AI Bubble Near Bursting? When The Financing Gets Crazy, The End May Be In Sight
Larry Ellison
As the collapse of the housing bubble approached the financing got ever crazier. In 2005, interest-only loans accounted for 23% of all mortgages, according to the Mortgage Bankers Association. An interest-only loan may not sound like a good way for people to accumulate equity, but whatever. It gets better.
Subprime loans got all the attention, but they may not have been the biggest tell that things in the mortgage market were out of whack. The category of mortgages known as Alt-A rose to 11 percent of the mortgages issued in 2005. Alt-A are mortgages given to people who ostensibly could qualify for prime mortgages but are unable to provide complete documentation. Typically, Alt-A accounts for two to three percent of mortgages.
The standard story is that they mostly go to small business owners. The generous interpretation is that they can’t fully document the income needed for a prime mortgage because their income fluctuates. The less generous interpretation is that they lie on their taxes so they can’t produce tax returns showing the income they claim.
Regardless of the interpretation, the number of people who fell into this category exploded in the housing bubble years. We can either believe that we had a lot more people with erratic income streams, or we had a lot more people lying on their mortgages. The latter seems more plausible.
The mortgage issuers didn’t care because they knew they could sell pretty much any mortgage they issued to the investment banks. The investment banks didn’t care because they could package the mortgages into mortgage-backed securities (MBS). They could count on investment-grade ratings from the rating agencies, since the banks were paying them for the ratings. Then the investment banks could sell their MBS anywhere in the world.
Anyhow, the explosion of interest-only and Alt-A mortgages presaged the beginning of the end, but it was still more than two years out before the final death march. This should be a warning for all of us hoping for a quick return to sanity, but we keep seeing more crazy in AI financing these days.
Last week Amazon revealed plans to sell off $8 billion in chips to a newly created special purpose vehicle (SPV). Amazon will then lease back the chips from the SPV. This one should raise all sorts of red flags.
This sale/leaseback agreement is essentially a loan to Amazon. They book the sale as current revenue and profit, but then the leasing fees are effectively interest that Amazon is paying to the investors that bought stakes in the SPV. The advantage that this offers Amazon is that the leasing obligations don’t appear as straight debt on its books. In principle, most leasing obligations should count as debt, but Amazon’s accountants may be trying to find a way to avoid this.
Amazon made $135 billion in the year ending on July 1. It is one of the most profitable companies in the world. But it apparently needs to find ways to hide debt on its books. And just to be clear, it costs money to set up this sort of SPV. Everyone involved is getting very nice Wall Street salaries. But Amazon felt this maneuver was better for its finances than just issuing normal bonds.
Oracle also got into innovative leasing in a big way last week, signing a deal with the Chinese tech giant Tencent that leases it $7 billion worth of computing power, with 30 percent supposedly being paid upfront. There are several interesting aspects to this story.
First, the computing power could be coming from top-end Nvidia processors. The Trump administration prohibits the sale of these processors to China, ostensibly to inhibit its ability to develop AI. However, if Chinese companies can simply buy the computing power from these chips from U.S. companies, it would seem to undermine the purpose of the sales ban. But Larry Ellison, the former CEO of Oracle and still head honcho, is a big contributor to Donald Trump, so I guess all is good.
This also raises the question of whether the company has more computing power than it has demand. At a time when Oracle and the other hyperscalers are investing trillions to build data centers, that would be a troubling development for them.
The other question is whether this is a sign of Oracle’s increasingly desperate need for cash. Two weeks ago, Oracle issued a force majeure notice to try to get out of some of its payments on a massive data center it is constructing in New Mexico. It’s not clear that Oracle will have much of a case (such notices usually are issued in response to unforeseeable events like weather disasters or wars), but it does indicate some desperation on its part.
And the desperation is showing up in financial markets. Oracle’s bonds now carry yields well over 8.0 percent, in other words, junk bond territory.
The story with Meta, which recently blew $80 billion on its Metaverse, also doesn’t look very good. It too has massive expansion plans with limited commitments from real buyers.
And it looks like those real buyers could be in short supply. Instead of soaring exponentially, demand for AI from Anthropic seems to be leveling off. Demand for AI from OpenAI looks to be edging downward.
The big money folks weren’t very good in seeing around the corner in the tech bubble, nor in the housing bubble. But they all are singing “this time is different.”
Dean Baker is a senior economist at the Center for Economic and Policy Research and the author of the 2016 book Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer. Please consider subscribing to his Substack, from which this is reprinted with permission.
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