The US stock market is bullish, but there are signs that the financial system has found new ways to re-produce risky lending crisis eerily familiar to the notorious sub-prime loans in 2008.
Michael Roberts is an Economist in the City of London and a prolific blogger.
Cross-posted from Michael Roberts’ blog
Let the Financial Times sum it up: “US stocks ride AI hype and trade truce to 6-month winning streak S&P 500 and Nasdaq post longest runs of monthly gains in years.” The FT points out that US stocks have hit their longest monthly winning streak in four years as AI hype, declining interest rates and Donald Trump’s move to dial back his trade war led the way. The S&P 500 rose in October for a sixth consecutive month of gains, and reached its 36th all-time high this year last Tuesday. It is the best run for the index since August 2021.
Any concerns about an AI bubble in the making, and signs of weakness in the US labour market have been eclipsed by a torrent of bullish spending announcements and strong earnings from Silicon Valley tech groups. And then the one-year deal between China and the US to postpone export controls on rare earths and chips added more to bullish sentiment. The Federal Reserve also delivered its second rate cut of the year on Wednesday. The Fed rate cut followed an explosion of mergers and acquisitions across corporate America, with more than $80bn worth of deals struck on last Monday.
The tech giants delivered their quarterly earnings results. Amazon shares rose 12 per cent on Friday, adding almost $300bn to its market value after the company’s cloud business reported its strongest quarterly growth in nearly three years. Meta sold $30bn of bonds to finance AI projects and the bond sale drew about $125bn of orders — the grade corporate bond. largest-ever demand in dollar terms for a US investment. Nvidia became the first company to reach a capitalisation of $5tn and Apple topped $4tn for the first time. “Yes, this is a bull market that’s run a long way . . . but at the moment the tech firms just keep on delivering,” said John Bilton, head of global multi asset strategy at JPMorgan Asset Management. “The fact everyone is telling me [tech] is a bubble makes me think it’s got further to go.”
Investment advisors were ecstatic: “There’s a greater consensus that the impact of AI is going to be real and transformational, earnings season is turning out well, we are at the beginning of a Fed rate cutting cycle, and there’s optimism that there could be a reasonable [US trade] deal with China,” said Venu Krishna, head of US equities strategy at Barclays. All the doom mongers have egg on their faces. The US economy is not in a slump, inflation is not out of control and Trump has made a trade truce with China. So everything is hunky dory in the best of all possible worlds.
But is all really so well? The stock market boom has taken the ratio of stock market prices to corporate earnings to new highs. The P/E ratio, as it is called, is now some 40% above its historic average and surpassing the ratio reached during the so-called ‘dot.com bubble of 2000. That bubble burst with a fall of 40% in the P/E ratio.
In previous posts, I have pointed out that the US success story is almost totally due to the expansion of AI investment by the tech giants, which continue to rack up big profits. But the rest of the US corporate economy is in the doldrums. In the corporate sector, earnings are still rising, but at a slower pace, up over 18% yoy at the end of 2024, but in in Q3 2025, rising at 10.7% – still good but on a downward trend.
Source: FactSet
The rate of profit, although up from the depths of the pandemic slump, is still low historically, while profit growth is slowing in the non-financial sector.
Source: BEA
Even the Magnificent Seven are forecasting a fall in earnings growth, mainly because of heavy AI spending. At Meta and Amazon, profits are supposed to grind down to nearly nothing. As for working people, the market for labour has been weakening. Net new jobs are disappearing.
And once people lose their jobs, it is increasingly difficult to get another.
No wonder the euphoria in the stock markets is not mirrored in the labour market. American consumers have never been so depressed by their situation.
But the only joker in the economic pack of cards, according to investors and corporate strategists, is the public sector. The US government is still running huge annual budget deficits and thus driving up the level of government debt, and so increasing the cost of servicing that debt.
Apparently, this is the reason for low investment in productive assets: government bond issuance is rising so fast that it is ‘crowding out’ credit for the private sector to invest in productive assets. This is nonsense. There are now many studies that show that interest costs are not the first worry for companies. The main question for firms is: what return in profits will there be from new investments?
The reason that public sector debt has risen so much in the 21st century was the bailing out of the finance and private sector during the global financial crash of 2008-9, the euro debt crisis through to 2012, and the fiscal support necessary for people to get through the pandemic slump of 2020. Those were the periods when government debt ratios rocketed. In the periods in between, policies of austerity (particularly in cutting welfare benefits and investment in infrastructure), along with a some recovery in growth, kept debt ratios more or less stable. Meanwhile, cuts in personal income taxes (particularly for higher income groups) and corporate profits taxes meant that government tax revenues as a share of GDP remained flat at around 35% of GDP, while government spending to GDP rose (IMF).
Source: OECD
Debt does matter, but the debt that matters in a capitalist economy is not so much public debt, but corporate debt. The latest estimates are that in the major economies, some 30%-plus of companies have so much debt that they do not earn enough profits to service that debt.
Source: Bloomberg
Despite most central banks cutting short-term interest rates, borrowing rates for corporations have not fallen so much. The big cash-rich companies do not need to borrow and if they do, they can get the best rates. The AI companies are still able to fund their huge capital investments from existing cash reserves and earnings from successful core businesses, although that cash is being drained fast. But other companies are dependent on the banking sector to keep bailing them out.
And here is the risk. In the US, smaller regional banks got into deep trouble in March 2023, when start-up tech companies started to take out their deposits to keep going and the banks could not meet their obligations. And last month, JPMorgan CEO Jamie Dimon delivered a cryptic warning to the financial system. Referring to the bankruptcies of auto parts supplier First Brands and subprime auto lender Tricolor Holdings, Dimon said: “When you see one cockroach, there’s probably more. Everyone should be forewarned on this one.” JPMorgan lost $170 million on Tricolor. Fifth Third Bancorp and Barclays also lost $178 million and $147 million. Some US regional banks were also back in the wars. First Citizens Bancshares and South State lost $82 million and $32 million, respectively.
And just as in March 2023, European banks are in the mix. Back then, it was the mighty Swiss bank Credit Suisse that went under. This time, European banks BNP Paribas and HSBC each called out specific write-downs of $100 million or more in loan exposure. And just as in March 2023, it appears that fraud is involved. Apparently, $2.3 billion in so-called ‘factoring deals’ have “simply vanished” from First Brands accounts.
That’s the risk to the commercial banks. But increasingly, the big banks are not lending directly to companies, particularly smaller ones, but instead providing ‘liquidity’ to non-bank lenders, so-called ‘private credit’ companies. Non-bank financial institutions now account for over 10 per cent of all US bank loans. While direct on-balance-sheet funding by banks has declined sharply since 2012, the use of credit lines to non-banks has expanded significantly, now representing approximately 3% of GDP. Having grown from $500 billion in 2020 to almost $1.3 trillion today, private credit is an increasingly important source of financing for companies.
Much of this private credit lending is now used for household mortgages – shades of 2007.
As this private credit is not on bank balance sheets, it is not regulated. That could mean that there may not be enough capital in the credit companies to meet any losses if the companies they lend to go bust. Then the private credit companies could also go bust or need a big bailout by the commercial banks – a classic ricochet through the financial system – and perhaps onto the ‘real economy’.
Such ‘systemic risk’, as it is called, is dismissed by most financial strategists. Goldman Sachs recently went out of its way to argue that there was no risk from non-bank private credit companies going belly up. On the other hand, Bank of England governor Andrew Bailey raised “alarm bells” over risky lending in the private credit markets following the collapse of First Brands and Tricolor. And he drew a direct parallel with practices before the 2008 financial crisis.
Referring to how ‘repackaged’ financial products have in the past obscured the risk of the underlying assets, Bailey said: “We certainly are beginning to see, for instance, what used to be called slicing and dicing and tranching of loan structures going on, and if you were involved before the financial crisis then alarm bells start going off at that point. Tricolor and First Brands both made use of asset-backed debt, with the subprime lender bundling up car loans into bonds and the car parts manufacturer tapping specialist funds to provide credit against its invoices.” Bailey’s comments follow a warning last month from the IMF that US and European banks’ $4.5tn exposure to hedge funds, private credit groups and other non-bank financial institutions could “amplify any downturn and transmit stress to the wider financial system”.
So the stock market may be booming and the AI hype is still exploding, but the rest of the economy is not so buoyant; and there appear to be cockroaches eating into the clean running of the world of debt. Watch that space.
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