President Trump’s promises to cut taxes and roll back regulations have hoisted business optimism and supercharged stock prices. Even with the demise of Republican efforts to replace the Affordable Care Act, equities have proven remarkably resilient as investors continue to bet on growth.
No doubt, corporate profits surging 22 percent last year have a lot to do with keeping equities strong, but history teaches when expectations are most buoyant, investors and decision makers are inclined to overlook festering problems that could abscess into a systemic collapse.
Here are five hot spots that could saddle Trump with the next financial crisis.
1. The Housing Bubble
Home prices and property values have soared in big cities where the economic recovery has been strongest — aided by low mortgage rates and Dodd-Frank regulations that push banks toward lending to the upper middle class and wealthy.
Now, Federal Reserve tightening could push up interest rates enough to depress the monthly payments and prices that would-be homeowners can afford. Similarly, overbuilding of apartments is stressing the rents big-city landlords can charge.
As during the savings and loan crisis of the 1980s and the more recent financial meltdown, homeowners and investors may find they have overpaid, and property values in affluent urban centers could be headed for an “adjustment.”
2. Student Debt
Outstanding student loans now exceed $1.4 trillion and more than 40 percent of borrowers are in default or behind on payments.
Eventually, the federal government will either have to make good on hundreds of billions of dollars of debt or let banks and bond investors take big losses.
It’s another unpopular bailout in the offing or, as we saw with Lehman Brothers in 2008, another opportunity for federal authorities to risk financial instability.
The Trump administration will have few pleasant choices.
3. European Banks
European banks are suffering from slow-growing economies and ultra-low interest rates that make difficult moving bad loans off their books. About 17 percent of Italian bank loans are underwater, and conditions are troubling elsewhere too.
Germany’s largest bank, Deutsche Bank, was recently hit with a large fine by the Justice Department for its role in the financial crisis. The incident highlighted that the bank is not well run or profitable but has wide interconnections with other banks in Europe and the United States.
It has repeatedly raised new capital and eventually could be forced by European banking authorities to resort to a bail-in — namely, force bondholders to accept stock for their securities and take huge losses.
That could easily ignite panic elsewhere. In Italy, ordinary depositors have been encouraged to purchase bonds in the manner that Americans invest in certificates of deposits. Bail-ins would impose huge losses of savings and purchasing power, and a contagious recession with severe repercussions for other European and American banks.
China’s national and provincial governments have subsidized inefficient state-owned enterprises and exporters with easy credit and propped up growth through excessive borrowing for wasteful public works and urbanization projects. Government deficits are estimated at least 15 percent of gross domestic product, and cumulative public and private debt at 250 percent.
Printing money has pushed stocks, bonds, commodities and housing prices to threatening levels, and large investors are fleeing China, driving down the dollar value of the yuan.
Should those bubbles burst and the yuan collapse, Asian and other developing economies dependent on exports to China could easily become unable to service their dollar-denominated debt. All this is reminiscent of the Asian currency crisis of the 1990s, which left many American lenders holding the bag.
5. Trump’s Promises and Political Divisions
Trump’s economic program to boost U.S. growth could easily be stalled in Congress. Any tax change requires at least accomplishing consensus within the Republican caucuses in the House and Senate. Many business regulations may be changed by executive order, but Mr. Trump can count on Democrats bringing challenges before liberal judges and new legislation would be much more efficient.
Facing opposition from the House Freedom Caucus and with only 52 Republican senators, Trump must find ways to build centrist coalitions. However, with moderate Democrats unwilling to break from party solidarity in opposing all of his initiatives, he lacks the opportunities enjoyed by Ronald Reagan and George W. Bush to build a bipartisan majority for even moderate legislation.
The hard right and the Democrats appear willing to cripple an American president to serve ideological purity and win political advantage — even at the risk of plunging the global economy into yet another massive crisis.
Peter Morici served as Chief Economist at the U.S. International Trade Commission from 1993 to 1995. He is an economist and professor at the Smith School of Business, University of Maryland, and a widely published columnist. He is thefive time winner of the MarketWatch best forecaster award.Follow him on Twitter @PMorici1.