Regular readers of this column may be aware that I have an arguably unhealthy fascination with black swans. To quote the late Donald Rumsfeld, these known unknowns and unknown unknowns can be pesky…at best and pretty horrible at worst (he wasn’t as dumb as people thought he was, was he?).
Black Swans and fat tails are fun to think about in the abstract. There’s a certain frisson of excitement around disaster, calamity, mishaps and cataclysms, particularly when life, liberty and treasure are not at risk, you know… a good novel or a scary movie. Our love affair of the genre must be baked into our DNA as we do love all those Hollywood horror movies, don’t we? (Frankly, why do we need zombie movies when we’ve got C-SPAN where we can watch our politicians do their lifeless staggering, ravenously hunger thing.)
Our love affair with dystopic story lines ends when reality intrudes. The good news is that bad, unexpected things are rather rare. In most areas of our life, in politics, economics and culture , continuity rules. Tomorrow looks pretty much like yesterday… most of the time. Of course, if you dial out to the longest possible timeline, you will see that history is replete with these events; events that created discontinuity, where the world was fundamentally affected. War, pestilence, economic crisis, riptides of technological change, divine revelation, etc. happen and, with a certain remove, are rather common, but don’t generally happen tomorrow. We can thank our cognitive bias toward continuity for the comfort we take from knowing (or thinking we know) that tomorrow will look a lot like today. (I remember my shock when I discovered that Coca Cola invented our current version of Santa Claus in the 1920s and Victorians invented the Christmas tree… who knew?)
In our business life we can ill afford to always assume tomorrow will continue to look a lot like today. I’m sure you worry it won’t, right, but what can you do? Can you rationally spend money to hedge those worries? For instance, how do you spend money rationally to de-risk your business from climate change, something that will have an indeterminate impact, might not happen or might not happen for a very long time? Probably you don’t spend much. When you don’t know what, and you don’t know when, it’s pretty tough to make the case for hunkering down. Staying in bed, pulling up the covers, keeping a go bag, stocking up on ammo, sticking bitcoin under the bed and wearing a bike helmet to the office is no way to run a business (or a life).
But if you knew something was wrong, if you knew there were indications that a black swan might be out there flapping its little wings, it gets increasingly productive to be attentive.
I’d argue it is productive to think about black swans and fat tails as a collective. Now, I barely squeaked through statistics in college (there was some stupid question about what Mrs. Washington did or didn’t do which baffled me), but nonetheless, we need to do a little math here. As a thought exercise, let’s say that a truly bad something that could meaningfully impact our business, has a 1 in 1000 chance of occurring each year. That’s pretty remote.
Let’s now come up with a list of potentially bad things that could happen in the next 5 years, could have a material deleterious impact on our business and have a 1 in 1000 chance of happening in any one year. Without being horribly creative, I bet we could come up with a list of 30 things that would be well within that 1 in 1000 chance threshold. Many of these are easy to identify. China attacking Taiwan, Putin exercising his revanchist dream of reconquering the old Soviet empire, Pakistan and India getting into a nuclear exchange, bond buyers turning on US Treasuries, collapse in the overnight, repo market, etc.. (With a 1 in 1000 chance threshold, we can scope out Zombie apocalypses and the outbreak of comity in the House of Representatives but that leaves us plenty of room for those swans and tails.)
For this thought exercise, I used five years because it’s a reasonable timeframe for planning. Here in the commercial real estate industry, borrowing on a five year floating rate basis is very common. Leases are typically more than five years. Development plans for projects from blueprint to permitting to CO are often five years or more. Lots of business plans can be wildly disrupted if the wheels come off in any five year period.
Let’s next define meaningful here as something that rapidly and in a disorderly way impacts our business and makes it hard to do deals, makes credit very expensive, radically reduces liquidity, reduces aggregate demand for products or space and reduces the flow of equity investments into our business lines.
The probability of one of those 30 things happening during a five year period is just under 15%, over 10 years it’s around 25%. That’s meaningful. If you knew something was afoot, you’d climb the battlements of your fortress balance sheet and begin to scan the horizon for those flapping wings. What we need is something to alert us that one of those bad things is on the horizon and might be negatively impacting our business. If we knew something was wrong with that heightened awareness, we’d have a much better chance of identifying the malefactor.
You need a tell.
Our tell is the credit markets; the shape of the interest rate curve, the market for spreads and the availability of liquidity, the conditions in the swap market and the currency markets and other analytically adjacent indices of credit availability. This is where we might get some notice that the wheels are coming off before the damage is done. Even when a thunderbolt comes out of the blue without warning, it’s the credit markets which will help us decide whether that thunderbolt will actually impact our business or if it’s merely a passing headline. In many cases, before the full extent of the damage is discernible, bad things will show up in the petri dish of liquidity and credit. That’s the media of transmission between bad stuff happening and missing a paycheck. It is the first derivative of our 30 swans. Think of it as a CAT scan that can see disease before the symptoms manifest or, like a senior Chinese general being scrubbed from a group picture before we hear that he’s been charged with serious violations of discipline and law (e.g., soon to be dead, or dead-ish).
Why does this work? Why does this make sense? It works because of the law of large numbers. Someone across our markets will see something bad happen, probably someone in a market segment specifically aligned with whatever bad news is on the horizon. Some smart people will see something in the data, will connect the dots and conclude that one of those black swans is about to land in our pond and impact our business. The credit markets will respond and we’ll have our signal. Will there be lots of false positives? Sure. Should we pay attention? Absolutely.
If indeed the tell for our cadre of black swans is disruption in credit markets, looking right now, one might argue that the tell is ticking. Is it telling us that a black swan is in play? It’s certainly not clear but it suggests a heightened level of scrutiny is appropriate.
I know, I know. We’re broadly acting like anxiety about credit is rather silly, rather tinfoil-hatted, rather conspiracy adjacent. But I’d urge you to push back on the eyerolls, rebuff fidelity to the herd’s consensus, tolerate the obloquy, have the courage of your convictions and, with an open mind, analyze whether we’ll soon be having a terrible, horrible, no good, very bad day (credit to Judith Fiorst). It’s all about paying attention to the canary in the mine. Remember lending gobs of money to folks with no income and no assets, then weaving AAA bonds from that rotten straw? The outcome was blindingly obvious in hindsight and while some noticed, the market really didn’t see it coming and largely vilified nattering nabobs of negativism (thank you Mr. Agnew). Contrarians made money.
There’s a bunch of data points, easy to find, that support, not with clarity, but in an impressionistic sort of way, that credit markets are vulnerable, signaling something is wrong.
Here’s a sundry and highly unscientific list of recent headlines (or my summaries of those headlines):
- Investors are simply not getting paid for risk unless everything stays perfect.
- Spreads on high yield bonds are at a 27 year low.
- The spreads between the AAA and BBB munis are barely 75 bps.
- Lenders of all sorts report that there’s loosening of credit standards.
- Jamie Dimon warns banks that they are doing dumb things reminiscent of pre-2008.
- Jamie Dimon, never to be ignored, also recently warned that US debt could trigger a future crisis. (Do you really want to ignore Mr. Dimon? I, for one, do not.)
- The MBA expects an almost 30% increase in CRE volume in 2026.
- Stable coins could be the new Silicon Bank (backed dollar for dollar yes, but with things that could be subject to a mark to market).
- There are systemic risks in the swaps and derivatives market which amount to almost $40 trillion in daily exposure. Who knows where risk is concentrated and how much leverage is employed? Contagion anyone?
- Our debt is close to 100% of GDP. Outside the confines of Modern Monetary Theory loonies, this is problematic.
- If the coupon on Treasuries moves out 200 bps it will add $4 trillion or more to our budget deficit over a decade.
- Markets may need to embrace 3% inflation as the new equilibrium. Treasury markets still imply 2% inflation. What happens when these numbers reconcile?
- Neither political party is willing to confront their more looney fringe and act responsibly about…well, pretty much anything.
- There are some signs out there that international buyers are getting twitchy about the US treasury market and with the current administration appearing to be content with, if not complicit in, the weakening of the dollar, there can be trouble there.
- We’ve returned to QT. Why is the Fed monetizing our fiscal excesses and can that go on indefinitely?
- The CMBS market has approximately $77 billion in hard currencies due this year.
- Across all credit sources, there are approximately $900 billion in total maturities on track for repayment or refinance in 2026.
- AI is doing…something. It might be good, but it also may be highly disruptive to markets like, the CRE market.
- Trepp reports special servicing rates rising in early 2026 (while office leads the way, all types have special servicing rates above 8%.
- Everyone wants to lend this year. Conventional loan origination, GSE origination and securitization volume are predicted to be up across the board.
What does all this tell us? Maybe nothing, but it suggests that problems are looming at the same time we are exuberantly investing as if all is well, in fact all is well-nigh perfect. I happily acknowledge that the data is far from homogeneous. It does not tell a compelling story. I can “yeah, but” much of it, but should it be ignored? I don’t think so. Bottom line is I can’t help but think that everyone in our space should spend more than a moment and more than a dollar monitoring these markets for evidence of rapid change and in being prepared to nimbly pivot to a more defensive stance if the data gets a bit more directionally clear.
In short, these markets might not be predicting something fast and bad, but might. Also, remember like Mr. Hemingway’s observation about bankruptcy, sometimes we enjoy it first slowly, then very, very fast. Is the fast bit at hand?
If really bad things were about to happen, you’d like time to grab that go bag, pull your bitcoins out from under the mattress and put on that bike helmet.