HUGE INSIGHTS: The Big Picture - Issue #51
Leveraged...How a Massive Debt Burden is Poised to Collapse the Economy and Markets
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Executive Summary
Empire of Debt
Macro Perspectives: Rates and Credit Markets
Geopolitics: Calexit…The Secession of California?
Market Analysis & Outlook: Anatomy of a Market Top
Conclusions & Positioning: Ch-Ch-Ch-Changes
Empire of Debt
On October 21, 2025, the U.S. federal debt reached $38 trillion. This milestone occurred just 71 days after the debt surpassed $37 trillion on August 12, 2025, reflecting the fastest $1 trillion increase outside of the pandemic era. The next day, Treasury Secretary Scott Bessent posted on twitter/X.com:
“From April to September, the cumulative deficit totaled just $468 billion. This is the lowest reading since 2019 and is down nearly 40% from the comparable period last year when Biden was spending recklessly. Today, President Trump is putting the U.S. financial system on solid footing. Revenues are soaring and government spending is under control.”
On the surface, this sounds like great news. But what the Treasury Secretary failed to disclose, was that the administration changed their accounting practices. Specifically, according to the Bureau of Fiscal Services, the agency changed their reporting for this period to subtract the surplus from the outlays. This artificially reduced the outlays to make it appear that costs were lower, when in fact, costs actually increased by $98 billion during the period. Cumulative outlays for FY25 were $7.01 trillion compared against FY24’s $6.75 trillion. As such, spending increased by roughly $260 billion throughout the fiscal year. What has also increased is individual taxes on income, import duties paid by American consumers (i.e. tariffs), and excise taxes, which are altogether up some $200 billion. What decreased was corporate taxes — by nearly $100 billion.
The side-by-side comparison of the September 2024 and September 2025 periods as well as the FY 2024 and FY 2025 periods elucidates this fairly clearly.
According to the Committee for a Responsible Federal Budget, “There’s simply no verified Treasury or CBO data showing a 40% Y/Y drop, or the ‘lowest since 2019’ figure cited here.” Indeed, the Treasury Department officially reported that the FY 2025 budget deficit was only $8 billion lower than the FY 2024 budget deficit — clocking in at $1.8 trillion, or about 5.9% of GDP vs. 6.4% of GDP for the former period. The improvement was entirely due to higher tax receipts and base effects, despite increases in both spending and interest payments on the national debt.
Of course, state governments have faired little better. As of December 31, 2024, U.S. state governments owed an additional $2.9 trillion, according to recent study at the University of Denver. State debt is estimated to grow by an additional $200 billion by year-end 2025. California, which now boasts the fourth largest economy in the world and is home to approximately 11% of the entire U.S. population, maintains the largest state government debt by far — approximately $500 billion. New York and Illinois are a distant second and third with debt totaling around $235 billion and $225 billion, respectively. Texas and New Jersey are tied for fourth place at about $215 billion, while Massachusetts rounds out the six top borrowers at $120 billion. The rest fall below the $100 billion threshold, with half of the states owing less than $20 billion. By this measure, South Dakota ranks #1 in fiscal responsibility, with a mere $2.5 billion in total state government debt.
Uniquely, governments have the ability to levy taxes on their citizens in order to generate the revenue necessary to meet their operating budgets and service their debts. Yet, the cost of servicing the federal debt in 2026 is estimated to reach $1 trillion, or about 3.2% of GDP. That’s about half of the nation’s expected fiscal budget deficit. The problem with the current fiscal situation in the United States is that it’s not sustainable. The fact that the federal government has to run a near 6% budget deficit during what government officials have repeatedly called the greatest economic boom in U.S. history is a contradiction on many levels. Indeed, the World Bank estimates Gross National Income (GNI) in the U.S. will reach $30.3 trillion in 2025. An operating budget of $7 trillion represents just 23% of GNI, suggesting that a balanced budget is achievable through effective tax policy. But policy makers have lacked the political will to do so over the past decade.
As such, the federal debt has doubled since hitting $19 trillion in July 2016. Under the first Trump administration, the government added approximately $7.8 trillion to the federal debt — a 39% increase. Under the Biden administration, the government added approximately $8.4 trillion to the federal debt — up another 30%. Since January 20, 2025, the federal debt has grown by an additional $2.2 trillion. At the current rate of change, it’s not inconceivable that the U.S. federal debt will exceed $50 trillion before the end of the decade. Perhaps most concerning is that while the federal debt has doubled in less than 10 years, GDP is up a mere 62% over the same period. Today, the nation’s debt-to-GDP ratio is an alarming 125% [$38T / $30.5T]. Put differently, it now takes $1.25 of debt to produce $1.00 of GDP.
That being said, government debt is the least of our worries. As detailed in Issue #49, student loan debt is a much more immediate concern. The total outstanding U.S. student loan balance is approximately $1.8 trillion as of mid-2025. Federal student loan debt accounts for about 93% of this total, owed by roughly 42.5 million borrowers. The resumption of federal student loan repayments after pandemic forbearance ended has led to a sharp increase in borrower delinquency rates, reaching record highs in 2025. Over 30% of borrowers with a payment due are now more than 90 days delinquent, nearly double pre-pandemic levels. The sharp rise in severe delinquencies reflects a “credit shock” following the end of relief programs, with many borrowers struggling with repayment requirements. Additionally, about one-third of those 90+ days delinquent may enter default soon, triggering collection actions. Financial stress among borrowers is evident, as is an increased risk of defaults and long-term credit impacts resulting from repayment resumption.
Also high on the list of worries is the other $3.2 trillion in consumer debt, and its derivative link to the asset-backed and collateralized loans that proliferate in the private credit market. To be sure, there is a distinction that must be made between the quality of loans to prime borrowers and those made to sub-prime borrowers. Prime borrowers have good to excellent credit ratings, typically above 660, indicating a strong credit history and low risk of loan default. Subprime borrowers have poor or limited credit histories, usually associated with a credit score below 660. A recent study by analysts at Morgan Stanley reveals a sharp divide between prime and subprime borrowers. For example, loan-level data show that prime auto loan performance has been stable or improving in 2025, whereas subprime borrowers are under mounting stress. Specifically, subprime auto loan delinquencies of around 6% are hovering near all-time highs, while lending standards have loosened. In contrast, over the past 12-months, prime auto loans have witnessed a Y/Y decline in delinquencies, and defaults are below expectations.
This stands to reason as the top income quintile — predominantly prime borrowers, which drives over 40% of personal consumption in the U.S., continues to enjoy strong wage growth, minimal impact from tariff driven price increases, and robust gains from housing and equity markets. Conversely, lower income households — often subprime borrowers — with minimal exposure to financial assets and a declining share of gross national income, face a far different reality. As such, subprime borrower performance is unlikely to see significant improvements anytime soon. Exacerbating the situation is the radical change in U.S. immigration policy over the past nine months. Immigrants, both documented and undocumented, make up a fifth of the working population in the U.S. — half of which are Hispanic — and account for a significant proportion of subprime borrowers. Importantly, when undocumented immigrants are deported, their credit obligations go unserviced and eventually fall into default. Even when they are not the direct creditor, the income that they once contributed to a household is greatly missed and cannot be easily replaced, leaving many documented immigrants unable to service their debts.
One recent example of this sort of collateral damage can be found in the bankruptcy filing of subprime auto lender and used car retailer Tricolor Holdings. While the company has been linked to alleged fraudulent activities, the catalyst for exposing the fraud at Tricolor was a sudden and material decline in loan servicing payments due to loose lending standards and a high concentration of undocumented immigrant borrowers. Tricolor is accused of double pledging the same collateral to securitize credit facilities at multiple banks. This led to a chapter 7 liquidation of the company’s assets and hundreds of millions of dollars in credit impairment charge-offs at four major banks including $170 million by JP Morgan, $147 million by Barclay’s, as much as $200 million by Fifth Third Bank, and $30 million by Origin Bank. UBS and Jeffries are also reported to have questionable receivables related to Tricolor in the amounts of $500 million and $715 million, respectively.
However, the lesson of Tricolor’s collapse extends beyond loose lending standards and customer concentration risks. It points to the opacity of the private credit market. That, coupled with the lack of regulation, leads to an inherent inability of investors to see the excess leverage that may encumber a company’s assets through its off-balance sheet transactions. The bankruptcy of auto parts manufacturer First Brands Group is a perfect example of this. First Brands’ reliance upon complex, short-term private credit financing coupled with supply chain challenges and rising debt servicing cost led it to use special purpose vehicles to silo over $2 billion of off-balance sheet transactions in order to mask its aggressive borrowing practices. Ultimately, its poor financial controls resulted in a chapter 11 bankruptcy reorganization, and an ongoing investigation over mysterious transactions, missing funds, and an effort to untangle its numerous creditors. Regional banking players including Zion’s Bank and Western Alliance have disclosed charge-offs of at least $50 million related to losses that were linked to their exposures to the bankruptcies of unspecified private credit market borrowers.
Importantly, some of the most respected companies in the technology and AI space have also turned to private credit markets in order to raise capital to fund massive AI infrastructure projects. After spending 60% of their operating cash flow on average, the so-called “hyperscalers” — MSFT, GOOG, AMZN, META, and ORCL — are now tapping the credit markets in order to meet their AI infrastructure funding needs. On October 16, Meta/Blue Owl closed a $27 billion private placement debt package arranged by Morgan Stanley and primarily funded by PIMCO and Blackrock. Not to be outdone, Larry Ellison’s Oracle/AI just closed on a $38 billion debt package from JP Morgan and Mitsubishi UFJ. In response, Michael Cembalest at JP Morgan wrote:
“Oracle’s debt to equity ratio is already 500% compared to 50% for Amazon, 30% for Microsoft and even less at Meta and Google. In other words, the tech capital cycle may be about to change.”
Morgan Stanley estimates that $800 billion will be deployed by private credit investors between 2025 and 2028 into AI infrastructure projects. In a separate article, Bloomberg reports, “The amount of debt tied to artificial intelligence has ballooned to $1.2 trillion, making it the largest segment in the investment grade market.” Yet, despite the brand name recognition of the borrowers, the debt is usually issued by subordinated enterprises within the capital structure of the organization and rated A+ or lower — indicating that the bonds are far from risk-free.
An October 22 article in the Wall Street Journal entitled, Is the Flurry of Circular AI Deals a Win-Win — or Sign of a Bubble?, discusses the growing trend of circular financing deals in the AI sector. The article highlights how these deals, where companies finance each other in a round-trip manner to support AI investments, resemble the excesses of the Dot-Com bubble in the late 1990s. While current deal sizes and complexities are much larger, the circular nature of the financing — where one company pays another, which then uses that money to buy the first company’s products or services — raises concerns about sustainability. The article warns that if enthusiasm for investing in AI data centers declines, major players like Nvidia and Microsoft could face declines in both revenue and the value of their stakes in client companies. The overall tone suggests wariness about whether these circular deals truly create value or simply inflate an AI investment bubble. We think it’s the latter, and it poses a significant risk for investors in the private credit market that is getting far-less attention than it deserves.
But there is a growing body of market pundits that are pointing to the private credit market as the economy’s Achilles heel, with the potential to unravel into another great financial crisis (GFC) surpassing the scale of even the 2008 subprime mortgage crisis. Others suggest that the private credit market, at just $1.5-$1.8 trillion in size, is just too small to have the same impact. They also point out that only a portion of that market caters to subprime borrowers. We would note that back in 2008, the subprime mortgage market was even smaller, having peaked at about $1.4 trillion. But as it turned out, bad underwriting standards didn’t just apply the subprime loans. They affected all of the loans. The world learned that lesson all too well during the GFC, but it now seems to have been forgotten. There is an old traders maxim: “One man’s asset is another man’s liability.”
Prime borrowers appear to be money good today, but a major economic shock could change that in a heartbeat. The long-term implications of tariffs are still unknown, and employment trends have greatly weakened over the past year. Margins are mean-reverting, and contrary to popular opinion, the business cycle has not been repealed. Fed rate cutting cycles have tended to precede recessions and as sure as Winter follows Autumn, another recession will manifest itself at some point. Finally, a sharp drop in stock prices could be all it takes to trigger a broader deterioration in the consumer credit cycle. Bear markets lead recessions — or, as George Soros once proposed, cause recessions. And with that, it should be noted that student loans, auto loans, credit cards, and mortgages aren’t the only consumer debts on the books these days. Margin debt eclipsed the $1.1 trillion mark during the month of September to post a new all-time record high, and has probably grown even further in October.
And the new extreme in margin debt is not the only source of equity market leverage. There is significant leverage also embedded into the structured products and derivatives markets. For example, the number of leveraged equity ETFs that trade in the public markets just hit a record 701 — a full 33% of all equity ETFs — with an unprecedented total market-cap of approximately $165 billion today. When leverage becomes a product, rather than a tool, it says a lot about where you are in the cycle. A growing part of this has been the rise of single-stock, ultra-leveraged products — some of which magnify the underlying stock’s daily price action by 5-fold. The sole purpose of these vehicles is dedicated toward speculation — not investment. Indeed, stock market leverage — the combination of margin debt plus assets under management in leveraged ETFs — relative to the money supply (M2) has now reached levels not seen since the Dot-Com mania.
Additionally, option volumes continue to set new weekly records, while cash equity volumes have risen to their highest levels of the year. Retail participation in the equity market now stands at approximately 22% — its strongest since February 2021 (the exact month that Cathie Wood’s ARK Innovation ETF hit its all-time record high). While there are varying interpretations of this activity, the data show retail flows have been consistently resilient since April, underscoring the persistence of this trend. Some view the bold market participation by this cohort as a positive macro signal reflecting underlying consumer and investor confidence. We think that if Charles Mackay were still with us, he would gladly take the other side of that argument. Given that the vast majority of retail option “buy to open” orders are of the long Call variety — with 0DTE contracts representing a record 60% of open interest — it’s a good bet that this will prove to be a temporary condition. Option markets are a zero-sum game, and the house wins about 90% of the time.
In short, there are cracks emerging in the underlying foundation of the credit markets — if not the fabric of civilization itself. Prime borrowers, while still holding their own, are now struggling to make payments on forgotten student loan debt. Subprime borrowers are just struggling — period. Undocumented immigrants are being swept up from their jobs in the middle of the day, or snatched from their beds in the middle of the night, and shipped off to El Salvador, leaving untold credit obligations behind to default. Federal and state governments are leveraged to the hilt. Corporations are leveraged to the hilt. Consumers are leveraged to the hilt. Investors are leveraged to the hilt. On September 25th, the Institute of International Finance reported that total worldwide public and private debt reached an aggregate $338 trillion as of mid-year 2025 — an all-time record extreme representing more than 300% of global GDP. That’s about double the level that existed in 2008.
It has become a game of musical chairs. And one-by-one the players are starting to drop. Today it’s Tricolor, and First Brands. Tomorrow, who knows? Well, Blackrock for one. BNP Paribas SA for another. In a late breaking story on October 30th, the two investment firms confessed to being ensnared in a “breathtaking” act of fraud in the private credit market involving loans made to two telecom companies — Broadband Telecom and Bridgevoice. Apparently, the fraud goes back to 2018 — pre-COVID! In our view, this all speaks to an utter lack of due diligence in the private credit market.
These are early days. Eventually, these revelations will reach a tipping point. The same pundits that told you everything was fine back in 2008 when Bear Stearns went down, are now telling you the same story today. But deep down inside, everyone knows that it’s B.S. The fraud is everywhere and all at once. Don’t be a bag holder. And with respect to the U.S. government’s debt, the truth is that it will never be repaid. It can’t ever be repaid. The entire system is predicated on perpetual balance sheet expansion. It must get bigger, or it will collapse. To pay down the debt in aggregate would be to deliberately let the air out of the balloon. They just won’t allow that to happen. The next recession won’t be a set back — it will be a bust.
Below, we present another 40 charts and other data visualization techniques, to take a deeper dive into the rates and credit markets to highlight concerning trends with respect to high yield debt, the steepening yield curve, the 10-year Treasury yield, and their relationship to the U.S. dollar. In addition, we will examine the possibility of a “Calexit” — a previously proposed plan for the State of California to secede from the union — and its potential implication for the U.S. economy. Finally, we present our comprehensive analysis of equity markets, real estate, commodities, currencies, crypto, and rates, then review our “Perfect Portfolio” tactical asset allocation strategy (+27.5% year-to-date through 10/31/25), which details how we believe investors should be positioned today in order to thrive during what promises to be a period of sustained volatility in the weeks and months immediately ahead.
Let’s begin…
