Known stock market leverage peaks WTF. On the other side of its mouth, the Fed warns of the hidden leverage that blew up Archegos


Margin debt is just the tip of the leverage iceberg, and it has reached the level of the mad zoo.

By Wolf Richter for WOLF STREET.

Market margin debt jumped an additional $ 25 billion in April, to an all-time high of $ 847 billion, according to FINRA data. It exploded by $ 188 billion in six months, 61% year-on-year and 55% as of February 2020:

The excess leverage is the precise and predictable result of the policies the Fed is promoting on one side of its mouth with its crackdown on interest rates and asset purchases.

On the other side of its mouth, the Fed – via its blissfully ignored Financial Stability Report – cautions against leverage, stock market leverage, and in particular the large and unknown parts of leverage among hedge funds and insurance companies.

He named names: The Archegos family office, a private hedge fund that needs to disclose very little, and then exploded because none of the brokers providing it with leverage knew that other brokers also provided leverage, and no one knew how much total leverage the outfit had. The amount of leverage did not come out until it exploded.

And this form of hidden leverage is not included in the known market margin debt reported monthly by FINRA, based on reports from its member brokerage firms.

This known stock market leverage is an indicator of the evolution of leverage, the tip of the iceberg. History shows that a sharp increase in margin balances preceded and may have been a prerequisite for larger stock market declines.

In April, it exploded to a new WTF high of $ 847 billion, up $ 188 billion in six months, after hitting the zoo-gone-mad level:

In this type of chart that covers two decades in which the purchasing power of the dollar has fallen, long-term increases in absolute dollar amounts are not the focal point; but the sharp increases in margin debt before sales are.

The leverage effect creates buying pressure and pushes up prices. As prices rise, collateral can be tapped more, and leverage increases with rising asset prices. And then when the prices go down, the leveraged bets are sold to pay off the debt, and the selling triggers more price cuts and the hard sell sets in. That’s when Archegos exploded.

For example, the Fed states in its Financial Stability Report that “measures of hedge fund leverage are somewhat above their historical averages, but available data may not capture significant hedge fund risks. or other leveraged funds ”. And he recounts the Archegos fiasco, in terms of how this hidden leverage works:

“In another episode at the end of March, a few banks suffered heavy losses when a heavily indebted family office, Archegos Capital Management, was unable to meet margin calls related to total return swap agreements and other positions financed by prime brokers. The price declines in the concentrated stock positions held by Archegos triggered the margin calls, prompting the sales of the stock positions, which led to further declines in the prices of the shares concerned and, ultimately, to substantial losses for some banks.

“The episode highlights the potential for material distress of NBFIs [Nonbank Financial Institutions such as hedge funds] affect the financial system at large, ”the Fed report said.

It is ironic that the Fed, on the other side of its mouth, is warning of the results of its policies, including inflated leverage which is not known until it explodes.

Ha, then said the Fed, still speaking from the other side of its mouth, if this risk appetite declines “from high levels,” and companies want to get out of that leverage, or are forced to pull out. subtracting from this leverage, “A wide range of asset prices could be vulnerable to large and sudden declines, which can lead to wider strain on the financial system.”

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