For many years I have refrained from extensive public commentary about financial markets. My work since 2012 building Exosphere has focused on education, science, technology, and philosophy. But like politics, my intrigue for the financial markets cannot be suppressed indefinitely because both are like poker: people think they are about logical, rational, self-interested behavior, but are in reality nearly the complete opposite. You're never playing the hand you're dealt--you're always playing the other players.
Also like politics, financial markets are a Who's Who of dogs returning to their vomit while advertising their feast as the never before seen creation of the hottest up and coming chef with an underground food truck in Williamsburg. Yet you won't be disappointed, the classic flavor is completely unchanged.
I'm also stepping into this particular fray because the latest news in the markets is of particular importance to the people I work with: technologists, scientists, and startup founders, and it's unlikely anybody else is going to bring this matter to their attention this early in the game.
This week the Commonwealth of Puerto Rico initiated the equivalent of bankruptcy proceedings, seeking protection from creditors owed $74 billion, the largest ever sub-sovereign bankruptcy in US history, and representing nearly 2% of the $3.8 trillion US sub-sovereign bond market. Puerto Rico has an additional $49 billion in unfunded pension obligations bringing the total of its insolvency to $123 billion.
To put this in perspective, Puerto Rico is a sub-sovereign territory of the United States with a population of less than 3.5 million people, about half the size of the metropolitan population of Houston, Texas. The sovereign nation of Greece, a member of the European Union with a population of more than 10.8 million people, has a debt of $246 billion.
Somehow Puerto Rico has managed to borrow more than $35,000 for every man, woman, and child living within its borders, a full third more per capita than Greece, the country largely considered responsible for the seemingly intractable financial crisis of the Eurozone for the past 6 years.
Yet today the markets have opened flat, apparently nonplussed by the event, and undoubtedly the chorus of market cheerleaders on Bloomberg and CNBC will dismiss the event as nothing more than a curious record being set--certainly nothing that should shake investor confidence.
No doubt I will be accused of being a veritable Chicken Little engaged in click-baiting and attention grabbing. But I recall the same dismissive tone on the lips of every market commentator back in 2006 and 2007 when each of the successive dominoes fell, culminating in the collapse of Bear Stearns, the conservatorship of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, and the bailout of AIG.
When the yield curve inverted, nearly three years before the bloodbath, sophisticated financial analysts ignored it, even ridiculing those who worried it might indicate anything other than unshakable strength in the housing-driven economy. If you want to hear what a turkey sounds like the week before Thanksgiving, check out this gem from the Wharton archives [I'm honestly surprised they haven't taken this link down].
On the other hand, the inversion of the yield curve spurred my interest in alternative markets and as the signs continued to add up, I sold everything I had and moved to Chile in June 2008, before the proverbial collision of the excrement and the oscillating ventilation device.
So now as I'm watching a familiar pattern begin anew, I am looking at the debts of New York State, New York City, California, Florida, Texas, Ontario (whose debt is larger than California's!) and imagining the sequence of events that might soon ensue. Just as the debts of banks and insurance companies were absorbed by the federal government, without actually provoking any real de-leveraging, the $3.8 trillion of sub-sovereign debts might as well be accounted for in the official liabilities of the US federal government--because they will be, before too long.
What I didn't understand back in 2007/8 was that the sub-prime mortgage crisis was a domino effect inside of a broader, much longer-term domino effect going back to the end of the Second World War. The social welfare policies of the US and European governments, combined with a culture of debt-driven infrastructure investment set in slow motion the chain of events that will eventually lead to the big default.
We just aren't there yet--and probably won't be for a (little) while longer.
The sub-sovereign debt crisis will undoubtedly be another domino in the chain before the wheels come off of the global financial system completely. If the subprime crisis is a model for understanding the sub-sovereign crisis, we have 1-2 years before things deteriorate to the point of a meaningful crash, followed by 5 years of fiscal and monetary stimulus (probably in the form of effectively nationalizing sub-sovereign debt), followed by 5 years of reassuring talk of a recovery before the cycle again repeats.
We live in the unique time of the gradual collapse of the contemporary version of the Roman Empire, except that it is global rather than regional, and has nuclear weapons and aircraft carriers. The only reason the day of reckoning hasn't come sooner is the silicon chip, which is the one truly transformational technology that changed the game. But the silicon chip didn't change the underlying rules of the game as many people seem to think.
It's like playing Monopoly. If you make it through the initial stage of the game without owning any serious revenue-generating properties, even if you manage to miss hitting Boardwalk, and pass Go a dozen times, one day your luck will run out, and the cash in your hand won't save you.
At a macroeconomic level, this is what the technological advances of the last 50 years have bequeathed us--a lot of cash, without real capital. What we have done is made existing capital unfathomably more efficient at extracting rents for a select oligopolists. Very little of these profits have been invested in the development of new capital, but rather merely in optimizing their own rent seeking operations.
We have been spending capital at an alarming rate since the end of the Second World War--economic, cultural, and environmental. The advances in technology mask the accounting reality in part by altering the relative costs of inputs, but also because iPhones are much shinier and interesting to look at than accounting records. It also doesn't help that the accountants themselves have become just as untrustworthy as the people they audit.
You should also pause to consider the qualitative difference between the subprime crisis and the coming sub-sovereign crisis. With mortgages, lenders at least have some sort of ultimate collateral. The can always repossess a house. It may be a tiny fraction of the value of the loan in a crisis market, but it's something. When it comes to sub-sovereign governmental entities, there is no collateral to repossess. Bondholders cannot demand cities dig up their roads or hand over the keys to their schools. The city of Chicago doesn't have idyllic Islands in the Aegean Sea to auction off as Greece did.
Imagine what will happen to the startup finance markets in the midst of municipal bond defaults. Many startup founders and employees, because of their age or technical background, do not fully appreciate the economic food chain that sustains them. VC funds are largely financed by family offices and institutional investors like insurance companies and pension funds, all three of which depend on the stability of the municipal bond market in their overall asset allocation strategy.
The Kauffman Foundation's extensive study of venture capital has already exposed that as an asset class, it has performed abysmally, but institutional investors have tolerated this risk with a tiny portion of their capital on the off chance they hit it big. When your livelihood depends on conservative institutional investors having the willingness to buy a lottery ticket, you should realize how sensitive that demand is to the safety of the rest of their accounts.
With Puerto Rico's bankruptcy, that safety is now going to be called into question.
If you are in the corporate world, expect that in addition to the already crushing force of automation, your job is even more at risk in times of crisis. If you are in the startup ecosystem, expect things to be even worse. Startup founders have become fragilized by the easy funding environment of the last several years, and the slightest hint of systemic global risk will thin the herd dramatically.
Even with the rise of the so-called "cockroach startup," even more paranoia would be prudent. Startup founders who want to survive the next half decade should examine what kind of metaphorical bunker they need to build. It probably means liquidating high cost cities, more outsourcing, and other things that optimize for flexibility and protect against downside risks, but the specifics are going to differ from startup to startup, depending on industry, product type, and minimum viable burn-rate.
However, those positioned to withstand the shock itself will be able to capitalize on the least competitive environment that has existed in tech since Google, PayPal, YouTube, Facebook, and others emerged alive from or started in the aftermath of the dot-com bubble.