The Expert Podcast

So this isn't the first time you've heard about the fact that we may be in a recession and it probably won't be the last. But where's this recession coming from? And beyond just some talking head on the news saying we're in a recession, what does that mean, how long is it going to last, and why is it happening? Well, here are two pieces of news you probably won't see somewhere else that gives you an indication of what is the core of the financial crisis that's causing the recession.

Here's an article from business journals where the CEO of one of the major hedge funds, Sequoia Capital, very similar to BlackRock or one of the other large capital investment companies, are advising their member companies to start conserving cash and slash spending. How does this happen? Well, the way that companies conserve cash and slash spending starts with layoffs, and you'll see this happening much more frequently in the news. Start paying attention to how often you see a news story about a company laying off workers.

Some of the major tech companies have already started: Netflix, Carvana, many other large companies are laying off hundreds, sometimes thousands of workers. And it may seem that, well, maybe it's just that industry — you know, major mortgage companies laying off workers — but it's more than just the industry. The smart money, the hedge funds, you know, Sequoia Capital, has billions of dollars invested in thousands of companies. So they know what's happening in the economy and they have to allocate their capital correctly. So they're gonna tell the companies that they rely on for income to start slashing spending. You're not going to do that when you're in growth mode. You're not going to lay off employees when you think you're going to need them in two or three years, or even six months for that matter. If you know from the inside that consumers aren't going to be spending as much money, your companies won't be having as much revenue and you don't need as many employees, you're going to start early. And that's where the smart money will start.

Look, the local mom-and-pop company, they won't know this in advance. The restaurant won't know to start cutting back and conserving cash. They won't know this in advance. The smart money will. It gets even more detailed than that. The venture firm shared a presentation with its founders which warned them of a pending economic downturn that will last much longer and be more severe than what happened at the outset of COVID-19. So here's the thing.

Remember when the pandemic first started, end of 2019, 2020? Many, many people were worried about the economic fallout. You had the PPP loans, the EIDL loans, you had many other economic regulations put in place. Companies were hunkering down expecting the worse. Well, in reality, it wasn't that bad. Some people lost their jobs but a lot of people quit their jobs too. Some restaurants went out of business but there was no major recession. Stocks have gone up, many companies have grown.

It wasn't the financial disaster everybody thought. Well, now is when there will be a financial disaster. Just when everybody thinks we're out of the woods with the economy and finances, it's going to be worse. And what is a double whammy about it now is prices are now higher. So if you're an employee, whether you're a service worker that has a salary or an hourly wage, or you're a mid-level executive that has a bonus or commissions, much of the income across the board is going to be slashed.

And this is going to happen right after your rent went up, your mortgage or the price of a house you just bought went up, your gas is higher. It's going to be the worst of both worlds. So we'll talk more about this in following videos. But at the same time, the Fed, the Federal Reserve, is carrying $330 billion in unrealized losses. So the Federal Reserve pumped a lot of money into the economy to keep that recession from happening when the pandemic hit. They invested in mortgages and corporate financing.

They've now realized that a lot of those investments are what they call "underwater," meaning they're not worth what they put into them. What do we mean by that? They bought U.S. Treasury and mortgage-backed securities, and the central bank's holdings of $9 trillion in assets is a big number. And that asset portfolio is now being analyzed and it may not be worth the $9 trillion it was put into it. It's very likely that the Fed was continuing to buy assets even as the economy was well on its way from healing from the pandemic.

What does that mean? The pandemic affected the economy in some ways but after it stabilized, the Fed kept buying assets. Now they're trying to reverse course and shrink its holding, especially of mortgage-backed securities. And we talked about this in another video. At the same time that the economy is shrinking, incomes are going down, house prices are up, the Federal Reserve will be purchasing less mortgage-backed securities. What that's going to do is affect the market of mortgages.

Where there will be fewer buyers and lenders on these mortgage products. So at the moment that $9 trillion in assets can stay on their books at full face value or book value, but if they want to start selling these assets, those paper losses would have to be booked as a tangible hit. And it's not just the Federal Reserve. There are many companies, hedge funds, and even operational firms that have unrealized losses on their books or unrealized liabilities. Maybe it's a lending facility that's coming due in the next year or two. Maybe it's a payroll level that's unsustainable as the inflation starts to create erosion of spending.

There's another little hidden gem. As the Fed raises its short-term rate, the way it does that is it pays more to banks for the reserves that they deposit at the Fed. So when banks have excess cash, they put the money in the Federal Reserve and the Federal Reserve has to pay interest on those. They have to pay interest at a higher rate if they raise their own rates. So what that does is it increases their expenses, the Federal Reserve. And if they sell off these assets, they're going to have less income because these assets create revenue. They buy up mortgages, they collect mortgage payments. They buy Treasury bonds and they collect bond payments. If they sell off that, they're going to have less earnings. So at the same time they have a higher expense because they're paying larger payments, they have less earnings. What does that tell you? They may have an operating loss. And the Federal Reserve is what kind of drives the whole economy.

If that happens, you're going to have less opportunity for companies and businesses to grow, develop, and even fund holes in their balance sheets if they become less profitable. These aren't the things you normally would see in the news. This deep dive — and it's not even really that deep of a dive — these are just two metrics that we're looking at. We're looking at the private sector advising to cut back on expenses and we're looking at the public sector, which is the Fed, facing maybe they have to cut back on expenses because they're not making as much profit. At the same time, we already have inflation. So the same thing happens to the consumer: you have higher prices, lower income. What happens if all three legs of the economy have higher prices and lower income? You have the consumer, you have the corporate level, and you have the government level. If all three legs of that economic stool all have higher cost, lower income, it's a recipe for disaster.

So if you are a consumer, you might want to take heed from the smart money: conserve cash, slash spending however you can, because you may find that you may not lose your job, you may not have less income, but your costs will be higher. Or you may have a risk to your employment or your income. If you're self-employed, if you have your own business, you may find that you have less revenue, less income. You may want to find ways to increase that income — maybe not through growth, maybe looking for other avenues of income that already exist. Tell us what you think in the comments.

Does this make sense? Is there more to the story? What is your perspective on it?