The predictor of virtually every major financial crisis during the last 200 years has been runaway private debt fueled by lending institutions and their leaders’ fierce ambition, according to Richard Vague, founder and managing partner of the venture capital firm Gabriel Investments.
In an interview with ThinkAdvisor, the former banker discusses his years-long research into these crises, which culminated in a new book, “A Brief History of Doom: 200 Years of Financial Crises” (University of Pennsylvania Press-May 2019).
Vague’s detailed analyses of 43 financial calamities in six of the biggest countries worldwide over two centuries show that lending misbehavior sparking rapid, excessive private-loan growth and subsequent overcapacity has been, unfailingly, the prelude to these meltdowns.
What’s more disconcerting is that the long-term global trend is toward ever-higher levels of private-sector — household and business — debt. Indeed, in a May 20 speech, Federal Reserve chair Jerome Powell expressed concern over growing business debt. “Could the increase in business debt pose greater risks to the financial system than currently appreciated?” he asked. “My colleagues and I continually ask ourselves that question.”
Before the 2008 crisis, the Federal Reserve sent Americans misleading signals, insisting that the U.S. economy was in good shape, Vague maintains. But the Fed was not including private-debt growth — that is, the rapidly rising rate of bad loans — in its models, and neither did mainstream economists, he says.
As for this former banker, who has run two commercial banks, Vague saw trouble brewing in mortgage loans as early as the fourth quarter of 2002, he recalls.
Government debt, contrary to popular thought, is not a forecaster of financial crisis, according to Vague. Another fact likely to surprise: Just $10 trillion of America’s $30 trillion in private debt is held at commercial banks, he says. The rest is with secondary institutions, like hedge funds, which are lightly regulated or unregulated.
Vague, 63, was CEO of First USA Bank (sold to Bank One) and Juniper Bank (sold to Barclays); and he founded and ran Energy Plus, a supplier of electricity and natural gas (sold to NRG Energy).
How to break the cycle of excessive private loans that lead to overcapacity, bank loss, bank failures — and ultimately financial crises? Vague discusses that in the interview. Spoiler alert: He’s not shy of the “R” word.
Notwithstanding, he offers advice to financial advisors on how they can help clients invest with caution by knowing which countries are rife with runaway private debt: A certain rise in the ratio of private debt to GDP over a specific period is an early warning sign of lending misbehavior.
ThinkAdvisor recently interviewed Vague, on the phone from Gabriel’s Philadelphia headquarters. The native of Wichita Falls, Texas, is a notable philanthropist who has been flirting with the idea of running for president in 2020. In our conversation, he comments on what America needs now. Vis a vis avoiding a financial crisis, he stresses: Heed the danger signs of out-of-control lending.
Here are excerpts from our interview:
THINKADVISOR: Periods of excessive runaway private debt — household and business — have occurred prior to numerous financial crises over centuries. Why is this pattern repeated over and over?
RICHARD VAGUE: We’ve had crises in 1792, 1819, 1837, 1873, 1884, 1893, 1907, 1914, 1929 — and the list goes on and on. It’s because the way you get ahead in the banking industry is by making more loans. The way you get a raise and a promotion, a bigger bonus and get your stock price up is by growing the revenue of the bank. So early on, lending serves to increase asset prices — and it looks like you’re doing something very smart.
And then what?
You’re making mortgage or commercial real estate loans, and that means there are more buyers of homes and buildings. Any time there are more buyers than sellers, prices get low.
Financial crises tend to follow the same plotline, in which runaway debt plays a major role, you write. Please describe that plotline?
Banks and other lenders get confident and start making more loans — especially in real estate. Prices rise, which increases the enthusiasm of the lenders. So over a relatively short period, they make increasingly aggressive loans under increasingly looser credit criteria.
What’s the upshot?
Vast excess capacity — houses that won’t be sold, buildings that won’t get tenants. The lenders who make these loans, in many cases, end up with more bad debt than capital. At that point, it all unravels.
Many believe that excess government debt is a forecaster of financial crises. True?
It isn’t growth in government debt that’s predictive of financial calamity in developed countries. Government debt doesn’t correlate to financial crises.
Why are there periods when bankers aren’t aggressive and loans aren’t growing too rapidly?
After a boom, because of the carnage, regulators have a stronger hand; and internal risk managers within lending institutions have more credibility and more sway.
Growth in the ratio of private debt to GDP can be an early warning sign of crisis, you write. What would be excessive?
If you see growth of more than 3% or 4% a couple of years in a row.
Is it hard to spot lending misbehavior?
No because it’s never subtle. It’s big, egregious changes to lending policy: It’s no down payment; it’s making a credit approval based on interest rates that are artificially low.
In which lending sector does the trouble start?
Generally not the mainstream commercial banks but the secondary financial institutions that are less regulated or unregulated. They include private equity and hedge fund lenders — all the sources of debt outside of banks.
How does that compare with bank-sourced debt?
In the U.S., there’s $30 trillion in private debt — but only about $10 trillion of that is held within commercial banks.
The long-term trend is toward ever-higher levels of private-sector debt, you write. In the U.S., what is recent history showing?
Debt has tripled from about 50% of GDP in around 1950 to 150% today. We’ll see a slight bit of deleveraging, but the long-term trend for most countries is toward higher levels.
Right now, where is the level worst?
The part of the world that has a lot of excess private debt growth is Asia, especially China and its economic satellites. China is now well above 200% private debt to GDP. Japan is near that level.
What’s the rate of increase in the U.S. nowadays?
The level of 150% has been reasonably flat over the last several years. There are some small pockets: High-yield lending has been a little excessive, like student debt, certainly. Subprime auto lending has been excessive. So we’re seeing an uptick in certain categories. The chairman of the Federal Reserve [Jerome Powell] made a pronouncement [on May 20] that he’s getting a little concerned about the growth of business debt. But it’s not anywhere near the level it was in 2007 and 2008.
Can runway private debt be prevented?