We don’t know how much total leverage there is, but from trends in margin debt we know it’s huge and skyrocketing.
By Wolf Richter for WOLF STREET:
Much of the leverage in the stock market is not tracked and no one knows what it is. Sometimes a treat surface when something explodes, like the Archegos fiasco.
Another part of stock market leverage, Securities-Based Lending (SBL), can be found on bank balance sheets if banks choose to disclose it. But not many banks disclose it, and no one is tracking it in a recap number, and we don’t know what the totals are. But they are big.
For example, Bank of America disclosed SBL’s $ 45 billion in its 10-Q filing with the SEC for the first quarter. This is a 25% increase over the previous year. The bank says securities loans present “minimal credit risk” to the bank because collateral – namely stocks and other liquid securities – has a market value that is “greater than or equal to the outstanding loan balance.”
Based on that, a client with a portfolio of securities valued at $ 1 million could borrow up to $ 1 million against those securities and then take the money and buy something else with it, including real estate or cryptos or pay a divorce settlement. When the market value drops sufficiently, the client must either bring in new money or start selling portfolio securities, that is, when the forced sale sets in.
Wells Fargo includes its SBL in “other consumer loans,” for a total of $ 25 billion, which is “mostly” made up of securities lending, as it says.
JPMorgan, in its 10-Q record, does not separate its SBL, but only says it increased in the first quarter. Goldman Sachs, in its 10-Q record, does not separate its SBL either.
So nobody knows what leverage there is in the stock market in relation to these securities lending. There are many other forms of leverage, including those that brought down Archegos Capital Management and caused banks more than $ 10 billion in losses – $ 5.5 billion in losses at Credit Suisse alone.
But there is a form of stock market leverage that is followed: regular margin loans at brokers that are reported by brokers to FINRA, which then reports them on a monthly basis, which he just did, and they are a doozie.
Stock market margin debt jumped an additional $ 14 billion in May, taking an all-time high to $ 862 billion, up $ 202 billion in seven months and 53% from January 2020 before the start sales.
In this graph over a period of more than two decades, what matters is not the absolute level of leverage then, compared to today, because the purchasing power of the dollar has decreases. What’s important is the trend – the sharp increase before each market sell-off.
Margin debt is the only known measure of stock market leverage available to us and is only one indicator of the trend in overall stock market leverage. This only shows the tip of the iceberg.
A sharp increase in margin balances precedes massive sales. They don’t trigger massive sales or predict massive sales. But leverage drives up stock prices by creating buying pressure as borrowed money skyrockets in the market; then when the sale begins, the forced sale by leveraged investors creates selling pressure and amplifies the sale and sets off its own downward spiral.
The Fed – whose policies have deliberately encouraged and contributed to this increase in leverage – has warned the other side of its mouth against too much leverage. In his Financial Stability Report, he specifically cautioned against the vast unknowns of leverage among hedge funds and insurance companies, and he cited Archegos as an example of what happens when something goes wrong.
Neither Credit Suisse nor any of the other major brokers disclosed in advance the leverage they were supporting in the case of a single client, Archegos. The amount of leverage only became apparent when it blew up the fund and caused more than $ 10 billion in bloodshed among the major brokers. Prime brokers have many clients. This type of leverage was just one example. It wasn’t even related to SBL. This is another example of stock market leverage. Another example of market leverage is margin debt. And there are other forms. We don’t know what the leverage is, but from the trends shown in margin debt, we know it’s huge and it’s skyrocketing.
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