Part I: History of the Credit Bubble

by Doug Noland

Adapted from my Friday, October 7, 2022, presentation at the annual McAlvany Wealth Management Client Conference in Durango, Colorado.

I fell in love with macro analysis sitting at a trading desk staring at Telerate and Quotron screens in the summer of 1987 – wild global market instability that culminated that October with the “Black Monday” crash.

Little did I know at the time that it would be the first of many crises I would witness, analyze and reflect upon.

There were the S&L and banking crises in the early nineties; the 1994 bond market and derivatives crisis;

the Mexican ‘tequila’ crisis in ’95;

the devastating Asian Tiger Bubble collapses in ’97;

the LTCM/Russia debacle in ’98;

the bursting tech bubble in 2000;


the 2002 corporate debt crisis;

the collapse of the mortgage finance Bubble in 2008;

the 2011/2012 European debt crisis;

and the 2020 pandemic crisis – just to name the most consequential. But I’ve seen nothing in my career as alarming as today’s environment – and it’s not even close.

My analytical framework has been a work-in-progress for 35 years. I’ll note two particular facets of my experience that have been especially valuable.

I am a CPA by training. My accounting education at the University of Oregon was rigorous and invaluable, as was my stint at Price Waterhouse. I have a passion for monetary theory – but I always view money and Credit through the lens of debits and credits. Finance is, after all, one vast global electronic general ledger.

Second, after graduate school, I accepted a position with Gordy Ringoen’s bearish hedge fund in San Francisco. We were up 63% in 1990. We were the geniuses – turning away investors. I’ve talked about this in the past. I remember sitting at my desk daydreaming what it was going to be like for this small town working class kid to become wealthy. And let me tell you, there is nothing that could have gotten me more focused and determined than to watch my hopes and dreams get absolutely crushed.

I owe my perspective and analytical framework to my obsession during the 1990s of trying to understand how a bear market, a severely impaired banking system, and deep economic recession morphed into one of history’s great bull markets and economic booms.

Early on, I became focused on non-bank Credit creation – asset-backed securities, MBS, commercial paper, money market funds, the big brokerages, the repo market, Wall Street structured finance… And in 1994, I watched as the government-sponsored enterprises – Fannie, Freddie, and the FHLB – provided huge liquidity injections to accommodate hedge fund deleveraging. They were operating as quasi-central banks, and no one seemed to care but me. The GSEs were again providers of enormous liquidity during the 1998 crisis, and then in 1999 and 2000.

By the late-nineties, I was convinced that finance had fundamentally changed. It was out with the traditional bank-dominated Credit system – restrained by bank reserve and capital requirements. Meaning there were mechanisms that at least placed some boundaries on lending and Credit expansion.

This new non-bank Credit was completely unfettered. The GSEs and Wall Street finance, in particular, basically operated without any constraints whatsoever.

From my study of history, I had become convinced that Credit was absolutely key to boom and bust and Bubble dynamics. First and foremost, Credit is inherently unstable. Credit begets more Credit and Credit excess ensures only greater amounts of destabilizing Credit excess. I looked at this new Credit structure and the acute instability in ‘93, ‘94, ‘95, ‘97, ‘98, and then the almost doubling of Nasdaq in 1999 – and it was clear to me this new financial structure was a disaster in the making.

I would explain my analysis to anyone who’d listen. And, let me tell you, no one was interested in listening. I expected the Federal Reserve would come to better understand this highly unstable Credit mechanism and move to rein it in. I spoke with Fed officials, economists, financial journalists and other market professionals, and basically everyone told me I was wrong.

You know, looking back years later – my analysis WAS dead wrong on something critically important. I thought this new finance was part of a late-cycle phenomenon that emerged after the ’87 crash. Instead, it was the dawn of historic Credit, speculation, economic and policy cycles.

I was actually right about the monumental evolution in finance in the nineties. Yet it was not until Pimco’s Paul McCulley in 2007 referred to the new “shadow banking” system that people began to take notice. By then, it was far too late.

The genesis of my analytical mistake can be directly traced to central bankers – and it is most pertinent to today’s predicament. As I mentioned earlier, I thought the Fed would respond forcefully when they understood the instability of market-based finance. Clearly, I was young and naive. They did the exact opposite. They accommodated it, and over a couple decades remade central bank policy doctrine to nurture, protect, rescue and revitalize this new financial structure.

So, I’ve dedicated my Friday nights for the past 24 years to chronicling the evolution of finance and policymaking and the inflation of the greatest Bubble in the history of mankind.

I’m here today with what I believe is a critically important message. The global Bubble – history’s greatest Bubble – is bursting. The previous cycle has ended, and a new cycle has begun to unfold. We are about to commence an adjustment period that I fear will shake us to the core.

I am reminded of a passage from a book I read some years ago. The author had interviewed Wall Street traders following the 1929 crash – asking them how they could not have seen peril coming. How could they have missed the egregious amounts of broker call loans, all the debt, the speculative excess, and market and international fragilities? Interestingly, their responses were consistent. They were all aware of the key issues – but they said they were fearful in 1927, and when operating in the markets you can only remain frightened by things for so long.

There’s another quote from that era that has always resonated. “Everyone was determined to hold their ground, but the ground gave way.”

At this point, we’ve become numb to all the excess – excessive debt, speculative excess, reckless monetary inflation and policymaking. My sense is that in the markets, within the business community, throughout the country, we know there are serious issues. Yet, individually we’re all determined to hold our ground.

Right now, I sense a major global earthquake. There are multiple fault lines. The ground is giving way in China. The ground is giving way in Europe. The emerging markets are fragile. Japan is an accident in the making. And these various fault lines are linked.

A deep complacency settled in here in the U.S. Most believe we are largely immune to global maladies. The view persists that the Federal Reserve has everything under control.

Analytically, there are interrelated Bubbles globally that essentially create one monumental Bubble. Why do I suggest a singular Bubble? Because of interconnectedness and commonality – because of similar structures.

There are similar policy regimes. The world essentially adopted inflationary Federal Reserve doctrine – low rates, QE, and market interventions and backstops.

Similar market structure – in particular derivatives, swap markets, leverage and speculation. Importantly, virtually the entire world readily adopted so-called “Wall Street finance.” And “whatever it takes” central banking became deeply embedded in market perceptions and prices everywhere.

Interconnectedness: trading systems, derivatives platforms, swaps trading, hedge funds and “family offices”, international mutual fund complexes, inflationary policies… Moreover, over the long boom, international finance became one fungible, commonly shared pool of liquidity – too much of it trend-following, levered speculative finance.

And now, with Bubbles faltering and global financial conditions tightening, I believe global policymakers have lost control of Bubble dynamics.

Clearly, they don’t control inflation dynamics. I believe we’re witnessing a secular change in pricing dynamics and inflation psychology. Moreover, the previous cycle of relatively tame consumer price inflation in the face of massive monetary inflation was aberrational. I won’t delve into details today, but a unique confluence of developments – including globalization, the rise of China, technological innovation, financial asset inflation and speculative Bubbles – all worked to repress consumer prices.

Today’s new cycle, with global fragmentation and the new iron curtain, deep-rooted supply chain issues, commodities supply/demand imbalances, climate change issues and the like, ensures very different inflation dynamics going forward.

Indeed, surging inflation is forcing the Fed into the first real tightening cycle since 1994 – 28 years ago. And since 1994, markets – rather than inflation – have been the Fed’s priority. Now, the powerful revival of traditional inflation dynamics has dictated an abrupt shift in focus and priorities. While early in the process, the Fed is being forced to revise doctrine back to more conventional central banking.

We cannot overstate the significance of the so-called “Fed put” during the previous cycle. This liquidity backstop – that morphed over time into “whatever it takes”, zero rates and endless Trillions of QE – created the perception of safety and liquidity – of “moneyness” – throughout the financial markets. Stocks became a can’t lose, corporate debt the same, and even the crazy cryptocurrencies. Can’t lose included derivatives and Wall Street structured finance – private equity, venture capital, hedge funds and leveraged speculation. With central bank backing, perceptions crystallized that the entire new financial structure was a can’t lose.

And this “moneyness of everything” was paramount to synchronized late-cycle Bubble “blow-off” excess across the globe, with historic misperceptions fundamentally changing how markets and financial structures function – market pricing, speculative dynamics, risk management, and the overall flow of finance. History offers nothing remotely comparable.

These days, it’s increasingly apparent that the world has changed, and this is at the heart of unfolding new cycle dynamics. Central bankers have been jolted – their policies, their doctrine, their views of how the world works. Importantly, their market liquidity backstops have turned problematic and ambiguous. In the end, I believe central banks will have no alternative than to employ additional QE to counter the forces of bursting Bubbles. For now, inflation’s resurgence suggests the halcyon “money” free-for-all days are behind us.

Back during the 1987 crash, so-called “portfolio insurance” played a meaningful role in the avalanche of sell orders that crashed the market. I then watched as derivatives were instrumental in market crises in ’94, ’95, ’97, ‘98, 2000, 2008, 2011, and 2020. And with each central bank market bailout, the monstrous derivatives Bubble inflated to even more dangerous extremes.

Peter Bernstein’s classic book, “Against the Gods: The Remarkable Story of Risk,” was published in 1996. It’s a masterpiece, though I’ve always had an issue with the notion that we live in an enlightened age where risks are better understood and managed. Over the past cycle, the view took hold that central banks can control market risk, while derivatives offer an inexpensive and reliable mechanism to mitigate risk.

I don’t believe we can overstate the role derivatives have played – within the markets, but also throughout the real economy. They’re ubiquitous – institutions, corporations, investment managers, and even individual investors all fell in love. I’ve already seen ample evidence that derivatives will be at the epicenter of unfolding financial crises. They’re certainly worthy of keen analytical focus.

There are serious fallacies embedded in the derivatives universe that I expect to be revealed with major consequences.

Part II: The Holy Crap Moment & Derivatives

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