"People Ask, Where's The Leverage This Time?" - Eric Peters Answers

One of the Fed's recurring arguments meant to explain why the financial system is more stable now than it was 10 years ago, and is therefore less prone to a Lehman or "Black monday"-type event, (which in turn is meant to justify the Fed's blowing of a 31x Shiller PE bubble) is that there is generally less leverage in the system, and as a result a sudden, explosive leverage unwind is far less likely... or at least that's what the Fed's recently departed vice Chair, and top macroprudential regulator, Stanley Fischer has claimed.

But is Fischer right? Is systemic leverage truly lower? The answer is "of course not" as anyone who has observed the trends not only among vol trading products, where vega has never been higher, but also among corporate leverage, sovereign debt, and the record duration exposure can confirm. It's just not where the Fed usually would look...

Which is why in the excerpt below, taken from the latest One River asset management weekend notes, CIO Eric Peters explains to US central bankers - and everyone else - not only why the Fed is yet again so precariously wrong, but also where all the record leverage is to be found this time around.

This Time, by Eric Peters

“People ask, ‘Where’s the leverage this time?’” said the investor. Last cycle it was housing, banks.


“People ask, ‘Where will we get a loss in value severe enough to sustain an asset price decline?’” he continued. Banks deleveraged, the economy is reasonably healthy.


“People say, ‘What’s good for the economy is good for the stock market,’” he said.


“People say, ‘I can see that there may be real market liquidity problems, but that’s a short-lived price shock, not a value shock,’” he explained.


“You see, people generally look for things they’ve seen before.”


“There’s less concentrated leverage in the economy than in 2008, but more leverage spread broadly across the economy this time,” said the same investor.


“The leverage is in risk parity strategies. There is greater duration and structural leverage.”


As volatility declines and Sharpe ratios rise, investors can expand leverage without the appearance of increasing risk.


“People move from senior-secured debt to unsecured. They buy 10yr Italian telecom debt instead of 5yr. This time, the rise in system-wide risk is not explicit leverage, it is implicit leverage.”


“Companies are leveraging themselves this cycle,” explained the same investor, marveling at the scale of bond issuance to fund stock buybacks.


“When people buy the stock of a company that is highly geared, they have more risk.” It is inescapable.


“It is not so much that a few sectors are insanely overvalued or explicitly overleveraged this time, it is that everything is overvalued and implicitly overleveraged,” he said.


“And what people struggle to see is that this time it will be a financial accident with economic consequences, not the other way around.”


Hkan Sun, 11/19/2017 - 09:29 Permalink

Draghi just announced another year of cheap credit. Indicator for US?Southern Europe crying for financial support. A lot.

BandGap Hkan Sun, 11/19/2017 - 10:29 Permalink

Extend and pretend. If this goes on we'll have the same conversation next year.Credit implies the risk of being paid back for the loans. The only risk is to the people taking the loans.What a gig. The ECB prints money out of nothing (no collateral), loans it out to people with little ability to repy, they default and the ECB gets the property from the issuence of thin air. Same shit here.Time to apply the brakes to this shit.

In reply to by Hkan

Bondosaurus Rex Sun, 11/19/2017 - 09:44 Permalink

 “It is not so much that a few sectors are insanely overvalued or explicitly overleveraged this time, it is that everything is overvalued and implicitly overleveraged,” he said.So like the force all around us it is. Hmmmmmm?

GooseShtepping Moron Sun, 11/19/2017 - 09:52 Permalink

In other words, inflation has begun. The "everything bubble" is just another name for the inflation generated by Central Banks' money-printing. The only difference is that it has taken a long time to affect general price levels because of the pitifully slow money velocity. First, the extra liquidity was used to mop up a bunch of toxic MBS sludge, which didn't raise prices much at all. Then it was channeled directly into bonds, thus lowering benchmark interest rates. Low interest rates allowed for stock buybacks with borrowed money, thus juicing the stock market, which is where we first started to see actual inflation of the sort that a normal person could understand. Now it's beginning to leak out into pension funds in the form of low-volatility VAR strategies. Eventually this will begin to directly impact consumer prices, but the impact will not be as great as theoretically possible because of the high costs of private debt service and the lack of disposable income. There is a deflationary hurricane raging at the same time which dilutes the effects of the inflationary hurricane.The key to all of this is interest rates. Once rates rise, the whole complicated derivative structure that holds the illusion in place will fall apart. And rates will rise once it becomes clear that the cost to borrow capital that's actually worth a damn is nothing like what the Fed or the Treasury says it is. The result will be not the collapse of the dollar, but something I like to call the 'fossilization' of the dollar. There will still be huge dollar sums on the accounts of the world's major players, but money velocity will drop to zero because nobody will be using them. This is similar to the Eurodollar funding crisis that Jeffry P. Snider describes.

dumbhandle GooseShtepping Moron Sun, 11/19/2017 - 11:01 Permalink

The shift from fiat to crypto can be calculated by running a curve through crypto market cap. The current state of the art is Ethereum, which confirms in 15 seconds with a transaction charge of a few pennies. The technology will continue to improve.  Fiats are flowing into crypto on an exponential formula.  The derivative structure will collapse when crypto market cap collides with USD30T global fiat market cap. 10% of fiat market cap into crypto is a few years away.  Then the dam will burst.

In reply to by GooseShtepping Moron

tion dumbhandle Sun, 11/19/2017 - 12:48 Permalink

There's any number of things that could poke a stick into the derivatives dark hole and stir that shitpot, I would be surprised if it ends up being interest rates, and I would be surprised if it holds out for the few years needed for the crypto tail to be the one wagging the dog, though I really would prefer to have those few years.People that have wealth but no tangible productive assets that can have value added/forced into them might want to consider exploring some options for changing that, JMO.

In reply to by dumbhandle

GooseShtepping Moron miker Sun, 11/19/2017 - 13:40 Permalink

What I mean to say is that the dollar has split into several distinct "atmospheric layers" and it is no longer the case that all dollars are created equal. The NIRP money that has been sloshing around in the world's financial markets is like the monetary stratosphere. This is the money that keeps the derivative structure in place, but you can't spend this money in the real economy without causing both inflation and interest rates to rise, so every effort is made to keep it stuck in the stratosphere where it never interacts with the ordinary economy.If you want to fund anything in the real world, you have to borrow in the monetary troposphere where all the life and activity of the physical economy exists. This is the realm of mass unemployment, of declining real wages for the lower 80%, of choking consumer debt, auto debt, student debt, etc. But this is the only "real" economy that exists. No one has a number for what the interest rate would be in the "real" economy, but we could infer that it must be quite high. First of all, no one has any savings so there isn't much capital to lend, anyway. Just imagine if you had to fund your new business venture by going around to your broke friends and neighbors and asking them to cough up some cash. How reluctant would they be to do so? What kind of return would they demand on their investment? What gruesome penalties would they inflict upon you if you failed to come through? Try to quantify all those factors, and that's the real rate of interest in the economy that actually matters.So, while you can use NIRP money to engage in financial repression, to artificially lower interest rates, to suppress volatility, and to shore up derivative structures, you cannot use it to move the levers of the physical economy without the whole thing falling apart. It's all a bluff, really; the logic of whole QE era is based on assumption that nobody will ever demand to cash out his nominal holdings for their full face value. Once that Rubicon is breached, that's when we'll find out how difficult it is to really borrow anything of actual worth, and that's when interest rates will shoot to the moon no matter what the Fed tries to do about it.The pendulum has to swing the other way. Interest rates have been suppressed so hard for so long that the release of the pent up pressure is going to be spectacular.

In reply to by miker

Cursive Sun, 11/19/2017 - 10:00 Permalink

No "news" with this article.  The question is what will be the catalyst and when.  I've more or less stopped "waiting" for it and yet, I know that it is coming and probably in my lifetime.  Extend and pretend has gone much longer than I imagined, but we naysayers have been correct about the effects of financial repression.  Yes, the stock market is at record highs, but economic circumstances of the 99% have declined precipitously every year.  I'm somewhat babbling, but my point is the temperature of the water is somewhere around 200 degrees and most frogs have lost consciousness.

Consuelo Cursive Sun, 11/19/2017 - 11:59 Permalink

  The 'catalyst' indeed.My crystal ball says the EGR system which the Fed/ECB/BOJ have engineered is fairly air-tight.I suspect however, it is also why other major rivals are purchasing physical gold like never before.  The catalyst as you say, I think begins with trade deterioration/trade war and/or a deterioration in foreign policy which prompts said nations to accelerate their de-dollarization plans to a point where it causes fault line crack in $USD global trade.

In reply to by Cursive

fulliautomatix Sun, 11/19/2017 - 11:19 Permalink

Everything is overvalued, except the tax-payer's dollar. That is sought with all due and undue process, it is characterised by a complete lack of trust between the parties to the transaction. How about that?

gm_general Sun, 11/19/2017 - 12:19 Permalink

Step right up, march, pushCrawl right up on your kneesPlease greed feed (no time to hesitate)I want a little bit I want a piece of it I think he's losing itI want to watch it come down - Pigs - Nine Inch Nails