Subprime mortgages caused much of the 2008 financial crisis by defaulting in much greater concentrations than the experts expected. The next financial crisis is likely to be caused by a similar disaster that surprises the experts. I have an excellent candidate: Fortune 500 companies that have been repurchasing their shares like maniacs for a decade, and in many cases have left themselves with negative net worth. In a major recession, when their business drops off and their cash flow turns negative, they will only need a breath of adverse wind to default. Like the subprime mortgages, once a few major companies default, the rest, with fragile credit structures, will fall like dominoes.

There are two mechanisms by which the balance sheets of major companies have been hollowed out: overpriced acquisitions and share repurchases. Both are products of a decade of interest rates held far below their natural level, which have abominably skewed the economy’s allocation of resources.

In the case of overpriced acquisitions, even companies that make a low return appear attractive purchases if you can borrow at a negative real cost to finance their acquisition. Share repurchases meanwhile are more attractive than dividends because they goose the value of management’s stock options. If long-term money can be borrowed at 3% on a tax-deductible basis, then it makes sense to go on buying the company’s shares up to 33 times earnings, even if there is no earnings growth to be had.

The effect on balance sheets of the two bad practices is significantly different. In the case of acquisitions, the accountants make the acquirer record a “goodwill” item reflecting the difference between the price paid for the company acquired and the value of its- assets. In the 1970s and 1980s, that goodwill item could be taken as reflecting real value. Much of the assets’ value in the books reflected construction and acquisition costs from decades earlier, so in a time of high inflation, when stock prices were not extended, acquirers generally did not pay much more than the true value of assets.

Now the “goodwill” item reflects genuine water, in the nineteenth-century sense of that term. Nineteenth-century investors, mostly in railroads, were very concerned at promoters “watering” the stock – issuing shares at a price far above net asset value – because they knew that railways could be replicated at the same cost, or even somewhat less (since some survey and other costs might be common). If your competitor had issued less stock than you to construct the same route, he would have lower costs, because he would have to pay fewer dividends and/or less debt interest.