It’s often said those that don’t learn from history are doomed to repeat it—and JPMorgan’s chief investment officer thinks markets need to go on a history refresher course.
Bob Michele, who is responsible for managing $700 billion in assets for the world’s most valuable bank, believes there are too many current parallels to the 2008 global financial crisis to simply dismiss the idea of a repeat out of hand.
Despite three of the four largest bank failures in U.S. history occurring this spring, economic data has proven resilient and equity prices have continued their march higher, underpinned by hopes for a coming productivity surge thanks to generative artificial intelligence.
Fifteen years ago, JPMorgan famously bought Wall Street’s fifth largest investment bank, Bear Stearns, in a government-brokered deal to stave off its collapse—not unlike its recent acquisition of First Republic Bank that looks to have stopped further contagion among regional lenders.
“This does remind me an awful lot of that March-to-June period in 2008,” Michele told CNBC in an interview on Friday, citing the three-month rally that followed the Bear deal. “The markets viewed it as: there was a crisis, there was a policy response and the crisis is solved.”
Michele is now stress testing his assets for a 3%-5% contraction in economic activity over a couple of quarters, since he’s not buying rosy predictions from Goldman Sachs that the U.S. can escape even the type of mild recession that had already befallen Europe.
“It would be a miracle if this ended without recession,” said Michele, who also serves as global head of fixed income for JPMorgan’s asset management arm.
The sheer size of the economy can often mean that by the time leaks spring in the façade, the structural damage has already been done.
Risks abound, from equity prices to commercial real estate
Many Wall Street veterans hadn’t launched their careers the last time the U.S. confronted inflation rates that were this high, and the subsequent draconian tightening by the Fed may not have been felt yet. This is because real rates—i.e. once adjusted for annualized inflation rates of 4.4% using Fed’s preferred yardstick—have, while no longer negative, not reached the point that they constitute being materially restrictive to economic growth.
And although residential property has become less of a concern, vacancy rates in the commercial real estate sector have shot up following the shift towards remote work.
More than $1.4 trillion in U.S. CRE loans are due to mature by 2027, with $270 billion alone coming due this year, according to real estate data provider Trepp. Much of this debt will have to be rolled over at higher rates.
“There are a lot of companies sitting on very low-cost funding,” Michele said. “When they go to refinance, it will double, triple or they won’t be able to [roll it over] and they’ll have to go through some sort of restructuring or default.”
Another red flag for Investors is the aftershock from the debt ceiling negotiations. The Treasury General Account, Uncle Sam’s coffer, is nearly exhausted due to a restriction on issuing new IOUs that was in place until the talks were resolved.
Now a $1 trillion tsunami of high-quality government paper is slated to hit markets before September, at a time when Michele warns the Fed is already draining $95 billion in liquidity—the oxygen that fuels asset prices—every month through quantitative tightening.
Should investors like billionaire Ken Griffin, the boss of Wall Street’s most successful hedge fund, decide the A.I. hype is more bubble than substance at current valuations, outflows from riskier stocks into safer bonds yielding respectable returns could hammer equities.
Economic threat was dismissed all the way until the end
What few might remember is that the subprime crisis was actually a train wreck moving so slowly few imagined at the time the cataclysm that was to befall the globe in the latter half of 2008.
Arguably the starting shot came back at end of March 2007, when Fed chair Ben Bernanke told Congress spillover risks to the broader economy emanating from the subprime mortgage market were “likely to be contained.”
At the time he spoke, the largest independent U.S. provider of loans to homebuyers with poor credit scores, New Century Financial, was already teetering on the edge; the following week it would ultimately file for Chapter 11 bankruptcy.
The problems at Bear Stearns didn’t even begin to materialize until the subsequent June, when the investment bank engineered a $3.2 billion rescue of its own hedge funds that speculated on the U.S. housing market.
Its March 2008 shotgun wedding to JPMorgan seemed to mark the high-water mark of the crisis, but it still took another six months before the bankruptcy of Lehman Brothers.
Just as importantly, Lehman, while the most spectacular victim, was by no means the only one.
American Insurance Group, the world’s largest insurer at the time, required a staggering $182 billion in taxpayer aid because of risky bets taken by a small number of London employees at AIG Financial Products, a relatively unknown unit.
Fannie Mae and Freddie Mac, the two government sponsored enterprises backing roughly half of all U.S. home loans, became wards of the state. Major banks like Washington Mutual, Wachovia and Merrill Lynch either collapsed or were gobbled up on the cheap.
“There are a lot of things that resonate with 2008,” Michele said. “Yet until it happened, it was largely dismissed.”
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