Leverage: an assignment
A friend on Facebook who studies economics posted a challenge: try to read this semi-insidery article about what’s going on in finance right now and post a summary. Below is my attempt. (He subsequently said I did pretty well!)
To me, this article is saying that one of the reasons the market is going down is that after years of low interest rates, finance capitalism is full of certain kinds of leveraging practices that can't take the stress of the production crisis resulting from coronavirus.
The thing is: after 2008, none of these kinds of practices were permitted to accrue *too much* tension in the system, so we're not seeing any pyrotechnic financial crises like we did in 08. Still, these different leveraging practices are unraveling, which has consequences for the overall structure.
The metaphor I'm thinking of is a Rube Goldberg machine with lots of levers and pullies and moving parts. Each smaller component of the machine has a different configuration, but all of them carry a certain amount of tension in the process of the machine's work, and, if they don't operate correctly, can therefore negatively impact the whole.
The production crisis is making certain components unwind and fall apart, but in idiosyncratic ways.
The swaps (or leveraged loans), for instance, are resting on the performance of certain ‘underlying debts’ and are falling through as loan prices decrease. The CLOs are forcing banks to make margin calls they wouldn’t have otherwise made.
When it comes to mortgages, firms have created leverage–and homeowners are defaulting on payments–in such a way as to create liquidity problems: the financial firms can’t pay up on the bets they made on these mortgages (I understand the credit risk transfer trading in Cherry Hill less). Trading in municipal bonds became too expensive short-term, so big funds pulled out of the weird leverage they’d created there, triggering a selloff. They even leveraged treasuries in a dangerous way.
So ultimately, the question (I think!?) is whether the leverage-rot throughout the system will be the cause of a wider crash, or the sickness is distributed enough (or the fiscal and monetary actions of the Fed using optimal power) to not let things really crash and burn, but rather just contract.