Heisenberg’s Doom Loop Update – Required Reading Edition

Presented without further interruption…

Hopefully you don’t need a refresher on this, because if you do it likely means you haven’t been paying much attention to how shifts in market structure are creating systemic risks that no one understands, but just in case, the idea is that thanks to the low starting point on the VIX, a nominally small spike could force inverse and levered VIX ETPs to panic buy VIX futs into said spike, thus exacerbating the situation and ultimately forcing CTAs, vol. control funds, and risk parity to deleverage into a falling market.

via Market Doom Loop Update: Risk From VIX ETPs, CTAs Flashes Red


Latest Sign of Market Top: Talk of “Minsky Moment”

In early 2007, when I worked for Breakingviews, we worried a lot that the long period of prosperity had allowed massive risks to fester unheeded – a syndrome famously described by economist Hyman Minsky. A “Minsky Moment” is when all those chickens come home to roost at once, which happened soon after.

Now the head of China’s central bank, no less, is raising the same worry. From the FT:

US bond traders have begun a new trading day looking at higher prices for Treasury paper while Wall Street is set to open lower. The mood swing comes as the head of China’s central bank has summoned the spectre of a Minsky Moment.

Hyman Minsky is a economist famed for his theory about the risk of a sudden collapse in asset prices triggered by excessive debt or credit growth. The recent surge in global equity and credit markets has been accompanied by a number of strategists warning of a Minsky scenario and that chorus has elevated in tone by Zhou Xiaochuan, the PBOC governor.

He reportedly expressed concern that corporate and household debt are rising too quickly and said China need to defend itself from excessive optimism that could lead to a “Minsky Moment’’.

via US stock futures lower as China warns on ‘Minsky moment’

Treasury Sets Stage for Financial Crisis Sequel

The good points in Treasury’s Dodd Frank reform priority list – in particular, acknowledging that cranking up regulatory capital requirements made the corporate bond market a LOT less liquid, and therefore prone to crisis – are overshadowed by one piece of truly head-shaking stupidity.

Treasury seems to have forgotten – or perhaps it never understood (or, more likely yet, just wants to cut its pals at the once and future wards of the state on Wall Street a break) – that it was all that super-senior synthetic CDO crap, requiring nearly no regulatory capital, that blew banks apart when the ratings firms realized their models were all wrong in 2007-08.

downloadBanks stuffed to the gills with that gilded manure – they couldn’t sell it, after all, initially because it yielded zilch and later because no one wanted to catch a falling knife – were suddenly insolvent when the three blind mice began their panicky widespread ratings downgrades and the squillions of super-senior crammed in banks’ attics suddenly started requiring – yup – lots of regulatory capital.

This proposal is doubly idiotic, since it assumes that investors will want to buy this stuff when it is declining in value, just when those investors themselves are scrambling to sell their own liquid assets to meet the true bogeyman of the crisis, the promised panacea that turned out to be the virulent contagion that spread the trouble from one basket of eggs to the next and pushing asset class correlations inexorably, painfully, toward 1 – the magic of collateral and margin calls.

From the FT:

The report seeks to soften bank capital requirements for securitised products, lowering some calculations in line with international recommendations. It also suggests the highest quality layers, or “tranches”, of debt should count towards banks’ liquid assets able to be sold in a crisis to raise cash, helping them meet another international regulatory requirement.

Oh boy.

via Five takeaways from the Treasury’s deregulation report

Corporate and Buyout Debt Levels In the Red Zone – This Time It’s Different, Right?

The Wall Street Journal, which didn’t exactly cover itself in glory with its reluctant and initially Pollyanna-ish coverage of the 2007-8 LBO and debt market meltdowns, is now sounding the alarm – on its front page no less:

Risky Loans Surge in U.S., Overseas

(Website headline: Leveraged Loans Are Back and on Pace to Top Pre-Financial Crisis Records)

Investors worry this could pressure financial markets if global economic expansion fades

Lending to the most highly indebted companies in the U.S. and Europe is surging, a development that investors worry could pressure financial markets if the global economic expansion starts to fade.Volume for these leveraged loans is up 53% this year in the U.S., putting it on pace to surpass the 2007 record of $534 billion…

Sure, the piece is essentially just LCD’s data through the WSJ’s megaphone, but it’s a step in the right direction, and, really, they had to get the worry beads out in the wake of Toys R Us.

Wolf Richter crunches his own numbers in a more insightful piece from yesterday (Corporate Mirage: Debt out the Wazoo, Sales Languish, Stocks Soar) that illustrates the absurdity of the current debt/sales/share price trend lines, and is well worth reading.


In short, debt jumped 35% since the prior peak before the Financial Crisis, as sales rose only 12% over the same period, but stocks have doubled from the highly inflated levels at that time.

It’s all part of the phenomenon of repressed yields and cheap credit: Companies are borrowing large amounts of money to buy back their own shares and to buy out each other, instead of funding investments in productive activities. The hype around these share repurchases and M&A fires up stock prices and contributes to the current stock price bubble, but does nothing for the economy and leaves corporate America and share prices in a very precarious position.

So is Toys R Us the Tribune of the new unwinding? As Richter writes, “Hype works, until it doesn’t.”

Alphaville: 1980s Credit Crisis Was Dress Rehearsal for 2000s.

Will people read across to the present day? Nah… this time it’s different.

They take advantage of differences in the timing of bank deregulation across US states in the 1980s — specifically, limits on both inter-state and intra-state branches — to measure the importance of “credit supply shocks” for employment, consumer spending, house prices, indebtedness, and inflation. States more willing to let banks from other states enter their market, such as New York, had bigger booms in the 1980s and bigger busts subsequently when compared to places less open to financial-sector competition, such as Illinois.

These booms took the form of greater household borrowing, significantly faster inflation, and a big uptick in the size of the notoriously unproductive construction sector. Rather than encouraging worthwhile investments, easier lending standards only exacerbated the amplitude of the cycle:

via Anyone awake in the 1980s should have known about the dangers in the 2000s | FT Alphaville