Why Wall Street Fears A Great Financial Crisis 2.0

David Reavill
5 min readMar 23, 2023
Irving Fisher, Economist

Most economists will tell you that the Great Financial Crisis of 2007–08 was the worst in 80 years. It was the worst economic blow since the Great Depression of the 1920s and 30s. Like the Depression of the Twentieth Century, the Financial Crisis of the Twenty-First Century was a period of deflation and falling prices.

For the Depression, those falling prices centered around the stock market and the Crash of ’29. In contrast, the Financial Crisis began mainly in the Real Estate Markets. An interlocking combination of securitized Real Estate Loans and sophisticated interest rate derivatives created a toxic variety that spiraled out of control and threatened to drag the entire financial system down.

In both crises, leverage made the situation so much worse. During the Great Depression, it was the stock market that was over-levered. And, as noted, the borrowing centered on Real Estate during the Great Financial Crisis. But in either case, whether it was the stock market or the real estate market, leverage took this proclivity toward excessive speculation to unheard-of heights by allowing speculators to multiply their position by borrowing.

And this is the key, the common thread that unites those two earlier financial crises with what’s occurring today. Once again, the leverage raises its ugly head and threatens our financial stability.

You may not recognize this leverage because, unlike the other two forms, this is from something other than mere speculation. Today, average Americans leverage their balance sheets to make ends meet. Borrowing against credit cards is becoming a convenient way to battle the higher cost of living due to inflation.

But you have already seen the result, the myriad of bank failures around the globe. However, we will confine this discussion to those Banks in the United States and why the current estimates are that there may be as many as a couple of hundred banks at risk.

Irving Fisher, The Framework

Sensing the similarity between the GFC in 2008 and the Depression of the 1920s, Wall Street analysts reviewed the work of economist Irving Fisher and his seminal work on Debt Deflation. Remember, when you speculate, you do it by using debt. Stock loans to speculate in securities and mortgages and various other loans when speculating in Real Estate.

Fisher’s basic concept is that the underlying collateral is often sold at a discount by liquidating bad debt, creating a deflationary spiral. As the cycle unfolds, bad loans default, and their underlying assets are foreclosed. This process drives the value of an entire asset class lower and lower. Fisher called this phenomenon his Debt-Deflation Theory.

It is important to note that Fisher in the 1930s and Wall Street Analysts earlier this century looked at this Debt-Deflationary Cycle when it was nearly complete.

Today, we are barely beginning such a cycle. Therefore, many of the indicators Fisher and the others employed have yet to appear. One of those indicators is price. Today we are experiencing inflation, not deflation. Instead of describing an ongoing process, we’re looking ahead to anticipate what may be coming our way.

Indeed, this rash of troubled banks indicates that something foul may lie ahead. One of the tenants of Fishers Debt-Deflation is that it becomes increasingly difficult for borrowers to meet their loan payments. In Fisher’s day, this was due to overall deflation. People were experiencing a drop in income, sometimes because of pay cuts, but most often because they lost their job. And with lower or no wages, people couldn’t make loan payments.

Observations: GDP is declining (green), Interest Rates are rising (red), and Consumer Loans are defaulting (blue).

Today we’ve been presented with the same phenomena, not because people have fewer funds, but because many loan payments have increased dramatically. For instance, the interest payment on mortgages has doubled in the past year. Affecting, not only new buyers but also borrowers with adjustable-rate mortgages. Short-term personal bank loans have also seen a dramatic rise in their interest rates.

All of this is brought to you by our Federal Reserve. So, in Fisher’s day, people couldn’t make their loan payments because they didn’t have sufficient income. While today, the issue is not income. The Fed’s hike in the interest rate has caused those loan payments to increase. So we arrive at the same point, people cannot make their loan payments.

And as night follows day, we can be sure that the rest of Fisher’s analysis will hold. The loan holder, usually a bank, will be forced to dispose of any collateral, real estate, etc., at “fire sale” prices, and the Debt-Deflation will have begun.

Fisher points to several other factors that can contribute to Debt-Deflation. These include some that we have yet to see. For instance, Fisher would predict a decline in corporate profits and the value of public and private companies. However, both of those factors have yet to happen.

But then he lists some factors that are eerily similar to what we see today. First, he predicts a loss of confidence. Today consumer confidence is down nearly 40% in the last 20 years.

And he predicted that the money supply would fall. Of course, that isn’t happening currently. Just over two years ago, the Government pumped over $5 trillion into the economy via stimulus programs. So obviously, today’s money supply is increasing. However, the speed with which currency changes hands has slowed dramatically. M1 and M2 Money Velocity is slower than we’ve seen in over 60 years.

Today’s economy differs significantly from the Great Depression or the Great Financial Crisis. Yet the fundamental characteristics of over-levered financing cause first foreclosure and latter overall Debt-Deflation as entire asset classes are driven down in value as the banks are forced to sell distressed collateral. As Fisher observed nearly a century ago, once the cycle of Debt-Deflation begins, it is almost impossible to stop. And that’s what worries Wall Street.

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David Reavill

David Reavill writer + finance +iconoclast + hiker + Pennsylvania #valueside daily podcast + medium + meditate valueside.com/links