Everyone Defaults But You

Happy Sunday.

Well, it has been a rough week if you own anything that plugs into a data center. The Nasdaq had its worst week since June. CoreWeave lost a quarter of its value. Dell had its worst week since it went public again in 2018.

Bonds were the bright spot. Investors piled into Treasuries, and the 10-year yield fell almost 15 basis points to 5.10%. That happened even though inflation came in hot at 3.7%.

People call that a flight to safety. But Treasuries aren’t safe because the government always pays. They’re “safe” because the government has the easiest way out when its debts get too big. Keep that in mind and the rest of this makes sense.

Start with the most patient borrower in history. In 1624, a Dutch water board sold a bond to pay for dike repairs. The bond never expires. It has paid interest for 402 years, through four different currencies, without missing a single payment. But inflation ate it alive. Measured in the gold it was originally priced in, it would be worth over $136,000 today. As an income stream, it’s worth about $600.

Perfect payment record. 99% loss. Same piece of paper.

Now a very different borrower. In 2012, a 73-year-old woman stood in an Arizona bankruptcy court owing $584,000 in student loans from the 1970s. She’d spent her career in public service and lived on Social Security. The law didn’t let the judge wipe out the debt. The best Judge Sarah Sharer Curley could do, she writes in her new book, The Price of Forgiveness, was knock it down to three more years of payments.

The Dutch borrower paid back about a penny on the dollar. She got three more years of bills in her mid-seventies.

Here’s the pattern. Big borrowers all have an escape hatch when the bill gets too big. Governments let inflation shrink the debt. Companies file for bankruptcy. China’s state banks just never ask for the money back. The loss doesn’t disappear. It gets pushed onto whoever doesn’t have an escape hatch.

In America, that’s the household. And over the next twenty years, the system is quietly turning families into the lender for everyone who does have a way out.

If you’re reading this, you’re probably on the lending side. Your kids might not be.

The polite default

Start with the biggest borrower of all: Washington. Federal debt is $40 trillion. The IMF said this week that by 2031, the interest alone will cost 5.7% of GDP. That’s about what we spend on Social Security, and double what it was before Covid. The IMF also pointed out that the U.S. borrows short-term more than any other major country, so every time the Fed raises rates, the government’s interest bill goes up faster.

Alexander Hamilton had a rule for this back in 1790: whenever you borrow, have a plan to pay it off. Washington doesn’t have one. It has two ways out. One is to grow the economy faster than the debt. That’s what BlackRock’s Larry Fink argued in the Wall Street Journal this week, that AI can get us back to 3% growth. The other is to let inflation shrink the debt.

We’ve done the second one before. After World War II, federal debt was about 116% of the economy. Ten years later it was about 66%. Economists Carmen Reinhart and Belen Sbrancia found that keeping interest rates below inflation wiped out 3 to 4% of GDP in debt every year back then. Nobody missed a payment. Nobody made headlines. People who bought war bonds got every dollar back. Those dollars just bought less.

You can already see it happening. A 30-year Treasury bond sold in 2020, when rates were under 2%, now sells for less than 45 cents on the dollar. That’s a 55% loss on the “safest” investment in the world, from a borrower that has never missed a payment. Same thing with paychecks: over the past year, prices rose 3.7% and wages rose about 3%.

So a safe haven isn’t a borrower that never defaults. It’s one whose default you won’t notice for a while. That’s where the money ran this week.

The legal default

Companies get a different escape hatch aka bankruptcy court.

Shareholders get wiped out, lenders get paid back less than they’re owed, and the business keeps running under new owners. If CoreWeave or any of the other heavily borrowed data center builders ends up there, the buildings won’t go dark. The servers will keep running for whoever buys them cheap out of bankruptcy.

The market started worrying about that this week. GMO’s Ben Inker said lenders now have to be “bribed” to take on more data center risk. The bond selloff started with the riskiest companies and spread to the safer ones by Friday. Fink’s fix is to bundle data center loans into investments the way Wall Street once bundled mortgages, so more people can own a piece. Either way, the risk ends up in somebody else’s account.

China has a third version. Total debt there is over 300% of the economy, and local governments keep losing companies alive with loans nobody expects to get back. Nobody officially defaults. The loss just leaks out slowly, as weak growth that every saver in the country pays for.

Three escape hatches, same result. The borrower survives, and the loss lands on someone else.

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The borrower with no exit

Federal student loans can't be wiped out in bankruptcy unless you prove "undue hardship," a bar courts have set close to impossible. Congress removed the last time limit on that rule in 1998. In 2005 it extended the same protection to private student loans, in the same law that made personal bankruptcy harder across the board. Curley's conclusion after nearly three decades on the bench is that the law hands breaks to big financial institutions and corporations and should start handing them to people.

This year the rules tightened again. The new federal repayment plan runs 30 years, as long as a mortgage. The deferments that let borrowers pause during unemployment or hardship are gone. Public service borrowers had their payment counts recalculated. A Wisconsin nurse and her husband, both in their mid-forties and expecting to be debt-free by year end, found out they owe two more years. His line to CNBC: "At least with a home loan, you know what you're getting."

Some 9.3 million federal borrowers are in default, up about 50 percent in a decade. Nearly 10 million Americans over 50 still carry student debt. Personal bankruptcy filings topped half a million last year, up almost 50 percent in three years.

Outside the mortgage, which I'll come back to, the household borrows exactly the way the IMF just warned governments not to. Credit card balances are $1.26 trillion at roughly 21 percent, and card rates reset within a billing cycle or two of a Fed move. Private student loans for borrowers with weaker credit can run 16 percent. Then come the bills nobody gets to schedule. About 38 percent of adults 18 to 34 carry medical debt, and an estimated 11 million Americans are paying for kids and aging parents at the same time.

Washington is being told to borrow long and fixed. Outside the mortgage, the household borrows short, floating, or both, through a bankruptcy door Congress has spent fifty years making narrower.

The bankruptcy court moved to TikTok

When the formal system won't forgive you, people build an informal one.

More than 28,000 debt videos went up on TikTok in the year through September. The format: post the exact number you owe, then update it as it moves. Rodney Morgan, a 33-year-old flight attendant, filmed himself on an air mattress with $40,058.44 on the screen and got 1.5 million views, about fifteen times his previous best. A personal finance app then paid him for a sponsored post that should clear the roughly $800 left on his Home Depot and Lowe's cards. Kayla Rose, 29, paid off $25,000 of credit card debt in August with money from what she called "these silly little videos."

Debt used to be the most private number in a family. Now it's a content category, and the audience tips. It works as a crowdfunded fresh start, for exactly the people who are good at being watched.

The ones not posting are running a quieter version. Coast FI, the idea that you save hard early until compounding alone can carry you to retirement, is all over the same feeds, and 15 percent of Americans in a recent TIAA survey said they're pursuing it. The same survey found Gen Z's confidence in retiring on time fell from 77 percent to 64 percent in a year. The whole formula hangs on one variable, the market's annual return. A generation without a bankruptcy exit is trying to build one out of the stock market.

Everyone's lender

The household isn't only the borrower with no exit. It's being wired in as the lender to every borrower that has one.

Fink said it plainly: "America needs more investors." He means the roughly four in ten Americans who own no stock, plus any new pool of savings that can be pointed at the buildout. Look at the plumbing going in. Last year's stablecoin law requires dollar tokens to hold their reserves in cash and short-term Treasuries, so every new token is a sliver of T-bill demand. An executive order last summer opened 401(k) plans to private credit and other alternatives, which is where a growing share of data center debt lives. Trump Accounts now hold about 70 million kids, with contributions defaulting into an S&P 500 fund. Through Oct. 11, about 45 AI-exposed companies produced roughly 39 percent of that index's return this year.

Now follow the loss. If Washington takes the polite exit, it lands on whoever holds fixed dollar claims: bond funds, pensions, money funds, the bond sleeve of every target date fund. If the data center borrowers take the legal exit, it lands on whoever holds the paper, and more of that paper is headed into retirement plans. When the household itself can't pay, the loss mostly stays right where it is.

The household is long everyone else's escape hatch and short its own.

What the bond market picked

This week handed the bond market two stories at once: a hot inflation print, which is the polite exit getting closer, and a credit scare in data centers, which is the legal exit getting closer. It had to choose which one to price. It chose the corporate scare and bought Treasuries.

That's the whole stock-bond correlation in one week. When the trouble is a company that can't pay, money climbs the ladder to the borrower with the softest exit, so bonds rise while stocks fall. When the trouble is the sovereign's own debt, the exit is inflation, and stocks and bonds fall together. That was 2022, when the classic 60/40 portfolio had one of its worst years in a century. It was most of the 1970s too. For roughly two decades before 2022 we lived almost entirely in the first kind of world, which is why owning bonds against stocks started to feel like a law of physics.

The next twenty years probably tilt toward the second kind. The IMF's point this week was that inflation shocks keep arriving more often, and a government whose interest bill matches Social Security has less room to fight each one. Every future shock carries a little more fiscal weight than the last. Bonds will still bail you out in the bad weeks. They may not bail you out in the bad decades.

Where the water goes

I’m not a financial advisor and none of this is advice. You know the drill.

Here’s your homework. Grab a legal pad and list every debt in the family, yours and your kids’. Next to each one, answer one question: does inflation make this easier to pay off, or harder?

A 30-year fixed mortgage gets easier. Your payment stays the same while your paycheck and prices go up, so the debt quietly shrinks. If rates drop, you refinance. That’s the same deal Washington gets on its own debt, and almost no other country offers it to regular families. I wrote in August that the house stopped being the family wealth machine. I missed something. It was also the one loan where a family gets treated like the government.

Credit cards, home equity lines and variable-rate student loans work the other way. When inflation runs, their rates go up, so the balance never shrinks. Every Fed hike makes it worse.

Now flip it around and list what you own. A long Treasury bond pays you back in full, but the government decides what those dollars are worth by the time they show up. Owning a piece of a real business at least puts you on the borrower’s side of that deal.

Remember the split from the top. You’re probably the lender. A lot of your kids are the borrowers. Over the next twenty years, that gap inside your own family will likely matter more to its wealth than any stock you pick.

The Dutch water board figured this out in 1624. You never have to miss a payment if the currency misses it for you. The loss still has to go somewhere. It settles wherever nobody built a dike.

Stay curious 😎

John

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