Debt can be a killer
The arrest last week of the founder of investment firm Archegos on charges of securities fraud is a stark reminder of the hidden debt. In March 2021, Archegos was overleveraged, allegedly hiding its debt from Wall Street firms as it used funky “total return swaps” to manipulate stock prices. The inevitable collapse destroyed $100 billion in stock market value. (Archegos’ lawyers have denied the allegations.) Separately, supply chain financier Greensill used what Fitch described as a “hidden debt loophole” and collapsed around the same time. moment.
Are there more there? I ask because we are in the most dangerous part of the economic cycle. Interest rates are rising to fight inflation, and there could be all kinds of levers that we don’t know about. There always are. A slowdown (and especially a recession) would reveal these hidden horrors. In 2018, this column claimed that “in a downturn, equity hurts but debt kills.” We’re about to find out if that’s still true.
Over $850 billion in credit card debt and $800 billion in margin debt are high but below their peaks, and at least those are known amounts. It’s always a hidden debt that comes back to bite when things fall apart. In June 1929, banks had $82 in deposits for every dollar in cash on hand. Bank runs followed. The 2008-09 financial crisis resulted from mispriced secured loans and bizarre derivatives on the balance sheets of Lehman Brothers, Bear Stearns and many others. Citibank used “structured investment vehicles” laden with mortgages and who knows what else to essentially hide $100 billion in debt by keeping it off its balance sheet.
Today, debt is back in fashion. You’re hereit is
The latest proxy statement shows Elon Musk holds 73 million options and 170 million shares, of which more than 88 million have been “pledged to secure certain personal debts”. Even assuming a loan-to-value ratio of 20%, that’s a lot of personal debt. As part of the ongoing Twitter deal, Morgan Stanley is providing a $12.5 billion margin loan for an additional $62 million of its Tesla shares.
Tesla sold around one million cars in 2021 and was worth $1 trillion last week at the time of the Twitter deal. Ford engine Co.
sold nearly four million vehicles worldwide in 2021 and is currently worth just under $60 billion. I’d rather have Tesla’s stuff than Ford’s, but maybe Tesla’s assessment is a little fluffy. Netflix shares have fallen 72% in six months. Carvana is down 84% since August. Valuations are fleeting and we are not even in a recession. Now may not be the time to borrow against Tesla stock.
There are reports that Mr. Musk could take out a loan against his current 9.2% stake in Twitter. Yes, borrow against Twitter to buy more Twitter. Why does this sound familiar to you? Oh yes, MicroStrategy.
Michael Saylor, a bitcoin evangelist and CEO of Virginia-based software company Tysons, called on the company to buy quantities of the cryptocurrency. He recently took out a $205 million loan, secured by his bitcoin holdings, to buy even more bitcoins, for a current total of 128,687 worth $5 billion. In March, Saylor tweeted: “Give me a long enough lever and #bitcoin to put it on, and I’ll move the world.” It does not say in which direction. Note that MicroStrategy’s enterprise value is worth less than its bitcoin.
The latest crypto craze is decentralized finance, the ability to transact between peers, bypassing centralized banks, Wall Street and governments. YouTube is filled with videos with titles like “Use the Power of DeFi to Leverage Any Asset”. There is even a lending and borrowing platform named DeFi Prime. Sounds safe, but buying condos in Las Vegas with leverage in 2007 does too.
A DeFi effort named Terra is surprisingly offering 20% returns on deposits to fund a blockchain platform that uses an “algorithmic stablecoin” that maintains a price of $1. To do this, there is a fluctuating (but backed by nothing) cryptocurrency named Luna which is created or destroyed to buy or sell the TerraUSD stablecoin as needed to keep it stable. More than 20 years ago, Enron created and issued stock to cover the losses of heavily indebted special purpose vehicles until the losses became so large that the program collapsed. Terra CEO Do Kwon told Bloomberg that high deposit yields are not a problem; they resemble the high commercial bank rates in many Asian countries in the 1990s. Someone could remind him how it ended: with bad debts and giant currency crises in 1997 and 1998.
How much debt is there in the crypto world? Nobody really knows, but I wouldn’t want to be in his path if it started to snowball during a downturn.
Even scarier is the $13.4 trillion in debt owed by non-US borrowers, according to the Bank for International Settlements. It’s doubled since 2010. It may be overstated because of hedging, but that’s a lot of dollar-denominated debt. Every time the Federal Reserve raises interest rates to fight inflation, the dollar strengthens against other currencies, making servicing dollar debt more expensive. Will this all explode? I’ve seen it happen a few times. Debt kills every time.
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This article has been updated to quote Ford’s figure for worldwide sales rather than just the US.
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