In 2005, years before the subprime mortgage crisis triggered the Great Recession and drove millions of Americans to lose their homes, Larry McDonald was vice president of the infamous and now defunct global Lehman Brothers financial services. As a young trader, he and many of his peers warned that something was wrong with the property market that year. He was “living on borrowed time,” he would explain years later in a 2009 New York Times articleand Lehman Brothers “was headed straight for the biggest subprime iceberg ever.”
But McDonald’s bosses ignored his warnings, and the 158-year-old institution that was Lehman finally went bankrupt in 2008 after the housing bubble burst. The S&P 500 would continue to lose about 50% of its value in the 17-month bear market that ended in March 2009.
Now McDonald, editor and founder of the widely read investment newsletter “The Bear Traps Report,” is warning that another stock market crash is on the way. He says the “Lehman Systemic Risk Indicators” he developed after the subprime mortgage crisis – which include things like the corporate default rate, stock market short-term interest rates and investor sentiment surveys – are all warning signs.
“[O]Our 21 systemic risk indicators from Lehman point to the highest probability of a crash or sharp decline over the next 60 days – the highest probability since COVID,” he said. said CNBC Tuesday, referring to the March 2020 COVID-induced market decline.
McDonald thinks investors are ignoring the risk of a ‘continuing credit crisis’ after the failure of Bank of Silicon Valley And Signature Bankas well as the unexpected demise of Swiss lender Credit Suisse, and focusing too much on the rise of new technologies like artificial intelligence and robotics.
“We’ve seen this before with Lehman, what happens is a shock happens, credit markets start pricing risk, but not stocks. They focus on things like AI or things like the internet revolution in the 90s,” he warned, winking at the mistakes investors made before the bubble burst. The Internet drove stocks down in 2001.
McDonald noted that even after the Federal Deposit Insurance Corporation (FDIC) stepped in to rescue uninsured and insured depositors from SVB and Signature Bank this month, US banks are still sitting on hundreds of billions of dollars. dollars of unrealized losses. Mortgage-backed securities and US Treasuries that make up the majority of many banks’ holdings have seen their value reduced after a series of aggressive interest rate hikes by the Federal Reserve last year. These losses have led to significant instability in some banks, forcing many of their counterparts to tighten their lending standards and prepare for possible bank runs.
McDonald said the problems with banks were starting to spill over to the commercial real estate market due to the slowdown in lending, and he fears they could infect other sectors of the economy as the Fed hikes rates. to fight inflation.
The good news is that this is “not a Lehman event” that will cause a devastating recession, “it’s just a slow, gradual credit crunch as the Fed fights it behind the scenes,” McDonald said. . But that doesn’t mean stocks are safe – a steep decline is on the way, he warned.
