Are CLOs the New Mortgage-Backed Securities? (w/ Danielle DiMartino Booth & Peter Boockvar)
DANIELLE DIMARTINO BOOTH: Hello. Joining us today is Peter Boockvar, Chief Investment Officer of Bleakley Advisory Group. I'll introduce him by saying he is as close to on Wall Street as being a brother from a different mother. For me. We've gotten to know each other very well over the years. The work that we started to do together was done very much covertly. You fed a lot of the intelligence that went into the market briefings that I prepared for Richard Fisher when I was his advisor working at the Dallas Fed, and I'd like, if you could, to take us to the culmination of that relationship of being an indirect advisor to Richard and how it ended up in a bar, the King Cole bar, on a cold night. It was you and me, Arthur Cashin, Howard Silverblatt of Standard and Poor's, and of course, Richard Fisher. Richard came to love your work after you made a particular outlook for the year and used the term beer goggles. It was interesting. The Wall Street Journal did a retrospective on all of his speeches. The number one most popular one that he ever made was your beer goggles reference. Take us back to that night and what it was like to meet Richard in person finally after having been such a critical part of his understanding of markets intelligence all those years. PETER BOOCKVAR: Well, what was special for me that night was actually getting to meet him for the first time in person. Previous to that, through you, and directly in the occasional email correspondence, the speech where he gave the shout out to me was special. The good thing is that we all had a similar viewpoint of the way of the world and monetary policy and how it interacted with the regular economy and saw things a little different than the conventional thought process in Washington. To actually get to meet him in person was pretty special, just as he was walking out the door and going off to his next thing, but one thing that did come out of that was also a continued correspondence. I don't think I've seen him since but the occasional email back and forth is always special to me. DANIELLE DIMARTINO BOOTH: I know Richard continues to enjoy your work. It's how I start my day as well. I think a lot of us do. Take us back for just a second. What are beer goggles? PETER BOOCKVAR: Back in the day in college, when you would have a little too much to drink, everything looked good. Everything looked better than it might have without the beer. The analogy was when the Fed is conducting extreme monetary policy, the zero rates for seven years and multiple rounds of QE, it puts beer goggles on investors. It makes that awkward lame investment all of a sudden look like roses. It looks at that money losing company. Well, if we do a little bit of this and that and give him some money, everything will turn up roses. That was the analogy that investors become much less focused on the risk when they have those beer goggles on. There's monetary bill got beer goggles on, and only focus on where's my upside? DANIELLE DIMARTINO BOOTH: I guess the CLOs all look better at closing time. PETER BOOCKVAR: Exactly, yes, yes. DANIELLE DIMARTINO BOOTH: Before we go to where we are today in collateralized loan obligations, tell us how you think the Fed got the idea in its head, how policymakers decided that they had to go to the zero bound before they could launch unconventional monetary policy, quantitative easing. There are examples that Chair Powell uses, as well as Vice Chair Rich Clarita. They reference back to the episodes in 1995 and 1998 when the Fed was able to execute three rate cuts and then gracefully extract itself from the markets and the economic expansion and the rally in risky assets continue undisturbed? Are we there today? Can he do this? What differentiates '95 and '98 from where we are now? PETER BOOCKVAR: The important thing about understanding '95 is looking at what happened in '94. That's when Alan Greenspan raised, I think, the Fed Funds Rate from 3% to 6%, 300 basis points within a year's obviously a rather short increase. There were negative side effects from that. The Orange County pension fund, I think, the [indiscernible] themselves out. DANIELLE DIMARTINO BOOTH: The Tequila Crisis in Mexico. PETER BOOCKVAR: That as well. Going into '95, by cutting rates 75 basis points after he just raised 300 the year prior, and also you were only four years into an economic expansion very early on. That was something that they were able to engineer. Then you fast forward to '98 and we have the long term capital management blow up. You have the Russian debt crisis. Well, that was coming together and a sharp decline in the stock market. The Fed was more responding to a decline in markets and a freeze up in markets rather than an actual deterioration in economic growth. DANIELLE DIMARTINO BOOTH: Third time Alan Greenspan ever did that. PETER BOOCKVAR: Well, exactly. That's how we became trained that on a market hiccup, as opposed to an economic hiccup, the Fed was going to come and cut interest rate, but we know in late '98, that sowed the seeds for the greatest stock market bubble in history. Saying that '95 and '98 are good reference points for us as the Fed, I think, is really not thinking through what went on during those two timeframes. DANIELLE DIMARTINO BOOTH: Certainly. The years that followed '98 were some of the most-- Alan Greenspan had already said, irrational exuberance in December of 1996. We knew that the train has already left the station and but animal spirits are what animal spirits are. Let's jump forward in time a little bit, because Alan Greenspan and you would agree on something. When he was still Chairman at the Fed, he insisted against the protest of Ben Bernanke and Janet Yellen, he insisted that the ideal inflation rate was zero percent, what say you? PETER BOOCKVAR: I agree, because that's actual price stability. When you think about zero, let's just take that, that means some things are going up 4%, some things are going down 4%, this price is going up, that price is going down but in a net way, prices are stable. Now we take technology, for example, it's a pretty safe bet since the history of time, the price of any technological good, whether it was a car in the early 1900s, or it's a computer or it's a phone, whatever, that those prices eventually continuously go down. Then there are going to be some things where prices go up, mostly on the services side, whether it's housing or medical care or tuition or whatever, but if you can net out that being around zero, that's actually price stability. It makes your currency stable, it makes decision making much, much easier. Now, if you get into too much debt, and you sell a commodity product and the price of that product goes down, well, then you're going to run into trouble. Maybe knowing that, knowing that you don't have pricing power, maybe you don't go into too much debt to begin with. DANIELLE DIMARTINO BOOTH: Now, there's a novel thought. PETER BOOCKVAR: Exactly. Now look at, now getting back to the technology companies, look how successful Silicon Valley has become when they're selling a product that goes down in price every single year. Deflation actually has been a benefit to them, because it has expanded the market at which they can sell their products. I like to give the analogy, so an IBM PC in 1981 which retails for about $3,000, if you raise that price 2% a year to today, it's costing you $6,000 for the same exact machine. DANIELLE DIMARTINO BOOTH: Technology, everything. PETER BOOCKVAR: Right. Now, you can go into Best Buy and you can buy a laptop for under $1,000 instead. Somehow, technology companies found a way to make money when the price of the product goes down. When you say let's get 2% annual increase, that means in theory that everything has to go up 2%. Now, that's obviously not the case but that's what they're saying. The reason why they want 2% is not because they model that out as being good for the economy or good for businesses are good for the consumer, they do it for selfish reasons. They do it because if the inflation rate is at 2%, they assume that the Fed Funds Rate is a certain level above that. If it's a certain level above that, let's just call it 3%, 4%, which historically, the spread was about 200 basis points, that in the next economic downturn, they would have ammunition to cut rates, a cushion. If inflation was zero, well, that would imply a very low Fed Funds Rate and that would imply very little ammunition to deal with any economic downturn. That 2% target is a central bank self-interest target, rather than what is economically good for the rest of us. DANIELLE DIMARTINO BOOTH: Okay. The minute Alan Greenspan walked out the door, Ben Bernanke managed to push through his 2% inflation target. How do you think that has changed, not just monetary policy here in the United States, but worldwide? You've written extensively, extensively about the Bank of Japan, which still has the 2% target, even though-- you can tell me you've got the history in your mind. I know you do. When the last time they hit 1% was? PETER BOOCKVAR: Right, the only time they actually even hit two was only after the VAT increase. It was a tax increase that resulted in higher prices. Higher inflation is a tax anyway, so whether it's a government administered hike in the valuate added tax or it's a central bank generated increase in the overall price scheme by 2%, it's the same thing. It still does the same damage to a consumer. I think the 2% was just in their minds, their desire to anchor policy around something. In their models, while these are very sophisticated models with a lot of PhDs around it, there's a lot of simplistic thinking behind it. It's low rates are good, high rates not so good. Well, if low rates are good, even lower rates are even better. If you print money, and Bernanke gave the helicopter speech in the early 2000s, you print money, well, then you can create inflation, regardless. Because the history of the Wyman Republic and Venezuela and Zimbabwe, you print a lot of money, you get inflation, but there was attached to that, at least with the Fed's experience since '08 was, well, you can print all this money but if it actually ends up back at the Fed in Reserves, it's not really out there. It's just landlocked back at the Fed. Japan realized, well, yeah, you can create all this money but if it doesn't change consumer behavior, and it doesn't incentivize businesses to borrow and take advantage of low interest rates well, then there's no inflation to be had. DANIELLE DIMARTINO BOOTH: It's the classic paradox of thrift. PETER BOOCKVAR: Exactly. Now, we're at a point where monetary policy, I argue, is actually restrictive monetary policy, particularly in Europe and Japan, rather than being easing because of what it's done to the profitability of their banking systems, which is the transmission mechanism for their policy. DANIELLE DIMARTINO BOOTH: Give us give us a feel for the banking stock indices in Japan and in in your-- given that, well, I don't know, our president is calling for negative interest rates, so just focus us on what's happened to the banking sector in those countries. PETER BOOCKVAR: The Japanese bank stock index, the TOPIX bank stock index, since 1989, when the Nikkei hit its peak, the TOPIX did as well, is down 90% in nominal terms over the past 30 years. We destroyed the equity of the entire banking system. Now, you're at the point in Japan where least a lot of the regional banks are actually on the cusp of going out of business. If you're a big Japanese bank, like Mizuho, Nomura, you have the opportunity to do some business overseas. You can offset the profitability pressures by having business in Japan. If you're a regional Bank of Japan, you really don't have anywhere to go. They're literally dying. Then you look at Europe, and since '07, the Euro STOXX banks index is down 70%. In particular since June 2014, when Draghi went down the negative rate route, that index is down 40%. Now, they will say at least in Europe that well, their volumes have gone up, their loan volumes have gone up. DANIELLE DIMARTINO BOOTH: Make it up on volumes. PETER BOOCKVAR: Yeah. Pets.com in 1999 kept selling more and more pet products, but because they were losing money on every product, they went out of business. Yeah, banks are trying to offset the compression on their margins by trying to increase the volume, but they're actually making less and less because the margins are falling faster than their loan growth is. DANIELLE DIMARTINO BOOTH: We know that unconventional monetary policy was not born in the United States. In fact, Bernanke gave a speech years ago in Japan where he suggested that perhaps if they wanted to generate inflation, they could just issue zero coupon bonds in perpetuity with no maturity at all, which I think you call cash, at last check, but I think something happened because the Federal Reserve is the world's leading central bank. When Bernanke crossed that Rubicon, he brought together all of his closest advisors at the 2007 Jackson Hole. It was there that the Bernanke doctrine was born, and that the precondition of zero interest rates getting to the zero bound was necessary before they could embark upon growing the Fed's balance sheet. Do we absolutely have to have and we're finding out in real time, aren't we? Was it a necessary condition to go to the zero bound in order to launch unconventional monetary policy, whether you agree with QE or not, was that a necessary condition? PETER BOOCKVAR: I don't think so. I think what the Fed did is they turned the business of banking upside down by what they did to the yield curve, because on paper, it was get short rates down to zero and if that is not enough, then try to suppress long term rates to encourage people to go out and lever up whether you're a business or a household. What they did was they flattened the yield curve, which then damages your financial system, and then leads to reduce profitability and unlimited growth. I think Bernanke he's mentality was-- and his learning process was the Great Depression when Milton Friedman came out and said, well, it wasn't, because it was not enough liquidity, and it was all this deflation and they didn't come to the rescue in the 1930s to save the day and then Bernanke saw what happened in Japan. Even though I think he misread Japan. Then he thought that Japan didn't act fast enough and soon enough, rather than saying, well, maybe what they did was the wrong medicine anyway. His idea was, I need to go big, I need to go fast. I need to get rates down to zero. If that doesn't work, then we'll start to open up the printing press to suppress longer term interest rates, because he knows at least back then, obviously, housing was depressed and mortgage rates are going to be priced off the 10-year. Well, how do I get that 10-year yield down? Well, let's buy as many 10-year treasuries as we can. DANIELLE DIMARTINO BOOTH: Once Bernanke embarked upon unconventional monetary policy, QE, it seemed like it was some a strange contagious disease. Now, we have $22 trillion and growing now that the European Central Bank is back in the QE game, now that the Fed is in the not QE, but still growing its balance sheet game. What do you think of the idea? Our mutual friend, Jim Bianco, made the comment, especially of 2017, when there was what, $2.2 trillion of global quantitative easing, the same year that the VIX was south of 10 in single digits 53 times, taking out the next closest year, which I think was in '93 or something when they had three days that the VIX was in a single digit type territory. What do you think of Jim's idea that QE is and has become global and fungible that it knows no boundaries, knows no borders? PETER BOOCKVAR: Well, it's dead on. The only border in a sense is your currency, because every time you go from one border to another, you take that currency risk, but putting that currency or risk aside, and assuming you can account for that currency risk through any hedging, yeah, it becomes borderless because it's that gets back to that old 506-- we call that old, search for yield. We have the big Japanese pension fund that is a huge holder of that three letter we talked about. DANIELLE DIMARTINO BOOTH: The CLOs, going there yet. Going there. PETER BOOCKVAR: Getting to my point of this simplistic thinking of a central banker is low rates are good and lower rates are even better. Well, if we cannot just lower rates to zero, but we thought how we can get that negative, well, then that's the greatest thing ever because we want to get you to lever up. DANIELLE DIMARTINO BOOTH: Right, of course. Yeah, there have been academic studies that have come out that suggests that had we just gone to negative 5% here in the United States, that the pain of the great crisis would have been greatly mitigate. These studies, they even shaved off one percentage point to account for balance sheet expansion, meaning, I think a lot of the conventional wisdom among monetary policymakers today is that we can go deep into negative territory. I know you don't agree with that. I know I don't agree with that. Talk to me if you will about Mario Draghi's legacy and what it implies for Christine Lagarde's future as head of the European Central Bank, because it would seem to me that if any bank is going to go way off the reservation when it comes to delving deeper into negative interest rates, that it's going to be the European Central Bank. Tell us about Draghi's legacy and what Christine Lagarde faces. PETER BOOCKVAR: Draghi took the lesson of Bernanke, which also took the lesson of the Japanese like, I think everyone looked at Japan and said that deflation is a Boogeyman and that the reason why Japan is suffer for all these years is because they have deflation. The problem with that analysis is that deflation was just a symptom, wasn't a cause of their economic malaise. It was just a symptom. It was just consumers wanted to save more, the banking system and the corporate sector needed to de-lever, population stopped increasing. DANIELLE DIMARTINO BOOTH: Aging population, demographic's [indiscernible]. PETER BOOCKVAR: Actually, the average CPI rate over the past 30 years in Japan is actually around zero, so they've actually had price stability. When you misdiagnose the patient and think that deflation is bad, well then you do everything you can, obviously, to prevent that. That was the mentality of Bernanke. That was the mentality of Draghi. Draghi drank that Kool Aid of just get rates as low as possible, and print all this money, and then poof, we're going to create inflation. I like to the natural, it's like a video game. You got the joystick, you hit the right spots, and all of a sudden, you get the outcome that you think, and that's how we think about trying to get a higher inflation rate just based on what you do on the monetary side. Things don't always work out that way you don't know where the money goes. Draghi, in way, followed with the Swiss bank did, Sweden and Denmark also had gone negative right around the time when Draghi decided to take that path with a very simple mentality of if I scare money away from me as a central bank, it will then go out into the private sector and everything will be great. DANIELLE DIMARTINO BOOTH: Magically create economic activity. PETER BOOCKVAR: The problem with that is that negative rates is a tax that somebody has to eat. If it's a bank that has money with me as the ECB, well on taxing them, and how did they get that back? Well, then they actually raise the cost of financing to their customers. Soon after he went negative, we saw mortgage rates in some countries actually go up after he was going negative. Now, we're at the point where banks are saying enough is enough. Individuals are now going to start eating this and businesses are going to start eating this, not through me embedding it in the cost of a loan, but just I'm going to penalize you for just having deposits with me as a regular bank. DANIELLE DIMARTINO BOOTH: I'm just going to charge you. PETER BOOCKVAR: Right. Now, you're getting into a really damaged part of this experiment, where you're actually now taxing individuals. DANIELLE DIMARTINO BOOTH: This is going to go beyond the banking sector into the private sector at a time when European growth is flatlining. PETER BOOCKVAR: Right. What no central banker really thought through, any central bankers, they're so good at getting into this policy. This is the asymmetry, but there's no thought about how to get out. We're now at a point where Draghi has proven to be, and now, Lagarde. They've trapped themselves. They've created in financial history, the greatest financial bubble in the history of the world, in credit and sovereign fixed income and everything that prices off that. How do you get out of that? Just imagine the damage done just by going back to zero from negative, just that, just now there's what, 11 trillion of negative yielding securities. Imagine that goes to zero, imagine the-- just, you only need a few basis points times 11 trillion, equals a lot of money. DANIELLE DIMARTINO BOOTH: Starting points matter. PETER BOOCKVAR: Right. Then that filters through the entire yield curve, not only in Europe, but Japan and infects the US. All of a sudden you get this rise. Getting out of this is now proven to be impossible. That gets the Fed. Jay Powell has a choice. Do you learn the lessons from what went on over there? Do you learn the lessons from Bernanke's experiment and Yellen where they got trapped at zero for seven years? Look, the Fed, the Fed is trapped with QE. It was so easy to get out of and now all of a sudden, their balance sheet is almost back to where it was. DANIELLE DIMARTINO BOOTH: Right. You and I were both really excited the first time that Jay Powell testified to Congress when he was-- his first day in office, yet at a four digit decline in the Dow and said nothing. Then his first testimony to Congress, he was like, well, but wouldn't have to backstop that stock market. I founded the Jay Powell fan club it and you were right there with me because it sounded like he was rational. He made comments in 2012 that the Fed risked blowing a fixed income duration bubble across the full credit spectrum, if I'm getting the quote right and that QE would become habit for me. It seemed, for a while after Powell took office, that he was determined to get somewhere close to normalized interest rates. I think he had 3% in mind on the Fed Funds Rate, and he was also equally determined to make good on Bernanke's commitment to truly exit unconventional monetary policy by shrinking the balance sheet via quantitative tightening. Neither of those things happened. Why? PETER BOOCKVAR: That 3% was really a magic number. He desperately wanted again, too, because in his eyes, if he was able to get around 2% inflation, the real rate would be 1% and while it's below where it was pre-crisis, it still was a positive real rate. Because the poison in the financial system has been proven to be when you have negative real rates so at least 3% was the goal, assuming the 2%. Then of course, you throw in the tariff and trade war, and all of a sudden, Powell's desperately trying to get there and throws in that December 2018 rate hike and everyone freaks out and obviously, we know what happened since. DANIELLE DIMARTINO BOOTH: Watching paint dry in his press conference. PETER BOOCKVAR: Right. With respect to the balance sheet, this is all new to everyone. No one knew at what point shrinking that balance sheet was going to break something, until something broke. DANIELLE DIMARTINO BOOTH: Well, we're breaking countries, but that didn't really matter. PETER BOOCKVAR: Yes. Things were beginning to break in the sense that that contributed to the decline in the fourth quarter of last year because rate hikes and shrinking the balance sheet was a double form of tightening and they're all winging it here. That's what this unconventional-- by definition, unconventional is you're winging something. You're trying something you didn't try before and you're in this dark room trying to feel where the walls are. Now, we're again seeing an instance where that like the Godfather, like I tried to get in, I'm out and then they pulled me back in and the Fed's getting pulled back in just as Al Pacino said in Godfather 3, because they're all now trapped in a policy where once the market feels like they don't have that cushion in that backdrop, somehow they can't figure it out on its own. DANIELLE DIMARTINO BOOTH: I think we'll learn a lot more as time goes by, especially as the yearend approaches and the window dressing at banks and yearend funding strains start to really kick in. I think we'll know more when we have the benefit of a rearview mirror. I've spoken with George Goncalves, interviewed him here on Real Vision and he really does a good job of explaining that foreign central banks are parking money at the Fed, currency in circulation is increasing. You add it all up and quantitative tightening ended up being twice its magnitude by virtue of other factors. The Fed knew this was happening. This is money park at the Fed, it wasn't like parked somewhere where they couldn't see it. They saw currency in circulation rising and tack on top of that, they knew once the debt ceiling was resolved, that the Treasury is going to have to refill its checking account at the Fed. They also knew what Treasury, how much Treasury had depleted its own funding, and they knew that quarterly tax payments would be coming due. These were all known knowns, to use Rumsfeld's term, what on earth went wrong? PETER BOOCKVAR: I think they underestimated what the response function was going to be from the dealer community. You had the bank primary dealers that I think when you're Jay Powell, you assume okay, if repo rates rise for whatever reason, then JPMorgan will say, yeah, I'll lend to you at 2% or 3% or 10%. We'll do that trade every day. I don't think they appreciated the regulatory constraints and how that handcuffed the primary dealer community. Therefore, they didn't foresee the non-bank primary dealers, how they tried to step in, well, they don't have the balance sheet like Bank of America and JPMorgan do, they have to go into the repo market to borrow to absorb that Treasury supply. That's how I think that this went on, is they really underestimated and didn't appreciate the handcuffs that have been put on the dealer community once you cross a certain level of Treasury supply that all of a sudden couldn't be handled anymore. DANIELLE DIMARTINO BOOTH: Then you pile on top of that the John Williams effect. You've got a pure play academic who's presumably a brilliant monetary economist. PETER BOOCKVAR: He doesn't have a quote machine, I don't think, in his office. DANIELLE DIMARTINO BOOTH: Famously, no Bloomberg machine on his desk. Are the lights on but nobody's home at Liberty Street? That's the sense you get, they have these extremely quiet announcements with somewhat regularity that they're going to be extending out. They just extended out two operations in November, December, and another in early December, that's 28 days, 42. It feels like-- is the Fed throwing spaghetti at the wall? PETER BOOCKVAR: They are and they're doing everything they can at least just to get through yearend by overdoing it, by overdousing that fire that went out on the hopes that at least through yearend, we'll quell it and then we can always pull it back in January, February, when some of these constraints get eased, which we have to see what happens. We don't know. The problem the Fed now is creating is this dependency again. Where is the Fed going to become the repo market? Is the Fed going to become this intermediary that they were never intended to do and to be because the market all of a sudden becomes addicted to them, and can function without them? That's the danger that they now put themselves in going into next year. Rather than saying you know what, maybe we overdid it on the regulatory side, now, they're hamstrung there because of Basel 3, and that's a whole regulatory discussion that needs to be had. DANIELLE DIMARTINO BOOTH: There's been major pushback by Powell at press conferences. He said no to easing the regulatory constraints. PETER BOOCKVAR: Exactly. That's where they're trying to overdo it and overcompensate on the monetary side. Again, like you said, January, February will be the real test to see whether this market can actually walk on its own after being handheld for the last couple of months and certainly into yearend. DANIELLE DIMARTINO BOOTH: I have this working theory that Jay Powell's Boogeyman is this great big monstrous fixed income exchange traded fund lurking in the background. A year ago, fixed income redemptions, fixed income ETF redemptions went up appreciably. We saw high yield spreads go up, the yearend funding strains exacerbated this. I don't think that Powell's forgotten how this worked last winter. I think that it is one of the reasons maybe that he is actually delving into what he won't call QE but on October the 11th, they announced that they were going to be growing the Fed's balance sheet by $60 billion a month, that's not too far off the 85 billion QE infinity rate when the Fed was at its peak level. Now, we're talking about a $1.6 trillion run rate on growing the Fed's balance sheet, 40% of quantitative tightening has vanished into thin air in the space of two months, what took them 21 months to put out there. He's afraid of something. I think that it may have more to do with more than to do with bank balance sheets. Walk us through, if you will, what's happened in corporate credit in the United States as a result of this policy that we're all clearly market participants, corporations alike addicted to? PETER BOOCKVAR: I'm going to rewind back to pre-crisis or actually through the crisis. If there was one area of credit that performed rather well, it was the CLO market. It was these-- and for the average person, these are senior secured loans, as opposed to a junk bond, which is mostly unsecured. It's subordinated to a senior secured bonds. In the crisis, those senior secured bonds actually made it through relatively well. Now, the equity below that, or the subordinated bond below that may not have done well, but the senior side did. People out of the crisis said, wow, this is an asset class, this is a real asset class, it survived the Great Recession, therefore, this is really viable. All of a sudden, this really small market became rather big. If you're a company, and all of a sudden you have this on the demand side for yield, you have this crop of investors that want yield, and if you can sell them debt as opposed to equity, you won't dilute your shareholders. You're getting low cost capital. You think that it's beneficial to you, and if you can sell it senior secured, well, then you'll get an even lower interest rate and if the Fed has rates at zero, and I'm paying LIBOR Plus and LIBOR is close to zero, I can pay LIBOR Plus 300 and because LIBOR is so low, I can afford that. It's great. All of a sudden, as the years went on, more and more, and then you created a bigger CLO universe, and all these entities that were created, so for every CLO that's created, that creates that new demand for these loans. Then Wall Street and companies see, okay, there's this huge demand from these loans and the CLOs, let's feed them more loans to put into their CLOs. DANIELLE DIMARTINO BOOTH: Nice feed as well. PETER BOOCKVAR: It's just back and forth and it's just a replay of the CDO market in the mid-2000s. They kept just creating these new products. DANIELLE DIMARTINO BOOTH: Right. I think that the percentage of covenant light leveraged loans in 2007 was somewhere in the 20% range and remind me, where are we today? PETER BOOCKVAR: Now, you're north of 80 and some that you're actually having-- there's no protections. Here, you have now the leveraged loan market that's north of a trillion, you have the high yield market that is north that. Now, you're in a situation where regardless of how much money somebody is going to lend you, you still at the end of the day have to make those payments, you still need a growing economy in order to service your balance sheet. Now all of a sudden, LIBOR, because the Fed Funds Rate is not zero anymore and even with the cuts, LIBOR is still north of two plus percent. That LIBOR based loan all of a sudden becomes more expensive. If you had sold debt last year, you probably paid even more. Now all of a sudden, the economy starts to slow. You go from a 3% GDP run rate and all of a sudden, you're now at a 2%. Now, that is a one third haircut in the rate of growth. For many companies out there that have profit margin, so let's just say 5% to 10%, all of a sudden, you lose some of that business and all of a sudden, your margins get tight and that loan obligation that you have to pay quarterly to investors, all of a sudden, becomes a bigger nut that you have to absorb. Now all of a sudden, from an investor standpoint, well, rates are going down so floating rate bonds aren't as attractive anymore. There's less demand now for this. Well, these companies need to refinance so they're going to refinance into a situation where there's less demand, credit quality is now deteriorating, you have a lot of now a growing percentage of the CLO market that are trading below 90 cents on the dollar, because investors are beginning to sniff out slower economy, crimp on cash flows, difficulty in paying back that debt. Now, it hasn't really shown up too much in the high yield market in the aggregate, but it's begun to show up in the junkiest part of the high yield market, the CCC area of the market. The CCC yield to worst in the Barclays index. The yield is back to where it was in January. Now, we remember January was right after a pretty rough fourth quarter. DANIELLE DIMARTINO BOOTH: The world was basically ending. PETER BOOCKVAR: Right. When you look at the depths of credit, investors are becoming more discriminating in different credits or beginning to pay attention. Just like with Lyft and Uber and WeWork and all of Silicon Valley private equity VC funded firms, everyone is now beginning to pay attention more to the balance sheet. Everyone is now beginning to pay more attention to cash flows. Even for investment grade companies, listen to their corporate conference calls and every CFO is telling you what their debt to EBITDA ratio is. They're telling you what their debt to EBITDA ratio wants to be by the end of 2020. Because now, investors care. One of the characteristics of the fourth quarter selloff in the stock market last year was those companies with the highest debt to EBITDA ratios got hit the hardest. Now of course, Powell came and save the day, and there's going to be a China trade deal any day now. All of a sudden, those worries went out the door but I do think, again, in that CLO, that CCC market, we're beginning to see the impact of a crimp on cash flows and a more discriminating investor, that's then going to then spill over into the Bs and the BBs. That's really the next thing to be watching. DANIELLE DIMARTINO BOOTH: Yeah. We've actually seen cash stores, cash was almost a $2 trillion, at one point, dominated, by the way, by the seven largest companies in the country. We've seen that come down to about $1.5 trillion in fairly short order. I heard a report at one of the big sell side firms that said, as long as we have growing earnings per share, we're going to be fine, this is a high yield strategist, but if we were to see earnings actually contract, then that would be highly problematic in terms of our default rate outlook. It's convenient that very few now, actually reference fact set data that's only been around since what? September 1978. Because now, fact set has gone negative for all of 2019. It seems to me that Jay Powell's got a growing challenge on his hand because-- you can fill in the blank. If you're Joe Q's CFO, and your investors are on conference calls telling you to pay attention to your balance sheet. What does that preclude you from doing? PETER BOOCKVAR: Exactly. You're obviously no longer buying back stock or you're doing at a much reduced pace. You're focusing more on your capital expenditures. You're hiring. You can imagine that every VC in this country called every single one of their portfolio companies after what happened with the IPOs and WeWork that okay, guys and girls, it's time to focus on profits sooner rather than later. The hiring, let's put a timeout on that and leasing that extra 30,000 square feet of space, well, let's work within our existing space. Because that's what's most important right now. To the point on earnings is the problem right now with earnings is that not only are you seeing a slowdown in the pace of revenue growth, theoretically, revenue growth at least for the S&P 500 should be nominal GDP growth around the world. Right now, the IMF has GDP growth this year at 3%. Let's just tack on 1.50%, 2% inflation, let's call it 5% revenue growth. Now, that's for if you're a multinational. Profit margins are now receding. You have the slowdown in revenue growth, and you actually have now profit margins which are contracting. The earnings estimates for 2020 in the S&P are still like 7%, 8%. Well, that implies that you'll get an acceleration of GDP growth, which maybe, maybe not, but that also improves a real big reversal in this decline in profit margins. One of the key reasons why profit margins are receding is because labor costs are becoming a bigger portion of the expense pot. Let's just say the economy does get better, well, with a labor market that's tight, we can assume that wages will pick up even further, will crimp profit margins even more. Now, it'll be great for those employees that are getting those wage increases. If companies then start to resort to layoffs or whatever reasons try to protect profit margins, that becomes a problem. We look at the last 10 years, earnings did a V bottom, earnings are up dramatically from '08, but revenues are barely higher. There are a few things that really goosed profit margins. It was the cotton in labor costs where the labor portion of the profit pie was the smallest since World War II. DANIELLE DIMARTINO BOOTH: That's a company's biggest cost. PETER BOOCKVAR: You had obviously the stock buybacks, which I argue that last year was the peak. Now, companies focus more on balance sheet improvement. You also had a dramatic decline in interest rates, which goosed or dramatically reduced interest expense which helped profit margins. Well, interest rates are low, but from a delta standpoint, you're not going to get a big drop in interest rates to goose profit margins. I think that that story is not going to be repeated. This is the profit margin side that people have to pay attention to at the same time that revenue growth is slowing. There's just people are trained to think that there's always this V inflection higher in terms of growth, because central bank easing lifts you higher. The problem right now is that the whole point of stimulus, when I want to stimulate behavior through monetary policy, just trying to convince you making a deal with the consumer in the business to say, if I lower your cost of funding today, will you buy the car today or the house today, rather than spending the next two years saving up for it? If rates are already low, that encouragement, that incentive is more-- it's more dull. It doesn't have that same impact because you're like, you know what, I don't need to rush, rates are low. I'm just going to wait. That's why forward guidance was a fraud policy because forward guidance actually slowed growth. DANIELLE DIMARTINO BOOTH: Right, it gave people an excuse to wait. PETER BOOCKVAR: To wait, as opposed to encouraging them to act and you still hear about forward guidance. Forward guidance I think is like an effective tool and it's the exact opposite. We're in a situation where monetary policy is no longer stimulative. DANIELLE DIMARTINO BOOTH: Dot, dot, dot. I love great central banker quotes, just love them. Janet Yellen saying that we will never have another financial crisis in our lifetimes, pure speculation, Peter, nobody's going to hold you to this, I promise, but why don't we end today by you telling me where, in your mind, systemic risk might be lurking in the system if there was to be a geopolitical event or a financial event, something that triggered a daisy chain. Where do you think the weak point is in the global financial system? PETER BOOCKVAR: I think it would be an uncontrollable rise in longer term interest rates that would start whether it's in Japan because now, Kuroda wants longer, higher long term interest rates, or it's the ECB where they finally say you know what, we got to get out of this negative rate environment because we're killing our banks. DANIELLE DIMARTINO BOOTH: Sweden's already gone there. PETER BOOCKVAR: Sweden is dead set on getting out of negative interest rates this December. It is uncontrollable rise in long term interest rates that central bankers cannot control is, in my opinion, the biggest threat because that's where the biggest bubble is. If you get a pop in that bubble, that's to me, the biggest worry. Now, they can control the short end, no question. They'll pin that to zero or negative as much as they want, but as we saw Italy last year where rates can rise uncontrollably in a very short period of time, irrespective of all those purchases by the ECB, that, to me is the biggest risk. DANIELLE DIMARTINO BOOTH: Those CLOs on Japanese bank balance sheets would be in a world of pain. PETER BOOCKVAR: Imagine you get a cost [indiscernible] in the sovereign, what it does to the whole corporate world. DANIELLE DIMARTINO BOOTH: Absolutely. Peter, thank you. Thank you so much for your time today. PETER BOOCKVAR: Thanks, Danielle. DANIELLE DIMARTINO BOOTH: Great visiting.