Unregulated industry boom heightens fears of a… market-shattering crash
Archegos Capital used borrowed funds to make bets that sent shares of SME companies skyrocketing.
Rubina Spathi
The quote that “History repeats itself the first time as a tragedy and the second time as a farce” also applies to financial crises, although one can disagree as to how accurate the assessment of “farce” is. Why The global financial crisis of 2008-2009 was a repeat of the 1929 crisis, a true tragedy since it led to World War II and what humanity is still trying to forget. Probably, however, it was not exactly a “joke” for everyone, and much more so when it evolved into the Eurozone debt crisis and the suffering it brought to Europeans. It is now an open secret that the cause of the 2008 crisis was the phasing out of all the safeguards imposed on the financial system by the Bretton Woods Agreement after World War II to prevent a repeat of 1929.
However, the possibility of a repeat of the global financial crisis is beginning to emerge precisely where no regulation of any kind has been imposed since the crisis of 2008-2009. The reason for shadow banks, the non-bank institutions under the traditional meaning but various types of schemes, such as investment funds, insurance funds, private equity funds, pension funds and hedge funds or hedge funds. Not only have these categories not been subject to the same rules that apply to banks after the 2008 crisis, but the risk has increased to the maximum, as many of these institutions have taken risks that banks could no longer take.
These are various schemes, such as investment funds, insurance funds, pension funds and hedge funds.
And while for about a year there has been constant talk about the risk of a recession, there are not a few who see a new financial crisis brewing. Recently, Lawrence Summers, the former US Treasury Secretary, who spoke of “tremors” in the markets and while trying not to cause too much concern by avoiding a prediction of a global financial crisis, emphasized that the current situation would justify increased concern, such as that which prevailed in August 2007. The most recent warning can be seen in the collapse of Britain's pension funds in the autumn, forcing the Bank of England to intervene with extensive bond purchases to restore calm to the market. A crisis that was overshadowed by the political storm of those days and the experiments of Liz Truss, the then prime minister with the most short-lived tenure at the helm of Britain. It was preceded during 2021 by a series of bankruptcies of all kinds of financial institutions with dark activity, such as fall of the Archegos fund, which caused big losses in banks with hidden bets, the resounding fall in the shares of the Japanese Softbank, but also of the British Greensill Capital. And in all of these crises, concern was widespread, as in most of them the risk of contagion of the problem to the wider financial system was visible.
As Politico points out in a related analysis, this is a repetition of the same familiar patterns that cause crises: short-term illiquidity, risky bets and the domino effect.
The downfall of the… leader
A sample of what can happen due to a combination of lack of liquidity, continuous leverage and excessive risk taking by shadow financial institutions was given in the spring of 2021 by a previously unknown hedge fund, in which banks and SME companies had a large exposure. Under the vainglorious name of Archegos Capital Management, the Greek word for “leader”, he took advantage of the Federal Reserve's low interest rates, engaged in extensive borrowing, amassed unimaginable profits on secret bets, and collapsed, causing chaos on Wall Street and losses for banks, with the vibrations to be felt from Zurich to Tokyo.
It was a usual story that repeats itself from time to time but with different companies and brands. Archegos Capital used borrowed funds to make bets that sent shares of SME companies skyrocketing. Its downfall began when Wall Street banks pressured the intrepid company to “hedge” its bets. Lacking sufficient liquidity, the fund went on a massive sell-off, sending shares of media giants such as ViacomCBS and Discovery, which it had driven up, crashing. Such was the extent of the mass selling that followed that Viacom lost half its stock market value within a week. And of course, the big banks suffered billions of dollars in losses because of their heavy exposure to Archegos. Both Switzerland's Credit Suisse and Japan's Nomura posted losses at the time and saw their shares plummet.
Archegos was a little-known company that few people had heard of until its sudden collapse. And yet, in the era of cheap money, Archegos was able to borrow so much thanks to near-zero interest rates that its collapse would send tidal waves big enough to rock Wall Street and impact Americans' retirement savings them.
This is the excessive borrowing facilitated by the Federal Reserve's near-zero interest rates. The scale of Archegos' bets had been kept secret. In order not to reveal its bets, Archegos made use of special derivatives, known as “total return swaps”, which effectively hide part of the investments. And of course, he had not disclosed his positions to the US Securities and Exchange Commission.
The collapse of the reckless fund led to financial ruin for its founder, Bill Huang, a man who had remained as unknown as his fund until now. the collapse. His wealth dissipated in a matter of days.
Liquidity fears intensify
The timing is now ripe for trouble in the shadow banking system as the good times come to an end as central banks aggressively raise borrowing costs and the steady flow of capital is disrupted.
This means that it is easy for a shadow financial institution to run out of liquidity. Speaking to Politico, Verena Ross, head of the European Union's securities regulator, points out that as money flows into the shadow banking system, “some of the problems that are there are starting to surface.” It is easy to see that after a series of relatively small and easily controlled crises, a problem can start in shadow financial institutions and spread to the wider financial system. This also happened, or at least threatened to happen, when the Russian invasion of Ukraine caused sharp fluctuations in the prices of futures markets, which created a lack of liquidity for European energy companies. The problem was easy to derail.
And it's not just the EU securities regulator. which warns. Others have also sounded the alarm, warning of how shadow banks can either cause or exacerbate a crisis. Jérôme Reboul, director-general of regulatory policy and directorate-general of international relations at France's Securities and Exchange Commission, points out that successive interest rate hikes can cause a short-term lack of liquidity, leading to forced mass selling of securities.
Something like this, he points out, could activate a “self-feeding mechanism”, a mechanism by which the sales of securities will lead to a fall in prices, increasing the pressure on investors and thus multiplying their demands for liquidity.
All this has already been recorded and regulators are beginning to worry about the contagion that shadow financial institutions have accumulated over the past few years and which may explode and send shockwaves around the world in the global financial system. And as Politico points out, what's troubling is that many perceive the shadow banking sector to be an accident in the making but there is no plan to deal with it.
Lawrence Summers
The former US Treasury Secretary warns that “we are in a period of increased risk and earthquakes do not come suddenly. There are vibrations first.” He clarified that he does not go so far as to predict a financial crisis, but notes that “just as the world was worried in August 2007, there should be intense anxiety now.”
$7.4 billion .had been lent to the Gupta construction company by Greensill. Crashed causing losses to Credit Suisse.
John Caravan
Referring to the prevailing concern about the possibility of a financial crisis, John Karavan, a senior analyst at Oxford Economics, pointed out that “the risks to financial stability are increasing and it looks increasingly likely that the Fed will need to react to the concern about the stability of the financial system before its inflation targets are met.”
Japan's Softbank lost $17 billion in market value and added to the decline of high-tech companies.
Verena Ross
The head of the EU securities regulator, Verena Ross, stressed that we are seeing a reduction in capital flows to the shadow banking system, meaning “we are seeing some of the usual factors of the crisis, liquidity problem, excessive leverage and a high degree of interconnectedness”. And he added that these are the “usual signs of problems that we need to look for in order to identify the source of potential risks”.
