Wednesday, May 19, 2021

Known Stock Market Leverage Hits WTF High. Out the Other Side of Its Mouth, the Fed Warns About Hidden Leverage that Blew up Archegos — Wolf Richter

Margin is form of private debt. It is secured by the equity borrowed against as collateral, but margin calls can result in forced selling at scale. This is what happened at the start what became the Great Depression, when the tumbling of a house of cards in equities led to "knock on effects" that paralyzed the American and global economies.

The Great Purge was on and it lasted until John Maynard Keynes convinced FDR that the treatment was abandoning the gold standard and using the expanded fiscal space to address the issues. The rise of the welfare state as a result of the New Deal was aimed at preventing that from happening again by providing fiscal support beforehand, e.g., in the form of social security. 

It is often overlooked that the New Deal was not only social but also economic, based on Keynes's General Theory as a replacement for the then current neoclassical economics, "sound money," and the Treasury view. It was a new way of managing the economy based on institutional analysis instead of the economic "laws"of neoclassical economics that mimicked the laws of nature discovered by physics.

The problem now is that with the pandemic and looming climate change, uncertainty prevails. The result of a debt crisis could be a catalyst for a wider financial and economic crisis, as Michael Hudson has been warning. "History does not repeat itself but it rhymes" is attributed to Mark Twain without sourcing, but it may be a paraphrase of he did say.

Low interest rates are being blamed mostly, but, as Warren Mosler has pointed out this overlooks the regulatory power of the Fed as the financial authority, as well as subsidiary regulators, in managing private credit growth and exposure. Subsequently, MMT-oriented legal scholars like Rohan Grey have also written on this.

On the other hand, critics will point out that free market capitalism is about creative destruction aka purging the weak in order to keep the system healthy and growing. However, this also has disproportionate effects on the economic strata without deep pocket to weather the storm. This is where fiscal policy can count, allowing for restructuring capital while protecting the innocent.

The good news is that strong fiscal policy from the past administration and continuing in the present one is already supportive, so the situation today is quite different from the events leading to the Great Depression.


Matt Franko said...

Fed has GSIBs prepared for 55% equity price reduction so won’t be a problem for the system if it happens...

Matt Franko said...

“ this overlooks the regulatory power of the Fed”

MMT overlooks the regulatory power of the Fed...