Nouriel Roubini is using his platform at Davos to warn the world, Cassandra-like, of the “mother of all highly leveraged asset bubbles” now in progress. Shorts in the US dollar have been built up to unprecedented levels, and are used to finance the purchase of every asset class, especially in energy, commodities, and precious metals.
This bubble will be pricked by a huge snap back rally in the greenback which may have already begun, the exhaustion of Fed support measures, a growth surprise in the US leading to an early Fed tightening, or a real double dip recession. The inevitable collapse will make the last financial crisis look like a cake walk, and take all markets, especially equities, down to new lows.
The flaw in the Turkish New York University economic professor’s logic is lurking in his own arguments. The basis for his “U” shaped recession (described by others as “bathtub” or “toilet bowl” shaped), is the absence of credit, especially at the regional and small business level. But I can tell you from my own experience that credit is also absent, or at least severely diminished, in the hedge fund community too.
Terms have been tightened across the board. Collateral requirements are much stricter. Margin requirements on the futures markets are vastly heavier than they were two years ago, especially for the most volatile contracts, like crude. You can forget about financing for any kind of instrument that is illiquid or trading over-the-counter.
Prime brokers now play hard ball. The days when big hedge funds borrowed stock and shorted them with no money down are a distant memory. If you want to borrow and short a highly volatile stock, expect to pledge your first born child as collateral. The last time I checked, Lehman, Bear Stearns, and AIG weren’t doing any new lending at all. Many credit markets, such as those for certain CDO’s, are still completely closed, and are never coming back.
So where is all this leverage? The net-net is that speculative positions are but a fraction of those seen at the 2007 peak. To get a real crash with new lows, you have to have the same kind of leverage that we had three years ago.
I think Nouriel is one of those Mount Olympus guys who gives broad, general views of what were mere mortals are up to. But never having worked on a trading desk, he doesn’t understand that what he is proposing can’t actually be executed. The eminent doctor is increasingly looking like a one hit wonder. When the current trends reverse, there will be much volatility, pain, hand wringing, and gnashing of teeth, for sure. But it is much more likely that we are going to die from ice, not fire, and of boredom, not from cardiac arrest.
For more iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com , where the conventional wisdom is mercilessly flailed and tortured daily, and where you can also catch me on Hedge Fund Radio weekly.