Credit Bubble Bulletin

Credit Bubble Bulletin2020-05-20T17:01:05-06:00

Presented by Doug Noland

Daily Commentary

Thursday, April 8, 2021

[Yahoo/Bloomberg] Stocks Rise With Europe; Treasuries Gain: Markets Wrap

[Yahoo/Bloomberg] Gold Gains After Dovish Fed Minutes Lift Equities, Weaken Dollar

[Yahoo/Bloomberg] Yuan Erases Year’s Gains Against Dollar as PBOC Steps Aside

[Reuters] Analysis: White House, U.S. companies could agree on 25% tax rate, officials, business groups say

[Reuters] U.S. weekly jobless claims unexpectedly rise

[Yahoo/Bloomberg] Fed Signals It’s Ready to Wield Power Over Short-Term Rates

[Yahoo/Bloomberg] Global Food Costs Keep Climbing in Threat to Consumer Wallets

[CNBC] Senate Banking Committee Chair Brown asks banks to detail their links to Archegos

[Yahoo/Bloomberg] Peter Thiel Calls Bitcoin ‘a Chinese Financial Weapon’ at Virtual Roundtable

[Reuters] China says U.S. to blame for tensions over Taiwan

[Reuters] Russia moves warships to Black Sea for drills: Interfax

[Reuters] Putin accuses Ukraine of provocations in phone call with Merkel: Kremlin

[Reuters] Eleven killed as Myanmar protesters fight troops with handmade guns, firebombs: media

[Bloomberg] America’s Population Growth Looks to Be the Slowest Since 1918

[Bloomberg] U.S. Consumer Credit Surges by the Most Since Late 2017

[Bloomberg] Bill Hwang Had $20 Billion, Then Lost It All in Two Days

[Bloomberg] China’s War Against Taiwan Could Come Sooner Rather Than Later

[NYT] After Pandemic, Shrinking Need for Office Space Could Crush Landlords

[NYT] What’s in Biden’s Tax Plan?

[NYT] Drought in Taiwan Pits Chip Makers Against Farmers

[WSJ] Credit Suisse Ignored Warnings Before Archegos and Greensill Imploded

[WSJ] Investors Sour on Emerging Markets as U.S. Prospects Brighten

[FT] Biden’s big fiscal gamble on America’s future

[FT] US offers new plan in global corporate tax talks

Weekly Commentary

Archegos and Ponzi Finance

I’ve been a longtime enthusiast for Hyman Minky’s analysis. His work plays prominently in my analytical framework. Financial structures evolve over time, and there is an innate propensity for this evolution to regress into a cycle of ever-increasing excess, fragility and instability. Success in finance – by borrowers, lenders, speculators, investment bankers, investors, businesses, central bankers and the like – ensures only more exuberant risk embracement over the course of the cycle. Importantly, debt structures degenerate over time, as the boom is perpetuated by expanding quantities of debt of deteriorating quality.

Minsky’s “financial instability hypothesis” models three categories of debt structures: Sound “hedge finance” – where “cash flows are expected to exceed the cash flow commitments on liabilities for every period.” Less sound “speculative finance” – where cash flows, although inadequate to fully service debt in the short-run, are generally sufficient over the longer-term. And unsound “Ponzi finance” – “cash flows from assets in the near-term fall short of cash payment commitments” and only with some future “bonanza” will cash flows ever be sufficient to service debts and provide any realistic hope of generating profits.

Importantly, “a ‘Ponzi’ finance unit must expand its debt load to meet its financial obligations.” New money and credit in abundance are a necessity for perpetuating the scheme. The greater the ratio of speculative and Ponzi finance, the greater the fragility of the financial sector to rising interest rates and/or other shocks. Ponzi financed assets, in particular, are highly sensitive to both changing perceptions and higher interest rates. Traditionally, higher rates are problematic as debt service costs rise at the same time the present value of future cash flows drops. Quoting Minsky, “The rise in long term interest rates and the decline in expected profits play particular havoc with Ponzi units, for the present value of the hoped for future bonanza falls sharply.”

Minsky: “It can be shown that if hedge financing dominates, then the economy may well be an equilibrium seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system… Over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance.”

Minsky witnessed a lot, but he surely never imagined an environment of zero rates and endless Trillions of Fed monetization, and how such a backdrop – the perpetual “bonanza” – would extend the “deviation amplifying” Ponzi phase. The Archegos fiasco had me this week sharpening my focus on Minskian analysis. The facts are not altogether clear. But from numerous reports it appears Archegos had fund equity of around $10 billion. Positions have been estimated in the range of $50 billion to $100 billion, meaning a leverage ratio between 5 and 10 to one. (more…)

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