For anyone alive and aware in 2008, this weekend’s economic news probably sent them to the drug store to buy some Pepto Bismol. First, the Federal Reserve demanded that the nation’s biggest banks detail their exposure to the opaque, multitrillion-dollar private credit market. Then, almost simultaneously, word broke that some of those same banks are imminently launching a credit default swap index with S&P Global, targeting that same market.
For the past two months, we’ve watched America’s macroeconomic program quickly erode. President Donald Trump’s illegal war in Iran, which closed the Strait of Hormuz and marked the end of the Carter Doctrine era, cut off the supply of cheap oil from the Persian Gulf, raising inflation at a time when many have yet to see their pre-Covid purchasing power restored.
Another consequence of this shortage is that the U.S. Treasury is now desperately trying to finance a $1.9 trillion deficit without a large pool of captive foreign buyers, having failed to prepare for the crisis in which the United States now finds itself. China is dumping U.S. Treasuries at a rate not seen since the Global Financial Crisis, while stalwart buyers like Japan are seeing their bond yield rates creep up to their highest levels in 27 years.
All of that is structurally unhealthy for the U.S. macroeconomy, representing the rapid acceleration of a dynamic that has been playing out more slowly for the past six years. But the events of this weekend mark a shift that might be felt on a one-to-two-year horizon in the form of a liquidity crisis.
The Fed’s request that major banks detail their exposure to the private credit market should terrify risk assessors. When macroeconomists picked through the rubble of 2008, many landed on the conclusion that there had been a catastrophic mispricing of risk. The rating agencies continued to slap pristine AAA labels on toxic subprime mortgages, operating in a state of highly incentivized denial. But in 2008, regulators generally knew where those underlying assets were parked. The financial system was, in theory, visible.
The $2 trillion private credit market, by contrast, is a black box, grown in the regulatory shadows to facilitate high-risk corporate loans that traditional banks were forced to abandon after the passage of Dodd-Frank. The recent limitations on withdrawals from many of these private funds tell us there’s a bank run taking place behind the velvet ropes, in the VIP section.
And if you’re interested in betting against this market, Wall Street has a product for you!
For anyone who lived through the 2008 global financial crisis, hearing the words “credit default swap, or CDS, probably brings to mind two things: first, and obviously, recession pop hits like “Just Dance,” “I Gotta Feeling,” and “Don’t Stop the Music”; perhaps more pointedly, the intense anger and confusion over how some people managed to profit from a crisis that saw nearly 10 million people lose their homes.
In 2008, these synthetic derivatives claimed a starring role in the drama that transformed a collapse in the U.S. housing market into the tits-up financial omnicrisis that nearly destroyed Southern Europe. To be introducing credit default swaps now into a $2 trillion market that is in the midst of a liquidity crisis, and which the Federal Reserve admits it does not fully understand, creates a mirror maze of transactions for regulators to navigate.
Eighteen years ago, the underlying subprime mortgage market peaked at around $1.3 trillion. Over a period of 12 to 18 months, following the inception of the infamous ABX index, the synthetic collateralized debt obligation market grew to $5 trillion in notional value. (And that’s just one type of CDS derivative.) Because CDSs allowed investors to place “side-bets” without ever owning the underlying asset, a small handful of mortgage defaults proved capable of triggering a cascade of multibillion-dollar payouts across the globe.
Now we could see the same multiplier effect applied to the private credit market. By introducing a standardized CDS index to this $2 trillion pool of corporate debt, Wall Street is once again seeding flammable barrels of fictitious capital in the financial sector, virtually guaranteeing that if the underlying loans bomb, the blast radius will be much larger than the asset class itself.
There is also a crucial difference between the macroeconomic environment leading up to the subprime mortgage crisis and the reality we’re living in today. In 2008, when the private financial sector imploded, there was still an “adult” in the room. The U.S. government had a clean-enough balance sheet to step in, socialize the losses, and keep the global financial system chugging.
Today, U.S. government debt is equal to 122 percent–124 percent of annual gross domestic product. In the past, this was manageable because the petrodollar paradigm forced the rest of the world to buy U.S. Treasuries. But with the Carter Doctrine scuppered, the Strait of Hormuz closed, and the State Department weaponizing the SWIFT system through sanctions, those once-captive buyers are finally beginning to abandon the U.S. dollar.
So what happens when the private credit market fractures and the “too big to fail” banks come begging for another bailout? The government will be backed into a corner with only a few viable exits, one of which is regressive debt monetization. To prevent a collapse of the global banking system, the Federal Reserve could be forced to act as the buyer of last resort for the Treasury, creating trillions of dollars out of thin air to purchase bonds so the government can turn around and bail out finance capital, again.
Monetization reduces the obligations of the debt-ridden U.S. government and investor class by eroding the wages and savings of the working class. The Treasury and the Fed would save the banks, but they would do so at the expense of America’s currency and credit outlook, plunging domestic consumers into an austerity crisis, while international central banks that are still exposed to the dollar are left to face potential sovereign debt crises.
When the domestic economy faced the last crisis of this magnitude, in the late 1970s, Fed Chairman Paul Volcker hiked interest rates, intentionally triggering a recession that broke the back of organized labor. The “Volcker shock” served as the founding act of the bipartisan neoliberal consensus, establishing a macroeconomic and foreign policy paradigm where the U.S. offshored its industrial base and policed maritime shipping lanes in exchange for cheap imports.
For decades, this consensus papered over a crisis of demand through the expansion of the debt market, sacrificing growth in real wages for the working class. With the return of the same derivative products that burned the global economy 18 years ago, we may soon witness the end of the program that has governed both Washington and Wall Street for the last 46 years.
The closure of the Strait of Hormuz to dollarized trade is an acute crisis for the subsidy that keeps the American empire afloat. The Trump administration’s attempt to simultaneously retreat from and expand its footprint in the Persian Gulf is incompatible with global finance capital that requires stable unipolar dominance to service its opaque, trillion-dollar private credit markets.
The American politicians who spent the last 46 years immiserating the working class while simultaneously blaming them for the predictable rise in addiction, depression, and violence, are finally waking up to reality. They operated under the assumption that U.S. unipolarity was eternally guaranteed by the Navy, the petrodollar, and an infinitely expandable debt market. In less than two months, President Donald Trump has dismantled the policy infrastructure that once undergirded these assumptions.
The tools of finance capital are now exhausted. A government that is drowning in $39 trillion of debt, and that has just lost a large segment of its captive foreign buyers, can neither afford Volcker shock–style rate increases nor a 2008-style bailout.
The U.S. economy has now entered a phase where the only solution left is monetization and the reindustrialization of the long-neglected Midwest and Northeast. We must abandon the failed project of financializing basic social reproduction and pivot toward creating tangible goods that other countries want to buy, slowly rebuilding the value of the dollar and promoting sustainable wage growth for the working class.
My generation, having lived through the 2001 recession, the 2008 financial crash, the Covid epidemic, and now the Hormuz crisis, would likely suffer the most in the short term under such a program. But it’s the only way to rebuild a U.S. economy that our children deserve to inherit. The era of papering over America’s decline with cheap credit, imperial dividends, and toxic derivatives is over. The last Jenga block will eventually be pulled, and the tower that has loomed over us for 46 years will collapse in a heap.
It’s never been clearer in my lifetime that the U.S. needs a trans-partisan political coalition of socialists, foreign policy and anti-waste realists, and blue-collar workers to win control of the government before finance capital and the private debt market can expand any further, and dedicate themselves to answering the singular economic question facing the United States in the twenty-first century. Which productive forces should we build from the ruins of neoliberalism? I have my own opinions, but simply acknowledging that this is a scenario worth preparing for would be a massive improvement over the current status quo in Washington.
While strong bank earnings this week offer the illusion of stability, the underlying reality is anything but. By introducing a standardized credit default swap index to the private credit market today, Wall Street is starting a one-to-two year countdown that mirrors the launch of the ABX index in 2006. The likeliest trigger of a liquidity crisis is a looming maturity wall in 2028, when hundreds of billions of dollars in debt must be refinanced in our new high-inflation, high-interest Iran war reality. When the debt hits that wall in the next 18 to 24 months, we will find out if our politicians have the spine to let these lenders fail, or if the American working class will, once again, be forced to socialize the losses from Wall Street’s glorified casinos.
