Financial analyst who called the subprime mortgage crisis warns of imminent stock market catastrophe

Larry McDonald was a vice president at the iconic, now-defunct, global financial services company Lehman Brothers in 2005, years before the subprime mortgage crisis started the Great Recession and caused millions of Americans to lose their homes. Like with many of his contemporaries, he foresaw problems in the real estate market that year when he was still a novice trader. Years later, in a 2009 New York Times story, he would say that it "was living on borrowed time" and that Lehman Brothers "was headed directly towards the biggest subprime iceberg ever seen."

The 158-year-old institution known as Lehman finally went bankrupt in 2008 after the housing bubble burst because McDonald's executives disregarded his warnings. The S&P 500 would later experience a 17-month bear market that concluded in March 2009, during which it would lose about 50% of its value.

A fresh stock market catastrophe is imminent, according to McDonald, the publisher and founder of the popular financial newsletter The Bear Traps Report. The corporate default rate, stock market short-interest ratios, and investor sentiment surveys, among other "Lehman systemic risk indicators" that he created following the subprime mortgage crisis, according to him, are all flashing warning lights.

He made reference to the COVID-caused market decline of March 2020 when he said, "Lehman systemic risk indicators are pointing at the highest possibility of a crash or a significant dip in the next 60 days—the highest probability since COVID.

Following the failures of Silicon Valley Bank and Signature Bank as well as the unexpected demise of the Swiss lender Credit Suisse, McDonald believes investors are ignoring the risk of a "rolling credit crisis" and concentrating too much on the advancement of new technologies like artificial intelligence and robotics.

McDonald pointed out that U.S. banks are still holding hundreds of billions of dollars in unrealized losses even after the Federal Deposit Insurance Corporation (FDIC) intervened this month to save both insured and uninsured customers at SVB and Signature Bank. Several banks' holdings, which mostly consist of mortgage-backed securities and U.S. Treasuries, have seen their value plummet as a result of the Federal Reserve's aggressive interest rate increases during the last year. Several of their colleagues have been forced to tighten lending rules and prepare for potential bank runs as a result of these losses at some banks, which have caused major instability.

Due to the lending slowdown, according to McDonald, banks' problems are starting to affect the commercial real estate market. McDonald is concerned that when the Fed raises interest rates to combat inflation, these problems could expand to other areas of the economy.

The good news is that the Fed is actively battling this credit crisis behind the scenes, so it is "not a Lehman scenario" that would trigger a severe recession, according to McDonald. But that doesn't imply stocks are secure; he cautioned that a significant drop is imminent.

Ref: (2023. March 27) Fortune. (2023. March 27) YahooFinance.