82 THE BiG DROP
Right now, my favorite hypothesis is that the world is fac-
ing a $2 trillion tsunami of bad debt coming from oil drilling,
emerging markets and corporate junk bonds. This debt will
not go bad until late 2015 or early 2016 and thereafter.
Even money-losing operations can keep up debt service for
a while by using working capital and cash flow — at least until
the cash runs out. Banks that hold some of the debt can also
cover up the losses for a while with accounting games such
as fiddling with what are called their loan loss reserves. If I’m
right, bank stocks may take a hit by early 2016 as these losses
come home to roost.
Using the language of Bayes’ theorem, bad debts will be
the “cause” of a decline in financial stocks. What “effects” am
I looking out for to test the validity of my hypothesis? There
are many.
For energy junk debt, we can look at rig counts in the oil
patch and layoffs among energy exploration companies. For
emerging-market debt, we can look at the strong dollar and
dwindling hard currency reserves in countries like Russia,
Turkey, Mexico and Brazil.
In short, we can work backward from these visible causes
to test the validity of the original hypothesis. Right now, the
idea that financial stocks will suffer due to write-offs by this
time next year looks like a good one.■ Junk Bond Meltdown
Over the coming months, I believe we could see an econom-
ic meltdown at least six times the size of the 2007 subprime
mortgage meltdown.
Circumstances lead me to believe it could play out like
the meltdown I experienced in 1998 after Long-Term Capital
Management (LTCM) failed.
This time, however, there will be several crucial differences