We don’t know how much total leverage there is, but from the trends in margin debt, we know it’s huge and ballooning.
By Wolf Richter for WOLF STREET:
A big part of the leverage in the stock market is not tracked and no one knows what it is. Occasionally, a tidbit bubbles to the surface when something blows up, such as 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 tracks this in a summary figure, and we don’t know what the totals are. But they’re big.
For example, Bank of America disclosed $45 billion in SBL in its 10-Q filing with the SEC for Q1. This was up 25% from a year earlier. The bank says that securities-based lending has “minimal credit risk” for the bank because the collateral – namely stocks and other liquid securities – has a market value that is “greater than or equal to the outstanding loan balance.”
On this basis, a customer with a portfolio of securities valued at $1 million could borrow up to $1 million against these securities and then take the money and buy something else with it, including real estate or cryptos or pay for a divorce settlement. When the market value drops enough, the customer has to either bring in new money or start selling securities in the portfolio – which is when forced selling sets in.
Wells Fargo includes its SBL under “other consumer loans,” totaling $25 billion, which consist “primarily” of securities-based loans, as it says.
JPMorgan, in its 10-Q filing, does not separate out its SBL, but only says that it grew in Q1. Goldman Sachs, in its 10-Q filing, does not separate its SBL out either.
So no one knows how much leverage there is in the stock market in terms of these securities-based loans. There are many other forms of leverage, including those that took down Archegos Capital Management and caused banks over $10 billion in losses – $5.5 billion in losses at Credit Suisse alone.
But there is one form of stock market leverage that is tracked: Regular margin loans at brokers that are reported by brokers to FINRA, which then reports them on a monthly basis, which it just did, and they’re a doozie.
Stock market margin debt jumped by another $14 billion in May, bringing the historic spike to $862 billion, up by $202 billion in seven months, and up by 53% from January 2020 before the sell-off started.
In this chart with a time span of over two decades, what’s important is not the absolute level of leverage back in the day, compared to today, because the purchasing power of the dollar has diminished. What is important is the trend – the steep increase before every stock market sell-off.
Margin debt is the only known stock-market leverage measure that we have, and is only an indicator of the trend in overall stock-market leverage. It just shows the tip of the iceberg.
A big surge in margin balances precedes sell-offs. They don’t trigger sell-offs and they don’t predict sell-offs. But leverage pumps up stock prices by creating buying pressure as borrowed money surges into the market; and then when the selling starts, forced selling by leveraged investors creates selling pressure and amplifies the sell-off and triggers its own downward spiral.
The Fed – whose policies have purposefully encouraged and contributed to this spike in leverage – warned out of the other side of its mouth about excess leverage. In its Financial Stability Report, it warned specifically about the vast unknown parts of leverage among hedge funds and insurance companies, and it pointed at Archegos as an example of what happens when something goes awry.
Neither Credit Suisse nor any of the other prime brokers disclosed ahead of time how much leverage they were backing in the case of just one client, Archegos. The amount of leverage didn’t come out until it blew up the fund and caused over $10 billion of bloodletting among the prime brokers. Prime brokers have many clients. This type of leverage was just one example. It wasn’t even related to SBL. That’s a different example of stock market leverage. Margin debt is another example of stock market leverage. And there are other forms out there. We don’t know how much leverage there is, but from the trends indicated in margin debt, we know it’s huge and ballooning.
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