US Downgrade, The Debt Tsunami, and the Week that Changed my Life Forever
Also this week - how I came up with the name of this blog - all wrapped into a very personal story about the week that changed the trajectory of my professional career forever.
Cartoons of the Week:
Flash Back - August 2011
It was a hot summer going into a new month. I was working in Philly the first week of August, spending most of my time on the train to and from New York for a credit conference and a handful of meetings to market the hedge fund I became manager of only a year earlier.
I was nervous to travel that week. My wife was 9 months pregnant and was due within a few weeks. This was my last scheduled travel before our due date.
At the time I was a father to a 20-month-old boy named Shane. I was still getting accustomed to this being a father thing. What they do not tell you as you become a father is the fact you really have nothing to do. It is very awkward. You prepare; paint a room; buy new furniture; have parties; and take crash courses on taking care of a little human. But as the father, it all just seems so unreal. At least for me, it was all show. It was not reality.
Even when my son was born, all he wanted was his mom. After all, she had the goods. She knew how to comfort him and had the food he needed to survive. My job was to clean the little guy after he relieved himself. I had the dirty job.
The one other thing they do not tell you when you become a father is just how regular a baby's bathroom schedule is. Before having kids, I never thought someone could go 5- 6 times a day.
In any event, this time it was going to be a girl. I had no idea at the time how to think about being a father to a girl. As an only child, I still could not get my arms around the fact I already had Shane who depended on me. Now I was going to have a girl. To say I was nervous would be an understatement.
In my professional life, everything was going great. I was living my dream.
In those early days as a broker back in 2000-2001, I was always upset trying to explain away what some random stranger running a mutual fund was doing with my client’s money. I felt I was on the hook to make excuses for someone else’s decisions and actions. That always rubbed me the wrong way. So my goal from those early days was to be the man in charge. It took me over 10 years to make it happen, but with a ton of luck, and a crap load of hard work, I finally made it. Now I was in charge. Now I was the one pulling the trigger. The person who gets paid for what he kills. And I loved every minute of it.
As we approached the first weekend of August, I worked from home that Friday, finishing up my daily review of our fund’s positions, our weekly performance in the market, and how much beta and market exposure we had to close out the week.
We were on a good run. In the previous 19 months, we were up 13 of them during a very turbulent time in the market. More importantly, during this time our biggest monthly drawdown was only 2.26%, which we made up for within 5 weeks. In the other down months, we were down less than 1%.
In the hedge fund world, especially for smaller funds, you are not judged on quarterly or yearly performance, but on monthly performance. Each month is do or die.
During this time the markets were volatile due to the European debt issues, Fed tightening, and debt ceiling talks. In 2010, the S&P 500 had a drawdown of over 14% in June and July and then another 6% drawdown during the summer months of 2011 going into August.
Because of our low volatility, minimum drawdown, and negative correlation to the markets, we were finally getting noticed. Or at least noticed by the fast-money guys. This is who I met with during my meetings in New York.
When you are starting out in the most competitive market in the world, you scrap and beg for any new dollars you can get invested with you.
Usually, those new dollars came from the fast-money guys. You know these guys. The fast-talking, slicked-back hair type of guy. They usually worked for a Fund-of-Funds or broker with some shady friendship with people in China or the Middle East. They want you to give everything and them to do nothing. They want discounts on fees, for you to be on call 24/7, to funnel some trading flows through their personal firm, and to give them your best ideas so they can trade their PA and make some money for themselves. It’s a shady business but to be expected when you have billions of dollars in fees and profits to doll out each year.
As Friday came to a close and I finished up my duties, I closed my computer and was planning on having a light weekend playing with the little guy, cooking a pork butt on my new Green Egg, and being there for my wife who was not feeling well and ready to pop.
As the day turned into night, a few hours in on the pork butt on the grill and my second beer, I received a message to look at the BREAKING NEWS.
The headline read:
This was big. I mean, really big….
This took away the U.S. AAA rating for the first time since 1941 and put the “risk-free” asset of the world at risk.
My boss and colleagues had an emergency call that Friday night to discuss the news and what our positions looked like and how they may be affected across the many different funds we managed.
No one really had an idea how the markets would react to this news, as this was the first time the “risk-free” asset of the world was downgraded. All we knew was that Monday was going to be a dozy.
August 2, 2023
Just like in 2011, this week the US debt was downgraded; this time by Fitch rating services.
Unlike the first time this happened in 2011, this time it was almost like a passing headline. No one really cared.
The markets moved lower on the news and the treasury market saw higher yields, but this time compared to 2011 seems like a nothing burger.
As Jamie Dimond stated on CNBC yesterday, ”It does not really matter that much.”
Treasury Secretary Janet Yellen described the downgrade as “arbitrary.”
Like any event we call a “black swan”, the second time it happens, the reaction is usually much more muted than the first.
But while this event and action may not be as big as the one from 2011, I think the validity of it is more timely today than it was in 2011.
As David Beers, the former head of S&P Global Rating agency who covered debt and was the lead analyst on the U.S. downgrade back in 2011 stated,
“The underlying fiscal position and underlying debt trajectory has picked up pace. AAA is the top rating that agencies can assign, and the U.S., and any other sovereign, has no God-given or automatic right to that.”
One of the reasons for the downgrade was the continued issues we have in Washington.
The issues in Washington are not new but are more acute than ever. Since 1985, the House and Senate have only agreed on a joint budget resolution four times, with the most recent in 2003.
This past debt ceiling debate had many feeling the U.S. was going to REALLY default this time on its outstanding debt. In fact, there are members in Congress today who would have cheered if this had happened.
[B]udgeting is a fundamental part of governing, and the fact that Congress has not taken this role seriously shows just how broken our budget process has become," Committee for a Responsible Federal Budget President Maya MacGuineas said in a statement.
https://rollcall.com/2023/04/14/congress-will-miss-its-budget-deadline-thats-not-unusual/
Besides the cesspool issues we see in Washington, what really caught my eye is how bad our fiscal situation has become.
Per the Fitch release, they see our debt-to-GDP ratio reaching 118% by 2025.
This is in line with where our debt-to-GDP ratio was AFTER World War II and after the COVID pandemic.
This is WAY higher than any other AAA-rated country debt, with the average AAA-rated debt at only 39.3% of GDP.
American privilege at its finest. The dollar reserve currency status has enabled us to get into this position.
As Mr. Beers continued,
“It’s fair to say that the rating agencies, based on their own criteria, have been pretty timid in their actions. If anything, Fitch’s actions today simply confirm what S&P decided back in 2011.”
As I will talk about in the coming months in my multi-part piece on Globalization, this is what is bringing our adversaries around the world together for the first time to try and combat the dollar dominance in the world markets.
The BRICS countries represent 43% of the world’s population, 16% of the world’s trade, and a larger share of the world’s GDP than the G7. Nineteen additional countries are reportedly interested in joining the alliance.
https://www.wilsoncenter.org/blog-post/brics-rivalry
If you go to usdebtclock.org, you can see in real-time what our situation looks like.
To pay off our national debt today, each tax-paying citizen would owe $253,686. That is on top of the $73,446 average personal debt bill each citizen owes today already.
Even with this ugly backdrop, no one is trying to make a change to this tsunami of debt.
Both political parties are in on the joke. Push major decisions out far enough to get reelected. Get reelected through distraction and creating anger with the voters. Once elected, continue with the distractions and anger while on the side you inside trade, get free healthcare, and increase your salary. In 20 years, exit as a multimillionaire ten times over. Some get so addicted, they stay forever.
While the people in charge are getting rich, we continue to fall further and further into the hole. As the Fitch piece highlighted, our yearly budget deficits continue to get bigger over the next few years.
With a forecasted deficit of 6.6% in 2024 and 6.9% in 2025 (red line below), we will continue to be adding to our national debt at unprecedented levels.
As you can see, we have only run deficits like this during World War 2, after the financial crisis, and during COVID.
And this is in spite of a very strong economy, markets, and tax base over the past year or two, which is quickly reversing.
Using future projections, within the next 25 years, interest expense will be our top spending expense as a country.
Some of this would not matter as much if we as a country took advantage of the low-interest rate environment and issued long-dated debt at record-low rates.
But like any ship without a captain, we failed to take advantage of the 0% interest rate environment we just went through for the past 10-plus years.
As you can see below, we have over $9 TRILLION in debt coming due in 2023-2024.
As this debt comes due, it is rolling off 0.50% and 1% interest rate expense in exchange for 5% to 5.50% interest rate expense.
This has quickly pushed our interest cost on our debt above $1 trillion per year.
And while many are arguing we need to look at interest cost as a percent of GDP, which looks a bit better than the chart above,
We are still above average and have seen it worse only during the Reagan and Bush years.
I am afraid if rates stay up near 5% and $9 trillion in debt is refinanced at that higher rate, the line above will go vertical, putting us on par with what we saw in the late 1980s and early 1990s.
Many have argued if you print your own currency and issue out debt in your own currency, you cannot default.
This may be true, but at what point does the world lose confidence in the security of the dollar?
At what point will it matter? Do we really think we can print endless dollars and endless deficits without the world noticing or looking for a different alternative?
I think we may already be there. (go back up to the BRIC picture above and read the small caption below it. It is real this time.)
The world is changing rapidly.
We as a society right now are so caught up in the stupid politics of today that we will NEVER get together and plan out accordingly how to combat this potential risk. It’s not sexy. Instead, we focus on a Trump indictment or the wicked “Biden Crime Family”, all drama that hits your social media account or cable news network each day. As a result, we will continue as we have for the last 12 years since the first downgrade, kicking the can down the road.
Just know this - While the U.S. has proven to be the best model for any society ever in human history, the most powerful and best societies of the past have ALL ceased to exist because of too much debt.
It does not matter until it does. Then it’s too late.
Flash Back - August 7, 2011
“Wake up!!!”. I was in my 3rd dream of the night when my wife shook me out of sleep.
“It’s time.”
That is all she had to say. I jumped out of bed, grabbed our “oh sh*t” bag from the corner of the room, and helped my wife to the car.
She was an absolute trooper. Despite the frequent contractions and dilation that was happening, she was able to walk herself into the hospital. Absolutely amazing. If you have never watched a child’s birth, just know, if it was up to men to have kids, we probably would have gone extinct as a species a long time ago.
Our little baby girl came out with no issues and was born at 10:10 am on August 7th, 2011.
We named her Mackenzie Kailani Nolan.
MacKenzie was an old Irish name we have always loved and Kailani was the name of the boat we were engaged on that does sunset sail trips still to this day each night out of Clearwater Beach, Florida.
The Week of August 8, 2011 – The Few Days That Changed My Life
My wife and Kenzie were released from the hospital the following day.
As we settled into our new life with two little kids, my phone was none stop with messages and calls on what was happening in the markets.
The Sunday evening futures opened up lower and continued to tank. I went to bed but was not able to sleep.
Between the excitement of the day and the worry of tomorrow, I tossed and turned nearly the entire night.
I woke at 4:30 am.
As I looked at the futures continuing to move lower, I looked at our projected loss in our fund. It was bad. I mean, really bad.
I can count on one hand, over the previous 3 years, when this fund closed down with over a $100,000 loss on the day.
The projected loss at 5 am on the morning of August 8th was $1.5 million!!!
That day, between getting my new baby girl home along with my wife, I implemented option and CDX rate hedges to stop the bloodshed.
The following day the markets rallied, creating bigger losses for the hedges we put in place.
Through the multiple meetings of the day, we decided to keep our hedges in place, despite the losses we accumulated over the past 24 hours.
The takeaway was to “trade around them” to keep losses as low as possible.
Each day after the close we held a detailed meeting on all our positions, hedges and liquidity profile.
By August 10th, the markets again tanked, testing the lows we saw on August 8th, making us happy and relieved that we had the right approach. The market was down big again and our losses were minimal.
But then the following day, the market again rallied, creating even larger losses on our hedge position and really setting in place another huge loss on the day.
The following morning I woke to a crying baby at 4:30 am, stressed, weary, and tired.
I told my wife to get some sleep and I will take our baby girl and try to feed her with a bottle.
As I held my little baby girl in my arms, feeding her a bottle and having her look at me with the innocence only a baby can exude, I was trying to trade our hedges and see if we could find liquidity for some of our positions to adjust for the new volatility and risk profile in the market. I was basically day trading and having the market dictate my actions.
I was an emotional wreck. But then something happened. Something that changed the course of my career forever.
I dropped my baby girl’s bottle on the floor. That was it.
Some say enlightenment, or wisdom, or whatever you call it comes in mysterious ways. Well for me, that moment was at 6 AM on Friday, August 12, 2011, when my baby girl’s bottle hit the floor.
At that moment I said to myself “WTF are you doing!!!”.
You have one chance in your life to hold your new baby on her first week at home and you are trading green and red dots on a computer and making moves in your fund that will probably be pointless when you look back in a few months.
At that moment a grabbed a screenshot of our fund’s positions and then closed my computer.
I texted my boss I could not work because of my daughter being home and my wife needing help and will not make any meetings that day.
On August 8th, 2011, the S&P 500 closed down close to 7%. That day is now known by the name “Black Monday.”
On August 9th it rallied over 5%, only to give all that back the following day, then rally into the end of the week to close down only 1.7% on the week.
Our fund closed the month of August down 10.11%, the worst drawdown the fund has seen since the middle of 2008 and by far the worst month I have ever witnessed as a member of the fund’s investment team.
Once we printed our return number for the month, I took calls from investors who were angry. Many of the fast money guys said we sucked, hung up the phone, and pulled their money.
In September, the S&P 500 was down another 7.20%. Our fund was down only -0.97%.
In October the market rallied back up 10.8% and continued to rally through April 2012.
In March of 2012, I pulled up that screenshot I took the morning of August 8th. I compared the performance of those holdings to that of the account we made changes with, including the hedges.
Wouldn’t you know it, if we did nothing at all, our performance would have been much better by March 2012 than it was with all the changes we made and hedges we put into place.
And that is when I saw through the joke of the entire thing. I was so caught up in the day-to-day and month-to-month action I forgot about the bigger picture.
Markets move. Markets fluctuate. But they inevitably go higher. Investing is about the long-term. No rational investor should ever judge performance on a monthly basis. There is just too much noise and not enough signal.
On a personal level, my ego’s need to compete and sell my soul to make the most money went away overnight.
No dollars in the world can compete with the precious time we have with loved ones.
At the end of the day, I made it to the top, looked out, and did not like what I saw. I did not like who I had become.
It took me a while to digest those feelings. I still traveled through 2012 and was on the road an average of 3-4 days a week in 2013, missing quality time with my two little ones and my wife, who was expecting our third child.
But looking back, that moment never left me. The need for something different continued to build up inside of me. The joy had left me that week and was replaced with me going through the motions and seeing how silly the entire process was.
In 2014 I started a new journey to find a job where I could do what I loved without selling out my family or my personal integrity to the highest bidder.
Shortly after that, I started working for Northern Trust, where I continue to work today.
I am here today writing this to you working for a firm that puts integrity and honesty first and allows me as a father and husband the opportunity to service you as a client but also put the things that are the most important in my life first.
I now have four kids between the ages of 8 to 13. My personal goals are no longer about Sharpe ratios, new dollars, or correlations. My goals now are being there for my family, never missing a soccer, baseball, or football game, coaching my kid’s teams, and helping my wife in her personal journey back into the working world.
Most importantly, my personal daily goal is to be the best I can be in this journey through the thing we call life.
As the rapper Eminem stated,
“Look, if you had one shot or one opportunity to seize everything you ever wanted in one moment would you capture it or just let it slip?”
I always thought this saying was about getting what you want in life. Money, power, and ultimately the position of FU. But now I view it and think it’s about loving what you got. About stopping for a moment, forgetting the past, and not worrying about the future, and just being, cherishing the little things that happen.
I feel like the week of the U.S. debt downgrade changed my perspective on life forever.
I went from being a true amadan (Irish Gaelic word for Idiot or Fool) who just focused on making money to a more enlightened soul, who has found a fantastic work-life balance and true meaning to why I get up each day.
So while many have looked back this week and talked about the very turbulent times we faced in 2011 during the first downgrade, every time I hear it come up, it puts a smile on my face.
Thank you to S&P Credit Agency. I owe you one.
Review of what happened in 2011.
Broadcast from that day.
https://www.cnbc.com/video/2011/08/08/market-crash-destroying-confidence.html
What happened the last downgrade in 2011