Debt Bubble Stretches to Breaking Point

GMAC's growth gives General Motors a huge problem. With car sales flat or falling and auto profits down so far this year, the company needs growth from its financing division to meet its growth targets, but profit margins in GM's main business of lending to finance car loans, as well as auto loan volume, are down.

Of course, the company could bite the bullet and simply admit that it wasn't going to meet Wall Street's targets. But anyone who remembers how tough it was for technology company executives to admit growth had slowed in 2000 won't think that's at the top of GM's list of solutions. No, the company plans to get more growth out of GMAC by expanding the company's mortgage and insurance businesses. I'm sure that a company that offers 0% auto loans will think of something that will work. For a while.

These three rules for bubbles don't pinpoint when the bubble will burst. And my examples hardly create a complete list of all the problems that lie in wait for the economy and the markets as we work through Mr. Greenspan's latest financial bubble.

The rules do suggest what to look for: Institutions that have the money to lend are so pressed by their own need to grow that they will make loans without much regard for the ability of borrowers to repay them.

Let's look at one more issue. The business of lending to hedge funds is incredibly lucrative for banks on and off Wall Street at a time when banks are facing profit pressure. One-quarter of hedge funds surveyed recently by Greenwich Associates said their banks had extended credit lines in the last six months. One-third of these funds reported that they had increased their use of leverage (using borrowed money to buy stocks and bonds) in the past year. I don't believe for a moment that all of those hedge fund loans went only to the most creditworthy funds. And I know for sure that leverage, which produces outsized profits in good markets, increases the risk that, in a bad market, a moderate loss will turn into a huge one.

I'd like to be more specific about the risks in the financial markets as this cheap money bubble plays out. One of the most frustrating things about this market and about the interlocking relationships so characteristic of our financial system is that it is so hard to figure out who will get left holding the bag.

I am certain, however, that this isn't the time for investors to let their guard down. This bubble is unlikely to break with the kind of pop that took down the entire stock market in 2000. But it is even less likely to deflate gently and painlessly.