity. Anything less is just adding fuel to a fire that’s already burning beneath the surface.
Now, let’s break down the everything bubble.
History
The direct and indirect quantitative easing that has created the current predicament, sometimes referred to as the Fed put, has earned the advocacy of adherents to Modern Monetary Theory (MMT), which in and of itself is sufficient evidence to question the rationale of the Fed put. In short, the MMT acolytes assert that excessive price inflation (aka what we’ve been experiencing since 2021) leads to an increase in real price inflation, with subsequent increases in yields and a corresponding reduction in asset price inflation: in other words, a self-stabilizing system. While these assertions make for wonderful theory, during almost no point in history has excessive asset price inflation produced self-stabilization; instead, these misguided fantasies have either produced financial collapse and real deflation (e.g. the Great Depression, post-1990 Japan, post-2008 Europe), or produced inflation that was uncontrollable and also subsequently led to collapse (e.g. the US in the 1970s). Interested readers are directed to the works of Graham Summers and Richard C. Koo for more in-depth examinations. While this is hardly the first work to use the term “everything bubble” (it was first used by Janet Yellen as part of the “Yellen put” of continual low rates and direct quantitative easing, but is most associated with Jerome Powell and the 2020–2021 period of the coronavirus pandemic), its effects (especially hypervaluation extremes across multiple asset classes) have forced the realization that the phenomenon was a central bank creation and called into question the integrity of market pricing.
There is also the matter of the Fed’s impact on wealth inequality, as Americans have become increasingly reliant on the central bank to support levitating prices based on increasingly questionable fundamentals. We are forced to embrace (admittedly with some somber reluctance) the words of financial historian, journalist, and investment strategist Edward Chancellor (called “one of the great financial writers of our era”), who has unequivocally stated that decades of incompetence by central bankers have created inflation as an economic hangover.
While Yellen may have coined the term it was the Powell put that caused questions to be raised regarding the sustainability of such irresponsibility, and even the IMF began to see parallels between the policies of the coronavirus pandemic and those of the 1920s. This was especially true as Powell began to embrace asset bubbles to combat the impact of covid. Powell, in fact, managed to create the loosest financial conditions ever recorded and most assets were at all-time highs, even eclipsing the dot-com madness. While the Fed chair rejected the bubble claims and asserted that low yields justified higher valuations (via the Fed model, a form of equity valuation that’s been repeatedly challenged by researchers, especially at low yields) he also rejected criticism that the simultaneous asset bubbles had exacerbated wealth inequality to levels not seen since the Roaring Twenties.
Most who have studied history are familiar with how that decade ended.
Powell’s assertions were based on the assumption that bubbles would promote job growth (thereby addressing the inequality concerns) while ignoring the fatal flaw of the Fed model: ultra-low yields are no guarantee of economic growth, as exemplified by Japan, which saw decades of valuation drops that were only stopped when the Bank of Japan began directly buying equities to support their price. The divide this caused, sundering the fortunes of Wall Street from the miseries of Main Street, is a bill that has still not been paid. Despite sometimes glowing support from Congress — Speaker Nancy Pelosi famously stated that the “Fed [was] shoring up the markets so that the stock market can do well” — -some have warned that Powell’s antics had reached dangerous levels: Jeremy Grantham (co-founder and chief investment strategist of GMO LLC) repeatedly warned that “All three of Powell’s predecessors claimed that the asset prices they helped inflate in turn aided the economy through the wealth effect,” yet in each instance the subsequent collapse was inevitable.
Value investing proponent Seth Klarman put it more succinctly: the Fed had “broken the market.”
But did the bubble actually get popped in 2022? The Wall Street Journal certainly seemed to think so. Rising inflation finally forced Powell to begin meagerly hiking rates in what would be a prelude to his “hawkish pause” and other, similar nonsense that earned him the ignominious title of “Mr. Contradiction” in our eyes. Yet inflation has not cooled nor have price levels returned to normal: since covid CPI, Core CPI, PCEPI, and PPI have all increased by more than twice what they would have under a 2% inflation rate, and affordability has all but disappeared for tens of millions of Americans. And it stands to reason that if Edward Chancellor’s words were correct — that central banks created unsustainable policies leading to an “everything bubble” and the economic hangover of inflation — then it would stand to reason that everything would be at risk from rising rates.
And that is precisely what we’re seeing now.
The lords of easy money
Business reporter Christopher Leonard (whose work has been featured in The Washington Post, The Wall Street Journal, Fortune, and Bloomberg Businessweek) crafted a fairly riveting tale (The Lords of Easy Money) about a fairly unlikely subject — the Federal Reserve, and specifically the artificially created risk as viewed through the experience of retired central banker Thomas Hoenig, who joined the Kansas City Fed in 1973 and rose through the ranks to earn a seat on the Federal Open Market Committee in 1991. The FOMC is the proverbial “big show” of the US central bank, which oversees open market operations (one of the three tools of Fed monetary policy, the other two being the discount rate and reserve requirements). Using these tools, the Fed influences the supply and demand of balances that depository institutions hold at Federal Reserve Banks, thus altering the federal funds rate (the interest rate at which said depository institutions lend balances to the Fed and each other overnight). Almost without exception, Hoenig voted in accordance with what Alan Greenspan (then Fed chair) wanted, and subsequently assented to whatever Ben Bernanke (the subsequent chair) wanted. But in 2010 came a string of dissenting votes, as Hoenig voted against the decision to keep rates at zero and begin a new round of purchases of long-term government debt. This policy was known as quantitative easing (QE), and has been the subject of nearly constant debate since.
In an organization where unanimity was prized, Hoenig’s dissent rang like cannon fire.
The long and short of QE is simple: it injects trillions of new money into the banking system (this is the “easy money” referenced in the book’s title), an act which both basic macroeconomics and common sense say would spike inflation and a philosophy that we’ve vociferously criticized since at least March 2024. Hoenig had been fine with such measures during the 2008 crisis (and we were fine with such measures during covid), but easy money is not a permanent solution no matter how loudly modern monetary theorists — such as Stephanie Kelton, one of several who adhere to the John Maynard Keynes quote: “Anything we can actually do, we can afford” — might claim to the contrary.
History and fundamentals disprove such fanciful notions.
Hoenig suffered plenty of slings and arrows to his reputation despite his repeated inflationary predictions. On the surface, these attacks on Hoenig seem like financial schadenfreude, as most people would be hard-pressed to find evidence of the Great Inflation of the 2010s.
…except that inflation did occur, just not in the way that most people would suspect.
The lords of inflation and unsustainable growth
Hoenig’s predictions didn’t come true in terms of consumer prices, but in terms of asset prices. Since 2010, the stock market has boomed: the Vanguard S&P 500 ETF (ticker $VOO) has increased by more than 10x over the past 15 years, but it’s truly since covid and the last batch of QE that the market has truly soared. Of course, the post-covid volatility has also spiked, especially relative to the more modest fluctuations post-2010, indicative of how QE promises a better tomorrow at a steep cost today.
Meanwhile, economic growth (as measured by GDP) has barely trudged along during the same time period (growing 2x to the S&P’s 10x), showing how the hype and hope of future growth has far outpaced the reality of actual growth. Unlike the market indices, which experienced a sharp increase in upward slope after 2020 (even when volatility is smoothed out), the change to GDP (as evidenced by the slope of the line) caused by Powell’s rampant money-printing has been somewhat muted. This is the aforementioned flaw of MMT and the QE faithful: easy money creates hype and hope, rather than results.
This everything-inflation is most readily seen in the main price indices, which show that Powell’s actions — and subsequent inactions, given that the Fed Chair waited until inflation turned red-hot before finally realizing that these things don’t resolve themselves of their own volition — tell a tale of increasingly desperate unaffordability. For instance, the CPI has increased by more than 23% since covid, whereas a 2% annual inflation rate would have seen a more meager 10% increase.
Stripping out the price actions of the more volatile food and energy segments (“core” CPI) doesn’t improve the outlook:
Even when examining PCE inflation — the Fed’s preferred metric (except when it hasn’t been: PCE has only been the “preferred metric” since 2000 and uses the Laspeyres formula rather than the Fisher formula, the latter of which accounts for substitution bias and is probably a more realistic measure) — the story doesn’t get much more optimistic.
From the viewpoint of the consumer, no amount of data chicanery — whether inflation is called “core,” “supercore,” or perhaps someday’s “super-duper core” — can disguise the fact that Powell has courageously led the Federal Reserve on a suicide mission to boldly fail the American people. But where Powell’s ineptitude has really outperformed is in the Producer Price Index (PPI), which has increased roughly 3x more than it should have since 2020. Of the common price indices, PPI is the only one that’s shown any meaningful response to Powell’s tepid rate hikes, which makes one wonder just how high this index would have spiked had Powell remained enamored of his transitory fantasy.
The end result is one which tens of millions of Americans intuitively (and painfully) understand: affordability has become a fantasy. Since 2020 prices have soared, but those working full time (aged 16 or older) have only experienced a 12% increase in real (inflation-adjusted) earnings.
This is why inflation is often called the hidden tax: it destroys purchasing power not by reducing net income (as a normal tax would) but by eroding the fundamental value of a currency. This slow erosion of purchasing power is sufficiently painful when inflation is at its 2% annual target, but is harrowing when mismanagement rapidly erodes purchasing power in a short amount of time.
So how does one square this reality with the deluge of rose-tinted headlines about the resilient consumer and strong consumer spending? Those headlines are not incorrect, per se, but they are (perhaps intentionally) only looking at one half of the equation. Yes, consumer spending is “strong” if one only looks at sales, but whereas businesses must contend with the difference between profits and cash flow, so too in the world of personal finance is there a big difference — sometimes a chasm — between purchases and payments. It’s in this latter factor that we see the greatest risk. The Fed’s actions are dooming the economy from the bottom up, as increasing numbers of Americans are being driven to rely on debt (and thus to rely on Fed rate policy, as mentioned previously) merely to survive.
Of course, there is no catastrophe that Wall Street cannot turn into an opportunity for financial “innovation.” Hedge funds, banks, private equity firms, et. al. are incentivized to create new (and potentially riskier) products in the best of times; but in the worst of times — when times are volatile, the future is uncertain, and yields are scarce — such “innovation” can take on a decidedly sadistic and shortsighted bent. Some of the more exotic forms of debt are symptoms of the Fed’s QE sickness, feeding another speculative bubble while simultaneously leaving little room for the Fed to maneuver in the event of another downturn.
That the Fed’s own actions are the proximal cause of such a potential downturn is a fact most frequently and most conveniently overlooked.
The lords of debt
There’s nothing fundamentally wrong with debt: when used properly and responsibly it’s the fuel that drives the economic engine forward. But the words “properly” and “responsibly” are doing a large amount of heavy lifting in that previous statement, and the reality of debt is that it’s no different from any other economic principle: it’s ruled by supply and demand, and with the national debt currently topping $36.2 trillion the demand issue is one of paramount importance.
To wit: what happens when no one wants to buy our debt?
That’s one of the stark questions asked by hedge fund billionaire Ray Dalio, who recently postulated that the US would need to sell a quantity of debt that the world is simply not going to buy. And while the federal deficit was actually positive in 2000, it’s only gotten progressively worse since then: it currently sits at -6.28% of GDP and is projected to barely improve (to -6.1%) by 2035, making the goal of reducing the deficit to 3% of GDP seem increasingly out of reach. Such a reduction in spending would require something not normally ascribed to politicians: fiscal discipline. But as fanciful as that may seem, the alternative — austerity measures, restructuring, cutting off payments to creditor countries, and applying pressure on other countries to buy US debt — would be far worse.
The often-quoted metric of total public debt as a percentage of GDP has not just reached, but remained, at concerning levels for years now. Despite the covid spike (most pandemic-related economic metrics can be explained away by the need to take timely emergency measures, a move which we have repeatedly praised as necessary but which required the necessary belt-tightening that never came) the public debt has continued to trend in the wrong direction for the past several years.
This deficit issue continues to reach milestones that should absolutely never be celebrated: for instance, the deficit for FY2025 hit a record $1.15 trillion in February, a new year-to-date record.
Cumulative receipts, outlays, and surplus/deficit through Fiscal Year 2025. Source: U.S. Treasury Monthly Treasury Statement, February 2025.
The federal deficit for the year is now over $318 billion higher than the 2024 level for the same period. That’s an increase of over 38%.
Receipts, outlays, and surplus/deficit for February 2024. Source: U.S. Treasury Monthly Treasury Statement, February 2024.
Concerningly, the US as a whole has levered up for decades, with debt securities and loans across all sectors now topping $101 trillion.
In and of itself, that $101 trillion is not meaningful: yes, it’s a very large number, but what so what? The economies of the world’s largest and most powerful countries are all composed of ridiculously large numbers. This returns attention to the fundamental point made earlier: debt isn’t inherently bad, so long as it’s used as a tool to drive some sort of return. Debt is leverage — the financial equivalent of a fulcrum used to move a heavy object, but used instead to drive returns. In theory, responsible use of such leverage would show meaningful increases in GDP — the “return on investment” of a country. Used responsibly, a marginal increase of x% in total debt load would result in a slightly larger increase of (x+)% to GDP. In reality, the growth of debt securities has outpaced GDP to a nearly comical degree.
Such a degree of outpacing is termed “nearly” comical because, while it’s undeniably ridiculous, it’s not at all funny: examining the slope of the two lines in the above graph (especially since 1990) shows that the rate at which debt has increased far outpaces the rate of GDP increase. In other words, we as a country have taken on incrementally higher debt burdens (risk) for progressively lower incremental increases in GDP (reward). This has been true since the 1980s, which was the first time that the debt and GDP curves began to meaningfully diverge. But not only has total debt growth outpaced GDP since 1990, it’s increasingly outpacing GDP: examining the slopes of these shows that, in essence, the country is receiving less and less incremental benefit from every dollar of debt over the past thirty years than at any point in time since the end of World War II.
This phenomenon cannot be attributed to some massive supply or demand shock, such as new technology that obviates workers: such technology would likely be debt-funded to begin with, but would positively impact GDP growth (i.e. increase the slope of the GDP line) at any rate. Put simply, this supports the argument that the US as a whole has become increasingly unproductive (from a leverage standpoint) for the past thirty-five years. This worrying increase in debt is also reflected at the personal and household level: total US household debt has topped $18 trillion for the first time in history, and balances have increased more or less linearly since 2010.
Unsurprisingly, most of the debt is attributable to housing-related debt: mortgages and HELOCs. This is to be expected, as the home (and its potential refinancing) is one of the most expensive, if not the most expensive, transaction that most Americans will ever make. Such an arrangement has a potentially deleterious effect on overall net worth as well: 60% of the net worth of middle class households is in their home, and only 10% is in the S&P 500 or other investments. From the standpoint of returns, this is ill-advised: whereas the average annual return for stocks (from 1928–2023) has been 9.8%, the average annual return for real estate over the same time period has been 4.2% (average inflation has been 3% annually, although over the past several years Chair Powell has certainly done his part to increase that number substantially).
By building the American Dream around home ownership in particular, rather than financial independence in general, and allowing the government to backstop loans — thereby artificially creating demand for mortgages as more buyers seek to buy a home than might otherwise be found in a truly free market — it would appear that the 2008 housing bubble was not only guaranteeable, but repeatable: viz. the cost of housing is artificially inflated and people are driven to increase their exposure to it via mortgages, rather than being incentivized to invest in productive value creation such as ownership of a business.
And “ownership of a business” is precisely what investing in the equity markets means. Stocks are called “shares” of a company for a reason: investing in a company by buying its stock literally means buying a piece of the business itself.
Home ownership is much like debt: there’s nothing inherently “bad” or wrong about it, because both home ownership and debt fulfill functional and aspirational requirements. But when policies and laws are created solely for the purpose of continuing to grow the real (and nominal) value of homes in order to increase the net worth of their owners, that is antithetical to free market principles. Moreover it incentivizes ludicrous behavior (discussed later) and increases the risk of contagions.
When the mortgage and HELOC components are excluded, the picture becomes a bit more concerning: automotive and credit card debt have grown progressively over the past ten years, whereas student loan debt has leveled off. The distinction is important: student loan debt is arguably “good” debt in the sense that it’s debt one incurs in exchange for potential future benefit: college graduates are 24% more likely to be employed and earn 86% higher than non-graduates, the earnings gap between college graduates and non-graduates continues to widen, and college degrees verifiably offer upward mobility. Automobiles, by contrast, are depreciating assets (with very rare exceptions) regardless of whether they’re employed to the benefit of a business, and credit card debt is the gift that keeps on taking: very few investments can reliably yield more than 24% annually, yet that’s the all-but-guaranteed average credit card rate.
From a proportional standpoint, the situation becomes increasingly grim: automobiles (which are a necessity in modern-day America, whether as a productive asset for a business or simply for mobility) and credit cards dominate the debt landscape. This situation has gotten progressively worse since the post-covid (and ongoing) inflationary crisis, which has forced millions of Americans to embrace credit cards and other revolving forms of debt merely to meet everyday needs. Given the nature of revolving debt, this can quickly create a positive feedback loop that makes affordability increasingly out of reach.
It bears mentioning that over $60 trillion of debt has been added globally since 2020. Therefore, while the current work focuses extensively on US debt, the astute reader will recall that in a truly global economy, interconnectedness is high, and geopolitical factors are as much of a risk — especially in touching off a massive downturn caused by cascading failures — as are purely financial matters.
There is also the matter of FHA loans, specifically mortgage loans backed by the Federal Housing Administration and provided by an FHA-approved lender. This type of loan structure protects lenders against losses and has historically allowed lower-income Americans to purchase a home that they would not otherwise be able to afford (the line from The Big Short — “These people just want homes!” — can and probably should come to mind). Because these loans are geared toward homeowners rather than investors (due to the owner-occupant requirement) and the lower down payment required presents more risk to the lender, the buyer must pay a two-part mortgage insurance. And while FHA mortgages have increased somewhat during the first fifteen years of the 21st century, they have absolutely exploded since covid.
The aforementioned increase in credit card debt presents a new issue when it comes to mortgages: it has helped create an FHA subprime bubble (a pending catastrophe aided by presidential policies), where in 2024 more than 64% of FHA borrowers had a debt to income (DTI) ratio in excess of 43%. This 43% figure is important, as it’s the highest DTI that a borrower can have and still qualify for a mortgage (although a DTI under 36% is preferred). Note that this high-DTI proportion is approximately 40% higher than during the 2008 crash. Thus, while Powell’s post-covid actions have certainly done their part to drive millions of Americans to reach for their credit cards just to stay alive, the underlying symptoms of an FHA subprime housing bubble have been years in the making.
Some fundamental facts about debt must be examined in light of the above figure. While it’s true that a wealthier consumer is more likely to carry debt, it’s also true that for a wealthier debtor it’s easier to erase that debt. This option does not extend down the income distribution. Lower-income debtors are more likely to require a higher percentage of their income to be used to service debt (the aforementioned DTI) and are less likely to be able to erase that debt due to their comparatively reduced income. Lower-income debtors are also less likely to have savings, which leaves them exposed to economic externalities that may not be of concern to higher-income debtors. This means that FHA borrowers may be more likely to default if caught in arrears, since these loans are primarily targeted toward lower- and middle-income buyers. And given the increasing reliance on credit cards to meet everyday needs, as well as increasing amounts of automobile debt (a function of both increasing vehicle prices as well as an elevated rate environment), many of the country’s most vulnerable face default risk from all sides.
The level of automobile debt is notable for the simple fact that America is a predominantly vehicle-centric society; while debates regarding the need for and/or utility of public transportation are beyond the scope of the present work, one fact is undeniable: you can sleep in your car, but you can’t drive your house to work. In other words, those borrowers who default on an FHA loan are more likely to default on other loans as well, causing a failure cascade that can spread throughout the economy. And automobile costs would be especially vulnerable in such a scenario, because if a debtor defaults on their mortgage due to financial hardship, an unexpected repair cost can drive their situation from tenuous to catastrophic in short order.
When the entire debt structure of the country is taken into account, one thing becomes clear: should America suffer another financial crisis, it’s likely to be a general credit event, rather than a housing-specific event as in 2008. In which sector of the economy such an event might begin is less relevant than its potential effects: when the potential inferno is sufficiently broad, it indicates that the risk is systemic, and therefore where the first spark was struck is less of an issue.
But while the aforementioned debt balances are cause for concern, if not alarm, we also mentioned that household debt had increased linearly since approximately 2010, whereas the total debt level for the entire country has exhibited a strongly nonlinear growth. The money supply (one of the primary drivers of inflation) has also exhibited highly nonlinear behavior, and where that money has gone is equally alarming.
Derivatives and the concentration of financial risk
The proximal cause of the current risk environment is simple: an overabundance of money and its potentially irresponsible use. While much of the market celebrated Powell’s declaration of endless money printing, some unavoidable consequences occurred which received far less attention than they should have. For starters, the monetary base (total currency in circulation plus money held in reserve at banks, including the central bank), unsurprisingly, jumped.
The most liquid form of money is called M1, a narrow measure of the money supply that includes not only physical currency and reserves, but also demand deposits (accounts from which deposits can be withdrawn at any time without advance notice, e.g. checking and savings accounts), traveler’s checks, and other checkable deposits. When discussing stimulus spending on the part of the government (such as the covid stimulus), the 2020 jump is obvious: from January to June of 2020, M1 increased by approximately $12 trillion. This was the single largest increase in M1 since 1959, the earliest year for which these data are published by the Fed. This massive spike in money supply is not only directly responsible for the country’s subsequent inflationary woes (which are likely to continue given the stickiness of inflation), they have massively increased the nation’s exposure to downside risk.
It should be noted that the M2 level, meanwhile, increased by a rather less dramatic amount; this is unsurprising, since M2 encompasses “near-money” such as savings deposits, money market securities, mutual funds, and other time deposits (e.g. bank CDs). These assets encompass all of M1 and are less liquid, but can still be quickly converted into cash or checking deposits. Because the “money printer” wasn’t directly printing these less-liquid assets, the jump in M2 is less severe, but no less noteworthy.
These actions created an insatiable appetite for spending opportunities for both individuals and institutions, and was the perfect fuel to feed a growing appetite of hidden risk.
This “hidden” risk can be found in the derivatives market, a massive global übermarket valued at close to $1 quadrillion at the high end. The phrase “on the high end” is critical here, because the derivatives market is difficult to estimate given the opacity of the market and the sheer number of derivatives in existence, which are available on nearly every possible type of investment asset: equities, commodities, currencies, bonds, and even interest rates (interest rate derivatives made up nearly 80% of the $729 trillion notional value of over-the-counter derivatives in June 2024). There’s also the issue of transparency: the majority of derivatives are “over the counter” (OTC), meaning they’re executed directly by counterparties rather than traded on an exchange. Estimates placing the value of the derivatives market at 10x global GDP are not uncommon, and although it’s not strictly a fair comparison: GDP is technically a flow, whereas the notional value of derivatives is a level (comparing the two is akin to saying that a car is faster than it is long), but the gargantuan size of the derivatives universe is undeniable.
At its heart, a derivative is a financial contract whose value is derived from an underlying asset, such as a stock or a bond. Rather than directly owning a stock, for example, an investor can instead buy a derivative as a side bet on how that stock will perform. But because derivatives often involve leverage, small movements in the underlying asset can result in massive gains or losses: for example, whereas 2:1 leverage is common on equities and 15:1 on futures, in forex markets leverage on the order of 100:1 is not uncommon.
In the derivatives world, billions of dollars can shift instantly. This is a house of cards built on speculation, not fundamentals.
And the top three US banks each hold more than $50 trillion in derivatives; all told, the top twenty-five banks, savings associations, and trust companies hold a combined $217 trillion in derivatives. That’s nearly 3x the combined market cap of NYSE and NASDAQ (as of January 2025).
Notional amounts of derivatives contracts for the top 25 commercial banks, savings associations, and trust companies. Table values in millions. Source: Office of the Comptroller of the Currency.
Examining the Total assets column in the above table shows just how leveraged some of these banks are. Goldman Sachs, for instance, holds nearly $57 trillion in derivatives against “only” $564 billion in assets; that’s over 100:1 leverage. JPMorgan Chase’s 16:1 leverage seems rather tame by comparison. This is where the concept of “too big to fail” comes from: the notion that some financial institutions are so large and interconnected to the broader economy that their failure would be disastrous for the nation as a whole, and they should be supported by the government (viz. by taxpayer money) when they face the consequences of their poor decisions. Institutions too big to fail, if allowed to fail, would trigger a cascade of failures that wipe out savings, freeze credit markets, and potentially ruin the entire financial system.
Hypothetically.
The institutions are aware of this, of course: Uncle Sam’s implicit safety net creates the ultimate moral hazard and encourages the taking on of ever-greater risks. There’s an argument to be made that banks “likely don’t hold exposure” to individual positions, instead acting as market makers and facilitating transactions between parties. That’s not to say the risk is zero: the existence of an intermediary requires the existence of counterparties, else there would be no exchange to intermediate. The lack of reporting and availability of data surrounding the derivatives market has created unique concerns, to wit:
- BIS has highlighted the growing trillions in “missing debt” created by certain derivatives.
- Forex swaps, forwards, and currency swaps create debts that usually don’t appear on balance sheets or other debt metrics; these off-sheet debts are estimated to reach $97 trillion globally.
The $200+ trillion held in derivatives underscores an extremely complex financial landscape where risk management and market speculation dance a dangerous waltz on the edge of a razor. Banks may be acting “only” as intermediaries rather than holders, but the sheer size of these positions raises obvious questions about systemic risk and market stability.
Thus, the “everything bubble,” where easy money, low rates, and a seemingly endless appetite for risk has artificially inflated everything from market indices to cryptocurrencies to pointless so-called “innovations,” and which has fueled a years-long frenzy that has driven valuations far above any semblance of rationality or intrinsic worth. So what’s a speculative investor with a healthy risk appetite — whether they’re managing “smart” money or dumb — to do in such a situation?
After all, yields must be had, sometimes at any cost.
For most individual investors, there’s always the tried and true option of stock market speculation or embracing crypto (speculation’s newer, dumber, and more volatile digital cousin). But institutions have a potentially more dangerous card to play: securitization.
Securitization — termed “financial alchemy” by some outlets — is the process of pooling together numerous (semi-)illiquid assets and selling tradeable shares in that pool to investors. Just as a company can slice itself into millions (or billions) of tiny pieces called “shares,” so too can a lender bundle together numerous types of loans and slice them up as well (called tranches). Broadly speaking, securitization could apply to any asset, but the term is most frequently used to refer to the design of marketable financial instruments by merging financial assets. While mortgage-backed securities are arguably the most infamous, other asset-backed securities can be formed from auto loans and student loans.
Most debt is securitized because it only makes good financial sense for lenders to do so. Due to the time value of money (succinctly, a dollar today is worth more than a dollar tomorrow) there’s little incentive for lenders to hold a loan — any loan — on their books until maturity. This is especially true for ultra-long duration loans such as mortgages, which have traditionally been thirty-year contracts (although there is such a thing as a forty-year mortgage, which seems like a highly efficient way to create multigenerational debt). Since interest is how lenders make money, it’s more prudent to hold a loan for a short period of time after origination (where the majority of each monthly payment is going toward interest, rather than principal) and then sell off that loan to have the capital to originate additional loans. This is part of the reason why notional debt level doesn’t always match securitized debt level: there’s a lag between when a lender originates a loan (which contributes to the notional debt level) and when a lender finally bundles it and sells it off (which contributes to the securitized debt level). Done properly, this is a self-sustaining system; done irresponsibly, it becomes a self-licking ice cream cone: a system that exists for no purpose other than to perpetuate itself.
The total (notional) debt level described previously is not a terribly valuable number (at least from a risk management standpoint) in and of itself: when debt is securitized is when the risks become apparent.
The most (in)famous of these securitized instruments is the mortgage-backed security. Mortgage-backed securities (MBS) are bond-like investments, each of which contain a bundle of home loans and other real estate debt acquired from various issuers (normally banks, but also government entities). MBS investors receive periodic coupon payments just like a “regular” bond, and while most people will now have at least a passing familiarity with MBS thanks to numerous films and documentaries focusing on the 2008 crisis, what’s quietly ignored is that MBS volume has increased over 172% since 2020, to the tune of just over $2.6 trillion.
There are also securitized student loans, a fairly recent phenomenon that has already eclipsed credit card debt from the standpoint of asset levels (“recent” in this instance means circa 1990s, as opposed to mortgage securitization as a whole, which is typically dated to the first issuance of an agency MBS pool by Ginnie Mae in 1970). And as previously mentioned, similar securitization structures also exist for auto loans, which have recently reached a level of $1.57 trillion.
All told, over $5 trillion in consumer debt is securitized.
The risk of this system is obvious: if too many borrowers default, securities values collapse. This is no different than the MBS collapse from 2008, except that since the last catastrophe that spawned reams of award-winning films and articles on the matter the economy as a whole has become massively reliant on debt — for all aspects of life, not just mortgages. “Too many borrowers” defaulting hardly sounds like a compelling risk metric (it’s nearly tautological in its simplicity), but again the spectre of coordinated defaults, not just multiple defaults within one asset class (see The Big Short) but multiple defaults across multiple asset classes, rears its ugly head. And just as there have been warnings regarding the risk of subprime auto loans, as credit card balances remain over $1 trillion the question must be asked:
What finally pops the bubble?
Inevitable collapse
It’s been cemented into pop culture zeitgeist that “Actually, no one can see a bubble. That’s what makes it a bubble.” We respectfully disagree: clairvoyance may lie perpetually beyond humanity’s grasp, but common sense shouldn’t. We see three potential factors that could lead to the start of the aforementioned general credit event, and while such an event might not be as dramatic a “pop” as most might imagine — in favour of a long, slow economic denouement — the overall results won’t be any less severe.
Threat 1: late payments and defaults
Americans are missing car payments at the highest rate in more than thirty years, with 6.56% of subprime borrowers (defined as those with a credit score below 640) at least 60 days past due on their accounts as of January 2025. This is the highest rate since data collection began in 1994, per Fitch Ratings. Overall macroeconomic conditions have made it difficult for the most financially vulnerable to keep up with their payments, but this issue isn’t merely confined to subprime auto borrowers: the Federal Reserve Bank of New York in February 2025 reported that the share of auto loans among all borrowers that transitioned into “serious delinquency” (defined as at least 90 days past due) rose to 3% in the fourth quarter of 2024. This is the highest level since 2010.
Unsurprisingly, the increases in car prices, combined with increases in rates, have driven monthly payments upward on consumers across the board. Fed Chair Powell’s “transitory” inflation hasn’t spared the automotive market: the cost of buying a new car has risen more than $10,000 since the pandemic, from $38,000 in January 2020 to more than $48,000 in January 2025. While the average monthly payment for a new car loan was $566 in 2019, it was $755 in January 2025: an increase of over 33%. Meanwhile the median weekly real earnings (i.e. accounting for inflation) for all wage and salary workers has increased only 6% during the same period. Repossessions surged 23% in July 2024 and in January 2025 the CFPB found that more vehicles were primed for repossession now than those acquired before the pandemic.
Adding insult to injury, the CFPB report also found that customers can continue to owe money on their vehicle even after it’s repossessed, increasing the risk of a car repo dragging a borrower down in other areas, including an increased likelihood of rejection for a future auto loan and negative impacts on employability. Those who are quick to say that these troubles are “just a subprime issue” conveniently forget history: a subprime loan crisis can absolutely drag down the rest of the economy, even at a global level (once more bringing the question to mind of whether bailouts are good policy or a breeding ground for moral hazard). While a subprime auto crisis in and of itself would not be as large as the subprime mortgage crisis, it would likely be connected to crises in other sectors, leading to a potentially larger impact on the economy.
The picture is hardly rosier in the realm of revolving credit. While the amount of credit card debt incurred by Americans in 2024 was a smaller increase than what was seen in 2023, credit card defaults (defined as being at least 180 days late on a minimum payment) have increased significantly. And in 2024 Americans defaulted on $59 billion in credit card debt, a 34% increase from 2023. This metric is unfortunately not evenly distributed across the population: nearly half of adults over the age of 50 with credit card debt lack the money to cover basic expenses. Yes, rate hikes are partly to blame for this, because any increase in the baseline rate is going to increase the rate paid by consumers; but more of the blame rests at the feet of persistent inflation, which has driven up prices to the point that millions have been forced to turn to revolving credit for everyday expenses.
The Fed’s efforts to find short-term solutions to the inflationary problem it created has instead resulted in long-term misery for millions, and in potentially elevated risk for the global economy.
Threat 2: FHA delinquencies
FHA delinquencies are no laughing matter: mortgages newly delinquent at least 90 days jumped 32% in 2024Q4 as borrowers face numerous headwinds such as persistent inflation, natural disasters, rising insurance rates, and a decades-long declining saving rate. Worse, the delinquency rate for FHA loans steeply outpaced late payments on conventional mortgages and loans offered by the Department of Veteran Affairs. This suggests that not only are first-time homebuyers struggling to pay their mortgage, but given the popularity of FHA loans such delinquencies could potentially grow to outstrip the 2008 crisis. Mortgage payments have also jumped during the past several years, due not only to increasing home prices but also increasing rates, sidelining many would-be homebuyers and clobbering many who bought a house to begin with. FHA and VA loans are very much the canaries in the coal mine for mortgage performance.
Threat 3: debt refinance
In 2025 more than $9 trillion of US debt will either mature or need to be refinanced. That level of debt represents nearly 32% of the country’s 2024 GDP. Unfortunately, Powell’s tepid rate policies were a two-for-one special, doing little to bring inflation back to target while simultaneously increasing borrowing costs for millions of Americans, including the federal government. Powell’s poorly-timed rate cuts in late 2024 only sent the two- and ten-year Treasury rates higher (they remain elevated as of the time of this writing), suggesting that the market essentially called the Fed’s bluff on the economy.
The ten-year/three-month spread, meanwhile, remains firmly (albeit barely) negative, a historical recession indicator.
This begs the question of whether the US government actually wants a recession. While the fledgeling DOGE has taken a hatchet to government spending, it’s also increased the likelihood of a recession, which would all but guarantee rate cuts and make refinancing existing debt cheaper. Every single recession dating back to the 1980s followed a peak in the federal funds rate (also known as the federal funds target rate, which is set to guide overnight lending among US banks), which effectively dictates the cost of money in the economy as a whole. When the economy stalls, the Fed enacts stimulus by lowering interest rates to lower cost of capital and promote spending.
Unfortunately, these actions tend to be inflationary, which is especially dangerous given the current stickiness of inflation.
The government isn’t the only one that needs to refinance its debts: the motto in commercial real estate was “survive until 2025,” and the delinquency rate for commercial mortgage-backed securities is at a record level as over $2 billion in office loans became newly delinquent in December 2024. This delinquency rate is rising twice as fast as during 2008 and is 5x worse than 2022. Many of these loans are on five-year terms with a balloon payment, meaning that the loans that were originated during the ultra-low rate environment of covid are coming due in a time of much higher rates. The picture gets much worse when examining the exposure of banks to commercial real estate as a multiple of equity.
“Core equity” for banks (usually called CET1, or common equity tier 1) represents the highest-quality capital a bank holds: ordinary shares, retained earnings, stock surpluses, etc. This represents the first line of defense against losses. At the close of 2024 the nationwide median of banks’ exposure to CRE loans sat at a concerning 2.5x CET1, and 62 banks met the definition of “excessive” exposure (greater than 300% of core equity) to commercial real estate loans. Landlords of office buildings have had trouble collecting enough rent to even make interest payments and are finding it difficult or impossible to refinance. Even in areas like Manhattan, some towers are selling for land value as their prices have plunged by up to 70%, meaning that the building itself is considered worthless.
In such an environment, rate cuts would be useless: no matter how low the interest rate, it will still be too high if the property itself remains vacant. That means vacancy is the fundamental issue, not just rates. Repurposing buildings into residential and multi-use properties is an option, but requires capital that some landlords may not have.
Banks are also in an interesting quandary regarding unrealized losses (“paper” losses of assets that have decreased in price but have not yet been sold for a loss): securities designated HTM (securities the bank intends to hold until maturity) versus AFS (securities the bank may hold for a period of time but could sell before maturity) create some concerning nationwide issues. The difference between HTM and AFS is that AFS securities are valued at market price and HTM securities are held at amortized cost. These losses are “unrealized” because while they decrease the value of the bank’s securities portfolio they do not affect the bank’s income; however, declines in their valuation in response to rate changes mechanically reduce regulatory capital and liquidity ratios, meaning the bank has less cushion to absorb a shock. Should the bank need to sell these securities when their valuations are low, the unrealized losses become very real indeed, eroding capital buffers and threatening the bank’s solvency. This also discourages the bank from lending, increasing loan prices and reducing loan growth.
In other words, realizing these losses can grind lending to a halt, and as mentioned several times, the world runs on debt.
Near the end of 2024 the nationwide mean of unrealized losses on investment securities hovered at around 20% of CET1 capital. While very few banks had unrealized securities losses in excess of 100% CET1, that number is not zero. When combined with the CRE exposure, it becomes very apparent that not all banks are on equally solid financial footing.
The US has chosen stagflation
While much has been written about Walmart continuing to pick up high-income customers, Dollar General — a business that has an extremely clear view into the pocketbooks of low-income Americans (given that those customers are the retailer’s core base) — has sounded the alarm that some customers are so financially strapped that they can no longer afford basic necessities. The US now finds itself at an economic crossroads after years of bungling by Powell and the Fed: the situation has worsened throughout 2024 and the delays in rate hikes (followed by tepid rate hikes) have written a bill that has finally come due.
The US has chosen stagflation as its fate, a dangerous outcome made all the more tragic by how easily it could have been avoided. The February 2025 jobs report painted warnings on the wall for all who care to read them: payrolls missed expectations by 8k, the participation rate fell to the lowest in two years, and markets have become intensely irrational and are demonstrating the seemingly endless power of fear. While the U3 unemployment rate is currently hovering at around 4%, the U6 rate (the real rate, as it accounts for underemployed and discouraged workers) is now at 8% — a level seen just before both the 2001 and 2008 recessions (it should be noted that the Fed only tracks the U6 rate from 1994, whereas U3 data are available from 1948, therefore only the first three recessions of the 21st century have a U6 level). Last month US-based employers have announced the highest number of layoffs since covid similar to the spikes seen in 2001 and 2008; while some of those numbers are attributable to DOGE, those cuts (62,350 through February 2025) account for only 36% of the 172k job cuts last month.
The conclusion is obvious: these job cuts are a result of macroeconomic conditions independent of the search for “government efficiency,” a term which is itself an oxymoron for the ages.
The concerning unemployment rate is exacerbated by the number of Americans who have been employed for at least twenty-seven weeks, which has recently hit a level not seen since 2008. This means that (excluding covid) not only are more Americans out of work, more Americans are out of work for longer than at any point in the past several years.
The number of Americans who have multiple jobs, meanwhile, continues to increase both as a level and as a percentage of the total workforce. Currently nearly nine million Americans have multiple jobs (this is a higher number than at any point in the past twenty-five years), which is approximately 5.4% of the total labor force — a rate on par with what was seen during 2008. This is one of the consequences of inflation that is often overlooked by headlines: Powell’s irresponsible management of the economy has put millions into a position where they must work ever-harder for less. That is the opposite of how a thriving economy should function.
Those metrics may not seem catastrophic, but it must be remembered that the labor force participation rate has been steadily declining for decades, and still hasn’t recaptured its pre-covid level.
To make matters worse, five of the regional Federal Reserve Banks (New York, Philadelphia, Kansas City, Dallas, and Richmond) have data on detailed surveys of manufacturing in their districts dating back at least two decades. The latest surveys, from February 2025, paint a grim picture even without capturing volatility spikes caused by presidential policy: less investment and higher prices.
This must necessarily bring attention to the myth of the “resilient consumer,” a phrase which has populated headlines for several years now despite fundamentals pointing out its flaws. Since 2020 only the top 10% of earners (those making over $250k annually) has shown consistent increases, and currently reflect a record 50% of all US consumer spending. While top earners have, unsurprisingly, spent more than other tiers since 1990, only since covid has so much of the economy depended so heavily on the spending habits of so few.
Current Treasury Secretary Scott Bessent has stated on CNBC some of the same facts we’ve espoused for a while now and which common sense should dictate: the economy has “become hooked, become addicted, to excessive government spending and there’s going to be a detox period.” We couldn’t agree more. Powell’s decisive actions during covid were rightly praised (even by us), but the gusto with which he ran the money printer should have also been applied to reining in inflation. Instead, the years of trepidation and lackadaisical rate decisions have painted the world’s most powerful economy into a corner from which there is no easy escape.
QE1 (2010) became QE2 became QE3 became QE Infinity (open-ended easing as needed), and the years of flooding the system with easy money changed everything, and not necessarily for the better: printing money out of thin air and using it to buy government bonds with the goal of keeping interest rates artificially low, pushing liquidity into banks, and forcing economic growth. Covid-era emergency printing became the new normal, and the primary reason why inflation remains rampant even today. Powell & Co. are running out of time to get the economy back on track, and they’re running out of platitudes to feed the public and the media for why the situation continues to worsen for tens of millions of Americans.
Inflation is not an accident: it is the direct result of reckless monetary policy. As Milton Friedman once said, and as we’ve continually espoused, “Inflation is always and everywhere a monetary phenomenon.”
Closing remarks
The biggest effects of the long years of quantitative easing wasn’t just inflation, but growing wealth inequality. While the net worth of both the top 1% and the 50th-90th percentiles have steadily increased over the decades, the share of the aggregate for these demographics has noticeably diverged over the past thirty-five years.
While we will hardly ever be accused of possessing bleeding hearts, we will always stand proudly accused of calling out poor decisions that adversely impact those who are least able to absorb their consequences. This is especially true when the lower-income classes are forced to take on additional debt to survive while real wages have severely trailed inflation.
These data not only show why it’s so vital to invest, but demonstrate why opportunities to invest — and the financial literacy that must necessarily accompany such opportunities — must be extended to the fullest amount possible, both as a matter of policy as well as national prosperity. Years of quantitative easing have all but ensured that almost every new dollar printing goes into the financial markets rather than directly into the hands of average workers, and the current “market detox” only serves to highlight what some of the best investors have repeated for over a century: investing in the market is the only way to build generational wealth within a single lifetime.
It’s unlikely that Hoenig was the only one who saw the current market detox as the only logical conclusion of quantitative easing: he repeatedly warned that the Fed would take a risky path that would deepen inequality, stoke the fires of dangerous asset bubbles, and enrich the banks over everyone else — all as the Fed got sucked into a money-printing quagmire that it would be unable to escape.
On all of these points, Hoenig was correct… and ignored.
And now we live in the world that Hoenig predicted, where the interconnectedness of the Fed with the US economy has been cranked to the point where even yelling “stop” is futile.
Buckle up.
