Warnings Before the Financial Crisis (2005–2007)
Selected excerpts from The Shepherd Investment Strategist, published prior to the 2008 financial crisis.
Introduction
Between late 2005 and mid-2007, my newsletters outlined why the U.S. economy and financial markets were increasingly vulnerable to a severe downturn. These observations focused on debt-driven consumption, deteriorating lending standards, housing as the primary financing mechanism for growth, and the systemic risks embedded in mortgage-backed securities and leverage.
The excerpts below are presented in chronological order and are shown as they were written at the time. They are offered as documentation of a process, not as hindsight commentary.
Early Warning Phase: Debt & Housing Dependence (December 2005 – January 2006)
December 9, 2005
“Never before have we seen such exotic ways to buy things we could not afford. The main area of concern, of course, is housing. The very reason the economy has continued to show apparent resilience over the last few years is because of all the ways consumers have had to tap into the equity in their homes… This allowed for consumer spending to continue, as homeowners borrowed over and over again from their homes as interest rates declined.”
January 13, 2006
“A recent Federal Reserve report indicated their view that at least 50% of all economic activity in the United States is related, directly or indirectly, to housing… With the Fed having raised short-term interest rates at every meeting since June 2004… there is little doubt that this area will be the deciding factor as we see the unfolding of the events we are expecting.”
Mechanism Identified: Lending Risk, Yield Curve, and Leverage (February – June 2006)
February 9, 2006
“An inverted yield curve poses some serious threats to the banking industry… Individuals that never should have been able to obtain mortgages were allowed to do so, utilizing exotic approaches such as zero down payments, adjustable interest rates and questionable valuation calculations. These mortgages are currently assets on the lenders’ balance sheets, but in times of duress, they will quickly become liabilities.”
March 10, 2006
“The most likely cause of a financial meltdown would be related to the housing sector… all converge to put this area of the economy at extreme risk.”
April 13, 2006
“The housing market boom was built on massive debt, much of which is questionable in quality… Consumers jumped into the housing market… based on the notion that they could always sell off their property for a profit to save the day.”
June 9, 2006
“As housing continues to decline, and then as many borrowers are forced to sell properties they cannot afford as variable rate mortgage payments skyrocket, the subsequent collapse in real estate should be quite dramatic. This will have a profound effect on the economy and will undoubtedly usher in a severe recession, or worse.”
Consensus Rejected: The ‘Soft Landing’ Illusion (September – December 2006)
September 15, 2006
“Do not think that just because many in the financial media are saying we will have a ‘soft landing’ in housing that it will be so… growth that is based on debt accumulation is doomed. Sooner rather than later, the reality of this will be apparent to all.”
October 13, 2006
“The crowd… is unified in their view that stocks will continue to rise indefinitely… They are told that the housing market will have a soft landing… despite the fact that this has never happened when the debt service and debt to equity ratios have been so high.”
December 15, 2006
“There has been a dramatic increase in default rates in sub-prime mortgages and this is just the first crack in the housing market foundation.”
Systemic Breakdown: Subprime, MBS, and Financial Contagion (2007)
February 9, 2007
“With the housing bust in full force and effect… the facility to borrow-to-spend has essentially ended; therefore, the next phase will be the shock to the economy of collapsing economic activity… Before this happens, the stock market will have declined precipitously.”
March 18, 2007
“The housing sector… is now in collapse. Those who claim we are headed for a soft landing in that area are not looking at the facts.”
July 13, 2007
“The mortgages that were used to finance homes that many buyers really could not afford… were packaged into instruments called Mortgage Backed Securities and sold to investors… The leverage that has been created and the pressure it will put on the financial system will be overwhelming.”
Closing Note
These excerpts are presented as a contemporaneous record of analysis describing how excessive debt, deteriorating lending standards, and financial leverage can distort economic growth and ultimately lead to systemic failure. While the specific circumstances evolve, the underlying dynamics remain relevant.
The Shepherd Investment Strategist was published monthly from the early 1990s through mid-2015. Prior to the 2008 financial crisis, it documented the risks posed by debt-driven growth, deteriorating lending standards, and systemic leverage — themes that continue to shape markets today.
Disclaimer: The information provided is for educational purposes only and should not be construed as investment advice. Financial markets involve risk, and past performance is not indicative of future results. Readers should consult a qualified financial professional before making any investment decisions.
