The Big Crunch to One Zero-Day
The Big Crunch to One Zero-Day
The Morgan Report July Edition
What do COVID-19, Julian Assange, Joe Biden, and Donald Trump all have in common?
They teach investors the value of being right in the long term. That makes sense if you’re a long-term investor, right?
Being right in the long term can be described as having foresight or possessing prescience. It means making predictions, decisions, or actions that are eventually proven correct over an extended period, despite potential initial skepticism or contrary short-term results.
Wisdom often encompasses the ability to make decisions or judgments that are proven correct over the long term. It involves not only knowledge and experience but also the insight and foresight to anticipate future outcomes and act accordingly. Wisdom is characterized by deep understanding and sound judgment, which leads to being right in the long term.
To condense time, space, volatility, or risk is really about being right in the long term.
1. Last week, Julian Assange condensed his 12 years in confinement or prison into one sentence about his actions that resulted in a net difference of 7 years after being found guilty on one count.
2. In the US Presidential debate, the public witnessed the choices they made regarding their head of state. It is fair to argue that many more people are qualified for this role compared to Biden.
3. In the same debate and the months leading up to it, the public may have realized some of the false accusations made against the former president.
4. Simultaneously, both the president and the former president were blaming each other for the unintended consequences of lockdowns and their ramifications on the job market, inflation, and a plethora of other economic indicators.
In the upcoming preview for the July edition of The Morgan Report, we delve into the unintended consequences of the global lockdown that could precipitate ‘The Big Crunch’. Over the past four years, there were warnings about the economic implications of the lockdown, but few have directly followed up and connected all the dots. It seems that many are indifferent or stunned like deer in headlights when discussing the ramifications in the post-COVID world. However, these consequences are very real and will persist until ‘The Big Crunch’ unfolds.
When one considers more criminal accusations and the geopolitical overlay of a multi-state war potentially escalating alongside the scenarios described below, readers will gain a heightened sense of the increased probabilities and permutations involved. At the very least, it serves as a realistic and thought-provoking mental exercise.
Enjoy!
The Big Crunch to One Zero-Day
Imagine a game of dominoes.
Setting up a domino run involves aligning the pieces and toppling the first to unleash a chain reaction. This analogy resonates with the current economic landscape, impacting sectors from commercial real estate (which constitutes 50% of global GDP) and municipal governments to community banks, residential housing (400% of global GDP), commercial banks, and central banks with assets totaling 50% of global GDP. Similar to the Global Financial Crisis that originated in Iceland, a comparable scenario is unfolding globally, marked by initial signals:
1. China, 2021:
Evergrande, the real estate giant, faces critical straits with $310 billion in debt, including $37.3 billion due within a year but only $13.5 billion in cash. Legal proceedings in Hong Kong have ordered its liquidation amid major restructuring challenges. Severe lockdowns have exacerbated Evergrande’s problems by slowing property sales and reducing cash flow, making debt management even harder.
2. United States, 2022:
New York Community Bancorp (NYCB) grapples with declining loan portfolio quality, selling over $6 billion in Flagstar Bank mortgages to boost liquidity. By 2024, heightened credit loss provisions, leadership shifts, and credit rating downgrades lead to a sharp decline in stock value.
3. Japan, 2023:
Aozora Bank reports substantial losses from large U.S. commercial property loans post-GFC, resulting in a fiscal year-end net loss of ¥49.9 billion due to increased loan allowances, exceeding earlier forecasts.
4. United States, 2023:
Major real estate firms like Vornado Realty Trust and SL Green Realty Corp face significant challenges as office vacancies soar and property values plummet. Urban markets witness occupancy rates below 90%, with property values down by double digits.
5. Germany, 2023:
German banks struggle in both domestic and U.S. real estate markets, resorting to high-quality mortgage-backed bonds for fundraising amidst crisis. They raised a record €40 billion, responding to what’s termed the “greatest real estate crisis since the financial crisis.”
6. United Kingdom, 2024:
London’s prime office districts experience a downturn, with property values dropping up to 25%. Major developers like Land Securities and British Land write down portfolios by £3 billion, incurring significant losses.
The dominoes click and clack as they crash and crunch, setting the stage for a global economic countdown towards what we term the Big Crunch.
Crunchy Roll
Globally, ominous signs point to a zero-day scenario, with a single tipping point potentially leading to systemic financial collapse. Amid uncertainties, one fact stands: the economy is undergoing profound changes, with only a few poised to emerge unscathed. Post-pandemic transitions and global monetary policies set the stage for the ‘Big Crunch.’ Attempts to downplay pandemic impacts cannot ignore unintended consequences. It’s crunch time.
In physics, the Big Crunch envisions the universe collapsing catastrophically, its expansion inverting until the cosmic scale factor hits zero. This analogy mirrors our societal shift towards a centralized banking system, foreshadowing a reset in the ‘new world order.’
Based on detailed analysis, here is a summary of the game theory probabilities and key factors for the economic “Big Crunch” scenario:
• Commercial Real Estate (CRE) faces a 70-80% likelihood of a significant downturn due to high vacancy rates, declining property values, and $4.4 trillion in global CRE loans maturing by 2027.
• Widespread bank failures have a 30-40% chance, particularly affecting smaller banks despite stress test results favoring larger institutions. This is driven by challenges in commercial mortgages.
• State defaults due to unfunded pension liabilities and underperforming Pension Obligation Bonds (POBs) appear to be significant, estimated in the range of 30-40% based on the analysis. However, the potential for Federal government intervention could help mitigate the risk of outright defaults.
• Government intervention to stabilize the market has a 60-70% probability, drawing on historical responses to similar crises. This indicates likely action by governments and central banks to prevent a complete financial collapse.
• The intervention is expected to facilitate banking consolidation and asset base accumulation for banks like JPMorgan Chase, with a 70% probability that JPM’s stock will rise within 3-12 months following a “Big Crunch” scenario, alongside strong performance anticipated for American Express as well.
The Domino Effect
7. New York City, 2024:
McDonald’s franchisee owners face increasing rents, leading to higher vacancies and driving up taxes needed for city social programs and infrastructure. Commercial real estate firms are scrambling for refinancing amid economic turmoil. Price hikes, exacerbated by rising minimum wages since COVID-19, have pushed McDonald’s meal prices up by approximately 40%, contributing to a downturn in revenues. This economic strain has transformed dining areas into gathering spots for marginalized groups, underscoring broader global economic challenges and the looming ‘big crunch’. Currently, McDonald’s stock reflects these concerns, trading near its 52-week low amidst slowing same-store sales growth and consumer price sensitivity issues.
Cap’n Credit Crunch
The commercial real estate sector in the United States faces historically high interest rates and declining asset values. The potential fallout could result in staggering losses, with high estimates suggesting up to $1 trillion in losses from office property revenues alone. The ‘Great Office Exodus’ triggered by shifts to remote work has amplified these challenges, prompting companies to relocate from urban cores to outer suburbs. This trend has driven office delinquency forecasts for the U.S. significantly upward, nearing 11% by 2025—surpassing even the peak rates observed during the Global Financial Crisis. Across the Americas, Europe, and Asia-Pacific, building occupancies remain stubbornly below pre-pandemic levels, further straining the commercial real estate sector.
Globally, the pressure mounts with approximately $4.4 trillion in commercial real estate loans set to mature by 2027, with the U.S. alone facing around $2.2 trillion due in the next two years. Already, office property values have plummeted by 25-35% from their peak, posing daunting refinancing challenges. The sector now faces a dismal 50% refinance success rate over the last 22 months, with predictions pointing towards further declines in office and retail valuations—potentially triggering a wave of defaults. The situation is exacerbated by the need for borrowers to inject significantly more equity (25-40%) to secure refinancing, highlighting an estimated $180-360 billion of high-risk loans maturing by 2025.
In major cities like New York City, Chicago, Philadelphia, Houston, and Portland, the cumulative loss of 2.5 million tax-paying residents since 2021 reflects a shift in commercial real estate dynamics. Hybrid work models and downsizing during COVID-19 lease renegotiations have reshaped urban landscapes, with remote-friendly industries such as San Francisco’s tech sector experiencing pronounced impacts. Municipalities now face daunting challenges in maintaining public infrastructure and services, often requiring state and federal assistance. For instance, New York City’s receipt of over $28 billion in COVID-19 relief funds underscores the interconnectedness between state finances and municipal resilience. However, this financial lifeline is precarious, given the staggering $1.49 trillion in unfunded pension liabilities across states, coupled with $266.5 billion in pension funding shortfalls across 75 cities.
These financial pressures have prompted some state and local governments to issue Pension Obligation Bonds (POBs), despite their significant investment risks. The assumption underlying POBs—that bond proceeds invested alongside pension assets will yield higher returns than bond interest rates in a historically high-interest rate environment—adds another layer of risk (30-40%) and complexity to an already fragile commercial real estate market. For instance, pensions invest heavily in POBs, deploying over $1.4 trillion in commercial property. As property values decline, especially in the office sector, regional bank write-downs exceeding $500 billion have already been triggered, heightening the risk that investment returns will fall short of POBs’ borrowing costs amidst an imminent credit crunch.
House Arrest: Lay of the Land
The ‘office exodus’ exacerbates this situation, impacting commercial real estate and residential sectors disparately. Heavily taxed urban centers are grappling with inflationary pressures in goods and services, particularly housing costs, which comprise about one-third of the CPI. Recent CPI data also highlights a resurgence in service costs influenced by urban developments that allocate essential services such as healthcare, education, and transportation in urban areas.
These patterns are creating a stark divide in the residential real estate market. Existing home prices are soaring to record highs in areas close to services due to severe supply constraints, while newly constructed homes experience price declines due to oversupply. Investor demand remains robust, contrasting with a dwindling number of first-time homebuyers, which bolsters rental prices. This imbalance is underscored by new construction maintaining an 8.3-month supply compared to just 3.2 months for existing homes—a factor that significantly contributes to housing inflation while limiting overall economic productivity.
One Bank to Rule Them All
Bankers globally face a quandary with residential housing inflation at $287.6 trillion, nearly three times global GDP, surpassing the $50.8 trillion crunch in commercial property. This disrupts dovish monetary policy, prompting the financial sector to brace for potential small bank failures due to mounting troubles in commercial mortgages. The regional banking industry’s ‘extend and pretend’ strategy seems unsustainable, with many office building owners offering fire sales and default on mortgages, risking inevitable losses and threatening community bank earnings. However, large commercial banks and credit card issuers appear better positioned in terms of pre tax net income contraction stress test below.
*Estimates are for the nine-quarter period from 2024:Q1 to 2026:Q1 as a percent of average assets.
The Fed stress tests large U.S. banks based on total assets, assessing their resilience in a volatile economic environment. The scenario involves a severe global recession: a 6.5% to 10% rise in U.S. unemployment, a 36% house price decline, and a 40% drop in commercial real estate prices.
Results indicate that the 32 big banks might lose about $77 billion from commercial real estate loans, similar to last year. Despite more predicted losses for offices, some hotels and shops perform better. This stress alters banks’ corporate portfolios, reducing loans to companies with high credit ratings. Commercial and industrial loans comprise over 60% of bank lending, with lower-rated loans three times more likely to default than higher-rated ones. The outcome projects $142 billion in defaults relative to big banks’ robust balance sheets meeting double the Fed’s minimum capital requirements and strong tier 1 capital ratios.
The Last Crunch
JPMorgan Chase, the largest U.S. bank, is well-positioned to absorb smaller banks in crisis, expanding its $3.9 trillion asset base through Fed mandates and strategic acquisitions. This strategy has proven effective, as seen in its acquisitions of Bear Stearns and Washington Mutual during the 2008 financial crisis, adding over $900 billion in deposits and expanding the branch network across 20 states, which contributed 50 cents to EPS in 2009. The acquisition of First Republic Bank in 2023 is expected to add $500 million to net income annually. By acquiring distressed banks at discounted prices, JPMorgan Chase strengthens its market position during economic downturns.
These strategic moves during economic downturns have significantly expanded JPMorgan Chase’s market presence and asset base. Its success is attributed to a “fortress balance sheet” strategy, maintaining high cash levels and strong capital ratios, such as a CET1 ratio of around 15%. Considering these factors, there is a 70% probability that JPMorgan Chase stock will rise within 3-12 months, even during a “Big Crunch” scenario. This assessment is based on the bank’s strong financial position, history of strategic acquisitions, and potential benefits from market conditions and consolidation. Additionally, rapid rate cuts would likely benefit JPMorgan Chase.
Crunching the Numbers
Using game theory and statistical analysis, I developed predictive models similar to the Evergrande case study. These models identify key variables and thresholds to assess crisis probabilities globally. This approach combines quantitative modeling with expert judgment to evaluate complex, interconnected risks in the global financial system.
Analyzing the potential “Big Crunch” scenario involves evaluating strategies of key players: Commercial Real Estate (CRE) firms deciding between loan defaults and refinancing amidst declining values; banks, both large and small, considering extending loans, acquiring distressed assets, or foreclosing; and government and central banks weighing interventions to manage systemic risks and ensure market stability. Investors must decide whether to buy distressed assets, divest from risk, or proceed cautiously.
Probability assessments reveal significant risks: a 70-80% chance of a CRE downturn driven by high vacancy rates and maturing $4.4 trillion in CRE loans by 2027; a 30-40% likelihood of widespread bank failures, with smaller banks at higher risk despite stress test results favoring larger institutions like JPMorgan Chase; and a 60-70% probability of government intervention to aid states at risk 30-40%. These systemic risks include fluctuating interest rates affecting borrowing costs, liquidity challenges in selling CRE assets, rising loan defaults, and overall market declines amidst operational complexities.
The scenario also faces vulnerabilities from black swan events such as financial collapses, geopolitical shifts, impacts of remote work on office demand, natural disasters, or cyberattacks, which could trigger the “Big Crunch.” Therefore, strategic decisions amidst market volatility and regulatory adjustments are crucial, highlighting the need for rigorous risk management and adaptive strategies to navigate upcoming economic uncertainties.
The unfolding economic scenario, characterized by a cascade of failing dominoes across various sectors, points to a potential “Big Crunch.” The interconnected nature of global financial systems means that shocks in one area, such as commercial real estate, can have far-reaching impacts on banks, governments, and other economic entities. Predictive models and game theory analyses suggest significant risks, underscoring the critical need for strategic, well-informed decision-making to mitigate the risk of a personal zero day.
Two, One, Zero, Day